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27 Cards in this Set

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Finance

System that includes the circulation of money, the granting of credit, the making of investments, and the provision of banking facilities.




Divided into three areas:


1. Financial management


2. Capital markets


3. Investments


(PG 4)



Financial Management(Corporate Finance)

Focuses on decisions related to how much and what type of assets to acquire, how to raise the capital needed to purchase the assets, and how to run the firm as to maximize its value. (PG 4)

Capital Markets

relate to the markets where interest rates, along with stock and bond prices, are determined. (PG 4)

Investments

relate to decisions concerning stocks and bonds and include a number of activities, including security analysis(finding proper values of individual debt and equity securities), portfolio theory(way to structure portfolios such as not putting all eggs in one basket), and market analysis(deals with the issue of whether stock and bond markets are "too high," "too low," or just "about right."




(PG 4)



Behavioral finance

Investor psychology is examined to determine why stock prices have bid up or bid down. (PG 4-5)

4 Main Forms of Business Organizations

1. Proprietorships


2. Partnerships


3. Corporations


4. Limited Liability Companies(LLCs) and Limited Liability Partnerships(LLPs)


(PG 6)

Proprietorship

Unincorporated business owned by one person




Three important advantages:




1. Inexpensive and easy to form


2. less government regulations


3. lower income taxes relative to corporations.






Three important disadvantages:


1. Unlimited liability


2. Limited ability to acquiring capital


3. Life of business limited to the life of the owner.




(PG 7)

Partnership

Legal arrangement between two or more people who decide to do business with each other.




Advantages: Relatively inexpensive and easy to establish, income allocated on a pro rata basis and partners taxed individually(no corporate income tax).




Disadvantages: All partners subject to unlimited liability, limited in acquisition of capital because of unlimited liability. (PG 7)

Corporation

Legal entity created by a state, and it's separate and distinct from its owners and managers; limits stockholders losses to the amounts they invested in the business.

Advantages: Unlimited lives, limited liability, easier to transfer stocks in a corporation than to transfer one's interest in an unincorporated business, Easier to acquire large amounts of capital.

Disadvantages: Double Taxation; Corporation's earnings taxed, then when it's after-tax earnings are paid out as dividends, those earnings are taxed again as personal income to the shareholders. (PG 7)

S Corporation

Corporations that are taxed as if they are Proprietorships or partnerships, thus they are exempt from corporate double taxation; To qualify, a firm can have no more than 100 stockholders, limiting their use to small, privately owned firms. Larger Corporations such as HP are known as C corporations. (PG 8)

Limited Liability Corporation(LLC)

Popular type of organization that is a hybrid between a partnership and a corporation. Provide limited liability to its owners and are taxed like a partnership. Not like a limited partnership where the general partner has full control of the business, but rather the investors have votes in proportion to their ownership interest. (PG 8)

Limited Liability Partnership(LLP)

Similar to an LLC, but are used for professional firms in the fields of accounting, law, and architecture, while LLCs are used by other types of businesses. (PG 8)

Why the value of most businesses would be maximized as a corporation

1. Limited Liability reduces the risks borne by investors; lower risk raises the firm's value.


2. A firm's value is dependent on its growth opportunities, which are dependent on its abilities to attract capital(corporations are the best at this).


3. Asset's value depends on it's liquidity and corporate investments(stocks and bonds) are relatively more liquid than interest in a partnership or proprietorship. (PG 8)

Intrinsic Value

An estimate of a stock's "true" value based on accurate risk and return data; can be estimated, but not measured precisely.(PG 10)



Managements goal should be to maximize the firm's intrinsic value, rather than its current market price. Doing this will maximize the firm's average price over the long run, but not necessarily the current price at each point in time. (PG 11)

Market Price

The stock value based on perceived(but possibly incorrect) information as seen by the marginal investor. Since not all investors agree, it's the "marginal" investor who determines the actual price. (PG 10)

Equilibrium

When a stock's actual market price is equal to its intrinsic value; when it exists, there is no pressure for a change in the stock's price. (PG 10)

Motivational tools to make managers act in the best interest of stockholders

1. Reasonable compensation packages


2. Firing of managers who don't perform well


3. The threat of hostile takeovers


(PG 13)

Compensation Packages

Should be sufficient to attract and retain able managers, but not go beyond what is needed. Should be structured in a way that managers are rewarded on the basis of the stock's performance over the long run, not the stock's price on an option exercise date. (PG 13)

Direct Stockholder Intervention

Stocks used to be owned mostly by individuals, but now institutional investors(pension funds, hedge funds, etc) are the majority owners of stocks. Due to their clout, they act as lobbyists for the body of stockholders and have effective influence on the management of a corporation. Also, the SEC has adopted changes to proxy rules to give shareholders the right to nominate directors of the company's board. (PG 13)

Corporate Raiders

Individuals who target corporations for takeover because they are undervalued. (PG 15)

Hostile Takeover

The acquisition of a corporation over the opposition of its management. (PG 15)

Manager's Response

The threat of hostile takeover from corporate raiders, gives managers the incentive to maximize the firm's average price over the long run, which will maximized if they focus on the stock's intrinsic value; however, they should be striving to communicate this information effectively to stockholders as to keep the actual price close to the intrinsic value. (PG 15)

Stockholder-Debtholder Conflicts

Stockholders and debtors experience conflicts, because a stockholder's rate of return depends on how well a company does, while a debtholder's rate of return doesn't.




This would lead to situations, which managers decide to take on riskier projects, which give stockholders higher rate of returns, but don't benefit debtholders at all.




Debtholders also try to limit the use of additional debt, because if a corporation has more debt, then it becomes harder for them to pay off their outstanding obligations, and debtholders suffer a loss as a consequence. (PG 16)

Shareholder Wealth Maximization

Primary goal for managers of publicly owned companies is to maximize the long-run value of the firm's common stock, but while behaving ethically, and following the laws and society imposed constraints.

Business Ethics

Can be thought of as a company's attitude and its conduct towards its employees, customers, community, and stockholders; related to reputation (PG 19)

What Companies Are Doing

Most firms today have strong written codes of ethics and offer training programs to employees on ethical behavior, but conflicts arise involving profits and ethics in which the right choice is unclear. (PG 19)

Consequences of Unethical Behavior

1. Bankruptcies and financial collapses of firms such as Enron and WorldCom.


2. Tarnishes reputation


3. Perception of widespread improprieties has caused investors to lose faith in American business and turn away from the stock market, making it harder for firms to acquire capital.




(PG 20)