Business Essentials Chapter 15

Business Essentials Chapter 15: Financial Decisions and Risk Management

• Financial managers are responsible for a firm's long-term investments, obtaining funds, conducting daily financials, and managing risks.
• Short-term expenditures (operating expenses) include accounts payable, accounts receivable, credit policy, inventory (raw materials and work in process).
• Short-term financing sources include trade credit, secured loans, unsecured loans, and factoring accounts receivable.
• Trade credit involves a seller granting credit to a buyer. Forms include open-book credit, promissory notes, and trade drafts.
• Secured short-term loans require collateral, usually with lower interest rates than unsecured loans.
• Unsecured short-term loans include lines of credit, revolving credit agreements, and commercial paper.
• Long-term expenditures (capital expenditures) involve assets with long lives and significant value, such as land, buildings, and machinery.
• Long-term financing sources include long-term loans and corporate bonds.
• Bonds (secured or unsecured/debentures, registered or bearer/coupon) are promises by the borrower to repay the lender a specific amount at a future date.
• Callable bonds can be repaid earlier than the maturity date; serial bonds have staggered redemption dates while convertible bonds offer an option for receiving common stock instead of cash.
• Equity financing includes common stock (having market, book, and par values), retained earnings (profit retained in the company instead of paid out as dividends).
• Preferred stock is a hybrid form of financing with fixed payments like bonds, but without a maturity date and no voting rights.
• Choosing between debt and equity financing involves understanding capital structure; equity is usually more expensive but has no formal obligations. Debt is cheaper but requires the company to service the debt.
• Securities Markets include the primary (sale of new securities) and secondary (sale of previously issued securities) markets.

Securities Markets (LO 15.5)

• Investment banks are financial specialists who issue and sell new securities.
• Stock exchanges provide a setting where members can buy or sell stock according to exchange rules; examples include TSX and NASDAQ.
• Stockbrokers facilitate buying and selling for customers in the secondary market, with types like discount, full-service, and online brokers.
• The over-the-counter (OTC) market includes individual dealers who trade securities, dealing in bonds and other fixed-income securities.
• Market indexes summarize stock market trends and include the Dow Jones Industrial Average, S&P Composite/500 index, NASDAQ Composite, and S&P/TSX index.
• Market orders, limit orders, stop orders, round lots, and odd lots are various types of orders used to buy or sell securities.
• Margin trading lets an investor make a down payment and finance the rest using the broker, who borrows from the bank. The broker charges a higher interest rate than what they pay.
• Short selling is when an investor borrows shares from the broker, sells them, and buys back an equal amount to return to the broker later.

Other Investments (LO 15.7)

• Mutual funds pool investor resources to purchase various securities; examples include no-load and load funds.
• Ethical funds invest in companies with strong social and environmental records.
• Exchange-traded funds (ETFs) act like stocks, traded continuously but do not have pricing tied to the end of the day and have lower operating expenses.
• Hedge funds are private pools of money that aim to provide positive returns regardless of the market, typically sold to wealthy investors, and sometimes labelled as "principal-protected notes".
• Commodities such as futures contracts, are undifferentiated products, involving agreements to buy or sell specific amounts at a future date.
• Stock options (call and put options) give the holder the right, but not the obligation, to buy (call) or sell (put) a particular stock at a specified price.

Securities Regulations (LO 15.7)

• Canadian securities regulations are primarily provincial.
• "Blue-sky laws" regulate how firms deal in securities.
• Prospectuses (offering documents) detail information on new securities.

Financial Management for Small Businesses (LO 15.7)

• Small business owners need to obtain and manage credit effectively, establish bank credit and trade credit, and plan for cash flow efficiently.

Risk Management (LO 15.8)

• Risk management aims to minimize the financial consequences of losses by conserving financial power and assets.
• Risk encompasses uncertainty about future events, speculative risk (with potential gain or loss), and pure risk (involving only loss).
• Risk management involves identifying risks, measuring frequency and severity of losses, evaluating and choosing risk-handling techniques (avoidance, control, transfer, retention), implementing a plan, and monitoring the results.

Quick Check Questions

• Example questions about financial management concepts are provided, but without answers.