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44 terms

Introduction to Finance

STUDY
PLAY
Finance
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.
Banks
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
Debentures
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