Chapter 1 Flashcards
Why is corporate finance important to managers
1.) add value to the firm
2.) Devise strategies to acquire funds
What is a proprietorship
business owned by one individual
what are the advantages of a proprietorship
- ease of formation
- fewer regulations
- no corporate income tax
what are the disadvantages of a proprietorship
- difficult to raise capital (grow company)
- unlimited liability
- limited life
What is a Partnership
two or more people conducting the business
What is the difference between a general partnership and a limited partnership
general: unlimited liability
limited partners: limited liability
What is a corporation
legal entity separate from its owners and managers
How to become a corporation
File papers to get a charter and create bylaws
what does a Charter include
Name, type of activities, amount of capital stock, # of directors and names and addresses of directors
what doe Bylaws include:
A set of rules drawn by founders of the corporation
What are the advantages of a corporation
-unlimited life
-easy transfer of ownership
-limited liability
what are the disadvantages of a corporation
- double taxation (earnings and dividends)
-cost of set-up
As a corporation grows what happens?
Initial Public Offerings (IPO’s) of Stock help raise proceeds
Which of the following represents a significant disadvantage to the corporate form of organization (class reflection question)
Exposure to taxation of corporate earnings and stockholder dividend income
What should be a mangers primary objective
Shareholder wealth maximization and maximizing the fundamental stock price
Do the same actions that maximize intrinsic stock value usually benefit society (yes/no)
Yes
What determines a firms intrinsic value?
The companies ability to generate cash flow now and in the future
What does a firms value depend on?
- The size of the firms free cash flow
- The timing of those flows
- The risk of the cash flow
What is Free Cash Flows
All cash flows that are available for distribution to all investors (stockholders and creditors) after expenses and taxes
What is WAAC
weighted average cost of capital is the average rate of return required by all of the companies investors
What is the definition of intrinsic value (fundamental value)
Value or price that incorporates all relevant information regarding expected FCF and risk
Who are the providers and users of capital?
- Individuals: net savers
- Non-financial corporation: net users (borrowers)
-Governments
-Financial corporations
-Financial Markets
What are the two ways to classify financial securities
1.) Time until maturity (capital and money market security)
2.) Types of claimes
What are the different types of claims for financial securities
- Debt: specified payments and maturity
- Equity: a claim upon residual value
- Derivatives: values depend on the values of some other traded assets
- Hybrid: mix of debt, equity and derivatives
- Securitized Financial Assets: created from packages of other financial assets
Money markets are markets for
Short term debt securities
What 4 factors affect the cost of Money
- Production opportunities (ability to turn capital into benefits)
- Time preference for consumption
- Risk
- Inflation
What is capital allocated through
the price system
“price” of money is a cost for the user but a return for provider
when does a financial instruments rate of return generally increase when…
maturity and risk increase
- if u are riskier with money their is higher risk
What are Economic conditions that affect the cost of money
1.) Federal Reserve policy - stimulate/slow down the economy
2.) The level of the federal budget deficit
3.)The level of business activity
4.) International factors: foreign trade balance, the international country risk, and the exchange rate
what does the federal reserve policy do
stimulate the economy: purchase treasury securities (lower interest rates)
Slow down the economy: issue treasury securities (higher interest rates)
For economic condition #2 what does level of federal budget deficit mean?
a budget deficit is when federal government spend more than it takes from tax revenues
What does economic condition #3 mean when it says level of business activity
interest and inflation typically rise prior to a recession and fall afterwards
What does economic condition #4 International factors
what does a foreign trade deficit mean… we import more than we export
increase borrowing drives up interest rates
What do investment banks do
help raise capital
what do commercial banks do
raise funds from depositors and from issuing stock and bonds
what are credit unions
member savings are only lent to other members
what are mutual funds
-pool funds and invest
-very regulated
what are hedge funds
limited to institutional investors and high-net-worth individuals
what are private equity funds
limited to a relative small number of large investors
- turn companies private and later sell them for a profit
What are life insurance companies
take premiums, invest, and make payments to beneficiaries
What is the process of securization
happened after housing crisis
- S& L’s now put their mortgages into pools and sell to other organizations like Fanny May (risk shifts to Fanny May)
Fanny Mae doesn’t keep mortgages and puts them in a pool and sells shares to investors (risk shifts to investors)
what is securitization def
new securities are created based on original securities
What is CollateralizedDebt Obligations
It is a part of the securities
is and is bundled debt resold to investors
