Chapter 1: Introduction to Financial Management

Question 1

what four main areas are financial topic gourd into?

Answer 1

corporate finance (business finance)
investments
financial institutions
international finance

Question 2

investments

Answer 2

broadly speaking, investments deal with the purchase and sale of financial assets, like stocks and bonds

value of financial assets, risk vs return, and asset allocation

Question 3

what job opportunities are open to students who specialize in investments and finance?

Answer 3

portfolio managers, stockbrokers, security analysis

Question 4

financial institutions

Answer 4

banks and insurance companies are probably the most popular

banks, credit unions, savings and loans, commercial and investment

a commercial loan officer at a ban would evaluate whether a particular business has a strong enough financial position to warrant extending a loan. at an insurance company, an analyst would decide whether a particular risk was suitable for insuring and what the premium should be

Question 5

international finance

Answer 5

people might specialize in non-US companies analysis. similarly, many US businesses have extensive overseas operations and need employees familiar with such international topics as exchange rates and political risk

may allow you to travel regularly and work in other countries

need to understand politics in other countries and potentially speak different languages

Question 6

marketing and finance

Answer 6

marketers constantly work with budgets, and they need to understand how to get the greatest payoff from marketing expenditures and programs

financial analysts rely heavily on marketing analysts, and the two frequently work together to evaluate the profitability of proposed projects and products

Question 7

accounting and finance

Answer 7

in smaller business especially, accountants have to make financial decisions as well as perform traditional accounting tasks

financial analysis takes extensive use of accounting information; they are some of the most important end users

Question 8

management and finance

Answer 8

in broader terms, management employees of all types are expected to have a strong understanding of how their jobs affect profitability, and they are expected to be able to improve p[profitability of their departments

Question 9

you and finance

Answer 9

you will have to make major financial decisions for the rest of your life

Question 10

what three main questions do you have to answer in business finance?

Answer 10

1) what long term investments should you take on?
2) where will you get the long-term financing to pay for your investments
3) how will you manage your everyday financial activities, such as collecting from customers and paying suppliers?

Question 11

financial manager

Answer 11

usually the CFO or vice president of finance (generally controls the controller and treasurer)

Question 12

the controller

Answer 12

handles financial and cost accounting, tax payments, and management information systems

Question 13

treasurer’s office

Answer 13

managing the firm’s cash and credit, its financial planning, and its capital expenditures. these treasury activities are all related to the three general questions raised above

Question 14

capital budgeting

Answer 14

the process of planning and managing a firm’s long-term investments

in capital budgeting, the financial manager tries to identify investment opportunities that are worth more to the firm than they cost to acquire (value of the cash flow generated by an asset exceeds the cost to acquire that asset)

Question 15

what is the essence of capital budgeting?

Answer 15

the size, timing, and risk of the asset

Question 16

capital structure

Answer 16

refers to the specific mixture of long-term debt and equity the firm uses to finance its operations

Question 17

working capital

Answer 17

a firm’s short-term asset, such as inventory, and its short-term liabilities, such as money owed to suppliers. managing the firm’s working capital is a day-to-day activity that ensures the firm has sufficient resources to continue its operations and void costly interruptions

Question 18

what are the three areas of business finance management?

Answer 18

working capital management, capital structure, and capital budgeting

Question 19

sole proprietorship

Answer 19

a business owned by a single individual. this is the simplest type of business to start and is the least regulated form of organization

the owner of the SP keeps all the profits

the owner has unlimited liability, which means hat creditors can look to the proprietor’s personal assets for payment

there is no distinction between personal and business income, so all income is taxed as personal income

Question 20

partnership

Answer 20

similar to a SP, but there is unlimited liability spread between all the partners. gains and losses are defined in the partnership agreement

Question 21

limited partnership

Answer 21

there are one or more general partners that run the business and have unlimited liability, but there will be one or more limited partners who do not actively participate in the business (common in real estate)

the limited partner’s liability is limited to the amount of the original contribution that partner made to the venture

Question 22

advantages and disadvantages of partnerships

Answer 22

similar to SP’s

easy to form and not heavily regulated

all income is taxed as personal income the partners, and the amount of equity that can be raised is limited to the partners’ combined wealth

having a written agreement is extremely important cause a partner in a general partnership can be help responsible for all partnership debts

Question 23

corporation

Answer 23

the most important form of business organization in the US.

a business created as a separate, distinct legal entity owned by one or more individuals or entities

corporations can own property and borrow money, can sue and be sued, and can enter into contracts. it can even be a general or legal partner in a partnership, and a corporation can own stop in another corporation

Question 24

what does it take to start a corporation?

Answer 24

involves preparing articles of incorporation (a charter) and a set of bylaws. the articles of incorporation must contain a byre of things, including a contraptions name, intended life, its business purpose, and the number of shares the can be issued

Question 25

bylaws

Answer 25

rules describing how the corporation regulates its own existence (describes how directors are elected)

Question 26

does a corporation have to pay taxes?

Answer 26

yes. money paid out to stockholders in the form of dividends is taxed again as income to those stockholders. this is double taxation, meaning that corporate profits are taxed twice: at the corporate level and when they are earned and again at the personal level when they are paid out

Question 27

profit maximization

Answer 27

the most commonly cited business goal

Question 28

what is the goal of financial management?

Answer 28

to maximize the value per share of existing stock

that is a more concrete goal than profit maximization

Question 29

what is a good business goal for a company that doesn’t issue stock?

Answer 29

to maximize the market value of the existing owner’s equity

Question 30

sarbanes oxley act

Answer 30

in response to corporate scandals involving companies such as enron, world com, tyco, and adelphi’s, congress enacted the sarbanes oxley act in 2002, which is intended to strengthen protection against corporate accounting fraud and financial malpractice

officers at a company must review and sign the financial reports (makes management personally responsible for the accuracy of the financial statements)

Question 31

the agency problem

Answer 31

when stockholders elect board members to represent their interests, there can be conflicts of interest when management is trying to maximize the value per share of exiting stock in the long term when investors may desire short-term payouts

Question 32

agency relationship

Answer 32

relationship between management and stockholders

such a relationship exists when someone (a principal) hires another (the agent) to sell a car that you own while you are away at school

Question 33

agency problem

Answer 33

a conflict of interest between a principal and an agent; or between management and the owners of a firm

not unique to corporations - they happen anywhere there is split ownership in things

Question 34

management goals

Answer 34

sometimes they overemphasize organizational survival to protect job security. they may have a somewhat risky venture that their stakeholders want them to invest in, but when equity in the company is diluted enough and management essentially run the business, they will choose not to engage in risky behavior sometimes for fear of it not working out

Question 35

managerial compensation

Answer 35

management will frequently have a significant economic inventive to increase share value for two reasons 1) managerial compensation, particularly at the top, is tied to financial performance 2) better performers tend to get promoted, so managers who are successful in pursuing stockholder goals will be in greater demand in the labor market and thus command higher salaries

Question 36

control of the firm

Answer 36

proxy fights occur when people vote other shareholders stock to vote out the board of directors so they can fire management

takeover also incentivizes management to act in the shareholders’ best interest because poorly run firms are more attractive for acquisitions because there is greater potential for profit

Question 37

conclusion on management goals

Answer 37

stockholders control the firm and that stockholder wealth maximization is the relevant goal of the corporation. even so, there will undoubtedly be times when management goals are pushed at the expense of the shareholders

Question 38

stakeholder

Answer 38

someone, other than the stockholder or creditor who potentially has a claim on the cash flows of the firm

Question 39

what is the primary advantage of a corporation?

Answer 39

ownership can be transferred very easily from one person or entity to the next and that money can be raised more readily

Question 40

primary markets

Answer 40

refers to the original sale of securities by governments and corporations

in a primary market transaction, the corporation is the seller and the transaction raises money for the corporation. there are two types of primary market transactions: public offerings and private placements

Question 41

secondary markets

Answer 41

those in which these securities are bought and sold after the original sale

there are two kinds: dealer and auction markets

Question 42

public offering

Answer 42

involves selling securities to the general public, whereas a private placement is a negotiated sale involving a specific buyer

public offerings of debt and equity must be registered with the securities and exchange commission, which requires the firm to disclose a great deal of information before selling any securities

Question 43

private placements

Answer 43

partly to avoid various regulatory requirements and the expense of public offerings, debt and equity are often sold privately to large financial institutions such as life insurance companies or mutual funds. such private placements do not have to be registered with the SEC and do not require the involvement of underwriters (investment banks that specialize in selling securities to the pubic)

Question 44

dealer markets

Answer 44

dealers buy and sell for themselves, at their own risk. a car dealer, for example, buys and sells automobiles. in contrasts, brokers and agents match buyers and sellers, but they do not actually own the commodity that is bought or sold

dealer markets in stocks and long-term debt are called over-the-counter (OTC) markets. most trading in debt securities takes place over the counter

Question 45

auction markets

Answer 45

have a physical location (Wall Street) unlike dealer markets, and in a dealer market, most of the buying and selling is done by the dealer. the primary purpose of an auction market, on the other hand, is to match those who wish to sell with those who wish to buy

Question 46

trading in corporate securities

Answer 46

the equity shares of most of the large firms int he United States trade in organized auction markets like the NYSE

Question 47

NASDAQ

Answer 47

national association of securities dealers automated questions system, is a large OTC market for stocks

Question 48

what large and important financial markets outside the US are there?

Answer 48

the Tokyo stock exchange and the London stock exchange