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FIN 2000 – Chapter 1

Financial Capital
Common stock, preferred stock, bonds, and retained earnings. appears on the corporate balance sheet under long-term liabilities and equity.
Real Capital
Long-term productive assets (plant and equipment)
Capital Structure Theory
addresses the relative importance of debt and equity in the overall financing of the firm.
The phenomenon of prices increasing with the passage of time
A leveling off or slowdown of price increases
Credit Default Swaps
Securities that were created by financial institutions as insurance against borrowers defaulting on their loans.
Sole Proprietorship
A form of organization that represents single-person ownership and offers the advantages of simplicity of decision making and low organizational and operating costs.
A form of ownership in which two or more partners are involved. Like the sole proprietorship, this arrangement carries unlimited liability for the owners. However, there is only single taxation for the partners, an advantage over the corporate form of ownership.
Articles of Partnership
An agreement between the partners in a business that specifies the ownership interest of each, the methods of distributing profits, and the means for withdrawing from the partnership.
Limited Liability Partnership
A special form of partnership to limit liability for most of the partners. Under this arrangement, one or more partners are designated as general partners and have unlimited liability for the debts of the firm, while the other partners are designated as limited partners and are only liable for their initial contribution.
A form of ownership in which a separate legal entity is created. may sue or be sued, engage in contracts, and acquire property. It has a continual life and is not dependent on any one stockholder for maintaining its legal existence. Owned by stockholders who enjoy the privilege of limited liability. There is, however, the potential for double taxation in the corporate form of organization: the first time, at the corporate level in the form of profits; and again, at the stockholder level in the form of dividends.
Articles of Incorporation
(term) A document that establishes a corporation and specifies the rights and limitations of the business entity.
Sub-chapter S Corporation
A special corporate form of ownership, in which profit is taxed as direct income to the stockholders, and thus is only taxed once, as would be true of a partnership. The stockholders still receive all the organizational benefits of a corporation, including limited liability. This designation can apply only to corporations with up to 75 stockholders.
Agency Theory
Examines the relationship between the owners of the firm and the managers of the firm. While management has the responsibility for acting as the agent for the stockholders in pursuing their best interests, the key question considered is: How well does management perform this role?
Institutional Investors
Large investors such as pension funds or mutual funds
Sarbanes-Oxley Act
An act passed by U.S. Congress in 2002 to protect investors from the possibility of fraudulent accounting activities by corporations. mandated strict reforms to improve financial disclosures from corporations and prevent accounting fraud.
Shareholder Wealth Maximization
Maximizing the wealth of the firm’s shareholders through achieving the highest possible value for the firm in the marketplace. It is the overriding objective of the firm and should influence all decisions.
Insider Trading
(term) This occurs when someone has information that is not available to the public and then uses this information to profit from trading in a company’s common stock.
Financial Markets
The place of interaction for people, corporations, and institutions that either need money or have money to lend or invest.
Public Financial Markets
in which national, state, and local governments raise money for highways, education, welfare, and other public activities.
Corporate Financial Markets
Markets in which corporations, in contrast to governmental units, raise funds
Money Markets
Competitive markets for securities with maturities of one year or less. The best examples of instruments would be Treasury Bills, commercial paper, and negotiable certificates of deposit, CDs. financial instruments with high liquidity and very short maturities are traded. Is used by participants as a means for borrowing and lending in the short term, from several days to just under a year.
Capital Markets
Competitive Markets for equity securities or debt securities with maturities of more than one year. The best examples of securities are common stock, bonds, and preferred stock.
Primary Market
The market for the raising of new funds as opposed to the trading of securities already in existence. A market that issues new securities on an exchange. Companies, governments and other groups obtain financing through debt or equity based securities.
Secondary Market
The market for securities that have already been issued. It is a market in which investors trade back and forth with each other. A market where investors purchase securities or assets from other investors, rather than from issuing companies themselves. such as the New York Stock Exchange and NASDAQ
Process that can take many forms in a corporation, such as changes in the capital structure (liability and equity on the balance sheet). It can also result in the selling of low-profit-margin divisions with the proceeds reinvested in better investment opportunities. Sometimes, results in the removal of the current management team or large reductions in the workforce. included mergers and acquisitions.
How did the recession of 2007 – 2009 compare with other recessions since the Great Depression in terms of length?
The recession of 2007-2009 was the longest recession since the Great Depression.
What effect did the recession of 2007-2009 have on government regulation?(LO3).
Congress started working on new regulations for financial institutions and creating new organizations to oversee.
What advantages does a sole proprietorship (ownership) offer? What is a major drawback of this type of organization?
Simplicity of decision-making and low organizational & operational costs. A major drawback is unlimited liability to the owner, in which he can lose his personal assets as well capital.
What form of proprietorship allows some of the investors to limit their liability? Explain briefly.
A limited partnership allows some of the partners to limit their liability. Under this arrangement, one or more partners are designated general partners and have unlimited liability for the debts of the firm; other partners are designated limited partners and are liable only for their initial contribution. The limited partners are normally prohibited from being active in the management of the firm.
In a corporation, what group has the ultimate responsibility for protecting and managing the stockholders’ interests?
The board of directors.
What document is necessary to form a corporation?
The articles of incorporation. (Sometimes also referred to as the Certificate of Incorporation or the Corporate Charter)
What issue does agency theory examine? Why is it important in a public corporation rather than in a private corporation?
Examines the relationship between the owners of the firm and the managers of the firm. In privately owned firms, management and the owners are usually the same people. Management operates the firm to satisfy its own goals, needs, financial requirements and the like. As a company moves from private to public ownership, management now represents all owners. This places management in the agency position of making decisions in the best interest of all shareholders.
Why are institutional investors important in today’s business world?
Because these investors such as pension funds and mutual funds own a large percentage of major U.S. companies, they are having more to say about the way publicly owned companies are managed. As a group, they have the ability to vote large blocks of shares for the election of a board of directors, which is suppose to run the company in an efficient, competitive manner. The threat of being able to replace poor performing boards of directors makes institutional investors quite influential. Since these institutions, like pension funds and mutual funds, represent individual workers and investors, they have a responsibility to see that the firm is managed in an efficient and ethical way.
Why is profit maximization, by itself, an inappropriate goal? What is meant by the goal of maximization of shareholder wealth?
The problem is that it fails to take account of risk, the timing of the benefits is not considered, and profit measurement is a very inexact process. The goal of shareholders wealth maximization implies that the firm will attempt to achieve the highest possible total valuation in the marketplace. It is the one overriding objective of the firm and should influence every decision.
When does insider trading occur? What government agency is responsible for protecting against the unethical practice of insider trading?
occurs when someone has information that is not available to the public and then users the information to profit from trading in a company’s common stock. Securities and Exchange Commission
In terms of the life of the securities offered, what is the difference between money and capital markets?
Money markets refer to those markets dealing with short-term securities that have a life of one year or less. Capital markets refer to securities with a life of more than one year.
What is the difference between a primary and a secondary market?
A primary market refers to the use of the financial markets to raise new funds for the corporation. After the securities are sold to the public (institutions and individuals), they trade in the secondary market between investors. It is in the secondary market that prices are continually changing as investors buy and sell securities based on the expectations of corporate prospects.
Assume you are looking at many companies with equal risk; which ones will have the highest stock prices?
Given companies with equal risk, those companies with expectations of high return will have higher common stock prices relative to those companies with expectations of poor returns.

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