Hailey College Of Commerce

1




Corporate Finance
Questions and Answers
1-98



Q.1: Finance
Finance addresses the ways in which individuals, business entities and
other organizations allocate and use monetary resources over time. The
term finance may thus incorporate any of the following:
y The study of money and other assets
y The management of those assets
y As a verb, "to finance" is to provide funds for business.
Q.2: Business Finance
Money that is made available by banks and other sources for commercial
use through short term and long term loans and equity share capital.
Managerial Finance
Managerial finance is the branch of the finance that concerns itself with
the managerial significance of finance techniques. It is focused on
assessment rather than technique.
Financial Management
This is the management related to the financial structure of the company
and therefore to the decisions of source and use of the financial resources,
that is reflected in the size of the financial income and/or charges.
Q.3: Financial Manager
Actively manages the financial affairs of any type of business, whether
financial or non-financial, private or public, small or large, profit seeking
or non-for-profit.
Q.4: Investing Decisions
Decisions concerning the asset side of a firm's balance sheet, such as the
decision to offer a new product.
Q.5: Financing Decisions
Decisions concerning the liabilities and stockholders' equity side of the
firm's balance sheet, such as a decision to issue bonds.


Q.6: Asset Management Decisions
It is decision taken to manage the overall assets of a company. Company
runs on assets and managing the assets effectively is one of the vital
operations that the management has to do. Taking combine decision of the
superior authorities regarding assets that how to manage and fit each
company's asset is known as assets management decision.

Q.7: Goal of Maximization of Shareholder Wealth

It is maximization of shareholders purchasing power. In an efficient
market, it is the maximization of the current share price.
Q.8: Agency Problem
It is a conflict of interest arising between creditors, shareholders and
management because of differing goals. For example, an agency problem
exists when management and stockholders have conflicting ideas on how
the company should be run.
Q.9: Role of CEO

The role of the CEO will vary from one company to another depending on
its size and organization. In smaller companies, the CEO will often have a
much more hands-on role in the company, making a lot of the business
decisions; even lower-level ones such as the hiring of staff. However, in
larger companies, the CEO will often deal with only the higher-
level strategy of the company and directing its overall growth, with most
other tasks deligated to managers and departments.

Q.10: Residual Owners
A way to refer to shareholders in a corporation which reinforces the fact
that if the company goes out of business (ie: liquidates), they will only get
what's left over (ie: the residue) after every one else is paid.
Example: FAIL Corporation's shareholders were loving life when the
company's stock was flying high and it was paying its owners a nice
quarterly dividend. Just a few short years later, the company was left in
the dust by competitors with superior new products. FAIL realized that it
was doomed, so it chose to close down. It liquidated its $5 million in assets


and paid off the nearly $5 million it owed suppliers. FAIL's shareholders,
as residual owners, received just pennies to distribute amongst
themselves.
Q.11: Difference in Debt Financing & Equity Financing

DEBT FINANCING EQUITY FINANCING
Debt financing tends to be the type
of financing you receive from a
traditional bank loan.
Equity financing tends to be
financing you receive from venture
capital into your business from
outside investors.
Lenders will most certainly want
you (and any other principals of the
organization) to personally
guarantee repayments of the loan.
A primary benefit of this type of
financing is that typically there is
no monthly payment requirement to
investors. Instead, you are giving
up ownership interest, most often,
permanently.
Your organization will be burdened
with some other type of regular
payment (usually a monthly
payment) depending on the terms
and conditions of the financing and
this can absorb critical cash flow,
especially with small business.

You will receive money in exchange
for equity in your business in the
form of stock or some other form of
equity like percentage of income or
gross/net sales.


Q.12: Role of CFO
CFO performs the following operations
Implements/Supervises Internal Controls
Handles Projects With Major Financial Impact
Cultivates Relationships With Outside Financing Sources
Drives Major Strategic Issues
Serves As Key Advisor To Company Management
An effective CFO is a key member of the management
team of a growing entrepreneurial company. Because of his/her financial
acumen and general business knowledge, a good CFO will help the


business owner and other top executives make the tangible connection
between a company's operations and its financial performance.
Q.13: Common Stock
Common Stock is the primary stock of a corporation. Common stock gives
shareholders the right to participate in management of the corporation
and give the shareholder a proportionate share of the dividends.
Q.14: Preferred Stock
It is a type of stock that has characteristics of both common stock and
fixed income securities. Preferred stock gives the holder ownership in a
corporation and a claim, prior to the claim of common stockholders, on
earnings and also generally on assets in the event of liquidation. Most
preferred stocks provide a fixed dividend that is paid prior to the common
stock. Preferred stock does not usually carry voting rights.
Q.15: Paid In Capital
Capital received from investors for stock, equal to capital stock plus paid-
in capital. Also called contributed capital.
Additional Paid In Capital
Capital contributed to a corporation by investors on top of the par value
of capital stock. In other words, the money that a company gets from
potential investors in addition to the stated value of the stock. Also called
contributed capital or paid-in capital.

Q.16: Redeemable and Irredeemable Capital

Capital which is eligible for redemption under the terms of an indenture is
called redeemable capital and vice verca.

Q.17: real owners

Buying a stock means ownership in a company and ownership gives you
certain rights. While common shareholders might be at the bottom of the
ladder when it comes to liquidation, this is balanced by other
opportunities like share price appreciation. As a shareholder, knowing


your rights is an essential part of being an informed investor - ignorance
is not a defense. Although the Securities and Exchange Commission and
other regulatory bodies attempt to enforce a certain degree of shareholder
rights, a well-informed investor who fully understands his or her rights is
much less susceptible to additional risks.
Q.18: Tax Deductible Expenses
In general, costs enabling you to run the business and are incurred for
business purposes are tax deductible.Equipment purchased to be used by
the business receives a tax deduction in the way of capital allowances, the
rules for which changed in April 2008.
Expenses deductible (a brief list)
y Costs of stock/materials sold
y Workwear, small tools etc (construction workers, kitchen fitters etc)
y Business telephone costs (including mobile phone)
y Motor expenses for business use (alternatively claim mileage from
your business at HMRC approved rates [40p for first 10,000 miles]
to minimse paperwork)
y Car hire or van rental if for specific business use (40p per mile rate
is not claimable for these trips)
y Postage, franking machines, courier charges , printing and
stationery eg business cards , leaflets , flyers, postcards, brochures
etc
y Advertising eg yellow pages, local newspapers, Google Adwords etc
Equipment
Your accounts may include a depreciation charge in respect of your
computer equipment, monitors, so that its cost is written off over its
estimated useful life. However, under current tax legislation, the accounts
charge is not tax deductible. Instead you can claim capital allowances,
which is effectively depreciation allowable for tax purposes.
For 2009/10 several rates apply:
y Annual Investment Allowance (AIA) of up to 50,000
y First year allowance [40% pa] which applies in the year of purchase
of any expenditure in excess of 50,000


y Writing down allowance (WDA) [currently 20% pa] which applies
to the balance on the capital allowance pool brought forward from
the previous year
y A special rate WDA of 10% which applies to certain types of plant or
machinery, such as electrical systems (for example, lighting), and
cars that have CO2 emissions of more than 160g/km
y Small Pools Allowance an alternative to the 20% WDA and 10%
special rate WDA, which can be claimed for the whole balance
brought forward from the previous year in either the main or
special rate pool where this is not more than 1,000.
For new businesses, existing equipment can be introduced into the
business at a market value and capital allowances claimed.
Credit cards
As a general tip, if you are using a credit card to pay for business costs,
have a separate one in your name for business use, so that your personal
expenditure is kept out of the business. Cashback or Reward cards are
ideal, especially if you pay them off in full as the cashback/reward is not
taxable.
Q.19: Dividend payment
The dividend tax is one of the most common investment taxes paid
investors, whether you own 100 shares of Johnson & Johnson or
1,000,000 shares of McDonald's. The rules on how the dividend tax works
and specific dividend tax rates, however, are not very well understood.
This guide was put together to help you understand the basics.
Interest Payment
Interest is calculated based on how much tax you owe. Interest rates
change every three months. Currently, the IRS interest rate for
underpayment of tax is 4% per year. The interest is calculated for each
day your balance due is not paid in full.
Q.20: Stakeholders
Stakeholders are an integral part of a project. They are the end-users or
clients, the people from whom requirements will be drawn, the people who


will influence the design and, ultimately, the people who will reap the
benefits of your completed project. It is extremely important to involve
stakeholders in all phases of your project for two reasons: Firstly,
experience shows that their involvement in the project significantly
increases your chances of success by building in a self-correcting feedback
loop; Secondly, involving them in your project builds confidence in your
product and will greatly ease its acceptance in your target audience.
Q.21: Corporate Social Responsibility

Corporate social responsibility (CSR) can be defined as the "economic,
legal, ethical, and discretionary expectations that society has of
organizations at a given point in time" . The concept of corporate social
responsibility means that organizations have moral, ethical, and
philanthropic responsibilities in addition to their responsibilities to earn a
fair return for investors and comply with the law.

Q.22: Corporate Governance

Corporate governance is a term that refers broadly to the rules, processes,
or laws by which businesses are operated, regulated, and controlled. The
term can refer to internal factors defined by the officers, stockholders or
constitution of a corporation, as well as to external forces such as
consumer groups, clients, and government regulations.

Q.23: Financial Environment

Financial environment of a company refers to all the financial institutions
and financial market around the company that affects the working of the
company as a whole. The financial environment has a number of factors.
It includes the financial institutions, government, individuals and firms
around the business. Firms use their financial markets to keep their
savings as property. It is extremely important for the monetary markets.

Q.24: Financial Markets

A market for the exchange of capital and credit, including the money
markets and the capital markets.




Q.25: Money Market & Capital Market

The money market is a subsection of the fixed income market. We
generally think of the term fixed income as being synonymous to bonds. In
reality, a bond is just one type of fixed income security.
Money market securities are essentially IOUs issued by governments,
financial institutions and large corporations. These instruments are
very liquid and considered extraordinarily safe. Because they are
extremely conservative, money market securities offer significantly lower
returns than most other securities. There are several different instruments
in the money market, offering different returns and different risks. In the
following sections, we'll take a look at the major money market
instruments.
A capital market is simply any market where a government or a company
(usually a corporation) can raise money (capital) to fund their operations
and long term investment. Selling bonds and selling stock are two ways to
generate capital, thus bond markets and stock markets (such as the Dow
Jones) are considered capital markets.
Q.26: Primary Market & Secondary Market

It is also called the new issue market, is the market for issuing new
securities. Many companies, especially small and medium scale, enter the
primary market to raise money from the public to expand their
businesses. They sell their securities to the public through an initial public
offering. The securities can be directly bought from the shareholders,
which is not the case for the secondary market. The primary market is a
market for new capitals that will be traded over a longer period.
Secondary Market
It is the market where, unlike the primary market, an investor can buy a
security directly from another investor in lieu of the issuer. It is also
referred as "after market".


The securities initially are issued in the primary market, and then they
enter into the secondary market. All the securities are first created in the
primary market and then, they enter into the secondary market. In the
New York Stock Exchange, all the stocks belong to the secondary market.
Q.27: Direct & Indirect Securities
Security, also known as a financial asset, is a piece of paper representing
a claim on an asset. Securities can be classified into two categories.
Direct Securities:
Direct securities include stocks and bonds. While valuing direct securities
we take into account the cash flows generated by the underlying assets.
Discounted Cash Flow (DCF) technique is often used to determine the
value of a stock or bond.
Indirect Securities:
Indirect securities include derivatives, Futures and Options. The securities
do not generate any cash flow; however, its value depends on the value of
the underlying asset.
Q.28: Financial Intermediaries
Financial institution (such as a bank, credit union, finance company,
insurance company, stock exchange, brokerage company) which acts as
the 'middleman' between those who want to lend and those who want to
borrow.
Q.29: Financial Brokers
A financial brokerage is a pillar of financial markets in modern
economies. It provides two types of services---financial planning and
market "intermediation." Financial planning services include evaluation
of client personal data, analysis of investment goals and selection of long-
term assets. Financial "intermediation" means serving as a middleman
between buyers and sellers in securities market transactions. For
instance, a New York-based financial brokerage may help a California-
based businessman purchase $1 million worth of stocks on the New York
Stock Exchange (NYSE).


Q.30: Functions of Investment Bankers
When corporation sells new securities to raise funds, the offering is
called a primary issue. The agent responsible for finding buyers for these
securities is called the investment banker. The investment banker
purchase primary issue from corporation and arranges immediate resell
of these securities to the investors. Merrill Lynch & Co., Goldman Sachs
are some examples of well-known investment banking firms. Broadly
investment bankers (investment banking firms) perform three functions:

Investigation, Analysis and Research (Origination),
Underwriting (Public Cash offerings)
Distribution.

Q.31: Default Risk
The possibility that a bond issuer will default, by failing to repay principal
and interest in a timely manner. Bonds issued by the federal government,
for the most part, are immune from default (if the government needs
money it can just print more). Bonds issued by corporations are more
likely to be defaulted on, since companies often go bankrupt.
Municipalities occasionally default as well, although it is much less
common. also called credit risk.
Q.32: Deferred income tax liability & Deferred Income tax Asset:
Deferred income tax liability account showing estimated amount of future
taxes on income earned and recognized for accounting purposes but not
yet for federal income tax purposes. Thus, book income will exceed taxable
income. In inter period income tax allocation , this will result in tax
expense being greater than tax payable. As a result, a deferred income tax
liability will occur. It will eventually write itself off when the period for the
temporary difference is fully reversed. Assume book income and taxable
income is both $10,000. However, straight-line depreciation is used for
book purposes amounting to a charge of $1000 while an accelerated
depreciation method is used for tax purposes amounting to $1500. The
corporate tax rate is 34%. Relevant computations and journal entry
follow:


Book
Income
Tax
Income
Income $10,000 $10,000
Depreciation 1,000 1,500
Income before tax $ 9,000 $ 8,500
Tax expense($9000 x 34%) $ 3,060 15
30

Tax payable($300 x 34%) $ 2,890
Deferred income tax liability($500 x 34%) $1
70


Deferred Income tax Asset:
1: Deferred tax items should be classified based on the classification of the
related
asset or liability for financial reporting.
For example: A deferred tax asset that relates to product warranty
liabilities (accrued expenses) would be classified as "current" because
warranty obligations are part of the current operating cycle.
2: Deferred tax asset that relates to product warranty liabilities (accrued
expenses) would be classified based on the expected reversal date of the
temporary difference. So the portion which gets reversed in 2011 would be
classified as DTA-current and the protion which will get reversed in 2012
or later will be classified as DTA- non-current.
Q.33: Compounding & Discounting
Compounding
A process whereby the value of an investment increases exponentially
over time due to compound interest.


Discounting
Multiplying an amount by a discount rate to compute its present value
(the 'discounted value'). It is the opposite of 'compounding' where
compound interest rates are used in determining how an investment will
grow on a monthly or yearly basis. For example, $1,000 compounded at
an annual interest rate of 10 percent will be $1,610.51 in five years.
Conversely, the present value of $1,610.51 realized after five years of
investment is $1,000 when discounted at an annual rate of 10 percent.
Q.34: Present & Future Value
Present versus future value is analogous to the concept that
today's dollar will be worth more in the future:
This concept is realized when that dollar is invested or put into savings.
Assuming no risk, in the future, that dollar will have accumulated interest.
Compounding interest is when the interest and the original principle are
reinvested to accumulate interest on the larger whole.
One can then determine the future value of money by using
financial tables and formula along with the present value:
Defining the present value (PV) as the cash in hand today that will be
invested, and the future value (FV) as the amount of money you will
possess when the investment has matured, you can then take the interest
(I) per compounding period and the number (n) of periods between the
present and future and compute FV = PV*(1+I)^n. That is, multiply the
present value by one plus the interest n times in order to get the future
value.
As an example:
Lets say you have a 5% APR savings account, which is compounded daily
and you invest $100 dollars in. The interest per day is .05/365 = .0137%.
At the end of one year, the future value of the savings account is
$100*(1+.000137)^365 = $105.13.
Suppose you wish to know how much to invest in order to obtain a


particular future value. This can be computed from the above formula, by
dividing the compounded interest and obtaining PV = FV/(1+I)^n. Lets
take the interest above, and suppose we want to have $1500 at the end of
five years.
Using our formula:
$1500/(1+.000137)^(365*5) = $1168.23.
Q.35: Annuity

1. A contract sold by an insurance company designed to provide payments
to the holder at specified intervals,usually after retirement. The holder is
taxed only when they start taking distributions or if they withdraw funds
from the account. All annuities are tax-deferred, meaning that the
earnings from investments in these accounts grow tax-deferred until
withdrawal. Annuity earnings are also tax-deferred so they cannot be
withdrawn without penalty until a certain specified age. Fixed annuities
guarantee a certain payment amount, while variable annuities do not, but
do have the potential for greater returns. Both are relatively safe, low-
yielding investments. An annuity has a death benefit equivalent to the
higher of the current value of the annuity or the amount the buyer has
paid into it. If the owner dies during the accumulation phase, his or her
heirs will receive the accumulated amount in the annuity. This money is
subject to ordinary income taxes in addition to estate taxes.

2. More generally, a series of payments of set size and frequency, often to
a retired person.
Q.36: Perpetuity
y The quality or condition of being perpetual: The perpetuity of the
Church was an article of faith
y Time without end; eternity.
y Law
a. The condition of an estate that is limited so as to be inalienable


either perpetually or longer than the period determined by law.
b. An estate so limited.
An annuity payable indefinitely.
Q.37: Nominal Interest Rates & Effective Interest Rates
Nominal interest rate:
Market interest rate unadjusted to reflect the erosion of the purchasing
power due to inflation. See also real interest rate.
Nominal Interest Rates vs. Real Interest Rates:
Suppose we buy a 1 year bond for face value that pays 6% at the end of the
year. We pay $100 at the beginning of the year and get $106 at the end of
the year. Thus the bond pays an interest rate of 6%. This 6% is the nominal
interest rate, as we have not accounted for inflation. Whenever people
speak of the interest rate they're talking about the nominal interest rate,
unless they state otherwise.
Now suppose the inflation rate is 3% for that year. We can buy a basket of
goods today and it will cost $100, or we can buy that basket next year and
it will cost $103. If we buy the bond with a 6% nominal interest rate for
$100, sell it after a year and get $106, buy a basket of goods for $103, we
will have $3 left over. So after factoring in inflation, our $100 bond will
earn us $3 in income; a real interest rate of 3%. The relationship between
the nominal interest rate, inflation, and the real interest rate is described
by the Fisher Equation:
Real Interest Rate = Nominal Interest Rate - Inflation
If inflation is positive, which it generally is, then the real interest rate is
lower than the nominal interest rate. If we have deflation and the inflation
rate is negative, then the real interest rate will be larger.
Effective rate of interest:
Actual interest paid on a loan, or earned on a deposit account, depending


on the frequency of compounding or effect of inflation. It is different from
the nominal rate of interest which ignores compounding and other
factors.
How to calculate effective annual interest rate
Firstly, the effective annual interest rate is also called effective
interest rate, or annual equivalent rate (AER), and is different from
the APR - annual percentage rate. In fact, the effective annual interest rate
is typically higher than the quoted APR.
The following example of how the effective interest rate is
calculated will help you understand why:
Let's assume you want to deposit in a bank $1000. The bank will pay you
10% interest annually. This means that at the end of the year you will
receive 10% x $1000 = $100 and this rate will turn your $1000 into $1100.
In this example, the effective interest rate is the same as the quoted
interest (10%).
Now let's examine the same example of a stated annual rate of 10% but
this time the bank will pay it semi-annually (the compounding will occur
twice a year). This means that when the first payment occurs the bank will
pay you 5% x $1000 = $50. However, at the end of the year, when the
second payment occurs, the bank will pay you 5% x $1050 = $52.50 and
this will turn your $1000 into $1102.50 . Thus, for the whole year you
would have actually earned $102.50 and the effective interest rate would
be 10.25% (more than the quoted interest of 10%).
Basically, the effective annual interest rate is the annual interest rate
that accounts for the effect of compounding.
Q.38: Liquidation Value & Going Concern Value
Liquidation value:
It is Cash price or other consideration that can be received in a forced-sale
of assets, such as that occurring when a firm is in the process of going out
of business.


Liquidation value -- may be analyzed as either a forced liquidation or
an orderly liquidation and is a commonly sought standard of value in
bankruptcy proceedings.
Liquidation value - the aggregate value of a business if its assets are
sold piecemeal.
matrix - a mailing list of creditors of the debtor.
Liquidation Value The amount that could be realized if an asset were
sold independently of the going concern.
Going-concern value:
The value of a company to another company or individual in terms of an
operating business. The difference between a company's going-concern
value and its asset or liquidation value is deemed goodwill and plays a
major role in mergers and acquisitions.
The value of a company as long as it remains in business. One calculates
the going-concern value by adding the value of its goodwill and income to
its net asset value. This is an important calculation when determining the
appropriate purchase price in a merger or acquisition. Mortgage lenders
also use it to determine the value of an income-producing property.
The value of a business in operation,taking into account the goodwill and
the value of the income, in addition to hard assets, such as real estate and
equipment. When appraising a project to develop income-producing
property,the appraiser will usually provide two numbersone for the
project on the day of completion,with no tenants,and one when it reaches
stabilized occupancy and is a going concern.Lenders who take mortgages
on income-producing property with intensive management aspectssuch
as hospitality propertiesusually obtain a going-concern rider for the
title insurance so that coverage will be increased above the value of the
real property.
Q.39: Par Value, Market Value & Book Value of a Security
Par value:
The nominal dollar amount assigned to a security by the issuer. For an


equity security, par value is usually a very small amount that bears no
relationship to its market price, except for preferred stock, in which case
par value is used to calculate dividend payments. For a debt security, par
value is the amount repaid to the investor when the bond matures
(usually, corporate bonds have a par value of $1000, municipal bonds
$5000, and federal bonds $10,000). In the secondary market, a bond's
price fluctuates with interest rates. If interest rates are higher than the
coupon rate on a bond, the bond will be sold below par value (at a
"discount"). If interest rates have fallen, the price will be sold above par
value. It is also called face value or par.
Market Value:
1. The current quoted price at which investors buy or sell a share of
common stock or a bond at a given time. Also known as "market price".
2. The market capitalization plus the market value of debt. Sometimes
referred to as "total market value".
Book value:
1. A company's common stock equity as it appears on a balance sheet,
equal to total assets minus liabilities, preferred stock, and intangible
assets such as goodwill. This is how much the company would have left
over in assets if it went out of business immediately. Since companies are
usually expected to grow and generate more profits in the future, market
capitalization is higher than book value for most companies. Since book
value is a more accurate measure of valuation for companies which aren't
growing quickly, book value is of more interest to value investors than
growth investors.
2. The value of an asset as it appears on a balance sheet, equal to cost
minus accumulated depreciation.
Q.40: Valuation Of Long Term Securities
Valuation of long term securities:
Debt investments and equity investments recorded using the cost method
are classified as trading securities, available-for-sale securities, or, in the
case of debt investments, held-to-maturity securities. The classification is


based on the intent of the company as to the length of time it will hold each
investment. A debt investment classified as held-to-maturity means the
business has the intent and ability to hold the bond until it matures. The
balance sheet classification of these investments as short-term (current) or
long-term is based on their maturity dates.
Debt and equity investments classified as trading securities
These are those which were bought for the purpose of selling them within
a short time of their purchase. These investments are considered short-
term assets and are revalued at each balance sheet date to their current
fair market value. Any gains or losses due to changes in fair market value
during the period are reported as gains or losses on the income statement
because, by definition, a trading security will be sold in the near future at
its market value. In recording the gains and losses on trading securities, a
valuation account is used to hold the adjustment for the gains and losses
so when each investment is sold, the actual gain or loss can be determined.
The valuation account is used to adjust the value in the trading securities
account reported on the balance sheet. For example if the Brothers
Quartet, Inc. has the following investments classified as trading securities,
an adjustment for $9,000 is necessary to record the trading securities at
their fair market value.
Valuation of
Trading Securities

Cost Fair Market
Value
Unrealized Gain
(Loss)
XYZ Bonds $25,0
00
$24,000 $(1,000)
ABC Stock 65,00
0
75,000 10,000
Total Trading
Securities
$90,0
00
$99,000 $9,000
The entry to record the valuation adjustment is:


General
Journal

Date Account Title and
Description
Ref. Debit Credit
20X0
Dec. 31 Trading Securities Market Value
Adjustment
9,000
Unrealized Gains and Losses
Trading Securities
9,000
Adjust trading securities to
market value


Debt and equity investments that are not classified as trading
securities or held-to-maturity securities are called available-for-sale
securities. Whereas trading securities are short-term, available-for-sale
securities may be classified as either short-term or long-term assets based
on management's intention of when to sell the securities. Available-for-
sale securities are also valued at fair market value. Any resulting gain or
loss is recorded to an unrealized gain and loss account that is reported as
a separate line item in the stockholders' equity section of the balance sheet.
The gains and losses for available-for-sale securities are not reported on
the income statement until the securities are sold. Unlike trading securities
that will be sold in the near future, there is a longer time before available-
for-sale securities will be sold, and therefore, greater potential exists for
changes in the fair market value. For example, assume the Brothers
Quartet has available-for-sale securities, whose cost and fair market
value are:
Valuation of Available-
for-Sale Securities

Cost Fair
Market
Value
Unrealized
Gain (Loss)


TLM Bonds $40,000 $38,000 $(2,000)
EAK Stocks 50,000 70,000 20,000
MJM Stocks 25,000 22,000 (3,000)
Total Available-for-Sale
Securities
$115,000 $130,000 $15,000

The entry to record the valuation adjustment is:
General
Journal

Date Account Title and
Description
Ref. Debit Credit
20X0
Dec. 31 Available-for-Sale Securities
Market Value Adjustment
15,000
Unrealized Gains and Losses
Available-for-Sale Securities
15,000
Adjust available-for-sale
securities to market value


In the balance sheet the market value of short-term available-for-sale
securities is classified as short-term investments, also known as
marketable securities, and the unrealized gain (loss) account balance of
$15,000 is considered a stockholders' equity account and is part of
comprehensive income. When the balance is a net loss, it is subtracted
from stockholders' equity.
Q.41: Intrinsic Value
Intrinsic value:
1. The actual value of a security, as opposed to its market price or book
value. The intrinsic value includes other variables such as brand name,


trademarks, and copyrights that are often dificult to calculate and
sometimes not accurately reflected in the market price. One way to look at
it is that the market capitalization is the price (i.e. what investors are
willing to pay for the company) and intrinsic value is the value (i.e. what
the company is really worth). Different investors use different techniques
to calculate intrinsic value.
2. The amount by which a call option is in the money, calculated by taking
the difference between the strike price and the market price of the
underlier. For example, if a call option for 100 shares has a strike price of
$35 and the stock is trading at $50 a share than the call option has an
intrinsic value of $15 share, or $1500. If the stock price is less than the
strike price the call option has no intrinsic value.
3. The amount by which a put option is in the money, calculated by taking
the difference between the strike price and the market price of the
underlier. For example, if a put option for 100 shares has a strike price of
$35 and the stock is trading at $20 a share than the put option has an
intrinsic value of $15 per share, or $1500. If the stock price is greater than
the strike price the put option has no intrinsic value.
Q.42: Bounds/Debentures:
it is A type of debt instrument that is not secured by physical asset or
collateral. Debentures are backed only by the general creditworthiness
and reputation of the issuer. Both corporations and governments
frequently issue this type of bond in order to secure capital. Like other
types of bonds, debentures are documented in an indenture.
Q.43: Perpetual Bond
A bond with no maturity date. Perpetual bonds are not redeemable but
pay a steady stream of interest forever. Some of the only notable
perpetual bonds in existence are those that were issued by the British
Treasury to pay off smaller issues used to finance the Napoleonic Wars
(1814). Some in the U.S. believe it would be more efficient for the
government to issue perpetual bonds, which may help it avoid the
refinancing costs associated with bond issues that have maturity dates. A
perpetual bond is also known as a 'consol'.


Q.44: Zero-Coupon Bond & Non Zero-Coupon Bond
Bond that (1) pays no interest but instead is sold at a deep discount on its
par-value, or (2) an interest paying bond that has been stripped of its
coupon which is sold separately as a security in its own right.
Bondholder's income is determined by the difference between the bond's
redemption value on maturity and its purchase price. Also called non-
interest bearing Bond, zero interest bond, or zero rated bond.
Q.45: subordinated loan/debt
It is a loan (or security) that ranks below other loans (or securities) with
regard to claims on assets or earnings. Also known as a "junior security"
or "subordinated loan".
Q.46: Required rate of return & Expected return
Required rate of return:
It is the required rate of return in a discounted cash flow analysis, above
which an investment makes sense and below which it does not. Often, this
is based on the firm's cost of capital or weighted average cost of capital,
plus or minus a risk premium to reflect the project's specific risk
characteristics. It is also called hurdle rate.
Expected return
Estimation of the value of an investment, including the change in price
and any payments ordividends, calculated from a probability distribution
curve of all possible rates of return. In general, if an asset is risky, the
expected return will be the risk-free rate of return plus a certain premium.
It is also called expected value.
Q.47: Opportunity cost
It is the cost of passing up the next best choice when making a decision.
For example, if an asset such as capital is used for one purpose, the
opportunity cost is the value of the next best purpose the asset could have
been used for. Opportunity cost analysis is an important part of a
company's decision-making processes, but is not treated as an actual cost


in any financial statement.
Q.48: Financial statement
It is a written report which quantitatively describes the financial health of
a company. This includes an income statement and a balance sheet, and
often also includes a cash flow statement. Financial statements are usually
compiled on a quarterly and annual basis.
Types:
1) Income Statement
2) Retained Earnings Statement
3) Balance Sheet
4) Statement of Cash Flows
Q.49: Mortgage bond
A bond secured by a mortgage on a property. Mortgage bonds are backed
by real estate or physical equipment that can be liquidated. These are
usually considered high-grade, safe investments. If an issuer in default
has both secured and unsecured bonds outstanding, secured bondholders
are paid off first. Naturally, because unsecured bonds carry greater risk
than secured bonds, they usually pay higher yields.
Q.50: Real Accounts & Nominal Accounts
It relates to asset, liability, reserve, and capital accounts that appear on a
balance sheet. The balances of real accounts are not cancelled out at the
end of an accounting period but are carried over to the next period. It is
also called permanent accounts. See also nominal accounts.
Nominal account:
Revenue or expense account that is a subdivision of the owners' equity
account, and which is closed to a zero balance at the end of each
accounting period. It starts with a zero balance at the beginning of a new
accounting period, accumulates balances during the period, and returns
to zero at the year end by means of closing entries. Nominal accounts are
income statement accounts and are also called 'temporary accounts' in


contrast to balance sheet (asset, liability, and owners' equity) accounts
which are called 'permanent accounts' or real accounts
Q.51: Retained Earning
Profits generated by a firm that are not distributed to
stockholders (shareholders) as dividends but are either reinvested in
the business or kept as a reserve for specific objectives (such as to pay off
a debt or purchase a capital asset). Balance sheet figure shown under the
heading retained earnings is the sum of all profits retained since the
firm's inception. Retained earnings are reduced by losses, and are also
called accumulated earnings, accumulated profit, accumulated
income, accumulated surplus, earned surplus, Undistributed Earning,
or undivided profits. See also retention ratio.
Q.52: Types of Dividend
Cash Dividends: This is the most common and popular method of
sharing a company's profits. A portion of the company's profits is paid to
shareholders as dollar per share. However cash dividends are subject to
double taxation in the US. A reason used by many companies to justify not
paying dividends. They are taxed at a maximum rate of 15%. The
dividends are distributed after the company has paid income tax. The
shareholders are also taxed once they received the dividends.
Stock Dividends: When dividends are given in the form of additional
shares of the same company or its subsidiary corporation according to the
proportion of the shares owned.
Property Dividends: Property dividends are paid out in the form of
products or services provided by the corporation. They are paid in the
form of assets such as gold, silver, cocoa beans etc. by companies.
Special Dividends: Special Dividends are offered rarely, such as during
times when the company wins litigation, when the company sells a
business or liquidation of investments. Some companies also offer special
dividends when they have high amount of excess cash, in order to boost
the market value of their stocks. Some times these special dividends are
documented as return of capital, meaning the company is returning a


portion of the money invested by the shareholders and hence these
dividends also called capital dividends, and are tax-free.
Q.53: Vertical Analysis & Horizontal Analysis

Vertical Analysis: reports each amount on a financial statement as a
percentage of another item. For example, the vertical analysis of the
balance sheet means every amount on the balance sheet is restated to be a
percentage of total assets. If inventory is $100,000 and total assets are
$400,000 then inventory is presented as 25 ($100,000 divided by
$400,000). If cash is $8,000 then it will be presented as 2 ($8,000 divided
by $400,000). The total of the assets will now add up to 100. If the
accounts payable are $88,000 they will be presented as 22 ($88,000
divided by $400,000). If owners equity is $240,000 it will be presented
as 60 ($240,000 divided by $400,000). The restated amounts from the
vertical analysis of the balance sheet will be presented as a common-size
balance sheet. A common-size balance sheet allows you to compare your
companys balance sheet to another companys balance sheet or to the
average for its industry.
Vertical analysis of an income statement results in every income statment
amount being presented as a percentage of sales. If sales were $1,000,000
they would be restated to be 100 ($1,000,000 divided by $1,000,000). If
the cost of goods sold is $780,000 it will be presented as 78 ($780,000
divided by sales of $1,000,000). If interest expense is $50,000 it will be
presented as 5 ($50,000 divided by $1,000,000). The restated amounts
are known as a common-size income statement. A common-size income
statement allows you to compare your companys income statement to
another companys or to the industry average.

Horizontal Analysis: looks at amounts on the financial statements over
the past years. For example, the amount of cash reported on the balance
sheet at December 31 of 2006, 2005, 2004, 2003, and 2002 will be
expressed as a percentage of the December 31, 2002 amount. Instead of
dollar amounts you might see 134, 125, 110, 103, and 100. This shows that
the amount of cash at the end of 2006 is 134% of the amount it was at the
end of 2002. The same analysis will be done for each item on the balance
sheet and for each item on the income statement. This allows you to see
how each item has changed in relationship to the changes in other items.
Horizontal analysis is also referred to as trend analysis.


Q.54: Benchmarking
Measurement of the quality of a firm's policies, products,
programs, strategies, etc., and their comparison with
standard measurements, or similar measurements of the best-in-
class firms. The objectives of this exercise are (1) to determine what and
where improvements are called for, (2) how other
firms achieve their high performance levels, and (3) use
this information to improve the firm's performance.
Q.55: Financial Ratio
These are Financial analysis comparisons in which certain financial
statement items are divided by one another to reveal their logical
interrelationships. Some financial ratios (such as net sales to net
worth ratio and net income to net sales ratio) are called 'primary' because
they indicate the fundamental causes underlying a firm's strengths and
weaknesses. Others (such as current assets to current liabilities ratio,
and current liabilities to net worth ratio) are called 'secondary' because
they depict the firm's competitive position and financial structure as
effects of the causes identified by the primary ratios. See also activity
ratios, efficiency ratios, investment ratios, leverage ratios, liquidity ratios,
and profitability ratios.
Q.56: Internal and External comparison with reference to
financial statement analysis
Internal Analysis: an internal financial statement analysis is done by
insiders of the firm who have access to all the financial information. E.g.
Analysis done by the top management, finance manager, employees, etc.
can be termed as internal financial statement analysis.

External Analysis: External analysis is an analysis done by outsiders
to the business firm. Such parties have access to limited financial
information which are published or revealed to the analysts by the firm.
Dynamic Analysis: In case of dynamic analysis more than one year's
financial data is essential. Examples of dynamic analysis are ratios
calculated for more than one year, comparative statement analysis, trend
analysis, etc. such an analysis has broader scope since it facilitates
comparison over a period of time i.e. year-to-year comparison.


Q.57: Types of ratio and their Significance
Liquidity Ratios: These ratios provide an idea about well a company is
situated to meet its current liabilities. Investors get this information by
comparing a company's current assets with its current liabilities. If the
company has an adequate level of assets to pay its liabilities, that is a
positive sign. Analysts consider a liquidity ratio of two to be healthy since
it indicates that the company has enough assets on hand to meet its
current liabilities. If the company does not have adequate assets to meet
its upcoming liabilities, investors should investigate further.
Leverage Ratios: These ratios give an idea about how much debt a
company has on its books. If the company uses its debt to generate better
earnings for shareholders, analysts view use of debt positively. One
common leverage ratio, the debt-to-equity ratio, looks at a company's
debt levels and compares that to the company's equity. Another way of
looking at leverage is to get an idea about how much money a company
has available to meet its interest payment obligations. It is a healthy sign
if a company has enough money on hand to meet its interest payment
commitments. On the other hand, it is a bad sign if a company is not
generating adequate earnings to cover its debt servicing.
Activity Ratios: Many useful gauges of operations can be calculated from
data reported in the financial statements. For example, you can determine
the average number of days it takes to collect on customer accounts, the
average number of days to pay vendors, and how much of the operation is
effectively being financed with payment terms extended by vendors.
Profitability Ratios: The purpose for a company's existence is to make
a profit for its shareholders. It is important to see how well the company is
doing in this respect. The ratios that provide this input are grouped
together as profitability ratios. The gross profit margin measures what
sort of profit a company is generating from its sales after deducting the
cost of the goods sold. It is a basic ratio that does not take into account
other costs that companies incur. Return on equity is another profitability
ratio that measures how much of a return the company is getting on the
equity it has invested. This ratio is generated by dividing a company's
earnings by the total shareholder's equity invested in the business. This
gives investors an idea about how profitable a company is too. It is not
easy to standardize profitability ratios since profits vary from one
industry to another.



Q.58: Operating Cycle & Cash Conversion Cycle

Operating Cycle
The average time between purchasing or acquiring inventory and
receiving cash proceeds from its sale.
OR
It is the average length of time between when a company purchases items
for inventory and when it receives payment for sale of the items. The
operating cycle is equal to the average age of inventories plus the average
collection period. A long operating cycle tends to reduce profitability by
increasing borrowing requirements and interest expense. It is also
called normal operating cycle.
Cash Conversion Cycle
The length of time between when a company pays for purchases of
inventory and when it receives cash from its own customers who purchase
the inventory. For example, a retailer orders goods on January 4 with
payment due on January 14. The goods are sold on January 10 with
payment received from customers on January 31. The cash conversion
cycle is 17 days, the difference between January 14, when the company
pays its suppliers, and January 31, when the company receives payment
from its own customers. A short cash conversion cycle allows a business to
quickly acquire cash that can be used for additional purchases or debt
repayment.
Q.59: Need & Significance Of Statement Of Cash Flows
Need of statement of cash flow
A cash flow statement is the motor oil for any business finance engine. It
measures the amounts of money that come into a company and out of it
over a given time period. This way a company is able to keep track of how
much cash it has on hand to pay expenses and buy assets.
Cash flow statements use information from both income statements and
balance sheets. Using this information, the cash flow statement will reveal
the net increase or decrease in cash for the period. Most cash flow
statements are divided into three separate activities: operating activities,
investing activities, and financing activities.


Operating Activities: Operating activities shows cash flow from net
income to net losses to cash used in and for operation procedures.
Sometimes, non- cash items are adjusted for any cash that was used or
provided by utilizing other operating assets and liabilities.
Investing Activities: Investing activities is usually the second part of a
cash flow statement. This includes the purchases or sales of long-term
assets, such as property, equipment, and even stocks. These actions are
still represented as " cash in" or " cash out" depending on what is
purchased.
Financing Activities: This is the third part of the cash flow statement.
And, as the name might suggest, the financing activities section tracks
financing activities. For large companies this includes money raised by
issuing stock in the company, or borrowing many from banks. Paying
back these loans are also considered under this section of the cash flow
statement.
Significance Of Statement Of Cash Flows
First, the statement of cash flows provides information about
the quality of the earnings. It shows how the available resources have
been effectively used, which gives observers a clue to the ability of the firm
to generate cash in the future. A yearly statement of cash flows also shows
if the firm will be able to face up to its responsibilities, to pay debts
falling due. Finally it may give explanations on the financial situation of
the firm; it may show if it is growing too fast, if it is over-leveraged, in
other words if it is borrowing too much money and will not be able to
pay installments in the future.
Q.60: Non Cash Expenses & Non Cash Revenues
Non Cash Expense:
It includes Expense (such as depreciation) that does not require a
cash outlay.
Non Cash Revenue:
It includes income that does not require a cash outlay.





Q.61: Investing Activities & Financing Activities

Investing Activities
Deals or transactions involving sale or purchase of
equipment, plants, properties, securities, or other assets generally
not held for immediate resale.

Financing Activities
Initiatives, transactions, and events (such as issuing of
stock/shares, bonds, promissory note, and arranging of
loans and supplies) employed and undertaken by an organization in
achieving its economic objectives.

Q.62: Operating Activities
It includes transactions and events that directly affect a firm's cash
inflows and outflows, and determine its net income. Cash
inflows result from sales of goods or services, sale of firm's stock (shares),
and from income earned on investments. Cash result
from equipment and inventory
purchases, interest and principal payments on loans, salaries, dividends,
and various other costs and expenses.
Q.63: Need of Financial Planning
Financial planning offers a coordinated and comprehensive approach to
helping you achieve your personal and reasonable financial goals.
Building, managing and preserving wealth is not an easy task. Maybe you
have recently retired and are concerned about outliving your nest egg.
Perhaps you are a baby boomer trying to plan for a secure retirement.
Maybe you are part of the "sandwich generation", caring for your own
children at home while also caring for the needs of aging parents. Maybe
you are recently widowed or divorced with all of the complications that
these life challenges bring. Maybe you have accumulated substantial
wealth and want to protect your assets from lawsuits, spendthrift
relatives, divorce or other potential threats not only to yourself but also to
your heirs. Selecting appropriate investments is simply one ingredient in
the recipe for an effective financial plan that should also include
retirement and estate planning. An experienced financial planning team
should help you to:
Identify your goals.


Develop a plan that addresses your goals with your risk tolerance in
mind.
Implement and monitor the financial plan.
If you are already retired, the following may be very real risks that
you are currently facing.

Q.64: Budget, Budgeting & Need To Prepare Cash Budget
An itemized forecast of an individual's or company's income and expenses
expected for some period in the future. With a budget, an individual is able
to carefully look at how much money they are taking in during a given
period, and figure out the best way to divide it among a variety of
categories. When making a personal budget, an individual will typically
designate the appropriate amount of money to fixed expenses such as rent,
car payments, or utility bills, and then make an educated estimation for
how much money they will spend in other categories, such as groceries,
clothing, or entertainment. By keeping track of where one's money goes,
one may be less likely to overspend, and more likely to meet their financial
goals

Budgeting: Establishing a planned level of expenditures, usually at a
fairly detailed level. A company may plan and maintain a budget on
either an accrual or a cash basis.
Need to Prepare the Cash Budget: Properly preparing your cash
budget will show how cash flows in and out of your business. Also, it may
then be used in planning your short-term credit needs. In today's financial
world, you are required by most financial institutions to prepare cash
budgets before making capital expenditures for new assets as well as for
expenditures associated with any planned expansion. The cash budget
determines your future ability to pay debts as well as expenses.
Q.65.Cash Inflows & Cash Outflows
Cash Inflows: Money received by a firm as a result of its operating
activities, investment activities, and financing activities.
Cash Outflows: Money paid out by a firm as a result of its operating
activities, investment activities, and financing activities.


Q.66: Flexible Budgeting
Financial plan designed to vary in accordance with the actual needs of
a department or firm.
Q.67: Projected Financial Statement
Projected Financial Statements is summary of various component
projections of revenues and expenses for the budget period. Projected
Financial Statements indicates the expected net income for the period.
Projected Financial Statements are an important tool in determining the
overall performance of a company. Projected financial statements have
the balance sheet, income statement and cash flow statements to indicate
the company performance.

Q.68: Securities and Exchange Commission
SEC Mission: The principal way that the SEC fulfills its mission is by
creating and enforcing regulations that set the standards for the public
disclosure of financial information by public companies. Its main areas of
enforcement activity are:
y Insider trading
y Accounting fraud
y False or misleading investment information OR
The Securities and Exchange Commission of Pakistan (SECP) is
a government agency whose purpose is to develop a modern and
efficient corporate sector and a capital market based on sound regulatory
principles, in order to foster economic growth and prosperity in Pakistan.
Q.69: Functions of SEC
The functions of the SEC are defined in Section 5 of the Securities
Regulation Code, and include the following major areas:
Supervision over all registered business entities in the country,
including suspensions and revocations of their registrations
Policymaking with regard to the market in securities
Control over and approval of security registration statements


Power to investigate violations of securities laws and to impose
sanctions for such violations
Power to issue subpoenas, punish for contempt, and issue cease and
desist orders in furtherance of its law enforcement mission.
Q.70: Stock Exchange Market & Its Functions
An exchange on which shares of stock and common stock equivalents are
bought and sold. Examples include the NYSE and the AMEX.
Established for the purpose of assisting, regulating and controlling
business of buying, selling and dealing in securities
Provides a market for the trading of securities to individuals and
organizations seeking to invest their saving or excess funds through
the purchase of securities
Provides a physical location for buying and selling
securities that have been listed for trading on that
exchange
Establishes rules for fair trading practices and regulates
the trading activities of its members according to those
rules
The exchange itself does not buy or sell the securities, nor
does it set prices for them
The exchange assures that no investor will have an undue
advantage over other market participants
Efficient market :This means that orders are executed and
transactions are settled in the fastest possible way
Transparency: Investor make informed and intelligent decision
about the particular stock based on information. Listed companies
must disclose information in timely, complete and accurate manner
to the Exchange and the public on a regular basis. Required
information include stock price, corporate conditions and
developments dividend, mergers and joint ventures, and
management changes etc




Q.71: Stockholder's Annual Report
The annual report, and other quarterly reports, a publicly-traded
company is required to distribute to shareholders. The report contains
information on the company's financial state, such as operational income
and net profit. Sometimes it also contains an accountant's opinion on the
general health of the company. Occasionally, stockholder's reports are
distributed at irregular intervals to explain a major event in the company.
Generally the front part of the stockholder's report states the "bottom line"
while the last part contains more detailed financial information. For
example, the front part of the report may contain a brief essay stating,
"Our company is healthy for reasons A, B, and C." At the conclusion of that
essay, the stockholder may view its financial statement
Q.72: Consolidated Financial Statement
It refers to financial statement combining the activities of a business and
its subsidiaries. Because consolidated financial statements present an
aggregated look at the financial position of a parent and its subsidiaries,
they enable you to gauge the overall health of an entire group of
companies as opposed to one company's stand alone position.
Q.73: Types of Depreciation
Basing on the nature of the asset the depreciation will be calculated.there
are different methods of depreciations. they are:
1) Straight line method,
2) Diminishing value method,
3) Sinking fund method,
4) Annuity method,
5) Depletion method. etc.
There are two types of depreciation
1.Physical Depreciation, which represents the accumulated loss in
market value caused by physical wear and tear since the date the
building was completed.


2.Functional Depreciation, which describes the loss of value caused
by outmoded or inadequate design
Q.74: Amortization & Depletion
Amortization
It is the paying off of debt in regular installments over a period of time.
The deduction of capital expenses over a specific period of time (usually
over the asset's life). More specifically, this method measures the
consumption of the value of intangible assets, such as a patent or a
copyright.
Suppose XYZ Biotech spent $30 million dollars on a piece of medical
equipment and that the patent on the equipment lasts 15 years, this
would mean that $2 million would be recorded each year as an
amortization expense. Amortization can be calculated easily using most
modern financial calculators, spreadsheet software packages such as
Microsoft Excel, or amortization charts and tables.
Depletion
It is an accounting term describing the amortization of assets that can be
physically reduced. Unlike depreciation and amortization, which mainly
describe the deduction of expenses due to the aging of equipment and
property, depletion is the actual physical reduction of natural resources
by companies.
For example, coal mines, oil fields and other natural resources are
depleted on company accounting statements. This reduction in the
quantity of resources is meant to assist in accurately identifying the value
of the asset on the balance sheet.
Q.75: Bond Indenture
Blanket, unconditional contract between the bond issuer and the bond
purchaser (bondholder) that specifies the terms of the bond. It states the
interest rate (called coupon rate), the dates when the interest will be paid,
maturity date(s), and other terms and conditions of the bond issue.


Failure to meet the payment requirements calls for drastic penalties
including liquidation of the issuer's assets. It is Also called bond resolution.
Q.76: Preemptive Right
A privilege extended to select shareholders of a corporation that will give
them the right to purchase additional shares in the company before the
general public has the opportunity in the event there is a seasoned
offering. A preemptive right is written in the contract between the
purchaser and the company, but does not function like a put option.
Also known as "preemption rights".
When shareholders, usually a majority shareholder or a shareholder
committing large amounts of capital to a startup company, purchase
shares, they want to ensure they have as much voting power in the future
as they did when they initially invested in the company. By getting
preemptive rights in its shareholder's agreement, the shareholder can
ensure that any seasoned offerings will not dilute his/her ownership
percentage.
Q.77: Treasury Stock (Treasury Shares)
It is the portion of shares that a company keeps in their own treasury.
Treasury stock may have come from a repurchase or buyback from
shareholders; or it may have never been issued to the public in the first
place. These shares don't pay dividends, have no voting rights, and should
not be included in shares outstanding calculations.
Q.78: Initial Public Offering - IPO
The first sale of stock by a private company to the public. IPOs are
often issued by smaller, younger companies seeking the capital to expand,
but can also be done by large privately owned companies looking to
become publicly traded.
In an IPO, the issuer obtains the assistance of an underwriting firm, which
helps it determine what type of security to issue (common or preferred),
the best offering price and the time to bring it to market.


IPOs can be a risky investment. For the individual investor, it is tough to
predict what the stock will do on its initial day of trading and in the near
future because there is often little historical data with which to analyze the
company
Q.79: Treasury Bill - T-Bill
A short-term debt obligation backed by the U.S. government with a
maturity of less than one year. T-bills are sold in denominations of $1,000
up to a maximum purchase of $5 million and commonly have maturities
of one month (four weeks), three months (13 weeks) or six months (26
weeks). T-bills are issued through a competitive bidding process at a
discount from par, which means that rather than paying fixed interest
payments like conventional bonds, the appreciation of the bond provides
the return to the holder.
Q.80: Financial Asset
An asset that derives value because of a contractual claim. Stocks, bonds,
bank deposits, and the like are all examples of financial assets. Unlike land
and property--which are tangible, physical assets--financial assets do not
necessarily have physical worth.
Q.81: Fixed-Income Security
An investment that provides a return in the form of fixed periodic
payments and the eventual return of principal at maturity. Unlike a
variable-income security, where payments change based on some
underlying measure such as short-term interest rates, the payments of a
fixed-income security are known in advance. Common examples of such
securities are bonds and certificates of deposit.
An example of a fixed-income security would be a 5% fixed-
rate government bond where a $1,000 investment would result in an
annual $50 payment until maturity when the investor would receive the
$1,000 back.



Q.82: Notes To The Financial Statements
Additional information provided in a company's financial statements.
Notes to the financial statements report the details and additional
information that are left out of the main reporting documents, such as the
balance sheet and income statement. This is done mainly for the sake of
clarity because these notes can be quite long, and if they were included,
they would cloud the data reported in the financial statements. It is also
known as the "footnotes".
Q.83: Holding Company & Subsidiary Company
Holding Company
A parent corporation that owns enough voting stock in another
corporation to control its board of directors (and, therefore, controls its
policies and management). A holding company must own at least 80% of
voting stock to get tax consolidation benefits, such as tax-free dividends.
Subsidiary
A company that is publicly-traded but has more than half its stock owned
by another company, known as the parent company. As long as the parent
company owns more than half the stock, it maintains control of the
subsidiary, though its other stock is still traded. Some subsidiaries belong
to the same industry as the parent company, while others do not.
Q.84: Callable Bond & Callable Preferred Stock
Callable Bond
It is a bond that can be redeemed by the issuer prior to its maturity.
Usually a premium is paid to the bond owner when the bond is called. It is
also known as a "redeemable bond. The main cause of a call is a decline
in interest rates. If interest rates have declined since a company first
issued the bonds, it will likely want to refinance this debt at a lower rate of
interest. In this case, company will call its current bonds and reissue them
at a lower rate of interest.


Callable Preferred Stock
It is a type of preferred stock that carries the provision that the issuer has
the right to call in the stock at a certain price and retire it. It is also known
as "redeemable preferred stock".
Q.85: Convertible Bond & Convertible Preferred Stock
Convertible Preferred Stock
Preferred stock that includes an option for the holder to convert the
preferred shares into a fixed number of common shares, usually anytime
after a predetermined date.

It is also known as "convertible preferred shares. Most convertible
preferred stock is exchanged at the request of the shareholder, but
sometimes there is a provision that allows the company (or issuer) to force
conversion. The value of convertible common stock is ultimately based on
the performance (or lack thereof) of the common stock.
Convertible Bond
It is a bond that can be converted into a predetermined amount of the
company's equity at certain times during its life, usually at the discretion
of the bondholder.

Convertibles are sometimes called "CVs". Issuing convertible bonds is one
way for a company to minimize negative investor interpretation of its
corporate actions. For example, if an already public company chooses to
issue stock, the market usually interprets this as a sign that the company's
share price is somewhat overvalued. To avoid this negative impression,
the company may choose to issue convertible bonds, which bondholders
will likely convert to equity anyway should the company continue to do
well.

From the investor's perspective, a convertible bond has a value-added
component built into it; it is essentially a bond with a stock option hidden


inside. Thus, it tends to offer a lower rate of return in exchange for the
value of the option to trade the bond into stock.
In finance, a convertible note (or, if it has a maturity of greater than 10
years, a convertible debenture) is a type of bond that the holder can
convert into shares of common stock in the issuing company or cash of
equal value, at an agreed-upon price.
y Convertible Preferred StockThese are preferred issues that the
holders can exchange for a predetermined number of the company's
common stock. This exchange can occur at any time the investor
chooses regardless of the current market price of the common stock.
It is a one way deal so one cannot convert the common stock back to
preferred stock.
Q.86: Call Price & Maturity Value With Reference To Long Term
Securities
Call Price: It is Money that the issuer must pay to the holder of a bond
when it is redeemed. It is the sum of the par value and the call premium,
and is specified in the bond indenture.
Maturity Value: The amount that will be received at the time a security
is redeemed at its maturity. For most securities, maturity value equals par
value.
Q.87: Private placement (or non-public offering) is a funding round of
securities which are sold without an initial public offering, usually to a
small number of chosen private investors.
Q.88: Business Risk & Financial Risk
Business Risk
Risk associated with the unique circumstances of a particular company,
as they might affect the price of that company's securities.
Financial Risk
It is the possibility that a bond issuer will default, by failing to repay
principal and interest in a timely manner. Bonds issued by the federal
government, for the most part, are immune from default (if the


government needs money it can just print more). Bonds issued by
corporations are more likely to be defaulted on, since companies often go
bankrupt. Municipalities occasionally default as well, although it is much
less common. It is also called default risk or credit risk.
Q.89: Sunk & Opportunity Costs
Sunk costs are retrospective (past) costs that have already been
incurred and cannot be recovered
Opportunity cost is the cost related to the next-best choice available to
someone who has picked among several mutually exclusive choices.[
Q.90: Initial Investment, Operating Cash Flows & Terminal
Cash Flows with Reference To Capital Budgeting
Initial Investment
An initial investment is the money a business owner needs to start up a
firm. It may include the business owner's own money, money borrowed
from a variety of sources including family and friends or banks, or money
raised from investors.
Also Known As: Owner's Capital; Owner's Equity
Examples:
Sam's initial investment to start up XYZ, Inc. was $20,000 for plant and
equipment.
How to Calculate an Initial Investment
Before you invest, it's important to make sure you know what your goals
are and how to attain them. The best way to determine your goal and how
to achieve it is to understand how your investment will be calculated and
do the math yourself.
Instructions



How to Calculate an Initial Investment
1.
Determine your goal, what interest rate you will get and how many
years you want will be investing your money.
2.
Write out the formula for interest, F = P(1 + i)^n.
F is the final amount.
P is your initial (or principle) investment.
i is the interest rate (should be written in decimal form).
n is the number of years the interest is compounded.
3.
Since you are actually looking for the initial amount you should
invest, you will need to re-write the interest formula to P = F / (1 +
i)^n
4.
Input your values into the formula.
For our example the final amount you want will be $250,000 in 45
years with an interest rate of 2.2%, so the formula now looks like
this:
P = 250,000 / (1 + 0.022)^45
5.
Solve the formula. The numbers inside the parentheses are added
together first, then you solve the exponential part of the formula,
then you can divide.
P = 250,000 / (1 + 0.022)^45
P = 250,000 / (1.022)^45
P = 250,000 / 2.6625
P = 93,897



operating cash flow
Net income plus depreciation and amortization. See also cash flows from
operating activities.
How to Calculate Operating Cash Flow
Operating cash flow is calculated by a relatively simple
equation:EBIT (earnings before interest and taxes)+ Depreciation-
Taxes.EBIT is also known as operating income. This information
can be found in a company's annual report.
1.
For this example, we'll use Microsoft's 2007 annual report. The
company reported EBIT (operating income) of $18,524, depreciation
of $1,440, and taxes of $6,036 (numbers in millions). So the math
looks like this:$18,524+ $1,440- $6,036= $13,928. In other words,
Microsoft's operating cash flow for 2007 was $13,928.
2.
Operating cash flow is a solid measure of a company's profits
because it refers to actual cash made from operations and is thus
hard to manipulate. A company could be bringing in tons of money
but still be struggling to pay its bills.
Looking at operating cash flow will show you whether a company is
burning more money than it is earning. If you don't want to (or
don't have time to) check every detail of a company's finances,
operating cash flow is a good at-a-glance snapshot of how the
business is doing. Positive cash flow is a good sign, while negative
cash flow needs to have a one-time explanation (an investment or
expense that will not be repeated; for example, an acquisition or a
new factory).
3.
In recent years, cash flow has gained in popularity as a financial
measure because it is more difficult to manipulate than certain other
metrics, such as revenues. A company could make its revenues look


bigger by, for example, postponing rebates (which would lower
revenues) until the next reporting period, thus creating the
appearance of a business that's more prosperous than it really is.
Terminal Cash Flows
y Is the last stage of a projects cash flows re: the cash flows that will
occur only at the projects termination/ending.
y Examples are: salvage/scrap value of new machines less tax and net
working capital recovered
Illustration:
Company XYZ intends to buy a new machine to increase its present sales.
The machine costs $200,000 with five years of useful life and its salvage
value is $25,000. By buying this machine, the company will incur
additional yearly working capital requirements of $10,000. Calculate the
terminal cash flows.
Solution:
Terminal cash flows= Salvage value = $25,000 + working capital
recovered of $10,000 = $35,000
Q.91: Net Present Value, Internal Rate Of Return, Profitability
Index & Pay Back Period
Net Present Value
The difference between the present value of cash inflows and the present
value of cash outflows. NPV is used in capital budgeting to analyze the
profitability of an investment or project. NPV analysis is sensitive to
the reliability of future cash inflows that an investment or project will
yield.

Formula:


In addition to the formula, net present value can often be calculated using
tables, and spreadsheets such as Microsoft Excel.


Internal Rate of Return
The discount rate often used in capital budgeting that makes the net
present value of all cash flows from a particular project equal to zero.
Generally speaking, the higher a project's internal rate of return, the more
desirable it is to undertake the project. As such, IRR can be used to rank
several prospective projects a firm is considering. Assuming all other
factors are equal among the various projects, the project with the highest
IRR would probably be considered the best and undertaken first.

IRR is sometimes referred to as "economic rate of return (ERR)".
Profitability Index
An index that attempts to identify the relationship between the costs and
benefits of a proposed project through the use of a ratio calculated as:
Pay Back Period



The payback period is both conceptually simple and easy to calculate. It is
also a seriously flawed method of evaluating investments. The payback
period is the time taken to recover the initial investment. So a 1m
investment that will make a profit of 200,000 a year has a payback
period of five years. Investments with a shorter payback period are
preferred to those with a long period. Most companies using payback
period as a criterion will have a maximum acceptable period.
Q.92: Discounted & Non Discounted Cash Flows Method To
Evaluate Investment Proposals
Non Discounted Cash Flow Models
Payback. This method of evaluating business investments uses cash
flows (not the accounting net income flows) to measure the amount of
time it takes for a company to recoup its investment dollars.
There are two drawbacks to the payback model: (a) cash flows are not
discounted for the time value of money, meaning that a dollar received


three years from now has the same value as a dollar received in the
current year, and (b) it fails to consider the profitability of the project in
its entirety. For example, a project with a fast initial payback might not
generate much profit over its life. Another project with a slow initial
payback might be phenomenally profitable over its life because its
profitability increases dramatically after the payback period.
Discounted Cash Flow Models
3. Net Present Value. This method of evaluating business investments
estimates all of the cash flowing in and out of a project. The estimated
cash flows are then discounted to the present to reflect the time value of
money.
This technique is referred to as a discounted cash flow model or a
present value model because it brings all of the estimated future cash
amounts back to the present time. Using our Treeline Manufacturing
example, the estimated cash flows in Year 5 will be discounted more than
the estimated cash flows in Year 1 because cash received in the future is
less valuable than cash received today.
When the net present value is a positive amount, the project is earning
more than the rate used to discount the cash flows. As you can see from
the above table, Treeline's proposed project is showing a positive net
present value of $14,668. This means that the new machine will provide
Treeline with $14,668 more in present value dollars than the
minimum specified return of 12%.
A net present value of $0 would indicate that a project is expected to earn
exactly the rate used to discount the future cash flows. If the net present
value is a negative amount, the project will earn less than the rate used to
discount the cash flows. (This doesn't mean, however, that the project is
showing a negative returnit could be the project is earning a return of
11% instead of the specified rate of 12%.)
4. Internal Rate of Return. This discounted cash flow model calculates
the rate that will cause the net present value to equal zero. In other words,
it answers the question, "What rate of return will the project earn over its
life?" It is similar to the net present value method in that (a) all of the
estimated cash flows over the entire life of the project are considered, and
(b) the estimated cash flows are discounted to the present.


Since the internal rate of return model produces the rate that will discount
all of the cash back to a net present value of exactly zero, you may need to
try various rates (as shown in present value tables) until you find the
exact rate that gives you zero. (You will save time by using a computer,
financial calculator, or programmable calculator.)
Q.93: CAPITAL STRUCTURE
The permanent long-term financing of a company, including long-term
debt, common stock and preferred stock, and retained earnings. It differs
from financial structure, which includes short-term debt and accounts
payable.
Q.94: Weighted Average & Marginal Cost of Capital
Weighted average cost of capital
It is an average representing the expected return on all of a company's
securities. Each source of capital, such as stocks, bonds, and other debt, is
weighted in the calculation according to its prominence in the company's
capital structure.
Weighted marginal cost of capital
It is Relationship between firms WACC and level of total new financing.
Q.95: Operating Leverage
The percentage of fixed costs in a company's cost structure. Generally, the
higher the operating leverage, the more a company's income is affected by
fluctuation in sales volume. The higher income vs. sales ratio results from
a smaller portion of variable costs, which means the company does not
have to pay as much additional money for each unit produced or sold. The
more significant the volume of sales, the more beneficial the investment in
fixed costs becomes.
Q.96: Aging Of Account Receivables
A periodic report showing all outstanding receivable balances, broken
down by customer and month due.


Q.97: Lease Financing
An agreement where the leaser receives lease payments to cover its
ownership costs. The lessee is responsible for maintenance, insurance, and
taxes. Some finance leases are conditional sales or hire purchase
agreements.
Q.98: Collection Float & Disbursement Float
Collection Float
Total amount representing (1) checks posted by customers but not
received, (2) checks received but not yet deposited, and (3) checks
deposited but not credited to the firm's account. See also float and
payment float.
Disbursement Float
The total time period between when a check is prepared by the remitter
and when the check is presented for payment. This float also includes the
delivery float, processing float, and transit float. Disbursement float is the
float period for the remitter. The collection float for the organization that
will receive the check is the same duration as the disbursement float.