Overview of Financial Management Flashcards
Capital Budgeting Decision
Decision made by the financial management department on internal investments
Investment Decision
Decision made by the financial management department on external investments
What are the two main aspects of financial managements?
Minimize the cost of financing, minimize the risk to cash flow
What are the two things finance people do?
Rearrange/translate/exchange cash flows over time, and manage risk
What is the main aspect of translating cash flows over time?
Converting today’s dollars into equivalent future value
What is a security?
A way of rearranging/translating/exchanging cash flows over time; investments
What is risk?
Uncertainty of future cash flows
Assets only have positive value today if
it gets more valuable in the future
Value is based on
future cash flows
Risk Aversion
Given two securities equally priced but with different degrees of risk, the rational investor would choose the one with lower risk
Value is also known as
theoretical value, fair market value, no-arbitrage price
The price of something is
what the seller wants you to pay for it
Fair market value is
the value of something based on theory and does not include profit
What makes the fair market value of something change?
Change in expected/estimated future cash flows
What makes the price of something change?
Market forces (supply & demand)
Profit
Market Price - Value
Decision Criteria
Basis for investing
Holding period
Amount of time you own the investment
Profit of an investment
Available market price at the end of the holding period - price paid at the beginning of the holding period
Rate of Profit
The percentage increase in the price (or value) of a financial asset
Rate of Growth
Profit/Investment
Rate of Profit may be thought of as
rate of wealth creation
Spot transaction
Passage of time does not matter
Investment transaction
Passage of time matters
New Price is equal to
Old Price(1 + Percentage of change)
The fair market value of the security is
the amount of money (in today’s dollars) the company must promise to pay in the future to those who buy security
Profit equation
(New Price - Old Price)/Old Price or New Price/Old Price - 1
What do we use rate of return?
Investments expressed as rates of return can be compared on the same basis and without bias
