Week 1-4 Flashcards
3 forms of business organisation
Sole proprietorship
Partnership
Corporation
Sole proprietorship
A business owned by a single individual.
Partnership
A business formed by two or more individuals or groups
Advantage/disadvantage of sole proprietorship
Owner takes all the profits but is liable to debt and the equity is limited to their personal wealth
Advantage/disadvantage of partnership
Easy and inexpensive to form and risk spread out, but amount of equity limited to partners wealth
Corporation
A business created as a distinct legal entity composed of one or more individuals or entities
Advantages/disadvantage of corporations
Easy to transfer ownership/limited liability/easy to raise capital
But pay corporation tax
Type I agency problem
A possibility of conflict of interest between shareholders and management
Type II agency problem
Possibility of interest between the controlling and minority shareholders
Single tier vs two tier board
In single tier the shareholders elect board of directors and in two tiers the supervisory board does this
Cumulative voting
A procedure in which a shareholder may cast all votes for one member of the board of directors (1/n+1 + 1 share guarantees you get a vote)
Straight voting
A shareholder may cast all votes for each member of the board of directors. Favours the larger shareholders much more.
Proxy voting
A grant of authority by a shareholder to allow another individual to vote their shares. Can pool votes together
Class A vs Class B shares
One class of shares have unequal voting rights. Some shareholders keep control over the firm
Shareholders, directors and manager relationship
Shareholders own the firm and they elect directors who can hire or fire managers.
Who does financial management in the firm
The finance director or the CFO. They coordinate activity between the treasurer and the controller
Treasurer
Responsible for managing the firms cash and credit and capital expenditures
Controller
Handles financial accounting and tax payments
Capital budgeting
Process of planning and managing a firms long term investments. (i.e investing in machinery, land, tech)
Capital structure
How the firm obtains and manages the long term financing it needs to support long term investment (mixture of long term debt and equity)
Working capital management
A firms short term assets and liabilities. Making sure the firm has sufficient resources to continue operations. (Assets = inventory. Liabilities = money owed to suppliers)
Goal of financial management
Maximise firms value - maximise the value of the firms equity
Financial markets
Facilitate the flow of money from those who have surplus cash to those that need financing
Nature of investment in finance markets
Cash flows to firm > firm invests in short/long term assets > generate profits that are reinvested or pay back shareholders
Primary market
Original sale of securities by government or corporations. (Public offerings or private investment)
Secondary market
Securities bought and sold after the original sale. Transfer ownership of corporate securities
Dealers vs brokers
Dealers buy and sell for themselves at their own risk whilst brokers or agents match buyers and sellers and do not own the commodity
Future value
The amount an investment is worth after one or more periods
Vt = Vo(1+r)^t
Single interest
Interest earned only on the original principal amount
Compound interest
Interest earned on both the initial principal amount and the interest reinvested from prior periods
Compounding
The process of accumulating interest on an investment over time
Present value
The current value of future cash flows discounted at the appropriate rate
PV = FV/(1+r)^t
For calculating the future value of multiple cash flows
Compound the accumulated balance forward one year at a time
Discount rate
The rate used to calculate the present value of future cash flows
To obtain capital
A firm must borrow money (debt financing) or sell a portion of the firm (equity financing)
Venture capital
Financing for new often high risk ventures
Stages of venture capital financing
Seed money < startup < growth capital < replacement capital < buyout financing
IPO
A company’s first equity issue made available to the public
SEO
A seasoned equity offering is new equity issue by a company that has previously issued securities to the public
Underwriting
Investment firms that act as intermediaries between a company selling securities and the investing public.
Syndicate
A group of underwriters formed to share the risk and help sell an issue
Gross spread
Compensation to the underwriter (difference between the underwriters buying price and the offering price)
3 types of underwriter
Firm commitment - underwriter assumes full financial responsibility for unsold shares
Best effort - can return unsold shares to the issuer without financial responsibility
Dutch auction - underwriter conducts an auction
Green shoe provision
Allows the underwriter the option to purchase additional shares form the issuer at the offering price
Lock up agreement
Specifies how long insiders must wait after an IPO before they can sell equity
Why shares are usually underpriced in IPO’s
So existing shareholders keep more control
Insurance for underwriters
Why share prices typically decline in a seasoned offering
Managerial information
Debt usage
Flotation cost
The cost associated with floating a new issue (direct/indirect/gross spread)
