FIN 384 Exam 1 Study Guide

FIN 384 Exam 1 Study Guide - CHAPTER 1 I. Financebody of...

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CHAPTER 1 I. Finance—body of facts, principles, and theories relating to using and raising money A. Three areas of Finance discipline: 1. Managerial 2. Investments 3. Financial Markets and Institutions B. Principles of Finance 1. Time Value of Money—‘dollar today worth MORE than a dollar tomorrow’ 2. Principle of Diversification 3. Risk-Return Tradeoff C. Decisions of Financial Management 1. Capital Budgeting Decisions—investment decisions; concerned with the use of funds- buying, holding, selling of all types of assets 2. Financing decisions—concerned with the acquisition of funds with which to make investments and finance day-to-day operations II. Role of the Financial System—facilitate the flow and allocation of funds throughout the economy A. Components 1. Financial Markets—markets for financial instruments (claims or securities) a. Claim (security, financial instrument, etc.)—is a claim against another’s wealth b. Holder = asset, Issuer = Liability; DSUs issue claims in return for funds 2. Financial Institutions (Intermediaries)—facilitate flow of funds from savers to borrowers B. Budget positions create financial needs for a given period 1. Surplus spending units (SSUs)-- economic units in a surplus budget position (aka saver, lender, investor) a. Households usually; have deficit periods when a capital expenditure is purchased 2. Deficit spending units—economic units in a deficit budget position (aka borrower) a. Businesses usually invest in more real assets than they receive in current operating cash flow C. Financial System facilitates the flow of saving to investment via direct and indirect financing; without it, DSUs would not always obtain timely financing for attractive projects and SSUs would under-utilize savings D. Direct financing to DSU from SSU is the simplest way for funds to flow 1. Direct markets are ‘wholesale’- large transactions (1million or more) 2. Institutional arrangements are common in direct finance; PRIVATE placements: a. DSU sells a whole security issue to an investor b. Advantages include speed and low transaction cost 3. Investment bankers often ‘underwrite’ new issues of securities: a. Buy entire issues from DSUs then b. Find SSUs to buy the securities at a higher price, in order to c. Profit from the difference; ‘underwriting spread’ 4. Brokers bring together buyers and sellers of financial claims a. Dealers buy securities at ‘bid price’ and sell for ‘ask price’ b. Bid-ask spread represents a dealer’s profit c. Dealers “make markets” by carrying inventories of securities E. Problems with direct financing 1. Requires more or less exact match between claims being sold and wanted to buy 2. Costly search and negotiation process, often complicated by information asymmetries 3. Intermediaries provide solutions: choices, drive costs down thru competition, and diversification III. Financial Intermediation—process by which financial institutions mediate unmatched preferences of DSUs and
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FIN 384 Exam 1 Study Guide - CHAPTER 1 I. Financebody of...

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