Introductions to Finance Flashcards
The objective of shareholders is assumed to be ______________________.
wealth maximisation
Compare between Investments and Corporate Finance.
Investments are mainly concerned with the decision of investors (stock valuation, portfolio diversification, asset pricing).
Corporate finance is mainly concerned with the decisions of company managers (capital budgeting, capital structure, payout policy).
What is Finance? How does it differ form accounting?
Finance is the study of how individuals, businesses, and institutions acquire, spend, and manage financial resources.
Accounting is the process of identifying, recording, and communicating economic information about an entity.
There are overlaps between the two, but finance is usually forward-looking while accounting backward-looking.
Recall the flow of funds through the financial system.
What are surplus and deficit units?
Surplus units are suppliers of funds.
Deficit units are users of funds.
Mention the advantages and disadvantages of direct financing.
Advantage:
- Provides access to a diverse range of capital suppliers (investors)
- Flexibility on the range of securities that users can issue for different financing needs
- Avoids the cost of intermediation
Disadvantage:
- Information asymmetries are usually more of a problem than with intermediaries
- Liquidity may be poor
- Search and transaction costs
What is a “security”?
A security is a financial contract that can be traded in a market and specifies:
- The asset involved
- Quantity or number of units
- Price, date, payment amount and settlement terms
Mention the advantage of indirect financing through intermediation.
- Asset Transformation
- Maturity Transformation
- Credit (default) risk diversification and transformation: Saver’s credit risk is limited to the risk of the intermediary
- Economies of Scale: benefit for greater organizational size and business volume - lower average cost by increasing the level of output
- Economies of Scope: benefit from offering a greater range of products - lower average cost
Mention the difference between intermediary and broker
By using an intermediary, the original asset deposited will be transformed into a different asset, in addition to the fact that the original asset will cease to belong to the investor. While by using a broker, the original asset deposited remain as the investor’s asset, even if it is under the custody of the broker (eg. put under a trust).
Outline the differences between primary and secondary markets and the main functions that they perform.
Primary markets are where the issue of new financial instruments occurs. Secondary markets are where the buying and selling of existing financial securities occur, which do not raise new funds for issuers.
The main function of the primary market is to raise funds for the issuer to purchase goods, services, or assets. While for secondary markets, a liquid and efficient market would greatly assist operations in the primary market as it makes the new securities more attractive. It also helps with “price discovery” as well as identifying investors who are interested in securities.
Briefly describe a sole proprietor business.
- The owner is the business
- Unlimited liability to the owner
- Easy to set up
- Size limited to owner’s wealth
Describe briefly a partnership.
- Similar to sole proprietors, except there is more than one owner
- Each partner is liable for all the debts of the business
- Combines the wealth and abilities of multiple individuals
- Easy to set up
Briefly describe a limited liability company.
- A company is a legal entity separate from its owners (the shareholders)
- Owner’s liability to repay debts is limited to their initial investments
- Taxed in its own right and can sue and be sued in its own right
- Can be public (Ltd) or private (Pty Ltd)
- Private shares cannot be listed and traded on a stock exchange
