01 L1 - An Overview of Financial Theory This overview...

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An Overview of Financial Theory This overview reviews the nature of capital markets and the interests of participants in those markets. It also reviews how the capital formation process works. Capital Markets and Long Term Finance Capital Formation Markets Common Stock Bonds Derivatives Financial Markets Exchanges Specialists Intermediary Firms Publicly Traded Forms of Ownership Partnership Corporation Privately Held Publicly Traded As we proceed through this course, we will be examining each finance issue from the perspective of corporations as users of capital and the perspective of investors as providers of capital.
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Common Stock Common Stock: a share in the ownership of the firm - Equity shares. Issuer Advantages: 1. Beyond the public offering, there are no fixed charges 2. There is not fixed "maturity" 3. Common stock increases the credit worthiness of a firm 4. Common stock can at times be sold more easily than debt (investors perception of common stock as inflation hedge) Issuer Disadvantages: 1. Extends voting rights or control to additional stockholders 2. Gives more owners the right to share in income 3. Initial costs of "underwriting" and distribution are higher than bonds 4. Changes the debt/equity mix of the firm 5. Dividends are not deductible from taxable income Common Stock: a share in the ownership of the firm - Equity shares. Investor viewpoint : Advantages 1. participate in growth of firms value 2. receive dividends 3. limited liability 4. vote for management/directors Investor viewpoint : Disadvantages 1. participate fully in risk of loss 2. loss of dividend 3. worthless paper Common stock provides many advantages to the issuers and attractive investment opportunities to the investor.
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Bonds
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Bonds are called fixed income securities because they provide a stream of income. This feature is very attractive to some investors. Bonds also have advantages for the issuer. Bonds: Debt instrument carrying a stated yield with maturity greater than 1 year. Issuer Advantages: 1. Cost of the debt is limited. Bondholders do not participate in superior profits. 2. Typically the expected yield is lower than the cost of common stock. 3. The owners of the corporation do not share control with debt holders. 4. Bond interest payments are tax deductible from taxable income 5. Flexibility can be achieved by a "call" provision. Issuer Disadvantages: 1. Debt is a fixed charge which must be funded from earnings/cashflow. 2. May raise the cost of capital by increasing perceived risk. 3. Definite maturity date must refund principal to bondholders. 4. Long term debt is a commitment over an extended operating period which cannot be adequately foreseen. (for example: Disney Bonds of 2093) 5. Debt is a long term contract which may contain additional restrictive covenants or limitations to dividend policy. 6.
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01 L1 - An Overview of Financial Theory This overview...

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