Goal of the Firm?

Maximize Shareholder Wealth

Maximize the price of exsiting common stock

Sole Proprietorship

A business owned by a single individual

unlimited liabilities

General Partnership

Each partner is fully responsible for the liabilities incurred by the partnership

Limited Partnership

A partnership which one or more of the partners has limited liability, restricted to the amount of capital they have invested

Corporation

an entity that legally functions separate and apart from the owners

Gross Profit

                           Sales

                         - Cost of Goods Sold

                           Gross Profit

Operating Income (EBIT)

                       Sales

                      -Cost of Goods Sold

                      -Operating expenses

                          Operating Income (EBIT)

Taxable Income (EBT)

                       EBIT

                     +Dividend income

                     - Interest Expenses

                          Taxable Income (EBT)

Dividend Exclusion

70% excluded from being taxed

Depreciation

The means by which a asset's value is expensed over it's useful life for federal income tax purposes.

Capital Gain/Loss

A gain or loss resulting from the sales or exchange of a capital assets.

Net Capital loss carryback/ forward

Back 3 Years

Forward 5 Years

Operating loss carryback/ forward

Back 2 years

Forward 20 years

Financial Markets

Markets that allow people to easily buy and sell (trade) financial securities (stocks and bonds), commodities (metals and agricultural goods) and other items of value at low transaction costs.

Real Assests

Assets that are tangible or physical in nature such as land, machinery, and livestock.

Financial Assets

An asset that derives value because of a contractual claim. Stocks, bonds, bank deposits are all examples of financial assets. 

Underwriter

The middleperson who buys the entire stock or bond issue from the issuing company and resells it to the general public in individual shares.

Secondary Market

Currently outstanding securities are traded.

Ex. If someone buys some shares from Google then sells them it is done in the secondary market.

You can think of it as akin to the used car market.

3 ways to transfer savings to businesses

1. Direct transfer -

you to the firm

2. Indirect transfer using Investment Banker -

you to investment bank to firm

3. Indirect transfer using financial intermediary -  you to Sun Trust to firm

Public offering

both individual and intutional investors have the opportunity to purchase the securities.

Private placement

a security offering limited to a small number of potential investors.

Primary Market

New shares of stock entering the market

Ex. new car market - The only time Ford receives money is when they sell a new car.

Money Market

Transactions in short term debt instruments (1 year or less).

Ex. US Treasury Bills

federal agency securities

commercial paper

Capital Market

transactions in long term financial instruments anything beyond 1 year.

Ex. Financial leases

Corporate stocks and bonds

Organized Security Exchange

are tangible entities;

they physically occupy space ( buildings);

financial instruments are traded on the premises

Over- the- Counter Exchanges

includes all markets except the organized exchange;

most corporate bonds are trade here;

does not occupy a building

Investment Banker

a financial specialist who underwrites and distributes new securities and advises corporate clients about raising new funds.

Investment Banker's functions

1. Underwriting

2. Distributing

3. Advising

Nogotiated Purchase

Underwriting in which the purchase price and the public offering price are determined through negotiations between the issuer and a single syndicate, as opposed to through multiple competitive bidding. Most underwriting is negotiated.

Distribution Methods

Negotiated Purchase

Competitive Bid Purchase

Best Effort Basis

Privileged Subscription

Dutch Auction

Direct Sale

Competitive Bid Purchase

Several underwriting groups bid for the right to purchase the new issue from the corporation that is raising funds.

The investment bank willing to pay the greatest dollar amount per new security will win the competitive bid.

Best Effort Basis

The investment banker attempts to sell the issue in return for a fixed commision on each security actually sold.

Unsold securities are then returned to the corporation.

Privileged Subscription

The process of marketing a new security issue to a select group of investors.

Tarket market

1.Current stockholder

2. Employees

3. Customers of the firm

Direct Sales

Issuing firm sells the securities directly to the investing public without involving an investment banker.

Flotation cost

Transaction cost incurred when a firm raises funds by issuing a particular type of security.

Securities Act of 1933

First Congressional law regulating the securities industry. Required registration and disclosure and included measures to discourage fraud and deception.

Securities Exchange Act of 1934

The act which created the SEC, outlawed manipulative and abusive practices in the issuance of securities, required registration of stock exchanges, brokers, dealers, and listed securities, and required disclosure of certain financial information and insider trading.

Securities Acts Amendments of 1975

Congressional law amending the Securities Act of 1933 to enable the establishment of a National Market System, and to encourage fair and efficient handling of securities transactions. 

Shelf Registration

A registration of a new issue which can be prepared up to two years in advance, so that the issue can be offered quickly as soon as funds are needed or market conditions are favorable.

Opportunity Cost of Funds

The next-best rate of return available to the investor for a given levelof risk.

Maturity Premium

The additional return required by investors in longer-term securities to compensate them for the greater risk of price fluctuations on those securities caused by interest rate changes.

Liquidity Premium

The additional return required by investors for securities that cannot be quickly converted into cash at a reasonably predictable price.

Nominal rate of Interest

The interest rate paid on debt securities without an adjustment for any loss in pruchasing power.

Real Rate of Interest

The nominal rate of interest less any loss in purchasing power of the dollar during the time of the investment.

Term structure of Interest Rates

The relationship between interest rates and the term to maturity, where the risk of default is held constant.

Unbiased Expections Theory

The term structure is determined by expections of future rates.

Liquidity Preference Theory

Investors require risk premiums to invest for longer terms.

Longer the term the higher expected rate of return.

Market Segmentation Theory

The term structure of interest rates is built on the notion that legal restrictions and personal preferences limit choices for investors to certain ranges of maturities.

commerical banks prefer short term liabilities

life insurence companies prefer long term liabilities

Yield to Maturity

Rate of return a bondholder will recieve if the bond is held to maturity.