Chapter 1 & 5 & 6 Flashcards
The goal of a corporation is to
maximize shareholder’s wealth (maximise stock price)
Ethics
Firms have an ethical responsibility to provide a safe working environment and to avoid polluting the iar or water.
Is stock price maximisation the same as profit maximisation
No. Shareholder wealth maximisation consists of cash flows available, timing and riskiness of cash flows
Is profit maximisation an appropriate goal?
No. Does not consider cash flows available to shareholders. Disregards timing and riskiness of cash flows
Some important trends
Corporate scandal spur additional regulations, changing information technology, globalization of business
Impact of technology
requires implementation of good controls and understanding risks involved
Globalization
affects international trade and firms need to keep abreast of changes
Agency Relationships
Principal hires agent to act on their behalf;
shareholders-managers
shareholders-creditors
Conflict between managers and stockholders
Agency problem (managers are inclined to act in their own interests)
Resolve conflict
Managerial compensation plans, direct intervention by shareholders, threat of firing, and threat of hostile takeover
Managerial compensation plans
executive stock option for managers to purchase firm’s stock at a fixed price in the future. performance shares given to managers on the basis of time performance
Threat of firing
through a proxy by voting out current management
Threat of takeover
when shares of the firm might be purchased for control by another firm
Shareholders vs Bondholders
Agency problem (risky projects of high return benefit shareholders at the expense of creditors; maximises stock price but are detrimental to creditors)
Shareholders vs Bondholders 2
Stockholders are more likely to prefer riskier projects. Bondholder received fixed payments and are more interested in limiting risks. They protect themselves by including covenants that limit use of additional debt
Responsibility of financial staff
forecasting and planning, investment and financing decisions, coordination and control, managing risk, transactions in financial market
Suppliers of capital
individuals/institutions with “excess funds” who save money and look for a rate of return on their investment
Demanders of capital
individuals/institutions who need to raise funds to finance their investment opportunities. Wiling to pay rate of return on the capital they borrow.
How is capital transferred between savers and borrowers
Direct transfer, investment banking house (underwrites), financial intermediaries
Market
a venue where goods and services are exchanged
Financial market
place where individuals and organizations wanting to borrow funds are brought together with those having a surplus of funds
Types of financial markets
physical vs financial, money vs capital, primary vs secondary, spot vs futures, public vs private
Well functioning financial markets
facilitate the flow of capital from investors to users of capital. promotes economic growth
Deriatives
a derivative security’s value is “derived” from the price of another security. it can be used to reduce risk. can be used to speculate future stock prices, interest rates, exchange rates, commodity prices.. Produce high return if guess write, large losses if guest wrong.
Types of financial institutions
commercial banks, investment banks, mutual savings banks, credit unions, pension funds, life insurance companies, mutual funds, hedge funds
IPO
company issues stock in public market for the first time.
affect level of interest rates
production opportunities, time preferences for consumption, risk, expected inflation
r
quoted/required return on a debt security
r*
real risk free rate of interest
rRF
rate of interest on treasury securities
assumptions of peh
mrp = 0, long-term rates are an average of current and future short term rates
equity consists of
common stock and retained earnings
liabilities consist of
long term debt, a/p, n/p, accruals
current assets consist of
a/r, inventories
operating cash flow add
net income, depreciation, increase in a/p, increase in accruals
operating cash flow less
increase in a/r, inventories
financial cash flow
add increase in long term debt, increase in notes payable and less dividends
federal reserve policy
increase ms, short term rates decline, long term rates increase due to inflation
federal deficit/surpluses
spends more than takes on taxes=deficit ->borrow $->increase demand of funds->push up interest rates
international trade
import more than export>foreign trade deficit>borrow $ from nations with surpluse
