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Subspecialities in Finance: A Comprehensive Overview, Study Guides, Projects, Research of Business Finance

Virginia State University (VSU)Business Finance

A comprehensive overview of subspecialities in finance, covering key concepts such as business finance, financial institutions, and risk management. It delves into the role of financial institutions, including central banks, commercial banks, and investment banks, and explores the importance of interest rates, cost of capital, and risk management in financial decision-making. The document also examines various financial ratios used for benchmarking and analysis, providing insights into financial performance and profitability.

Typology: Study Guides, Projects, Research

2024/2025

Available from 01/25/2025

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D076 Study Guide Review Update 2025
Unit 2
•Finance: The study of managing and allocating fund at the personal or business level.
•Accounting: The system of recording, reporting, and summarizing past financial
information and transactions.
•Capital: A financial asset that can be used by a firm or individual. Examples of
capital may be machinery or cash held by a firm.
Subspecialities in Finance:
•Business finance- an area of finance that deals with sources of funding, the capital
structure (the mixture of debt and equity used to finance a firm) of corporations, the
actions that managers take to increase the value of a firm for tis owners, and the
tools and analysis used to allocate financial resources. It is also known as managerial
finance, financial management, and organizational finance.
•Investments:
oAsset pricing- The process of valuing assets
oCurrent market value- what someone would pay right now for an asset
•Financial institutions- includes firms or organizations that exist to accept a wide variety
of deposits, to offer investment products to individuals and businesses, to provide
loans, or to broker financial transactions.
oMajor financial institutions- central banks, consumer and commercial banks,
insurance companies, investment banks, mortgage companies, and even
pension fund management companies.
•Utility- the total satisfaction received from consuming goods and services.
•The goal of business finance is to maximize owner wealth for a privately held company
(firms that have not issues shares to the public where the ownership rights are privately
held) and to maximize shareholder wealth for a publicly held company (firms that have
issues shares to the public).
•Private equity- deal with finance within organizations and financial dealings between
businesses.
Careers in Finance
•Financial manager of firm- making financing decisions (issuance of new stock & bonds)
•Some—such as careers in corporate finance, investment banking, and private equity
— deal with finance within organizations and financial dealings between businesses.
Financial skills, though, are also needed in the analysis of assets, risk, and other
investment opportunities, such as in the fields of real estate management, insurance,
and personal financial planning.
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Download Subspecialities in Finance: A Comprehensive Overview and more Study Guides, Projects, Research Business Finance in PDF only on Docsity!

D076 Study Guide Review Update 2025

Unit 2

  • Finance: The study of managing and allocating fund at the personal or business level.
  • Accounting: The system of recording, reporting, and summarizing past financial information and transactions.
  • Capital: A financial asset that can be used by a firm or individual. Examples of capital may be machinery or cash held by a firm. Subspecialities in Finance: - Business finance- an area of finance that deals with sources of funding, the capital structure (the mixture of debt and equity used to finance a firm) of corporations, the actions that managers take to increase the value of a firm for tis owners, and the tools and analysis used to allocate financial resources. It is also known as managerial finance, financial management, and organizational finance. - Investments: o Asset pricing- The process of valuing assets o Current market value- what someone would pay right now for an asset - Financial institutions- includes firms or organizations that exist to accept a wide variety of deposits, to offer investment products to individuals and businesses, to provide loans, or to broker financial transactions. o Major financial institutions- central banks, consumer and commercial banks, insurance companies, investment banks, mortgage companies, and even pension fund management companies.
  • Utility- the total satisfaction received from consuming goods and services.
  • The goal of business finance is to maximize owner wealth for a privately held company (firms that have not issues shares to the public where the ownership rights are privately held) and to maximize shareholder wealth for a publicly held company (firms that have issues shares to the public).
  • Private equity- deal with finance within organizations and financial dealings between businesses. Careers in Finance
  • Financial manager of firm- making financing decisions (issuance of new stock & bonds) - Some—such as careers in corporate finance, investment banking, and private equity — deal with finance within organizations and financial dealings between businesses. Financial skills, though, are also needed in the analysis of assets, risk, and other investment opportunities, such as in the fields of real estate management, insurance, and personal financial planning.

- Liquidity- investors can turn their financial securities into cash easily without losing significant value. Primary Financial Market

  • Primary market- The financial market where securities (stocks and/or bonds) are first sold. o Syndicate- A group of intermediaries that is used to oversee the issuance of stocks and/or bonds.
  • Secondary market- The financial market where securities are traded after the initial issuance. o Auction market- A secondary market with a physical location and where prices are determined by investors’ willingness to pay. ▪ New York Stock Exchange (NYSE)- A physical trading floor and a computer network where stocks are bought and sold. It is the largest stock exchange in the world. o Dealer market- A secondary market made up of multiple dealers that hold an inventory of securities and quote prices. ▪ NASDAQ- A computer network where stocks are bought and sold. It is the second-largest stock exchange in the world. Typically, technology-related companies will go public through this exchange.
  • Money market- short-term borrowing and lending
  • Capital market- long-term borrowing and lending
  • U.S. Securities and Exchange Commission (SEC)- an independent federal government agency with the responsibility to (1) protect investors, (2) maintain fair, orderly, and efficient markets, and (3) facilitate capital formation. Types of Indicator - Leading- indicators that usually change before the economy as a whole changes. o Yield curve- a graph that plots the interest rates of bonds with different maturity dates, oftentimes U.S. Treasury bonds. When long-term bonds have a lower interest rate than short-term bonds, you will see an inverted yield curve which may indicate an economic downturn. A flat yield curve results when both short- term and long-term bonds have the same interest rate, indicating that the economy is in a transitional state. o Stock Market Return- Often considered a leading indicator. An improving economy, while a declining market may signal a worsening economy.

1. Depository institution Financial institution that accepts monetary deposits and provides loans. Includes savings banks, commercial banks, savings and loan associations, and credit unions. Bankrate reports that the largest banks in America were JP Morgan Chase and Bank of America as of May 2019. a. Savings and loans association A type of depository institution also known as a “thrift” institution that places a significant focus on providing loans for residential mortgages and real estate. 2. Non-depository institution Financial institution that is not allowed to accept monetary deposits but may perform functions such as lending money or acting as an intermediary between savers and lenders. Examples include brokerage firms, investment firms, mutual funds, and hedge funds. a. Securities firm Financial institution that facilitates the investment and purchase of securities in financial markets. Common services include underwriting, trading of securities on secondary markets, and the general sale of securities. b. Investment firm Company that invests the capital of investors in financial securities. Examples include mutual funds and investment trusts. The company may also be involved in issuing securities. (See securities firm below). Financial Institution Role Central Bank Ensure that a nation’s economy remains healthy by controlling the amount of money circulating in the economy Banks and Credit Unions Receive deposits and extend loans to individuals and businesses Insurance Charge premiums to invest in bonds and stocks to pay claims Mutual Funds Offer investments and buy financial securities and instruments on behalf of investors Pension Funds Retirement funds contributed through companies to invest and provide retirement Investment Banks Offer various services such as underwriting, facilitating mergers, and trading financial securities on behalf of large institutions and companies. Provides individuals and firms access to financial markets. Private Equity Receive money from institutional investors and wealthy individuals to buy high-potential companies or troubled companies to improve and earn returns by selling them or going public Unit 3

  • Interest rate- percentage of the principal that a lender charges a borrower for the use of assets.
  • Cost of capital- Also known as Discount rate, the cost to a firm to use an investor’s capital

By contrast, simple interest would provide the following annual interest: Annual Interest=$100×0.10=$10Annual Interest=$100×0.10=$ Since you save the money for two years, the total interest using simple interest will be $20: Total Interest=$10×2=$ o If the lender requires you to pay interest as stated by a required rate, the required rate becomes the cost of borrowing to you. Since it is the cost to the borrower to raise capital or borrow capital, we call the interest rate from the borrower’s perspective the cost of capital. Types of Interest ▪ Simple interest: Annual Interest = Principal x Interest Rate ▪ Total interest: Total Interest = Annual interest x t ▪ Compounding Interest: Total Interest = Principal x (1 + – Principal o Example: $100 deposit, 10% annual interest, Money is kept for two years in the account ▪ Interest = $100 x (1 + – 100 = $ Required Return ▪ Required rate of return- the rate of return or compensation that an investor or a lender will accept for investments such as stocks, bons, or loans. The word compensation is used because this is the rate that investors or lenders will be compensated for a given level of risk associated with investments or loans. o Also known as the hurdle rate in the context of corporate finance. ▪ Components of required rate of return: o Opportunity cost- the loss of potential gain from other alternatives when one alternative is chosen. o Risk- possibility that the realized or actual return will differ from the expected return. o Inflation- the rate at which the average price level of goods and services in an economy increases over a period of time. Inflation

Time Value of Money ▪ Time value of money- the concept that today’s dollar is worth more than a dollar in the future. ▪ Compounding- finding a future value given a present value. ▪ Discounting- finding a present value given a future value. Annuities ▪ Annuity- a stream of cash flows of an equal amount paid every consecutive period. ▪ Ordinary annuity- series of equal payments made at the end of consecutive periods over a fixed length of time. ▪ Annuity due- paid at the beginning of consecutive periods. ▪ Perpetuity- a constant stream of identical cash flows that continues forever. Return

  • Return: the gain or loss on an investment over some period of time.
  • Holding period return: the return that an investor gets over the entire period during which he or she owns a financial security.
  • Expected return: A hypothesized estimate of future prices or returns under different scenarios based on expectational data. Risk
  • Standard deviation: A measure of dispersion of possible outcomes about the mean.
  • Market Risk (Also known as systematic risk or no diversifiable risk)
  • Firm-specific risk (Also known as nonsystematic risk or idiosyncratic risk) Different Types of Risk
  • Interest rate risk: the probability that changes in interest rates will impact the value of a bond. (Market risk)
  • Default risk: the probability of a loss resulting from a borrower’s failure to repay a contractual obligation. Firm-specific risk and affects both the bonds and stocks of the firm. Firm-specific risk can be diversified. o Firm-specific risk is the risk associated with problems that companies may face because of lawsuits, labor problems, or management decisions, among other factors.
  • Price risk: the potential for the decline in the price of a financial security or an asset relative to the market. Risk Management
  • Risk reduction (also known as risk mitigation): a series of techniques that help reduce the amount of risk a person is exposed to by taking a particular action.

Types of Ratios Benchmarking: the process of completing a financial analysis and comparing a firm’s performance to that of other similar firms is known as benchmarking. Standardization- Ratios standardize financial data to make them comparable across firms, even those of distinctly different sizes. Flexibility Focus Evaluation

  • The higher the systematic risk an asset has, the higher the expected return.
  • Higher-return financial securities typically have greater uncertainty in returns.
  • Time diversification is the concept that riskier financial securities have lower risk in the long term than in the short term. o Example: “No Lifeguard on duty” or “Swim at your own risk”
  • Diversification: a process of “spreading: your money over many different assets
  • Correlation: the way two variables move in relation to each other.
  • Risk Separation: dispersing assets geographically instead of concentrating them in one location. The Key Trade-Off
  • Utility companies have low systematic risk because as the market moves up and down, their level of risk will also move up and down but in a diminished way.
  • Stock investments are more risky over a shorter period of time than over a longer period of time. Unit 4 Why Are Ratios Useful? i. Liquidity: measure a firm’s ability to meet short-term obligations without raising external capital. While everybody is concerned about liquidity, short-term creditors such as banks and suppliers are particularly interested. Liquidity is a measure of not only how much cash you have but also how easily you can convert short-term assets into cash.
  • Current Ratio=Current Assets/Current Liabilities
  • Quick Ratio=Current Assets – Inventory/Current Liabilities Activity: (also called efficiency ratios ) measure how well the company uses its assets to generate sales or cash—the firm’s operational efficiency and profitability.
  • A positive net profit margin that is higher than the industry’s indicates that the firm has a strong performance in its operations and ability to convert sales into profits for shareholders. Unit 5
  • Cash budgets: A forecast of future events. Usually prepared for a shorter time horizon — generally between one month and one year. Used to estimate whether a company had sufficient amount of cash for regular operations. Three Major Uses of Cash Budgeting
  1. Future Financing Needs
  2. Corrective Action
  3. Performance Evaluation Key Principles for Effective Budgeting
  4. Know Yourself
  5. Understand the Key Areas of Savings, Income, and Expenses
  6. Develop Savings, Income, and Expense Strategies
  7. Keep Records
  8. Use a Method That Meets Your Needs and Objectives
  9. Eliminate Consumer Debt and Minimize Long-Term Debt Creating a cash budget
  10. Determine cash receipts
  11. Estimate cash disbursements
  12. Create the cash budget Application to Personal Finance
  13. Understand your goals
  14. Track your savings, income, and expenses
  15. Develop a cash budget (plan_
  16. Implement your plan
  17. Compare the cash budget to your actual spending and make necessary changes Item in a Cash Budget
  18. Cash Receipts: include cash sales and the collected portion of accounts receivable for businesses and include salary or wages for individuals.
  19. Cash Disbursements: may be for suppliers of materials, interest, taxes, and so on for businesses. For individuals, cash disbursements come from day-to-day expenditures such as groceries, gas, and insurance.
  1. Borrowing Key Forecasts
  2. Profit forecasting: the projection of future earnings after all the projected costs are subtracted from the projected sales. The earnings change with changes in production or service costs, depreciation policies, and taxes. It may be necessary for a company to conduct a thorough study and estimation of both economic and non-economic variables that affect its sales volume as well as costs to operate the business that affect profits in the future.
  3. Balance sheet forecasting: typically done in conjunction with projecting income statements. Given an understanding of the sales growth and a project forecast, a financial manager can construct a pro forma balance sheet to understand how sources and uses of finances change in a company. Balance sheet forecasting helps management understand the future implications of the company’s financing strategies.
  • Budgeting is concerned with where management ideally wants to take the company, and forecasting is concerned with whether the company is heading in the right direction. The Percent of Sales Method
  1. Project sales revenues and expenses
  2. Forecast change in spontaneous balance sheet accounts
  3. Deal with discretionary accounts
  4. Estimate fixed asset account
  5. Calculate retained earnings (RE) a) Payout ratio: The percent of net income distributed to the shareholders b) Plowback ratio (retention ratio): The percent of net income retained in the firm
  6. Determine total financing need (projected total assets)
  7. Calculate DFN a) DFN=Projected Total Assets−Projected Total Liabilities−Projected Owner’s Equity The Sustainable Growth Rate
  • The SGR is the growth rate at which a firm can grow without issuing new equity.
  • The components of SGR are profitability, asset use efficiency, capital structure, and dividend policy.
  • Controlling the variable that changes the SGR will decrease the DFN. Ways to Reduce DFN

Bonds

  • Premium bond: Bond is selling above its par value
  • Par bond: the bond’s price is exactly equal to its face value
  • Discount bond: Bond is selling below its par value - Par or face value (aka maturity value)- the amount the investor will be paid when the bond matures. - Coupon rate (aka stated interest rate)- the amount of interest received each year Advantages Disadvantages
  1. Considers the time value of money
  2. Takes into account the risk of future cash flows through the cost of capital
  3. Includes all future cash flows
  4. Indicates whether an investment will create value for the company
  5. requires calculation of cost of capital and
  6. is not useful for mutually exclusive projects. Advantages Disadvantages
  7. Interest payments are tax deductible
  8. Does not dilute ownership
  9. Lowest risk and rate
  10. Requires repayment
  11. Increases firm’s debt and equity ratio assumes reinvestment at the IRR rate, cannot be used to compare projects with different durations, and requires conventional cash flows. Profitability Index The PI is the ratio of discounted benefits to discounted costs.

Advantages Disadvantages

  1. Never has to be repaid
  2. Not required to pay dividends on common stock 3. Dividends are not tax deductible 4. Dilutes ownership 5. Higher risk and rate Financial Security Valuation and Capital Investment Evaluation
  • Capital budgeting: process of evaluating and planning for purchases of long-term assets
  • Incrimental Cash flows: Cash clows, whether in or out of the firm, that are created as a result of our accepting the project. They include any additional revenue, expenses, taxes, or other costs. The net incremental cash flow is the sum of all additional cash flows, or in other words, incremental cash in minus incremental cash out

Common Stock Preferred Stock

Equity, ownership in the firm Equity, ownership in the firm Typically has voting rights Set, preferred dividend payments Residual claim upon the assets of the firm Most payments are cumulative No set dividends; some firms may not pay dividends at all to common shareholders Preferred liquidation status over common stock Potential for return from increased value of stock share and any dividends paid Return to investor provided from dividends paid and increase in value of stock share

- Maturity- the length of time until the bond expires (becomes due) - Yield to maturity (YTM)- rate of return earned by an investor if the bond is purchased at market rate today and held to maturity. Stocks