Financial Management Flashcards
What is financial management?
Is the identification and implementation of strategies designed to maximize a firm’s value. It includes:
A. Managing the capital and financial structure of an entity
B. Planning, allocating and controlling an entity’s financial resources
C. Identifying and managing financial risks
What are sunk costs?
The costs of resources incurred in the past; they cannot be changed by current or future decisions
What are opportunity costs?
The discounted dollar value f benefits lost from the next best opportunity as a result of choosing another opportunity
What are differential/ incremental costs?
Those costs that are different between two or more alternatives
What is cost of capital?
Is comprised of long-term sources of funds used in financing the firm’s assets
What is the cost of debt?
The rate of return that must be earned in order to attract ad retain lender’s funds. Debt is considered to be less risky than equity
What is cost preferred stock?
The rate of return that must be earned in order to attract and retain preferred shareholders investment. Preferred stock is considered riskier than debt but less risky than common stock
What are the cost of common stock?
The rate of return that must be earned in order to attract and retain common shareholders’ investment. Common stock has been considered the most risky
What is Weighted Average Capital (WACC)?
A company will seek to minimize is weighted average cost of capital. WACC is not only the cost to the firm from its long-term financing but also the minimum the firm must earn in investments. The lower the WACC the lower the required revenue needed to earn a profit and the easier it is to increase shareholder value
The valuation of a business should be carried out according to what process?
A. Establishing standards and premise of the valuation
B. Assessment of the economic environment of the business
C. Analysis of financial statements
D. Formulation of valuation
What does CAPM incorporates?
Both the time value of money and the elements of risk:
A. The time value of money is incorporated as the risk-free rate of return. The element of risk is incorporated in a risk measure called “beta”. CAPM recognizes that the expected rate of return on an investment.
B. If an investment is expected to provide a rate of return equal to or greater than the computed rate using CAPM, the investment is economically feasible
C. If an investment is expected to provide a rate of return less that computed using the CAMP formula, the investment is not economically feasible, and should not be undertaken
What is the basic CAPM formula?
RR=RFR+B(ERR-RFR)
RR- required rate of return
RFR - risk free rate of return
B - Beta
ERR - expected rate of return
What is hedging?
Hedging is a management strategy for mitigating the risk of loss associated with certain transactions and positions
Derivatives are contracts with all 3 of what following elements?
A. One or more underlying and one or more notional amount
B. Requires no initial net investment or one that is smaller than would be required for other types of similar contracts
C. Can be settled with a net cash payment
What are the 4 types of derivative contracts?
- Future contracts - contracts to deliver or receive a commodity, foreign currency, security instrument, or other asset in the future
- Forward contracts - are executed directly between two parties. The buyer of a forward contract will gain when prices increase because the buyer had a lower purchased price (contract price) vice versa.
- Option contracts - contract between buyer and seller that give they buyer of the option the right to buy (call option) or sell (put option) a particular asset in the future at a price set now (strike price)
- Swap Contracts - contract between a buyer and seller by which they agree to exchange cash flows, currencies, commodities or risk
