Ch. 1
What is Finance?
Finance is concerned with applying value to things.
ex: shares of stocks, mortgage payment
What are financial markets?
They manage the flow of funds from investors to borrowers
Dollar return = (Ending value - Beginning value) + Income
What is the formula for expected return?
Sum of (Probability of Scenario * Return in the Scenario)
What are the different forms of efficiency?
Weak form, Semistrong form, and Strong form
What is the difference between accounting and finance?
Accounting keeps track of what happened in the firm's past regarding money.
Finance uses accounting's historical figures to determine what should happen with the firm's money
What is a primary market?
In a primary market, the firm sells new securities to investors and receives cash. This is known as an Initial Public Offering (IPO)
What is the formula to calculate Percentage Return?
Percentage Return = Dollar return/ Beginning value
Percentage Return = (Ending value - Beginning value) + Income / Beginning value
What is risk premium?
is the added return (over and above the risk-free rate) representing the reward for bearing risk.
What is the security market line?
The Security Market Line (SML) shows the relation between systematic risk (b) and expected (required) return for assets held in well-diversified portfolios
What are the four types of business organizations?
- Sole proprietorship
- Partnership (General and Limited)
- Corporation
- Hybrids (LLC)
What are the 3 types of funds?
Mutual fund - investment vehicle using a pool of money from many investors that can be invested in stocks, bonds, money markets, etc.
Exchange-Traded Fund (ETF) - marketable security that tracks an index, a commodity, or a basket of assets. ETFs trade like common stocks on a stock exchange.
Hedge Fund - milar to mutual funds, however, they are only able to take money from individuals with high net worth or income
What is Geometric Average?
Geometric Average - average compound return per period over multiple periods
=[(1+R1)(1+R2)…(1+Rn)]1/n−1
What does beta measure?
measures the responsiveness of a security to movements in the market portfolio
What is firm-specific risk?
Risk factors that affect a limited number of assets.
Also known as diversifiable risk
What is the agency problem?
The agency problem is when the manager's interest may not align with shareholder goals.
What are examples of securities in a Money Market? Capital Market?
Money Market: U.S. Government T-bill, commercial paper, & certificates of deposit (CD)
Capital Market: Common stock, preferred stock, and bonds
What is systematic risk? Include an example
Risk factors that affect a large number of assets. Otherwise, known as market risk.
Ex: COVID shutdown, 2008 financial crisis, 9/11, the Great Depression
What is the formula for Capital Asset Pricing Model (CAPM)?
Expected return on a security= Risk-free rate + Beta of the security × Market risk premium
What is one of the three regulations we learned about?
The Securities Act of 1933 - Firms must file a registration statement containing relevant information about securities being offered.
The Securities Exchange Act of 1934 - Extended disclosure requirements to securities trading in the secondary market. Created the SEC
Sarbanes-Oxley Act (2002) - Brought about by corporate scandals. Features of SOX: auditor independence, certification of financial statements by management, enhanced disclosure of financial data, independence of audit committee members, enhanced penalties
What are examples of financial intermediaries?
commercial banks, investment banks, mutual funds, pension funds, and insurance companies
What is a Money Market? What is a Capital Market?
Money Market - when firms want to raise cash for a short time, issue money market securities
Capital Market - when firms want to raise cash for a long period of time, issue capital market securities
What is Diversification?
substantially reduces the variability of returns without an equivalent reduction in expected returns.
What is an efficient capital market?
is one in which stock prices fully reflect available information.
What are securities?
document that certifies the bearer has a claim to funds in the future
ex: stocks, bonds, T-bills