1.1 Introduction to Corporate Finance Flashcards
What does accounting look at?
Records, collates and reports information about a company’s operations.
Backward looking and generally conservative in nature.
How is accounting and finance different in the metrics/methods they use?
Financial accounts are based on accruals and not on the cashflows, which is the focus of finance.
What are financial markets? Examples?
Where financial assets are traded.
London Stock Exchange: where shares in companies are traded.
Forex markets: where currencies are exchanged.
Chicago Mercantile Exchange: where commodity and financial futures are traded.
What are financial intermediaries?
Everything from banks - take deposits and lend it out - to hedge funds, which invest it into all kinds of financial assets.
Also: investment banks, fund managers, stock brokers, insurance companies, commodity brokers, mutual funds, pension funds, etc.
Why do hedge funds (in America) invest in civil litigation cases, funding legal claims?
Most other types of investments (and their prospects) depend on economic activity. Whereas for legal cases, there is more certainty and depends on static legal system.
What is a key factor in asset pricing (shares) within investment banking?
Conflict of interest between different parts of the IB firm.
What are the functions of financial markets?
- Resource allocation. Across time (borrowing and saving) and across different countries (booms and busts).
- Information dissemination/price discovery. Determining the price of a loan (credit rating/scores), required return from an investment (market demand), and evalutating who has better technology & managers.
How is finance theory broken down?
Financing and investing
- Traditional view
- Modern view
- Neoclassical (we will focus on this one)
- Neoinstitutional
What is the traditional view of finance theory?
Pre-1950s. Finance treated as an ancillary service to production process, not as a factor that alters choices of capital structure (debt vs. equity) or whether financing can be raised (cost of capital).
What is the modern view of finance theory?
Focus on rational individuals who maximise their utility, no longer “firm” centric since the firm is just a nexus of people and contracts.
Focus on decisions (i.e. should a firm invest? Management implications) and allows for different preferences (e.g. time preferences).
What assumptions does the neoclassical view take?
There exists a perfect and complete capital market.
What is the perfection assumption?
All individuals have equal and costless access to the same information (market transparency). There are no transaction costs, search costs, or other frictions when securities are bought or sold. (Including such things as taxes).
What is the market completeness assumption?
Any asset (including fractions of such assets) is tradable.
What is the neoinstitutional view?
Builds on the perfect world of neoclassical, but eases various assumptions. Includes role of informational asymmetry (principal-agent problem, moral hazard, adverse selection), role of transaction costs.
Markets no longer complete or perfect and thus capital structure matters and uncertainty leads to some (viable) projects being unfunded
What are the main differences between neoclassical and neoinstitutional approaches?
Neoclassical approach is about the basic tools of valuation.
Neoinstitutional approach is about the complexities that make assessment of investments more difficult and corporate governance important.
