Understanding Financial Resources

Financial

1. Introduction to Business Chapter 16 UNDERSTANDING FINANCIAL MANAGEMENT AND SECURITIES MARKETS

2. Learning Outcomes How do finance and the financial manager affect a firm’s overall strategy? What types of short-term and long-term expenditures does a firm make? What are the main sources and costs of unsecured and secured short-term financing? What are the key differences between debt and equity, and what are the major types and features of long-term debt? When and how do firms issue equity, and what are the costs? How do securities markets help firms raise funding, and what securities trade in the capital markets? Where can investors buy and sell securities, and how are securities markets regulated? What are the current developments in financial management and the securities markets?

3. Exhibit 16.2 How Cash Flows through a Business

4. Risk/Return Tradeoff After watching the video, which provided a real-life illustration from the 2008 financial crisis, what might you think would be some similar examples that could be made from the negative economic consequences of the global COVID-19 pandemic? 

5. _____ management is the art and science used to determine the most effective ways to acquire and use funds to achieve the firm's goals. A. Operations B. Financial C. Accounting D. Corporate E. Money Financial managers constantly strive for a balance between: A. the opportunity for profit and the potential for loss B. cash and marketable securities C. economic responsibility and social responsibility D. common and preferred stock E. dividends paid out and interest payments The primary goal of the financial manager is to: A. maximize the value of the firm to its owners B. concentrate on short-term growth strategies C. develop new goods and services for the company D. make sure all employees get paid on a regular schedule E. pay off all debt as quickly as possible Financial managers focus on _____, the inflow and outflow of cash. A. financial flows B. sales revenues C. cash flows D. revenue streams E. profit and loss patterns

6. In finance, _____ is the potential for loss. A. leverage B. risk C. factoring D. business chance E. probability In finance, the opportunity for profit is called: A. return B. potential C. risk D. value E. maximization In seeking a balance between the opportunity for profit and the potential for loss, a financial manager is dealing with the concept of _____ trade-off. A. potential profit B. risk-return C. profit-loss D. sales-profit E. profit-budget

7. 1. How do finance and the financial manager affect a firm’s overall strategy? CONCEPT CHECK What is the role of financial management in a firm? How do the three key activities of the financial manager relate? What is the main goal of the financial manager? How does the risk-return trade-off relate to the financial manager’s main goal?

8. Short Term Expenses Operating Expenses Support current selling and production activities Accounts Receivable & Current Assets Converted to Cash Cash Management Managing Accounts Receivable Managing Inventory Make sure enough cash is on hand to pay bills Sales that have not been paid Purchase price Set Credit Terms Ordering, handling, storage, interest, and insurance costs Long Term Expenses Capital Expenditures Land, buildings, machinery, equipment, and information systems

9. Inventory Management Concepts and Amazon's Inventory As stated in Section 16.2 , the cost of inventory includes its purchase price, plus ordering, handling, storage, interest, and insurance costs. Watch the first video for a brief summary of the various components of the inventory management process. .

10. Inventory Management Concepts and Amazon's Inventory Next, view the second video which showcases one of Amazon’s warehouses. Although this video is a few years old, it does display a balance of both human and non-human touchpoints along the way to getting a package out the door. One fascinating aspect of the “SLAM” line described in the video is the ability of Amazon’s computerized labeling and shipping apparatus to know the anticipated package weight, and thus detect the likelihood of pulling the wrong item since the package apparently had an incorrect weight.

11. Inventory Management Concepts and Amazon's Inventory Which processes do you think must be manual, or could this warehouse become 100% automated at some point?   Was there anything else about Amazon’s inventory and shipping procedure that seemed interesting or unusual to you? 

12. Making sure that enough cash is on hand to pay bills as they come due and to meet unexpected expenses is called cash: A. maintenance B. capitalization C. targeting D. management E. administration _____ is a short-term unsecured debt issued by a financially strong corporation. A. A treasury bill B. A certificate of deposit C. A money market deposit D. Commercial paper E. Investment credit Financial managers often shift temporary funds from checking accounts to _____ securities to earn higher interest returns. A. commercial B. marketable C. administrative D. strategic E. operational Grainger Distribution Company sold Long Electronics ten circuit breakers for $179.00 each. Long Electronics will be allowed thirty days to pay the bill. Grainger will carry the $1790.00 on its books as a(n): A. account payable B. current liability C. account receivable D. fixed liability E. marketable security

13. _____ are specific repayment conditions as to how long customers have to pay bills and the amount of cash discount allowed. A. Credit credentials B. Credit terms C. Revolving accounts D. Liability procedures E. Sales terms Funds invested in long-lived assets, such as land, buildings, machinery, and equipment, are called: A. manufacturing expenses B. operating expenses C. capital expenditures D. production costs E. material costs The cost of inventory to the firm includes all of the following EXCEPT: A. ordering costs B. handling costs C. purchase price D. selling costs E. insurance costs _____ is the process of selecting the capital expenditures that offer the best returns and meet the goal of maximizing the firm's value. A. Capital evaluation B. Capital allocation C. Budget analysis D. Capital budgeting E. Budget allocation

14. 2. What types of short-term and long-term expenditures does a firm make? CONCEPT CHECK Distinguish between short- and long-term expenses. What is the financial manager’s goal in cash management? List the three key cash management strategies. Describe a firm’s main motives in making capital expenditures.

15. Trade Credit Accounts Payable Bank Loans Line of Credit Revolving Credit Commercial Paper - IOU Pledge Assets or Collateral Factoring Firm sells accounts receivable to another financial institution Acquires cash Don’t wait for loan

16. The three main types of unsecured short-term loans are: A. treasury bills, certificates of deposit, and accounts payable B. accounts payable, notes payable, and loans payable C. trade credit, accounts payable, and bank loans D. trade credit, bank loans, and commercial paper E. commercial paper, accounts payable, and trade credit A(n) _____ is a type of loan often used to finance buildup of inventory for seasonal (cyclical) businesses just before their strongest sales period. A. secured bank loan B. trade credit C. unsecured bank loan D. collateral loan E. commercial paper loan An IOU is most similar to which type of bank loan? A. revolving credit B. collateralized credit C. commercial paper D. business trade credit E. a line of credit Gerald Cooksie owns a restaurant in Panama Beach, Florida. He has arranged a business loan with the bank where he has his business account. The terms of the loan allow him to borrow up to $13,500 within the next year if the bank has funds available to lend; he must pay interest only on the unpaid loan balance. Cooksie has arranged a: A. collateralized loan *B. line of credit C. secured loan D. mortgage loan E. credit-line loan

17. A secured loan requires that the borrower pledge specific assets to secure the loan. These assets are called: A. collateral B. pledges C. intangible assets D. negotiable assets E. asset requirements A loan that requires the borrower to pledge specific assets as collateral is called a(n) _____ loan. A. promissory B. commercialized C. unsecured D. amortized E. secured A company sells its accounts receivable to a financial institution that is in the business of buying accounts receivable at a discount. This sale is called: A. bartering B. collateralizing C. factoring D. countertrading E. buying on the short Secured short-term loans are usually secured by: A. accounts payable and accounts receivable B. buildings and equipment C. equipment and inventory D. inventory and raw material E. accounts receivable and inventory

18. 3. What are the main sources and costs of unsecured and secured short-term financing? CONCEPT CHECK Distinguish between unsecured and secured short-term loans. Briefly describe the three main types of unsecured short-term loans. Discuss the two ways that accounts receivable can be used to obtain short-term financing.

19. Understanding Debt and Equity Financing Business ventures of course need capital to get them open and rolling, and often later to help the enterprise stay in business if incoming revenue is insufficient.  Additionally, opportunities to expand the business may need financing at some level to fund this growth.  The two main ways to finance are debt and equity .  View the video and consider taking notes so that you may confidently explain the key pros and cons for management to use debt versus equity to obtain financing.  

20. Table 16.1 Major Differences between Debt and Equity Financing

21. Term loan   Maturity of more than one year. 5 to 12 years and can be unsecured or secured. Commercial banks, insurance companies, pension funds, commercial finance companies, and manufacturers’ financing subsidiaries . Bonds   Long-term debt obligations (liabilities) of corporations and governments Principal Interest Mortgage loan  long-term loan made against real estate as collateral. The lender takes a mortgage on the property, which lets the lender seize the property, sell it, and use the proceeds to pay off the loan if the borrower fails to make the scheduled payments .

22. The major advantage of debt financing is the: A. number of different sources from which it is available B. lack of dependence on collateral C. absence of factoring D. deductibility of interest expenses E. amortization benefits Three important forms of long-term (capital) expenditures are: A. accounts payable, notes payable, and commercial paper B. treasury bills, certificates of deposit, and accounts payable C. trade credit, accounts payable, and bank loans D. trade credit, bank loans, and commercial paper E. term loans, mortgage loans, and bonds   Term loans: A. are available from commercial banks, insurance companies, pension funds, commercial finance companies, and manufacturer’s financing subsidiaries B. may be repaid on a quarterly, semiannual, or annual schedule C. are capital expenditure loans with a maturity of more than one year D. can be secured or unsecured E. are accurately described by all of the above Long-term debts (liabilities) for corporations and governments are called: A. preferred stock B. common stock C. bonds D. equity funds E. lines of credit

23. A(n) _____ loan is a long-term loan using real estate or other assets as collateral. A. unsecured B. line of credit C. prime D. discount E. mortgage Business loans available from commercial banks with terms generally five to twelve years and secured or unsecured are called _____ loans. A. collateral B. mortgage C. line of credit D. term E. prime Long-term debt would be used to: A. pay employees’ salaries B. buy new tablecloths for a restaurant C. replace broken glass in a window D. provide customer with a cash discount E. do none of the above

24. 4. What are the key differences between debt and equity, and what are the major types and features of long-term debt? CONCEPT CHECK Distinguish between debt and equity. Identify the major types and features of long-term debt.

25. Equity Owners’ investment in the business Preferred and common stockholders are the owners Dividends – payment of more stock Retained Earnings – reinvested in the firm A firm obtains equity financing Selling new ownership shares (external financing), Retaining earnings (internal financing) Small and growing Typically high-tech, companies, through venture capital (external financing).

26. Common stock   Security that represents an ownership interest in a corporation Initial Public Offering (IPO) Company’s first sale of stock to the public Dividends  Payments to stockholders from a corporation’s profits. Paid in cash or in stock.  Stock dividends   Payments in form of more stock. Retained earnings Profits reinvested in firm Preferred stock Dividend amount that is set at the time the stock is issued. Must be paid before the company can pay any dividends to common stockholders. Firm goes bankrupt and sells its assets, preferred stockholders get their money back before common stockholders do. Increases the firm’s financial risk because it obligates the firm to make a fixed payment. Venture capitalists Invest in new businesses in return for part of the ownership As much as 60 percent. New businesses with high growth potential, and they expect High investment return within 5 to 10 years. Angel investors Wealthy private investors focused on financing small business ventures in exchange for equity

27. _____ stock is a security that represents an ownership interest in a corporation and has voting rights. A. Preferred B. Common C. Par value D. Treasury E. Equity Payments in the form of more stock to existing stockholders are called: A. warrants B. rights offerings C. stock dividends D. stock offerings E. IPOs When a firm goes public, it must reveal such information as: A. financing plans B. product details C. financial data D. operating data E. all of the above Dividends are: A. annual payments on bonds B. the earnings of the corporation C. payments to the shareholders from company earnings D. guaranteed payments to the common shareholders E. loans made to the shareholders

28. The funds that are reinvested in the firm out of profits and after dividends are paid are called: A. retained earnings B. stock equity C. investor earnings D. secondary earnings E. convertible bonds _____ invest in new businesses in return for part of the ownership, sometimes as much as 60 percent. A. Intrapreneurs B. Multipreneurs C. Venture capitalists D. Leveraged capitalists E. Business opportunists Which of the following statements about preferred stock is true? A. Preferred stock carries voting rights. B. Preferred stockholders receive dividends before bondholders receive interest. C. Preferred stock can be owned only by upper management. D. Preferred stockholders receive dividends after common stockholders. E. Preferred stock produces a fixed-amount dividend. Private individual investors who sometimes provide venture capital to small firms in need of equity capital are called: A. opportunists B. entrepreneur backers C. benefactors D. angel investors E. equity developers

29. 5. When and how do firms issue equity, and what are the costs? CONCEPT CHECK Compare the advantages and disadvantages of debt and equity financing. Discuss the costs involved in issuing common stock. Briefly describe these sources of equity: retained earnings, preferred stock, venture capital.

30. Types of Markets Primary Secondary New securities sold to public Bought & sold or traded among investors Roles Investment Banker Stockbroker Help companies raise long-term financing Buys & sells securities on behalf of clients Underwriting Buys securities from corporations & resells to public

31. Stocks vs. Bonds Can you explain the distinctions between a primary and a secondary market for stocks?  (Hint: primary = new , as in an Initial Public Offering (IPO), and secondary = used , or already issued).  Remember: stocks are also called equities because the buyer receives a part ownership in that company. 

32. Stocks vs. Bonds Are you able to identify the key features of bonds that distinguish their investment potential from equities (stocks)?  What about the different kinds of bonds, such as corporate, municipal and particularly government bonds?  U.S. government bonds are considered to probably have the lowest risk of most bonds, whereas “junk” bonds would have the highest.  What would be some of the reasons why companies would issue “junk” bonds, and what would also be the main motivating factor for buyers to consider purchasing them, despite the higher risk?

33. Table 16.2 Moody’s and Standard & Poor’s Bond Ratings

34. Trading Places In this video Winthorpe and Valentine use information from a stolen report that will cause the price of orange juice to fall, and replace it with a report that says OJ prices will rise. They do this because they know their enemies, the Duke brothers, will trade on the phony report. Moving to the big scene, the Duke brothers, through their trader, starts buying OJ futures. Then everyone buys. The value skyrockets. Once the price gets to a high point, and the whole market thinks the price will only go up, Winthorpe calls out a promise to sell OJ at that high price in the future. Essentially he is making a bet that the price will fall. (He knows it will because he’s read the report.) 

35. Trading Places What are the ethical considerations of using "inside information" for the Duke brothers and for Winthorpe and Valentine?  Should individual investors consider investing in speculative commodity futures? 

36. _____ are investment certificates that represent either ownership of a corporation or a loan to the corporation. A. Capital funds B. Securities C. Deposits D. Contracts E. Liquid assets _____ are investment professionals who are paid to manage other people’s money. A. Account managers B. Category managers C. Fiduciary experts D. Institutional investors E. Fiscal managers The primary activity of _____ is underwriting. A. Securities and Exchange Commission (SEC) B. the New York Stock Exchange C . The Wall Street Journal D. stockbrokers E. investment bankers Blackwell Investments specializes in acting as an intermediary in taking companies public. This financial middleman is an example of a(n): A. stockbroker B. investment banker C. transfer agent D. commercial banker E. public distributor

37. _____ are the link between public companies and the investors interested in buying their stock. A. Underwriters B. Stockbrokers C. Investment bankers D. Account managers E. Securities expert Another name for a stockbroker is a(n): A. underwriter B. fiscal manager C. investment banker D. account executive E. fiduciary expert Dalrymple Bay Coal Terminal, a coal-handling facility and export terminal in Queensland, Australia, has issued triple-A rated bonds for $680 million in Australian dollars. The bonds will be used to refinance existing bank debt caused by the acquisition of eases from the Queensland government in 2002. The Commonwealth Bank of Australia acted as investment bankers to the transaction. This means the Commonwealth Bank of Australia: A. engaged in factoring the sale B. bought the bonds from Dalrymple and sold them to the public C. operates in the secondary securities market D. was responsible for co-insurance of the bond premium E. would be responsible for paying the dividend if Dalrymple were unable to

38. 6. How do securities markets help firms raise funding, and what securities trade in the capital markets? CONCEPT CHECK Distinguish between primary and secondary securities markets. How does an investment banker work with companies to issue securities? Describe the types of bonds available to investors and the advantages and disadvantages they offer. Why do mutual funds and exchange-traded funds appeal to investors? Discuss why futures contracts and options are risky investments.

39. Exhibit 16.6 The Secondary Markets: Broker and Dealer Markets

40. What risks are unique to investing in emerging or foreign markets ?

41. Banned Insider Trading Register all offered securities with the Securities and Exchange Commission (SEC) Circuit Breakers stop trading for a short cooling-off period to limit the amount the market can drop in one day Regulation FD (for “fair disclosure”) in October 2000. Regulation FD requires public companies to share information with all investors at the same time, leveling the information playing field.

42. Organized stock exchanges operate like a(n): A. indirect distribution channel B. retailer C. auction company D. wholesaler E. warehouse company Securities that are not traded on the organized stock exchanges are traded in the: A. primary market B. futures market C. over-the-counter market D. dealers market E. open market operation The _____ system is the first electronic-based stock market and the largest over-the-counter market. A. AMEX B. NASDAQ C. AMC D. NASA E. NYSE Because of the different ways each calculates its index, there is no competition between the NYSE and the NASDAQ. B. The NYSE lists significantly more stock that NASDAQ. C. Neither NASDAQ nor NYSE is feeling any competitive pressure from ECNs. D. ECNs are computerized indexes that are limited to high-tech companies. E. Electronic communications networks (ECNs) allow institutional traders to make direct transactions in what is called the fourth market

43. The Securities Act of 1933: A. requires all companies to comply with IRS rules B. requires full disclosure of information about new securities issues C. deals with rules for operating the stock exchanges D. controls all mutual fund offerings E. has complete control over the commodities traded through futures contracts   The Securities Exchange Act of 1934 gave the SEC the power to: A. control the organized exchanges B. police all security transactions C. deal with commodities as well as stocks D. oversee real estate exchanges E. control speculation in the stock market The Securities Investor Protection Corporation (SIPC): A. protects stock brokers from bad-risk investors B. is a mutual fund that invests in only profitable securities C. is like an insurance company for online stock exchanges that sometimes experience technological difficulties beyond their control D. protects investors up to $10,000 in the event of a bear market E. insures the accounts of customers of brokerage firms for up to $500,000 against a firm failure What is the name of the SEC regulation that requires public companies to share information with all investors at the same time? A. Regulation FD B. the Investment Company Act of 1940 C. the Sarbanes-Oxley Act D. the Investment Advisors Act of 1940 E. the Securities and Exchange Act of 1934

44. Regulation FD was designed to eliminate: A. embezzlement by investment bankers B. short circuiting C. factoring D. insider trading E. the sale of securities without proper SEC registration The _____ is a law that requires full disclosure of information on new issues and registration statements of financial information. A. Securities Exchange Act of 1934 B. Securities Industry Act of 1936 C. National Securities Dealers Act of 1934 D. Securities Act of 1933 E. Investment Company Act of 1940  

45. 7. Where can investors buy and sell securities, and how are securities markets regulated? CONCEPT CHECK How do the broker markets differ from dealer markets, and what organizations compose each of these two markets? Why is the globalization of the securities markets important to U.S. investors? What are some of the other exchanges where U.S companies can list their securities? Briefly describe the key provisions of the main federal laws designed to protect securities investors. What is insider trading, and how can it be harmful? How does the securities industry regulate itself?

46. The Stock Market

47. 8. What are the current developments in financial management and the securities markets? CONCEPT CHECK How has the role of CFO changed since the passage of the Sarbanes-Oxley Act? Describe the major changes taking place in the U.S. securities markets. What trends are driving these changes? This OpenStax ancillary resource is © Rice University under a CC-BY 4.0 International license; it may be reproduced or modified but must be attributed to OpenStax, Rice University and any changes must be noted. Any images credited to other sources are similarly available for reproduction, but must be attributed to their sources.