FINA%3770.007%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%February%7,%2014%%1%Reference'Sheet'Exam'1'%Five%Principles%of%Finance%1) Cash%flow%is%what%matters%2) Money%has%a%time%value%3) Risk%requires%a%reward%4) Market%prices%are%generally%right%5) Conflicts%of%interest%cause%agency%problems%%The%Legal%Forms%of%Business%Organization%1) Sole%Proprietorship%• Business%owned%by%an%individual%• Minimum%amount%of%legal%structure%• Owner%maintains%title%to%assets%and%profits%• Unlimited%liability%• Termination%occurs%on%owner’s%death%or%by%the%owner’s%choice%2) Partnership%• General% Partnership:% A ll% partne r s% are% fully% re sp o n sib le% for% liabilities% inc ur red % by% the%partnership.%• Limited% Partnerships:% One% or% more% partner s% can% have% limited % liability ,% restricte d % to% t he %amount%of%capital%invested%in%the%partnership.%%• One%partner%is%the%general%partner%and%has%unlimited%liability%3) Corporation%• Legally%functions%separate%and%apart%from%its%owners%• Corporation%can%sue,%be%sued,%purchase,%sell,%and%own%property%• Owners%(shareholders)%dictate%direction%and%policies%of%the%corporation,%oftentimes%through%elected%board%of%directors.%%• Shareholder’s%liability%is%restricted%to%amount%of%investment%in%company.%• Life%of%corporation%does%not% depend% on%the% owners% …%corporation%continues%to% be% run%by%managers%after%transfer%of%ownership%through%sale%or%inheritance.%4) Hybrid%Organizations:%%SXCorporation%and%Limited%Liability%Companies%(LLCs)%• SXType%Corporations%• Benefits%1. Limited%liability%2. Taxed%as%partnership%(no%double%taxation%like%corporations)%• Limitations%1. Owners%must%be%people%so%cannot%be%used%for%a%joint%ventures%between%two%corporations.%• Limited%Liab ilit y%C o m p a n ie s%(L L C )%• Benefits%1. More%flexibility%than%SXcorp%2. Limited%liability%3. Taxed%like%a%partnership%%• Limitations%1. Qualifications%vary%from%state%to%state%2. Cannot%appear%like%a%corporation%otherwise%it%will%be%taxed%like%one%%3%ways%to%transfer%capital%in%the%economy:%1) Direct%transfer%%2) Indirect%transfer%u sing %the%in ves tm en t%ban k er %FINA%3770.007%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%February%7,%2014%%2%3) Indirect%transfer%u sing %a%finan cial%inte rm e diar y%%Public%Offering%%• Both%individuals%an d %ins tit u tio n al%in v es to rs %have%the%opportunity%to%purchase%securities%o The%securities%are%initially%sold%by%the%managing%investment%bank%firm%o The%issuing%firm%never%actually%meets%the%ultimate%purchaser%of%securities%Private%Placement%%%• The%securities%are%offered%and%sold%to%a%limited%number%of%inves tor s%%Primary%Market%• Stock%is%sold%directly%(or%through%an%investment%bank er)%by%the %offering%firm %• This%is%the%only%time%the%issuing%firm%ever%gets%any%money%for%the%securities%• The%first%time%a%company%issues%stock%to%the%public%is%referred%to%as%an%initial%public%offering%or%IPO.%• A%seasoned%equity%offering%is%the%sale%of%additional%shares%by%a%company%whose%share s%are%already%publicly%traded%and%is%also%called%a%secondary%share%offering.%%Secondary%Market%(subsequent%trading)%• Market%in%which%previously%issued%securities%are%traded%• The%issuing%corporation%does%not%get%any%money%for%stocks%traded%on %th e %sec on d a ry %m a rk et .%%%Primary%Markets:%Initial%vs.%Seasoned%Issue%• Initial%Public%Offering %–%The%first%time%a%company%issues%its%stock%to%the%public%• Seasoned%Equity%Offering%X%refers%to%sale%of%additional%shares%by%a%company%whose%shares%are%already%publicly%traded%%Functions%of%an%Investment%Banker%• Underwriting:%o Underwriting%means%assuming%risk.%%o Since%money%for%securities%is%paid%to%the%issuing%firm%before%the%securities%are%sold,%there%is%a%risk%to%th e %inv e st m e n t%b a nk ( s) %• Distributing:%o Once%the%securities%are%purchased%from%issuing%firm,%they%are%distributed%to%ultimate%investor s%• Advising:%o On%timing%of%sale,%type%of%security%etc.%%Private%Debt%Placements%• Advantages%o Faster%to%raise%money%o Reduces%flotation%costs%o Offers%financing%flexibility%• Disadvantages%o Interest%costs%are%h ighe r%tha n%p ub lic%issues %o Restrictive%covenants%o Possible%future%SEC%registration%%SarbanesXOxley%Act%(SOX)%• In%response%to%co rp ora te%sca nd als,%Con gr ess%p asse d%th is%Act%in% 2002%• This% Act% holds% senior% corporate% advisors% (such% as% accountants,% lawyers,% board% of% directors,%officers)%responsible%for%any%instance%of%misconduct%FINA%3770.007%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%%February%7,%2014%%3%• The%Act%attempts%to%protect%the%interest%of%investors%by%improving%transparency%and%accuracy%of%corporate%disclosures%%Interest%Rate%D ete rm ina nts %• Nominal'interest'rate'=%%%%%Real%risk%free%rate%%+%Inflation%risk%premium%%+%Default%Risk%premium%%+%Maturity%Premium%%+%Liquidity%Premium%%%Fisher%Effect:%%(1%+%nominal%rate)%=%(1%+%real%rate)(1%+%inflation%rate ) %%Term%Structure%of%Interest%Rates%or%Yield%to%Maturity%• Unbiased%Expectations%Theory%o Term%Structure%is%determined%by%an%Investor’s%expectations%about%future%interest%rates%o The%idea%is%that%if%you% invest%for%2% years% at% a%given%rate,%your%return%is%the%same%as% it%would%be% if% you% invested% for% one% year%at%the%current%1%year%rate%and%then%reinvested%for%another%year%o 100(1+x)(1+x)=100(1+y)(1+z)%§ where%x%=%2%yr%return%§ y=%1%yr%return%in%Year%1%§ z=%1yr%return%in%Year%2%• Liquidity%Preference%Theory%o Investors%require%maturity%premium s%to%compen sate %them%for%risks%of%uncertain%future%interest%ra te s %o The%current%interest%rate%for%a%future%time%period%may%contain%a% premium% for%the%risk%and%uncertainty%between%now%and%next%year%• Market%Segmentation%Theory%o Legal%restrictions%and%personal%preferences%limit%c h oic es%for%in v esto rs %to%ce rta in%ranges %of%maturities%%Income%Sta tem e nt %Sales%–%expenses%=%Profits%%% Sales%Less:%% Cost%of%goods%sold%Equals:%% Gross%profits%Less:%% Operating%expenses%%% (selling%and%marketing %expe