Chapter 7 Flashcards
When there is only one person who owns the firm it is called
Sole proprietor
What is business partnership
a business owned jointly by two or more individuals, who share in the
profits and are jointly responsible for losses.
What is a corporation or a company
an organization with a legal identity separate from its
owners that produces and trades.
The owners of a corporation are known as
Shareholders
The profits of the corporation can be used in 2 ways
1) paid to shareholders in the form of a dividend
2) retained for corporation future use
What is a dividend
payments made from after-tax profits to company shareholders
What are capital gains (losses)
arise from the ownership of a corporation when an individual
sells a share at a price higher (lower) than when the share was purchased.
What is a real return to corporate stock
inflation-adjusted sum of dividends and capital
gain (or loss).
A key difference between a company and a patnership
a company involves limited liability,
whereas a partnership does not. Limited liability means that the liability of the company is limited
to the value of the company’s assets.
What are retained earnings
the profits retained by a company for reinvestment and not
distributed as dividends.
What is principal-agent relationship
The shareholder-manager relationship
Agent: usually a manager who works in a corporation and is directed to follow the
corporation’s interests
What is principal-agent problem
arises when the principal cannot easily monitor the actions
of the agent, who therefore may not act in the best interests of the principal
What is stock option
an option to buy the stock of the company at a future date for a fixed,
predetermined price
As a bonus to managers
Accounting profit vs economic profit
Accounting profit: is the difference between revenues and explicit costs.
Economic profit: is the difference between revenue and the sum of explicit and implicit
costs.
What are explicit costs and implicit
Explicit costs: are the measured financial costs.
Implicit costs: represent the opportunity cost of the resources used in production
What is a capital market
a set of financial institutions that funnels financing from investors
into bonds and stocks.
What is a portfolio of investments
a combination of
different stocks and bonds.
What is risk pooling
Combining individual risks in such a way that the aggregate risk is
reduced.
What is a risk in stocks
A higher degree of risk is associated with increased variation in the possible
returns around an unchanged mean return.
What is risk spreading
Dividing the risk
Works by reducing the stake of each participant
What does diversification do to the risk
reduces the total risk of a portfolio by pooling risks across several
different assets whose individual returns behave independently
What is system risk
Macroeconomic conditions may impact the incomes of both individuals in a similar manner- correlation between 2 events
The real return is
nominal return minus inflation
3 main types of firms
- self-employed sole traders
- partnerships
- companies/corporations
Most investors seek to ___ risk
reduce
