financial management

Definition:

1. Financial management Concerns the acquisition, financing and management of assets with

some overall goal in mind.

2. Agency (theory) A branch of economics relating to the behavior of principals (such as owners)

and their agents (such as managers).

3. Stakeholders All constitutes with a stake in the fortunes of the company. They include

shareholders, creditors, customers, employees, suppliers and local communities.

4. Corporate governance the systems by which corporations are managed and controlled. It

encompasses the relationships among a company's shareholders, board of directors, and senior management.

5. Investment banker A financial institution that underwrites (purchases at a fixed price on a

fixed date) new securities for resale.

6. Annuity A series of equal payments or receipts occurring over a specified number of periods.

In an ordinary annuity, payments or receipts occur at the end of each period; in an annuity due, payments or receipts occur at the beginning of each period.

7. Common stock Securities that represent the ultimate ownership (and risk) position in a

corporation

8. Yield to maturity (YTM) The expected rate of return on a bond if bought at its current market

price and held to maturity.

9. Risk The variability of returns from those that are expected.

10. Coefficient of variation (CV) The ratio of the standard deviation of a distribution to the mean

of that distribution. It is a measure of relative risk.

11. Certainty equivalent (CE) The amount of cash someone would require with certainty at a

point in time to make the individual indifferent between that certain amount and an amount expected to be received with risk at the same point in time. 12. Portfolio A combination of two or more securities or assets.

13. Characteristic line A line that describes the relationship between an individual security's

returns and returns on the market portfolio. The slope of this line is beta.

14. Beta An index of systematic risk. It measures the sensitivity of a stock's returns to changes in

returns on the market portfolio. The beta of a portfolio is simply a weighted average of the individual stock betas in the portfolio.

15. Fund Broadening our conception of funds to include all of the firm's investments and claims

(against those investments) allow us to capture all of these transactions as both sources and use of funds.

16. Net working capital Current assets minus current liabilities.

17. Gross working capital The firm's investment in current assets (like cash and marketable

securities, receivables, and inventory).

18. Working capital management The administration of the firm's current assets and the

financing needed to support current assets.

19. Spontaneous financing Trade credit, and other payables and accruals, that arise

spontaneously in the firm's day-to-day operations.

20. Outsourcing Subcontracting a certain business operation to an outside firm instead of doing

it “in-house”

Blanks filling:

1. We assume in this book that the goal of the firm is to maximize the wealth of the firm's present owners. 2. In the USA, there are 4 basic forms of business organization: sole proprietorships, partnerships, corporations, and limited liability companies(LLCs). 3. The notion of compound interest is crucial to understanding the mathematics of finance. 4. As a result, interest is earned on interest as well as the initial principal. It is this interest-on-interest, or compounding, affect that accounts for the dramatic difference between simple and compound interest.

5. The intrinsic value of a security, on the other hand, is what the price of a security should be if properly priced based on all factors bearing on valuation.

6. The valuation approach taken in this chapter is one of determining a security's intrinsic value——what the security ought to be worth based on hard facts.

7. The relationship between expected return and systematic risk, and the valuation of securities that follows, is the essence of Nobel Laureate William Sharpe's capital-asset pricing model (CAPM).

8. The various collection and disbursement methods that a firm employs to improve its cash management efficiency constitute two sides of the coin.

Multiple choices:

1. Partnerships including general partnerships and limited partnerships

2. Financial markets can be broken into 2 classes- the money market and the capital market.

the money market is concerned with the buying and selling of short-term government and corporate debt securities. The capital market, deals with relatively long-term debt and equity instrument.

3. Within money and capital markets there exist both primary and secondary market.

4. Risk characteristics: default risk, marketability, maturity, taxability and embedded options. 5. 3 attitude toward risk:

Certainty equivalent < expected value, risk aversion is present. Certainty equivalent = expected value, risk indifference is present. Certainty equivalent > expected value, risk preference is present. 6. Total risk= systematic risk + unsystematic risk

Systematic risk is due to risk factors that affect the overall market – such as changes in the nation’s economy, tax reform by congress and etc. t

Unsystematic risk is risk unique to a particular company or industry; it is independent of economic, political, and other factors that affect all securities in a systematic manner.

7. The relationship between expected return and systematic risk and the valuation of securities

that follows, is the essence of capital- asset pricing model ( CAPM) 8. Three forms of market efficiency:

Weak- form efficiency: current prices fully reflect the historical sequence of price. In short, knowing past price patterns will not help you improve forecast of future prices.

Semistrong-form efficiency: current price fully reflect all publicly available information, including such things as annual reports and news items.

Strong-form efficiency: current price fully reflect all information, both public and private

9. Financial statements:

Balance sheet summarizes the assets liabilities, and owners’ equity of a business at a moment in time.

The income statement summarizes the revenues and expenses of the firm over a particular period of time.

From these two statements, certain derivative statements can be produced, such as a

statement of retained earnings, a sources and uses of funds statement, and a statement of cash flows.

10. The commonly used financial ratios are of essentially two kinds: balance sheet ratios, income

statement rations. We can further subdivide our financial ratios into five distinct types: liquidity, financial leverage (or debt), coverage, activity, and profitability ratios.

11. Each activity’s cash inflow or outflow is segregated according to one of three broad category

types: operating, investing, or financing activity. 12. Classification of working capital

time, as either permanent or temporary.

13. Two broad aspects of working capital management: what level of currents assets to maintain

and how to finance current assets.

14. A number of methods are designed to speed up the collection process by doing one or more

of the following: (1) expedite preparing and mailing the invoice; (2) accelerate the mailing of payments form customers to the firm; (3) reduce the time during which payments received by the firm remain uncollected funds.

15. The firm’s portfolio of short-term marketable securities can be thought of as a pie cut into 3:

ready cash segment: optimal balance of marketable securities held to take care fo probable deficiencies in the firm’s cash account.

controllable cash segment: marketable securities held for meeting controllable outflow, such as taxes and dividends

free cash segment: “free” marketable securities (that’s available for as yet unassigned purposes)

16. Variables in marketable securities selection: safety, marketability, yield, maturity.

Chapter 2 The Business, Tax, and Financial Environments Problems

2. The Loann Le Milling Company is going to purchase a new piece of testing equipment for $28,000 and a new machine for $53,000. The equipment falls in the three-year property class, and the machine is in the five-year class. What annual depreciation will the company be able to take on the two assets?

4. the Castle Cork Company was founded in 20X1 and had the following taxable income through 20X5：

20X1 20X2 20X3 20X4 20X5

$0

$35,000

$68,000

-$120,000

$52,000

Compute the corporate income tax or tax refund in each year, assuming the graduated tax rates discussed in the chapter.

Chapter 3 The Time Value of Money Self-Correction Problems

6. Your late Uncle Vern’s will entitles you to receive $1,000 at the end of every other year for the next two decades. The first cash flow is two years from now. At a 10 percent compound annual interest rate, what is the present value of this unusual cash-flow pattern? (Try to solve this problem in as few steps as you can.)

9. Xu Lin recently obtained a 10-year, $50,000 loan. The loan carries an 8 percent compound annual interest rate and calls for annual installment payments of $7,451.47 at the end of each of the next 10 years.

a. How much (in dollars) of the first year’s payment is principal?

b. How much total interest will be paid over the life of the loan? (Hint: You do not need to construct a loan amortization table to answer this question. Some simple math is all you need.)

Problems

9. The H & L Bark Company is considering the purchase of a debarking machine that is expected to provide cash flows as follows:

Cash flow

Cash flow

6 $1,400

7 $1,400

END OF YEAR

8 $1,400

9 $1,400

10 $1,400

1 $1,200

2 $2,000

END OF YEAR

3 $2,400

4 $1,900

5 $1,600

If the appropriate annual discount rate is 14 percent, what is the present value of this cash-flow stream?

19. Assume that you will be opening a savings account today by depositing $100,000.The savings account pays 5 percent compound annual interest, and this rate is assumed to remain in effect for all future periods. Four years from today you will withdraw R dollars. You will continue to make additional annual withdrawals of R dollars for a while longer-making your last withdrawal at the end of year 9- to achieve the following pattern of cash flows over time. (Note: Today is time period zero; one year from today is the end of time period 1; etc.)

Cash withdrawals at the END of year …

0 1 2 3 4 5 6 7 8 9 R R R R R R How large must R be to leave you with exactly a zero balance after your final R withdrawal is

made at the end of year 9? (Tip: Making use of an annuity table or formula will make your work a lot easier!)