Chapter 16 Financial Management and Securities Markets

Summary

 

Objectives:

 

Chapter Outline:

  1. Define current assets and describe some common methods of managing them.
    1. Current Assets – short-term resources such as cash, investments, accounts receivable, and inventory
    2. Managing short-term assets and liabilities is sometimes called working capital management
    3. The chief goal of financial managers who focus on current assets and liabilities it to maximize the return to the business on cash, temporary investments of idle cash.
    4. Managing cash:
      1. Transaction balances
        1. Cash kept on hand to pay normal daily business expenses.
      2. Lockbox
        1. Address for receiving payments that are colleted by the bank and credited to the business’ account
    5. Investing idle cash
      1. Marketable securities
        1. U.S. Treasury bills (T –bills)
          1. Short-term debt obligations of the U.S. government
        2. Commercial certificates of deposit (CD’s)
          1. Issued by commercial banks; available in minimum amounts of $100,000.
        3. Commercial paper
          1. Written promise from one company to another to pay a specific amount of money
        4. Eurodollar market
          1. Market for trading U.S. dollars in foreign countries.
    6. Maximizing accounts receivable
    7. Optimizing inventory

  2. Identify some sources of short-term financing (current liabilities).
    1. Potential sources of short-term cash:
      1. Accounts payable
        1. Trade credit – credit extended by suppliers for the purchase of their goods and services
      2. Bank loans
        1. Line of credit
          1. Bank agrees to lend a specified amount of money upon request
        2. Secured loans
          1. Collateral backs the loan
        3. Unsecured loans
          1. Backed only by the borrower’s good reputation and credit rating
        4. Prime rate
          1. Interest rate commercial banks charge their best customers for short-term loans.
      3. Nonbank liabilities
        1. Virtually all financial institutions from insurance companies to pension funds, make short-term loans
        2. Businesses may sell their accounts receivable to a finance company – known as a factor

  3. Summarize the importance of long-term assets and capital budgeting.
    1. Long-term (fixed) assets – assets expected to last for many years, such as plants and equipment
    2. Capital budgeting – process of analyzing the needs of business and selecting the assets that will maximize its value
      1. Capital budget is the amount of money budgeted for investment in long-term assets.
    3. Assessing risk – every investment in capital assets has risk.
      1. Foreign investment risk
      2. Time risk
      3. Risk affected by stability and competitive nature of the marketplace

  4. Specify how companies finance their operations and manage fixed assets with long-term liabilities, particularly bonds
    1. Long-term liabilities – debts that will be repaid over a number of years, such as long-term loans and bond issues.
    2. Bonds: corporate IOU’s
      1. Debt instrument that a company sells to raise long-term funds.
      2. Issued by corporations, public utilities, nonprofit corporations, etc.
      3. Bonds can be transferred from one owner to another in a bond market
    3. Types of Bonds:
      1. Unsecured bonds
      2. Secured bonds
      3. Serial bonds
      4. Floating-rate bonds
      5. Junk bonds

  5. Discuss how corporations can use equity financing by issuing stock through an investment banker.
    1. Financing with Owner’s Equity
      1. Common Stock – single most important source of financial capital for a new company
        1. Par value
        2. Market value
        3. Capital in excess of par – difference between a stock’s par value and its offering price.
      2. Preferred stock – preference in the distribution of the company’s profits; no voting privileges
      3. Safer investment than common stock
      4. Retained earnings and dividends – profits left over after paying expenses and taxes, can retain some or all of the earnings to invest in corporate expansion or pay out some of the earnings to stockholders
    2. Investment Banking – sale of stocks and bonds for corporations
      1. First time issue is called a "new issue."
      2. First time offer to public is called an initial public offering (IPO).
      3. Primary market – market where firms raise financial capital
      4. Secondary markets are stock exchanges where investors trade their securities with others.

  6. Describe the various securities markets in the United States
    1. Securities markets – provide the mechanism for buying and selling securities.
    2. Organized exchanges are central locations where investors buy and sell securities.
      1. Buyers and sellers are not actually present
      2. Brokers represent them
      3. The New York Stock Exchange (NYSE) is the largest and most important of all exchanges in the U.S.
    3. Over the counter (OTC) market is a network of dealers all over the country linked by computers, telephones, and Teletype machines. There is no central location.
    4. Measuring market performance through averages and indexes is important
      1. An index compares current stock prices with those of a specified base period.
      2. An average is the average of certain stock prices.
      3. Many investors follow the activity of the Dow Jones Industrial Average (DIJA)
      4. A period of large increases in stock prices is known as a bull market, while a declining market is known as a bear market.