FM chatper 1 flashcards
(27 cards)
What is the primary goal of financial management?
To maximize shareholder wealth.
What does financial management ensure?
Efficient use of resources and capital.
What are the advantages of incorporating a business?
Unlimited life, limited liability for shareholders, easier access to capital markets.
What are the disadvantages of corporations?
Double taxation and complex regulatory requirements.
What is a common stock?
An equity instrument representing ownership with voting rights.
What is a preferred stock?
An equity instrument with fixed dividends but no voting rights.
Name two types of short-term debt instruments.
Treasury bills and commercial papers.
Name two types of long-term debt instruments.
Corporate bonds and mortgages.
What is a primary market?
A market where new securities are issued.
What is a secondary market?
A market where existing securities are traded.
What is the difference between money markets and capital markets?
Money markets deal with short-term debt, while capital markets handle long-term debt and equity.
What is the agency problem?
Conflicts of interest between shareholders (principals) and managers (agents).
What are direct costs of the agency problem?
Corporate expenditures benefiting managers and monitoring costs.
What are indirect costs of the agency problem?
Lost investment opportunities due to conflicts between shareholders and managers.
What are some solutions to the agency problem?
Performance-based compensation,
shareholder activism (when shareholders take action to influece how a company is ran)
independent board of directors.
What role do financial institutions play?
They act as intermediaries, facilitating capital flows and earning income through interest spreads.
What is the cost of capital?
The required rate of return for using funds, reflecting the risk-return tradeoff.
Name four factors influencing the cost of capital.
Production opportunities
time preferences for consumption
risk
inflation.
Write the formula for firm value.(Entreprise Value)
Value = Σ (Future freeCF_t /
(1 + WACC)^t).
In the firm value formula, what does WACC stand for?
Weighted Average Cost of Capital.
What are the key differences between primary and secondary markets?
Primary markets deal with new securities, while secondary markets handle existing securities.
What are the advantages of secondary markets?
They provide liquidity, price discovery, and opportunities for reallocating capital.
How does the agency problem arise?
When managers prioritize personal goals over shareholder wealth maximization.
What is the relationship between intrinsic value and free cash flows?
Intrinsic value depends on the size, timing, and risk of free cash flows.
