Margins Study Assistant

Chapter 1

Introduction to Finance

Summary

There are three broad areas of finance: business finance, investments, and financial markets and institutions Finance is the study of the trade-off between risk and expected return. The accounting department creates financial statements, and the finance department implements the firm’s policy objectives, monitors results, and responds to necessary strategic and tactical changes. Finance is responsible for budgeting and forecasting.

Key terms

business finance: the study and application of how managers can apply financial principles to maximize the value of a firm in a risky environment
investments: one of the three main areas of finance; products and processes used to create individual and institutional portfolios with the intent of growing wealth
financial markets and institutions: one of the three main areas of the field of finance; firms and regulatory agencies that oversee our financial system
commercial paper (CP): short-term, unsecured financial obligations issued by firms as a means of short-term financing for items such as inventory or payables
economic value: the amount a consumer is willing to pay for a particular asset or service, usually greater than or equal to the current market price or present value of the asset
treasurer: position responsible for monitoring cash flow at a firm and frequently is the contact person for bankers, underwriters, and other outside sources of financing
brokers: individuals or a firm that brings together potential buyers and sellers of a product and receives a commission at transaction
capital market: market for longer-term financial instruments, such as stocks and bonds, used to finance long-term projects for organizations

Chapter 2

Corporate Structure and Governance

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Summary

The most common forms of business organizations are sole proprietorships, partnerships, corporations, and hybrids. The most common type of organization for larger businesses is the corporation, the establishment of which involves filing articles of incorporation A stakeholder is any individual or group that has an interest in the outcomes of an organization’s actions. Shareholders are relevant to a corporation form of business because they own stock in the corporation.

Key terms

corporation: a legal entity that is separate and distinct from its owners
partnership: a formal arrangement by two or more parties to manage and operate a business and share its profits and liabilities equally
board: also tasked with a number of other responsibilities, including setting company goals, creating dividend and stock option policies, hiring and firing CEOs, and ensuring th
articles of incorporation: a set of formal documents filed with a government body to legally document the creation of a corporation
stakeholder: a person with an interest or concern in a business
agency theory: a principle that is used to explain and resolve issues in the relationship between business principals and their agents, most commonly between shareholders (principals) and…
investor relations (IR): a strategic management responsibility that is capable of integrating finance, communication, marketing, and securities law compliance to enable the most effective two-way…
non-stock corporation: a corporation that does not have owners represented by shares of stock but typically has members who are the functional equivalent of stockholders in a stock corporation (having…

Chapter 3

Economic Foundations: Money and Rates

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Summary

The point of intersection of the supply and demand curves determines the equilibrium price and quantity In the marketplace, buyers and sellers come together. The buyers are represented by a downward-sloping demand curve; lower prices are associated with a larger quantity demanded. The sellers are represented by an upward-sloping supply curve; higher prices are associated with a large quantity supplied.

Key terms

demand: the quantity of a good or service that consumers are willing and able to purchase during a given time period, ceteris paribus
supply: the quantity of a good or service that firms are willing to sell in the market during a given time period, ceteris paribus
buyers: represented by a downward-sloping demand curve; lower prices are associated with a larger quantity demanded
sellers: represented by an upward-sloping supply curve; higher prices are associated with a large quantity supplied
microeconomics: the study of the economy at the individual level, focusing on how individuals and businesses choose to allocate scarce resources
macroeconomics: the study of the economy as a whole, focusing on unemployment, inflation, and total output
equilibrium: the point at which the demand and supply curves for a good or service intersect
equilibrium price: the price at which quantity demanded equals quantity supplied

Chapter 4

Accrual Accounting Process

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Summary

Cash-basis accounting records revenues and expenses only when cash is received or distributed. Accrual-basis accounting, on the other hand, records revenues and expenses when they are earned or incurred rather than waiting until cash changes hands. Double-entry accounting means that each time a transaction is recorded, there are at minimum two accounts impacted by the entry. In accrual accounting, the timing of revenues (when to record them) is governed by the revenue recognition principle.

Key terms

accrual-basis accounting: an accounting system in which revenue is recorded or recognized when earned yet not necessarily received, and in which expenses are recorded when legally incurred and not…
cash-basis accounting: a method of accounting in which transactions are not recorded in the financial statements until there is an exchange of cash
revenue recognition: principle stating that a company must recognize revenue in the period in which it is earned; it is not considered earned until a product or service has been provided
net income: income earned when revenues and gains are greater than expenses and losses
transaction: recorded, there are at minimum two accounts impacted by the entry
revenue: inflows or other enhancements of assets of an entity or settlements of its liabilities (or a combination of both) from delivering or producing goods, rendering services, or other…
double-entry accounting: an accounting method that requires the sum of the debits to equal the sum of the credits for each transaction
debit: a record of financial information on the left side of each account

Chapter 5

Financial Statements

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Summary

It is laid out to clearly depict and support the accounting equation: assets = liabilities + owner ’ s equity . A classified balance sheet breaks down the assets and liabilities sections into current and noncurrent for greater transparency The income statement reflects a firm’s performance over a period of time. The income statement reflects sales less cost of goods sold to arrive at gross profit.

Key terms

net income: revenues and gains that are greater than expenses and losses
assets: tangible or intangible resources owned or controlled by a company, individual, or other entity with the intent that they will provide economic value
liabilities: probable future sacrifice of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a…
income statement: financial statement that measures the organization’s financial performance for a given period of time
accounting equation: assets = liabilities + owner’s equity
accrual basis: accounting system in which revenue is recorded or recognized when earned yet not necessarily received, and in which expenses are recorded when legally incurred and not…
cash basis: method of accounting in which transactions are not recorded in the financial statements until there is an exchange of cash
direct method: approach used to determine net cash flows from operating activities, whereby accrual basis revenue and expenses are converted to cash basis collections and payments

Chapter 6

Measures of Financial Health

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Summary

Common ratios to measure liquidity include the current ratio, the quick ratio, and the cash ratio. Common efficiency ratios include accounts receivable turnover, total asset turnover, inventory turnover, and days’ sales in inventory Each of these three ratios includes more (cash ratio) or less liquid (current ratio) current assets in its measure of liquidity Liquidity ratios help analysts measure how well an organization can meet its short-term obligations (liabilities) as they come due.

Key terms

cash ratio: represents the firm’s cash and cash equivalents divided by current liabilities; often used by investors and lender to assess an organization’s liquidity
current ratio: current assets divided by current liabilities; used to determine a company’s liquidity (ability to meet short-term obligations)
quick ratio: also known as the acid test ratio ; ratio used to determine a firm’s ability to pay short-term debts using its most liquid assets
solvency: implies that a company can meet its long-term obligations and will likely stay in business in the future
inventory turnover: measures the number of times an average quantity of inventory was bought and sold during the period
liquidity: ability to convert assets into cash in order to meet primarily short-term cash needs or emergencies
total asset turnover: measures the ability of a company to use its assets to generate revenues
days’ sales in inventory: the number of days it takes a company to turn inventory into sales

Chapter 7

Time Value of Money I: Single Payment Value

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Summary

Because it is possible to earn interest income on cash that you decide to deposit in an investment or an interest-bearing account, money that you have now or receive sooner will be more valuable to you than the same… Future value refers to the value that a current amount will eventually grow into at a given interest rate over a specific period of time. The single-period scenario is one way in which future amounts are calculated. Compounding, which is interest earned on interest, also affects the future value of money

Key terms

interest: the amount of money that is paid by a borrower to a lender for the use of their money, typically calculated from an annualized rate
single-period scenario: one way in which future amounts are calculated
growth rate: the percentage increase of a specific variable within a specific time period; synonymous with interest rate in the context of the time value of money
investment: an asset or item acquired with the goal of generating financial gain through increased income or appreciation in value
Bureau of Labor Statistics: a group within the United States Department of Labor that is the primary fact-finding agency for the US government in the fields of labor, statistics, and economics; serves as…
uninvested: describes cash that is being held in reserve, is not invested in an account or financial instrument, and is not earning interest or any return
time value of money (TMV): the concept that an amount of money is worth more today than the exact same amount of money at some point in the future
money supply: the total dollar value of legal tender that is available to consumers within an economy at any single point in time

Chapter 8

Time Value of Money II: Equal Multiple Payments

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Summary

A perpetuity is an investment that is intended to provide an expected return indefinitely, either remaining constant or growing by an incremental amount. Preferred stock is a common example with a preestablished dividend formula. An annuity is a stream of fixed periodic payments that is expected to be paid or received. An indefinite stream of payments cannot be compounded into a future value, but it can be discounted to a present value, providing an opportunity to determine the amount an investor should be willing to pay for a share…

Key terms

perpetuity: a stream of periodic payments that is expected to continue indefinitely
preferred stock: shares of ownership in a corporation that typically entitle the holder to a fixed dividend per share, if declared by the corporation, with priority over holders of that…
annuity: a stream of regular, periodic payments to be received or paid
growing perpetuity: a stream of periodic payments that is expected to continue indefinitely with growth of the amount paid or received in the future, usually by a fixed percentage
constant perpetuity: a stream of periodic payments that is expected to continue indefinitely with no change in the amount paid or received
structured settlements: monetary legal settlements that are paid out in installments, such as an annuity, rather than a lump sum cash amount
discount rate: an interest rate used in time value of money calculations to determine present value; may derive from several sources, such as stated contract rates, costs to borrow, or expected…
loan amortization: the scheduling of periodic repayment of a debt, typically involving regular payments or receipts of amounts that include both interest payment and repayment of the principal of…

Chapter 9

Time Value of Money III: Unequal Multiple Payment Values

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Summary

These future cash flows could involve inflows or outflows of cash in unequal amounts. This section analyzed the determination of present and future value of these uneven or mixed cash flows This is relevant for investments for the future and for analyses of the value of projects that require investment today to produce expected flows of cash later. This section discussed the use of two tools for managing and understanding the time value of money and its many applications when the flows of cash are unequal: the TI BA II Plus™ Professional financial calculator and…

Key terms

cash flow: the amount of cash actually flowing into and out of a business, as opposed to income (which is based on accounting rules, accruals, and reports)
future value: the value of an asset or holding at a point in the future based on expectations of that asset’s growth at a certain rate of return
flows of cash: unequal: the TI BA II Plus™ Professional financial calculator and…
capital investment: a major expenditure that requires a large up-front investment and is expected to generate substantial cash inflow in return
present value: the value of an asset in today’s dollars based on future growth expectations at an assumed interest rate
mixed stream: a set of cash flows over a period of time that can vary in amount from one period to the next

Chapter 10

Bonds and Bond Valuation

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Summary

When interest rate yields are plotted against their respective maturity periods and these plotted points are connected, the resulting line is called the yield curve. There are three primary categories of bonds: government bonds, corporate bonds, and convertible bonds. It is important to ascertain what a given bond is worth to a willing buyer and a willing seller. The essential steps are (1) identify the amount and timing of the future cash flow; (2) determine the discount rate; (3) find the present values of the lump sum principal and the annuity stream of coupons; and (4) add…

Key terms

convertible bonds: fixed-income corporate debt securities that yield interest payments but can be converted into a predetermined number of common stock or equity shares
yield curve: a line that plots yields (interest rates) of bonds having equal credit quality but differing maturity dates; gives an idea of future interest rate changes and economic activity
essential steps: (1) identify the amount and timing of the future cash flow; (2) determine the discount rate; (3) find the present values of the lump sum principal and the annuity stream
given bond: worth to a willing buyer and a willing seller
coupon rate: the amount of annual interest paid by the bond issuer; is multiplied by the face value of a bond to determine annual interest or coupon payment amounts
discount bond: a bond currently trading for less than its par value in the secondary market; offers a coupon rate that is lower than prevailing interest rates
fixed-income securities: investments that provide a return in the form of fixed, periodic interest payments and the eventual return of principal at maturity; the most common forms are bonds

Chapter 11

Stocks and Stock Valuation

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Summary

The most common DDM is the Gordon growth model, which values stock entirely on expected future dividends. This section introduced common stock and some of the models and calculation methods used by investors and financial analysts to determine the prices or values of common shares. The dividend discount model, or DDM, is a method used to value a stock based on the concept that its worth is the present value of all of its future dividends. Other techniques include the zero growth DDM, which depends on fixed dividends; the constant growth DDM, which assumes that dividends will grow at a constant rate; and the variable growth or nonconstant growth DDM…

Key terms

Gordon growth model: a methodology used to determine the intrinsic value of a stock based on a future series of dividends that grow at a constant rate
dividend: a sum of money paid regularly (typically quarterly) by a company to its shareholders out of its profits or reserves
most common DDM: the Gordon growth model, which values stock entirely on expected future dividends
common stock: a security that represents partial ownership of a corporation
dividend discount model (DDM): a quantitative method for predicting the price of a company’s stock based on the theory that its present-day price is worth the sum of all of its future dividend payments when…
intangible assets: assets that are not physical in nature, such as goodwill, brand recognition, and intellectual property (i.e., patents, trademarks, and copyrights)
precedent transaction analysis (precedents): a method for valuating a company in which the price paid for similar companies in the past is considered an indicator of the company’s current value
efficient markets: markets in which costs are minimal and prices are current, fair, and reflective of all available relevant information

Chapter 12

Historical Performance of US Markets

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Summary

The Federal Reserve considers moderate inflation rates optimal in their oversight of the US economy. We measure inflation by comparing the price of a bundle or basket of goods over time and documenting how prices change. One way to parse financial markets is by the maturity of financial instruments. With this dichotomy, we explored the money market and the capital market.

Key terms

inflation: a general increase in prices and a reduction in purchasing power; expected rate is a key component of interest rates
bond returns: sums the periodic interest payments and the change in bond price in a given period and divides by the bond price at the beginning of the period
commercial paper (CP): a short-term, unsecured security issued by corporations and financial institutions to meet short-term financing needs such as inventory and receivables
negotiable certificates of deposit (NCDs): large CDs issued by financial institutions; redeemable at maturity but can trade prior to maturity in a broad secondary market
shelf registration: part of Securities and Exchange Commission (SEC) Rule 415; allows a company to register with the SEC to issue new shares but allows up to two years before issuing the shares
stock returns: sums the periodic dividend payments plus the change in stock price in a given period divided by the stock price at the beginning of the period
total returns: the sum of all cash flows received from an investment; includes periodic cash flows plus price appreciation or price depreciation
municipal bonds (munis): bonds issued by a local government, territory, or agency; generally used to finance infrastructure projects

Chapter 13

Statistical Analysis in Finance

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Summary

The standard deviation and variance are measures of the spread of a data set. Several measurements are used to provide the average of a data set, including mean, median, and mode. The terms mean and average are often used interchangeably. The geometric mean redistributes not the sum of the values but the product by multiplying all of the individual values and then redistributing them in equal portions such that the total product remains the same.

Key terms

geometric mean: a measure of center of a data set, calculated by multiplying the data values and then raising the product to the exponent 1 n , where n is the number of data values
standard deviation: a measure of the spread of a data set that indicates how far a typical data value is from the mean
variance: the measure of the spread of data values calculated as the square of the standard deviation
mode: the most frequently occurring data value in a data set
median: the middle value in an ordered data set
standard deviation and variance: measures of the spread of a data set
terms mean and average: often used interchangeably
normal distribution: a bell-shaped distribution curve that is used to model many measurements, including IQ scores, salaries, heights, weights, blood pressures, etc

Chapter 14

Regression Analysis in Finance

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Summary

A correlation coefficient called r is used to assess the strength and direction of the correlation. A positive value of r means that when x increases, y tends to increase and when x decreases, y tends to decrease (positive correlation). A negative value of r means that when x increases, y tends to decrease and when x decreases, y tends to increase (negative correlation) Correlation is the measure of association between two numeric variables.

Key terms

correlation coefficient: a measure of the strength and direction of the linear relationship between two variables
correlation coefficient called r: used to assess the strength and direction of the correlation
correlation: the measure of association between two numeric variables
value of r: always between - 1 and + 1
method of least squares: a mathematical method to generate a linear equation that is the “best fit” to the points on the scatter plot in the sense that the line minimizes the differences between the…
linear correlation: a measure of the association between two variables that exhibit an approximate straight-line fit when plotted on a scatter plot
prediction: a forecast for the dependent variable based on a specific value of the independent variable generated using the linear model
scatter plot (scatter diagram): graphical display that shows values of the independent variable plotted on the x -axis and values of the dependent variable plotted on the y -axis

Chapter 15

How to Think about Investing

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Summary

As investors hold multiple assets in a portfolio, they are able to eliminate firm-specific risk. The return to a portfolio is measured by the arithmetic average, and the risk is measured by the standard deviation of the returns of the portfolio. The risk of the portfolio will be lower than the weighted average of the risk of the individual securities because the returns of the securities are not perfectly correlated. However, systematic or market risk remains, even if an investor holds the market portfolio.

Key terms

return to a portfolio: measured by the arithmetic average, and the risk is measured by the standard deviation of the returns of the portfolio
firm-specific risk: the risk that an event may impact the expected revenue or costs of a firm, thereby impacting the returns to investors; also known as diversifiable risk
risk: measured by the standard deviation of returns
portfolio: a collection of owned stocks
capital gain yield: the difference between the price a stock is sold for and the price that was originally paid for it divided by the price originally paid
holding period percentage return: the gain received from holding a stock, calculated by adding the amount received when the stock is sold to any dividends earned while holding the stock, subtracting the price…
risk-free rate: the reward for lending money when there is no risk of not receiving the principal and interest as promised

Chapter 16

How Companies Think about Investing

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Summary

The discounted payback period uses the time value of money to discount future cash flows to see how long it will be before the initial investment of a project is recovered. The payback period is the simplest project evaluation method. Net present value (NPV) is calculated by subtracting the present value of a project’s cash outflows from the present value of the project’s cash inflows. The internal rate of return (IRR) of a project is the discount rate that sets the present value of a project’s cash inflows exactly equal to the present value of the project’s cash outflows.

Key terms

discounted payback period: the length of time it will take for the present value of the future cash inflows of a project to equal the initial cost of the investment
payback period: the length of time it will take for a company to make enough money from an investment to recover the initial cost of the investment
net present value (NPV): the present value of the cash inflows of a project minus the present value of the cash outflows of the project
internal rate of return (IRR): the discount rate that sets the NPV of a project equal to zero
mutually exclusive projects: projects that compete against each other so that when one project is chosen, the other project cannot be done
replacement chain approach: a method of comparing projects of differing lives by repeating shorter projects multiple times until they reach the lifetime of the longest project
equal annuity approach: a method of comparing projects of different lives by assuming that the projects can be repeated forever

Chapter 17

How Firms Raise Capital

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Summary

Capital structure refers to how a company finances its assets. The two main sources of capital are debt financing and equity financing. The market values of debt and equity are used to calculate the weights of the components of the capital structure The cost of equity capital is not directly observed, so financial managers must estimate this cost.

Key terms

capital: a company’s sources of financing
capital structure: the percentages of a company’s assets that are financed by debt capital, preferred stock capital, and common stock capital
two main sources of capital: debt financing and equity financing
interest tax shield: the reduction in taxes paid because interest payments on debt are a tax-deductible expense; calculated as the corporate tax rate multiplied by interest payments
trade-off theory: a theory stating that the total value of a levered company is the value of the firm without leverage plus the value of the interest tax shield less financial distress costs
conversion ratio: the number of shares of common stock receivable for each convertible bond that is converted

Chapter 18

Financial Forecasting

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Summary

Interrelationships among historical data, the forecasted income statement, and the forecasted balance sheet are all used to estimate each line item in the financial statements The sales forecast is the foundation on which much of the rest of the forecast is built. Thus, the sales forecast is completed first. Historical sales data and any other information on the firm, its products, the economy, its customers, and its competitors are all used to create the most accurate sales forecast possible

Key terms

forecast: an estimate of future performance based on historical performance and other contextual information
sales forecast: the foundation on which much of the rest of the forecast is built
balance sheet: a financial statement that reflects a firm’s asset, liability, and equity account balances at a given point in time
income statement: a financial statement that measures a firm’s financial performance over a given period of time
forecasted balance sheet: all used to estimate each line item in the financial statements
pro forma: in the context of financial statements, forward-looking
common-size: describes a financial statement in which each element is expressed as a percentage of a base amount
investing activities: cash business transactions reported on the statement of cash flows that reflect the acquisition or disposal of long-term assets

Chapter 19

The Importance of Trade Credit and Working Capital in Planning

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Summary

Financial managers understand the significance of net working capital (current assets - current liabilities) and various liquidity ratios as they attempt to ensure that bills can be paid. Working capital is not only necessary to run a business; it is a resource that will expand and contract with business cycles and must be carefully managed and monitored. The cash conversion cycle and the cash budget provide additional working capital management tools Many business exchanges (sales) could not take place without trade credit and the credit terms that are offered.

Key terms

working capital: the resources that are needed to meet the daily, weekly, and monthly operating cash flow needs
trade credit: credit granted to a business, also called accounts payable; allows a business to buy goods and services on account and pay the cash at some point in the future
credit terms: the terms that are part of a sales credit agreement that indicate when payment is due, possible discounts, and any fees that will be charged for a late payment
current assets: assets that are cash or cash equivalents or are expected to be converted to cash in a short period of time and will be consumed, used, or expire through business operations…
ratios: numerical values taken from financial statements that are used in formulas to examine financial relationships and create metrics of performance, strengths, weaknesses; help…
cash budget: a report that shows an estimation of cash inflows, outflows, and cash balances over a specific period of time, such as monthly, quarterly, or annually
net working capital: the difference between current assets and current liabilities (Current Assets - Current Liabilities = Net Working Capital)
business; it: a resource that will expand and contract with business cycles and must be carefully managed and monitored

Chapter 20

Risk Management and the Financial Manager

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Summary

This leads to transaction risk, translation risk, and economic risk as currency values change. Some ways that a company can hedge this risk are through vertical integration, long-term contracts, and futures contracts One job of the financial manager is to manage the risks of both cash inflows and cash outflows. A forward contract is an agreement between two parties to make an exchange at a particular rate on a given date in the future.

Key terms

option: an agreement that gives the owner the right, but not the obligation, to purchase or sell an asset at a specified price on some future date
forward contract: a contractual agreement between two parties to exchange a specified amount of assets on a specified future date
transaction risk: the risk that a change in exchange rates will impact the value of a business’s expected receipts or expenses
translation risk: the risk that a change in exchange rates will impact the value of items on a company’s financial statements
economic risk: the risk that a change in exchange rates will impact the number of customers a business has or its sales
futures contract: a standardized contract to trade an asset on some future date at a price locked in today
company can hedge this risk: through vertical integration, long-term contracts, and futures contracts