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Financial Management Essay Sample

Financial Management Pages
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1. Required Return – return necessary to induce an individual to make an investment 2. Risk – possibility loss; the uncertain that the anticipated return will not be achieved 3. Diversifiable Risk – risk associated with individual events that affect a particular asset: • Firm – specific risk that’s reduced through the construction of diversified portfolios 4. Business Risk – risk associated with the nature of a business 5. Financial Risk – risk associated with the types of financing used to acquire assets 6. Non-diversifiable risk (systematic risk) – risk associated with fluctuations in securities prices and other non-firm-specific factors; market risk that is not reduced through the construction of diversified portfolios 7. Market risk – risk associated with fluctuations in securities prices 8. Interest rate risk – risk associated with changes in interest rates 9. Reinvestment rate risk – the risk associated with reinvesting earnings on principal at a lower rate than was initially earned

10. Purchasing power risk – uncertainty that future information will erode the purchasing power of assets and income 11. Exchange rate risk – risk of loss from charges in the value of foreign currencies 12. Standard deviation – measure of dispersion around an average value; a measure of risk 13. Beta Coefficient – index of systematic risk; measure of volatility of a stock’s return relative to the market return 14. Portfolio risk – total risk associated with owning a portfolio; sum of systematic and unsystematic risk 15. Capital Asset Pricing Model (CAPM) – model used in the valuation of an asset that specifies the required return for different level of risk 16. Common stock – security representing ownership in a corporation: owners have a final claim on the firm’s assets and earnings after the firm has met its obligation to creditors and preferred stockholders 17. Board of Directors (BOD) – body elected by & responsible to stockholders to set policy & high management to run a corporation 18. Cumulative Voting – voting system that encourages minority representation by permitting stockholders to cast all their shares for one candidate for the firms BOD 19. Preemptive rights – right of current stockholders to maintain their proportionate ownership in the firm.

1. What are Financial Markets?
Financial Markets refer to a conceptual “mechanism” rather than a physical location or a specific type of organization or structure. It is a system of individuals & institutions, instruments & procedures that bring together borrowers and savers

2. Importance of Financial Markets

The primary role of financial markets is to facilitate the flow of funds from individuals and business that have surplus funds to individuals, business and government that have needs for funds in excess of their income 3. Flow of funds

a. Direct Transfer – occurs when a business sells its stocks/bonds directly to savers (investors) without going through any type of intermediary/financial institution b. Investment banking house – serves as a middleman that facilitates the issuance of securities by firms that need to raise funds c. Financial Intermediaries – the intermediary obtains funds from savers and then uses the money to lend out or to purchase another company’s securities

4. Market Efficiency

a. Economic Efficiency – funds are allocated to their optimal use at the lowest costs in the financial markets b. Informational efficiency – the prices of investment reflect existing information and adjust quickly when new information enters the market 3 Categories

• Weak – efficiency states that all information contained in past price movement is fully reflected in current market prices • Semistrong-Form – efficiency states that current market prices reflect all publicly available information • Strong-Form – efficiency states that current market prices reflect all pertinent information whether, it is publicly available or privately held

5. TYPES OF FINANCIAL MARKETS

1. Money Market versus Capital markets

2. Debt Markets versus Equity Markets

3. Primary Markets versus Secondary Market

4. Derivatives Markets – financial markets where options & futures are traded

1. Credit policy – a set of decisions that includes a firm’s credit standards, credit terms, and methods used to collect credit accounts, and credit monitoring procedures. 2. Credit standards – standards that indicate the minimum financial strength customer must have to be granted credit 3. Terms of credit – the payment conditions offered to credit customers; these terms include the length of the credit period and any cash discounts offered 4. Cash period – the length of time for which the credit is granted; after that time, the credit account is considered delinquent 5. Cash discount – reduction in the invoice price of goods offered by the seller to encourage early payment 6. Collection policy – the procedures followed by a firm to collect its accounts receivable

7. Receivables monitoring – the process of evaluating the credit policy to determine whether a shift in the customers’ payment patters has occurred 8. Days Sales Outstanding (DSO) – the average length of time required to collect accounts receivables; also called the Average Collection period 9. Aging Schedule – a report showing how long accounts receivables have been outstanding; the report divides receivables into specified period, which provides information about the proportion of receivables that is current and the proportion that is past due for give lengths of time

STOCK MARKET

1. Listing Requirements – characteristics a firm must possess to be on a stock exchange 2. Over-the-counter market (OTC) – a collection of brokers & dealers, connected electronically by telephones & computers, that provide for trading in securities not listed on the physical stock exchange 3. Securities and Exchange Commission (SEC) – the US government that regulates the issuance & trading of stocks and bonds 4. Dual listing – when stocks are listed for trading in more that one stock market 5. Investment banker – an organization that underwrites & distributes new issues of securities, it helps business and other entities obtain needed financing 6. Underwritten arrangement – agreement for the sale of securities in which the investment bank guarantees the sale by purchasing the securities from the issuer, thus agreeing to bear any risk involved in selling the securities in the financial market 7. Best-efforts arrangements – agreements for the sale of securities in which the investment bank handling the transaction gives no guarantee that the securities will be sold

8. Flotation cost – the costs associated by issuing new stocks/bonds 9. Registration statement – a statement of facts with the SEC about a company that plans to issue securities 10. Prospectus – a document describing a new security issue and the issuing company 11. Underwriting syndicate – a group of investment banking firms formed to spread the risk associated with the purchased and distribution of a new issue of securities 12. Shelf registration – registration of securities with the SEC for sale at a later due. The securities are held “on the shelf” until the sale 13. Financial intermediaries – organization that create various loans & investments funds provided by depositor. Types of Financial Intermediaries

1. Commercial Bank – are the traditional “department stores of finance”. They offer a wide range of products and services to a variety of customers.

2. Credit Unions – is a depository institution that is owned by its depositors

3. Thrift Institution – also known as savings and loan associations, cater to savers, especially individual who has relatively small savings or need long-term loans to purchase houses

4. Mutual Funds – are investment companies that use funds provided by savers to buy various types of financial assets, including stocks and bonds

5. Whole-life Insurance Company – provides long-term contract that provides lifetime protection

6. Pension funds – are retirement plans funded by corporation/government agencies for their workers

Physical Stock exchanges – are tangible physical entities

Types of Exchange Member:

1. Floor Brokers – act as agent for investors who want to buy/sell securities 2. Specialists – their role is to ensure that the auction trading process is completed in a fair and efficient manner

INVESTMENT BANKING PROCESS

STAGE 1

1. Dollars to be raised
2. Type of securities used
3. Competitive bid VS. negotiated deal
4. selection of an investment banker
STAGE 2

1. reevaluating the initial decisions
2. best efforts or underwritten issue
3. Issuance (flotation) costs
4. setting the offering price

Benefits with the Financial Intermediaries

1. Reduced Costs
2. Risk/Diversification
3. Finds divisibility / Pooling
4. Financial Flexibility
5. Related Services

The segments of the financial markets where the instruments that are traded have maturities equal to one year or less

The segments of financial market where the instrument that are traded have maturities greater than one year

Financial markets where loans are traded

Financial markets where corporate stocks are traded

Markets in which various organization raise funds by issuing new securities.

Markets where financial assets that have previously been issued by various organization are traded among investors

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