Foundations Of Finance Exam 1

Front 1

goal of the firm in terms of finance

Back 1

maximization of shareholder wealth or rather maximization of existing common stock

Front 2

goal of the firm in a microeconomics class

Back 2

profit maximization

Front 3

what does microeconomics commonly ignore to present profit maximization?

Back 3

uncertainty and risk to present theory more easily

Front 4

Ther is a very definite relationship between risk and expected_______/

Back 4

return

Front 5

who are the shareholders?

Back 5

legal owners of the firm

Front 6

sole propeietorship

Back 6

a business owned by an individual

- owner retains the title to assets and all liabilities
- gets both all profits and losses
- no legal requirement must be met to start up
- termination occurs upon owner's death or owner's choice
- "the absence of any formal legal structure"

Front 7

partnership

Back 7

an association of two or more individuals joining together to operate a business for profit

Front 8

two types of partnerships

Back 8

1. general partnership
2. limited partnership

Front 9

general partnership

Back 9

partnership in which all partners are fully liable for the indebtness incurred by the partnership (can be oral or formal agreement)

Front 10

limited partnership

Back 10

partnership in which all one or more of the partners has limited liability restricted to the amount of captial he or she invests in the partnership

Front 11

Several conditions to qualify as a limited partner

Back 11

1. At least one general partner must have unlimited liability
2. the names of the limited partners may not appear in the name of the firm
3. limited partners may not participate in the management of the firm

Front 12

A limited partnership provides ____ _____ for a partner who is purely a(n)_____.

Back 12

limited liability; investor

Front 13

corporation

Back 13

an entity that legally funcitions separtate from its owners

Front 14

Organizations can ____ and be _____.

Back 14

sue; sued

Front 15

A corporation does not have owners.

Back 15

False, stock holders are the owners of the company

Front 16

How is a owner's liability in a corporation determined? Is this an advantage? Why or why not

Back 16

the number of stocks owned relative to the number of shares outstanding. This is an advantage because it prevents creditors from confiscating stockholders' personal assets in settlement of unresolved claims

Front 17

The life of a corporation is ________ on the status of investors.

Back 17

not dependent

Front 18

What is the ideal form of business in terms of raising new capital

Back 18

corporation

Front 19

What forms of business are deterrent to raising equity capital?

Back 19

sole proprietorship and general partnerships

Front 20

What is a major drawback for a corporation's owners in terms of taxes?

Back 20

dividends are doubly taxed

Front 21

Qualified dividends and foreign corporations are taxed at what maximum rate?

Back 21

15%

Front 22

When will the Tax Act of 2003 end if Congress does nothing?

Back 22

2011

Front 23

s type corporation

Back 23

a corporation that because of specific qualifications is taxed as though it were a partnership

Front 24

What is one restriction that an s type has on its owners?

Back 24

the must all be people

Front 25

Are s type corporations rising or declining over the years?

Back 25

declining

Front 26

limited liability company

Back 26

a cross between a partnership and a corporation under which the owners retain limited liability but the company is run and is taxed like a partnership

Front 27

Limited liabilities provide more _____ than s type corporations

Back 27

flexibility

Front 28

Corporations can be owners in LLCs

Back 28

True

Front 29

LLCs operate under federal law only.

Back 29

False. LLCs operate under both federal and state rules

Front 30

duties of a CFO

Back 30

1. oversee financial planning
2. corporate strategic planning
3. control corporate cash flow

Front 31

shelf registration

Back 31

SEC provision that allows a single registration document to be filed for multiple securities. It is a registration of a new issue that may be prepared up to 2 years in advance

Front 32

opportunity cost of funds

Back 32

want the rate of return on the next best investment alternative to the saver (rate of returns must be competitive with each other)

Front 33

maturity premium

Back 33

additional return required by investors in long term securities to compensate them for higher risk of price fluctuations on securities caused by interest rate changes

Front 34

liquidity premium

Back 34

additional return required by investors in long term securities that cannot be easily converted to cash at a reasonably predictable price

Front 35

nominal rate of interest

Back 35

interest rate paid on securities w/o adjustment for loss of how much more money power you will have

-The rate read in the WSJ for a specific income security

Front 36

Real rate of interest

Back 36

the nominal (quoted) rate less any loss in purchase power during the time of investment

- the rate of increase in actual purchasing power after adjustment for inflation

Front 37

term structure of interest rates

Back 37

the pattern of rates of return for debt securities that differ only in length of time to maturity

- normally the yield curve will be upward sloping, meaning that the longer a securities is held, the more likely there is a higher return

- in a recession, the term may be downward slopping or inverted if the rates are expected to fall

Front 38

the symbol for risk free interest rate

Back 38

krf

Front 39

the symbol for risk free interest rate

Back 39

k*

Front 40

the symbol for risk premium

Back 40

IRP

Front 41

mathematical formula for the real return of interest

Back 41

(1+krf)=(1+k*)(1+IRP)

Front 42

what are securities?

Back 42

financial assets that investors are hoping to earn a high return on

Front 43

what happens during a direct transfer of savings?

Back 43

the saver gives cash to the firm and the firm gives securities back to the saver

Front 44

what happens during an indirect transfer of funds using an investment banker

Back 44

the saver gives the funds to the banker, the banker gives the funds to the firm and it is the FIRM that gives securities to the saver

Front 45

what happens during an indirect transfer using a financial intermediary

Back 45

the saver gives the money to a the f.i. who gives the fund to the firm. The firm gives securities to the f.i. who then gives securities to the saver

This provides the saver with a sense of security

Front 46

unbiased theory

Back 46

the term structure is determined by the expectations of future rates

Front 47

liquidity preference

Back 47

investores require risk premiums to invest for longer terms

Front 48

market segmentation theory

Back 48

there are separate markets for long and short term investemnts

Front 49

financial markets

Back 49

markets where financial capital is raised. Long term funds are raised in the capital markets

Front 50

real assets

Back 50

physical assets such as gold, land, equipment,patents, etc. They are desirable in times of high inflation

Front 51

Financial assets

Back 51

securities not tangible. Derives value from a contractual claim and includes items such as stocks, bonds, bank deposits, etc

Front 52

direct securities

Back 52

securities obtained directly frm the company

Front 53

indirect securities

Back 53

securities obtained by an intermediary

Front 54

public offering

Back 54

security offering where all investors have the opportunity to acquire a portion of the financial earnings being sold

Front 55

private placement

Back 55

security offered to a limited group of potential investors

Front 56

advantages to private placements

Back 56

1. speed- there is no registration with the SEC required

2.reduced costs- No need to register with SEC (that costs $$)

3. Financing flexibility- face to face interaction with investors can means that their needs and specifications can be tailored and individualized for each investor

Front 57

Disadvantages of private placements

Back 57

1. interest costs- interest costs here generally exceed that of the public offerings

2. restrictive covenants- dividends policies and raising more debt capital may be affected by provisions in the private placement debt contract

3. Possible future SEC registration- if the company wants to go public, it must register its issue w/the SEC

Front 58

flotation costs

Back 58

the transaction costs incurred when a firm raises funds by issuing a particular type of security

Front 59

types of flotation costs

Back 59

1) underwriter's spread
2)issuing costs

Front 60

underwriter's spread

Back 60

the difference between gross and net proceeds from a given security issue expressed as a percent of the gross proceeds

Front 61

issue costs

Back 61

1. printing and engraving of security certificates
2. legal fees
3. accounting fees
4. trustee fees
5. miscellaneous fees

Front 62

Costs associated with issuing common stock are ________ than costs associated with preferred stock offerings

Back 62

higher

Front 63

Costs associated with preferred stocks are ________ than those of bonds

Back 63

higher

Front 64

Flotation costs (as a percentage of gross proceeds) _________ as the size of the security ________

Back 64

decreases; increases

Front 65

What are flotations costs' relationship to a securities' risk?

Back 65

The flotation cost merely mirrors the risk associated with a security

Front 66

Private placement is a ______ ______

Back 66

distribution method

Front 67

negotiated purchase

Back 67

firms that need funds contact the investment banker and both deliberated over the new issue. If all goes well, they choose a method for determining the price of the investment banker/syndicate

-most prevalent among private sector

- most profitable for investment bankers

Front 68

competitive bid purchase

Back 68

underwriting groups make bids for the right to purchase; the firm does not directly sell. An auction is held and whoever pays highest dollar per security wins the account

Front 69

what securities most likely use competitive bid purchase?

Back 69

1. railroad issues
2. public utility issues
3. state and municipal bond issues

Front 70

Reason for favoring a competitive bid purchase?

Back 70

any undue influence of an investment banker over the firm will be mitigated and the price received by the firm will be higher

Front 71

Problem with competitive bid purchases from a firm's perspective?

Back 71

benefits gained from the advisory function of the investment banker are lost

Front 72

commission/ best efforts process

Back 72

-Investment banker acts as an agent
-securities are not underwritten
-used for more speculative purchases
-investment banker tries to sell the issue in return for a fixed commission on each security actually sold
-Securities not sold are returned to the company
-no underwriting=less risk for i. bankers
-less costly to the issuer
-successful sale is not guaranteed

Front 73

privileged subscription

Back 73

- marketing a security issue to a definite and select group of investors
- some i.bankers act only as the selling agent
- others have to sign a standby agreement which obligates them to underwrite anything not sold

Front 74

three target markets for a privileged subscription

Back 74

1) current stockholders
2) employees
3) customers of the firm

Front 75

Which target market is most common for privileged subscriptions?

Back 75

current stockholders; they recieve right offerings

Front 76

dutch auction

Back 76

a method of issuing securities where investors place bids indicating how many shares they are willing to purchase and at what price. The price of the stock is then sold for becomes the lowest price at which the issuing company can sell all of the available shares

Front 77

direct sale

Back 77

the sale of securities by a corporation without the services of an investment banking firm

Front 78

Securities act of 1933

Back 78

Goals:
1. ensure transparency in financial information

2. Establish financial laws against fraudulent behavior

-companies required to register with the SEC for better disclosure and provide potential investors with relevant information

Front 79

Securities Exchange Act of 1934

Back 79

established the SEC; all companies on the stock exchange must follow SEC requirements including registering securities, disclosure, proxy solicitations and margin and audit requirements

Front 80

Securities Acts Amendments of 1975

Back 80

congressional amendment to securities act of 1933 to establish a national market system and encourage fair and efficent handling of securities

Front 81

capital market

Back 81

all institutions and procedures that facilitate transactions in long term financial instruments

Front 82

investment banker

Back 82

a financial specialist who underwrites and distributes new securities and advises corporate clients about raising new funds

Front 83

shelf registration

Back 83

an SEC provision that allows a single registration document to be filed for multiple securities it is a registration of a new issue that may be prepared up to 2 years in advance

Front 84

yield to maturity

Back 84

rate of return a bond holder will receive if the bond is held to maturity

Front 85

secondary market

Back 85

market where outstanding securities are sold (consumers)

- transactions occur from investor to investor

Front 86

primary market

Back 86

market in which securities are offered for the first time for sale to potential investors (usually in high volume, to large investment companies)

Front 87

money market

Back 87

all institutions and procedures that facilitate transactions for short term instruments and issued by borrowers with very high credit scores

Front 88

syndicate

Back 88

a group of investment bankers who contractually assist in the buying and selling of a new security issue

Front 89

functions of an investment banker

Back 89

1. Underwriting
2. Distributing the securities to the hands of the ultimate investors
3. Advising

Front 90

stock exchange benefits

Back 90

1. provide a continuous market (price volatility is reduced)
2. establishing and publicizing fair security prices
3. Helping Businesses raise new capital

Front 91

Listing requirement considerations for the NYSE

Back 91

1. profitability
2. size
3. market value
4. public ownership

Front 92

NASDAQ

Back 92

a computerized network that provides a link for brokers and dealers operating in the over the counter markets. NASDAQ is a quoting system, not a transaction system. Transactions are done by direct negotiation between traders. It houses more securities than the NYSE

Front 93

Avaliability of prices is not as _____________ in the over-the-counter market as it is on organized exchange

Back 93

continuous

Front 94

future markets

Back 94

can buy or sell something at some future date; you sign a contract that states what you're buying how much of it you're buying, at what price you will buy it and when you will make the purchase

Front 95

spot markets

Back 95

buy today, receive today

Front 96

organized security exchanges

Back 96

tangible entities that occupy space and financial instruments are traded on there premises

Front 97

Examples of organized security exchanges

Back 97

NYSE, AMEX, smaller exchanges in Philadelphia, Boston, Chicago, Cincinnati and the Pacific Stock Exchange

Front 98

NYSE

Back 98

oldest organized security exchange, considered the bigg player, over half of trading takes place there

Front 99

seasoned equity offering

Back 99

the sale of an additional stock by a company whose shares are already publicly traded

Front 100

venture capital

Back 100

funds made available to start up companies or companies in the early stages of business, as well as firms in "turnaround" situations". These are risky investments generally in innovative enterprises and many times in high tech areas

Front 101

term structure

Back 101

the relationship between interest rates and the term of maturity, where the risk of default is held constant

Front 102

income statment

Back 102

profit and loss statement- a basic accounting statement that measures the results of a firm’s operations over a specific period, commonly 1 year

Front 103

balance sheet

Back 103

a statement that shows a firm’s assets, liabilities, and shareholders equity at a given point in time. It is a snapshot of the firm’s financial position on a particular date

Front 104

current assets are also known as ...

Back 104

gross working capital

Front 105

fixed assets

Back 105

buildings, equipment,land

Front 106

debt

Back 106

liabilities consisting of credit extended by suppliers or loans from the bank

Front 107

equity

Back 107

stockholder's investment in the firm and cumulative profits retained in the business up to date of the balance sheet

Front 108

equity

Back 108

stockholder's investments in the firms and cumulative profits retained in the business up to date of the balance sheet

Front 109

working capital

Back 109

a concept traditionally defined as a firm's investments in current assets

Front 110

THE MOST BASIC FORMULA IN ACCOUNTING (evah!)

Back 110

assets= liabilities + equity

Front 111

Income statement format

Back 111

Operating Activities
Sales
Less: CGS
=Gross Profit
Less: Operating expenses
(marketing, depreciation, administrative expenses)
= NOI/EBIT

Financing Activities
Less: Interest Expense
(cost of borrowing money)
=Earnings before taxes
Less: income taxes
= Net Income (earnings available to common stock holders

Front 112

What does not matter when calculating corporate tax liability?

Back 112

the dividends paid last year to stockholders (cross them out)

Front 113

current assets examples

Back 113

- cash
-accounts receivable
-inventories
-other current assets

Front 114

fixed assets

Back 114

-machinery and equipment
-buildings
-land

Front 115

other assets

Back 115

-goodwill
-patents

Front 116

current liablities

Back 116

-accounts payable
-accrued expenses
-short term notes

Front 117

long term liabilities

Back 117

debt
mortgages

Front 118

equity

Back 118

-preferred stock
-common stock
-retained earnings