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AcF100 > Week 11 - Managerial Finance > Flashcards

Week 11 - Managerial Finance Flashcards

1
Q

What is finance the study of?

A

making choices
- comparisons of expected costs and expected benefits
- expectations are based on past experiences

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2
Q

What are the two basic principles of finance?

A
  1. time
  2. uncertainty (risk)
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3
Q

What are the 4 main areas of finance?

A
  1. Corporate finance
  2. Investments
  3. Financial institutions
  4. International finance
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4
Q

What is corporate finance?

A

to undertake financial decisions for corporations

what long-term investments should the firm take on?
where to get long-term financing to pay for the investments?
how to manage the everyday financial activities of the firm?

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5
Q

What do you work with in investments?

A

financial assets such as stocks and bonds

how to determine the correct price of stocks and bonds
how to calculate risk and return
how to allocate money into different financial assets

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6
Q

What are financial institutions?

A

companies that specialise in financial matters

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7
Q

What are examples of financial institutions?

A

banks - commercial banks, investment banks, central bank

insurance companies

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8
Q

What is international finance?

A

an area of specialisation within each of the areas discussed so far

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9
Q

What are examples of international finance?

A

overseas operations
investing in foreign securities

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10
Q

What is a sole proprietorship?

A

it is owned by one person who is the manager

it has unlimited liability

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11
Q

What is a partnership?

A

owned by two or more owners (limited or unlimited liability)
ownership is combined with management
legal contract of partnership required

examples: many legal and accounting firms

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12
Q

What is a corporation/ firm?

A

many owners (limited liability)
ownership and control may be separate

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13
Q

What are 3 forms of business organisation?

A
  1. sole proprietorship
  2. partnership
  3. corporation/ firm
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14
Q

What is unlimited liability?

A

investors are personally responsible for all business debts

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15
Q

What is limited liability?

A

the most an inventor can lose is the amount she initially invested

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16
Q

How do you payoff to debt and equity holders of a corporation to debt holders?

A

debt holders are promised £F
if the value of the firm is less than £F, they get whatever the firm is worth
algebraically, the bondholder’s claim is min [F,X]

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17
Q

How do you payoff to debt and equity holders of a corporation to debt holders in a diagram?

A

x axis, Value of the firm (X)
y axis, Payoff to debt holders

line is upward sloping then is horizontal

if the value of the firm is more than £F. debt holders get a maximum of £F

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18
Q

How do you payoff to debt and equity holders of a corporation to shareholders?

A

if the value of the firm is more than £F, shareholders get everything above £F

algebraically, the shareholder’s claim is max [0, X - F]

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19
Q

How do you payoff to debt and equity holders of a corporation to shareholders in a diagram?

A

x axis, Value of the firm (X)
y axis, Payoff to shareholders

line is horizontal on the x axis a bit then is upward sloping

if the value of the firm is less than £F, shareholders get nothing

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20
Q

What is the structure of a corporation?

A
  1. Hire professional management to run the company
  2. This management buys productive assets
  3. They can buy these assets by borrowing money (debt), or by attracting shareholder’s capital (equity) by selling shares essentially

this is a legal entity and is a separate person away from investors

  1. Investors are debt holders that provide debt and talk directly to management about whether their debt is going to be repaid
  2. Shareholders do not directly have control over management, they provide equity capital, they are last to get money out of the assets, dont have control over a corporation.
    They get voting rights and allowed to vote for the directors on the board
  3. Board of directors, an oversight committee, look after the shareholders, can replace bad managers and the course of where the corporation is going
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21
Q

Who is an owner of a corporation?

A

someone who provides funds, takes the business risk and doesnt have any claim to pre-specified payment

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22
Q

Who has a financial stake in a corporation?

A

debit holders (creditors), are entitled to principal and interest
shareholders who receive dividends and capital gains, they are residual claimants

those who do not provide finance
- employees, customers, supplies, government

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23
Q

What is the internal organisational chart for a corporation?

A
  1. Board of Directors
  2. Chairman of the Board and Chief Executive Officer (CEO)
  3. President and Chief Operations Officer (COO)
    3a. Vice President Marketing
    3b. Vice President Finance (CFO)
    i. Treasurer
    ii. Controller
    3c. Vice President Production
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24
Q

What does the CEO do?

A

institutes rules and policies thats set by the board of directors

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25
Q

What does the COO do?

A

responsible for the day-to-day activity of the company and the person reports back to the CEO

26
Q

What does the CFO do?

A

responsible for managing financial risk for a company
has two teams that this person manages, treasurer and controller

27
Q

What does the controller do?

A

this person takes care of the accounting function, so record keeping

28
Q

What does the treasurer do?

A

manages cash, financial planning and capital expenditure

29
Q

What is within corporate finance?

A

financial management decisions including capital budgeting, capital structure, working capital management

and forms of business organisation including sole proprietorship, partnership and corporation

30
Q

What are 3 financial management decision?

A
  1. Capital budgeting
  2. Capital structure
  3. Working capital management
31
Q

What is capital budgeting?

A

how to spend money

32
Q

What is capital structure?

A

how to raise money and whether to issue debt or equity

33
Q

What is working capital management?

A

how to manage day-to-day cashflow and raise short term cash

34
Q

How do you think of capital structure in terms of a pie?

A

the value of the firm can be compared to a pie
the goal of the manager is to increase the size of the pie
the capital structure decision can be viewed as how best to slice up the pie
if how you slice the pie affects the size of the pie, then the capital structure decision is important

35
Q

What is the goal of a corporation?

A

to maximise shareholder value
- maximise the current value per share of the company’s existing stock
- maximise the market value of the existing owners’ equity

36
Q

What is the managers’ incentive?

A

the financial managers should act in the best interests of the stockholders

37
Q

What is an agency relationship?

A

someone (principal) hires another (agent) to represent his or her interests, eg shareholders and management

38
Q

What is an agency problem?

A

agents’ interest might be different from the principals’ goal - ‘conflict of interest’

39
Q

What are examples of management goals

A

to have a luxurious office or private jet

to spend more time with their families (might not work hard to maximise shareholders value)

to build an empire (making a firm as large as possible by raising funds and investing them, even into money-losing businesses)

40
Q

Example of an agency problem

A

Eg Own an old car you want to sell
Possible price £1000-£2000
Hire a friend to sell it for you, offer £100 to help you, does she have the incentive to try hard and sell it for £2000 probably not

how to solve this agency problem:
closely monitoring
Change your offer to 10% of the sales price

41
Q

How do you align managers’ incentive and stockholders’ interests?

A

managerial compensation and corporate control

42
Q

How is managerial compensation used to align managers’ incentive and stockholders interests?

A

incentives can be used to align management and stockholder interests

incentives need to be carefully structured to ensure that they achieve their goal (use of stock options, bonuses and promotions)

43
Q

How is corporate control used to align managers’ incentive and stockholders interests?

A

internal control: replace bad managers

external control: threat of a takeover may result in better management, firms with poor management may be taken over

44
Q

How do corporations raise money in a financial market?

A
  1. the corporation will issue financial securities onto the market and the investors will give cash to the corporation (money flows to the company from the investors)
    this money will be used to invest in productive assets (manufacturing)
  2. these productive assets should generate cash, cash flow from assets will flow out of the company
  3. this cash flow is used to pay taxes to the government, pay stakeholders, salaries. alot of this gets reinvested back into the company.
    also can include debt payments
  4. goal is to try get the dividends and debt payments over long period of time to be larger than the cost to the investors initially
45
Q

What is a financial market?

A

markets where debt and equity securities are bought and sold

46
Q

What are 2 examples of a financial market?

A
  1. London Stock Exchange (LSE)
  2. New York Stock Exchange (NYSE)
47
Q

What is a primary market?

A

where securities are issued for the first time, raising finance through capital markets (ie equity, bonds) and the money goes to firms

48
Q

What is a secondary market?

A

securities are traded between investors and the money goes to the ‘owner’ of securities

49
Q

What does a financial market look like in a diagram?

A

. Stocks and bonds
Firms————–>Investors
Money securities
<————| A——>B|
{Primary market} <——-
money
{secondary market}

50
Q

What do financial markets allow?

A

companies, governments and individuals to increase their investment choices

51
Q

How do savers use the financial market?

A

invest in financial assets so they can defer consumption and earn a return to compensate them for doing so

52
Q

How do borrowers use the financial markets?

A

they can invest in productive assets since they have better access to the capital

53
Q

What information do financial markets provide?

A

information about the returns that are required for various levels of risk

54
Q

What do financial assets claim on?

A

future cash flows

55
Q

What do financial assets differ in?

A
  1. maturity
  2. frequency of expected payments
  3. uncertainty of cash flows and/or final price
  4. ordering of repayment in case of bankruptcy
56
Q

What are the characteristics of debt: money market instruments (ie Treasury Bills)

A

short term maturity (usually less than 1 year)
issues by government, financial institutions or corporations

57
Q

What are the characteristics of debt: bonds?

A

maturity usually longer than 1 year,
issues by governments or corporations

58
Q

What are the characteristics of government bonds?

A

long term, usually fixed interest payments

59
Q

What happens in corporate bonds?

A

entitled to cash payments before equity holders

60
Q

What are the characteristics of equity: shares?

A

no maturity, variable payments (=dividends), last to be paid in case of bankruptcy

AcF100 (13 decks)

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