FINANCE | Perfectgrader

business ethics

standards of conduct or moral judgment that apply to persons engaged in commerce

Marginal cost-benefit analysis

is the economic principle that states that financial decisions should be made and actions taken only when the added benefits exceed the added costs

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making investment decisions

current assets and fixed assets

making financing decisions

current liabilities and long term funds

institutional investors

are investment professionals, such as banks, insurance companies, mutual funds, and pension funds, that are paid to manage and hold large quantities of securities on behalf of others

sarbnes-oxley act of 2002

established an oversight board to monitor the accounting industry, tightened audit regulations and controls

principal-agent relationship

is an arrangement in which an agent acts on the behalf of a principal. For example, shareholders of a company (principals) elect management (agents) to act on their behalf

agency problems

arise when managers place
personal goals ahead of the goals of shareholders

agency cost

arise from agency problems that are borne by shareholders and represent a loss of shareholder wealth

incentive plans

are management compensation plans that tie management compensation to share price; one example involves the granting of stock options

performance plans

tie management compensation to measures such as EPS or growth in EPS. Performance shares and/or cash bonuses are used as compensation under these plans

the three legal forms of business are

The legal forms of business organization are the sole proprietorship, the partnership, and the corporation

describe the goal of the firm, and explain why maximizing the value of the firm is an appropriate goal for a business

The goal of the firm is maximize its value, and therefore the wealth of its shareholders.Maximizing the value of the firm means running the business in the interest of those who own it—the shareholders

firms that require funds from external sources can
obtain them in three ways

through a financial institution
2. through financial markets
3. through private placements

commerical banks

are institutions that provide savers with a secure place to invest their funds, and offer loans to individual and business borrowers

investment banks

are institutions that assist companies in raising capital, advise firms on major transactions such as mergers or financial restructurings, and engage in trading and market making activities

the glass steagall act

was an act of Congress in 1933 that created the federal deposit insurance program and separated the activities of commercial and investment banks. It was repealed it 1999 by Congress.

shadow banking system

describes a group of institutions that engage in lending activities, much like traditional banks, but do not accept deposits, and are not subject to the same regulations as traditional banks

financial markets

are forums in which suppliers of funds and demanders of funds can transact business directly

private placement

involves the sale of a new security directly to an investor or group of investors.

public offering

is the sale of either bonds or stocks to the general public

primary market

is the financial market in which securities are initially issued; the only market in which the issuer is directly involved in the transaction

secondary market

are financial markets in which preowned securities (those that are not new issues) are traded

capital market

is a market that enables suppliers and demanders of long-term funds to make transactions

bonds

are long-term debt instruments used by businesses and government to raise large sums of money, generally from a diverse group of lenders

common stock

are units of ownership interest or equity in a corporation

preferred stock

is a special form of ownership that has features of both a bond and common stock

broker market

are securities exchanges on which the two sides of a transaction, the buyer and seller, are brought together to trade securities

dealer market

such as Nasdaq, are markets in which the buyer and seller are not brought together directly but instead have their orders executed by securities dealers that “make markets” in the given
security

foreign bond market

is a market for bonds issued by a foreign corporation or government that is denominated in the investor’s home currency and sold in the investor’s home market

efficient market

allocates funds to their most productive uses as a result of competition among wealth-maximizing investors and determines and publicizes prices that are believed to be close to their true value

the federal deposit insurance corporation (FDIC)

provides insurance for deposits at banks and monitors banks to ensure their safety and
soundness

the gramm leach bliley act of 1999

allows business combinations (e.g. mergers) between commercial banks, investment banks, and
insurance companies, and thus permits these
institutions to compete in markets that prior
regulations prohibited them from entering

securities exchange act of 1934

regulates the trading of securities such as stocks and bonds in the secondary market.

marginal tax rate

represents the rate at which additional income is taxed

average tax rate

is the firm’s taxes divided by taxable income

explain the root causes and subsequent effects of the 2008 financial crisis and recession

Financial institutions lowered their standards for lending to prospective homeowners and invested heavily in mortgage-backed securities. When home prices fell and mortgage delinquencies rose, the value of the mortgage-backed securities
held by banks plummeted, causing some banks to fail and many others to restrict the flow of credit to business. That contributed to a severe recession in the United States and abroad

discuss business taxes and their importance in
financial decisions

Corporate income is subject to corporate taxes. Corporate tax rates apply to both ordinary income (after deduction of allowable expenses) and capital gains. The average tax rate paid by a corporation ranges from 15 to 35 percent. Corporate taxpayers can reduce their taxes through certain provisions in the tax code: dividend income exclusions and tax-deductible expenses. A capital gain occurs when an asset is sold for more than its initial purchase price; they are added to ordinary corporate income and taxed at regular corporate tax rates.

income statement

provides a financial summary of a company’s operating results during a specified period

balance sheet

presents a summary of a firm’s financial position at a given point in time

statement of retained earnings

reconciles the net income earned during a given year, and any cash dividends paid, with the change in retained earnings between the start and the end of that year

fasb 52

mandates that U.S.-based companies translate their foreign-currency-denominated assets and liabilities into dollars, for consolidation with the parent company’s financial statements. This is done by using the current rate (translation) method

current rate (translation) method

is a technique used by U.S.-based companies to translate their foreign-currency-denominated assets and liabilities into dollars, for consolidation
with the parent company’s financial statements, using the year-end (current) exchange rate

cross sectional analysis

is the comparison of different firms’ financial ratios at the same point in time; involves comparing the firm’s ratios to those of other firms in its industry or to industry averages

benchmarking

is a type of cross-sectional analysis in which the firm’s ratio values are compared to those of a key competitor or group of competitors that it wishes to emulate

current ratio

measures the ability of the firm to meet its short-term obligations

current ratio formula

current ratio = current assets / current liabilities

the quick (acid-test) ratio

(current assets - inventory) / current liabilities

inventory turnover

measures the activity, or liquidity, of a firm’ s inventory

inventory turnover ratio

inventory turnover = cost of goods sold/ inventory

average age of inventory

is the average number of days’ sales in inventory

average age of inventory ratio

average age of inventory = 365 / inventory turnover

average collection period

is the average amount of time needed to collect accounts receivable

average collection period ratio

accounts receivable/average sales per day, then accounts receivable/(annual sales/365)

average payment period

is the average amount of time needed to pay accounts payable

average payment period ratio

accounts payable/average purchases per day, then (accounts payable)/(annual purchases/365)

total asset turnover

total asset turnover indicates the efficiency with
which the firm uses its assets to generate sales.

total asset turnover ratio

total asset turnover = sales/ total assets

debt ratio

the debt ratio measures the proportion of total
assets financed by the firm’ s creditors.

debt ratio formula

debt ratio = total liabilities / total assets

debt to equity ratio

the debt-to-equity ratio measures the relative proportion of total liabilities and common stock equity used to finance the firm’ s total assets

debt to equity ratio formula

debt to equity = total liabilities / common stock equity

times interest earned ratio

the times interest earned ratio measures the firm’ s ability to make contractual interest payments; sometimes called the interest coverage ratio.

times interest earned ratio formula

times interest earned ratio = EBIT / taxes

the fixed payment coverage ratio

the fixed-payment coverage ratio measures the
firm’ s ability to meet all fixed-payment obligations

the fixed payment coverage ratio formula

gross profit margin

gross profit margin measures the percentage of
each sales dollar remaining after the firm has paid for its goods

gross profit margin

(sales-cogs)/sales = gross profits/sales

operating profit margin

operating profit margin measures the percentage of each sales dollar remaining after all costs and
expenses other than interest, taxes, and preferred
stock dividends are deducted

operating profit margin ratio

operating profit margin = operating profits / sales

net profit margin

Net profit margin measures the percentage of each sales dollar remaining after all costs and expenses, including interest, taxes, and preferred stock dividends, have been deducted

net profit margin ratio

net profit margin = earnings available for common
stockholders / sales

earnings per share

earnings per share represents the number of
dollars earned during the period on the behalf of each outstanding share of common stock.

eps formula

earnings available for common stockholders / # of shares of common stock outstanding

return on total assets (ROA)

the return on total assets measures the overall
effectiveness of management in generating profits
with its available assets

ROA formula

return on total assets (ROA) = earnings available for common stockholders / total assets

the return on equity (ROE)

the return on equity measures the return earned on common stockholders’ investment in the firm

the return on equity (ROE) formula

(ROE) = earnings available for common
stockholders / common stock equity

price/earnings (P/E) ratio

measures the amount that investors are willing to pay for each dollar of a firm’ s earnings

P/E Ratio formula

Price Earnings (P/E) Ratio = Market price per share of common stock ÷ Earnings per share

market book ratio

market/book (M/B) ratio provides an assessment of how investors view the firm’ s performance

market book ratio formula

market price per share of common stock / book value per share of common stock

the dupont system

of analysis is used to dissect the firm’s financial statements and to assess its financial condition

the financial leverage multiplier

is the ratio of total assets to common stock equity

depreciation

is the portion of the costs of fixed assets charged against annual revenues over time

MACRS

modified accelerated cost recovery system

free cash flows (fcf)

is the amount of cash flow available to investors (creditors and owners) after the firm has met all operating needs and paid for investments in net fixed assets (NFAI) and net current assets (NCAI)

long-term (strategic) financial plans

lay out a company’s planned financial actions and the anticipated impact of those actions over periods ranging from 2 to 10 years

cash budget (cash forecast)

is a statement of the firm’s planned inflows and outflows of cash that is used to estimate its short-term cash requirements

sales forecast

is a prediction of the sales activity during a given period, based on external and/or internal data

pro forma financial statements

are projected, or forecast, income statements and balance sheets

judgemental approach

is a simplified approach for preparing the pro forma balance sheet under which the firm estimates the values of certain balance sheet accounts and uses its external financing as a balancing, or “plug,” figure

future value

is the value at a given future date of an amount placed on deposit today and earning interest at a specified rate. Found by applying compound interest over a specified period of time

compound interest

is interest that is earned on a given deposit and has become part of the principal at the end of a specified period

principal

is the amount of money on which interest is paid

future value for end of the period

FVn = PV x (1 + r)^n

present value

is the current dollar value of a future amount—the amount of money that would have to be invested today at a given interest rate over a specified period to equal the future amount. It is based on the idea that a dollar today is worth more than a dollar tomorrow

discounting cash flows

is the process of finding present values; the inverse of compounding interest.

annuity

is a stream of equal periodic cash flows, over a specified time period

ordinary (deferred) annuity

is an annuity for which the cash flow occurs at the end of each period

annuity due

is an annuity for which the cash flow occurs at the beginning of each period

perpetuity

is an annuity with an infinite life, providing continual annual cash flow.

continous compounding

involves the compounding of interest an infinite number of times per year at intervals of microseconds.

nominal (stated) annual rate

is the contractual annual rate of interest charged by a lender or promised by a borrower

effective (true) annual rate (EAR)

is the annual rate of interest actually paid or earned.

loan amortization

is the determination of the equal periodic loan payments necessary to provide a lender with a specified interest return and to repay the loan principal over a specified period

loan amortization schedule

is a schedule of equal payments to repay a loan. It shows the allocation of each loan payment to interest and principal

interest rate

is usually applied to debt instruments such as bank loans or bonds; the compensation paid by the borrower of funds to the lender; from the borrower’s point of view, the cost of borrowing funds

required return

is usually applied to equity instruments such as common stock; the cost of funds obtained by selling an ownership interest

real rate of interest

is the rate that creates equilibrium between the supply of savings and the demand for investment funds in a perfect world, without inflation, where suppliers and demanders of funds have no liquidity preferences and there is no risk

nominal rate of interest

is the actual rate of interest charged by the supplier of funds and paid by the demander

term structure of interest rates

is the relationship between the maturity and rate of
return for bonds with similar levels of risk

yield curve

A graphic depiction of the term structure of interest rates

yield to maturity curve

is the compound annual rate of return earned on a debt security purchased on a given day and held to maturity

nominal yield curve

is an upward-sloping yield curve indicates that long-term interest rates are generally higher than short-term interest rates

inverted yield curve

is a downward-sloping yield curve indicates that short-term interest rates are generally higher than long-term interest rates

flat yield curve

is a yield curve that indicates that interest rates do not vary much at different maturities

expectations theory

is the theory that the yield curve reflects investor expectations about future interest rates; an expectation of rising interest rates results in an upward-sloping yield curve, and an expectation of declining rates results in a downward-sloping yield curve

liquidity preference theory

suggests that long-term rates are generally higher than short-term rates (hence, the yield curve is upward sloping) because investors perceive short-term investments to be more liquid and less risky than long-term investments. Borrowers must offer
higher rates on long-term bonds to entice investors away from their preferred short-term securities

market segmentation theory

suggests that the market for loans is segmented on the basis of maturity and that the supply of and demand for loans within each segment determine its prevailing interest rate; the slope of the yield
curve is determined by the general relationship between the prevailing rates in each market segment

corporate bond

is a long-term debt instrument indicating that a corporation has borrowed a certain amount of money and promises to repay it in the future under clearly defined terms

coupon interest rate

is the percentage of a bond’s par value that will be paid annually, typically in two equal semiannual payments, as interest

bond indenture

is a legal document that specifies both the rights of the bondholders and the duties of the issuing corporation

standard debt provisions

are provisions in a bond indenture specifying certain record-keeping and general business practices that the bond issuer must follow; normally, they do not place a burden on a financially sound business

restrictive covenants

are provisions in a bond indenture that place operating and financial constraints on the borrower

subordinations

means that subsequent creditors agree to wait until all claims of the senior debt are satisfied

sinking-fund requirement

are a restrictive provision often included in a bond indenture, providing for the systematic retirement of bonds prior to their maturity

security interest

is a provision in the bond indenture that identifies any collateral pledged against the bond and how it is to be maintained. The protection of bond collateral is crucial to guarantee the safety of a bond issue

trustee

is a paid individual, corporation, or commercial bank trust department that acts as the third party to a bond indenture and can take specified actions on behalf of the bondholders if the terms of the indenture are violated

conversion feature

for convertible bonds allows bondholders to change each bond into a stated number of shares of common stock

call feature

which is included in nearly all corporate bond issues, gives the issuer the opportunity to repurchase bonds at a stated call price prior to maturity

call price

is the stated price at which a bond may be
repurchased, by use of a call feature, prior to maturity

call premium

is the amount by which a bond’s call price exceeds its par value. is equal to one year of coupon interest and compensates the holder for having it called prior to maturity

stock purchase warrants

which are instruments that give their holders the right to purchase a certain number of shares of the issuer’s common stock at a specified price over a certain period of time

valuation

is the process that links risk and return to determine the worth of an asset

interest rate risk

is the chance that interest rates will change and thereby change the required return and bond value.

yield to maturity (ytm)

is the rate of return that investors earn if they buy a bond at a specific price and hold it until maturity. (Assumes that the issuer makes all scheduled interest and principal payments as promised.)

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