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Fin316 Study Materials Essay

1977 words - 8 pages

1. Agency problems – why they arise, ways to reduce them (board of directors for ex.)

• Corporations are owned by shareholders that want managers to maximize their wealth.

• Agency problems arise due to the separation of ownership and management

* Managers may have conflicts of interest with shareholders (maybe they want to maximize their own wealth rather than the shareholders wealth) – This is called an Agency Problem because the managers are acting as agents for the shareholders.

Examples of agency problems:
1. Purchasing private jets for personal use
2. Overindulging in expense account dinners
3. Avoiding risky projects because they are worried about the security of ...view middle of the document...

4. Investing (capital budgeting) vs. Financing (capital structure) Decisions vs. Working
Capital Management.

5. Real vs. financial assets – definitions and which deal with investing vs. financing decisions

6. Adjustments to accounting numbers-market instead of book values, cash flow instead of
earnings, why?

7. Concept behind the time value of money – a dollar today is worth more than a dollar
tomorrow, why? Also, present and future value relationships.

8. Annuity and perpetuity definitions.
Annuity: a special case of multiple cash flows where there is a level cash
payment (C) that ends at some point.
Perpetuity – A stream of level cash payments that never ends. Perpetuities are infinite,
or perpetual.

9. Determinants of required rate of return – real rate, expected inflation, risk

10. Stock exchanges: Physical exchanges: NYSE; OTC exchanges: NASDAQ; what
determines stock prices?

11. Yield to maturity – definition, estimate, use as discount rate

Yield to maturity is the single interest rate that implies a present value of cash flows of a
bond that equals its current price.

In general, the yield to maturity is a complicated average of interest rates in the term
structure. The yield to maturity is not a market rate of interest, but it can be used as our
discount rate to find price.

Yield to maturity is frequently quoted -

- It is important to remember that yield to maturity does not determine prices;
rather yield to maturity is implied by a bond's price and its pattern of future cash flows.
- Prices are determined by market rates of interest (or spot rates) that make up the
term structure.
- Yield to maturity is just an easy way to summarize the “average” rate of discount
for a bond with multiple cash flows.
- We often use the yield to maturity of a bond with a quoted market price to value a
bond that does not have an easily observed market price.

12. Primary vs. secondary stock markets – what happens/who gets money on each
Primary Market - when stocks are sold from the company to investors for the first time.
This is where corporations sell equity to raise money.
• Initial public offerings (IPOs)
• New issues from existing companies (Seasoned Equity Offerings or SEOs)

Secondary Market - markets where already issued securities sell.
• What we know as “the stock market”
• Provides liquidity by allowing investors to easily sell their shares to other
investors. (Note that the corporation whose stock is being sold is not who gets the
money on secondary market)
• NYSE and NASDAQ are examples
See text for description of NYSE and NASDAQ operations.

13. Risks you face when you own bonds – interest rate risk, credit (default) risk, how do these differ for government versus corporate (default premium), and short versus long term bonds

1. Interest Rate Risk
- We know that as interest rates change, bond prices change as well.
- If interest rates rise and you are locked into a...

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