Finance Skills For Managers Flashcards
Capital
A financial asset that can be used by a firm or individual - cash or machinery for ex
What are the 3 subspecialties of finance?
- Business finance
- Investments
- Financial institutions
Personal Finance Goals
Utility - total satisfaction received from consuming goods and services
What are the 3 main tasks that a financial manager does?
- investment decisions
- financing decisions
- Manage working capital
What are the 3 types of securities?
- Treasuries
- Corporate bonds
- Stocks
Treasuries
Bonds that are issued by the government
Money market
financial market used to borrow and lend money short term
Capital market
used for long-term assets that are held for greater than one year
What are the 2 types of financial markets?
- Money market
2. Capital market
Why do financial markets exist?
to manage liquidity and risk
Primary financial market
the financial market where securities (stocks and/or bonds) are first sold
Syndicate
a group that is temporarily formed to handle a bond or stock issue
How can firms place bonds with syndicates?
through a competitive or negotiated sale
Initial public offering (IPO)
when a privately held company first offers shares of stock to outside investors to raise capital, therefore becoming a publicly owned company
Secondary financial market
The stock market - markets where assets are priced
What are two types of secondary markets?
- Auction market
2. Dealer market
Auction market
secondary market with a physical location and where prices are determined by investors’ willingness to pay
Dealer market
secondary market where securities are bought and sold through a network of dealers who trade for themselves
Bid-ask spread
Compensation the specialist receives for risk associated with providing liquidity
What are the 3 roles of prices?
- convey information to consumers
- affect incentives
- affect the distribution of income
What is an efficient market?
when prices fully reflect the available information about securities
What are the 3 types of financial institutions?
- Depository
- Non-depository
- Securities and investment firms
Depository financial institution
financial institution that accepts monetary deposits and provides loans - includes savings banks, commercial banks, savings and loan associations, and credit unions
Non-depository financial institutions
financial institution that is not allowed to accept monetary deposits but can lend money - includes brokerage firms, investment firms, mutual funds, and hedge funds
Securities firms
financial institution that facilitates the investment of securities - includes underwriting
Investment firms
company that invests the capital of investors in financial securities - includes mutual funds and investment trusts
Mutual fund function
investment company that offers investments and buys securities on behalf of investors
Private equity function
financial institution that invests in an entity that is not publicly listed or traded using money received from institutional investors
What are the 3 types of economic indicators?
- Leading
- Lagging
- Coincident
Leading economic indicators
- Yield curve
2. Stock market return
Yield curve
basis for an interest rate on a loan
Normal: results when longer maturity bonds have higher interest rates than shorter ones
Inverted: when longer-term bonds have a lower interest rate than shorter-term bonds
Flat: when both short-term and long-term bonds have the same interest rate, indicating that the economy is in a transitional state
Stock market return
rising market = improving
declining market = worsening
Lagging indicators
- unemployment rate
2. consumer price index (CPI)
Consumer Price Index (CPI)
measures changes in the inflation rate
Coincident Indicators
- gross domestic product
2. personal income
Gross Domestic Product (GDP)
monetary value of all finished goods and services
securitization
process of combining several types of debt and reselling them as a package to investors
Bond holder
interested in projects that give them a higher chance of getting their investment back
What are the 2 types of interest rates?
- Simple interest
2. Compound interest
Simple interest
Principal × Interest Rate
Compounding interest
interest on interest
What is an interest rate composed of?
- Opportunity cost
- Risk
- Inflation
Risk
the possibility that the actual return will differ from the expected return
What are interest rates made of?
- Risk free rate
2. Risk premium
Risk free rate
rate of return on an investment with no risk
What are the 3 components of interest rates?
- Opportunity cost
- Risk
- Inflation
What is the interest rate calculation?
Risk free rate + risk premium
Risk premium
compensation for the amount of risk taken on by investors
Nominal rate
rate at which money grows over time including inflation - does not measure actual purchasing power
Real rate
nominal minus expected inflation rate
time value of money (TVM)
present money is worth more than future money
What are the 3 variables of TVM?
- amount of cash flows
- timing of cash flows
- rate at which the value of cash flows changes over time
Compounding
finding a future value given a present value
Discounting
finding a present value given a future value
Annuities
a stream of cash flows of an equal amount paid every consecutive period
What are the 3 different types of annuities?
- Ordinary annuity
- Annuity due
- Perpetuities
Ordinary annuity
series of equal payments made at the end of consecutive periods over a fixed length of time
Annuity due
paid at the beginning of consecutive periods
Perpetuity
constant stream of identical cash flows that continues forever
What are the measures of return?
- Holding period return
2. Annualize based on simple interest
Holding period return
return that an investor gets over the entire period during which they own a financial security
What are the types of risk?
Market risk and firm specific risk
Interest rate risk
probability that changes in interest rates will impact the value of a bond - market risk
Default risk
probability of borrower’s failure to repay a contractual obligation - firm specific
Price risk
potential for the decline in the price of a security relative to the market - diversifiable
Diversification
process of “spreading” your money over many different assets
Risk separation
dispersing assets geographically instead of concentrating them in one location
Time diversification
concept that riskier financial securities have lower risk in the long term
What are the 4 uses of financial ratios?
- Standardization
- Flexibility
- Focus
- Evaluation
Standardization ratio analysis
making financial data comparable across firms
What are three main comparison methods used in ratio analysis?
- Trend analysis
- Cross-sectional analysis
- Progress measurement
Trend analysis
looks at a firm’s financial ratios over time and compares the performance this year with performance in the past
Cross-sectional analysis
compares a firm’s financial ratios with those of a peer group
What are the 5 types of ratios?
- Liquidity
- Leverage
- Activity
- Market
- Profitability
Liquidity ratios
measure a firm’s ability to meet short-term obligations without raising external capital
Activity ratios
measure how well the company uses its assets to generate sales or cash
Leverage ratios
considers how the firm is financed
Profitability Ratios
used to judge how profitable the company is
Market ratios
used to evaluate the current share price of a public firm’s stock
DuPont Framework
expanded formula of the return of equity
Cash budgets
forecast of future events less than a year
What are the steps to creating a cash budget?
- Determine cash receipts
- Estimate cash disbursements
- Create the cash budget
Profit forecasting
projection of future earnings after all costs are subtracted from sales
Balance sheet forecasting
Using sales growth and profit forecast to understand future implications
discretionary financing needed (DFN)
additional financing needed given a firm’s expectations for future growth
Financial Forecasting vs. Budgeting
budget: quantified expectation of what a business wants to achieve
financial forecasting: estimate of what will actually be achieved
Spontaneous accounts
Accounts that vary naturally with sales
discretionary accounts
Accounts that do not vary automatically with sales but are left to the discretion of management
How to calculate DFN
Projected total assets - projected total liabilities - projected owners equity
sustainable growth rate (SGR)
growth rate that allows a firm to maintain its present financial ratios without issuing new equity
Ways to Reduce DFN
Slow sales growth
examine capacity constraints
lower dividend payments
Dividend
distribution of profits to shareholders
capital budgeting criteria
calculations used to determine if a project will add value to the firm
Net present value (NPV)
the sum of the present values of all of the expected cash inflows and outflows - calculated by adding the cash inflows and then subtracting the cash outflows
Internal rate of return (IRR)
the rate of return that a firm earns on its capital projects
Profitability index (PI)
The ratio of payoff to investment
Bonds
the primary means of borrowing money in the corporate world
Fixed income securities
security where the borrower pays a fixed interest payment to investors annually
Par value
The sum of money that a corporation promises to pay at the expiration of a bond; also called face value
Yield to maturity
The rate of return received on a bond purchased today at market price and held until maturity
Premium bond
bond whose price is above its par value
Common stock
stock that represents equity in a firm and allows the right to vote at shareholder meetings
Preferred stock
A hybrid security that has no fixed maturity, has fixed payments, and does not confer voting rights on bondholders
dividends in arrears
A feature of preferred stock specifying if a company ignores preferred stock dividends, it cannot pay anything to its common stockholders
Capital investment
the sum of money invested to purchase long-term assets
Intrinsic value
the value of an investment without referring to its market value
How to value preferred stock
Annual fixed dividend divided by the discount rate
How to value common stock
Dividend to be paid next year divided by the discount rate minus the constant growth rate
Beta
how the price of a security varies with the market
Defensive assets
beta less than 1
Capital budget
process of evaluating and planning for purchases of long-term assets
What are the Criteria to Consider for Capital Investment?
- includes all cash flows that occur during the life of the project
- considers TVM
- incorporates the cost of capital
Incremental cash flows
Cash flows that result from accepting a project
Incidental cash flows
cash flows that are created by the project, but are not revenues or costs
Standard deviation
Smaller the SD the better
Ar turnover
Company’s ability to collect debts
Leverage multiplier
How much capital comes in the form of debt - assets/equity
Net margin
How much profit is generated as a percentage of revenue
Current ratio
measures whether a firm has enough resources to meet its short-term obligations
Market to book ratio
assets minus liabilities
Leverage ratios
assesses the ability of a company to meet its financial obligations
Hurdle rate
the minimum rate of return on a project required by an in investor
Bond vs stock payments
Stocks: partial ownership in a company - stocks must appreciate in value and be sold later on the stock market
Bonds: loan from you to a company - bonds pay fixed interest over time
