Professional Documents
Culture Documents
Date: 7/14/06
Class: Intro to Business BA11 5040
Professor: McNamara
Chapter 19
Questions from page 588
Name three finance functions important to the firms overall operations and performance.
The three functions important to the firms overall operations health would be forecasting
financial needs, working with the budget process and establishing controls. Forecasting
financial needs deals with short term and long term forecasting as well as cash flow
forecasting. Short term forecasting predicts revenues, costs and expenses for a period of
one year or less. This forecast is the foundation for most other financial plans, so its
accuracy is critical, cash flow forecasts does exactly what it sounds like it does, forecasts
future inflows and out flows of cash. Long term forecast predicts revenues, costs and
expenses for a period longer than 1 year and sometimes as far as 5 or 10 years into the
future. This plays a crucial role as you would imagine in the companies long term goals.
What are the three primary financial problems that cause firms to fail?
The three problems that cause firms to fail are undercapitalization, poor control over cash
flow and inadequate expense control. Undercapitalization is when a firm does not have
enough funds to adequately start the business.
In what ways do short term and long term financial forecasts differ?
Short term forecasts deal with issues a company may have no more than 1 year out. A
long term forecast would deal with thing that could go out as far as 5 to 10 years and
would deal with issues such as what technology should they invest in, where should they
be in 5 years, should they buy a new plant and so forth.
What is the organizations purpose in preparing budgets? Can you identify three different
types of budgets?
The organizations purpose in preparing budgets is to establish a viable financial plan that
sets forth managements expectations and on the basis of those expectations allocates the
use of specific resources throughout the firm. Without a budget in place a firm would go
belly up in no time. A capital budget estimates a firms projected cash inflows and
outflows that the firm can use to plan for any cash shortages or surpluses during a given
period (e.g. monthly, quarterly). Cash budgets are important guidelines that assist
managers in anticipating borrowing, debt repayment, operating expenses, and short term
investments. The operating budget or master budget as it is sometimes called ties
together all the firms other budgets and summarizes the business’s proposed financial
activities. It can be defined more formally as the projection of dollar allocations to
various costs and expenses needed to run or operate a business, given projected revenues.
Finally a capital budget highlights a firms spending plans for major asset purchases that
often require large sums of money. The capital budget primarily concerns itself with the
purchase of such assets as property, buildings, and equipment.
Questions from page 592
What’s the difference between trade credit and a line of credit at a bank?
Trade credit is the practice of buying goods and services now and paying for them later.
A line of credit comes from a bank and gives a firm an amount of unsecured short term
funds, so a firm can have funds readily available for when it is needed.
Earnings $125,000
Less bond interest $45,000
Net earnings/Income $80,000
Earnings $125,000
Chapter 20
Questions from page 614
What does it mean when a firm states that it is issuing a 9 percent debenture bond due in
2025?
A debenture bond is a bond that does not require any collateral but instead relies on the
creditworthiness of the firm and their reputation. The 9 percent referred to is the amount
of interest paid on the bond, and the amount of the bond plus all accruable interest is due
in 2025.
Name at least two advantages and disadvantages of issuing stock as a form of equity
financing.
The following are forms of advantages by issuing stock as a form of equity financing:
As owners of the business, stockholders never need to be repaid.
There's no legal obligation to pay dividends to stockholders, therefore, income (retained
earnings) can be reinvested in the firm for future financing needs.
Selling stock can improve the condition of a firm’s balance sheet since issuing stock
creates no debt. (A corporation may also buy back its stock to improve its balance sheet
and make the company appear stronger financially)
Some disadvantages of issuing stock are as follows:
As owners, stockholders (usually common stockholders) have the right to vote for the
company’s board of directors. Typically one vote is granted per one share of stock held.
Hence, the direction and control of the firm can be altered by the sale of additional shares
of stock.
Dividends are paid out of profit after tax and are not tax deductible.
Management’s decisions can be affected by the need to keep shareholders happy.
What are the major differences between preferred stock and common stock?
Preferred stock is stock that gives its owners preference in the payment of dividends and
an earlier claim on assets than common stockholders if the company is forced out of
business and its assets sold. Preferred stock dividends differ from common stock
dividends in several ways. Preferred stock is generally issued with a par value that
becomes the base for the dividend the firm is willing to pay. For example, if a preferred
stocks par value is $100 a shares and is dividend rate is 4 percent, the firm is committing
to pay $4 per share in dividends. Common stock which is the most common form of
ownership in a firm; it confers voting rights and the right to share in the firms profits
through dividends, if offered by the firms board of directors.
In what way are bonds and preferred stock similar?
Bonds and preferred stock are similar in a sense that they both have a face value and both
have a fixed rate of return. Also like bonds rating agencies can rate preferred stock
according to risk.
Questions from page 625
What is the primary purpose of a stock exchange? Can you name the largest stock
exchange in the United States?
The purpose of a stock exchange is actually two fold. First companies need to sell stock
the public through what is known as an IPO. This is the primary market for stocks.
There is also a secondary market where stocks and various other instruments are traded
between individual investors with the proceeds going to them not the company. The
largest stock exchange in the United States is the NYSE, New York Stock Exchange “The
World Puts It’s Stock In Us”
What does NADAQ stand for? How does this exchange work?
NASDAQ stands for National Association of Securities Dealers Automated Quotations.
The NASDAQ is a telecommunications network. It links dealers across the nation so that
they can buy and sell securities electronically rather than in person. Today NASDAQ
handles major companies such as Dell and Starbucks. For a company to be listed on the
NASDAQ they must meet certain requirements. These are some of them: Total market
value of all shares of $8 million; 400 shareholders holding at least 100 shares. ECNs
were created out of the NASDAQ Market Makers Antitrust Litigation led by lawyer
William Lerach. The litigation alleged collusion between Wall Street traders, and was
proven in 1998, leading to a $1 billion settlement from major Wall Street firms. At the
time of the settlement, the SEC also put in a new regulation, the Limit Order Display
Rule (rule 11Ac1-4), which authorized "electronic communication networks," or ECNs.
Major ECNs that became active at this time were Instinet and Island, (which were since
merged into INET and acquired by NASDAQ), Archipelago Exchange (which was
acquired by the NYSE), and Brut (now acquired by NASDAQ). ECNs increased
competition amongst trading firms by lowering transaction costs, giving clients full
access to their order books, and offering order matching outside of traditional exchange
hours.
What is the key advantage of online investing? What do investors need to remember if
they decide to do their investing online?
The commissions charged by online firms are far less than those of regular stockbrokers.
Trades that used to cost hundreds of dollars now can cost as little as $4 on the web.
Online services will provide information but how much is decided on the size of your
account and how much activity you produce for them. Also if you decide to use online
investing you need to do your own objective research as you will not have the assistance
of a broker.
What services do such companies such as Standard & Poor’s and Moody’s Investor
Service provide in bond markets?
Standard and Poor’s and Moody’s provide services in the bond market by way of rating
bonds and companies risk levels, naturally the higher the risk the higher the rate of return.
What is a stock split? Why do companies sometimes split their stock?
A stock split is when a companies stock is trading at a high price say $100 a share and the
market is not responding well to the price because it is to high. The company could do a
2 for 1 forward split and the shares would now be worth $50 per share. This is good for
the investors as well as the company if they are buying shares before the split. Now if an
investor has 1,000 shares at $100 they will now have 2,000 shares at $50. Now every
time the stock goes up $1 they are now making twice as much as they were before. This
also allows a company to grow its market cap without having to issue any more shares.
What is a mutual fund and how do such funds benefit from small investors?
A mutual fund is an organization that buys stocks and bonds and then sells shares in those
securities to the public. A mutual fund is an investment company that pools investor’s
money together to buy stocks and bonds. In 2000 bond and stock mutual funds
controlled $7.47 trillion of investor’s money.
Why would manufacturers of products such as candy, coffee, and bread be interested in
the futures market?
Futures markets are a commodities market that involves the purchase and sale of goods
for delivery sometime in the future. Say you own a cereal company and need to by
wheat; you would purchase a futures contract so that you could plan your budget
accordingly, and you know how much the wheat is going to cost you in the future so you
are able to set up your future budget.
What exactly does the Dow Jones Industrial Average (DJIA) measure? Why is it
important?
The DJIA is a broad index of about 30 companies and it is an indicator for the overall
market condition. The Dow Jones Industrial Average (NYSE: DJI) is one of several
stock market indices created by Wall Street Journal editor and Dow Jones & Company
founder Charles Dow. Dow compiled the index as a way to gauge the performance of the
industrial component of America's stock markets. It is the oldest continuing U.S. market
index. Today, the average consists of 30 of the largest and most widely held public
companies in the United States. The "industrial" portion of the name is largely historical
—many of the 30 modern components have little to do with heavy industry. To
compensate for the effects of stock splits and other adjustments, it is currently a weighted
average, not the actual average of the prices of its component stocks.
Chapter 21
Questions from page 650
What is money?
Money is anything that people generally accept as payment for goods and services. In the
past, objects as diverse as salt, feathers, stones, rare shells, tea and horses have been used
as money. In fact, until the 1880’s, cowries’ shells were one of the world’s most abundant
currencies.
What are the various ways the Fed controls the money supply, and how do they work?
The Fed can control money trough various means but does so primarily through raising
the rates it charges retail banks for money which will directly correlate to the amount of
money available for use in the economy. The Federal Reserve System controls the size of
the money supply by conducting open market operations, in which the Federal Reserve
engages in the lending or purchasing of specific types of securities with authorized
participants, known as the Fed's primary dealers. All Open Market Operations in the
United States are conducted by the Open Market Desk at the Federal Reserve Bank of
New York with an aim to making the federal funds rate as close to the target rate as
possible. For a detailed look at the process by which changes to a reserve account held at
the Fed affect the wider monetary supply of the economy, see money creation. The Open
Market Desk has two main tools to adjust the monetary supply, repurchase agreements
and outright transactions. To smooth temporary or cyclical changes in the monetary
supply, the desk engages in repurchase agreements (repos) with its primary dealers.
Repos are essentially secured, short-term lending by the Fed. On the day of the
transaction, the Fed deposits money in a primary dealer’s reserve account, and receives
the promised securities as collateral. When the transaction matures, the process unwinds:
the Fed returns the collateral and charges the primary dealer’s reserve account for the
principal and accrued interest. The term of the repo (the time between settlement and
maturity) can vary from 1 day (called an overnight repo) to 65 days, though the Fed will
most commonly conduct overnight and 14-day repos. Since there is an increase of bank
reserves during the term of the repo, repos temporarily increase the money supply. The
effect is temporary since all repo transactions unwind, with the only lasting net effect
being a slight depletion of reserves caused by the accrued interest (think one day of
interest at a 4.5% annual yield, which is 0.0121% per day). The Fed has conducted repos
almost daily in 2004-2005, but can also conduct reverse repos to temporarily shrink the
money supply. In a reverse repo the Fed will borrow money from the reserve accounts of
primary dealers in exchange for Treasury securities as collateral. At maturity, the Fed will
return the money to the reserve accounts with the accrued interest, and collect the
collateral. Since this drains reserves, reverse repos temporarily contract the monetary
supply, except, again, for the extremely small lasting increase caused by the accrued
interest. The other main tool available to the Open Market Desk is the outright
transaction. Outrights differ from repos in that they permanently alter the money supply.
Outright transactions overwhelmingly involve the purchase of Treasury securities in the
secondary market. In an outright purchase, the Fed will buy Treasury securities from
primary dealers and finance these purchases by depositing newly created money in the
dealer’s reserve account at the Fed. Since this operation does not unwind at the end of a
set period, the resulting growth in the monetary supply is permanent. The Fed also has the
authority to sell Treasuries outright, but this has been exceedingly rare since the 1980s.
The sale of Treasury securities results in a permanent decrease in the money supply, as
the money used as payment for the securities from the primary dealers is removed from
their reserve accounts, thus working the money multiplier process in reverse.
What are the major functions of the Fed? What other functions does it perform?
The main tasks of the Federal Reserve System are to: Supervise and regulate banks,
implement monetary policy by open market operations, setting the discount rate, and
setting the reserve ratio, maintain a strong payments system, Control the amount of
currency that is made and destroyed on a day to day basis (in conjunction with the Mint
and Bureau of Engraving and Printing) Other tasks include: Economic research,
Economic education, Community outreach
What’s the difference between a bank, savings and loan association and a credit union?
Commercial banks are profit-seeking institutions that receive deposits from individuals
and corporations in the form of checking and savings accounts and then use some of
these funds to make loans. Some deposits would be demand deposits which are the
technical term for a checking account, the money in a demand deposit can be withdrawn
anytime on demand from the depositor. A time deposit is the technical name for a
savings account; the bank can require prior notice before the owner withdraws money
from a time deposit. There are also CD’s or certificates of deposit. This is a time deposit
account that earns interest to be delivered at the end of the certificates maturity date,
which helps to enforce the principal of Money Time Value. Savings and loan associations
are financial institutions that accept both savings and checking deposits and provides
home mortgage loans. They are also commonly known as thrift institutions since their
original purpose was to promote thrift and home ownership. Credit unions to which is
something I belong to, are member-owned financial cooperatives that offer the full
variety of banking services to their members, today the 10,000 or so credit unions in the
US serve some 83 million clients. Credit unions have grown at four times the rate of the
commercial banking industry. Typically, credit unions offer their members interest-
bearing checking accounts at relatively high rates, short-term loans at relatively low rates,
financial counseling, life insurance policies, and a limited number of home mortgage
loans.
Credit cards
EFT may be initiated by a cardholder when a payment card such as a credit card or debit
card is used. This may take place at an automated teller machine (ATM) or point of sale
(POS), or when the card is not present, which covers cards used for mail order, telephone
order and internet purchases.
Card-based EFT transactions are often covered by the ISO 8583 standard. Transaction
types: A number of transaction types may be performed, including the following: Sale,
where the cardholder pays for goods or service. Refund: where a merchant refunds an
earlier payment made by a cardholder. Withdrawal: the cardholder withdraws funds from
their account, e.g. from an ATM. The term Cash Advance may also be used, typically
when the funds are advanced by a merchant rather than at an ATM. Deposit: where a
cardholder deposits funds to their own account (typically at an ATM). Cash back: where a
cardholder withdraws funds from their own account at the same time as making a
purchase. Inter-account transfer: transferring funds between linked accounts belonging to
the same cardholder) Payment: transferring funds to a third party account. Inquiry: a
transaction without financial impact, for instance balance inquiry, available funds inquiry,
linked accounts inquiry, or request for a statement of recent transactions on the account.
Administrative: this covers a variety of non-financial transactions including PIN change.
The transaction types offered depend on the terminal. An ATM would offer different
transactions from a POS terminal, for instance.
Authorization
Authentication
EFT transactions may be accompanied by methods to authenticate the card and the
cardholder. The merchant may manually verify the cardholder's signature, or the
cardholder's Personal identification number (PIN) may be sent online in an encrypted
form for validation by the card issuer. Other information may be included in the
transaction, some of which is not visible to the cardholder (for instance magnetic stripe
data), and some of which may be requested from the cardholder (for instance the
cardholder's address or the CVV2 value printed on the card). EMV cards are smartcard-
based payment cards, where the smartcard technology allows for a number of enhanced
authentication measures.
Chapter 22
Questions from page 677
What are the six steps you can take today to control your finances?
First you need to take an inventory of you financial assets. You need to develop a
balance sheet for yourself. Remember; a balance sheet starts with the fundamental
accounting equation: Assets = Liabilities + Owners equity. Next you need to keep track
of all expenses right down to the last penny. This is the only way you will be able to
trace where your money goes if you need to track you’re spending or if you run into a
problem in the future. Once you know what your financial situation is you must prepare
a balanced budget. Budgets as you remember are financial plans. Some important items
would include mortgage, utilities, food, clothing and vehicle expenses just to name a few.
Next you must have a plan in place to pay off your debts. You should always start with
the ones that carry the highest interest rate. Next you need to start a savings plan. It’s
important to set aside some money each month in a separate account for large purchases
you’re likely to make such as a new car or house. Finally you should only borrow money
to pay for assets that have the potential to increase in value or generate income. Only the
most unexpected of expenses should cause you to borrow money to pay for them.
What are the advantages of investing in a 401(k) account and IRA and a Keogh account?
The 401(k) plan is a type of employer-sponsored retirement plan named after a section of
the United States Internal Revenue Code. A 401(k) plan allows a worker to save for
retirement while deferring income taxes on the saved money or earnings until
withdrawal. Comparable types of salary-deferral retirement plans include 403(b) plans
covering workers in educational institutions, churches, public hospitals, and non-profit
organizations and 457 plans which cover employees of state and local governments and
certain tax-exempt entities. Starting in the 2006 tax year, employees can opt to use the
Roth 401(k), Roth 403(b) to have the same tax effects of a Roth IRA. However, in order
to do so, the plan sponsor must amend the plan to make those options available.
Therefore, the following discussion does not involve Roth 401(k) accounts unless
specified. The employee does not pay federal income tax on the amount of current
income that he or she defers to a 401(k) account. For example, a worker who earns
$50,000 in a particular year and defers $3,000 into a 401(k) account that year only
recognizes $47,000 in income on that year's tax return. In 2004, this would represent a
near term $750 savings in taxes for a single worker, assuming the worker remained in the
25% marginal tax bracket and there were no other adjustments (e.g. deductions).
Furthermore, earnings from the investments in a 401(k) account (in the form of interest,
dividends, or capital gains) are not taxable events. The resulting compound interest
without taxation can be a major benefit of the 401(k) plan over long periods of time. An
Individual Retirement Account (or IRA) is a retirement plan account that provides some
tax advantages for retirement savings in the United States. There are a number of
different types of IRAs which may be either employer provided plans and self-provided
plans. The types include: Roth IRA - contributions are made with after-tax assets, all
transactions within the IRA are tax-free, and withdrawals are usually tax-free. Named for
Senator William Roth. Traditional IRA - contributions are often tax-deductible (often
simplified as "money is deposited before tax" or "contributions are made with pre-tax
assets"), all transactions and earnings within the IRA are tax-free, and withdrawals at
retirement are taxed as income (except for contributions that were not deducted). SEP
IRA - a provision that allows an employer (typically a small business or self-employed
individual) to make retirement plan contributions into a Traditional IRA established in the
employee's name, instead of to a pension fund account in the company's name. SIMPLE
IRA - a simplified employee pension plan that allows both employer and employee
contributions, similar to a 401(k) plan, but with lower contribution limits and simpler
(and thus less costly) administration. Although it is termed an IRA, it is treated
separately. An IRA can only be funded with cash or cash equivalents. Attempting to
transfer any other type of asset into the IRA is a prohibited transaction and disqualifies
the IRA from its beneficial tax treatment. (Of course, rollovers, transfers, and conversions
between IRAs and other retirement accounts can include any asset.) The maximum for an
IRA contribution in the year 2006 is $4,000 for an individual under the age of 50.
Individuals aged 50 and older can contribute up to $5000. Keep in mind, this limit is for
Roth IRAs, traditional IRAs, or some combination of the two. You cannot put more than
$4,000 into your Roth and traditional IRA combined. So if you are 45 and put $3,500 into
your traditional IRA this year so far, you can either put $500 more into your traditional
IRA or $500 in your Roth IRA- no more. However, because this is still before the filing
deadline (April 15, 2007) for calendar year 2006, the cash method taxpayer could get the
full $4000 limit for the Roth by simply calling the $3,500 a Roth and NOT claiming the
$3,500 above the line (i.e reduces AGI) deduction and making the remaining $500 a
Roth. There may be an additional administrative step needed so that the trustee which
holds the IRA proceeds actually retitles or transfers the $3500 Traditional proceeds into
the Roth category for their internal book keeping to survive an IRS audit. The same is
true of individuals over 50, but the combined limit is currently (2006) $5,000. Keogh
plans are designed for self employed people, and are similar to an Individual Retirement
Account (IRA). They are funded completely by wage earner contributions and provide
either a lump sum payment or periodic withdrawals upon retirement. Penalties apply for
early withdrawal. Keogh plans generally have the same investment opportunities as
traditional IRAs. Contributions to Keogh plans are tax deductible within limitations.
They have fallen out of favor in recent years to investment vehicles that have much less
cumbersome paperwork.