chapter 1 Flashcards
sole proprietorship
a business owned and run by one person. there is no separation between the firm and the owner. the owner has unlimited personal liability for any of the firm’s debts and the life of a sole proprietorship is limited to the life of the owner.
partnership
is identical to a sole proprietorship, except it has more than one owner. all partners are liable for the firm’s debt and the partnership ends on the death or withdrawal of a partner.
limited partnership
a partnership with two kinds of owners; general partners and limited partner.
general partners
have the same rights and privileges as partners in a partnership. they are personally liable for the firm’s debt obligations.
limited partners
have limited liability. meaning that their liability is limited to their investment.
limited liability company (LLC)
a limited partnership without a general partner. so, all owners have limited liability, but unlike limited partners they can also run the business.
corporation
a legally defined, artificial being, separate from its owners. It has many legal powers, eg. entering into contracts, acquiring assets, and incurring obligations. It has protection against seizure of its property. The owners are not liable for any obligations of the corporation. the entire ownership stake of a corporation is divided into shares known as stocks.
equity of the corporation
the collection of all the outstanding shares of a corporation.
shareholder/stockholder/ equity holder
an owner of a share of stock in the corporation who is entitled to dividend payments. they are called ‘owners’ but do not have full ownership rights, only some economic and voting rights.
dividend payments
payments made at the discretion of the corporation to its equity holders. shareholders usually receive a share of the dividend payments that is proportional to the amount of stock they own.
double taxation
corporation’s profits are subject to taxation separate from its owners’ tax obligations. first, the corporation pays tax on its profits. then, the remaining profits are distributed to shareholders who pay personal income tax on this income.
‘S’ corporations
when the firm’s profits are not subject to corporate taxes but are allocated directly to shareholders based on their ownership share.
‘C’ corporations
corporations subject to corporate taxes. double taxation occurs.
board of directors
a group of people who have the ultimate decision-making authority in the corporation.
chief executive officer (CEO)
charged with running the corporation by instituting the rules and policies set by the board of directors.
chief financial officer (CFO)
the most senior financial manager who often reports directly to the CEO.
investment decisions
the most important task. Costs and benefits of investments and projects are weighed. These decisions shape what the firm does and how it adds value for its owners. ‘what assets to purchase/investments to make?’
financing decisions
means deciding how to pay for the investments. A corporation can raise more money by selling more shares of stock (equity) or borrowing the money (debt). ‘how to fund investments? what is the optimal capital structure?’
cash management
ensuring the firm has enough cash to meet its day-to-day obligations, also known as managing working capital. It can mean the difference between success and failure.
agency problem
the agency problem arises because a corporation is run by a management team, separate from its owners which gives rise to conflict of interest. it arises when managers put their own self-interest ahead of the interest of shareholders.
corporate charter
specifies the initial rules that govern how the corporation is run.
hostile takeover
when an individual or organisation acts as a corporate raider and purchases a large fraction of the stock and acquires enough votes to replace the board of directors and the CEO. it creates a “market for corporate control” and disciplines bad managers and motivates boards of directors to make difficult decisions.
liquidation
involves the business shutting down and selling off its assets. It is usually best for debt holders to run the firm in the most profitable way possible.
corporate bankruptcy
best thought of as a change in ownership of the corporation and not necessarily as a failure of the underlying business.
private companies
have a limited set of shareholders and their shares are not regularly traded. the value of their shares can be difficult to determine.
public companies
companies whose shares are traded on stock markets.
stock markets
organised markets that provide liquidity and determine a market price for a company’s shares.
liquid investment
an investment is liquid if it possible to sell it quickly and easily for a price very close to the price at which you could contemporaneously buy it.
primary market
used when the corporation issues new shares and sells them to investors.
secondary market
used when investors trade shares without involvement of the corporation. This is the majority of trading in the stock market.
market makers
match buyers and sellers. they two prices for every stock in which they made a market; the bid price and the ask price. they provide liquidity by ensuring that market participants always have somebody to trade with.
bid price
the price at which market makers are willing to buy the stock.
ask price
the price at which market makers are willing to sell the stock.
bid-ask spread
the difference between the bid price and the ask price. it is a transaction cost investors pay to trade.
limit order
an order to buy or sell a set amount at a fixed price, eg. buy 100 shares at a price of $138/share. anyone can make a market in a stock by posting a limit order. this provides liquidity.
limit order book
the collection of all limit orders.
market orders
orders that trade immediately at the best outstanding limit order. they are said to be ‘takers’ of liquidity.
high frequency traders (HFTs)
a class of traders who, with the aid of computers, will place, update, cancel, and execute trades many times per second in respond to new information and other orders, profiting by providing liquidity and taking advantage of stale limit orders.
dark pools
alternative trading systems that do not make their limit order books visible. They offer investors the ability to trade at a better price, but the order might not be filled if an excess of buy or sell orders is received.
It is attractive for traders who do not want to reveal their demand price and are willing to sacrifice the guarantee of immediacy for a potentially better price.
fintech
the relation between financial innovation and technical innovation.
blockchain technology
technology allows a transaction to be recorded in a publicly verifiable way without the need for a trusted third party to certify the authenticity of the transaction.
cryptocurrency
a currency whose creation and ownership is determined via a public blockchain.
bitcoin
the first cryptocurrency. All transactions are recorded in a public ledger using blockchain technology to allow individuals to create and trade bitcoins and verify those transactions digitally.
robo-advisors
computer programs intended to replace the work of financial advisors by providing detailed and customised investment recommendations.
stale limit orders
occurs when information causes the price of the stock to move. traders can take advantage of this by quickly executing trades at the old price.
separation of ownership and control
firms have managers and shareholders who are often not the same people. this leads to separation of ownership and control. shareholders are ‘owners’ and managers are ‘control’. this introduces an agency problem.
