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Finance Exam One Review 1Chapter 1- Finance and The FirmI. Field of Finance and Duties of Financial Managers**Adding value to a business by applying economic principles and using accounting numbersA. 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 assetsB. Financial Markets and Institutions■ handle the flow of money in financial markets and institutions, markets in whichfinancial 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 groupsII. 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○ necessary to pay bills, not same as sales or profits● timing of cash flows-wants to receive sooner, pay out later, stock increases○ **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 measuringIIII. 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 capital1. Cash2. Accounts receivable3. 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○ agents: represent principals or owners, act on behalf, responsibility to stockholders for legal and ethical issues○ 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 conflictV. 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○ 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● Limited Partnership○ 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 organizationsFinance Exam One Review 3○ Advantages: limited liability, no double taxationsChapter 2-Financial Markets and Interest RatesI. 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 paidA. 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 riskyB. Brokers: agents who work on behalf of an investor, find someone to trade suitable investments”, paid on comissionC. 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 unemploymentA. Primary Market: where the deficit economic units sell new securitiesB. 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


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CSU FIN 300 - Chapter 1- Finance and The Firm

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