Transcript Slide 1

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Chapter
2
Operating Environment
of Financial Management
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Chapter 2 – Operating Environment of Financial Management
•Circular Flow of Income – shows the interactive nature
between household income, the purchase of goods and services,
and business expenditures.
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Money Income
Economic Resources
Production of
Goods and Services
(Business)
Providers of
Resources
(Households)
Goods and Services
Consumption Expenditures
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Chapter 2 – Operating Environment of Financial Management
•Depository Financial Institutions – called such because they
accept demand and savings deposits.
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•Commercial Banks – represent largest type of financial
institutions in terms of assets held. Businesses depend on
such banks for both borrowing and lending transactions.
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•Mutual Savings Banks – invest primarily in mortgages
guaranteed by the Federal Housing Administration (FHA)
and Veterans Administration (VA). Mutual Savings Banks
are primarily located in the northeast.
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Chapter 2 – Operating Environment of Financial Management
•Depository Financial Institutions (cont)
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•Savings and Loan Associations – chartered by either
federal government or the state in which they operate.
Savings and loans specialize on mortgages.
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•Credit Unions – this type of institution is composed of a
group of people with common ties such as church, fraternal
order or labor union. Members own, control and operate
the credit union under either a federal or state charter.
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Chapter 2 – Operating Environment of Financial Management
Companies
divided
0011 •Insurance
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into the following two
broad categories.
•Life Insurance Companies – collect premiums from
customers that will permit them to cover the necessary
payments based upon prior mortality statistics. These
premiums are invested until needed in corporate securities
and mortgages.
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•Property and Casualty Insurance Companies – collect
premiums from policyholders to offer protection against
financial losses and other such perils.
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Chapter 2 – Operating Environment of Financial Management
•Other Financial Institutions
•Pension
Funds
– established
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persons.
•Private Pension Funds – generally controlled by commercial
banks and life insurance companies and invested heavily in
stocks.
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•Government-Sponsored Pension Funds - controlled by
legislation and invested in corporate bonds and stocks.
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•Mutual Funds – acquires small amounts of monies from
many different individuals and invest in a wide variety of
corporate securities.
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Chapter 2 – Operating Environment of Financial Management
•Other Financial Institutions (cont)
•Finance
Companies
– depend
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heavily on open market
commercial paper and borrow funds from commercial
banks. These companies use these funds to make loans.
Many times finance companies are formed by parent
companies to assist with the financing of their goods and
services. One such example is GMAC, a subsidiary of
General Motors.
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Chapter 2 – Operating Environment of Financial Management
consists
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of capital markets and money
markets and serve to bring deficit spenders and surplus savers
together to transact business.
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•Money Markets – consists of a group of markets where
short-term instruments are traded. Generally, such instruments
are issued by those with the highest credit ratings and
characterized by a high degree of safety. Maturities may be as
long as one year but are usually 90 days or less.
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Chapter 2 – Operating Environment of Financial Management
•Money Markets (cont)
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•Treasury
– direct
obligations
of the U.S.
government and perhaps the most important type of money
market instrument. T-bills with maturities of 91 – 182 days
are auctioned on a weekly basis and sold on a discount
basis.
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•Commercial Paper – represents unsecured promissory
notes sold by finance companies among others.
Commercial paper bears the name of the issuer.
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•Bankers’ Acceptance – short-term credit instruments that
arise out of foreign transactions. They are time drafts
issued by business firms (often an importer of goods) and
accepted by a bank.
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Chapter 2 – Operating Environment of Financial Management
•Money Markets (cont)
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•Negotiable
Certificates
Deposits – large
denomination CDs issued by commercial banks to attract
idle corporate assets.
•Repurchase Agreements - agreement whereby a dealer
sells it short term securities along with a simultaneous
agreement to buy them back at a later date.
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•Federal Funds – loans between bank on an overnight
basis.
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Chapter 2 – Operating Environment of Financial Management
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with
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long-term securities such as
stock, bonds and mortgages. Such markets are comprised of
“Primary” and “Secondary” markets.
•Primary markets – when firms sell new securities they
take place in primary markets. New securities are offered
in either an initial public offering (IPO) or private
placement.
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•Secondary markets - deals with securities that have
been previously issued and sold. The major secondary
markets include the NYSE, AMEX (both physical
exchanges) and the NASDAQ (over-the-counter or OTC).
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Chapter 2 – Operating Environment of Financial Management
0011 •Capital
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•Bonds – an agreement to make interest and principal
payments to the bondholder. Generally issued in
denomination of $1,000 and referred to as a fixed income
security because interest payments are fixed. Bonds fall
into one of four categories
•U.S. Treasury
•U.S. Agency
•Municipal
•Corporate
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Chapter 2 – Operating Environment of Financial Management
0011 •Capital
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•Stocks – common stockholders represent ownership of
the company and have a claim to any asset return after all
debt obligations are fully satisfied.
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Chapter 2 – Operating Environment of Financial Management
– a percentage
measure
0011 •Inflation
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in the increase in the level
of prices.
•Quantity theory of money – hypothesis that states that
commodity prices are primarily determined by the quantity
of money in circulation. “Too much money chasing too
few goods”
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•Demand-pull inflation – product prices increase due to
the products demand exceeding its supply.
•Cost-push inflation – prices are increasing due to the
rising level of labor costs.
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Chapter 2 – Operating Environment of Financial Management
– represents
0011 •Interest
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market’s price of money and
serves as the pricing mechanism for the flow of monies
between surplus savers and deficit spenders.
•Nominal rate of interest – consists of the real interest
rate and the expected rate of inflation.
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•Real rate of interest – nominal rate minus expected
inflation rate. Thought to be relatively stable over time.
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•Risk-free rate of interest – typically estimated with U.S.
treasury bill.
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Chapter 2 – Operating Environment of Financial Management
of 1101
Business
Organization
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•Sole Proprietorship – a business owned by an individual
who is responsible for all aspects of the business. As a
sole proprietor, the owner is entitled to all profits but is
also personally responsible for all debts.
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•Partnership – a business that is jointly owned by two or
more individuals. A contractual agreement specifies the
amount of each partner’s capital contribution, how profits
will be distributed and provisions for withdrawal from the
partnership.
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Chapter 2 – Operating Environment of Financial Management
of 1101
Business
Organization
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(cont.)
•Corporation – a legal entity capable of owning assets,
incurring liabilities and engaging in certain activities. One
of the major advantages of a corporation is that investors
liability is limited to their initial investment. Other
advantages include the ease in the transfer of ownership
and raising additional capital.
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Chapter 2 – Operating Environment of Financial Management
•Tax
of Corporate
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Income
•Depreciation
•Straight-line
•Double declining-balance
•Sum-of-Years Digits
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•Accelerated Cost Recovery System
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Chapter 2 – Operating Environment of Financial Management
•Tax
of Corporate
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Income
•Interest and Dividends
•Interest payments by a corporation are treated
as a tax deductible expense.
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•Dividends paid are not tax deductible
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