WGU Financial Management C214,100% Confirmed Correct
Financial Securities (3 types)
1. Gov Securities(treasury bonds)- gov invest in natl defense to freeways. Loans provide by the public to gov. When tax revs fall short to cover expenditures, gov issues bonds from 60 days-30yrs.
2. Corporate B...
1. Gov Securities(treasury bonds)- gov invest in natl defense to freeways. Loans provide by the public to
gov. When tax revs fall short to cover expenditures, gov issues bonds from 60 days-30yrs.
2. Corporate Bonds- Google might be looking to invest another $50 billion in low-orbiting satellites;
however, because of its size, the company cannot walk into a local bank hoping for a $50-billion loan.
Instead, Google will likely issue bonds with a face value of $1,000 that make one or two annual coupon
payments a year and might be paid back over a 20-year period.
Corporate finance is NOT devoted to understanding various types of financial instruments; investments
are. *Corporate finance focuses on the decision making by the management of the firm.
3. Stocks- share of ownership in a co. If Google did not want to borrow money from bondholders to
finance the $50-billion low-orbiting satellite project, Google could sell shares of ownership in the
company.
Syndicate
is a group that is temporarily formed to handle a bond or stock issue. Syndicates are generally made up
of large investment banks or other types of institutional investors. These large investment banks that
make up a syndicate might also be the underwriters of the security issue. An underwriter has the
responsibility of determining the value of the security and then, in some cases, the underwriter will
purchase all of the securities from the issuer and then sell them to other investors.
Two ways a firm issuing a bond can place the bonds with a syndicate:
1. Competitive Sale- Those wishing to underwrite the bond issue will submit bids (on bond's prices and
interest rate) to the issuing firm. Firm will then select the underwriter that offered the highest price and
lowest interest rate. Underwriter will sell bonds to various investors at (hopefully) a slightly higher price
than purchase price.
2. Negotiated Sale- like the competitive sale, a negotiated sale is the process of underwriters submitting
proposals including bids. However, this latter type of sale involves a more thorough interview process
with the underwriters. Further, the issuing firm will carefully select the management team that will
place these bonds.
Primary Markets (Stocks & Bonds)
The primary market for stock issuance works in a similar way to the bond primary market. However,
some terminology is different. A firm that is going public (or selling shares of ownership for the first
time) is going to perform an initial public offering (IPO). These IPOs are sometimes called new equity
offerings. However, much of the underwriting occurs in a similar manner, which we have discussed
above.
Secondary Markets (2 types)
,1. Auction Market- an auction financial market has a physical location and prices are determined by the
highest price an investor is willing to pay. The New York Stock Exchange (NYSE), the world's largest
secondary financial market. NYSE has a single dealer that provides liquidity.
*Some high frequency traders provide liquidity to the rest of the market.
*If providing liquidity becomes more risky, then dealers will increase the spread.
*If the price of a particular stock begins to heavily fluctuate, then the specialist will INCREASE the
spread.
2. Dealer market- does not require a physical location. Securities are bought and sold through a network
of dealers that trade for themselves. a dealer might hold inventory for particular stock and willing to sell
to those that demand the stock and buy from those that will supply the stock. NASDAQ, (second-largest
secondary market worldly), is example of a dealer market. Most stocks that are listed on NASDAQ have
multiple dealers for each. The idea behind having multiple dealers providing liquidity to investors is that
the dealers must compete with one another, thus lowering the cost of transacting.
Spread
The difference between the bid price and the ask price.
If the price of a particular stock begins to heavily fluctuate, then the specialist will INCREASE the spread.
Stock Orders (2 types)
Market orders- are time sensitive and would execute at the current ask price.
Limit orders-
-Buy Limit Order can only be executed at the limit price or lower
-Sell Limit Order can only be executed at the limit price or higher.
Market Prices
-Convey info to consumers. Perhaps the newly priced milk is of lower quality or the grocer has excess
inventory.
-Affect incentives. For instance, a sophisticated consumer might not be in the market for a brand new
car at its current price. However, the dealership could incentivize the consumer by dramatically lowering
the price.
-Affect the distribution of income. Nearly all students would agree that the price of garbage collection is
lower than the price of health care.
Calculating Security Returns
two types:
, 1. Dollar returns- are calculated by taking the difference between the previous price and current price,
plus any additional cash flow that came from the security. (EX: bonds pay a coupon (or interest)
payment 1 or 2 times yearly; stocks pay a dividend. Mathematically, dollar returns are calculated in the
following way.
Pt - Pt-1 + CFt
In this equation, Pt is the sold price, Pt-1 is the bought price, and CFt is the cash flow (coupons for
bonds; dividends for stocks).
2. Percentage returns- Percentage returns are calculated by simply dividing the dollar returns by the
price of the security at time t-1, or the previous time period.
Pt-Pt-1/Pt-1 + CFt/Pt-1
Maximizing Shareholder Value
There are two issues:
1. Agency costs- are real costs and the way that most firms mitigate some of these costs is by aligning
managers' interests with shareholders' interests; they are costs by management not acting in the best
interests of the shareholders; asymmetrical costs. Most commonly, management might be compensated
with shares of ownership in the company or take on projects just because they want to.
2. Focusing solely on profits- (unethical maximization), in some cases, (Enron 2001), the pursuit of profit
has led to unethical behavior. However, profitable businesses are employing other workers and are
providing their employees the means to consume goods and services from other businesses in the
economy.
Finance v Accounting
Accounting- is backward-looking and risk free.
Finance- is forward-looking and involves massive uncertainty.
Accrual Accounting & Matching Principle
(regardless of when a company incurs cost or revenue, it is reported only when the associated cost or
revenue is recognized. Neither COGS not revenue represents actual cash.)
allows managers to decide what is "recognized" on the financial statements. Accrual accounting:
Revenues are recognized when the earnings process is complete; expenses are "matched" to recognized
revenues.
*The accrual system also employs the matching principle.
The matching principle requires that revenue recognized must be matched with the expenses incurred
to generate the revenue.
*So, while both accrual and cash systems report $0 in revenue during 20x1, an accrual firm matches $0
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