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COMM 121

COMM 121 Chapter 1 1.1 What is corporate finance? 1. Capital budgeting: the process of making and managing expenditures on long-lived assets (capital expenditure) – left side of balance sheet 2. Capital structure: the proportions of the firm’s financing from current and long-term debt and equity – right side of balance sheet - V (value) = B (bonds) + S (shares) 3. Net working capital: (current assets – liabilities) the mismatching of cash inflows and outflows - Financial managers: create value from firm’s capital budgeting, financing, and liquidity activities - Timing of cash flows: one dollar received today is worth more than one dollar received next year because today’s dollar can be invested to earn interest 1.3 The Corporate Firm - Partnership & Sole Proprietors: advantage = cost of getting started, disadvantages = (1) unlimited liability (2) limited life of the enterprise (3) difficulty of transferring ownership - Corporation: difficult to start- become their own citizen of its province of incorporation o Shareholders (the owners) o Directors o Corporation officers (top management) - Income trusts: hold the debt and equity of an underlying business and distribute the income generated to unitholders 1.4 Goals of the Corporate Firm - Shareholders and managerial interest conflict – pricey to enforce agency costs - Managers: survival, independence, and self-sufficiency (corporate wealth) - Stakeholder concerns are attaining additional clout through the growth of interest in ethical or socially responsible investing 1.5 Financial Institutions, Financial Markets, and the Corporation - Financial institutions: intermediaries between investors and firms raising funds - Money markets: where short-term debt securities of many varieties are bought and sold - Capital markets: for long-term debt and shares of stock - Primary market: the corporation is the seller and raises money through the transaction - Secondary market: one owner or creditor selling to another (auction and dealer markets) - Foreign exchange market: where one country’s currency is traded for another’s 1.6 Trends in Financial Markets and Management - Hedgefunds: collective term for different types of investment funds Chapter 4 4.1 The Financial Market Economy - Market clearing: the total amount one party wishes to lend equals the total amount that the others would like to part - Equilibrium rate of interest: an interest rate that clears the market ç 4.3 The Competitive Market - Assume Perfectly competitive financial markets: trading is costless, borrowing and lending is readily available, the single trader can have a significant impact 4.6 Illustrating the Investment Decision - Net present value rule: an investment is worth making if it has a positive NPV Chapter 5 5.1 The One-Period Case - Future value (compound value): the value of a sum after investing over one or more periods. - Present value (PV): C /(1+r) where C is ca1h flow at date 1 and r is interest rate - Net Present Value of Investment = cost today (negative) + present value of next year’s sales price 5.2 The Multiperiod Case - Compounding: the process of leaving money in the capital market and lending it for another year - Simple interest: r is interest on interest - Compound interest: each interest payment is reinvested - Future Value of an Investment: FV = C x (1+r) where T is the number of period over which the 0 cash is invested - Discounting: the process of calculating the present value of a future cash flow - Present Value Factor: the factor used to calculate the present value of future cash flow PV= (C/(1+r) )x 5.3 Compounding Periods m - C 01+r/m) where r is the stated annual interest at m times a year - Effective annual interest rate: the annual rate of return m (1+r/m) – 1 - Future value with compounding: FV = C (1+r/m)0 mT for T years - Continuous compounding: to compound every infinitesimal instant C0x e rT 5.4 Simplifications - Perpetuity: a constant stream of cash flows without end - Formula for present value of perpetuity: PV = C/r - Growing perpetuity: assuming that the rise will continue indefinitely - Formula for present value of growing perpetuity: PV = C/ (r-g) where g is growth per period - Annuity: a level stream of regular payments that lasts for a fixed number of periods T - Formula for present value of annuity: PV = C [(1/r) – (1/(r(1+r) ))] - Annuity factor: the term we use to compute the value of the stream of level payments, C, for T years - Mortgages: annuity with monthly payments - Growing annuity: finite number of growing cash flows - Formula for present value of growing annuity: PV = C [ (1/(r-g)) – (1/(r-g)) X ((1+g)/(1+r)) ] T Chapter 6 6.1 Definition and Example - Bond: a certificate showing that a borrower owes specified sum 6.2 How to Value Bonds - Pure discount bond: promises a single payment at a fixed future date - Maturity date: the date the issuer of the bond makes the last payment - Face value: payment of bond at maturity - Value of pure discount bond: PV = F/(1+r) T - Coupons: cash issued at regular times before reaching maturity - Value of a level-coupon bond: PV = C[(1/r) + (1/(r x (1+r) ))] + F/(1+r) T T Or PV = C X + F/(1+r) - Clean price: quoted price net of “accrued interest” - Dirty price: price actually paid that includes accrued interest - Consols: bonds that never stop paying a coupon 6.3 Bond Concepts - Trade at a face value of $1000 if he coupon rate is equal to the marketwide interest rate - Trade at discount if the coupon rate is below the marketwide interest rate - Trade at a premium if he coupon rate is above the market wide interest rate - Discount: to sell the bond at lesser value - Premium: to sell the bond at greater value - Yield to maturity: percent return - Holding-period return = (ending price – beginning price)/ Beginning price 6A Appendix - Spot rates: different rates of interest over different years - Term structure: describes the relationship of spot rates with different maturities - Forward rate: hypothetically return the second year of a spot rate - Forward rate:
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