1.
1 INTRO TO FINMAN
CAPITAL BUDGETING – The process of planning and managing
a firm’s long term investments.
CAPITAL STRUCTURE – The mixture of debt and equity
maintained by a firm.
WORKING CAPITAL – a firm’s short term assets and liabilities.
SOLE PROPRIETORSHIP – a business owned by a single person.
PARTNERSHIP – A business owned by two or more individuals
or entities.
CORPORATION – a business created as a distinct entity owned
by one or more individuals or entities.
AGENCY PROBLEM – the possibility of conflict of interest
between the owners and management of a firm.
Control of the firm ultimately rests with stockholders.
PROXY FIGHT – a mechanism by which unhappy stockholders
can act to replace existing management.
STAKEHOLDERS – Someone other than a stockholder or
creditor who potentially has a claim on the cash flows of the
firm.
PRIMARY MARKETS – In this transaction, the corporation is
the seller, and the transaction raises money for the
corporation.
SECONDARY MARKETS – involves one or more owner or
creditor selling to another.
1.2 LESSONS from CAPITAL MARKETS HISTORY
RETURN ON INVESTMENT – gain or loss from the purchase of
an asset.
CAPITAL GAIN/LOSS – a change on the asset purchased.
FORMULAS:
TOTAL DOLLAR RETURN = (P1 - PO) + Dividend
Div Income + Capital gain or loss
DIVIDEND = Div per share x number of shares
DIVIDEND YIELD = Div + PO
DIVIDEND INCOME = Dividend x # of shares
CAPITAL GAIN = (P1 - PO) x # of shares
CAPITAL LOSS = (P1 - PO) x # of shares
TOTAL DOLLAR RETURN =
TOTAL CASH IF STOCK IS SOLD
= Initial Investment + total return
PERCENTAGE RETURNS (%)
= Div paid during the year – Beg. Stock price
= {(P1 - PO) + Div} / P0
CAPITAL GAINS YIELD
= (P1 - PO) / PO
RISK PREMIUM – The excess return required from an
investment in a risky asset over that required from a risk free
investment.
1ST LESSON: Risky assets on average, earn a risk premium.
VARIANCE- The variance squared difference between the
actual return and the average return.
STANDARD DEVIATION – the positive square root of the
variance.
ARITHMETIC AVERAGE RETURN – the return earned in an
average year over a particular period.
FORMULAS:
TOTAL AVERAGE = Total Actual Return / Years
DEVIATION = actual - average return
SQUARED DEVIATION = Dev2
VARIANCE = Total deviation2 / N-1
*N = number of periods
SD = Square root of Var (%)
NORMAL DISTRIBUTION – a symmetric, bell shaped
frequency distribution that is completely defined by its
average and standard deviation.
2nd LESSON: The greater the potential reward, the greater is
the risk.
GEOMETRIC AVERAGE RETURN – The average compound
return earned per year over a multiyear period.
- Less than arithmetic mean
{(1+R1)
Average Return
= TAE => trial and error
Interpolation
Dev = Actual Return – Average Return
1.3 THE TIME VALUE OF MONEY
FUTURE VALUE – The amount an investment is worth after
one or more periods. Also Compound Value
COMPOUNDING – the process of accumulating interest in an
investment over time to earn more interest.
INTEREST ON INTEREST – Interest earned on the reinvestment
of previous interest payments.
COMPOUND INTEREST – Interest earned on both the initial
payment and the interest reinvested from prior periods.
SIMPLE INTEREST – interest earned only on the original
principal amount invested.
PRESENT VALUE – the current value of future cash flows
discounted at the appropriate discount rate.
1.4. DISCOUNTED CASH FLOW VALUATION – a.) calculating
the present value of a future cash flow to determine its value
today. b.)The process of valuing an investment by discounting
its future cash flows.
DISCOUNT – Calculation of the present value of some future
amount.
DISCOUNT RATE – The rate used to calculate the present
value of future cash flows.
ANNUITY – A level stream of cash flows for a fixed period of
time.
ANNUITY DUE – An annuity for which the cash flows occurs at
the beginning of the period.
PERPETUITY – An annuity in which the cash flows continue
forever.
STATED INTEREST RATE – the interest rate expressed in terms
of the interest payment made each period. Also Quoted
interest rate.
QUOTED INTEREST RATE- expressed in terms of the interest
payment made each period.

EFFECTIVE ANNUAL RATE – expressed as if it were

compounded once per year.

ANNUAL PERECENTAGE RATE – the interest rate charged per

period multiplied by the number of periods per year.

1.5. INTEREST RATES & BOND VALUATION

COUPON – the stated interest rate made on a bond.

FACE VALUE or PAR VALUE - the principal amount of a bond

that is repaid at the end of the term.

COUPON RATE – the annual coupon divided by the face value.

MATURITY – specified date on which the principal amount of

a bond is paid.

YIELD TO MATURITY (YTM) – rate required in the market on a

bond.

INTEREST RATE RISK – risk that arises for bond owners from
fluctuating rates.

CURRENT YIELD – a bond’s coupon payment divided by its

closing price.

INDENTURE - a written agreement between the corporation

and the lender detailing the terms of the debt issue.

DEBENTURE – unsecured debt, usually with a maturity of 10

years or more.

NOTE – unsecured debt usually with a maturity of under 10

years.

ZERO COUPON BOND – makes no coupon payments, and thus

is initially priced at a deep discount.

CLEAN PRICE – the price of a bond net of accrued interest, this

is the price that is typically quoted.

DIRTY PRICE – price of a bond including accrued interest, also

known as the full or invoice price. The buyer actually pays.

REAL RATES – interest rates or rates of return that have been

adjusted for inflation.

NOMINAL RATES – interest rates or rates of return that have

not been adjusted for inflation.

FISHER EFFECT – relationship among nominal returns, real

returns and inflation.