Finance and Banking Concepts Quiz

Capital Markets

• Stock Market: A place where company stocks are bought and sold. Financial managers aim to maximize their firm's stock price.
• Physical Location Exchanges: Formal organizations with physical locations for auction-style trading of listed securities.
• Over-the-Counter (OTC): A large network of brokers and dealers connected electronically, trading unlisted securities.
• Dealers Markets: Facilities for security transactions outside of physical location exchanges. A few dealers hold inventories, while many brokers connect them with investors.

Equity Valuation

• Comparables Approach: Companies' equity values are evaluated based on similar companies in the same sector.
• Discounted Cash Flow: Equity value is determined by projecting future cash flows and using net present value. Strong operating forecast data is most useful.
• Precedent Transactions: Equity value is assessed based on historical prices of similar mergers and acquisitions. Only relevant for recently valued/sold similar entities.
• Asset-Based Valuation: Equity value is determined by the fair market value of a company's net assets, factoring in outstanding liabilities.
• Book-Value Approach: Equity value is determined by the previous acquisition cost, which is most relevant for companies with minimal growth and recent acquisitions.

Capital Structure

• Capital: Funds (debt, preferred stock, common stock, and retained earnings) provided by investors. Accounts payable and accruals are not included; they come from standard operations.
• Capital Structure: The percentage mix of investor-supplied capital (debt, preferred stock, common stock, retained earnings).

Behavioral Finance

• Mental Accounting: Allocation of money for specific purposes.
• Herd Behavior: Mimicking the financial behaviors of the majority.
• Emotional Gap: Decisions based on extreme emotions.
• Anchoring: Attaching spending levels to a reference point.
• Self-Attribution: Choosing based on overconfidence in one's knowledge.

Interest Rates

• Real Risk-Free Rate: Interest rate on default-free US Treasuries if inflation is zero. Fluctuates with economic conditions.
• Nominal Risk-Free Rate: Rate of return on a risk-free security, including an inflation premium.
• Inflation Premium: The added return for anticipated inflation.
• Default Risk Premium: Difference between interest on US Treasury bonds and corporate bonds of the same maturity.
• Liquidity Premium: Added to the equilibrium rate for securities that cannot be quickly converted into cash.
• Interest Rate Risk: Risk of capital loss due to interest rate changes.
• Maturity Rate Premium: Premium reflecting interest rate risk.
• Reinvestment Risk: Risk of lower income from declining interest rates when maturing funds are reinvested.

Cost of Money

• Production Opportunities: Investment opportunities in productive, cash-generating assets.
• Time Preferences for Consumption: Consumer preferences for current consumption versus future accumulation.
• Risk: Chance that an investment may provide low/negative return.
• Inflation: Price increases over time; higher inflation = higher required return.

Interest Rate Levels

• Short-Term Rates: Responsive to current economic conditions.
• Long-Term Rates: Reflect long-term inflation expectations.
• Term Structure of Interest Rates: Relationship between long-term and short-term interest rates, displayed as a yield curve.

Monetary Policy

• Contractionary Policy: Increases interest rates & limits money supply to slow growth and reduce inflation.
• Expansionary Policy: Lowers interest rates to stimulate the economy during slowdowns or recessions. Decreases unemployment.
• Goals: Inflation control, unemployment reduction, & exchange rate management.
• Tools: Open market operations, interest rates, & reserve requirements.

Income and Business Taxation

• Corporate Tax: Income tax on a corporation's profits (revenue minus expenses).
• Corporate Tax Deductions: Allowed reductions of taxable income based on business expenses.
• Individual Income Tax: Levied on wages, salaries, etc. Taxes owed are reduced by credits.

Financial Analysis and Reporting

• Financial Statements Analysis: Evaluating a company's financial statements for decision-making. External stakeholders use it for understanding the organization's health and value, while internal stakeholders evaluate performance and manage finances.
• GAAP (Generally Accepted Accounting Principles): Standards for financial reports (balance sheet, income statement, cash flow statements) followed by public companies.
• Horizontal Analysis: Comparing data across different years.
• Vertical Analysis: Analyzing the proportions of line items.
• Ratio Analysis: Using ratios (price-to-earnings, earnings per share, dividend yield) for analysis.

Liquidity Ratios:

• Current Ratio: Measures ability to pay short-term obligations with current assets.
• Quick Ratio: Similar to current ratio but excludes inventory.
• Cash Ratio: Measures ability to pay short-term obligations with cash and equivalents.

Asset Management Ratios, Debt Management Ratios, and Profitability Ratios:

• Used to evaluate efficiency of asset utilization, debt load management, profit generation, and return on investment. Details omitted.

Market Value Ratios:

• Used to understand investor perceptions of a firm's prospects.

Cash Flow Analysis

• Cash Flow From Operations: Cash from income statement based on accrual accounting practices.
• Cash Flow From Investing: Cash from capital expenditures & asset sales.
• Cash Flow From Financing: Cash from debt and equity transactions.
• Operating Cash Flow Margin: Ratio comparing operating cash flow to sales revenue.
• Free Cash Flow: Operating cash flow minus investments (capital expenditures). Provides insight into ability to pay investors & fund business growth.

Financial Modeling

• Financial Modeling: Summarizing a company's expenses & revenue within a spreadsheet to assess future scenarios.
• Validation of Financial Models: Testing assumptions and calculations thru outside parties within financial institutions, project promoters or equity houses.

Financial Reporting and Disclosure

• Financial Reporting: Documenting & communicating financial activity over time. Vital to inform stakeholders, meet legal obligations and ensure transparency.

Banking and Financial Institutions

• Bank Regulation: Imposes requirements, restrictions, & guidelines on banks to reduce risk & protect consumers.
• Types of Financial Institution Risks: Credit risk, market risk, operational risk, reputational risk, & liquidity risk.

Risk Management Practices in Banks:

• Risk Assessment: Gathering & analyzing data to assess risk likelihood and prioritize mitigation.
• Risk Mitigation: Reducing risk exposure & minimizing likelihood of incidents.
• Monitoring: Continuously tracking risks, testing controls, & addressing emerging trends.
• Connecting & Reporting: Building relationships between risks, and reporting the effectiveness of the risk management program.

Financial Institutions and Markets

• Financial Instruments and Services: Banks, credit unions, investment companies, brokerage firms, insurance companies, & financial advisors facilitate savings, loans, & investment advice for individuals.
  • Stock Markets: Platforms where company stock shares are traded to potentially earn profits or dividends.
  • Bond Markets: Markets where bonds (loans to companies/govts) are traded; investors earn interest & get principal.
  • Money Markets: Markets for short-term debt securities like treasury bills & CDs.

Capital Budgeting

• Capital Budgeting: Choosing projects with added value and generating revenue & profitability in the long run
• Discounted Cash Flow Analysis: Evaluating investments by factoring in the time value of money.
• Payback Analysis: Determining the length of time required to recoup an investment.
• Throughput Analysis: Examining revenue and expenses across an entire organization, not just specified projects.

Cost of Capital

• Cost of Capital: The minimum return needed to justify a capital budgeting project.
• Weighted Average Cost of Capital (WACC): Overall cost of capital, calculated by considering the costs of all sources of capital (debt and equity).
• Capital Structure: The specific mix of debt and equity financing a firm uses.
• Cost of Debt: Interest rate paid by a company on its debt.
• Cost of Equity: Typically approximated by the Capital Asset Pricing Model (CAPM), considering risk and market conditions.

Dividend Policy

• Stable Dividend Policy: Regular dividend payments, regardless of earnings.
• Constant Dividend Policy: Consistent dividend payments; earnings changes may not affect it.
• Residual Dividend Policy: Paying out dividends as remaining earnings after capital expenditures & working capital.
• No Dividend Policy: Retaining earnings for reinvestment.

Mergers and Acquisitions (M&A)

• Merger: Two companies combining to form a new organization.
• Acquisition: One company purchasing another company.
• Hostile Takesover: One company attempts to purchase another company without its cooperation.
• Horizontal Acquisition: Acquiring a similar competitor.
• Vertical Acquisition: Acquiring a company in a related stage of the supply chain.
• Tender Offer: Directly approaching shareholders to purchase their shares at a premium offer.
• Acquisition of Assets: Purchasing assets, not the company.
• Management Acquisition (MBO): Executives taking a company private thru purchasing.

Corporate Governance

• Corporate Governance: The system of rules, practices, & processes by which a company is directed & controlled.
• Key Actors: Board of Directors (BOD) including insiders (company executives/shareholders) & independent directors.