ECON 2560 Midterm review
Chapter 1: Terms
Corporation: Business owned by shareholders who are not personally liable for the
Limited liability: Principle that the owners of the corporation are not personally
responsible for its obligations
Public Company: corporation whose shares are listed for trading on a stock exchange
Private Company: corporation whose shares are privately owned
Sole proprietorships: Owned and operated by one individual, responsible for all the
business’ debts and other liabilities. Bank can target personal belongings if loan payments
can’t be made
Partnership: similar to sole proprietorship, partners also have unlimited liability and
must agree on how earnings will be divided.
Capital Budgeting Decision/ Investment decision: Decision as to which real assets the
firm should acquire
Financing Decision: Decision as to how to raise the money to pay for investments in real
Capital Structure: A firm’s mix of long term financing
Real assets: Assets used to produce goods and services
Financial Assets: Claims to the income generated by real assets. Also called Securities.
Treasurer: Manager responsible for financing, cash management, and relationships with
financial markets and institutions
Controller: Officer responsible for budgeting, accounting and auditing.
Chief Financial Officer (CFO): Officer who oversees the treasurer and controller and
sets overall financial strategy.
Agency Problems: Conflict of interest between the firm’s owners and managers
Stakeholder: Anyone with financial interest in the firm.
Chapter 2: financial markets and institutions Primary Market: Market for the sale of new securities by corporations
Secondary Market: Market in which already issued securities are traded among
FixedIncome Market: Market for debt securities
Capital market: Market for longterm financing
Money Market: Market for short term financing (less than a year)
Financial Institution: A bank, insurance company or similar financial intermediary
Financial Market: Market where securities are issued and traded
Pension Fund: Investment plan set up by an employer to provide for employees’
Private Equity Fund: Investment fund focused on investing in equity of privately owned
Financial intermediary: An organization that raises money from investors and provides
financing for individuals, corporations or other organizations
Mutual Fund: A managed investment fund, pooling the savings of many investors and
investing in a portfolio of securities
Exchangetraded fund: An investment fund, traded on a stock exchange, that pools the
savings of many investors and invests in a portfolio of securities, selected to replicate an
established securities index.
Liquidity: The ability to sell or exchange an asset for cash on short notice
Cost of Capital : Minimum acceptable rate of return on capital investment
Chapter 3: Accounting and Finance: Balance Sheet: Financial statement that shows the value of the firm’s assets and
liabilities at a particular time
Generally Accepted accounting principles (GAAP): Procedures for preparing financial
Book value: Net worth of the firm according to the balance sheet (EX: bought equipment
for 1 million two years ago, but would now sell for 1.3 Million. Book value = 1 million,
market value = 1.3mil
Income Statement: Financial statement that shows the revenues, expenses and net
income of a firm over a period of time. (measures profitability)
Statement of Cash flows: Financial statement that shows the firm’s cash receipts and
cash payments over a period of time. (sources and uses of cash during the year) The
change in company’s cash balance is the difference between sources and uses
Cash flow from assets: Cash flow generated by the firm’s operations, after investment in
working capital and fixed assets. Also called free cash flow.
Financing flow: Cash flow to bondholders and shareholders plus increase in cash
balances; also equals cash flow to assets.
Marginal tax rate: Additional taxes owed per dollar of additional income
Average Tax Rate: Total taxes owed divided by total income
Chapter 3 Summary Investors and other stakeholders in the firm need regular financial
information to help them monitor the firm’s progress. Accountants summarize this
information in balance sheet, income statement and statement of cash flows.
Income is not the same as cash flow. Investment in fixed assets is not deducted
immediately from income, but is spread over the expected life of equipment, and the
accountant records revenues when a sale is made, rather than when the bill is paid.
Cash flow from assets measures the cash generated through operating activities and after
making necessary investments in net working capital and fixed assets. Either distributed
to firm’s investors, creditors, and shareholders, or held in reserve by the firm as cash and
marketable securities. Must equal Financing Flow of the firm.
Chapter 5 Bond: security that obligates the issuer to make specified payments to the bondholder
Coupon: The interest payments paid to the bondholder
Face value or principal: Payments at the maturity of the bond. Also called par value, or
Coupon Rate: Annual interest payment as a percentage of face value
Accrued interest: Coupon interest earned from the last coupon payment to the purchase
date of the bond. = Coupon payment X number of days from last coupon to purchase
date/number of days in coupon period
Clean Bond Price: Bond price excluding accrued interest
Dirty Bond Price: Bond price including accrued interest.
Current Yield: Annual Coupon payment divided by bond price
Premium Bond: Bond that sells for more than its face value
Discount Bond: Bond that sells for less than its face value
Yield to Maturity: Interest rate for which the present value of the bond’s payments
equals the price. Ex. Buying 3 year bond at face value, yield to maturity is the coupon
rate, 10%. $100/(1.10) + 100/(1.10)^2 + 1100/(1.10)^3 = $1,000
Rate of Return: Total income per period per dollar invested. = coupon income + price
change divided by investment
Yield curve, or Term structure of interest rates: Graph of the relationship between
time to maturity and yield to maturity, for bonds that differ only in their maturity dates.
Real Return Bond: Bonds with variable nominal coupon payments, determined by a
fixed real coupon payment and the inflation rate.
Fisher Effect: The nominal interest rate is determined by the real interest rate and the
expected rate of inflation.
Interest rate risk: The risk in bond prices due to fluctuations in interest rates
Default (or credit) risk: The risk that a bond issuer may default on its bonds
Default premium or credit spread: The additional yield on a bond that investors require
for bearing credit risk. Investment grade: Bond rated Baa or above by Moody’s, or BBB or above by Standard
and Poors or DBRS.
Junk Bond: Bond with a rating below Baa or BBB
Summary Chapter 5
A bond is a long term debt of a government or corporation. When you