Goal of the Firm Shareholder Wealth Maximization Sole Proprietorship business owned by a single individual General Partnership an association of 2 people joining as co owners to operate a business for profit Each partner is fully responsible for liabilities incurred Limited Partnership 1 partners has limited liability restricted to amount of capital he she invests Corporation an entity that legally functions separate and distinct from its owners Gross Profit a firm s dollar sales minus cost of goods sold Operating Income Gross Profit minus Total Operating Expenses Taxable Income gross income from all sources except for allowable exclusions less any tax deductible expenses Dividend Exclusion a corporation can normally exclude 70 of any dividends it receives from another corporation Depreciation the means by which an asset s value is expensed over its useful life for federal income tax purposes Capital Gain a gain resulting from sale exchange of a capital asset Capital Loss a loss resulting from sale exchange of a capital asset Net Capital Loss carryback carryforward may be carried back 3 years and forward up to 5 years applied against net capital gains Operating Loss carryback carryforward may be carried back 2 years and forward up to 20 years Financial Market Markets that allow people to easily buy and sell trade financial securities stocks and bonds commodities metals and agricultural goods and other items of value at low transaction costs Real Assets Assets that are tangible or physical in nature such as land machinery and livestock Financial Assets An asset that derives value because of a contractual claim Stocks bonds bank deposits are all examples of financial assets Underwriting The process of acting as an intermediary between an issuer of a security and the investing public The purchase and subsequent resale of a new security issue The risk of selling the new issue at a satisfactory profitable price is assumed underwritten by the investment banker Secondary Market A market where current outstanding securities are traded 3 Ways to Transfer Savings to Businesses 1 Direct transfer of funds 2 Indirect transfer using investment banker 3 Indirect transfer using a financial intermediary Public Offering A offering of securities where all investors have the opportunity to acquire a portion of the financial claims being sold Private Placement A security offering limited to a small number of potential investors Primary Market A market where securities are being offered for the first time for sale to potential investors Money Market All institutions and procedures that facilitate transactions for short term instruments issued by borrowers with very high credit ratings Capital Market All institutions and procedures that facilitate transactions for long term financial instruments Exchange To provide goods or services and receive goods or services of approximately equal value in return Organized Security Exchanges formal organizations that facilitate the trading of securities Physical entities ex Building where financial instruments are traded Over the counter all security markets except organized exchanges Most corporate bonds are traded in this market Ex money market Investment Banker A financial investor who underwrites and distributes new securities and advices corporate clients about raising new funds Investment Banker Functions 1 Underwriting 2 Distributing 3 Advising Negotiated Purchase Underwriting in which the purchase price and the public offering price are determined through negotiations between the issuer and a single syndicate as opposed to through multiple competitive bidding Most underwriting is negotiated Competitive Bid Purchase Several underwriting groups bid for the right to purchase the new issue from the firm that is raising funds The firm does not directly select the investment banker he she is chosen by an auction process The one willing to pay the greatest dollar amount per new security wins Best Efforts Basis The investment banker attempts to sell the issue in return for a fixed commission on each security actually sold He she acts as an agent the securities are not underwritten Unsold securities are returned to the corporation Less costly to issuer the risk is not selling all the securities Privileged Subscription The process of marketing a new security issue to a select group of investors Direct Sale The sale of securities by a corporation to the investing public without the services of an investment banking firm Flotation Costs The transaction cost incurred when a firm raises funds by issuing a particular type of security Securities Act of 1933 First Congressional law regulating the securities industry Required registration and disclosure and included measures to discourage fraud and deception Securities Exchange Act of 1934 The act which created the SEC outlawed manipulative and abusive practices in the issuance of securities required registration of stock exchanges brokers dealers and listed securities and required disclosure of certain financial information and insider trading Securities Acts Amendments of 1975 Congressional law amending the Securities Act of 1933 to enable the establishment of a National Market System and to encourage fair and efficient handling of securities transactions Shelf Registration A registration of a new issue which can be prepared up to two years in advance so that the issue can be offered quickly as soon as funds are needed or market conditions are favorable Opportunity Cost of Funds the next best rate of return available to the investor for a given level of risk Maturity Premium The additional return required by investors in long term securities to compensate them for the greater risk of price fluctuations on those securities caused by interest rate changes Liquidity Premium The additional return required by investors for securities that cannot be quickly converted into cash at a reasonably predictable price Nominal Rate of Interest The interest rate paid on debt securities without an adjustment for any loss in purchasing power Real Rate of Interest The nominal quoted rate of interest less any loss in purchasing power of the dollar during the time of investment Term Structure of Interest Rates The relationship between interest rates ad he term to maturity where the risk of default is held constant Unbiased Expectations Theory The theory that the shape of the term structure of interest rates is determined by an investor s