Corporate Finance

financial statements

Corporate Finance
1. The securities, sometimes called financial instruments or claims, may be roughly classified as equity or debt, loosely called stocks or bonds. Roughly speaking, there are two basic types of financial markets: the money markets and the capital markets.
A short-term debt is called a current liability. Short-term debt represents loans and other obligations that must be repaid within one year.
Long-term debt is debt that does not have to be repaid within one year. Shareholders’ equity represents the difference between the value of the assets and the debt of the firm. In this sense it is a residual claim on the firm’s assets. Net working capital is defined as current assets minus current liabilities. The persons or institutions that buy debt from the firm are called creditors. The holders of equity shares are called shareholders.
We can write the value of the firm, V, as
V  = B  + S
where B is the value of the debt and S is the value of the equity. In the words of finance theory, debt and equity securities are contingent claims
on the total firm value.
The treasurer is responsible for handling cash flows, managing capital-expenditures decisions, and making financial plans. The controller handles the accounting function, which includes taxes, cost and financial accounting, and information systems.
The corporate form of business, that is, organizing the firm as a corporation, is the standard method for solving problems encountered in raising large amounts of cash. However, businesses can take other forms.
sole proprietorship:
The sole proprietorship is the cheapest business to form. No formal charter is required,
and few government regulations must be satisfied for most industries.
2. A sole proprietorship pays no corporate income taxes. All profits of the business are
taxed as individual income.
3. The sole proprietorship has unlimited liability for business debts and obligations. No
distinction is made between personal and business assets.
4. The life of the sole proprietorship is limited by the life of the sole proprietor.
5. Because the only money invested in the firm is the proprietor’s, the equity money that
can be raised by the sole proprietor is limited to the proprietor’s personal wealth.
The Partnership
Any two or more persons can get together and form a partnership. Partnerships fall into
two categories: (1) general partnerships and (2) limited partnerships.
In a general partnership all partners agree to provide some fraction of the work and
cash and to share the profits and losses. Each partner is liable for the debts of the partnership.
A partnership agreement specifies the nature of the arrangement. The partnership
agreement may be an oral agreement or a formal document setting forth the understanding.
Limited partnerships permit the liability of some of the partners to be limited to the
amount of cash each has contributed to the partnership. Limited partnerships usually require
that (1) at least one partner be a general partner and (2) the limited partners do not
participate in managing the business. Here are some things that are important when considering
a partnership:
1. Partnerships are usually inexpensive and easy to form. Written documents are required
in complicated arrangements, including general and limited partnerships. Business licenses
and filing fees may be necessary.
2. General partners have unlimited liability for all debts. The liability of limited partners is
usually limited to the contribution each has made to the partnership. If one general partner
is unable to meet his or her commitment, the shortfall must be made up by the other
general partners.
3. The general partnership is terminated when a general partner dies or withdraws (but this
is not so for a limited partner). It is difficult for a partnership to transfer ownership without
dissolving. Usually, all general partners must agree. However, limited partners may
sell their interest in a business.
4. It is difficult for a partnership to raise large amounts of cash. Equity contributions are
usually limited to a partner’s ability and desire to contribute to the partnership. Many
companies, such as Apple Computer, start life as a proprietorship or partnership, but at
some point they choose to convert to corporate form.
5. Income from a partnership is taxed as personal income to the partners.
6. Management control resides with the general partners. Usually a majority vote is required
on important matters, such as the amount of profit to be retained in the business.
It is very difficult for large business organizations to exist as sole proprietorships or
partnerships. The main advantage is the cost of getting started. Afterward, the disadvantages,
which may become severe, are (1) unlimited liability, (2) limited life of the enterprise,
and (3) difficulty of transferring ownership. These three disadvantages lead to (4) the
difficulty of raising cash.

It is very difficult for large business organizations to exist as sole proprietorships or
partnerships. The main advantage is the cost of getting started. Afterward, the disadvantages,
which may become severe, are (1) unlimited liability, (2) limited life of the enterprise,
and (3) difficulty of transferring ownership. These three disadvantages lead to (4) the
difficulty of raising cash.
There is, however, one great disadvantage to incorporation. The federal government
taxes corporate income. This tax is in addition to the personal income tax that shareholders
pay on dividend income they receive. This is double taxation for shareholders when compared
to taxation on proprietorships and partnerships.

The financial markets are composed of the money markets and the capital markets.
Money markets are the markets for debt securities that will pay off in the short term (usually
less than one year). Capital markets are the markets for long-term debt (with a maturity
at over one year) and for equity shares.

The primary market is used when governments and corporations initially sell securities.
Corporations engage in two types of primary-market sales of debt and equity: public offerings
and private placements.
Most publicly offered corporate debt and equity come to the market underwritten by a syndicate
of investment banking firms. The underwriting syndicate buys the new securities from the
firm for the syndicate’s own account and resells them at a higher price. Publicly issued debt and
equity must be registered with the Securities and Exchange Commission. Registration requires
the corporation to disclose all of the material information in a registration statement.
The legal, accounting, and other costs of preparing the registration statement are not negligible.
In part to avoid these costs, privately placed debt and equity are sold on the basis of
private negotiations to large financial institutions, such as insurance companies and mutual
funds. Private placements are not registered with the Securities and Exchange Commission.

After debt and equity securities are originally sold, they are traded in the secondary markets.
There are two kinds of secondary markets: the auction markets and the dealer markets.
The equity securities of most large U.S. firms trade in organized auction markets, such
as the New York Stock Exchange, the American Stock Exchange, and regional exchanges,
such as the Midwest Stock Exchange. The New York Stock Exchange (NYSE) is the most
important auction exchange. It usually accounts for more than 85 percent of all shares
traded in U.S. auction exchanges. Bond trading on auction exchanges is inconsequential.
Most debt securities are traded in dealer markets. The many bond dealers communicate
with one another by telecommunications equipment—wires, computers, and telephones.
Investors get in touch with dealers when they want to buy or sell, and can negotiate
a deal. Some stocks are traded in the dealer markets. When they are, it is referred to as
the over-the-counter (OTC) market.
Auction markets are different from dealer markets in two ways: First, trading in a given auction
exchange takes place at a single site on the floor of the exchange. Second, transaction
prices of shares traded on auction exchanges are communicated almost immediately to the
public by computer and other devices.
Unlike auction markets, the benefit of this type of market is the rapid access that investors have to buyers and sellers of a particular security. The best example of a dealer market is the Nasdaq.
http://www.wisegeek.com/what-is-a-dealer-market.htm

Dealers are essentially market makers making money off the bid-ask spread, and don't take positions for hedging and/or speculation.

Proprietary traders usually take hedging/speculative positions using the banks money.

Chapter2 Accounting statements and cash flow
2.1 The balance sheet.
The accounting definition that underlies the balance sheet and describes the balance is
Assets ≡  Liabilities +  Stockholders’ equity
Accounting liquidity refers to the ease and quickness with which assets can be converted to cash. Current assets are the most liquid and include cash and those assets that will be turned into cash within a year from the date of the balance sheet.
2.2 The income statement
The income statement measures performance over a specific period of time, say, a year. The accounting definition of income is
Revenue -   Expenses ≡   Income
Net working capital is current assets minus current liabilities.
Operating cash flow, defined as earnings before interest and depreciation minus taxes,measures the cash generated from operations not counting capital spending or working capital requirements. It should usually be positive; a firm is in trouble if operating cash flow is negative for a long time because the firm is not generating enough cash to pay operating costs. Total cash flow of the firm includes adjustments for capital spending and additions to net working capital. It will frequently be negative. When a firm is growing at a rapid rate,the spending on inventory and fixed assets can be higher than cash flow from sales.

The net present value of an investment is a simple criterion for deciding whether or not to undertake an investment.
The pure discount bond is perhaps the simplest kind of bond. It promises a single payment,say $1, at a fixed future date. The payment at maturity ($1 in this example) is termed the bond’s face value. Pure discount bonds are often called zero-coupon bonds or zeros to emphasize the fact
that the holder receives no cash payments until maturity. We will use the terms zero, bullet,and discount interchangeably to refer to bonds that pay no coupons.

An important example of a consol, though, is called preferred stock. Preferred stock is stock that is issued by corporations and that provides the holder a fixed dividend in perpetuity. If there were never any question that the firm would actually pay the dividend on the preferred stock, such stock would in fact be a consol.

bond prices fall with a rise in interest rates and rise with a fall in interest rates. Furthermore, the general principle is that a level-coupon bond sells in the following ways.
1. At the face value of $1,000 if the coupon rate is equal to the marketwide interest rate.
2. At a discount if the coupon rate is below the marketwide interest rate.
3. At a premium if the coupon rate is above the marketwide interest rate.
Bond traders also state that the bond has
a yield to maturity of 8 percent. The yield to maturity is frequently called the bond’s yield
for short. So we would say the bond with its 10-percent coupon is priced to yield 8 percent
at $1,035.67.
At the bottom of the list you will find AT&T and an entry AT&T 81⁄8 /22. This entry represents AT&T bonds that mature in the year 2022 and have a coupon rate of 81⁄8. The coupon rate means 81⁄8 percent of the par value (or face value) of $1,000.
Therefore, the annual coupon for AT&T bonds is $81.25.
Under the heading “Close,” you will find the last price for the AT&T bonds at the close of this particular day. The price is quoted as a percentage of the par value. So the last price for the AT&T bonds on this particular day was 100 percent of $1,000 or $1,000.00. This bond is trading at a price less than its par value, and so it is trading at a “discount.” The last column is “Net Chg.” AT&T bonds traded up from the day before by 3⁄8 of 1 percent. The AT&T bonds have a current yield of 8.1 percent. The current yield is simply the current coupon divided by the current price,or 81.25 divided by 1,000, equal to 8.1 percent(rounded to one decimal place).