Econ 2560* Midterm Review

Chapter 1 Goals & Governance of the firm

Investment v Financing Decisions
Investment
The Financial manager has to help the firm identify
promising projects & decide how much to invest in each
project
Also called the Capital Budgeting Decision
Decision about which real assets the firm should acquire
Financing
Raising money that the firm needs for the investments and
operations
Capital Structure A firms mix of long-term financing

Real v Financial Assets

Real

Financial

Are used to produce the firms products and services

Include tangible assets such as machinery, factories, and
offices
Also intangible assets such as technical knowledge,
trademarks, and patents.

The firm finances it investments in real assets by issuing

financial assets to investors
Ex; Share of stock, bank loan.
Shares of stock and other financial assets that can be
purchased and trades by investors are called securities

What is a corporation?

Public Company Corporation whose shares are listed for trading on a

stock exchange
Private Company Corporation whose shares are privately owned
Corporation Business owned by shareholders who are not personally
responsible for it obligations
Limited Liability Principle that the owners of the corporation are not
personally responsible for its obligations

Other Forms of Business Organizations

Sole Proprietorships
Business owned and operated by one individual
Bare all costs and keep all profits after CRA share
Easy to establish and lacking government regulation
Do not have to pay income tax or file tax return

Partnership

Hybrid Forms

Business owned by two or more people who are

personally responsible for all its liabilities
Do not have to pay income tax or file tax return

Limited liability partnerships (LLPs) and, Limited

liability companies (LLCs)
Partners are classified as general or limited. General
partners manage the business and have UL. Limited
partners are liable for only the money they put into the
company
Professional Corporation (PC) Used by Doctors,
lawyers, and accountants. The business has limited
liability but the professional can still be personally
sued.

Agency Problems

Conflicts of interest between the firms owners and managers

How do Cs ensure managers and stockholders interests coincide?

Agency Problems are kept in check by compensation plans that link the
well-being of employees to that of the firm, by monitoring the
management board of directors, security holders, and creditors; and by
the the threat of takeover

Chapter 2 Financial Markets and Institutions

Financial Markets
Stock Market
The most important financial market
Primary Market Market for sale of new securities by
corporations
Secondary Market Market in which already issued
securities are traded among investors
TSX is the main SE for big corporations
TSX-V and CNSX are for smaller emerging companies

Other Financial Markets

Bond Market
Securities representing a companies promise to make regular
interest payments and and to repay investors money on a
specified future date.
Bonds can vary in maturity, the degree of protection, and the
level and timing of interest payments.
Fixed-income market Market for debt-securities
Capital market Market for long-term financing

 Money market Market for short-term financing (less than

one year)
Commodities markets B/S corn, wheat, cotton , oil etc..

Financial Intermediaries
An organization that raises money from investors and provides financing
for individuals, corps, and other Os

Mutual Fund
A managed investment fund, pooling the savings of many investors
and investing in a portfolio of securities.
Exchange-traded fund (ETF)
An investment fund, traded on a stock exchange, that pools the
savings of many investors and invests in a portfolio of securities,
selected to replicate an established securities index.
Hedge Fund
A private investment pool, open to wealthy or institutional
investors, that is only lightly regulated and therefore can pursue
more speculative policies that mutual funds.
Private equity fund
Investment fund focused on investing in equity of privately owned
businesses
Pension fund
Investment plan set up by an employer to provide for employees
retirement

Advantages of MFs & ETFs

Offer investors low-cost diversification and professional

management. For man investors, its more efficient to buy a mutual
fund or an ETF than to assemble a diversified portfolio of stocks
and bonds

Financial Institutions

 A bank, and insurance companies are FIs

Act as an intermediary that does more than just pool and invest

savings. FIs raise financing in special ways;

Accepting deposits or selling insurance
policies
Providing additional financial services
Unlike a MF, they do not only invest in
securities but also loan money directly to
individuals, businesses, or other
organizations

Functions of FMs & FIs

Transporting cash across time

Lenders transport money forward in time, borrowers
transport it back
Risk Transfer and Diversification
FMs and FIs allow investors and businesses to reduce and
reallocate risk.
o Ex. Insurance I reduced risk of fires etx
o I company diversifies by issuing thousands of policies,
and it expects losses to average out over the policies.
Liquidity
The ability to sell or exchange an asset for cash on short
notice.
The payment mechanism
Chequing accounts, credit cards, and E-transfers allow
individuals and firms to send and receive payments quickly
and safely over long distances
Information provided by FMs

Commodity Prices
o Ability to look up prices of commoditys and budget
accordingly
Interest Rates

o Higher bond rating = lower IR

Company & Stock Values

Opportunity cost of capital

The minimum acceptable rate of return on capital investment

Rates higher than the COC add value to the firm

Chapter 3 Accounting & Finance

SFP or Balance Sheet
Financial statements that shows the book value of the firms
assets, liabilities, and equity as of a specific date

Book value VS Market Value

The market values of assets and liabilities might not equal their
book values, depending on the accounting rules used. Some BVs
are based on historical or original values, but others are based on
fair values, which is close to market value
o MV measures current values of A&Ls

The difference between the market value of A&Ls is the MV of the

SE claim. The stock price is simply the market value of SE/#OUSs

Income Statement

Financial statement that shows the revenues, expenses, and

profits or net earnings or net income from operations of a firm over
a period of time
Measures profit from the OAs of the company during the year

Profit VS Cash Flow

Profit is not the same as cash flow. There are 3 reasons

1. Investment in fixed assets is not deducted immediately from
income but is instead spread over the expected life of the
equipment
2. The accountant records revenues when a sale is made rather than
when the customer actually pays the bill, & at the same time,
deducts the production costs even though those costs may have
been incurred earlier.
3. Other comprehensive income, a component of total comprehensive
income, is not due to operation activities but captures changes in
boo value of certain A&Ls due to accounting methods

Taxes

For larger companies the marginal rate of tax on income is around 29%
and around 15% for small business.
In calculating the company deducts operating costs, an allowance for
Dep, and interest payments.
Individuals are also taxed on their income, which included dividends and
interest on their investments.
Dividens are taxes less than interest and employee income.
Capital gains are taxes at the personal tax rate, only when the
investment is sold and the gain is realized.