final Flashcards
What is Finance?
The study of how we allocate money and how it’s done
Finance addresses how resources are allocated, under what terms, and through what channels.
What are financial contracts/securities?
Occur whenever funds are transferred from issuer to buyer
What are real assets?
Tangible items owned by persons and businesses, such as:
* Residential structures and property
* Major appliances and automobiles
* Office towers, factories, and mines
* Machinery and equipment
What are financial assets?
What one individual has lent to another, such as:
* Consumer credit
* Loans
* Mortgages
Define money.
A scarce resource that serves as:
* A medium of exchange
* A measure of value
* A means of payment
What role do households play in the financial system?
Households provide funds to businesses and government, hold both real and financial assets, and must accumulate financial resources for retirement.
What is intermediation?
The transfer of funds from lenders to borrowers
What are the 3 ways funds can be channeled from savers to borrowers?
Funds can be channeled through:
* Direct transfer in a non-market transaction
* Direct intermediation through a market intermediary
* Indirect claims through a financial intermediary
What is the primary function of financial intermediaries?
Transform the nature of the securities they issue and invest in
What is the difference between market intermediaries and financial intermediaries?
Market intermediaries help make markets work by adding liquidity, while financial intermediaries invest on behalf of others.
What are the major categories of financial securities?
Two major categories:
* Debt instruments
* Equity instruments
What are non-marketable assets?
Assets that cannot be traded between investors, such as:
* Savings accounts
* Term deposits
* Guaranteed investment certificates (GICs)
What are marketable assets?
Assets that can be traded between investors after their original issue, such as:
* Stocks
* Bonds
What is a stock?
An investment that represents ownership in a company, typically through shares.
What is a bond?
A debt security issued by corporations or governments, where you lend money for a set period at a set interest rate.
What is the primary market?
Markets that involve the issue of new securities by a company in exchange for cash from investors.
What is the secondary market?
Markets that involve buyers and sellers of existing securities, with no new capital formed.
What is market capitalization?
The total market value of a company calculated as:
* Number of shares x Share price
What is venture capital?
Investing in early-stage companies until they become profitable.
What is bootstrapping?
The process by which entrepreneurs raise seed money and obtain resources necessary to start their businesses.
What are the three principal ways VC firms exit venture-backed companies?
Exit strategies include:
* Selling to a strategic buyer
* Selling to a financial buyer
* Initial public offering (IPO)
What is an IPO?
A company’s first sale of common stock in the public market.
What is the importance of staged funding in venture capital?
Allows venture capitalists to reassess performance and manage risk at each funding stage.
What does syndication in venture capital involve?
The common practice of selling a percentage of a deal to other VC firms to reduce risk and obtain financing.
True or False: Only 10% to 20% of firms that receive venture capital funding are successful.
True
What does VC stand for?
Venture Capital
Venture Capital refers to financing provided to early-stage, high-potential growth startup companies.
What is the typical annual return generated by a VC fund?
15-25%
These returns may vary based on market conditions and individual fund performance.
What is an IPO?
A company’s first sale of common stock in the public market
Initial Public Offerings allow companies to raise larger sums of cash and facilitate VC exits.
What is one advantage of a company going public through an IPO?
Larger amount of equity capital can be raised
Public equity markets typically allow for larger capital raises compared to private sources.
What is a disadvantage of an IPO related to management focus?
Encourages focus on short-term profits rather than long-term wealth maximization
This is due to the requirement for quarterly earnings forecasts and financial statements.
What are the three basic services provided by investment bankers during the IPO process?
- Origination
- Underwriting
- Distribution
What is the risk-bearing part of the investment banking process?
Underwriting
Underwriters assume the risk of selling shares to the public.
What is the difference between firm-commitment and best-efforts underwriting?
- Firm-commitment: IB guarantees a fixed amount from stock sale
- Best-efforts: IB does not guarantee sale at a specific price
What happens during the pricing call in the IPO process?
Management makes the final pricing decision based on IB recommendations
This typically occurs after the due diligence process is complete.
What is underpricing in the context of IPOs?
Offering new securities for sale at a price below their true value
Underpricing can lead to financial losses for underwriters if the offer price is set too high.
What is the average first-day return for IPOs as a measure of underpricing?
Typically between 10 and 15 percent below the closing price
This indicates the common practice of underpricing in the market.
What is a general cash offer?
Sale of debt or equity, open to all investors, by a registered public company
This is often the lowest-cost source of external funds for firms with high credit ratings.
What is the main difference between competitive and negotiated sales in a general cash offer?
- Competitive sale: Underwriters bid to buy the issue
- Negotiated sale: Issuer selects the underwriter upfront
What does shelf registration allow a firm to do?
Register an inventory of securities for a 2-year period for future sales
This provides firms flexibility and reduces the costs associated with selling securities.
What are private placements?
Sales of unregistered securities directly to investors
This method is often used by firms to raise capital without the costs associated with public offerings.
What is a leveraged buyout?
A transaction where a large amount of debt is used to take over a company
This is a common strategy used by private equity firms.
What are PIPE transactions?
Transactions in which a public company sells unregistered stock to investors
PIPE deals often occur at a discount to market prices due to liquidity restrictions.
What is the Loan Pricing Model?
Interest rate = prime rate + default risk premium + adjustment for yield curve
This model helps banks determine the appropriate interest rate for loans.
What are the three basic costs associated with issuing stock in an IPO?
- Underwriting spread
- Out-of-pocket expenses
- Underpricing
What does payout policy refer to?
A firm’s overall policy regarding distributions of value to stockholders
This includes dividends and other forms of shareholder value distribution.
What is a dividend?
Something of value distributed to stockholders on a pro-rata basis
This can include cash, assets, or discounts on products.
What is a dividend?
A dividend is a distribution of value to a firm’s stockholders, typically in the form of cash, assets, or discounts on products.
How does a dividend affect a stockholder’s claims against a firm?
It reduces the value of the stockholders’ claims against the firm.
What is the impact of a dividend on a stockholder’s investment in a firm?
It reduces the stockholders’ investment in a firm by returning some of that investment to them.
What are non-cash distributions?
Distributions of value that are not in the form of cash and do not reflect proportional ownership in the firm.
Who owns a corporation?
Shareholders are the owners.
Who governs a corporation?
The board of directors governs the corporation.
Who manages a corporation?
The CEO and other C-suite executives manage the business.
What is the formula for earnings per share (EPS)?
EPS = Income available to common shareholders / Common shares outstanding.
What is the tax treatment of dividends for individuals?
Dividends received are taxed in the hands of the shareholder and receive preferential tax treatment.
True or False: New firms are least likely to pay dividends.
True.
What are the four types of cash dividends?
- Regular cash dividend
- Extra dividend
- Special dividend
- Liquidating dividend
What does the dividend yield represent?
The ratio that shows how much a company pays out in dividends each year relative to its stock price.
What marks the beginning of the dividend payment process?
The board votes to approve the dividend.
What is the ex-dividend date?
The first date on which the stock will trade without rights to the dividend.
What is the record date?
The date on which the company assesses all shareholders to determine who will receive the dividend.
What is the payable date?
The date when the stockholders of record actually receive the dividend.
What is the cash flow identity?
A company’s cash flows are equal to the cash paid to shareholders and the payments made to creditors.
Why do managers use dividends?
To distribute excess earnings and avoid surprising investors with bad news.
What did the 1956 survey by John Lintner reveal about dividend policy?
Firms have a long-term target payout ratio, and dividends change if there is a shift in long-term sustainable earnings.
What is a practical consideration in setting a dividend payout?
Managers should ensure they can maintain dividends during periods of lower earnings or higher investment requirements.
What can affect the value of a firm regarding dividend policy?
Dividend policy can affect the value of a firm under certain conditions.
What are the costs associated with dividends for a firm?
- Taxes
- Increased cost of debt
- Brokerage fees for reinvesting dividends
How is a stock repurchase different from a dividend?
It does not represent a pro-rata distribution of value to stockholders.
What are the two types of tender offers in stock repurchases?
- Fixed-price
- Dutch auction
What is the difference in tax treatment between dividends and stock repurchases?
Dividends are taxed on the full amount, while stock repurchases are taxed only on the profit from the sale.
What happens to earnings per share (EPS) after a stock repurchase?
EPS typically increases because the number of shares outstanding decreases.
What is a stock dividend?
A type of dividend that does not involve the distribution of cash or assets.
What is the rationale for stock splits?
To make shares more affordable and increase liquidity.
What do managers prefer when purchasing shares?
Managers prefer purchasing shares when they believe that the shares are undervalued in the market.
What is the primary motive for mergers and acquisitions?
Creation of synergy.
Define cash dividend.
Shareholders receive cash.
What is a stock dividend?
Type of dividend that does not involve the distribution of value.
How does a stock dividend affect the number of shares owned?
It increases the number of shares each stockholder owns.
What happens to the value of shares when a stock dividend is paid?
The value goes down proportionately.
What is a stock split?
Division of each share into more than one share.
What is a key distinction between stock dividends and stock splits?
Stock dividends are typically regularly scheduled events, while stock splits occur infrequently.
What can stock splits signal to investors?
A positive signal about the outlook management has.
What is synergy value in the context of mergers?
The amount by which the value of the combined firm exceeds the sum value of the two individual firms.
List two types of operating synergies.
- Economies of scale
- Geographic synergies
What are financing synergies?
Access to funding and reducing cash flow variability.
What are managerial motivations for mergers?
- Increased firm size
- Reduced firm risk through diversification
What is a takeover?
Occurs when control is transferred from one ownership group to another.
What distinguishes an acquisition from a merger?
An acquisition involves one firm purchasing another.
What is a going private transaction?
An acquisition where the purchaser already owns a majority stake in the target company.
What is the purpose of securities legislation in takeovers?
To ensure transparency and fair treatment of all shareholders.
What is the ‘10% early warning’ rule?
A report is sent to alert other shareholders that a potential acquirer is accumulating a position.
What does a shareholder control when they own 50.1% of a company?
Voting decisions under normal voting.
What is a friendly takeover?
The acquisition of a target company that is willing to be taken over.
What is due diligence?
The process of evaluating a target company by a potential buyer.
What is a tender offer?
An approach to shareholders offering compensation for their shares to control majority voting shares.
What are defensive tactics in a hostile takeover?
- Poison pills
- Selling the crown jewels
- White knights
What characterizes a horizontal merger?
Two firms in the same industry combine.
What is a vertical merger?
Merger between companies that operate on different stages of the same supply chain.
Define a conglomerate merger.
Two firms in unrelated businesses combine.
What is globalization in the context of financial management?
Supports free trade and the integration of national economies.
What is a multinational corporation?
A business firm that operates in more than one country but is headquartered in its home country.
What is country risk?
Political uncertainty associated with a particular country.
What does foreign exchange rate risk refer to?
Uncertainty of future exchange rate movements.
How do cultural differences impact international business?
They shape business practices and attitudes toward business.
What is foreign exchange rate risk?
Uncertainty of future exchange rate movements
Also known as exchange rate risk
What does an economic system determine?
How a country mobilizes its resources to produce and distribute goods and services needed by society
What are the goals of International Financial Management?
- Stockholder value maximization
- Maximizing corporate wealth
- Maximizing market share
- Maintaining full employment
True or False: The time value of money is affected by whether a transaction is domestic or international.
False
What are the three basic economic benefits of foreign exchange markets?
- Mechanism to transfer purchasing power
- Way for corporations to pass risk
- Channel for credit acquisition
Which city is the largest foreign exchange trading center?
London
What is the equilibrium exchange rate?
The price at which the quantity of currency demanded equals the quantity supplied
Fill in the blank: A cross rate allows you to find the exchange rate between the 3rd pair of currencies when given _______.
2 quotes of foreign exchange rates involving 3 currencies
What is the forward premium or discount?
Difference between forward rate and spot rate
Calculated using the formula: (forward rate - spot rate) / spot rate x 360 / number of days x 100
What are the reporting requirements for foreign currency in financial statements?
- Balance sheet items reported at the current rate
- Income statement items reported at the average rate
What is foreign exchange rate risk?
Risk associated with unexpected exchange rate changes when conducting business abroad
What does hedging a currency transaction involve?
Engaging in a financial transaction to reduce risk
What is the main objective of international capital budgeting?
To maximize stockholder wealth by accepting projects with positive NPV
What is a country risk premium?
An additional return required by management for projects in politically unstable countries
What can extreme nationalization entail?
Local government taking over a plant without compensation
What is the purpose of taxation?
- Revenue generation
- Distribution of wealth
- Provide services
- Influence behavior
What are the different levels of government responsible for in Canada?
- Municipal: Road service, waste management
- Provincial: Healthcare, schooling
- Federal: National defense
What is a tax return?
Reconciliation of how much tax you’ve paid and owe
What is the difference between tax deductions and tax credits?
- Deductions reduce taxable income
- Credits reduce tax payable
What is the capital gains tax rate for gains above $250,000?
66.6%
What is the maximum contribution limit for a TFSA?
$7,000
What tax rate do small businesses under $500,000 in Canada pay?
9%
True or False: You can lower your tax rate by setting up a corporation.
False
