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Finance Final Exam Review

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Queen's University
COMM 121
Kory Salli

Finance Final Exam Review December 2013Chapter 1Lecture 12 Financethe study of how and under what terms savings money is allocated between lenders and borrower Capital budgeting capital expenditurethe process of making and managing expenditures on long lived assets Capital structurerepresents the proportions of the firms financing from current and long term debt and equity think of the firm like a pie composed of debt and equity Creditorsthe persons or institutions that buy debt from the firm Shareholdersthe holders of equity sharesValue of the firmdebtequity the shareholders claim on firm value at the end of the period is the amount that remains after the debtholders are paidthey get nothing if the firms value is equal to or less than the amount promised to debtholders or they get the residual of the firms value over the amount promised to debtholders if the firms value is greater than the amount promised to debtholders debt and equity are contingent claims on the total firm value Arbitrageexploiting price differences to earn riskless profit There must be an absence of arbitrageas soon as different interest rates are offered for essentially the same risk free loans arbitrageurs will take advantage of the situation by borrowing at the low rate and lending at the high rate The gap between both rates will be closed quickly ie Seinfeld video in classtravelling across state border to get more money for beer cans Sole proprietorshipa business owned by one person cheapest to own no corporate income taxes unlimited liability the life extends over the length of the sole proprietor equity money limited to proprietors personal wealth PartnershipsGeneral partnershipbusiness in which any two or more partners agree to provide some fraction of the work and cash to share the profits and losses Each partner liable for debtsLimited partnershippermit the liability of some of the partners to be limited to the amount of cash each has contributed to the partnership partnerships are inexpensiveeasy to form have life the length of any general partner taxed as personal income difficult to raise large amounts of cash Corporationa business that is a distinct legal entity that can issue stocks does not hold any shareholder personally liable has a perpetual life and has corporately taxed income Agency coststhe costs of resolving the conflicts of interest between managers and shareholders Direct agency costscosts of things like job perks corporate jet monitoringyou are spendingIndirect agency costscosts of a missed opportunity ie management buys the CEO an expensive painting missing the opportunity of a profitable investment managerial goals are different from those as shareholdersthe principal hires the agent management to represent his interest but agents have a tendency to be motivated by their expenses like company cars company dinners etc which definitely dont maximize shareholder wealth shareholder wealth maximization is considered the most appropriate goal to guide agents NOT accounting profit maximization since it changes with depreciation and ignores timingshareholders owners dont necessarily control managers depends on the costs of monitoring management the costs of implementing control devices and the benefits of control How can you address the conflict of interest a Compensation plansie stock options b Have a board of directorschosen by shareholders choose the management team c Market disciplineie layoff hostile takeover Financial Institutionsfacilitate flows of funds from savers to borrowers ie banks insurance companies etc Financial Marketsmarkets where you can trade financial instruments or claimssecuritiesshortterm debt securities are bought and sold in money marketslongterm debt and shares of stock are sold in capital markets Primary marketsrefer to the original sale of securities by governments and corporations ie an IPO Secondary marketsmarkets where these securities are bought and sold after the original sale either in an exchange or over the counter in a dealer market Foreign exchange marketthe market where one countrys currency is traded for another Direct financing involves financial intermediaries whereas indirect financing does not2 Major Categories of Financial Securities Debt Instruments Equity Instruments Commerical Paper Common stock Tbills and notes Preferred stock Mortgage loans BondsChapter 4Lecture 2 Financial intermediariesinstitutions that match borrowers and lenders traders Market clearingthe total amount of people who wish to lend to the market must equal the total amount of people that wish to borrow from the market If lenders wish to lend more than the borrowers wish to borrow the interest rate is too high and vice versa The interest rate that clears the market is the equilibrium rate of interestInvestment RuleBasic Principlean investment must be at least as desirable as the opportunities available in the financial markets ie you wont take on an investment whose return is 5 if the interest rate in the markets is 7 A Competitive market has three qualities 1 trading is costless 2 information about borrowing and lending opportunities is readily available to all market participants 3 there are many traders and no individual can move market prices price takersExample 1 A person has an income of 50 000 this year and 60 000 next year The interest rate r10 The figure shows all possible consumption opportunities open to the person through borrowing and lendingPoint A represents consuming nothing this year lending 50000 and everything second year incomeproceeds from the loan next yearA6000050000 110Point B represents spending everything this year including taking out a loan to spend next years incomeB5000060000110Point C represents spending 40000 of this years income this year and saving 10000next year you would be able to spend 6000010000110The line has a slope of 1r so that for each additional dollar spent today 1r less dollars can be spent next year
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