Reviewer in Financial Management 1

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TERMS:

1. Required Return – return necessary to induce an individual to make an investment 2. Risk – possibility loss; the uncertain that the anticipated return will not be achieved 3. Diversifiable Risk – risk associated with individual events that affect a particular asset: • Firm – specific risk that’s reduced through the construction of diversified portfolios 4. Business Risk – risk associated with the nature of a business 5. Financial Risk – risk associated with the types of financing used to acquire assets 6. Non-diversifiable risk (systematic risk) – risk associated with fluctuations in securities prices and other non-firm-specific factors; market risk that is not reduced through the construction of diversified portfolios 7. Market risk – risk associated with fluctuations in securities prices 8. Interest rate risk – risk associated with changes in interest rates 9. Reinvestment rate risk – the risk associated with reinvesting earnings on principal at a lower rate than was initially earned 10. Purchasing power risk – uncertainty that future information will erode the purchasing power of assets and income 11. Exchange rate risk – risk of loss from charges in the value of foreign currencies 12. Standard deviation – measure of dispersion around an average value; a measure of risk 13. Beta Coefficient – index of systematic risk; measure of volatility of a stock’s return relative to the market return 14. Portfolio risk – total risk associated with owning a portfolio; sum of systematic and unsystematic risk 15. Capital Asset Pricing Model (CAPM) – model used in the valuation of an asset that specifies the required return for different level of risk 16. Common stock – security representing ownership in a corporation: owners have a final claim on the firm’s assets and earnings after the firm has met its obligation to creditors and preferred stockholders 17. Board of Directors (BOD) – body elected by & responsible to stockholders to set policy & high management to run a corporation 18. Cumulative Voting – voting system that encourages minority representation by permitting stockholders to cast all their shares for one candidate for the firms BOD 19. Preemptive rights – right of current stockholders to maintain their proportionate ownership in the firm.

1. What are Financial Markets?
Financial Markets refer to a conceptual “mechanism” rather than a physical location or a specific type of organization or structure. It is a system of individuals & institutions, instruments & procedures that bring together borrowers and savers

2. Importance of Financial Markets

The primary role of financial markets is to facilitate the flow of funds from individuals and business that have surplus funds to individuals, business and government that have needs for funds in excess of their income 3. Flow of funds

a. Direct Transfer – occurs when a business sells its stocks/bonds directly to savers (investors) without going through any type of intermediary/financial institution b. Investment banking house – serves as a middleman that facilitates the issuance of securities by firms that need to raise funds c. Financial Intermediaries – the intermediary obtains funds from savers and then uses the money to lend out or to purchase another company’s securities

4. Market Efficiency

a. Economic Efficiency – funds are allocated to their optimal use at the lowest costs in the financial markets b. Informational efficiency – the prices of investment reflect existing information and adjust quickly when new information enters the market 3 Categories

• Weak – efficiency states that all information contained in past price movement is fully reflected in current market prices • Semistrong-Form – efficiency states that current market prices reflect all publicly available...
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