Intro to Business Unit 16 ReviewFinancial Management and Securities Basics

Key Concepts and Terminology

• Financial management involves planning, organizing, directing and controlling financial activities such as procurement and utilization of funds
• Securities are tradable financial instruments used to raise capital in public and private markets (stocks, bonds, options)
• Financial instruments are assets that can be traded, or they can also be seen as packages of capital that may be traded
• Market participants include investors, brokers, dealers, and regulators who facilitate the buying and selling of securities
• Valuation is the process of determining the fair value of an asset or company using various financial models and metrics
• Risk management is the process of identifying, assessing, and controlling threats to an organization's capital and earnings
• Portfolio management involves selecting and managing a group of investments to achieve specific financial goals while minimizing risk
• Regulatory environment consists of laws, regulations, and governing bodies that oversee the financial markets to protect investors and maintain stability

Financial Management Fundamentals

• Financial management is the process of planning, organizing, controlling and monitoring financial resources to achieve organizational goals and objectives
  • Involves applying general management principles to financial resources of the enterprise
• Key objectives of financial management include maintaining liquidity, profitability, and solvency of the business
• Capital budgeting is the process of making long-term investment decisions, such as investing in new equipment or expanding operations
  • Involves estimating future cash flows and determining the present value of those cash flows using a discount rate
• Working capital management focuses on a company's short-term assets and liabilities to ensure it has sufficient cash flow to meet short-term obligations
• Financial managers use financial statements (balance sheet, income statement, cash flow statement) to assess a company's financial performance and make informed decisions
• Effective financial management requires an understanding of financial ratios, which provide insights into a company's liquidity, profitability, and efficiency
• Time value of money is a key concept that recognizes the value of money changes over time due to factors such as inflation and interest rates

Types of Securities and Financial Instruments

• Stocks represent ownership in a company and entitle shareholders to a portion of the company's profits and assets
  • Common stock provides voting rights and variable dividends, while preferred stock typically offers fixed dividends and no voting rights
• Bonds are debt securities that represent a loan made by an investor to a borrower (typically corporate or governmental)
  • Bondholders are creditors of the issuer and are entitled to interest payments and repayment of principal
• Derivatives are financial contracts whose value is derived from an underlying asset, index, or entity (futures, options, swaps)
  • Used for hedging risk or speculating on the future price movements of the underlying asset
• Mutual funds pool money from many investors to purchase a diversified portfolio of stocks, bonds, or other securities
  • Offer professional management, diversification, and liquidity, but also involve fees and potential tax implications
• Exchange-traded funds (ETFs) are similar to mutual funds but trade on exchanges like stocks, providing greater liquidity and transparency
• Commodities are physical goods such as gold, oil, and agricultural products that can be traded on financial markets using futures contracts
• Currencies can be traded in the foreign exchange (forex) market, which is the largest and most liquid financial market globally

Market Structures and Participants

• Primary markets are where new securities are issued and sold to investors, such as through an initial public offering (IPO)
• Secondary markets are where previously issued securities are traded among investors (stock exchanges, over-the-counter markets)
  • Provide liquidity for investors and help establish fair market prices for securities
• Investors include individuals, institutional investors (pension funds, mutual funds), and corporations who buy and sell securities to earn returns or manage risk
• Brokers act as intermediaries between buyers and sellers, facilitating trades and providing advice and research to clients
  • May be full-service or discount brokers, with varying levels of service and fees
• Dealers are market makers who buy and sell securities for their own account, providing liquidity to the market
• Regulators, such as the Securities and Exchange Commission (SEC), oversee the financial markets to protect investors and maintain fair and orderly markets
  • Enforce securities laws, monitor market activities, and take enforcement actions against fraudulent or manipulative practices
• Clearing houses and depositories play a critical role in the post-trade process, ensuring the proper transfer of securities and funds between buyers and sellers

Valuation Methods and Techniques

• Intrinsic value is the actual value of a company or asset based on its fundamental characteristics and future cash flows
• Discounted cash flow (DCF) analysis estimates the intrinsic value by discounting future cash flows to their present value using a required rate of return
  • Relies on assumptions about future growth rates, margins, and discount rates
• Relative valuation compares a company's valuation multiples (P/E ratio, EV/EBITDA) to those of similar companies or industry benchmarks
  • Assumes that similar companies should trade at similar multiples, after adjusting for differences in growth and risk
• Asset-based valuation methods value a company based on the fair market value of its underlying assets minus its liabilities
  • Useful for valuing companies with significant tangible assets (real estate, natural resources)
• Dividend discount model (DDM) values a stock based on the present value of its expected future dividend payments
  • Assumes that a stock is worth the sum of all its future dividend payments discounted back to the present
• Option pricing models (Black-Scholes, binomial) are used to value options contracts based on factors such as the underlying asset price, strike price, volatility, and time to expiration
• Technical analysis uses historical price and volume data to identify patterns and trends that may predict future price movements
  • Relies on the assumption that market psychology and investor behavior can be inferred from price and volume charts

Risk Assessment and Management

• Market risk is the risk of losses due to changes in market prices (stock prices, interest rates, exchange rates)
  • Can be managed through diversification, hedging, and setting stop-loss orders
• Credit risk is the risk that a borrower will default on a loan or bond obligation
  • Managed by assessing creditworthiness of borrowers, diversifying credit exposure, and using credit derivatives
• Liquidity risk is the risk that an investor will not be able to buy or sell an asset quickly enough to prevent a loss
  • Mitigated by investing in highly liquid assets and maintaining sufficient cash reserves
• Operational risk is the risk of losses due to inadequate or failed internal processes, people, and systems
  • Managed through strong internal controls, risk management systems, and business continuity planning
• Systemic risk is the risk of a breakdown of the entire financial system, often due to a series of interconnected defaults
  • Difficult to manage at the individual investor level, but can be mitigated through proper regulation and oversight
• Value at Risk (VaR) is a statistical measure of the maximum potential loss an investment or portfolio may incur over a given time horizon at a specified confidence level
• Stress testing involves simulating how a portfolio would perform under various adverse market scenarios to identify potential vulnerabilities and inform risk management strategies

Investment Strategies and Portfolio Management

• Active management involves selecting investments and making buy/sell decisions with the goal of outperforming a benchmark index
  • Relies on fundamental or technical analysis to identify mispriced securities
• Passive management aims to match the performance of a benchmark index by investing in a diversified portfolio that mirrors the index composition
  • Typically involves lower fees and turnover compared to active management
• Asset allocation is the process of dividing an investment portfolio among different asset categories (stocks, bonds, cash) based on an investor's goals, risk tolerance, and time horizon
  • Helps manage risk through diversification across asset classes
• Rebalancing involves periodically buying or selling assets to maintain the desired asset allocation weights
  • Helps control risk and can be done on a time-based (quarterly, annually) or threshold-based (when allocation deviates by a certain percentage) approach
• Dollar-cost averaging is an investment strategy where equal amounts of money are invested at regular intervals regardless of market conditions
  • Helps mitigate the impact of market volatility by buying more shares when prices are low and fewer shares when prices are high
• Socially responsible investing (SRI) and environmental, social, and governance (ESG) investing incorporate ethical and sustainability factors into investment decisions alongside financial considerations
• Tax-efficient investing strategies aim to minimize the impact of taxes on investment returns by utilizing tax-advantaged accounts, harvesting tax losses, and holding investments for the long term

Regulatory Environment and Ethical Considerations

• Securities Act of 1933 requires that investors receive financial and other significant information concerning securities being offered for public sale and prohibits deceit, misrepresentations, and other fraud in the sale of securities
• Securities Exchange Act of 1934 created the Securities and Exchange Commission (SEC) and empowers it with broad authority over the securities industry, including the power to register, regulate, and oversee brokerage firms, transfer agents, and clearing agencies
• Investment Advisers Act of 1940 regulates investment advisers and requires them to register with the SEC and conform to regulations designed to protect investors
• Sarbanes-Oxley Act of 2002 introduced major changes to the regulation of corporate governance and financial practice, including increased penalties for fraudulent financial activity
• Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 made significant changes to financial regulation in response to the Great Recession, including increased oversight of systemically important financial institutions
• Insider trading is the illegal practice of trading securities based on material, non-public information
  • Prohibited under the Securities Exchange Act of 1934 and enforced by the SEC
• Fiduciary duty requires investment professionals to act in the best interests of their clients and place their clients' interests above their own
• Conflict of interest arises when an individual or organization has multiple interests, one of which could corrupt the motivation for an act in the other
  • Must be disclosed and managed to ensure fair treatment of clients
• Ethical considerations in finance include honesty, integrity, fairness, and transparency in all dealings with clients, counterparties, and regulators
  • Guided by professional codes of conduct and personal moral principles