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Financial Managment > Lecture notes before midterm > Flashcards

Lecture notes before midterm Flashcards

1
Q

Three things that grow economies

A
  • capital growth
  • population growth
  • productivity growth
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2
Q

Asset (for the sake of this class)

A

Something that is expected to, directly or indirectly, generate cash

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3
Q

types of shareholders

A
  • retail investors (individuals)
  • institutional (pensions, hedge funds, etc…)
    (institutional investors tend to have a larger ownership share and more control of businesses)
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4
Q

Corporate governance failure

A

stems from incentives for those running the business (CEO/ executive team) not aligning with the interests of the shareholders (creation of long-term value)

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5
Q

purpose of auditors

A

specific to public companies
lend credibility to the statements of the mangement

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6
Q

stakeholders within the marketplace

A

o Customers
o Shareholders
o Lenders
o Suppliers
o Regulators
o Auditors
o Institutions

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7
Q

influence on business outside of the direct marketplace

A

regulations (government)
lobbying

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8
Q

main business decisions

A

capital budget
capital raising
distribution of return

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9
Q

“Most important” stakeholder

A

Shareholders, but only because they own the residual value of the company and theoretically are only paid after everyone else is taken care of

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10
Q

Goal of a comapany

A

to maximize the shareholder’s wealth (which is about maximizing long-term value, not about maximizing short-term profit)

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11
Q

Enterprise value

A

= company’s equity + it’s debt = value of the whole company (essentially cost to buy company)

market value of a company

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12
Q

Market capitalization

A

Equity cost of a company. Shares outstanding * share price

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13
Q

benefits of fintech

A
  • access and inclusion
  • efficiency
  • lower startup costs for new business from cloud based resources
  • force adaptations and growth from more traditional businesses
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14
Q

segments of fintech

A
  • payments
  • marketplace lending
  • wealthtech/ robo advisors
  • insurtech
  • reg tech
  • crypto blockchain
  • cybersecurity
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15
Q

what is DEFI

A

Decentralized finance

peer to peer financial services

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16
Q

shareholder vs bondholder conflict

A

Shareholders likely to be more interest in risk for potential gain vs lenders wanting fewer risk and higher certainty of repayment

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17
Q

What is agency cost?

A

Gap between potential value (if all agent incentives were perfectly aligned) of a company and actual value driven by conflict of interest between management and shareholders

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18
Q

Potential sources for conflict that creates agency cost

A
  • excessive perks for executive not benchmarked to valuation
  • differential information
  • mismatched planning horizons
  • managerial risk-aversion
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19
Q

Internal controls for agency cost

A
  • board of directors (composition, leadership structure)
  • performance sensitive compensation
  • ownership structure
  • firm’s charter
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20
Q

Composition of corporate board

A

public company’s board required by regulation to be 50% independent (no current or past affiliation with the company)

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21
Q

types of performance sensitive compensation

A
  • stock options
  • cap bonuses (limits effects of short term gains in favor of long term)
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22
Q

determining exercise price for stock options

A

designed with desired return to incentivize right company growth (what stock price should be after the given amount of time)

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23
Q

External controls for agency costs

A
  • market for corporate control
  • managerial labor market
  • shareholder activism
  • regulation
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24
Q

agency relationship

A

arises when one or more individuals (principals) hire other individuals or organizations (agents) to perform some service and delegates the decision making authority to that agent

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25
Q

Corporate governance

A

a set of mechanisms through which outside investors protect themselves against expropriation by insiders

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26
Q

Financial markets

A

exist to bring together economic agents who are saving (have cash now) an economic agents who provide opportunities to convert cash now into potentially more cash later

transfers may be direct or indirect (via investment bank or financial intermediaries)

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27
Q

Major types of financial instruments

A

From least to most risky

  • U.S. Treasury bills
  • commercial paper
  • money market mutual funds
  • commercial loans
  • U.S. treasury notes and bonds
  • mortgages
  • municipal bonds
  • corporate bonds
  • preferred stocks
  • common stocks
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28
Q

Treasury bonds

A

essentially risk free. loan of money to the government for a given period of time

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29
Q

Commercial paper

A

debt issued by very large companies wanting to borrow money in the short term
- low default risk
- interest rate slightly higher than treasury bills
- maturity up to 270 days

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30
Q

Money market mutual fund

A

mutual fund that invests money in short term securities

very safe, low return

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31
Q

US treasury and government bonds

A

one of the largest markets (debt market much bigger than equity)

32
Q

Preferred stock

A
  • usually comes with a guarantee that holder will get dividends before common stock holders
  • claim only superseded by debt claim
  • more risky than bonds, less risky than common stock
33
Q

NYSE

A

New York Stock Exchange
has certain requirements for company’s to be listed on it

34
Q

What does it mean for a stock to be listed on an exchange

A
  • members of the exchange can trade the stock

(broker contacted by investor, broker contacts member of exchange)

35
Q

NASDAQ

A

Dealer’s market
- Dealer posts bid price and ask price
- broker gets prices posted
- by regulation broker has to choose currently lowest ask price or highest bid price
- network connecting dealers: National Association of Security Dealer’s Automated Quotation System

36
Q

How interest rate drives currency value

A
  • higher interest rate in US drives money flows into the US in pursuit of the higher return, increases demand for US currency so price of currency increases
  • may cause decrease in exports (exports comparatively more expensive to other countries)
  • may cause increase in imports as cost of imported raw materials drop
37
Q

why companies may prefer to borrow money than fund via equity

A

because interest payments are deductible and dividends are not borrowing (and paying back the money) can result in lower taxes (overall decreasing the cost of borrowing)

38
Q

types of markets

A

physical vs. financial
primary vs. secondary
money vs. capital
spot vs. future

39
Q

ways banks evaluate loan applications

A
  • look at source and uses of cash
    to see where cash flows go and if they are appropriate (comparative balance sheets help with this - looking where cash is sitting (inventory? A/R?)
40
Q

Bank reserve requirements and federal interest rates

A

banks want to lend out all deposits (to make money off all of them) but Fed requires that a certain percentage of the deposits must be held in the reserve

if bank lacks money to meet the reserve requirement can borrow overnight from a bank with excess funds

This overnight rate is the rate that the fed sets, becomes a benchmark for everything else

41
Q

why will raising interest rates limit inflation

A

Idea is that demand for money is high so if cost of borrowing is higher demand will subside

42
Q

Why is inflation an issue to be controlled

A
  • potential wage-price spiral
  • potential hording behaviors
  • generally keeping control of economy

but risk increasing unemployment

43
Q

How does the internet dampen inflation?

A

because it has allowed people to source everything from somewhere else if the price is lower elsewhere (including inflation)

44
Q

how does interest going up affect the stock market?

A
  • higher foreign demand for us securities
  • people may leave equity investing for less risky bond investments if rates are similar
45
Q

Trade credit

A

accounts and notes payable to other suppliers (rather than bank)

to evaluate rate paying for trade credit have to look at discount given up as % of what would have paid without discount and CONVERT IT TO AN ANNUAL RATE to compare to the bank rate

46
Q

what do investors prefer to see as the predominant source of funds for the business?

A

Retained earnings

47
Q

Evaluating if inventory level is appropriate

A

Use inventory turns = (accounts receivable + inventory)/ sales for the year
compared year to year

if percentage is same or decreases can assume comparatively okay, but if grows then there is more inventory than justified by sales

48
Q

External funds needed by a company

A

= (expenses - revenue) * growth rate

requires forecasting next year’s income statement (usually based on previous growth)

essentially solving for notes payable (bank) by estimating the rest of the balance sheet based on forecast

49
Q

Bank’s balance sheets

A

Assets = Loans receivable, market securities

Liabilities = deposits (are essentially accounts payable - interest-sensitive short-term)

50
Q

Do banks prefer giving long-term or short term loans?

A

short term, since deposit accounts are essentially short term

51
Q

Which is a better long-term source of funding debt or equity?

A

Equity, but it means potentially giving up control, especially if aiming for rapid rather than slow growth

52
Q

Initial sources of capital

A
  • FFF (friends, family, fools)
  • Angels
  • venture capitalists
  • corporate partners (who may eventually want to consolidate)
  • debt capital (unlikely at early stages)
  • venture leasing
  • internal financing
53
Q

What is venture leasing?

A

Leasing assets and paying for them with stocks

54
Q

Why might debt be a preferable funding source for a new business?

A
  • allows retention of control
  • offers a tax advantage (interest deduction)
  • leverage
55
Q

Estimating value of private company

A

base on some information publicized about a purchase that gives amount paid & % ownership

investment / ownership percentage = total implied value of company (after investment)

Pre-investment valuation = total implied value - investment

56
Q

P/E ratio

A

stock price / earnings per share

57
Q

What factors affect the P/E ratio

A
  • expectations of growth (rapid growth –> high P/E)
  • company risk
    (high risk –> low P/E)
58
Q

Bottom up valuation

A

a way to estimate the value of a private company

  • take average P/E ratio for the given industry
  • assuming that company has stabilized can assume it should have about the same P/E ratio so can use the ratio and solve for estimated stock price based on expected earnings
59
Q

using bottom up valuation to find % ownership for given investment

A
  • use average industry P/E ratio and estimated after tax profit after N years to get expected valuation in N years
  • calculate future value of $1 after N years at required rate of return to get dollar return
  • multiply required investment by dollar return to get required payoff in N years
  • divide required payoff in N years by expected valuation in N years to get required % ownership at given investment amount and required return rate.
60
Q

What country has the largest number of successful startups per capita?

A

US

61
Q

Exit options for start up

A

IPO
getting company acquired

62
Q

How to value financial assets

A

need to determine
- how many payments
- what are the payment
- what is the discount rate (is the desired) or market return

63
Q

Discount bond

A

Market rate is higher than the coupon rate so investors are not willing to pay the face value of the bond

64
Q

Premium bond

A

Mark rate sinks below coupon rate so investors are willing to pay more than the face value of the bond

65
Q

Debt investment strategy if interest rates expected to rise

A

Since bond prices drop when interest rates rise bonds should be sold now before the prices drop

66
Q

Debt investment strategy if interest rates expected to fall

A

Buy bonds now as can sell higher after interest rates falls

67
Q

Valuing bonds paid semi annually

A

remember to adjust payments to that receiving half coupon rate twice a year!

(also adjust interest)

68
Q

Yield to maturity

A

Also Promised yield

rate of return in bond is held to maturity (PV known)

use calculator to solve for I/Y given known:
- PMT (payments)
- FV (maturity)
- N (number of years
- PV (amount paid

69
Q

Use of yield to maturity

A

in comparing different bonds

70
Q

Bond rating agencies

A

Moody’s
S&P

71
Q

Bond sale regulations

A

to sell bonds to the public a company must get a rating from a rating agency in advance

(can sell to private investors no matter what, but they cannot later sell it to public)

72
Q

Junk bonds

A

Ba/Bb and below

highly risky compared to higher rated bonds but still less risking than stocks

banks, insurance companies, other institutional investors are not allowed to invest in junk bonds

73
Q

Constant growth stock price

A

price = Dividend period 1 / (required rate of return - growth rate)

constant dividend growth model

ONLY WORKS if growth rate is less than the required rate of return

74
Q

P/E multiple

A

using P/E ratio to estimate stock price by finding average P/E ratio for industry or comparable firms and multiplying it by the expected earnings to get estimated stock price

75
Q

Valuation of stock

A

Present value of all future dividends

if in constant growth phase can use constant growth model

if not can try P/E multiple

76
Q

Valuation of preferred stock

A

risk between common stock and bonds

promises fixed dividend so can use value of a perpetuity to find the stock price

just need to know required return and the dollar amount of the dividend

77
Q

Value of a perpetuity

A

= payment / rate

Financial Managment (11 decks)

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