Physical asset markets (also called tangible or real asset markets) are those for such products as

wheat, autos, real estate, computers, and machinery. Financial asset markets, on the other hand,
deal with stocks, bonds, notes, mortgages, derivatives, and other financial instruments.
Spot markets and futures markets are markets where assets are being bought or sold for on-thespot delivery (literally, within a few days) or for delivery at some future date, such as 6 months or a
year into the future.
Money markets are the markets for short-term, highly liquid debt securities, while capital markets
are the markets for corporate stocks and debt maturing more than a year in the future. The New York
Stock Exchange is an example of a capital market. When describing debt markets, short term
generally means less than 1 year, intermediate term means 1 to 5 years, and long term means
more than 5 years.
Mortgage markets deal with loans on residential, agricultural, commercial, and industrial real estate,
while consumer credit markets involve loans for autos, appliances, education, vacations, and so on.

a. Why is corporate finance important to all managers?

Answer: Corporate finance provides the skills managers need to: (1) identify and select the
corporate strategies and individual projects that add value to their firm; and (2) forecast the
funding requirements of their company, and devise strategies for acquiring those funds.
How do corporations go public and continue to grow? What are agency problems? What
is corporate governance?
Answer: A company goes public when it sells stock to the public in an initial public as the firm
grows, it might issue additional stock or debt. An agency problem occurs when the managers of
the firm act in their own self interests and not in the interests of the shareholders. Corporate
governance is the set of rules that control a companys behavior towards its directors,
managers, employees, shareholders, creditors, customers, competitors, and community.
What should be the primary objective of managers?
Answer: The corporations primary goal is stockholder wealth maximization, which translates to
maximizing the price of the firms common stock.
Is stock price maximization good or bad for society?
Answer: The same actions that maximize stock prices also benefit society. Stock price
maximization requires efficient, low-cost operations that produce high-quality goods and
services at the lowest possible cost. Stock price maximization requires the development of
products and services that consumers want and need, so the profit motive leads to new
technology, to new products, and to new jobs. Also, stock price maximization necessitates
efficient and courteous service, adequate stocks of merchandise, and well-located business
establishments--factors that are all necessary to make sales, which are necessary for profits.
What are financial securities?
Answer: Financial assets are pieces of paper with contractual obligations. Some short-term (i.e.,
they mature in less than a year) are instruments with low default risk are u.s. treasury bills,
bankers acceptances, commercial paper, negotiable CDs, and eurodollar deposits.
What is free cash flow? Why is it important? What are the five uses of FCF?
Answer: FCF is the amount of cash available from operations for distribution to all investors
(including stockholders and debtholders) after making the necessary investments to support
operations. A companys value depends upon the amount of FCF it can generate.
1. Pay interest on debt.

2. Pay back principal on debt.

3. Pay dividends.
4. Buy back stock.
5. Buy nonoperating assets (e.g., marketable securities, investments in other companies, etc.)
Why are ratios useful? What three groups use ratio analysis and for what reasons?
Answer: Ratios facilitate comparison of (1) one company over time and (2) one company versus
other companies. Ratios are used by managers to help improve the firms performance, by
lenders to help evaluate the firms likelihood of repaying debts, and by stockholders to help
forecast future earnings and cash flows.
What are some potential problems and limitations of financial ratio analysis?
Answer: Some potential problems are listed below:
1. Comparison with industry averages is difficult if the firm operates many different divisions.
2. Different operating and accounting practices distort comparisons.
3. Sometimes hard to tell if a ratio is good or bad.
4. Difficult to tell whether company is, on balance, in a strong or weak position.
5. Average performance is not necessarily good.
6. Seasonal factors can distort ratios.
7. Window dressing techniques can make statements and ratios look better.
What are some qualitative factors analysts should consider when evaluating a companys
likely future financial performance?
Answer: Top analysts recognize that certain qualitative factors must be considered when
evaluating a company. These factors, as summarized by the American Association Of Individual
Investors (AAII), are as follows:
1. Are the companys revenues tied to one key customer?
2. To what extent are the companys revenues tied to one key product?
3. To what extent does the company rely on a single supplier?
4. What percentage of the companys business is generated overseas?
5. Competition
6. Future prospects
7. Legal and regulatory environment
A liquidity ratio is a ratio that shows the relationship of a firms cash and other current assets to
its current liabilities.
Asset management ratios are a set of ratios that measure how effectively a firm is managing its
assets.
Financial leverage ratios measure the use of debt financing.
Profitability ratios are a group of ratios, which show the combined effects of liquidity, asset
management, and debt on operations.
Market value ratios relate the firms stock price to its earnings and book value per share.
Trend analysis is an analysis of a firms financial ratios over time. It is used to estimate the
likelihood of improvement or deterioration in its financial situation.
Comparative ratio analysis is when a firm compares its ratios to other leading companies in the
same industry. This technique is also known as benchmarking.
Du Pont equation is a formula, which shows that the rate of return on assets can be found as the
product of the profit margin times the total assets turnover.
Management is interested in all types of ratios for two reasons. First, the ratios point out
weaknesses that should be strengthened; second, management recognizes that the other parties

are interested in all the ratios and that financial appearances must be kept up if the firm is to be
regarded highly by creditors and equity investors.

The par value is the nominal or face value of a stock or bond. The par value of a bond generally
represents the amount of money that the firm borrows and promises to repay at some future date.
The maturity date is the date when the bond's par value is repaid to the bondholder.
A call provision may be written into a bond contract, giving the issuer the right to redeem the
bonds under specific conditions prior to the normal maturity date.
A bond's coupon, or coupon payment, is the dollar amount of interest paid to each bondholder
on the interest payment dates.
Convertible bonds are securities that are convertible into shares of common stock, at a fixed
price, at the option of the bondholder.
Bond prices and interest rates are inversely related; that is, they tend to move in the opposite
direction from one another.

Stand-alone risk is only a part of total risk and pertains to the risk an investor takes by holding
only one asset.
Risk is the chance that some unfavorable event will occur.
Expected rate of return (^r) is the expected value of a probability distribution of expected
returns
Risk averse investor dislikes risk and requires a higher rate of return as an inducement to buy
riskier securities.
A risk premium is the difference between the rate of return on a risk-free asset and the expected
return on Stock i which has higher risk.
The market risk premium is the difference between the expected return on the market and the
risk-free rate.
CAPM is a model based upon the proposition that any stocks required rate of return is equal to
the risk free rate of return plus a risk premium reflecting only the risk remaining after
diversification.
Market risk is that part of a securitys total risk that cannot be eliminated by diversification. It is
measured by the beta coefficient.
Diversifiable risk is also known as company specific risk, that part of a securitys total risk
associated with random events not affecting the market as a whole.
The relevant risk of a stock is its contribution to the riskiness of a well-diversified portfolio.
The beta coefficient is a measure of a stocks market risk, or the extent to which the returns on a
given stock move with the stock market.
The security market line (SML) represents in a graphical form, the relationship between the risk
of an asset as measured by its beta and the required rates of return for individual securities.
If risk aversion increases, the slope of the SML will increase,
Investment return measures the financial results of an investment. They may be expressed in
either dollar terms or percentage terms.
The standard deviation is a measure of a securitys (or a portfolios) stand-alone risk. The larger
the standard deviation, the higher the probability that actual realized returns will fall far below the
expected return, and that losses rather than profits will be incurred.
Using either or CV as our stand-alone risk measure, the stand-alone risk of the portfolio is
significantly less than the stand-alone risk of the individual stocks.