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Finance Quiz

Chapters 1,2,6,18

QuestionAnswer
What is corporate finance? It involves "projects" which are investments in property, stock, etc. They ask the question; do we invest in this "project".
What does EBITDA mean? Earnings before interest and tax depreciation and amortization. (Sales - Operating Expenses = EBITDA) The goal of the firm or corporation is to maximize EAT or NI
Where does net income go? Either retained earnings or dividends.
What are the main forms of businesses? Sole Proprietorship, Partnership, Limited Partnership, S-Corporation, C-Corporation.
What are the characteristics of a sole proprietorship? It is easy to set up, has one owner, and there is unlimited liability.
What are the characteristics of a general partnership? Each partner shares part of the entity and shares the unlimited liability.
What are the characteristics of a limited partnership? There is one general partner with others. It has limited liability and there is single taxation.
What are the characteristics of an S or C-corporation? They have limited liability and have shareholder. Because of shareholders, there is almost always a separation of ownership and control which created agency problems.
How do shareholders measure wealth? By the stock price.
What are financial markets? Where financial instruments or securities trade.
What are securities? Securities represent claims against the value of, or cash flow from, real estate. Bonds are a good example of this. They are long-term and give coupons annually.
How are bonds a strong claim about the company? If the company doesn't pay their bonds, they'll go bankrupt.
What are the two major market dimensions? Primary versus Secondary
What is a primary market? Companies or the government sells stocks and bonds to the public and the companies or government gets cash.
What is an IPO? Initial public offering. When new bonds/stocks are issued.
What is a secondary market? Where securities are traded after issue (used securities). It provides liquidity and diversification benefits for investors and security valuation information for issuers.
What are money markets? They trade debt securities or instruments with maturities for one year or less. Treasuries are one example.
What are capital markets? They trade stock and long-term debt. Common stock has no maturities.
Describe foreign exchange markets. They trade currency for immediate delivery (spot) or for some future delivery. They are subject to foreign exchange risk due to currency fluctuations.
What are derivatives? Value is based on value of some other asset or security.
Describe the characteristics of derivatives. Often highly leveraged and high risk. Include options and futures and are used for hedging and speculating. An example is a call option.
What is a call option? It gives the buyer the right to buy something.
What do commercial banks do? Take in deposits and make loans. Commercial bankers tend to be conservative or risk averse since they're making loans with other people's money.
What are thrifts? They're savings and loans. They make mortgage loans, etc. and are an alternative to commercial banks.
Why do thrifts hire people right out of college? To analyze financial statements or savings and loans opportunities such as insurance companies and mutual funds.
What are mutual funds? They are an easy way to diversify. The investor can buy shares in that fund and the manager decides what to buy/sell.
What economic functions to financial institutions perform? They transform financial claims. They monitor costs, provide liquidity, and price risk.
What is a financial intermediary? It changes the nature of the claims it takes in.
What do investment banks do? They buy x-number of shares and immediately sell them to the public.
What are fixed income securities? Debt securities which promise to pay a series of fixed payments based on a fixed interest rate. Examples are bonds, bills, and notes.
Who borrows in the public? Mostly governments such as federal, state, and foreign but also corporations and securitized loans.
What do rating agencies try to measure? Default risk. S&P measure as BBB-AAA investment grade and BB and below as high yield/junk bonds.
What are interest rates? Rent on borrowed funds. Affected by economic conditions and the FED. Usually quoted as nominal rates meaning they're not adjusted for inflation.
What are nominal interest rates? The quoted rate affected by inflation, real interest rate, default and liquidity risk, provisions of security issuer, and term to maturity.
What is inflation? Percentage increase in the cost of goods or sales over a given period of time. Interest rates increase in response to expected increase in inflation.
What is the nominal risk free rate or "RF"? RF = (1+RR)(1+INF) - 1 RR = real rate and INF = inflation
What is deflation? Percentage decrease in prices and asset values.
What does the FED do? The federal reserve is charged with promoting max employment and stable prices.
What is the FED funds rate? An average of transactions made.
What is the default risk premium calculation? Credit risk premium = interest rate on a security issued by a non-treasury issuer (issuer j) of maturity m at time t - interest rate on a security issued by the US Treasury of maturity m at time t
What is a yield or credit spread? A composition of market yields on securities assuming all characteristics except maturity are the same.
How do you get a yield curve? Plot time to maturity against yield to maturity for fixed income securities of the same risk level where yield is annual percent return.
What relationship does the FED have with the yield curve? If the FED thinks there will be inflation they raise interest rate and therefore the yield curve goes flat.
New York Stock Exchange A secondary market where transactions occur. 1-3 letters implies trading on NYSE
What is the exchange traded funds? Pulls together portfolios; creates shares percentage change
NASDAQ Dealers and market makers entering bid ask/offer. Four or more letters represents stock traded on NASDAQ.
What does it mean if stock is liquid? It is liquid if it can be sold immediately at the then market price.
What is short trading? You sell something you don't own with the expectation of buying it back at a later date.
What are the steps to building a company? Start, bank, angel investors, venture capital, IPO
Should private issuers be able to promote to general public? It gives the public more options and the company has another avenue to finance. A con is that the public doesn't know enough about investing.
What was the start of the financial crisis? Mortgages where people were taking loans they couldn't repay and the banks didn't care because they would get their money back by selling the mortgages on wall st.
What are the four basic financial statements? Balance Sheet, Income Statement, Statement of Cash Flows, Statement of Retained Earnings
What are the characteristics of the balance sheet? It reports the frims' assets, liabilities, and equity at a point in time. Assets are in order of liquidity, liabilities are in order of maturity, and equity is listed last.
What are current assets? They can be converted to cash within 1 year: cash, accounts receivable, inventory
What are fixed assets? They have a useful life longer than 1 year.
What are current liabilities? Examples are, accruals, account payables, notes payable.
What is long term debt? Long term debt and bonds.
What types of equity exist? Preferred stock, Common stock, Retained Earnings
What is preferred stock? It's a hybrid security with the characteristics of long term debt and common stock. There are fixed dividends paid first.
What is common stock and paid-in-surplus or capital? Fundamental ownership claim in public or private company
What are retained earnings? Cumulative earnings reinvested, not paid as dividends.
What is the fixed asset depreciation accounting method? Used for reporting purposes. Firms often use straight line method. For tax purposes, firms usually use accelerated depreciation such as MACRS meaning a higher depreciation expense but lower taxable income.
What is net working capital? Net working capital = current assets - current liabilities. It measures the firms ability to pay obligations.
Created by: efgreenberg