FINANCIAL MANAGEMENT VOCABULARY AND THEORY Flashcards
Give a brief explanation and history of the Sarbanes-Oxley Act.
The Sarbanes-Oxley Act (or SOX Act) is a U.S. federal law that aims to protect investors by making corporate disclosures more reliable and accurate. The Act was spurred by major accounting scandals, such as Enron and WorldCom (today called MCI Inc.), that tricked investors and inflated stock prices. Spearheaded by Senator Paul Sarbanes and Representative Michael Oxley, the Act was signed into law by President George W. Bush on July 30, 2002.
Also known as the SOX Act of 2002 and the Corporate Responsibility Act of 2002, it mandated strict reforms to existing securities regulations and imposed tough new penalties on lawbreakers.
What is Financial Management?
Financial Management, also called Corporate Finance, focuses on decisions relating to how much and what types of assets to acquire, how to raise the capital needed to purchase assets, and how to run the firm so as to maximize value.
Financial Management means planning, organizing, directing and controlling the financial activities such as procurement and utilization of funds of the enterprise. It means applying general management principles to financial resources of the enterprise.
What does “intrinsic value” of stocks mean?
Intrinsic value means an estimate of a stock’s “true” value based on accurate risk and return data. It can be estimated, but not measured precisely.
What does market price of stocks mean?
Market price is the stock value based on perceived but possibly incorrect information as seen by the marginal investor.
What is a marginal investor?
A marginal investor is one whose views determine the actual stock price. It is a representative investor whose actions reflect the beliefs of those people who are currently trading a stock. It is the marginal investor who determines a stock’s price.
What is a non-marginal investor?
Non marginal investors are investors who generally do not trade on the margin. They are not the investors who determine stock price.
What happens when there is market equilibrium in stocks?
Market equilibrium involving stocks occurs when the actual market price equals the intrinsic value, so investors are indifferent between buying or selling a stock.
T or F
Management’s goal should be to take actions designed to maximize the firm’s market value, not its intrinsic value.
False. Management’s goal should be to take actions designed to maximize the firm’s intrinsic value, not its current market price.
What is a corporate raider?
A corporate raider is an individual who targets a corporation for takeover because it is undervalued.
What is hostile takeover?
A hostile takeover is the acquisition of a company over the opposition of its management.
What are the types and classifications of markets?
- Physical asset markets
- Financial asset markets
- Spot markets - markets in which assets are sold on the spot
- Futures markets - markets in which participants agree to buy and sell at some future date
- Money markets - markets in which funds are borrowed or loaned for short periods
- Capital markets - markets for stocks and for intermediate and long-term debt
- Primary markets - markets in which corporations raise capital by issuing new securities
- Secondary markets - markets in which securities are traded among investors after issuance
- Private markets - markets in which transactions are worked out directly between two parties
- Public markets - markets in which standardized contracts are traded on organized exchanges.
What does “going public” mean?
Going public is the act of selling stock to the public at large by a closely held corporation or it principal stockholders.
What does Initial public offering mean?
IPO means the market for stocks of companies that are in the process of going public.
What is net working capital?
Current assets - current liabilities
What is net operating working capital?
Current assets - non-interest bearing current liabilities
(CA - (CL - Notes Payable)
What is the concept of “free cash flow”?
FCF is defined as the amount of cash that could be withdrawn without harming a firm’s ability to operate and to produce future cash flows.
A positive FCF means that the firm is generating more than enough cash to finance its current investments.
Explain the concept of “Market Value Added”
MVA is the excess of the market value of equity over its book value.
Explain the concept of “Economic Value Added”
EVA is an estimate of a business’ true economic profit for a given year.
A positive EVA means after tax operating income exceeds cost of capital needed to produce that income.
What is the purpose of liquidity ratios?
Liquidity ratios show the firm’s ability to pay off debts that are maturing within a year and its ability to continue operating.
What is the purpose of asset management ratios?
Asset management ratios show how efficiently the firm is using its assets.
What is the purpose of debt management ratios?
Debt management ratios give an idea on how a firm has financed its assets well as well as the firm’s ability to pay its long-term debt. It shows how risky the firm is and how much of its operating income must be paid to bondholders rather than stockholders.
What is the purpose of profitability ratios?
Profitability ratios show how profitably a firm is operating and utilizing its assets. It combines asset and debt management categories to show their effects on return on equity.
What is the purpose of market value ratios?
Market value ratios show what investors think about the firm and its future prospects.
What is a liquid asset?
An asset that can be converted to cash quickly without having to reduce the asset’s price very much.
What does benchmarking mean?
It is the process of comparing a particular company with a set of benchmark companies.
What is stand-alone risk?
It is the risk an investor would face if he or she held only one asset.
What is the expected rate of return?
It is the rate of return expected to be realized from an investment; it is the weighted average of the probability distribution of possible results. It is symbolized as r̂ or r-hat.
What is standard deviation?
In statistics, the standard deviation is a measure of the amount of variation or dispersion of a set of values. A low standard deviation indicates that the values tend to be close to the mean (also called the expected value) of the set, while a high standard deviation indicates that the values are spread out over a wider range.
Its symbol is σ (the Greek letter sigma)
What does a lower standard deviation mean?
It means that there is a tighter probability distribution and accordingly, lower risk.
What is the coefficient of variation?
It is the quotient derived by dividing standard deviation by the r-hat. It is the standardized measure of the risk per unit of return.
What is risk premium?
Risk premium is the difference between the expected rate of return on a given risky asset and that on a less risky asset.
What is the Capital Asset Pricing Model?
CAPM is a model based on the proposition that any stock’s required rate of return is equal to the risk-free rate of return plus a risk-premium that reflects only the risk remaining after diversification.
What is correlation?
It is the tendency of two variables to move together.
What is correlation coefficient?
It is a measure of the degree of relationship between two variables.
