Exam Flashcards
What are the two major financial decisions made by financial managers?
- The capital budgeting decision i.e. which real assets to invest in
- The financing decision i.e. how to raise the necessary funds
What does “real asset” mean?
- Real assets are tangible or intangible assets used in the production or sale of a company’s goods / services
- Financial assets are claims on assets generated by real assets
What are the advantages and disadvantages of forming a corporation?
- A: Limited personal liability
- A: Separation of ownership and control
- A: Operation continues even if ownership / management changes
- D: Cost of legal administration
- D: Corporations subject to double taxation
Who are the principal financial managers in a corporation?
- Treasurer: responsible for raising capital and maintaining relations with creditors
- Controller: responsible for preparing financial statements and managing budgets
- CFO: oversees treasurer and controller, involved in financial policies and corporate planning
Why does it make sense for corporations to maximize shareholder wealth?
- Shareholder value maximisation = natural financial goal of company
- Macroeconomic benefit that shareholders can invest/consume increased wealth as they wish (assuming well-functioning financial markets)
What is the fundamental trade-off in investment decisions?
- Reinvesting shareholder capital (retained earnings) or paying out dividends to SHs
- Companies create shareholder value when reinvesting can earn higher returns than what shareholders could have earned for themselves (opportunity cost of capital)
How do corporations ensure that managers act in the best interest of stockholders?
- Conflicts of interest can lead to agency problems and agency costs
- Companies try to avoid agency problems/cost through financial controls, well-designed compensation packages, and effective corporate governance
Is value maximization ethical?
- Shareholders want the maximum honest stock price
- A good reputation with customers, employees, and other stakeholders is important for long-term success, profitability, and value
Where does the financing for corporations come from?
- Individuals’ savings which flow through financial markets and intermediaries
- Intermediaries: mutual funds, pension funds, financial institutions (banks, insurance companies)
Why do nonfinancial corporations need modern financial markets and institutions?
- All companies need access to financing to innovate and grow
- Different types of financing depending on age / nature of businesses
- Examples: venture capital for start-ups, bond markets for mature businesses
What if a corporation finances investment by retaining and reinvesting cash generated from its operations?
Retained earnings = savings on behalf of shareholders
What are the key advantages of mutual funds?
- High degree of diversification even with small investment
- Professionally managed portfolios
- Access to expensive stocks without having to pay full share price
What are the functions of financial markets?
- Channelling savings into investments
- Matching up borrowers and lenders
- Providing liquidity and diversification opportunities for investors
- Providing useful information for financial managers
Do financial institutions have different functions?
- Serve as intermediary between borrower and lender
- Provide liquidity for depositors
- Play important role in payment system
- Insurance companies allows policyholders to pool risk
What happens when financial markets and institutions no longer function well?
- Can lead to collapse of banking system (financial crisis 2007-2009)
- Governments must bail out financial institutions –> government debt increases
- Recession –> economic activity decreases, unemployment increases
