BEC Another71 FCs Flashcards
CAPITAL BUDGETING
What is Capital Budgeting? How is it used?
Managerial Accounting technique used to evaluate different investment options
Helps management make decisions
Uses both accounting and non-accounting information
Internal focus
GAAP is not mandatory
CAPITAL BUDGETING
What values are used in Capital Budgeting?
Capital Budgeting ONLY uses Present Value tables.
Capital Budgeting NEVER uses Fair Value.
CAPITAL BUDGETING
When is the Present Value of $1 table used?
For ONE payment- ONE time.
CAPITAL BUDGETING
When is the Present Value of an Annuity Due used?
Multiple payments made over time- where the payments are made at the START of the period.
CAPITAL BUDGETING
When is the Present Value of an Ordinary Annuity of $1 (PVOA) used?
Multiple payments over time- where payments are made at the END of the period.
Think A for Arrears.
CAPITAL BUDGETING
What is the calculation for the Present Value of $1?
1 / (( 1+i )^n)
i : interest rate
n : number of periods
CAPITAL BUDGETING
What is Net Present Value (NPV)?
A preferred method of evaluating profitability.
One of two methods that use the Time Value of Money
: PV of Future Cash Flows - Investment
CAPITAL BUDGETING
How is NPV used to calculate future benefit?
NPV : PV Future Cash Flows - Investment
If NPV is Negative- Cost is greater than benefits (bad investment)
If NPV is Positive- Cost is less than benefit (good investment)
If NPV : 0- Cost : Benefit (Management is indifferent)
CAPITAL BUDGETING
What is the rate of return on an investment called?
The Discount Rate.
CAPITAL BUDGETING
What does the Discount Rate represent?
The rate of return on an investment used.
It represents the minimum rate of return required.
CAPITAL BUDGETING
What are the strengths of the Net Present Value system?
Uses the Time Value of Money
Uses all cash flows- not just the cash flows to arrive at Payback
Takes risks into consideration
CAPITAL BUDGETING
What are the weaknesses of the Net Present Value system?
Not as simple as the Accounting Rate of Return.
CAPITAL BUDGETING
How do Salvage Value and Depreciation affect Net Present Value?
NPV includes Salvage Value because it is a future cash inflow.
NPV does NOT include depreciation because it is non-cash.
Exception - If a CPA Exam question says to include tax considerations- then you have to include depreciation because of income tax savings generated by depreciation.
CAPITAL BUDGETING
If multiple potential rates of return are available- which is used to calculate Net Present Value?
The minimum rate of return is used.
CAPITAL BUDGETING
What is the Internal Rate of Return (IRR)?
It calculates a project’s actual rate of return through the project’s expected cash flows.
IRR is the rate of return required for PV of future cash flows to EQUAL the investment.
Investment / After Tax Annual Cash Inflow : PV Factor
CAPITAL BUDGETING
Which rate of return is used to re-invest cash flows for Internal Rate of Return?
Cash flows are re-invested at the rate of return earned by the original investment.
CAPITAL BUDGETING
How does the rate used for Internal Rate of Return (IRR) compare to that used for Net Present Value (NPV)?
Rate of return for IRR is the rate earned by the investment.
Rate of return for NPV is the minimum rate.
CAPITAL BUDGETING
What are the strengths and weaknesses of the Internal Rate of Return system?
Strengths: Uses Time Value of Money- Cash Flow emphasis
Weakness: Uneven cash flows lead to varied IRR
CAPITAL BUDGETING
When is NPV on an Investment positive?
When the benefits are greater than the costs.
IRR is greater than the Discount Rate
CAPITAL BUDGETING
When is NPV on an Investment Negative?
When Costs are greater than Benefits
IRR is less than the Discount Rate
CAPITAL BUDGETING
When is NPV Zero?
When benefits equal the Costs
IRR : Discount Rate
CAPITAL BUDGETING
What is the Payback Method? How is it calculated?
It measures an investment in terms of how long it takes to recoup the initial investment via Annual Cash Inflow
Investment / Annual Cash Inflow : Payback Method
Compare to a targeted timeframe; if payback is shorter than target- it’s a good investment. If payback is longer than target- it’s a bad investment.
CAPITAL BUDGETING
What are the strengths of the Payback Method?
Takes risk into consideration
2 year payback is less risky than a 5 year payback
CAPITAL BUDGETING
What are the weaknesses of the payback method?
Ignores the Time Value of Money
Exception: Discount payback method
Ignores cash flow after the initial investment is paid back
CAPITAL BUDGETING
What is the Accounting Rate of Return?
An approximate rate of return on assets
ARR : Net Income / Average Investment
Compare to a targeted return rate; if ARR greater than target- good investment. If ARR less than target- bad investment.
CAPITAL BUDGETING
What are the strengths of the Accounting Rate of Return (ARR)?
Simple to use
People understand easily
CAPITAL BUDGETING
What are the weaknesses of the Accounting Rate of Return (ARR)?
Can be skewed based on Depreciation method that is used.
Ignores the Time Value of Money.
CAPITAL BUDGETING
What is an Expected Return?
An approximate rate of return on assets.
CORPORATE GOERNANCE
What is the primary duty of the board of directors?
To monitor management behavior.
CORPORATE GOERNANCE
What is the responsibility of the Nominating or Corporate Governance Committee of the board of directors?
Oversees the board
Responsible for hiring new CEO
CORPORATE GOERNANCE
What is the responsibility of the audit committee of the board of directors?
The audit committee appoints and oversees the external auditor.
CORPORATE GOERNANCE
What is the duty of the compensation committee of the board of directors?
The compensation committee handles the CEO’s compensation package.
CORPORATE GOERNANCE
What does the NYSE and NASDAQ require of the board of directors?
They require the board to be independent.
CORPORATE GOERNANCE
What is the main goal in an executive compensation package?
The package should ensure that the goals of management should match those of the shareholders.
CORPORATE GOERNANCE
How can an executive compensation package ensure that goals of management align with those of shareholders?
Executive compensation should create an incentive for management to govern in a shareholder-friendly way that doesn’t sacrifice the long-term success of the enterprise for short-term gain.
CORPORATE GOERNANCE
Which influences help mold the direction that management takes?
They range from internal (Board of Directors- Audit Committee- Internal Control) to external (Creditors- SEC- IRS)
These influences should not be tainted by undue influence from management or have financial ties to management such as compensation-related duties
CORPORATE GOERNANCE
What is shirking?
When management doesn’t act in the best interest of shareholders.
It can be alleviated by tying compensation to stock performance or company profit.
CORPORATE GOERNANCE
What requirements are imposed on a public company under Sarbanes-Oxley?
Management must submit a report on the effectiveness of Internal Control in the 10K.
Management must disclose significant Internal Control deficiencies.
CEO/CFO must certify that the financial statements comply with securities laws and fairly present the financial condition of the company.
CORPORATE GOERNANCE
What characteristics are promoted by the COSO framework on Internal Control?
Reliable financial reporting
Effective and efficient operations
Compliance
CORPORATE GOERNANCE
What are the elements of the control environment?
Integrity & Ethics Competence The Board of Directors & Audit Committee Management's Operating Style Organizational Structure Authority & Roles of Responsibilities HR Policies
CORPORATE GOERNANCE
What are control activities?
A component of Internal Control that includes actions being taken to promote the control environment.
CORPORATE GOERNANCE
What are the basic elements of Internal Control?
Control Environment Risk Assessment Control Activities Information and Communication Monitoring
CORPORATE GOERNANCE
What is the significance of the Information and Communication aspect of Internal Control?
Management must have access to relevant and timely information to make good decisions.
CORPORATE GOERNANCE
How does Monitoring affect Internal Control?
Internal Control activities must be constantly monitored and evaluated for effectiveness.
CORPORATE GOERNANCE
What activities does the COSO framework for enterprise risk management include?
Identifies Risk Factors Promotes Risk Response Decisions Compares Management Risk vs. Shareholder Goals Aids in evaluating opportunities Promotes Quicker Capital movement
Does NOT eliminate all risk
CORPORATE GOERNANCE
What are possible responses to risk under the COSO framework for enterprise risk management?
Avoid or Reduce
Share or Accept
COST ACCOUNTING
What is Cost Accounting?
Cost Accounting is a component of GAAP that records Ending Inventory on the Balance Sheet for
o Direct Materials
o Direct Labor
o Work in Process
o Finished Goods
Cost Accounting also records for the Income Statement
COST ACCOUNTING
What is the difference between Cost Accounting and Managerial Accounting?
Cost Accounting - External Focus- GAAP
Managerial Accounting - Internal Focus- Not GAAP
COST ACCOUNTING
What are Product Costs (aka Inventory Costs)?
Prime Costs
Conversion Costs
COST ACCOUNTING
What are included in Prime Costs?
Direct Material USED - Have become part of the product or had a direct impact on the product
Direct Labor Used - Employees who worked on product and had direct impact
COST ACCOUNTING
What is Factory Overhead?
All factory costs except for DM and DL used in production- including Spoilage (except for abnormal spoilage- which is a period cost and not included in OH).
COST ACCOUNTING
What is included in Fixed Factory Overhead?
FFO : Estimated Costs / Normal Capacity
Uses Normal Activity
Examples of Fixed Factory OH: Depreciation (SL)- Utilities- Taxes
Under/Over-applied Fixed OH always goes to COGS
COST ACCOUNTING
What is included in Variable Overhead?
VO : Estimated Activity / Actual Activity
Uses Actual Activity
Examples of Variable Factory OH: Deprecation (Units of Prod)- Indirect materials (supplies & insignificant items)- Indirect labor (factory foreman- janitors- machine maintenance)
COST ACCOUNTING
Where is Under/Over-applied Variable OH recorded?
If Immaterial - Goes to COGS
If Material - Goes to WIP- Finished Goods- or COGS- based on their Ending Balance
COST ACCOUNTING
Where is Under/Over-applied Fixed OH recorded?
It always goes to COGS
COST ACCOUNTING
What is indicated by a Debit balance in Actual Factory Overhead? How is it corrected?
Under-applied overhead.
If it’s Fixed OH- under-applied goes to COGS.
If it’s Variable OH- under-applied goes to COGS if immaterial- but is allocated to WIP- FG or COGS based on ending balances.
COST ACCOUNTING
What is indicated by a Credit balance in Applied Factory Overhead? How is it corrected?
A credit balance indicates over-applied overhead.
If Fixed overhead- it is corrected from COGS.
If Variable overhead- it is corrected through COGS if immaterial- but if material overage is allocated to WIP- FG or COGS based on ending balances.
COST ACCOUNTING
Which variables are used to calculate Direct Material balances?
Beginning Balance DR Net purchases (plus freight-in)CR Direct Materials Used
: Ending balance (goes to BS)
COST ACCOUNTING
What variables are used to calculated Work in Process (WIP)?
Beginning Balance (End Bal of Previous WIP)DR Direct Materials UsedDR Direct Labor Used (Conversion Cost)CR COGMDR Factory Overhead Applied (Conversion Cost)
: Ending Balance (Goes to BS)
COST ACCOUNTING
What variables are included in Finished Goods calculations?
Beginning BalanceDR COGM
: COGAS (Cost of Goods Avail for Sale)
CR COGS
: Ending Balance (Goes to BS)
COST ACCOUNTING
How does Freight In affect Cost Accounting calculations?
Inventory (Product) Cost
Part of DM Purchases
COST ACCOUNTING
How does Freight Out affect Cost Accounting?
Selling (Period) Cost
Not part of inventory
COST ACCOUNTING
When is Job-Order Costing used?
Used when costs are easily connected to a specific product or product line
Can also be applied to services
Calculation is the same as normal cost accounting - just use your T Accounts
- DM to WIP to FG to COGS
- You’re likely going to be solving for the last job in the queue
COST ACCOUNTING
What is the Direct Method for allocating service department costs?
No services allocated between service departments- even if they serve each other. Only allocate to product(s)
COST ACCOUNTING
What is the Step Method for allocating service department costs?
Services can be allocated to both other service departments and the product(s)
COST ACCOUNTING
Under process costing- how are the units shipped calculated?
Beginning Inventory+ Units Started- Ending Inventory
: No. Units Shipped
COST ACCOUNTING
Which two inventory methods are used under Process Costing?
FIFO
Weighted Average
COST ACCOUNTING
What is another name for Process Costing?
Equivalent Units of Production
COST ACCOUNTING
How will Equivalent Finished Units under FIFO compare to EFU under the Weighted Average method?
EFU FIFO will always be LESS than EFU Weighted Avg (unless Beginning Inventory is Zero)
COST ACCOUNTING
How are Direct Materials calculated under the Weighted Average Method?
Beginning Inventory + Current Costs / EFU WA
COST ACCOUNTING
How are Conversion Costs calculated under Weighted Average Method?
Beginning Inventory + Current Costs / EFU WA
COST ACCOUNTING
How are Equivalent Finished Units calculated for Direct Materials?
Units Shipped + EI x % Complete DM
: EFU (Weighted Average Method)
- Beginning Inventory x % Complete
: EFU (FIFO)
COST ACCOUNTING
How are Equivalent Finished Units calculated for Conversion Costs?
Units Shipped+ EI x % Complete CC
: EFU (Weighted Average)
- Beginning Inventory x % Complete
: EFU (FIFO)
COST ACCOUNTING
How are Direct Materials calculated under the FIFO method?
Current Costs / EFU FIFO
Note: FIFO method uses Current Period costs only and ignores Beginning Inventory
COST ACCOUNTING
How are Conversion Costs calculated under the FIFO method?
Current Costs / EFU FIFO
FIFO method uses Current Period costs only and ignores Beginning Inventory
COST ACCOUNTING
How is WIP calculated?
Beginning balance (DM- DL- OH)+ Current Costs (DM- DL- OH)- COGM (Goes to Finished Goods)+ DM EFU x Cost per DM EFU+ CC EFU x Cost per CC EFU
: Ending WIP
COST ACCOUNTING
How do period costs and product costs relate to net sales- gross margin and operating income?
Net Sales - Product Costs
: Gross Margin
- Period Costs
: Operating Income
COST ACCOUNTING
What is the focus of Activity Based Costing (ABC)?
Focuses on eliminating non-value-added activities for poor quality and inventory and things customers don’t want or don’t care about
Inventory is expensive to store and storing something is not a value-added expenditure
Uses Cost Pools - Different departments can have different OH rates
Uses Several OH rates based on Activity - Cost Pool / Cost Driver
COST ACCOUNTING
How do Cost Pools and Allocations compare under ABC versus traditional costing system?
Cost Pools and Allocations increase compared to a traditional costing system
COST ACCOUNTING
What is Backflush Costing?
Connected to Just-in-Time Production- which is part of Activity-Based Costing and Total Quality Management (TQM)
- Works backward to flush out COGS
- Mostly GAAP
COST ACCOUNTING
What are the characteristics of By-Products?
Usually immaterial and common costs aren’t allocated to them
Low Market Value
Can be valued at NRV
Can be treated as a contra expense and netted against COGS - Can be treated as a contra sale and netted against Sales
Recognition rules are very flexible with valuing and classifying by-products
COST ACCOUNTING
What are Cost Functions?
Measure how costs change relative to activity levels
High-Low Method
Change in Cost (High-Low pts) / Change in Activity (High-Low pts)
ECONOMICS
How does a price increase affect supply?
When the prices of an item increases supply increases- because more sellers are willing to sell.
ECONOMICS
What is a supply curve shift?
When supply changes due to something other than price.
ECONOMICS
What are the characteristics of a positive supply curve shift (shift right)?
Supply increases at each price point
Higher Equilibrium GDP
Number of sellers increases - market can get flooded
Examples: Government subsidies or technology improvements that decrease costs for suppliers
ECONOMICS
What are the characteristics of a negative supply curve shift (shift left)?
Supply decreases at each price point
Lower Equilibrium GDP
Cost of producing item increases
Examples: Shortage of gold- so less gold watches are made; wars or crises in rice-producing countries means there is less rice on the market
ECONOMICS
How does price affect the demand for an item?
When the prices of an item increases- demand for it decreases.
ECONOMICS
What is a Demand Curve Shift?
When demand changes due to something other than price.
ECONOMICS
What is a Positive Demand Curve Shift (Shift Right)?
When demand increases at each price point
Price of substitutes go up - price of beef rises- so people buy more chicken
Future price increase is expected - War in Middle East- people go out and buy gas
Market expands - i.e. people get new free health care plan- demand at clinic rises
Expansion - more spending increases equilibrium GDP
ECONOMICS
What is a Negative Demand Curve Shift (Shift Left)?
Demand decreases at each price point.
Price of complement goes up - price of beef goes up- less demand for ketchup
Boycott - Company commits social blunder- consumers boycott
Consumer income rises - Demand for inferior goods drops as people have more money to spend
Consumer tastes change
Contraction - less spending decreases equilibrium GDP
ECONOMICS
What is the Marginal Propensity to Consume?
How much you spend when your income increases
Calculate: Change in Spending / Change in Income
ECONOMICS
What is the Marginal Propensity to Save?
How much you save when income increases
Calculate: Change in Savings / Change in Income
Also equals 1 - Marginal Propensity to Consume
ECONOMICS
How is the multiplier effect calculated?
(1 / 1-MPC) x Change in Spending
ECONOMICS
How does increased spending by consumers and the government affect the demand curve?
As spending by consumers or the government increases- the demand curve increases (shifts right).
ECONOMICS
How does spending change due to the multiplier effect?
The increase in demand ends up being larger than the amount of additional income spent in the economy due to the multiplier effect.
One consumer spends money- which:
*Increases the income of a business
*Increases the income of a vendor
*Increases income of employees
*Increases tax revenue
ECONOMICS
How is Price Elasticity of Demand calculated?
% Change in Quantity Demand / % Change in Price
ECONOMICS
Under elastic demand- how does price affect revenues?
Price increases- Revenue decreases
Price decreases- Revenue increases
ECONOMICS
What conditions would indicate Elastic Demand?
Many substitutes (luxury items)
Considered elastic if elasticity is greater than 1
10% drop in demand / 8% increase in price : 1.25 (Elastic)
Price increases- Revenue decreases
Price decreases- Revenue increases
ECONOMICS
How does revenue react to price under Inelastic Demand?
Price increases- Revenue increases
Price decreases- Revenue decreases
ECONOMICS
What conditions would indicate Inelastic Demand?
Few substitutes (groceries- gasoline)
Considered inelastic if coefficient of elasticity is less than 1
5% drop in demand / 10% increase in price : .5 (inelastic)
Price increases- Revenue increases
Price decreases- Revenue decreases
ECONOMICS
What is Unitary Demand?
Total revenue will remain the same if price is increased
Considered unitary if coefficient of elasticity : 1
ECONOMICS
How is Income Elasticity of Demand calculated?
% Change Quantity Demanded / % Change in Income
Normal goods greater than 1 (demand increases more than income)
Inferior goods less than 1 (demand increases less than income)
ECONOMICS
What conditions occur under periods of inflation?
Interest rates increase
Reduced demand for loans
Reduced demand for houses- autos- etc.
Value of bonds and fixed income securities decrease
Inferior good demand to increase
Foreign goods more affordable than domestic
Demand for domestic goods decrease
ECONOMICS
What happens under Demand-Pull inflation?
Overall spending increases
Demand increases (shifts right)
Market equilibrium price increases
ECONOMICS
What happens under Cost-Push inflation?
Overall production costs increase
Supply decreases (shifts left)
Market equilibrium price increases
Note: Demand-Pull and Cost-Push Inflation BOTH result in market equilibrium price to increase
ECONOMICS
What is the Equilibrium Price?
The price where Quantity Supplied : Quantity Demanded
ECONOMICS
What is Optimal Production?
When Marginal Revenue : Marginal Cost
ECONOMICS
What is the result of a Price Floor?
Causes a surplus if above equilibrium price.
ECONOMICS
What is GDP (Gross Domestic Product)?
The annual value of all goods and services produced domestically at current prices by consumers- businesses- the government- and foreign companies with domestic interests
Included: Foreign company has US Factory
Not included: US company has foreign factory
ECONOMICS
What is included under the income approach for calculating GDP?
Sole Proprietor and Corp Income
Passive Income
Taxes
Employee Salaries
Foreign Income Adjustments
Depreciation
ECONOMICS
What is included under the Expenditure Approach for calculating GDP?
Individual Consumption
Private Investment
Government Purchases
Net Exports
ECONOMICS
What is Nominal GDP?
Measures goods/services in current prices.
ECONOMICS
For what is a GDP Deflator used?
Used to convert GDP to Real GDP
ECONOMICS
What is Real GDP?
Nominal GDP / GDP Deflator x 100
ECONOMICS
What is Gross National Product (GNP)?
Like GDP; Swaps foreign production. US Firms overseas are included- Foreign firms domestically are not included
ECONOMICS
What is the Consumer Price Index (CPI)? How is it applied?
Price of goods relative to an earlier period of time- which is the benchmark. Year 1 : 1.0
((CPI Current - CPI Last) / CPI Last) * 100
ECONOMICS
How is disposable income calculated?
Personal Income - Personal Taxes
ECONOMICS
How is Return to Scale calculated?
% Increase in output / % Increase in input
Greater than 1 : Increasing returns to scale
Less than 1 : Decreasing returns to scale
ECONOMICS
When is the economy in Recession?
When GDP growth is negative for two consecutive quarters.
ECONOMICS
What is a Depression?
A prolonged- severe recession with high unemployment rates
No requisite period of time for the economy to officially be in a depression
ECONOMICS
What are the stages of the Economic Cycle?
Peak (highest)
Recession (decreasing)
Trough (lowest)
Recover (increasing)
Expansion (higher again)
ECONOMICS
What are leading indicators?
Conditions that occur before a recession or before a recovery
Example: Stock Market or New Housing Starts
ECONOMICS
What are lagging indicators?
Conditions that occur after a recession or after a recovery
Examples: Prime Interest Rates- Unemployment
ECONOMICS
What are coincident indicators?
Conditions that occur during a recession or during a recovery
Example: Manufacturing output
ECONOMICS
Which people are included in the calculation of unemployment?
Only people looking for jobs
ECONOMICS
What is Cyclical Unemployment?
GDP doesn’t grow fast enough to employ all people who are looking for work
Example: People are unemployed in 2010 because there aren’t enough jobs available due to the economy
ECONOMICS
What is Frictional Unemployment?
People are changing jobs or entering the work force. This is a normal aspect of full employment.
Example: A recent college graduate is looking for a job
ECONOMICS
What is Structural Unemployment?
A worker’s job skills do not match those necessary to get a job so they need education or training
Example: A construction worker wants to work in an office- so they quit their job and get computer training
ECONOMICS
How does inflation relate to unemployment?
High Unemployment : Low Inflation (Vice Versa)
ECONOMICS
What is the Discount Rate?
The rate a bank pays to borrow from the Fed.
ECONOMICS
What is the Prime Rate?
The rate a bank charges their best customers on short-term borrowings.
ECONOMICS
What is the Real Interest Rate?
Inflation-adjusted interest rate
ECONOMICS
What is the Nominal Rate?
Rate that uses current prices
ECONOMICS
What is the Risk-Free Rate?
Rate for a loan with 100% certainty of payback.
Usually results in a lower rate.
US Treasuries are an example.
ECONOMICS
What is included in the M1 money supply?
Currency- Coins- and Deposits
ECONOMICS
What is included in the M2 money supply?
Highly liquid assets other than currency- coins or deposits
ECONOMICS
What is Deficit Spending?
Increased spending levels without increased tax revenue.
Lower taxes without decrease in spending
Gamble that the multiplier effect will take over and boost economy
ECONOMICS
How can the Fed control the money supply?
By buying and selling the government’s securities.
ECONOMICS
How does the Fed control economy-wide interest rates?
By adjusting the discount rate charged to banks
ECONOMICS
What is a Tariff?
A tax on imported goods
ECONOMICS
What is a quota?
A limit on the number of goods that can be imported
ECONOMICS
How do international trade restrictions affect domestic producers?
They are good for domestic producers.
Demand curve shifts right
Fewer substitutes
They can charge higher prices
ECONOMICS
How to international trade restrictions affect foreign producers?
They are bad for foreign producers
Demand curve shifts left
Fewer buyers
They must charge lower prices
ECONOMICS
How do international trade restrictions affect foreign consumers?
They are good for foreign consumers
Supply curve shifts right
Goods purchased at lower prices in the foreign markets
ECONOMICS
How do international trade restrictions affect domestic consumers?
They are bad for domestic consumers
Supply curve shifts left
Fewer goods bought due to higher prices
ECONOMICS
What is Accounting Cost?
Explicit (Actual) cost of operating a business
Implicit costs are opportunity costs
ECONOMICS
What is Accounting Profit?
Revenue - Accounting Cost
ECONOMICS
What is Economic Cost?
Explicit + Implicit Cost
ECONOMICS
What is Economic Profit?
Revenue - Economic Cost
FINANCIAL MANAGEMENT
What is the primary focus of working capital management?
Managing inventory & receivables (current assets & liabilities)
FINANCIAL MANAGEMENT
How is Net Working Capital calculated?
NWC : Current Assets - Current Liabilities
FINANCIAL MANAGEMENT
What are the characteristics of effective Working Capital Management?
Shorten the cash conversion cycle
Don’t negatively impact operations
FINANCIAL MANAGEMENT
What is the Inventory Conversion Period?
Average time needed to convert materials into finished goods and sell them
Average Inventory : (BI + E) / 2
Inventory Conversion Period : Average Inventory / Sales Per Day
FINANCIAL MANAGEMENT
What is the Receivables Collection Period?
Average time needed to collect A/R
RCP : Average Receivables / Credit Sales Per Day
FINANCIAL MANAGEMENT
What is the Payables Deferral Period?
Average time between materials and labor purchase and their A/P payment
Average Payables : (BP + EP) / 2
Payables Deferral Period : Average Payables / (COGS/365)
FINANCIAL MANAGEMENT
What is the Cash Conversion Cycle?
Amount of time it takes to receive a cash inflow (Customers) after making a cash outflow (Vendors)
Inventory Conversion Period
+ Receivables Collection Period
- Payables Deferral Period
: Cash Conversion Cycle
(Inventory Really (-Pays) Cash)
FINANCIAL MANAGEMENT
What traits should Cash and Short-Term Investments have?
Liquid
Safe
FINANCIAL MANAGEMENT
For what are Letters of Credit used?
Used for importing goods.
Issued by importer’s bank.
FINANCIAL MANAGEMENT
What is the advantage of using Trade Credit?
No interest cost if paid timely.
FINANCIAL MANAGEMENT
What is a Lockbox System? What are the advantages?
Customer Payments are sent to a bank-managed PO box.
Employees don’t have access to cash.
Deposits are more timely.
Interest income from deposits should pay for the Lockbox fees (if they don’t- lockbox is not beneficial)
FINANCIAL MANAGEMENT
What is float?
Time it takes to mail a payment and have it clear your bank account
Maximize float on cash payments
Minimize float on cash receipts
FINANCIAL MANAGEMENT
What are Zero Balance Accounts?
Regional bank sends enough cash to cover daily checks
Advantages:
Checks take longer to clear -more float
Low amounts of cash tied up for compensating (minimum) balances
FINANCIAL MANAGEMENT
What is the difference between Treasury Bills- Notes and Bonds?
Treasury Bills: Short term (less than one year) Think: $1 Bill
Treasury Notes: Medium term (less than 10 years- more than 1)
Treasury Bonds: Long term (greater than 10 years) Think: government is in long-term bondage to you; they owe you money
FINANCIAL MANAGEMENT
What is commercial paper?
Similar to T-Bill- but issued by corporations instead of Government
Greater than 9 Months Maturity
Unsecured
Issued by large firms
FINANCIAL MANAGEMENT
What are the advantages and disadvantages of Commercial Paper?
Advantages: Financing at less than Prime. No compensating balances required.
Disadvantages: Unpredictability of markets. Credit crisis emerges and large insurance/investment companies aren’t lending.
FINANCIAL MANAGEMENT
What is Economic Order Quantity?
The order quantity that minimizes inventory costs.
EOQ : Square Root of (2DO/C)
D : Unit Demand (Annual)
O : Order Cost
C : Cost of Inventory
FINANCIAL MANAGEMENT
What is Carrying Cost?
The cost of keeping inventory.
FINANCIAL MANAGEMENT
What is Order Cost?
Cost of executing an order and starting product production.
FINANCIAL MANAGEMENT
What is inventory reorder point?
How low inventory should get before it should be re-ordered.
IOP : Average Daily Demand x Average Lead Time
FINANCIAL MANAGEMENT
What is a Just In Time (JIT) system?
Orders inventory so that you get it just in time for when it’s needed
JIT is valuable when Order Cost is low and Cost of Carrying Inventory is high
FINANCIAL MANAGEMENT
What is Factoring of receivables?
Receivables are sold to a financing company where they pay less than the value of the receivables due to a discount related to risk of non-collection
FINANCIAL MANAGEMENT
What is a Trade Discount?
Buyer saves if paid early
Example: 1/10 Net 30
1% Discount if paid within 10 days
If not- bill is still due in 30 days
FINANCIAL MANAGEMENT
What is the cost of forgoing a discount?
(Discount % x 365) / ((100% - Discount) x (Pay Period - Discount Period))
FINANCIAL MANAGEMENT
What is the Prime Rate?
A benchmark used for lending only to the best customers
Most customers will be charged Prime + 3%- for example
If the lending institution and the customer are not in the same country- the LIBOR rate is often used
FINANCIAL MANAGEMENT
What is the Nominal (Face- Coupon- Stated) Rate?
Interest rate stated on the face of a bond.
FINANCIAL MANAGEMENT
How is Current Yield calculated?
CY : Interest Payment / Bond Price
FINANCIAL MANAGEMENT
What is the Effective (YTM- Market) Rate?
PV of Principle + Interest : Bond Price
FINANCIAL MANAGEMENT
What is a Zero Coupon Bond?
No interest payments made
Bond sold at a discount
Interest reflected when Bond matures
FINANCIAL MANAGEMENT
What are the characteristics of a Junk Bond?
High interest rate
High default risk
FINANCIAL MANAGEMENT
What are debenture bonds?
Bonds unsecured by collateral
FINANCIAL MANAGEMENT
What are subordinated debentures?
Debenture Bonds that will be repaid if any assets are left after liquidation of a company
FINANCIAL MANAGEMENT
What are Redeemable Bonds?
Provision in Bond contract allows demand of Bond payment under certain circumstances
FINANCIAL MANAGEMENT
What is a Callable Bond?
Borrower can pay off debt early
FINANCIAL MANAGEMENT
What is a Convertible Bond?
Lender can demand payment via company stock instead of money
FINANCIAL MANAGEMENT
What is a Sinking Fund?
Borrower deposits regular sums into an account that will eventually pay off the debt
FINANCIAL MANAGEMENT
What is the disadvantage of Common Stock in comparison to bonds?
Common Stock is more expensive to issue than debt.
Why? Investors demand a greater ROI than debtors (bondholders)
FINANCIAL MANAGEMENT
What is the advantage of Preferred Stock?
Hold dividend priority over common stock
FINANCIAL MANAGEMENT
What is Weighted Average Cost of Capital?
A company uses this to determine the true cost of their capital
Example: Debt costs 5%; 40% of Cap. Equity costs 12%; 60% of Cap. (5% x 40%) + (12% x 60%) WACC : 9.2%
FINANCIAL MANAGEMENT
What is CAPM?
A stock’s expected performance is based on its beta (risk) compared to that of the stock market.
More risk : more expected return.
FINANCIAL MANAGEMENT
How is Cost of Debt calculated?
(Interest Expense - Tax Benefit) / Carrying Value of Debt
FINANCIAL PLANNING
What is a Static Budget?
Budget targeted for a specific segment of a company.
FINANCIAL PLANNING
What is a Maser Budget?
Budget targeted for the company as a whole
Includes budgets for Operations and Cash Flows
Includes set of budgeted Financial Statements
FINANCIAL PLANNING
How do Fixed Costs affect budgeting?
Costs independent of the level activity within the relevant range
Property Tax is the same whether you produce 100-000 units or zero units
However - Fixed Costs per unit vary given the amount of activity
If you produce fewer units- fixed costs per unit will be greater than if you produce more units - i.e. less units to spread the cost over
FINANCIAL PLANNING
How do Variable Costs affect budgeting?
The more Direct Materials or Direct Labor used- the more Variable Costs per unit
However - Variable Costs per unit don’t change with the level of activity like Fixed Costs per unit
FINANCIAL PLANNING
How are Material Variances calculated?
SAM:
Standard Material Costs
- Actual Material Costs
= Material Variance
FINANCIAL PLANNING
How are Labor Variances calculated?
SAL
Standard Labor Costs
- Actual Labor Costs
= Labor Variance
FINANCIAL PLANNING
How are Overhead Variances calculated?
OAT
Overhead Applied
- Actual Overhead Cost
= Total Overhead Variance
FINANCIAL PLANNING
How does Absorption Costing compare to Variable Costing?
Absorption Costing - External Use- Cost of Sales- Gross Profit- SG&A
Variable Costing - Internal Use- Variable Costs- Contribution Margin- Fixed Costs
FINANCIAL PLANNING
How is Contribution Margin calculated?
Sales Price (per unit)
- Variable Cost (per unit)
= Contribution Margin (per unit)
FINANCIAL PLANNING
How is Break-even Point (per unit) calculated?
Total Fixed Costs / Contribution Margin (per unit)
= Break-even Point Per Unit
Assumption: Total Costs & Total Revenues are LINEAR
FINANCIAL PLANNING
What is the focus in a Cost Center?
Management is concerned only with costs
FINANCIAL PLANNING
What is the focus in a Profit Center?
Management is concerned with both costs and profits
FINANCIAL PLANNING
What is the focus in an Investment Center?
Management is concerned with costs- profits- and assets
FINANCIAL PLANNING
What is the Delphi technique?
Forecasting technique where Data is collected and analyzed
Requires judgement/consensus
FINANCIAL PLANNING
What is Regression Analysis?
A forecasting technique where Sales is the dependent variable.
Simple Regression - One independent variable
Multiple Regression - Multiple independent variables
FINANCIAL PLANNING
What are Econometric Models?
Forecast sales using Economic Data
FINANCIAL PLANNING
What are Naive Forecasting Models?
Very Simplistic
- Eyeball past trends and make an estimate
FINANCIAL PLANNING
How does a Moving Average compare to Exponential Smoothing?
Both project estimates using average trends from recent periods
Difference: Exponential Smoothing weighs recent data more heavily
FINANCIAL PLANNING
What are the characteristics of Short-term Cost Analysis?
Uses Relevant Costs Only
Ignore Sunk Costs
Opportunity Cost is a Must
INFORMATION TECHNOLOGY
Which IT personnel roles should always be segregated?
Operators
Programmers
Librarians
INFORMATION TECHNOLOGY
What are the duties of a systems analyst?
Designs or purchases IT system
Responsible for flowcharts
Liaison between Users and Programmers
Note: Think IT Manager
INFORMATION TECHNOLOGY
What is the primary duty of a Systems Administrator?
A Systems Administrator controls database access.
INFORMATION TECHNOLOGY
What are the duties of a Systems Programmer?
Writes- Updates- Maintains- & Tests software- systems- and compilers
INFORMATION TECHNOLOGY
Which duties should a Systems Programmer NOT have?
In order to maximize internal control- a Systems Programmer should NOT have application programming duties/abilities or be an Operator on the system.
INFORMATION TECHNOLOGY
What are the duties of a Systems Operator?
Schedules and Monitors Jobs
Runs IT Help Desk
INFORMATION TECHNOLOGY
What duties should a System Operator NOT have?
For internal control purposes- they should not be a Programmer on the system.
INFORMATION TECHNOLOGY
If it is not possible to segregate duties in an IT System- what actions should be taken to compensate for internal control purposes?
Include Computer Logs.
Control Group should review the logs.
INFORMATION TECHNOLOGY
What is the purpose of a Management Information System (MIS)?
To assist with decision making.
INFORMATION TECHNOLOGY
What is an Accounting Information System (AIS)?
A type of Management Information System (MIS) that processes accounting transactions.
INFORMATION TECHNOLOGY
What are the characteristics of an Executive Information System (EIS)?
Specialized for Company Executive needs
Assists with Strategy Only
No Decision-Making Capabilities
INFORMATION TECHNOLOGY
What are the characteristics of an Expert System (ES)?
Computer uses reasoning
Structured
No human interpretation needed
INFORMATION TECHNOLOGY
What are the characteristics of a Decision Support System (DSS)?
Computer provides data
Gives Interactive Support
Human interpretation needed
INFORMATION TECHNOLOGY
What are the characteristics of an Ad Hoc computer report?
User initiates the report.
The report is created upon demand.
INFORMATION TECHNOLOGY
When are Exception reports generated?
Exception reports are produced when Edit Tests- Check Digits- or Self-Checking Digits identify a problem
INFORMATION TECHNOLOGY
What is a query?
A type of Ad Hoc report- initiated by a user.
INFORMATION TECHNOLOGY
What is End-User Computing?
The User develops and executes their own application.
INFORMATION TECHNOLOGY
What is the primary benefit of E-commerce?
E-commerce makes business transactions easier.
INFORMATION TECHNOLOGY
What are the risks of E-commerce?
Compromised data or theft.
Less paper trail for auditors.
INFORMATION TECHNOLOGY
What are the benefits of Electronic Data Interchange?
Uses globally-accepted standards
Efficient
INFORMATION TECHNOLOGY
What is a File Server?
A file server stores shared programs and documents.
INFORMATION TECHNOLOGY
What is the purpose of a Database?
Located on a File Server- a Database allows users to share documents.
INFORMATION TECHNOLOGY
What is the purpose of a LAN (Local Area Network)?
It connects computers in close proximity.
INFORMATION TECHNOLOGY
What is the purpose of a WAN (Wide Area Network)?
It connects computers that are far apart.
INFORMATION TECHNOLOGY
What are the characteristics of a VAN (Value-Added Network)?
Privately-owned Network
Serves as 3rd Party Between 2 Companies
Routes EDI Transactions
Accepts wide range of Protocols
Very Costly
INFORMATION TECHNOLOGY
What is the purpose of a Firewall?
Prevents unauthorized access to a network.
INFORMATION TECHNOLOGY
What are the characteristics of a virus?
Takes over a computer
Needs a host program to run
INFORMATION TECHNOLOGY
What are the characteristics of a computer worm?
Takes over multiple computers
Doesn’t need a host program to run
INFORMATION TECHNOLOGY
What is the purpose of Automated Equipment Controls?
They prevent and detect hardware errors.
INFORMATION TECHNOLOGY
What is RAM?
Random Access Memory.
Internal memory in the computer used during immediate processing.
INFORMATION TECHNOLOGY
What is a CPU?
Computer Processing Unit
It processes commands within a computer.
INFORMATION TECHNOLOGY
What is Job Control Language?
It schedules and allocates system resources.
INFORMATION TECHNOLOGY
What are examples of input devices?
Keyboard
Mouse
Scanner
Magnetic Ink Reader
Magnetic Tape Reader
EDI
Point of Sale Scanner
INFORMATION TECHNOLOGY
What are examples of Output Devices?
Speakers
Monitors
Printers
INFORMATION TECHNOLOGY
What are the characteristics of Magnetic Tape storage?
Sequential Access - Sorts data in order
Slower data retrieval
Header Label prevents Operator error by loading wrong tape
External Labels prevent accidental destruction by operator
INFORMATION TECHNOLOGY
What are the characteristics of Magnetic Disks?
Random Access - Finds data in random spots
Faster data retrieval
Uses Boundary Protection for data
INFORMATION TECHNOLOGY
What is a Gateway?
Connects one network to another
Note: the Internet is connected by Gateways
INFORMATION TECHNOLOGY
What are Parity Checks?
A control that detects internal data errors.
A bit is added to each character- it checks to see if a bit was lost.
INFORMATION TECHNOLOGY
What is an Echo Check?
Transmitted data is returned to the sender for verification (it echoes back to the sender)
INFORMATION TECHNOLOGY
What is a Change Control?
It authorizes program changes and approves program test results.
INFORMATION TECHNOLOGY
What is security software?
Software that controls access to IT systems.
Note: Don’t confuse this with anti-virus software
INFORMATION TECHNOLOGY
What is the purpose of a Digital Signature?
It confirms a message has not been altered.
INFORMATION TECHNOLOGY
List the types of computers from smallest to largest
PDA/Smartphone/Tablet
Microcomputer - PC- Laptop (cost-effective)
Minicomputer - Like a Mainframe- but smaller
Mainframe - Large computer with terminals attached
Supercomputer - Very powerful and very big
INFORMATION TECHNOLOGY
What are the units of computer data from smallest to largest?
Bit - 1 (on) and 0 (off)
Byte - 8 bits to a byte/character
Field - group of related characters/bytes (i.e. Name- Zip Code- Serial #)
Record - Group of related fields (i.e. Member name- address- phone number)
File - Group of related records (i.e. Membership directory)
INFORMATION TECHNOLOGY
What is the duty of a design engineer?
Determine language used for a specific computer- on a computer-to-computer basis
INFORMATION TECHNOLOGY
What are object programs?
Programs written in base computer language- not similar to English.
INFORMATION TECHNOLOGY
How can source programs be recognized?
They are written in a language close to English.
INFORMATION TECHNOLOGY
What is the purpose of a Compiler?
Takes Source language (English) and converts to Object (Computer) Language
INFORMATION TECHNOLOGY
How does Online Analytical Processing work?
It uses a Data Warehouse to support management decision making.
INFORMATION TECHNOLOGY
What is Data Mining?
Using artificial intelligence and pattern recognition to analyze data stores within a Data Warehouse.
INFORMATION TECHNOLOGY
What is the purpose of online transaction processing?
To process a company’s routine transactions.
INFORMATION TECHNOLOGY
What are the characteristics of batch processing?
Data held- updates multiple files all at once
Leaves a better audit trail
Uses Grandfather-Father-Son backup (3 levels of backup kept in 3 locations)
INFORMATION TECHNOLOGY
What does an output control check for?
Checks to see if output data is valid- distributed and used in an authorized manner.
INFORMATION TECHNOLOGY
What does a processing control check?
Checks if data processing produced proper output
INFORMATION TECHNOLOGY
What is a hash total?
An input control number- a meaningless sum of values included in the input.
Example would be summing a list of SSNs to make sure the data is the same once entered as it was prior to input into the system.
INFORMATION TECHNOLOGY
What is a validity check?
Checks to see if data in existing tables or files belongs in the set
For example- is there a # in an alpha-only field or a letter in a numeric-only field
INFORMATION TECHNOLOGY
What is a limit check?
Checks to see if numbers surpass a certain limit- i.e. in an age field is the number greater than 110.
INFORMATION TECHNOLOGY
What is a check digit?
An input control that adds an identification number to a set of
digits - usually at the end
INFORMATION TECHNOLOGY
What is a field check?
An input check that prevents invalid characters- i.e. checks for alphabetic letters in a SSN field
INFORMATION TECHNOLOGY
What is a Hot Site?
A disaster recovery system where if the main system goes down- a Hot Site is ready to take over immediately.
INFORMATION TECHNOLOGY
What is a Cold Site?
If a main system goes down- a Cold Site will take time to get set up and running.
INFORMATION TECHNOLOGY
What is the most common database language?
SQL - Structured Query Language
INFORMATION TECHNOLOGY
What is a Data Definition Language?
Defines SQL Database
Controls SQL Tables
INFORMATION TECHNOLOGY
What is a Data Manipulation Language?
Queries SQL Database tables
INFORMATION TECHNOLOGY
What is a Data Control Language?
Controls Access to SQL Database
INFORMATION TECHNOLOGY
What are the characteristics of a Relational Database?
Logical structure
Uses rows and columns similar to spreadsheet
INFORMATION TECHNOLOGY
What are the characteristics of a Hierarchical Database?
Has various levels
Uses trees to store data
INFORMATION TECHNOLOGY
What are the advantages of a database?
Data is more accessible
Reduced redundancy
INFORMATION TECHNOLOGY
What are the disadvantages of a database?
Cost of installation
Skilled personnel required to maintain
INFORMATION TECHNOLOGY
What are the components of a database?
Desktop client
Application Server
Database Server
Think: Your desktop computer runs applications and saves to a database
PERFORMANCE MANAGEMENT
What four perspectives are included in Balanced Scorecard?
Financial / Customer / Internal Business Processes / Learning and Growth
PERFORMANCE MANAGEMENT
Why was Balanced Scorecard created?
To measure Performance.
PERFORMANCE MANAGEMENT
What are Strategy Maps?
Diagrams of Strategic Cause and Effect Relationships.
PERFORMANCE MANAGEMENT
What is a Strategic Initiative?
A plan to achieve goals.
PERFORMANCE MANAGEMENT
What measures are used under Value-Based Management?
Return on Investment Residual Income Spread Economic Value Added Free Cash Flow
PERFORMANCE MANAGEMENT
How is Return on Investment (ROI) calculated?
ROI : Return / Investment
Example: You Invest $100 to buy a machine that generates $60 in Operating Income
$60 / $100 : 60% ROI
PERFORMANCE MANAGEMENT
How is Residual Income calculated?
Operating Income - (Required Rate of Return x Invested Capital) : Residual Income
PERFORMANCE MANAGEMENT
What is another name for Required Rate of Return (RROR)?
RROR is also called ‘Cost of Capital’
PERFORMANCE MANAGEMENT
What is Weighted Average Cost of Capital (WACC)? How is it calculated?
Cost of Capital is the weighted average of the interest rates you pay for your Capital.
Includes Debt and the Rate of Return your Equity Shareholders expect
Example: 45% of your Capital is supported by debt and has an interest rate of 9%. 55% of your Capital is supported by equity and shareholders expect a ROR of 12%
Your Cost of Capital is: (.45 x .09) + (.55 x .12) : 10.65%
PERFORMANCE MANAGEMENT
How is Spread calculated?
Spread : ROI - Cost of Capital
PERFORMANCE MANAGEMENT
What is the primary point of Economic Value Added? How is it calculated?
Investments should exceed costs- with an emphasis on stockholder value.
Economic Value Added : Operating Income After Tax - (Net Assets x WACC)
PERFORMANCE MANAGEMENT
How is Free Cash Flow calculated?
Operating Income After Tax \+ Depreciation & Amortization - Capital Expenditures - Change in Net Working Capital \: Free Cash Flow
PERFORMANCE MANAGEMENT
What is measured by Six Sigma?
It measures a product versus its quality goal.
PERFORMANCE MANAGEMENT
What is the Asset Turnover Ratio?
Sales / Average Assets
PERFORMANCE MANAGEMENT
What does the Current Ratio tell us? How is it calculated?
Can the company pay their short-term liabilities?
Current Ratio : Current Assets / Current Liabilities
PERFORMANCE MANAGEMENT
What does the Debt to Equity Ratio tell us? How is it calculated?
How is the company financing its capital?
Debt to Equity Ratio : Total Debt / Total Equity
PERFORMANCE MANAGEMENT
What does the Debt to Total Assets ratio tell us? How is it calculated?
What proportions of the company’s assets are encumbered with debt?
Debt to Total Assets : Total Liabilities / Total Assets
PERFORMANCE MANAGEMENT
What does Gross Margin % tell us? How is it calculated?
How profitable is the product after COGS?
Gross Margin : Gross Profit / Net Sales
PERFORMANCE MANAGEMENT
What does Operating Profit Margin tell us? How is it calculated?
How profitable is the product after all expenses (except interest and taxes)?
Operating Profit Margin : Operating Profit / Net Sales
PERFORMANCE MANAGEMENT
How is Times Interest Earned calculated and what does it mean?
Can the company make their interest payments?
Times Interest Earned : Earnings Before Tax & Interest / Interest Expense
PERFORMANCE MANAGEMENT
What does Return on Assets tell us? How is it calculated?
What % return are the assets generating?
Return on Assets : Net Income (net of interest & taxes) / Average Total Assets
PERFORMANCE MANAGEMENT
How is Market/Book ratio calculated?
Market Value of Common Stock / Book Value of Common Stock
PERFORMANCE MANAGEMENT
What is Inventory Turnover and how is it calculated?
How quickly does inventory get sold?
Inventory Turnover : COGS / Average Inventory
PERFORMANCE MANAGEMENT
What is the Quick Ratio and how is it calculated?
It measures short-term liquidity- and only includes assets that are quickly available (i.e. not inventory)
Quick Ratio : (Current Assets - Inventory) / Current Liabilities
PERFORMANCE MANAGEMENT
What is Average Collection Period- and how is it calculated?
How many days does it take the company to collect payment on A/R?
Average Collection Period : Average AR / Average Sales Per Day
PERFORMANCE MANAGEMENT
What is an Internal Failure?
Products have quality defects- but are caught BEFORE they leave the warehouse.
PERFORMANCE MANAGEMENT
What is an External Failure?
Product reaches the customer- but they are not satisfied with the quality of the product.
This includes recalls.
PERFORMANCE MANAGEMENT
What is Appraisal Cost?
Quality control- testing & inspection costs.
RISK MANAGEMENT
Define Market Risk
The risk that a sluggish economy will affect the value of a debt instrument
RISK MANAGEMENT
Define Sector Risk
The risk that an event in the investment’s business sector will harm the investment
For example- the banking sector is sluggish- so even stocks of healthy banks suffer
RISK MANAGEMENT
Define Credit/Default Risk
The risk that a debtor will be unable to make loan payments or pay back the principal
RISK MANAGEMENT
Define Interest Rate Risk
The risk that a change in interest rates will adversely affect the value of the note
Example: Bond is for 10% but prevailing market rate is now 12%. If bondholder wants to sell it- they will have to sell it at a discount.
RISK MANAGEMENT
What does Standard Deviation measure?
It measures the volatility of an investment.
RISK MANAGEMENT
What is Systematic Risk?
Risk that impacts the entire market and can’t be avoided or reduced through diversification
Example: Wars
RISK MANAGEMENT
What is Unsystematic Risk?
Relates to a particular industry or company
Example: You own stocks in ethanol plants and an untimely freeze kills all of the corn in the Midwest
RISK MANAGEMENT
What does Beta measure?
Beta measures how volatile the investment is relative to the rest of the market.
In other words- how quickly (and in what amount) does the value of the stock change when the market sways?
RISK MANAGEMENT
What is Variance?
It compares volatility of an investment to the market average.
Factors include both Systematic and Unsystematic Risk.
RISK MANAGEMENT
What is a Derivative?
An asset whose value is DERIVED from the value of another asset.
Derivatives are measured at Fair Value.
RISK MANAGEMENT
How is an Option used?
Gives the buyer the option to buy or sell a financial derivative at a certain price
Traders use them to speculate where they think the price will be at a certain point and make a profit
Hedgers use them to offset risk
RISK MANAGEMENT
What is a Future?
A Forward Contract with a future value.
They are sold and traded on the futures market.
RISK MANAGEMENT
What is an Interest Rate Swap?
Forward Contract to swap payment agreements
They are highly liquid and often valued using the Zero-Coupon method.
Example: Steve pays Sally a fixed payment with a fixed interest rate. Sally pays Steve a variable payment tied to a benchmark such as LIBOR
RISK MANAGEMENT
What is Legal Risk?
Risk that a law or regulation will void the derivative
RISK MANAGEMENT
What is a Fair Value Hedge?
Hedge that protects against the value of an asset or liability changing.
Changes in value are reported in earnings.
RISK MANAGEMENT
What is a Cash Flow Hedge?
A hedge that protects against a set of future cash flows changing.
Changes in value are reported in OCI.
RISK MANAGEMENT
What is a Foreign Currency Hedge?
A hedge that protects against the value of a foreign currency changing.
For example- a foreign currency hedge might be used to protect against the following: If you have receivables denominated in a foreign currency and that currency dips in value - your receivables are worth less than before.
