1
Q
Cost Analysis
A
Made up of variable and fixed costs
2
Q
Variable Costs
A
Increase as more products/services are sold
3
Q
Fixed Costs
A
Do not change regardless of how much you sell
4
Q
Profit Formula
A
Sales - Costs = Profits
5
Q
Contribution Margin
A
(Selling Price) - (Unit Costs)
6
Q
Basic Change of GDP/Econ Growth/Stability
A
Peaked in 90s, slumped in recession, currently 1.5%-3% per year
7
Q
Planned Economy
A
Centralized government to control all or most factors of production and to make all or most production and allocation decisions
8
Q
Market Economy
A
Individual producers and consumers control production and allocation by balancing supply and demand mediated by price
9
Q
Mixed Market Economy
A
Compromise between planned and market economies
10
Q
Demand in a Market Economy
A
- The willingness and ability of buyers to purchase a product
- Demand decreases as price increases
11
Q
Supply in a Market Economy
A
- The willingness and ability of producers to offer a good or service for sale
- Supply increases as price increases
12
Q
Market Clearing
A
Process by which buyers and sellers interact to determine a price at which supply is equal to demand, no production is wasted, and goods trade at the market (clearing) or equilibrium price
- Customers prepared to pay the market price receive their goods, customers prepared to pay less receive no goods
13
Q
GDP
A
Total value of all goods and services produced within a given period by a national economy through domestic factors of production
A measure of aggregate output
Factors:
- Land/physical resources
- Capital expenditures
- Information
- Labor
- Entrepreneurship
14
Q
Factors of Production
A
Resources that a country’s businesses use to produce goods and services
15
Q
Balance of Trade
A
Economic value of all the products that a country exports minus the value of the products imported
If more exports than imports:
- Positive trade balance
- Have a surplus that they can invest internationally
If more imports than exports:
- Negative trade balance
- Must borrow to fund the imports
16
Q
Inflation
A
When price of goods in an economy increases over time
- Measured by calculating price of a set of goods and comparing with previous year
- US had avg annual inflation of 2.6%
- Deflation in Japan corresponds w low/no growth
17
Q
National Debt
A
Amount of money a government owes to its creditors (domestic/international investors)
Government receives money from taxes and spends on programs/departments
- National debt increases when the government spends more than it receives, and vice versa
18
Q
Fiscal Policies
A
Government policies regarding how and how much it collects in taxes and spends on programs
19
Q
Monetary Policies
A
- Government policies regarding the control of the size of the money supply in US dollars
- Government can directly or indirectly control the number of dollars in circulation
20
Q
Financial Research Stats
A
GDP Growth Rate: 2.2% Inflation Rate: 1.5% Unemployment Rates: Around 4% Bond Rates: 2.3%-2.5% Equity Market Average: Around $2800
21
Q
Equity Market Averages
A
Dow 30 (most discussed) - $26000
S&P 500 (most broad) - $2800
NASDAQ (tech-heavy) - $7900
Stock/equity prices are function of:
- future earnings/cash flows
- perceptions of market risk
22
Q
Company/Firm
A
Business organizations which sell goods or services with the aim of making a profit
- Have assets such as buildings, computers, and equipment that enable them to do business
- Assets are financed by issuing stockholders’ equity and debt
23
Q
Accounting Equation
A
Assets = Liabilities + Stockholders’ Equity
24
Q
Stockholders’ Equity
A
- Funded through issuance of common stock
- Stockholders pay cash for common stock
25
Financial Seniority
Order in which company's assets are paid out if company is liquidated
- Composed of liabilities and stockholders' equity
- Liquidation is sale of all assets for cash and then payment of that cash to investors
26
Financial Seniority Rules
- Liabilities are paid first
- Residul cash after debt is paid to stockholders
- Liquidation usually only occurs when company is in bad shape
27
Debt Summary
- High seniority
- Legal right to be repaid and get interest
- Low risk, low reward
- Risk of bankruptcy
- Low cost of capital
- No voting power
28
Equity Summary
- No seniority
- Earn residual cash
- High risk, high reward
- No bankruptcy risk
- High cost of capital
- Voting power in hands of shareholders
29
Secured Loan
Loan to finance an asset, backed by the borrower pledging the asset as collateral to the lender
30
Collateral
- Asset pledged for fulfillment of loan repayment
| - Ex: Land, equipment, accounts receivable, mortgage-backed securities
31
Unsecured Loan
Loan in which collateral is not required
32
Loan Principal
Amount of money loaned that must be repaid
33
Interest
Periodic payments that must be made on a loan or on a bond
34
Corporate Bond
Formal pledge obligating the issuer (the company) to pay interest periodically (usually every 6 months) and repay the principal at maturity
35
Bond Indenture
Contract/legal document containing complete details of a bond issue
36
Maturity Date
Future date when repayment of a bond principal is due from the bond issuer (borrower)
37
Face/Par Value
Amount of money that the bond buyer (lender) will receive on the maturity date
38
Default
Failure of a borrower to make payment (of interest orprincipal) when due to a lender
39
Bondholders’ Claim
Request for court enforcement of a bond’s terms of payment
40
Start-up Funds (1st Stage)
- Founders money or friends/family
| - Angel investors
41
Venture Capitalists (VC) (2nd stage)
- Professional investors who manage private funds from wealthy individuals in a VC fund
42
IPO
First sale of a company’s stock to the general public
43
Stock Price Factors
- Rises when profit margins or profit growth are expected to be high
- Dividend yield also helps
44
Market Cap
- Dollar value of all outstanding shares
| - Formula: (share price) x (# shares outstanding)
45
Market Cap Sizes
Micro-Cap: < $250 million
Small-Cap: $250 million - $2 billion
Mid-Cap: $2 billion - $10 billion
Large-Cap: > $10 billion
46
Dividend
Cash payment paid by company to the stockholder for each share they hold
47
Dividend Yield Equation
(Annual Dividend Paid)/(Stock Price)
48
EPS (Earnings per Share)
(Net Income)/(# of Shares)
49
PE (Price to Earnings) Ratio
(Stock Price)/(EPS)
| - Similar companies have similar PE ratios
50
Accounting
Comprehensive system for collecting, analyzing, and communicating financial information
- Decision relevant
- Distinct from bookkeeping
51
Accounting Users
Internal Decision Makers
- Use firm's managerial accounting system
External Decision Makers (investors, unions, governments, etc)
- Use firm's financial accounting system
52
3 Financial Statements
Income statement
Balance sheet
Cash flow statement
53
Financial Statement Responsibility
Though audited by CPAs, must be prepared under company's management
- Legal responsibility of management
54
Private Accountant
Salaried accountant hired by a business to carry out its day-to-day financial activities (including bookkeeping)
55
Management Accountant
Private accountant who provides financial services to support managers in various business activities within a firm
56
Certified Public Accountant (CPA)
State-licensed accountant who can
- offer services to public independently (only they can do audits)
- work as a management accountant for a company
57
Audit
Systematic examination of a company’s accounting system to determine whether its financial reports are in accordance with GAAP, including reliably representing its operations
- Only provides reasonable assurance of no large errors
58
Generally Accepted Accounting Principles (GAAP)
Accounting guidelines that govern the content and form of financial reports
59
Balance Sheet
Financial statement that supplies detailed information about a firm’s assets, liabilities, and owners’ equity
60
Current Asset (Assets)
Asset that can or will be used up or converted into cash within a year
61
Liquidity (Assets)
Ease with which an asset can be converted into cash
62
Fixed or long term asset (Assets)
Asset with long-term use or value, such as land, buildings, and equipment
63
Depreciation (Assets)
Accounting method for distributing the cost of an asset over its useful life
64
Intangible Asset (Assets)
Nonphysical asset, such as a patent, trademark or license that has economic value in the form of an expected benefit
65
Goodwill (Assets)
Type of intangible asset created when one company (acquirer) buys another (the target)
- $ paid by the acquirer above the target’s balance sheet value (e.g. for management team know-how)
66
Current Liability (Liabilities)
Debt that must be paid within one year
67
Accounts Payable (Payables) (Liabilities)
Current liability consisting of bills owed to suppliers
68
Long-Term Liability (Liabilities)
Debt that is not due for at least one year
69
Paid In Capital (Shareholders' Equity)
Money the stockholders invested in the firm
70
Retained Earnings (Shareholders' Equity)
Earnings retained by a firm for its use rather than paid out as dividends
71
Additions to Equity
- New investments from stockholders increase shareholders equity as paid in capital
- Income generated by the company increases shareholders equity
72
Deductions from Equity
- Payment of cash dividends decreases shareholders equity (returnon investment)
- Losses by the company decrease shareholders equity
73
Current Ratio
Current Ratio = Current Assets/Current Liabilities
- Rule of thumb is should be > 2:1
- Some large companies have < 1
74
Income Statement
Financial statement listing a firm’s annual or quarterly revenues and expenses so that the bottom line shows the period’s profit or loss
- Also known as earnings
Profit = Revenues - Expenses
75
Revenues
Funds/net assets that flow into a company from selling goods or services
- Can be cash or accounts receivable
- Flows of value into a company from selling goods/services
- Recorded when goods are delivered or when a service is performed
- Not dependent on when payment occurs, just the good or service delivered/performed
- Also called sales or turnover
76
Expenses
Costs of doing business
- Use up of value company needs to sell goods/services
- Recorded when good or service is sold
77
Cash Flow Statement
Financial statement describing a firm’s yearly or quarterly cash receipts and cash payments
Made up of:
- Operating cash flows from earnings (usually positive)
- Investing cash flows to buy new long term assets such as machinery (usually negative)
- Financing cash flows from/to the investors (varies)
Startup: usually a positive financing cash flow as it raises money from stockholders and banks to build the business
Mature company: negative financing cash flow as it pays back its debts to the banks and pays dividends to stockholders
78
Cost of Goods Sold (COGS)
Costs of products sold, payments to partners, or content providers
79
Operating Expenses (OpEx)
Costs, other than sales costs, incurred by firm
80
Gross Profit
Revenues - Cost of Revenues
81
Operating Income
Gross Profit - OpEx
82
Net Income/Profit/Earnings
Gross profit - all expenses including taxes
83
Profit Margin Ratio
(Annual Net Income)/(Annual Revenues)
84
Return on Equity (RoE)
(Annual Net Income)/(Stockholders' Equity)
- Cents on dollar per year per dollar invested
- Emphasizes efficiency and maximum profit per dollar
- Best measure of return for equity investor
85
Dupont Framework
RoE = (Net Profit Margin) x (Asset Turnover) X (Financial Leverage)
86
Net Profit Margin
(Net Income)/(Net Sales)
| - Measure of profitability
87
Asset Turnover
(Net Sales)/(Avg Total Assets)
| - Measure of investment efficiency
88
Financial Leverage (Equity Multiplier)
(Avg Total Assets)/(Avg Stockholders' Equity)
- Dependent on financial strategy; companies with low sales need high margins/leverage, and vice versa
- Measure of financing strategy
89
Inditex Case Study
- Inditex (Zara) has fast fashion and this helps them command high margins
- GAP has lower margins but higher asset turnover (sales vs quantity sold)
- Due to poor operating performance, Nordstrom improved its financial leverage through share buybacks to decrease equity
- Can also improve FL by increasing debt to ensure that assets are levered up/much larger than the equity financing of the company
90
How Market Values Stocks
- Future expectations of EPS are important
| - Growth potential is a major influence
91
Present Value
- Cash now is preferred to cash in the future (t - # of years)
Future cash has risk
- Represented by (r - expected return rate)
- Higher risk should provide higher return
PV Formula: (FV)/(1 + r)^t
FV Formula: PV x (1 + r)^t
92
Revenue Growth Formula
(Year 2 Revenue)/(Year 1 Revenue) - 1 --> express as percentage
93
Money Function
- Medium of exchange
- Store of value
- Measure of worth
94
Money Definition
Portable, divisible, durable, stable object that serves as a medium of exchange, store of value, and a measure of worth
95
Barter Problem
Bartering without money requires a coincidence of wants; where people need to agree to the same deal and have the same mutual wants and the same time
96
Money Precursors
Familial Relationships --> Tribal Relationships --> Debt/Duty-based Relationships --> Tally Stick/Beads or Written Records --> Precious Metal Money
97
Money Supply
How much money is in circulation at any given time
98
M-1
Measure of money supply that includes only most liquid currency
Currency:
- Government-issued paper money and metal coins
Travelers'/Cashier's Check:
- Demand deposit order instructing a bank to pay a given sum to payee where money has already been deducted from payor's account
```
Checking Account (Demand Deposit):
- Bank account funds, owned by depositor, that may be withdrawn at any time by check or cash
```
99
M-2
Measure of money supply that includes all of M-1 plus forms of money that can be easily converted to spendable forms
100
Included in M-2 but not M-1
Time Deposit:
- Bank funds that have fixed maturity time and cannot be withdrawn/transferred by check
Money Market Mutual Fund
- Short-term, low risk financial security fund purchased with pooled assets of investor-owners
101
Reasons to Watch Money Supply
- Excessive growth in supply can lead to inflation
- Slack (less than capacity production) damps down inflation as prices cannot rise in periods of oversupply
- Though unemployment has fallen since 2009, so has labor force participation which is only recently increasing
102
Commercial Banks
- Accept deposits to make loans, profit, pay interest, and pay dividends
- Wide variety of services
103
Savings Institutions
Savings and Loan Associations (S&L):
- Investor owned, and focus on mortgages
Mutual Savings Banks:
- Depositor owned
Credit Unions:
- Non-profit, co-op
- Focus on service to group
104
Financial Services provided by Banks
Checking accounts, deposit accounts, certificates of deposit, credit cards, loans, mortgages, etc
105
Prime Rate
Interest rate available to a bank's most creditworthy customers
- Is on the rise
106
Bank's Role in Creating Money
- Within Fed parameters, banks increase money supply by lending out money that savers deposit
- Can lend out leftover after reserve requirement
- Creates new money because original depositor's balance is in M-1, and borrower's cash in hand is also M-1
107
Reserve Requirement
Percentage of any deposit the bank must retain
108
Fractional Reserve Banking
Use of a reserve requirement in order to increase money supply
109
Full Reserve Banking
Deposits can only be loaned out if they're over the time period of the loan
- Keeping funds intact means higher customer fees
- Would only be able to make a 5 year loan with a 5 year fixed savings
- No risk of bank runs but more risky
- Chokes off money supply due to less ease of lending
110
Bank Run
Depositors lose faith in a bank or financial institution's ability to repay money
- Depositors run to bank to cash out accounts
- Bank only has reserve requirement (10%) available
- Bank fails
111
Federal Deposit Insurance Corporation (FDIC)
- Supervises banks and insures deposits in banks and thrift institutions
- Commercial banks pay membership fees
- Guarantees safety of all deposits of every account owner up to $250k per bank
- Stock and mutual funds not insured
- Has right to examine activities and accounts of member banks
112
Nondeposit Institutions
Pension Fund:
- Nondeposit fund pool managed to provide retirement income for members
Insurance Company:
- Nondeposit institution that invests funds collected as premiums charged for insurance coverage
Finance Companies
Broker-dealers
113
Federal Reserve System (The Fed)
Central US bank
- Acts as government bank
- Serves member commercial banks
- Controls nation's money supply
114
Structure of the Fed
- Board of Governors
- Reserve Banks
- Open Market Committee
- Member Banks
- Depository Institutions
115
Fiscal Policy
How much the government spends vs how much it raises in taxes
- Expansionary fiscal policy is government spending more than tax revenue
- Deflationary fiscal policy is the government taxing more than it spends
- Decided by Congress and managed by Treasury; executed by Bureau of Fiscal Service
116
Monetary Policy
How much money the central government/bank allows there to be in circulation
- Expansionary monetary policy is an increase in money supply
- Deflationary monetary policy is a decrease in money supply
Controlled my managing money supply and interest rates
- Influences ability and willingness of banks to loan money
- Managed by Federal Reserve
117
Goals of Fed
Dual Mandate (Congress 1977)
- Achieve price stability (low/no inflation)
- Maximize employment
118
Functions of Fed
- Government's bank
- Bankers' bank
- Check clearing
Controlling Money Supply
- Tools: Reserve requirement
- Discount/Federal Funds Rate
- Open-Market Operations
119
Tools of the Fed
Reserve Requirement
- Percentage of deposits that bank must hold in cash/deposit
Discount Rate
- Interest rate at which member banks can borrow from the Fed
Federal Funds Rate
- Interest rate at which banks lend reserves to each other
Open-Market Operations
- Fed's sale/purchase of securities in open market
- Fed buys = more money supply, Fed sells = less money supply, historically limited to treasury securities
120
Financial Crisis 2008
Fed expanded open market operations to increase the money supply
- Quantitative Easing (QE): Fed created money to buy treasury bonds and mortgage-backed securities (MBS)
- QE involved Fed decreasing assets
- Fed facilitate many bank reorganizations
121
Open Market Operations Changing Money Supply
Process of Fed Buying Bonds:
1. Investor sells bonds to Fed
2. Fed keeps bonds as assets
3. Investor gets cash which can be lent
4. Lending encourages economic activity
5. Only works as Fed can "create" dollars
- Process of decreasing money in circulation is opposite of above
122
Fed's Administrative Role and "Check 21"
- Historically, check clearing was important Fed function
- Check Clearing for 21st Century Act allows receiving bank to make an electronic image of check and send to paying bank for payment
- Paper check volumes decreased and only one processing center
123
Automated Clearing House (ACH) Network
ACH is an electronic funds transfer system that provides interbank clearing of electronic payments for nation's financial institutions
- Allows businesses, government, and consumers to choose an electronic alternative for payments
- ACH payments include internet-initiated debit/credit payments, payroll taxes, tax refunds, taxes, e-checks, and consumer bills
124
International Trade
Links countries so that those who have a comparative advantage in make a good can make more
125
Trade Barriers (Tariffs)
Limit trade by imposing an extra import tax
- Tariffs only increase price so producer with a huge advantage can still compete
- Tariffs are considered less undesirable than restrictions that stop imports
126
Exchange Rate
- Value of one currency compared to value of another
- A high Euro per $ (strong dollar) rate means US tourists are encouraged but discourages European tourists
- High rate means US can get cheaper imports but discourages US exports
127
Non Tariff Barriers to Trade (NTBs)
Import Embargos/Quotas:
- Prohibit or limit imports
Excessive licensing, documentation, or inspection
Procurement policies
NTBs impost additional admin costs and uncertainties compared to tariffs
128
Major Organizations in International Finance
Federal Reserve (Jerome Powell), European Central Bank (Mario Draghi), World Bank (vacant/David Malpass), IMF (Christine Lagarde)
129
World Bank
UN agency that provides limited scope of financial services, such as funding improvements in underdeveloped countries
130
International Monetary Fund (IMF)
UN agency of 150 nations that combined resources to promote stable exchange rates, temporary short-term loans, and other purposes
131
Returns if invested at $1 in 1900
Equities --> Bonds --> Bills
132
Risk-Return Relationship (Low --> High)
Treasury Bills --> Treasury Bonds --> Corporate Bonds --> Common Stock
133
Bond
Lending to a government or a company
- Pays a fixed amount per year
- Good deal if interest rates go lower
- Bad deal if rates are rising
Rising bond price means interest rates are likely to fall
Falling bond price means rates are likely going up
134
Bonds and Present Value
Bonds are fixed income securities
- Buyer of bond buys right to fixed future cash flows
- Bond prices move inversely to interest rates
135
Treasury Bond Market
Very liquid market that's attractive to large investors such as China
Treasury is most dominant borrower
- Supply/demand for treasury bonds set terms for borrowing by others
- Affects mortgage borrowing, as well as auto/student loans
136
Stock
Investment in shareholders' equity
| - Make money through dividends or selling stock for more than purchase price
137
Stock/Market Indices
- Way of averaging prices of a group of company stocks
- Individual stock movements are highly correlated
- Index useful to summarize total market movement
138
Main US Indices
- Dow 30 (Industrial)
- S&P 500 (Broad Large Cap)
- NASDAQ (Tech)
- Russell 2000 (Small Cap)
139
Personal Finance
Planning financial resources/liabilities to achieve life goals
140
Human Capital Management
- Career is fundamental source of value for investments
- No efficient market for services
- Maximize human capital through networking, skill development, being in growth industries, learning from roles, and negotiating better pay
141
Portfolio
Combined holdings of all investments of any entity/person
142
Diversification
- Buying several different kinds of investments instead of only one
- Purchase different securities within a category
- Falls in one stock can be offset by rises in another
- All risk can't be eliminated due to economy-wide ups and downs
143
Maximum Return Strategy
- Stock returns are 5% greater than treasury over last 100 years, but have more volatility
Asset allocation is relative amount of funds in several investment alternatives
- Optimal asset allocation emphasizes stocks early and bonds near retirement
- Rule of Thumb: Take age and invest that percent in bonds, rest in stocks
144
Tips for Finding a Fund
Seek low fees:
- 80% of mutual funds underperform
- Find low fees in large well-run employer schemes, or in high-volume managers like Vanguard
Rebalance periodically:
- Sell what you have too much of, buy what you have too little of
- When stocks rise, sell a few to keep an appropriate % of stocks vs bonds
- Can put this into safer investment like bonds/cash
145
Long term investing for Retirement risks
- Transfers risk from employers to employees
- Difficult time to invest
- Can't trust brokers to work in your interest (Fiduciary rule withdrawn)
- Many people on sidelines s avg 401k is $98400 and equal $4000/year retirement income
146
2 Brain Systems
System 1 (Fastthinking)
- Always on
- Quick reaction to immediate stimuli
- Loves patterns
System 2 (Reasoning self)
- On call but slow reaction
- Huge energy/attention use
- Invents reasons for System 1 conclusion
147
New Realities of Retirement Planning
- Decreased number of defined benefit pension schemes (dependent on years worked)
- Increased proportion of defined contribution schemes (dependent on amount saved)
- 50% of elderly married couple and 71% of elderly singles use Social Security for 50+% of income
- Independent Contractor model has little or no provision for pensions/benefits
148
Pension Terminology
Contribution/Cost - Sum of money paid in by employee and/or company during the working life of the employee
Pension - Income paid to the retired employee after they have retired
149
Defined Benefit Scheme
Defined benefit; specified benefit
- Provides a know post retirement pension income; percentage of final salary/year of employment w organization
Characteristic of Local, State, Federal governments, defense industry, Coke, 3M, UPS, etc
- Some plans closed to new employees
150
Defined Contribution Plan
Defined contribution; uncertain benefit
- Contribution put in now is unknown
- Doesn't guarantee any benefit or monthly pension
- Employee contribution and employer match invested to build up a fund to meet retirement needs
Typical pension nowadays is DC
- 401l, 403b are DC pension schemes
151
IRAs
- Designed to give same tax efficiency to people who do not have employer scheme
- Limited contribution of $5500 is too low to significantly accumulate capital
- Must be funded from earned income
- Can rollover from employer scheme to IRA, but fees may happen
152
Key Retirement Scheme Takeaways
- DB scheme is attractive and should factor into job decision if available
- Cashing out when changing employers has negative investment consequences, negative tax consequences, and 35% do it anyway
153
Psychological Reactions that Interfere with Investing
Investors prone to myopic loss aversion:
- Deeply averse to losses, can cause panic selling
- Take comparatively little pleasure from gains
- Not concerned with non-immediate threats
- Tend to go with crowd
154
Avoiding/Awareness of Biases
- Can't totally avoid
- Avoid being caught up in excitement of rising market or panic of falling one
- Invest regularly and buy/hold through good and bad times
UGBA 10
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