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Financial Management > Module 1 - Chapter 1 > Flashcards

Module 1 - Chapter 1 Flashcards

1
Q

Answer:

There is no ___(a)___ of finance

A

a. unifying

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2
Q

List:

Basic Ideas Used in Many Areas of Finance

A
  1. Trade off between risk and return
  2. All else equal, more money is better than less money
  3. All else equal, money today is better than money at some point in the future
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3
Q

Answer:

In the trade off between risk and return, people want ___(a)___ when accepting ___(b)___

A

a. higher promised return

b. higher risk

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4
Q

Answer:

Most people won’t take risk when there is a ___(a)___

A

a. less risky alternative at the same price

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5
Q

Answer:

There is a lot of controversy as to if markets are ___(a)___ and ___(b)___

A

a. efficient

b. to what extent

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6
Q

Define:

Market Efficiency

A

All relevant information about the risk and cash flows of a financial asset is quickly and accurately incorporated into price

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7
Q

Answer:

There is “no free lunch”, in other words, it is hard to find ___(a)___ to buy, or ___(b)___ to sell/short

A

a. undervalued

b. overvalued assets

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8
Q

Answer:

Wise/good investments are associated with price ___(a)___ because it becomes an assessment of ___(b)___

A

a. increase

b. managements performance

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9
Q

Answer:

It is more expensive to raise capital in equity markets if stock is ___(a)___

A

a. undervalued

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10
Q

Answer:

If stock is undervalued, the firm would need to ___(a)___ to raise a given amount of capital, which it may not want to do due to ___(b)___

A

a. issue more shares

b. dilution of existing shares

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11
Q

Answer:

If stock is overvalued, the firm has incentive to ___(a)___ in order to ___(b)___

A

a. issue equity or raise capital in the equity markets now

b. get overvalue money (“get lunch for free” for the firm)

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12
Q

List:

How/When to raise capital

A
  1. Debt vs equity
  2. Private Placement (of debt or equity) vs public issue (in financial markets)
  3. Timing - when to raise capital
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13
Q

List:

Financial Decisions Regarding Capital

A
  1. How/when to raise capital for investment
  2. How to Manage Liquidity/How to Finance Ongoing Operations - financing vs internally generated funds
  3. How to Invest Capital
  4. How to Measure Performance
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14
Q

List:

Steps to Invest Capital

A
  1. Allocation through market mechanism (external)

2. Allocation through individual/group decisions (internal)

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15
Q

Define:

Allocation Through Market Mechanisms

A

External

Investors in market choose what to invest in

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16
Q

Define:

Allocation Through Individual/Group Decisions

A

Internal

Capital budgeting decisions

Allocation through market mechanism leads to this

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17
Q

List:

Measures of Performance

A
  1. Returns
  2. Profits
  3. Market Share
  4. Value
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18
Q

Define:

Liquidity

A

Availability of cash

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19
Q

Define:

Value

A

The measure generally considered to incorporate the most characteristics that investors and people in general care about

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20
Q

List:

What We Look at With Cash Flows

A
  1. Magnitute
  2. Timing
  3. Risk
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21
Q

List:

Measurement of Value Incorporates Measures of

A
  1. Time Value of Money
  2. Risk/Return trade off
  3. More Money Being Better than Less
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22
Q

Define:

Value of the Firm

A

The present value of all expected future cash flows, discounted to the current period at the appropriate risk adjusted discount rate

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23
Q

Answer:

Returns measure ___(a)___ relative to the ___(b)___, but it often doesn’t consider ___(c)___ or ___(d)___

A

a. magnitudes of cash flows
b. original price
c. risk/return trade off
d. time value of money

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24
Q

Answer:

Profit is a measure of ___(a)___ relative to ___(b)___

A

a. cash flow magnitude

b. cost

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25
Q

Answer:

Market value is a measure of ___(a)___ compared to ___(b)___, but it often doesn’t look at ___(c)___ or ___(d)___

A

a. magnitude of sales
b. competitor’s magnitude of sales
c. time value of money
d. risk/return trade off

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26
Q

Answer:

Value measures ___(a)___ and ___(b)___ better than ___(c)____, ___(d)___ or ___(e)___

A

a. time value of money
b. risk/return trade off
c. returns
d. Profit
e. Market Value

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27
Q

Accronym:

FCF

A

Free Cash Flows

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28
Q

Define:

Free Cash Flows

A

Measures magnitude of the cash flow at the point in time it is received

(expected in the future)

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29
Q

Answer:

What is the goal of the firm?

A

*Maximize value

Maximize present value of all expected future cash flows

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30
Q

Acronym:

PV

A

Present Value

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31
Q

Acronym:

NPV

A

Net Present Value

32
Q

Answer:

Most projects are ___(a)___ because they have a/an ___(b)___

A

a. finite

b. expected end point

33
Q

Answer:

How is the value added by a project estimated?

A

The present value of all investment outlays/costs is deducted from the present value of expected future cash flows

34
Q

Decision Rule:

NPV Project

A

The firm should accept any positive NPV project that it is able to identify

The project will maximize the value of the firm as a whole

35
Q

List:

Factors Influencing Firm Financial Decisions

A
  1. Size of the firm and form of business organization
  2. Agency problems - do managers/employees act in their own best interests or in the interest of the owners of the firm
  3. Conditions in external financial markets
36
Q

List:

Advantages of Sole Proprietorship

A
  1. Easy to start
  2. Less regulation and reporting requirements
  3. Single owner keeps all profits
  4. Profits are taxed as personal income to the owner
37
Q

List:

Disadvantages of Sole Proprietorship

A
  1. Limited to life of owner
  2. Equity capital limited by owner’s personal wealth (limits size)
  3. Unlimited liability
  4. Difficult to sell/transfer ownership
38
Q

List:

Advantages of Partnership

A
  1. Allows for multiple owners
  2. Can make use of personal wealth of all partners for equity
  3. Relatively easy to set up
  4. Income taxed as personal income of partners
39
Q

List:

Disadvantages of Partnership

A
  1. Unlimited liability for general partner(s); limited partners are not liable for business debts
  2. Partnership dissolve when one partner dies or wishes to sell
  3. Difficult to transfer ownership/partnership
40
Q

Answer:

A partnership has the capacity to grow ___(a)___ than a ___(b)___

A

a. larger and faster

b. sole proprietorship

41
Q

List:

Advantages of C-Corporation

A
  1. easier to raise external capital, take in new equity
  2. Unlimited life
  3. Transfer of ownership is not difficult
  4. Separation of ownership and management
42
Q

List:

Disadvantages of C-Corporation

A
  1. Double taxation if income is distributed to owners

2. Separation of ownership and management

43
Q

Answer:

Why is separation of ownership and management an advantage for a C-Corporation?

A

Allows for specialization of employees within the firm to maximize value

44
Q

Answer:

Why is separation of ownership and management a disadvantage for a C-Corporation?

A

Because of the agency problem (do managers/employees act in their own best interest or in the interest of the owners of the firm

45
Q

Answer:

An S-Corporation primarily differs from a C-Corporation in terms of ___(a)___. A firm that has filed (form 2553) as an S-Corporation is a ___(b)____ entity

A

a. tax status

b. pass-through

46
Q

Answer:

Explain how there is no income tax at the corporate level for a S-Corporation

A

Profits or losses are “passed through” to the owners, and are reported for tax purposes on the owner’s personal tax returns.

Any taxes paid are at personal level and at personal rate

47
Q

List:

Restrictions on S-Corporations

A
  1. Restricted to no more than 100 shareholders
  2. Shareholders must be US citizens/residents
  3. Cannot be owned by other corporations or trusts
  4. Can only have one class of voting rights
48
Q

Answer:

S-Corporations are ___(a)___ common than C-Corporations because they are ___(b)___

A

a. less

b. more restrictive

49
Q

Answer:

What is the tax status of LLC’s?

A

Do not pay taxes at corporate level

Members report a share of profits or losses on personal tax returns, the same as a partnership

50
Q

List:

Disadvantages of LLC

A
  1. limited life (ignore that this is incorrect)
  2. Self employment taxes are contributed to Medicare and Social Security - entire net income of the LLC is subject to the tax
51
Q

List:

Financial Managers in a Corporation

A
  1. Treasurer
  2. Controller
  3. Chief Financial Officer (CFO)
52
Q

Define:

Treasurer

A

Manages cash and credit (short term liquidity), capital expenditures, provides input to financial planning

53
Q

Define:

Controller

A

Manages cost accounting, financial accounting/reporting, taxes, and financial data

54
Q

Define:

Chief Financial Officer

A

Oversees the treasurer and controller, all financial operations. Signs off on financial disclosures of the firm. Contributes to decisions related to risk management. Increasingly involved in decisions and operations of key areas of the firm

55
Q

Answer:

What is the result of the Sarbanes-Oxley on CFOs?

A

Must sign off on financial disclosures

56
Q

Answer:

When does an agency relationship arise?

A
  • When principal hires an agent to represent their interests

- When stockholders (principals) hire managers (agents) to run the company, make decisions

57
Q

Answer:

Describe the conflict of interest when an agency relationship arises

A
  • Stockholders want to maximize the value of the firm

&

-Managers want to maximize personal wealth and consumption

58
Q

Answer:

Separation of ownership and control allows for ___(a)___, but usually results in ___(b)___

A

a. specialization

b. conflicts of interest

59
Q

List:

Methods for Reducing the Agency Problem

A
  1. Provide incentives that give managers ownership stake
  2. Market for corporate control
  3. Role of Stakeholders
60
Q

List:

What incentives giving managers and ownership interest can be offered?

A
  1. Stock options

2. Stock grants

61
Q

Define:

Stock Options

A

Give managers (agents) the option to purchase stock at the price on the grant date

62
Q

Define:

Stock Grants

A

Stock blocks given to managers (agents) - usually with a vesting period

63
Q

Answer:

How does the market for corporate control reduce the agency problem?

A

Threat of takeover by other firms gives incentives to operate efficiently, increase value

Poor management increases the possibility of takeover at which point the manager may be removed

64
Q

List:

Other stakeholders that can reduce the agency problem

A
  1. Board of directors
  2. Other employees competing for the job
  3. Shareholder initiatives
65
Q

Answer:

How can the board of directors reduce the agency problem?

A

Have the capacity to fire the manager/agent

66
Q

Answer:

How can shareholder initiatives reduce the agency problem?

A

Shareholders can act together to fire or replace a manger/directors

67
Q

List:

The primary function of financial markets is to facilitate transactions between which 2 parties

(2 sets of 2)

A
  1. Those who need capital
  2. Those with excess capital

OR

  1. Those who want to reduce risk and are willing to pay someone to take it
  2. Those who want returns and are willing to bear risk to get high return
68
Q

Answer:

In many financial market transactions, there is a combination between ___(a)___ and ___(b)___, so there are not always separate transactions for ___(c)___ and ___(d)___

A

a. needing to to raise capital
b. willingness to assume risk
c. capital
d. risk

69
Q

List:

Market Participants

A

a. Business firms
2. Households
3. Governments
4. Financial Intermediaries

70
Q

Define:

Business Firms as Market Participants

A

Net borrowers

Borrowing/raising money in equity markets to invest in projects and create value

71
Q

Define:

Households as Market Participants

A

Net savers

Generally savings increase with age

72
Q

Define:

Governments as Market Participants

A

Can be both borrowers and savers

73
Q

Define:

Financial Intermediaries as Market Participants

A

Connectors of borrowers and lenders, but may also trade on their own account

74
Q

List:

Types of Financial Intermediaries as Market Participants

A
  1. Commercial Banks
  2. Investment Banks
  3. Insurance companies
  4. Pension funds
  5. Hedge funds
75
Q

List:

Primary Issues of Cash Flows to the Firm

A
  1. Initial Public Offerings (IPOs)
  2. Seasoned Equity Offerings (SEOs)
  3. Private Equity Investment
  4. New debt issue (can be publicly or privately placed)
  5. New loan initiated with commercial bank
76
Q

Answer:

With the exception of ___(a)___, most transactions issuing cash flows to the firm require the assistance of ____(b)___ to ____(c)____

A

a. commercial bank loans
b. investment banks
c. facilitate the transaction

Financial Management (3 decks)

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