Finance Exam One Review 1 Chapter 1 Finance and The Firm I Field of Finance and Duties of Financial Managers Adding value to a business by applying economic principles and using accounting numbers A Financial Management analyze and forecast a firm s performance evaluate investment opportunities inside firm measuring performance to make decisions capital budgeting firm s investment in long term real assets capital structure policy long term financing of firm s activities working capital management management of short term current assets B Financial Markets and Institutions handle the flow of money in financial markets and institutions markets in which financial assets are sold impact of interest rates on flow of funds outside of firm decide to invest or not matchmakers C Financial Investments locate select and manage money producing assets connect other two groups II Basic Financial Goal of a Firm The primary financial goal of the business firm is to maximize the wealth of the firm s owners wealth value stock price indicates the value of a business because stockholders become part owners of the corporation higher stock price means people believe the company will perform well in the future affected by cash flows and risk cash moving through a business amount of cash flows want to increase inflows decrease outflows stock increases increases necessary to pay bills not same as sales or profits timing of cash flows wants to receive sooner pay out later stock sooner better than later riskiness of those cash flows want to more certain stock increases Profit vs company value profit is the difference between sales revenue and expenses accountants have different ways of measuring IIII Balance Sheet Liabilities and equity are sources of funds liabilities represent a debt claim how much investor is owed back equity represents an ownership claim Assets tool box what a firm needs to succeed use of funds Short term current working capital 1 Cash 2 Accounts receivable 3 Inventory do not want too much Finance Exam One Review 2 Priority of claims 1 Taxes employees 2 Secured debt holders collateral 3 Unsecured debt bonds 4 Preferred stockholders dividend 5 Common stockholders owners residual income IV Legal and Ethical Challenges Agency Issues legal and ethical issues agents represent principals or owners act on behalf responsibility to stockholders for owners stockholders non owner stakeholders workers creditors suppliers customers and others do not own but have a stake agency costs monitor managers and their actions ex audits agency problems when agents and principals conflict V Forms of Business Organization Sole Proprietorship biz and person are the same Advantages easy cheap profits Disadvantages unlimited liability losses absorbed by owner limited capital and life General Partnership Limited Partnership Advantages minimal organizational requirements negligible gov regulations larger share of profit distribution when firm is successful Disadvantages unlimited liability inflexible when partner leaves or dies Investing partners can only lose investments general partners no limit to the number of partners Advantages limited liability Disadvantages not active in management less favorable allocation of ownership profit losses Limited Liability Partnership operates like a corporation Advantages limited liability get what you put in partnership not taxed income passed through to partners who are taxed Disadvantages only for professional groups certain businesses Corporation Advantages limited liability permanency transferability of ownership better access to capital legal entity most complex Disadvantages double taxation time and cost of incorporation C Corporation regular Subchapter S limited liability for its owners income passed to owners small no more than 100 shareholders PC Corporations for professional services ie medical legal accting architechtural Limited Liability Company members are individuals or organizations Finance Exam One Review 3 Advantages limited liability no double taxations Chapter 2 Financial Markets and Interest Rates I Operation of the US financial system The purpose of the financial system is to bring together individuals businesses and government entities economic units that generate and spend funds households have most surplus funds surplus economic units funds left over after spending all they wish to spend provide funds to economic sectors in need of financing their investments deficit economic units need to acquire additional funds to sustain their operations constantly looking to expand buy more assets now rather than later II Function of financial intermediaries Facilitate the process of exchanging funds for financial securities securities documents that represent the right to receive funds in the future bearer person that holds security has claim to future funds maturity date when security is to be paid A Investment bankers help businesses and state and local gov sell securities to public underwriting basis purchase of new securities from issue and resells them to public investors sells on best effort basis because can be risky B Brokers agents who work on behalf of an investor find someone to trade suitable investments paid on comission C Dealers buying securities and reselling them to others buy at bid price and sell for higher price called ask offer price IV Financial Markets flow of funds from surplus to deficit provide the liquidity function to investors market efficiency refers to ease speed and cost of trading securities easier to transfer idle funds idle funds cause lower growth for economy and higher unemployment A Primary Market where the deficit economic units sell new securities B Secondary Market where investors trade previously issued securities with each others over the counter Money Market trade short term 1 3 6 mo 1 yr debt instruments Tokyo London NY treasury bills issued by federal gov min denominations of 100 face value paid at maturity traded in secondary no risk certificates of deposit CD s interest bearing securities issued by financial institutions banks maturities of one yr or less negotiable demand deposit demand money back at any time commercial paper unsecured debt issued by corporations w good credit ratings borrow at low rate lend at high rate buyers are large institutions 270 days to mature alt to cash eurodollars dollar denominated deposits located in non US banks buyers and sellers are large institutions traded banker s acceptance