Corporate Finance
Questions and Answers

Hailey College Of Commerce

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 y y

The study of money and other assets The management of those assets 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 higherlevel 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 Debt financing tends to be the type of financing you receive from a traditional bank loan. Lenders will most certainly want you (and any other principals of the organization) to personally guarantee repayments of the loan. 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. EQUITY FINANCING Equity financing tends to be financing you receive from venture capital into your business from outside investors. 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. 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 paidin 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 y y y

y y


Costs of stock/materials sold Workwear, small tools etc (construction workers, kitchen fitters etc) Business telephone costs (including mobile phone) Motor expenses for business use (alternatively claim mileage from your business at HMRC approved rates [40p for first 10,000 miles] to minimse paperwork) Car hire or van rental if for specific business use (40p per mile rate is not claimable for these trips) Postage, franking machines, courier charges , printing and stationery eg business cards , leaflets , flyers, postcards, brochures etc 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 y

Annual Investment Allowance (AIA) of up to £50,000 First year allowance [40% pa] which applies in the year of purchase of any expenditure in excess of £50,000




Writing down allowance (WDA) [currently 20% pa] which applies to the balance on the capital allowance ³pool´ brought forward from the previous year 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 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 longterm 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 Californiabased 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:

Income Depreciation Income before tax Tax expense($9000 x 34%)

Book Income $10,000 1,000 $ 9,000 $ 3,060

Tax Income $10,000 1,500 $ 8,500 15 30

Tax payable($300 x 34%) Deferred income tax liability($500 x 34%)

$ 2,890 $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: Let¶s 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, lowyielding 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: ³The 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 numbers²one 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 aspects²such as hospitality properties²usually 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 shortterm 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 XYZ Bonds Fair Market Value $24,000 Unrealized Gain (Loss) $(1,000) 10,000 $9,000

$25,0 00 ABC Stock 65,00 75,000 0 Total Trading $90,0 $99,000 Securities 00 The entry to record the valuation adjustment is:

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

9,000 9,000

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-forsale 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 availablefor-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 Availablefor-Sale Securities Cost Fair Market Value Unrealized Gain (Loss)

TLM Bonds EAK Stocks MJM Stocks Total Available-for-Sale Securities

$40,000 50,000 25,000 $115,000

$38,000 70,000 22,000 $130,000

$(2,000) 20,000 (3,000) $15,000

The entry to record the valuation adjustment is: General Journal Date 20X0 Dec. 31 Available-for-Sale Securities Market Value Adjustment Unrealized Gains and Losses Available-for-Sale Securities Adjust available-for-sale securities to market value 15,000 15,000 Account Title and Description Ref. Debit Credit

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 noninterest 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 owner¶s 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 company¶s balance sheet to another company¶s 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 company¶s income statement to another company¶s 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-inclass 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 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 y y

Insider trading Accounting fraud False or misleading investment information


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 & It¶s 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% fixedrate 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 Stock²These 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)+ DepreciationTaxes.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 y

Is the last stage of a project¶s cash flows re: the cash flows that will occur only at the project¶s termination/ending. 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 return²it 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 firm¶s 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.

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