Managerial Finance > Chapter 1 > Flashcards

Chapter 1 Flashcards

Overview of Financial Management (54 cards)

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1
Q

Finance

A

Social Science that describes the creation, study, and management of money, banking, credit, assets, and liabilities under the conditions of certainty and uncertainty

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2
Q

3 Functions of Money:

A
  • Medium of Exchange
  • Store of Value
  • Unit of Account
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3
Q

Medium of Exchange

A

Money is used to facilitate the exchange of goods and services between individuals

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4
Q

Store of Value

A

An item people can use to transfer purchasing power from the present to the future

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5
Q

Unit of Account

A

The standard way of measuring and comparing the value of goods, services, and assets

  • Money is fungible and divisible
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6
Q

Fungible

A

Interchangeable with the same kind

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7
Q

Commodity Money

A

Takes the form of a commodity with intrinsic value

Ex/ Gold and Silver coins

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8
Q

Fiat Money

A

Money that has value because the government declares it to be legal currency

  • Not backed by intrinsic value
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9
Q

Personal Finance

A

Financial management of individuals and families, how to budget, plan, save and spend to meet goals for future life events

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10
Q

Public Finance

A

Study of finances that relate to sovereign states and related public entities

Ex/ Schools, etc

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11
Q

Corporate Finance
(Financial Management)

A

Study of firm’s capital structure, sources and uses of funds, capital markets, securities and portfolio valuation, financial institutions and risk

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12
Q

Capital Markets

A

Study of markets where interest rates, stock prices, and other financial assets are priced

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13
Q

Investments

A

Study of individual securities and markets, portfolio theory and analysis, and market efficiency

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14
Q

Financial Market

A

Place where individuals and organizations wanting to borrow funds are brought together with those having a surplus of funds

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15
Q

Asymmetric Information

A

One party in a transaction knows more than the other, giving them the advantage

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16
Q

Forms of Business Organization

A
  • Proprietorship
  • Partnership
  • Hybrid (LLC, LLP)
  • Corporation
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17
Q

Proprietorship

A

A business owned by a single individual

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18
Q

Partnership

A

A business owned by two or more individuals

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19
Q

Advantages to Partnerships / Proprietorships:

A
  • Easy and inexpensive to form
  • Subject to few government regulations
  • No corporate taxes
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20
Q

Disadvantages to Partnerships / Proprietorships

A
  • Unlimited personal liability for owners *
  • Life of the business is limited to the life of the owners
  • Difficult to transfer ownership
  • Difficult to raise large amounts of Capital
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21
Q

Limited Liability Company (LLC)

A

A hybrid between a partnership and corporation

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22
Q

Limited Liability Partnership (LLP)

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A

Partnership, but are not responsible for the firm’s debts beyond what they invested

23
Q

Advantages of hybrid forms:

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A
  • Limited liability for owners
  • Relatively few government regulations
  • Investors can vote in proportion to their ownership stake
  • No corporate taxes
24
Q

Disadvantages of Hybrid Forms:

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A
  • Can be difficult/expensive to set up
  • Life of business limited to the life of the owners
  • Difficult to transfer ownership
  • Difficult to raise large amounts of capital
25
Corporation
A legal entity created by a governmental body that is separate and distinct from its owners and managers
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S Corporation
Designation that allows small business to enjoy benefits of corporate structure but be taxed as if it were a partnership
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C Corporation
Any US. corporation that is taxed separately from its owners and pays corporate taxes - typically, bigger corporations
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Advantages of Corporations:
- Limited liability of owners - capped at total amount of investment - Unlimited life - Relatively easy to transfer ownership - Easier to raise capital
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Disadvantages of Corporations
- Double taxation: any profits distributed to owners is after-tax income - Relatively difficult and expensive to set up - High level of government regulation
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Individual Securities
Single financial assets you can buy or sell on their own Ex/ One stock, one bond, etc
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Portfolio
Collection of investments that someone owns and manages together as a group
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Behavioral Finance
The study of how human psychology causes people to make financial decisions that are not perfectly rational - Examined to determine whether stock prices are unreasonably high/low
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Board of directors
The top governing body in a business who make the big-picture decisions - Oversees management and major decisions
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Chair
Head of the board
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Chief Executive Officer (CEO)
The person who runs the company and makes the major decisions about its direction - Head of management - Reports to the board of directors
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Chief Operating Officer (COO)
Executive who runs the day-to-day operations of a company (Marketing, sales, manufacturing, etc) - Manages internal processes - Oversees daily operations - "Organizer"
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Chief Financial Officer (CFO)
The executive who manages a company's money and financial decisions - In charge if accounting, finance, budgeting, financial reporting, credit policy
38
Intrinsic Value
An estimate of a stock's "true" value based on accurate risk and return data - Long-run Process - Can be estimated, not precisely measured * Management's goal should be to maximize intrinsic value, rather than market price for long-run gain
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Market Price
Current price at which the stock is being bought and sold in the market right now
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Market Equilibrium
When a stock's actual market price is equal to its intrinsic value - Investors are indifferent between buying/selling stock
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Corporate Raiders
Individuals who target corporations for takeover because they are undervalued
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Takeover
When an outside individual/company buys enough of a company's shares to gain control of it
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Hostile Takeover
When an outside individual/company tries to gain control of a company without the approval of its management or board of directors
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Debtholders
Someone who lends money to a company or government and is owed with repayment with interest - Generally, receives fixed payments, regardless of company performance - Want lower risk - opposing incentive to stockholders
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Stakeholder
Any person or group that is affected by, or has interest in, a company's decisions and performance Ex/ Employees, customers, suppliers, etc
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Management's Main Goal:
Maximize Shareholder Wealth
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3 Problems Arising from Asymmetric Information:
- Adverse Selection - Moral Hazard - Principal-Agent Problem
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Adverse Selection
Any situation in which an uninformed party gets the wrong people wanting to trade with them Ex/ Used car buyers purchasing defective vehicles Remedies: - Warranties - Consumer Education
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Moral Hazard
Happens when one party takes more risks because someone else will bear the cost Ex/ Insurance markets, subprime mortgages - Occurs after a market transaction Remedies: - Deductibles - Incentivize/reward good behavior - Penalize bad behavior
49
Principal-Agent Problem
The agent (who is hired to act on behalf of the principal) knows more about their actions than the principal (owner) does and may use that information advantage to act in their own interest instead of the principal’s. - Ex/ Restaurant owner / bartender, Athlete / owner * Principal and agent have divergent interests Remedies: - Performance-based contracts - Regulation and monitoring
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Incentives for Management Behavior: (Examples)
- Performance-based compensation - Stock options - Threat of firing - Threat of Hostile Takeover
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Functions of Financial Markets:
- Provide ways to transfer economic resources through time, across borders and among sectors and industries - Provide essential information to facilitate and coordinate decentralized decision-making. - Provide a way to manage risk. - Provide a means to facilitate trade. - Provide a means for pooling resources and subdividing ownership interests. - Provide means to deal with problems arising from asymmetric information.
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Stockholders' vs Bondholders Conflict:
Stockholders want more risk → more upside Bondholders want less risk → they only get fixed payments
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Market Price vs Intrinsic Value
Market Price: The actual price the stock is trading for in the market right now - Based on supply and demand - Changes constantly Intrinsic Value: The true value of the stock based on fundamentals Based on: - Expected future cash flows - Risk - Growth - If Intrinsic Value > Market Price → stock is undervalued (BUY) - If Intrinsic Value < Market Price → stock is overvalued (SELL)
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