Chapter Sixteen

Financial Management
and Securities Markets

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 Current Assets
and Current Liabilities
••Current
Currentassets:
assets: •• Current
CurrentLiabilities:
Liabilities:
Financial
Financialresources
resourcesthat
that Short-term
Short-termdebt
debt
can
canbebeconverted
convertedtoto obligations
obligationsthat
thatmust
mustbebe
cash
cashwithin
withinaayear.
year. paid
paidwithin
withinaayear.
year.
–– Cash
Cash –– Accounts
Accountspayable
payable
–– Marketable
Marketablesecurities
securities –– Wages
Wagespayable
payable
–– Accounts
Accountsreceivable
receivable –– Taxes
Taxespayable
payable
–– Inventory
Inventory –– Notes
Notes(loans)
(loans)payable
payable

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 Managing Current
Assets and Liabilities
Working Capital Management
• Managing Current Assets:
– Short-term resources: cash, investments,
accounts receivable, inventory
• Managing Current Liabilities:
– Short-term debts: accounts payable,
accrued salaries, accrued taxes, short-
term bank loans

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 Managing Current Assets
• Managing Cash:
– Cash flow
– Transaction balances
– Lockbox

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 Managing Current Assets
• Investing Idle Cash:
– Marketable securities
– US Treasury bills (T-bills)
– Commercial certificates of deposit
(CDs)
– Commercial paper
– International investments – the
Eurodollar

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 Short-term Investment
Possibilities for Idle Cash

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 Maximizing Accounts
Receivable
• Accounts Receivable:
– Money owed to a business by credit
customers.
– Typically due within 30, 60, or 90 days.
– 1-2% discount if paid between 10 and 30
days
– 1-1.5% penalty charged if paid late

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 Maximizing Accounts
Receivable
• Optimizing Inventory
– The objective is to maximize inventory
investment without production cutbacks
because of materials shortfalls or lost
sales due to insufficient finished goods
inventories.

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 Maximizing Current Liabilities
• Accounts Payable:
– Managing cash collections
– Managing trade credit
• Taking advantage of discounts – “1/10 net 30”

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 Bank Loans
Line of Credit An arrangement by
which a bank agrees to lend a
specified amount of money to an
organization upon request.
Secured Loans Loans backed by
collateral that the bank can claim if
the borrowers do not repay the debt.

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 Bank Loans
Unsecured Loans Loans backed only by the
borrowers’ good
reputation and previous
credit rating
Prime Rate Interest rates commercial
banks charge their best
customers (usually large
corporations) for short-
term loans

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 Non-Bank Liabilities
• Short-term loans from insurance
companies, pension funds, money
market funds, or finance companies
• The Eurodollar and commercial paper
markets
• Factoring – selling accounts
receivable at a discount

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 Managing Fixed Assets
• Long-term (fixed) assets:
– Plants
– Offices
– Equipment
– Heavy machinery
– Automobiles

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 Managing Fixed Assets
• Capital Budgeting:
– Analyzing business’ needs and selecting the
assets that will maximize its value.
• Assessing Risk

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 Qualitative Assessment of
Capital Budgeting Risk
Highest Risk
Add to a Product Line
Introduce a New Product in
Foreign Markets (risk depends
on stability of country)
Buy New Equipment for
an Established Market
Expand into a New Market

Repair Old Machinery

Introduce a New Product in
a Familiar Area
Lowest Risk

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 The Impact of Organizational Performance
on Investment Decisions

Projected Return on Investment for Project X

20%
15% 14% 12% 14%
15%
10%
5%
0%
Ineffecient Company Efficient Company

Cost of Money Return on Investment

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 Pricing Long-term Money

• Factors to Consider:
– How much cash will be generated
– Cost of financing
– Supply of funds available for investment
– Accurately identifying opportunities with
the greatest potential for ROI

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 Financing with
Long-Term Liabilities
• Debts that will be repaid over a
number of years, such as long-term
loans and bond issues.
– Equity Financing
– Debt financing

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 Bonds: Corporate IOUs

• Bonds:
– Debt instruments that larger companies
sell to raise long-term funds.
– Indenture:
• The bond contract specifying all terms of
agreement between bondholder and the
issuing organization

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 A Basic Bond Quote

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 Types of Bonds
Unsecured Debentures, or bonds, that are not
backed by specific collateral
Secured Bonds that are backed by specific
collateral that must be forfeited in the event the
issuing firm defaults
Serial A sequence of small bond issues of
progressively longer maturity

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 Types of Bonds

Floating-rate Bonds with interest rates that

change with current interest
rates otherwise available in
the economy
Junk Special type of high interest
rate bond that carries higher
inherent risks

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 Financing With Owners’ Equity
• Owners’ Equity:
– The owners’ investment in an organization.
• Cash
• Common Stock
• Retained Earnings

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 A Basic Stock Quote

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 Investment Banking
• Investment Banking:
– The sale of stocks and bonds for corporations.
• New Issue
• Initial Public Offering (IPO)
– Primary Market – used to raise capital
– Secondary Market – stock exchanges and OTC
markets where investors
trade securities with each
other

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 The Securities Markets
• Securities Markets:
– The mechanism for buying and selling
securities.
• Organized Exchanges
– Central locations where investors buy and sell
securities.
• Over-the-counter Market (OTC)
– A network of dealers all over the country, and
world, linked by computers, telephones, and
Teletype machines

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 Measuring Market Performance
• The Investor’s Key Question:
– “How well are my investments performing
relative to the market as a whole?”

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 Measuring Market Performance
• Indexes
• Averages
• A Bull Market
• A Bear Market

AST FACT:
nline investing is the fastest growing area
personal finance management. The number
online investment accounts grew to
0.5 billion in 2001.

Source: Dave Pettit, “Still Clicking,” Wall Street Journal, June 11, 2001, p. R4.

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 The 30 Stocks in the Dow Jones
Industrial Average
AT&T Exxon Mobil JP Morgan Chase
Alcoa General Electric McDonald's
American Express General Motors Merck
Boeing Hewlett-Packard Microsoft
Caterpillar Home Depot Minnesota Mining &
Manufacturing
Citigroup Honeywell Philip Morris
Coca-Cola IBM Procter & Gamble
Disney Intel SBC Communications
Du Pont International Paper United Technologies
Eastman Kodak Johnson & Johnson Wal-Mart

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 Dow’s Milestones

• The Dow climbed from 860 in August

1982 to a high of 11,497 at the beginning
of 2000.
• The worst drop in history (684.81 points)
was on September 17, 2001 after the
markets were closed for 4 days following
terrorist attacks on September 11 that
destroyed the World Trade Center and parts
of the Pentagon.

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 Solve the Dilemma
1. Normally, rapidly increasing sales is a good
thing. What seems to be the problem here?
2. List the important components of a firm’s
working capital. Include both current assets
and current liabilities.
3. What are some management techniques
applied to current liabilities that Glasspray might
use to improve its working capital position?

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 Explore Your Career Options

What types of skills would be most

useful to a financial manager? What
are some of the most stressful aspects
of the job?

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 Additional Discussion Questions
and Exercises
1.Why would a business use a lockbox to receive
payments?
2.What are the advantages of a firm using electronic
funds transfer rather than traditional check-clearing
procedures?
3.What is a junk bond? Why do investors buy junk bonds?
4.What do companies do with retained earnings?
5.Why is the prime rate of interest important for business
firms?

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 Chapter 16 Quiz
1. Which one of the following is an example of a current
liability?
a. accounts receivable
b. marketable securities
c. wages payable
d. inventory
2. Which of the following is an example of a current asset?
a. cash
b. accounts payable
c. accrued salaries
d. short-term bank loans

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 Chapter 16 Quiz
3. Which of the following is where new issues of stocks and
bonds are sold directly to the public?
a. primary market
b. secondary market
c. over-the-counter market
d. investment banks
4. Dividend yield refers to
a. the dividend rate divided by the stock market average.
b. dividends per share divided by stock price.
c. the percentage of return an investor has earned on the
original investment.
d. the coupon rate on bonds that change with current interest
rates.

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 Multiple Choice Questions
about the Video
1. If a company wanted to raise external sources of equity
financing it would
a. retain earnings rather than pay dividends.
b. sell bonds.
c. sell common stock.
d. sell debentures.
2. Small business would most likely be able to raise external
funds by
a. selling common stock in the capital market.
b. selling bonds.
c. borrowing money form friends and relatives.
d. retaining earnings.

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