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The study of how and under what terms savings (money) are allocated between lenders and borrowers

Role of Management

a) Serves as an arbitrator (middleman) and moderator between conflicting interest groups or stakeholders and objectives
b) Creditors, managers, employees, and customers hold contractual claims against the firms revenues
c) Shareholders have residual claims against the company
Also act on the best interest of the shareholder

Role of Financial Manager

a) Getting the funds and investing it in the right things and hopefully getting the return back to the investors
b) Long term investments and look to generate ideas
c) Decisions such as using debt or equity to fund organization
d) Their objective is to "MAXIMIZE SHAREHOLDER WEALTH"

Six Principles of Finance

Time Value of Money, Risk-Return trade off, Diversification of investments, Efficient Financial markets, Management-Owner objectives, Reputation matters

Real Assets

Tangible things owned by persons and businesses. Examples include: land, building, machinery

Financial Assets

What one individual has lent to another. Examples include: consumer credit, loans, mortgages

Functions of Money

Medium of exchange, Standard of Value, Store of Value

Financial intermediaries

Work to facilitate the transfer of funds, these people will transfer the nature of securities to something else. Invest funds on behalf of others and change the nature of the transactions. Ex. Banks, insurance companies, pension funds, mutual funds.


Core activity is acting as deposit takers and lenders, these are the most important financial intermediaries

Insurance companies

Takes in premiums and pay off when an incident occurs, also called contractual saves because premiums are paid on a monthly basis

Pension Funds

Take in contributions and provide payments after plan members retire

Mutual Funds

Acts as a pass through. Convenient way to invest in the equity and debt markets. Provides two major functions: pool sums of money so that people can make investments that would not be possible for smaller investors, and offer expert advice

Direct Intermediation

Lender provides money directly to the ultimate borrower. Ex. relative lending you money.

Second Channel

Help is needed from a broker through market intermediaries

Market intermediaries

An entity that facilitates the working of markets and helps provide direct intermediation but does not change the nature of the transaction

Financial Institution

Intermediary lends the money to the ultimate borrowers but raises the money itself by borrowing directly from other individuals

Retail Market

Market intermediaries help inviduals

Institutional Market

Market intermediaries help financial intermediaries

Primary Market

Cash goes to company, involves the issue of new securities by the borrower in return for cash from investors

Secondary Market

Trading environment that permit investors to buy and sell existing securities. Consists of auction/exchange markets and dealer/OTC markets

Exchange/Auction market

Involve bidding process at a specific location

OTC market

Do not have a physical location - consists of a network of dealers who trade directly with one another

Capital market

Long term debt and sales trade

Fourth Market

Trading of securities directly between investors without the involvement of brokers or dealers

Financial instruments issued by corporations

Commercial paper, Bankers acceptance, Corporate bonds


Unsecured debt, backed only by general assets of the issuing corporation

Secured debt

Debt secured by specific assets

Subordinated debt

In default, holders get payments only after other debt holders get their full payment

Senior debt

In default, holders get payment before other debt holders

Zero Coupon

A bond bought at a lower price than the face value

Junk Bonds

Bonds with below investment grade rating

Common Stocks

The common stockholders are the owners of the corporation's equity. Do not have a specified maturity date and the firm is not obliged to pay dividends to shareholders. Returns come from dividends and capital gains.

Preferred Stocks

Have face value, predetermined periodical (dividend) payments with priority over common stockholders

Commercial bank lending

Prime rate loans and bank term loans.

Prime rate loans

Loans in which the borrowing rate is based on the prime rate of interest

Bank term loans

Business loans with maturities greater than one year. May be secured or unsecured, the funds can be used to buy inventory or to finance plant and equipment.

Derivative securities

Include options and futures. Prices are influenced by demand and supply. Reflect market expectations regarding the future.

Market capitalization

Total market value of the securities of an entity

Money market securities

Short term debt instruments

Capital market securities

Debt securities with maturities less than one year

Convertible bond

Bonds that are issued by corporations and that can be converted to shares of the issuing company's stock at the bondholder's discretion

Callable bond

A bond that can be redeemed by the issuer prior to its maturity

Retractable bond

A bond that features an option for the holder to force the issuer to redeem the bond before maturity at par value

Collateralized bond

Collateral is required on a bond when standard issue bonds are not available due to heightened risk of non performance

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