PR-FinMar (Midterms) PDF

TIME VALUE OF MONEY Future Value What is Time Value of Money? - A peso received today is worth more than a The amount of money today di ers from what it peso to be received tomorrow. The valuation will be in th...

TIME VALUE OF MONEY Future Value What is Time Value of Money? - A peso received today is worth more than a The amount of money today di ers from what it peso to be received tomorrow. The valuation will be in the future. holds true because of the interest money can be earned after having been invested Time Value of Money - Compounding interest means that an interest - An insurance company that pays P500,000.00 not withdrawn also earns interest. Knowing after 20 years to a policyholder receives a how much individuals decide is earned on the premium payment of P12,500.00 a year. For money placed in the present helps individuals 20 yrs the premium payment made by the decide whether or not to look for other policy holder will amount to a sum of investment opportunities. P250,000.00 only. Why is the insurance company willing to sacri ce the other Advantages of Calculating Future Value P250,000.00? - It helps with nancial planning. Knowing the - The insurance company believes that it can do future value of an investment can allow a much more using the P12,500.00 that it nancial expert to help a client meet their actually received every year. The rm believes savings and investing goals. It helps with that the expected return will exceed what it is comparisons willing to pay the policy holder. Time Value of Money, Calculate Future Value with Simple Interest Kelso invested $15000 in an account that pays 6 percent simple interest. How much money will he have at the end of twelve years? Future value is how much an investment made ‣ Future value = PV + (PV x r x n) today will be worth at some point in the future. ‣ Future value = $15000 + ($15000 ×.06 × 12) = Therefore, future value is critical in making informed 25800 decisions about investments or even savings. The time value of money is a critical consideration FV = Future value ( present +interest) or the in nancial and investment decisions. It helps amount of money at year end n individuals and rms determine how much money PV = Principal values must be placed today to accumulate a future sum r = rate given an interest rate for a given period. i = annual interest The placement may be in either lump-sum or n = number of periods regular intervals, at the beginning or end of the If the amount of PV per year is placed at a rate i, period. The time value of money determines how then much interest will be earned if placed today at a certain rate for a certain period. FORMULA: F V = PV(1 + i )n The compounding of interest determines the future amount of money earned if an investment is made FUTURE VALUE OF ANNUITY at the present. Ex. Pension fund for retiring - Annuity a sum of money that is paid in regular employees, sinking funds for long-term equal payments. obligations, etc. - Annuities are investment options that are trade LUMP-SUM - a single payment made at a present-day deposits for a series of future particular time, as opposed to a number of smaller payouts. Money deposited into an annuity payments or installments. grows over time based on various factors fi fi  fi fi fi fi ff  including the type of annuity you have and the Present Value of Annuity Formula rate of interest that the annuity earns. - In the nancial world, many transactions - If the payment occurs at the end of the period involve regular payments made over extended it is called an ordinary annuity. periods; some examples include mortgage ‣ Example: mortgage on housing, car loans payments or the interest paid on a bond. A and bank loans series of equal payments on equal intervals is - If payment occurs at the beginning of each typically known as an annuity. period the annuity is called annuity due. - The present value of an annuity is the ‣ Example: life, car insurance premiums, equivalent value of a series of future payments rental payment at the beginning of its duration, accounting for Between the 2 annuities the ordinary is more in the "time value of money" - practice meaning compound interest. The value of the ANNUITY - is a series of equal payments (or annuity is equal to the sum of the present receipts) made at xed intervals for speci ed values of all of the regular payments. numbers of periods. The time value of money is the notion that the Most Common Types of Issuers of Annuities money present now is worth more than money ❖ Insurance Companies available sometime in the future. Money available in ‣ e.g. Retirement Planning the present can be invested to make interest and ❖ Mutual Funds increase to a larger future value. ❖ Brokerage Firms ❖ Mortgage and Auto Financing Factors That A ect Present Value Interest Rates - an annuity’s interest rate is used Present Value at Compounded Interest to discount future payments. The discount rate - The present value of a future sum is the reduces future cash ow from the annuity. So, amount that must be invested today at the higher the interest rate is, the lower the compound interest to reach a desired sum in annuity’s present value will be. the future. The process of calculating present Payment Amount and Frequency - since the values, or discounting, is usually the opposite present value of an annuity is the value of future of nding the compounded future value. In payments, the more payments you have and the connection with present value calculations, the higher each payment is, the greater your present interest rate is called a discount rate. value will be. - Recall that: F V = PV(1 + i )n Time to Maturity - this is the time until payments are received from the annuity. The - Transpose: PV = F V(1 + i )n longer the wait until payments are received, the more time it takes for compound interest to build DISCOUNTING - the opposite of compounding, is value in the annuity. This longer time period will used to evaluate future cash ows associated with increase the annuity’s present value. capital budgeting projects and the valuation of In ation - in ation or other external factors can bonds and stocks. erode the future value of an annuity. When you take in ation into account, it can reduce the - The present value of an annuity is the current present value of an annuity. value of future payments from an annuity, given a speci ed rate of return, or discount rate. The higher the discount rate, the lower the present value of the annuity. fl fi fi fl   fl fi ff fi fl fl fi  Factors that A ect the Present Value of an - When you sign an annuity contract, you’ll Annuity contribute money, either in a large lump sum There are several factors that can a ect the or as smaller monthly payments, called present value of an annuity. Most of these are premiums once invested, your money grows related to the annuity contract dealing with interest on a tax-di ered basis, which allows you to rates, guaranteed payments and time to maturity. take advantage of compound interest. When it But external factors — most notably in ation — comes time to withdraw your funds, you may may also a ect the present value of an annuity. owe taxes on either the full withdrawal amount or any interest accrued, depending on the type Present Value of an Annuity of annuity you have. Interest received from bonds, pension funds, and - Annuities comes in many forms. For insurance obligations all involve annuities. To Instance, you can choose between annuities compare these nancial instruments, the present with xed or variable interest rates, or between value of each must be known. annuities that o er immediate or deferred payouts. Present Value of Unequal Cash Flow - Future and present value has numerous Simple Annuity applications in nancial and investment - It is an annuity certain whose compounding decisions. they are useful in decision-making period is the same as the payment interval. whether for ‣ Example: A deposit of P5000 was made at - Personal Reasons the end of every three month to an account ‣ Example: how much deposit must be that earns 5.6% interest compounded made to acquire a certain amount of quarterly. money, amortize a loan, or pay o a sinking fund Classi cations of Simple Annuity - Corporate Reasons Ordinary Annuity - it is an annuity in which the ‣ Example: capital budgeting, bond and periodic payment is made at the end of each stock valuation and the right nancing mix payment interval. Key word: End Annuity Due - it is an annuity in which the A sinking fund is a fund containing money set periodic payment is made at the beginning of aside or saved to pay o a debt or bond. A each payment interval. company that issues debt will need to pay that debt o in the future, and the sinking fund helps to soften RISK AND RATE OF RETURN the hardship of a large outlay of revenue. Return - Every time an investment is made, a return is Future Value is the dollar amount that will accrue expected. (may be in the form of money, over time when that sim is invested. service, or merchandise) Present Value, before purchasing the annuity, is - 2 Sources the amount you must invest in order to realize the ❖Flow of Income - savings, TD, or xed- future value. income securities ❖Capital Appreciation - stocks, house/land How Do Annuities Work? - Annuities are o ered by insurance companies, Credit risk management is the practice of banks and other nancial institutions as a way mitigating losses by assessing borrowers' credit to secure extra cash during retirement. risk, including payment behavior and a ordability. ff fi fi ff ff ff ff fi ff fi fi ff fi ff fi ff fl ff  This process has been a longstanding challenge for 2. Unsystematic Risk - is sometimes called nancial institutions. controllable or diversi ed risk. Risk Principal Risk - is the risk of losing the amount - is the exposure to uncertainty or danger invested due to bankruptcy or default. It is the resulting in changes in the expected return in a ubiquitous possibility that through some set of given investment circumstances, the money invested will - can be referred to as the chances of having an decrease or completely disappear. The pro t unexpected or negative outcome. Any action and even the principal are lost. or activity that leads to loss of any type can be Credit Risk - the possibility that the bond termed as risk. issuer will delay the payment of the principal and interest. Bonds issued by corporations are CLASSIFICATION OF RISKS more likely to be defaulted, since company can 1. Systematic Risk - sometimes called go bankrupt. This is also called default risk. uncontrollable or undiversi ed risk. It results from Liquidity Risk - is the risk that arises from the forces outside of the rm’s control. And is di culty in selling asset. Sometimes an therefore not unique to a given security. investment needs to be sold quickly. Currency Risk- the risk that the business Unfortunately, an insu cient secondary market operation or investment will be a ected by may prevent the liquidation needed or limit the changes in the exchange rates. funds that can be generated from the assets. Equity Risk- the risk that the market value of Some assets are highly liquid and therefore the shares will increase or decrease. have low liquidity risk. Publicly traded stocks In ation Risk- the possibility that the value of are highly liquid. assets or income will decrease as in ation Call Risk - is the cash ow risk resulting from shrinks the purchasing power of a currency. the possibility that a callable bond is redeemed In ation causes money to decrease in value at before maturity. Callable bonds, maybe called some rate, whether the money is invested or by the company that issued them. not. Business Risk - the risk associated with the Country Risk - the potential volatility of foreign unique circumstances of a particular company. stock or the potential default of foreign As they might a ect the price of that government bonds due to political and/or company’s securities. It is caused by the nancial events in the given country. uctuation in the earnings before interest and Interest Rate Risk - the possibility that the taxes. The business risk depends on the value of a security, particularly bonds, is variability in demand, sales, price, and cost. reduced due to an increase in the interest rate. This risk can reduced by diversifying the 5 Ways To Measure Risk durations of the xed-income investments that There are numerous ways your advisor can are held at a given time. calculate risk tolerance or the level of risk you as an Purchasing Power Risk - the risk that in ation investor are willing to take to achieve your nancial will erode the purchasing power of the portfolio goals. of securities. 1. Alpha Event Risk - the uncertainty that an - Alpha is a measure of investment performance unexpected event will happen. An example is that factors in the risk associated with the the likelihood that the rating of a bond will drop speci c security or portfolio, rather than the due to the incurrence of additional debts or the overall market (or correlated benchmark). It is recapitalization of a company. a way of calculating so-called “excess return” fi fi fl fl ffi fl fi ff fi fi fi ffi fl fi ff fl fl fi fi  – that portion of investment performance that The higher a portfolio’s Sharpe ratio, the better exceeds the expectations set by the market as its risk-adjusted performance has been. well as the security’s/portfolio’s inherent price 5. Standard Deviation sensitivity to the market. - Standard deviation is a measure of investment - Alpha is a common way to assess an active risk that looks at how much an investment’s manager’s performance as it measures return has uctuated from its own longer-term portfolio return in excess of a benchmark average. index. In this regard, a portfolio manager’s - Higher standard deviation typically indicates added value is his/her ability to generate greater volatility, but not necessarily greater “alpha.” risk. That is because while standard deviation 2. Beta quanti es the variance of returns, it does not - Beta is the statistical measure of the relative di erentiate between gains and losses – volatility of a security (such as a stock or consistency of returns is what matters most. mutual fund) compared to the market as a whole. The beta for the market (usually Required Rate of Return (RRR) represented by the S&P 500) is 1.00. A security - is the minimum amount an investor or with a beta above 1.0 is considered to be more company seeks, or will receive, when they volatile (or risky) than the market. One with a embark on an investment or project. The RRR beta of less than 1.0 is considered to be less can be used to determine an investment's volatile. return on investment (ROI). The RRR for every 3. R-Squared investor di ers due to the di ering tolerance - R-squared (R2) quanti es how much of a for risk. fund’s performance can be attributed to the - the required rate is commonly used as a performance of a benchmark index. The value threshold that separates feasible and of R2 ranges between 0 and 1 and measures unfeasible investment opportunities. the proportion of a fund’s variation that is due to variation in the benchmark. For example, for The General Rule a fund with an R2 of 0.70, 70% of the fund’s If an investment's return is less than the required variation can be attributed to variation in the rate, the investment should be rejected. The metric benchmark. can be adjusted for the needs and goals of a 4. Sharpe Ratio particular investor. - The Sharpe ratio is a tool for measuring how well the return of an investment rewards the 2 Methods to Calculate the Required Rate of investor given the amount of risk taken. Return (RRR) - For example, a Sharpe ratio of 1 indicates one There are a couple of ways to calculate the unit of return per unit of risk, 2 indicates two required rate of return—either using the units of return per unit of risk, and so on. A Dividend Discount Model (DDM) negative value indicates loss or that a Capital Asset Pricing Model (CAPM) disproportionate amount of risk was taken to generate a positive return. The choice of model used to calculate the RRR - The Sharpe ratio is useful in examining risk depends on the situation for which it is being used. and return, because although an investment The dividend-discount model calculates the may earn higher returns than its peers, it is RRR for equity of a dividend-paying stock by only a good investment if those higher returns utilizing the current stock price, the dividend do not come with too much additional risk. payment per share, and the forecasted dividend growth rate. The formula is as follows: ff fi ff fl fi ff  RRR = (Expected dividend payment / Share structure. The RRR should always be higher Price) + Forecasted dividend growth rate than the cost of capital. To calculate RRR using the dividend discount Limitations of the Required Rate of Return model: - The RRR calculation does not factor in in ation Take the expected dividend payment and divide it expectations since rising prices erode by the current stock price. investment gains. However, in ation Add the result to the forecasted dividend growth expectations are subjective and can be wrong. rate. - Also, the RRR will vary between investors with di erent risk tolerance levels. A retiree will Calculating RRR Using the Capital Asset Pricing have a lower risk tolerance than an investor who recently graduated college. As a result, Model (CAPM) the RRR is a subjective rate of return. Another way to calculate RRR is to use the capital - RRR does not factor in the liquidity of an asset pricing model (CAPM), which is typically investment. If an investment can't be sold for a used by investors for stocks that do not pay period of time, the security will likely carry a dividends. higher risk than one that's more liquid. The CAPM model of calculating RRR uses the beta of an asset. Beta is the risk coe cient of the Probability Distribution holding. In other words, beta attempts to measure the riskiness of a stock or investment over time. A probability distribution is a statistical function Stocks with betas greater than 1 are considered that describes the likelihood of obtaining all riskier than the overall market (often represented possible values that a random variable can take. In by a benchmark equity index, such as the S&P other words, the values of the variable vary based 500 in the U.S., or the TSX Composite in Canada), on the underlying probability distribution. Typically, whereas stocks with betas less than 1 are analysts display probability distributions in graphs considered less risky than the overall market. and tables. The formula also uses the risk-free rate of return, Probability which is typically the yield on short-term U.S. - Is the occurrence or non-occurrence of an Treasury securities. The nal variable is the market event. rate of return, which is typically the annual return - If all the possible outcomes are considered of the S&P 500 index. The formula for RRR using and a probability is taken into consideration for the CAPM model is as follows: each possible outcome, then a probability distribution can be listed. RRR = Risk-free rate of return + Beta X - Probability is applicable not only in statistics, it (Market rate of return - Risk-free rate of return) is widely used in nance. - If the investor buys a bond, there is a Required Rate of Return vs. Cost of Capital probability that the issuer of the bond will - Although the required rate of return is used in default on the payment. If the probability of capital budgeting projects, RRR is not the default is high, the individual will expect a same level of return that's needed to cover higher return because of the higher risk the cost of capital. The cost of capital is involved. Moreover, if the probability of the minimum return needed to cover the cost receiving payment is high, the investor will of debt and equity issuance to raise funds for expect a lower return. the project. The cost of capital is the lowest return needed to account for the capital ff fi fi fl ffi fl  Expected and Realized Return Understanding Bond Discount - The expected return is the return made after A bond sold at par has its coupon rate equal to the probabilities of occurrence, the state of the the prevailing interest rate in the economy. An economy, and the individual’s expected investor who purchases this bond has a return outcomes are considered. This type of risk is on investment that is determined by the periodic “factored in”. coupon payments. Note: the expected return is the weighted A premium bond is one for which the market average of the individual possible returns price of the bond is higher than the face value. If and their probabilities of occurrence. If one the bond's stated interest rate is greater than of the variable changes, the expected return those expected by the current bond market, this changes. bond will be an attractive option for investors. - A REALIZED RETURN IS AN ACTUAL A bond issued at a discount has its market RETURN. The realized return usually turns out price below the face value, creating a capital to be di erent from the expected return except appreciation upon maturity since the higher face for xed income securities such as T-bill. value is paid when the bond matures. The bond discount is the di erence by which a bond's market price is lower than its face value. LONG TERM FINANCING - DEBT ‣ For example, a bond with a par value of 1. Debts and Mortgage $1,000 that is trading at $980 has a bond 2. Requisites of Mortgage discount of $20. The bond discount is also 3. Bonds and its Features used in reference to the bond discount rate, 4. Sale of Bonds which is the interest used to price bonds via 5. E ects of Bond Premiums and Discounts on present valuation calculations. Firm’s Cash Flow Long-Term Financing: Debt E ects of Bond Premiums and Discounts on - Usually paid on installment, long-term debts Firm’s Cash Flow are obligations that mature in 2 to 20 years. Below are some e ects of amortizing the - Long-term debts are incurred to purchase premium and discount on a rm’s cash ow capital assets such as land, buildings, and 1. The amortization of a bond discount or premium machinery equipment. They are obtained for does not involve the receipt or payment of cash, expansion or payment of mature obligations. which must be considered when preparing a Similar to bonds long-term debts are statement of cash ow. Thus, a bond discount sometimes collateralized by real estate or increases the cash ow from operating activities chattel. In some instances, however, bonds do while a bond premium decreases it. not require any security. 2. When a bond discount is amortized, the interest - Firms without access to nancial market expense reported on the income statement is approach commercial banks, insurance higher than the interest paid. The net income companies or other nancial institution as an (bon cash basis) is also understated. alternative even if the latters interest are 3. The amount of bond premium amortization is considerably high. subtracted from the net income to determine the cash ow from the operation. Mortgages 4. The direct method requires the conversion of - Are obligations granted by banks and other individual accrual-basis revenue and other items nancial institution to the borrower that uses into cash. real state or movable assets as collateral. - The borrower is called the Mortgagor fi ff fi ff fl ff ff fl fl fi ff fi fi fl  - The lender is called the Mortgagee 3. If a property is pledged as security for the bond - A mortgage takes place when the owner of the issue, a trustee holding the title to the property property conveys the title to the mortgagee by serving as the security is identi ed. signing a deed of assignment. As a rule 4. A bank or trust company is appointed as the mortgage can only cover xed assets. registrar or disbursing agent. The issuing rm - Real State Mortgage - real state deposits the interest and principal payments to - Chattel Mortgage - automobile equipment the disbursing agents who will then distribute the funds to the bondholders. In other words, the Requisites Of Mortgage bank or trust company is the one that ensures 1. The mortgage is constituted to secure the that all the terms and covenants indicated in the ful llment of the obligation. indentures are followed strictly by the issuing 2. The absolute owner of the property to be rm. mortgages, is the mortgagor himself/herself 3. The mortgagor has the free disposal of the asset Bond Indentures to be mortgaged. - The terms and conditions of a bond issuance in a bond are determined in the bond indenture Bonds which describes the features of the bond - Is a long-term debt in which the corporation issuance. The bond indenture is sometimes that issued the bonds owes the bondholders a called a deed of trust. A nancial intermediary, debt and is obliged to repay the principal at its normally a bank, acts as a trustee and face value on the maturity date or to make represents the bondholders. periodic interest payments until the principal is - A bond indenture is a legal document that paid. contains the rights of the bondholders and the - When a rm needs a large sum to nance bits corporation. activities, it may have to borrow from the - Provisions for a Bond Denture: general investing public by using a bond issue. 1. detailed of the terms of the bonds issued Prior to issuance, the approval of SEC must be 2. covenants obtained. Bonds are primarily used by 3. call provision corporations and government agencies. In 4. conversion provision case the issuer becomes insolvent, the bond 5. retirement provision holders have priority of claim on the rms 6. sinking fund provision assets and dividend over preferred and - Are part of bond indentures that restrict certain stockholder. actions of the issuer e.g. incurring additional obligations. Features of Bond Issue 1. Bond Indenture or Deed of Trust is a detailed Details of the Terms of the Bond Issued document which contains essential information 1. The nominal rate or principal or face amount regarding the bond issued. It also includes the of the bond issuance is the agreement as rights and duties of the borrower and the parties regards the nominal rate to be used when to the contract. computing the interest and principal to be paid 2. Bond Certi cate representing a portion of the on the maturity date. total loan is used. The usual minimum 2. The issue price is the price at which investors denomination in business practice is P1000 can buy the bonds when they are rst issued. although smaller denominations are occasionally The net proceeds the issuer receives are issued. computed as the issue price less the issuance fi fi fi fi fi fi fi fi fi fi fi  fees. The issue price consists of the present - The cost of the bond issues are added to the value of the face value of the bond and the bond discount or deducted from the bond present value of all the coupon payments. premium and amortized over the life of the 3. The maturity date is the date on which the bond. issuer has to repay the nominal amount. As long - When bonds are issued between the dates of as all the payments are made, the issuer no interest payment, the accrued interest is longer has any other obligation to the bond charged against the bondholder. holders after the maturity date. The length of - When bond is sold below its face value, the time from the start-up to the maturity date is bond is considered sold at a discount. A bond often referred to as the term or maturity of a that is sold above its face value is considered bond. The maturity can be of any length of time, issued at a premium. although debt securities with a term of less than - Both the amount of the discount and the one year are generally designated as money- premium are amortized from the time period market instruments rather than bonds. Most the bond is acquired up to the time the bond bonds have a term of up to 30 years. Some matures. bonds are issued with maturities of up to 100 - The bond issue costs, also a tax-deductible years. Some do not even mature at all. expense, must also be amortized over the year of the bond. Sale of Bonds - Bonds are usually too expensive to sell to only LONG TERM FINANCING – EQUITY a few investors. Thus, a borrower may split a 1. Composition of Equity bond issuance into many small units of say 2. Trading in Stock Exchange 1000, 10000, or 100,000. 3. Common and Preferred Stocks - Often bonds are sold in equal denominations 4. Stock Rights for convenience. Each of the bonds issued is 5. Value of Rights evidenced by a bond certi cate. A bondholder looks for a nancial intermediary What is Equity Financing? who will assume responsibility for the sale of - Equity nancing refers to the sale of company the bonds. shares to raise capital. Investors who purchase - The bond issued may either be an interest- the shares are also purchasing ownership bearing bond or a non-interest-bearing bond. rights to the company. Equity nancing can An interest-bearing bond that earns interest on refer to the sale of all equity instruments, such speci c intervals, normally a period of 6 as common stock, preferred shares, share months. warrants, etc. - The interest payment to the bondholder is - Equity nancing is especially important during called nominal interest, which is the interest a company’s startup stage to nance plant on the face of the bond. assets and initial operating expenses. - The interest on the bond is tax deductible, Investors make gains by receiving dividends or hence rms prefer to issue bonds rather than when their shares increase in price. new shares of stock because bonds function - Equity nancing is used when companies need as tax shield. to raise cash. - The bond issuance is not tax free from cost. - It is accomplished by selling a portion of the When bonds are issued, printing, engraving equity in a company through shares. and promotional costs, legal, accounting, commission and registration fees and other similar charges are paid. fi fi fi fi fi fi fi fi fi  - Equity nancing can come from friends and can invest substantial amounts and provide family, professional investors, or an initial insight, connections, and advice. public o ering (IPO). Venture Capitalists: Individuals or rms who make substantial investments in businesses that Selling Shares they view as having very high and rapid growth - Equity nancing involves the sale of equity potential, competitive advantages, and solid instruments such as preferred stock, prospects for success. They usually demand a convertible preferred stock, and equity units noteworthy share of ownership in a business for that include common shares and warrants. their nancial investment, resources, and - A startup that grows into a successful connections. company will have several rounds of equity Initial Public O ering: A business can raise nancing as it evolves. funds through IPOs, selling company stock - Once a company has grown large enough to shares to the public. Due to the expense, time, consider going public, it may consider selling and e ort that IPOs require, this type of equity common stock to institutional and retail nancing occurs in a later stage of development investors. If the company needs additional after the company has grown. Investors in IPOs capital, it may choose secondary equity expect less control than venture capitalists and nancing options, such as a rights o ering or angel investors. an o ering of equity units that includes warrants. Advantages of Equity Financing 1. Alternative funding source Equity Financing vs. Debt Financing 2. Access to business contacts, management Debt nancing involves borrowing money. Equity expertise, and other sources of capital nancing involves selling a portion of equity in the company. Most companies use a combination of Disadvantages of Equity Financing equity and debt nancing. The most common form 1. Dilution of ownership and operational control of debt nancing is a loan. Unlike equity nancing, 2. Lack of tax shields which carries no repayment obligation debt nancing requires a company to pay back the Composition of Equity money it receives, plus interest Four components that are included in the shareholders' equity calculation are: Major Sources of Equity Financing ❖ Outstanding Shares ❖ Angel Investors ❖ Additional Paid-in Capital ❖ Venture Capital ❖ Retained Earnings ❖ Crowdfunding ❖ Treasury Stock ❖ Corporate Investors ❖ IPO If shareholders' equity is positive, a company has enough assets to pay its liabilities; if it's Types of Investors negative, a company's liabilities exceed its assets. Individual Investors: Friends, family members, and colleagues of business owners with little to The formula for owner's equity is: no relevant industry experience. Owner's Equity = Assets - Liabilities Angel Investors: Wealthy individuals or groups interested in funding businesses they believe will provide attractive returns. Angel investors fi fi fi fi fi ff fi ff fi fi fi ff fi ff fi fi ff fi  Trade in the Stock Exchange - Preferred shareholders also get repaid rst if Stock exchanges are organized marketplaces the company dissolves or enters bankruptcy. where shares of ownership in companies are traded Preferred stock doesn't carry voting rights and between buyers and sellers. These exchanges play suits investors seeking reliable passive a vital role in the global economy by providing a income. centralized location for businesses to raise capital - Authorized shares are established when the and investors to buy and sell securities company is founded, which is the number of shares a company can sell to investors. If a What do you mean by trading on a stock company authorizes 1 million shares, it may exchange? sell up to 1 million shares of stock. Companies Stock trading involves buying and selling shares give up ownership (stock) in return for capital of publicly traded companies on stock exchanges. (money). Types of stock traders include long-term, short- - Most companies do not sell all of their term, day trading, swing trading, and high- authorized shares during their initial public frequency trading, with each having a di erent time o ering ( rst public sale of their shares), horizon and goal. allowing the opportunity to raise additional capital later by selling “leftover” authorized What is Trading in Stocks? shares. - Stock trading involves buying and selling - The number of shares a company sells during shares in public companies — called stocks — its initial public o ering (IPO) is referred to to try to make money. You can earn a pro t by as issued shares. Once shares are issued, they buying stocks at a lower value than when trade in the secondary market among - Trading refers to the buying and selling of investors. nancial assets in markets to make a pro t. It - This is called the pre-emptive right, which involves analyzing market trends and gives current stockholders the right to buy the identifying opportunities to enter the market, new shares the company is issuing before thereby making a pro t. they’re publicly o ered. In our example, you owned 10% of the outstanding shares in the Common and Preferred Stock beginning. Prior to the public sale of these new - Common Stock - sometimes referred to shares, you’ll have the opportunity to purchase 10% of the o ering to maintain the same as ordinary shares, represents partial ownership percentage. ownership in a company. This stock class - The company issues pre-emptive rights to its entitles investors to generate pro ts, usually current stockholders to purchase these new paid in dividends. Common stockholders elect shares. Investors receive one right for every a company's board of directors and vote on share of stock owned. corporate policies. Holders of this stock class - Rights have intrinsic value, which means they have rights to a company's assets in a have immediate value. liquidation event, but only after preferred - The company automatically provides this value stock shareholders and other debt holders because they’re saving money by avoiding the have been paid. services of an underwriter. - Company founders and employees typically receive common stock. What are Stock Rights? - Preferred Stock, or preference shares, entitles - Stock rights give their owner the right, but not the holder to regular dividend payments before the obligation, to buy the shares of a company dividends are issued to common shareholders. at a speci c exercise price for a designated fi ff fi fi ff ff ff fi fi fi ff fi fi  period of time. The term primarily applies to giving current shareholders the right to buy additional shares as part of the issuer's next stock sale. - The intent is to give existing shareholders the ability to maintain their current proportion of ownership in the business by acquiring the same proportion of the new issuance. This is a particular concern in closely held organizations, where some shareholders want to maintain their control over the entity. Stock Rights Best Practices Stock rights may be issued at an exercise price somewhat below the current market price, with no commission charge. By doing so, the issuer makes the shares more enticing to investors. This is also an advantage for the issuer, since it retains its existing shareholders through several rounds of stock issuances, rather than having to deal with new investors.