Finance

Financial Markets Bond market Stock (Equities) Market Forex market Derivatives market Commodity market Spot (cash) Market OTC market Real Estate market Gears on a piece of farm equipment, gear ratio 1:1. ... Finance studies and addresses the ways in which individuals, businesses, and organizations raise, allocate, and use monetary resources over time, taking into account the risks entailed in their projects. ... This is a file from the Wikimedia Commons, a repository of free content hosted by the Wikimedia Foundation. ... This article does not cite any references or sources. ... The bond market, also known as the debit, credit, or fixed income market, is a financial market where participants buy and sell debt securities usually in the form of bonds. ... A stock market is a market for the trading of company stock, and derivatives of same; both of these are securities listed on a stock exchange as well as those only traded privately. ... In finance, the exchange rate between two currencies specifies how much one currency is worth in terms of the other. ... The derivatives markets are the financial markets for derivatives. ... Chicago Board of Trade Futures market Commodity markets are markets where raw or primary products are exchanged. ... Template:The Spot Market The Spot Market or Cash Marketis a commodities or securities market in which goods are sold for cash and delivered immediately. ... Over-the-counter (OTC) trading is to trade financial instruments such as stocks, bonds, commodities or derivatives directly between two parties. ... Real estate is a legal term that encompasses land along with anything permanently affixed to the land, such as buildings. ...

Market Participants Investors Speculators Institutional Investors There are two basic financial market participant catagories, Investor vs. ... Investment is a term with several closely related meanings in finance and economics. ... Speculation is the buying, holding, and selling of stocks, commodities, futures, currencies, collectibles, real estate, or any valuable thing to profit from fluctuations in its price as opposed to buying it for use or for income - dividends, rent etc. ... An institutional investor is an investor who is an institution like a bank, insurance fund, retirement fund, or mutual fund manager. ...

Corporate finance Structured finance Capital budgeting Financial risk management Mergers and Acquisitions Accounting Financial Statements Auditing Credit rating agency Domestic credit to private sector in 2005 Corporate finance is an area of finance dealing with the financial decisions corporations make and the tools and analysis used to make these decisions. ... Structured finance describes any non-standard way of raising money. ... The process of determining which potential long-term projects are worth undertaking, by comparing their expected discounted cash flows with their internal rates of return. ... Financial risk management is the practice of creating economic value in a firm by using financial instruments to manage exposure to risk, particularly credit and market risk. ... The phrase mergers and acquisitions (abbreviated M&A) refers to the aspect of corporate strategy, corporate finance and management dealing with the buying, selling and combining of different companies that can aid, finance, or help a growing company in a given industry grow rapidly without having to create another business... It has been suggested that Accounting scholarship be merged into this article or section. ... Historical financial statement Financial statements (or financial reports) are formal records of a business financial activities. ... Basic definition Audit is the examination of records and reports of a company, in order to check that what is provided is relevant and accurate. ... A credit rating agency (CRA) is a company that assigns credit ratings for issuers of certain types of debt obligations. ...

Personal finance Credit and Debt Employment contract Retirement Financial planning Personal finance is the application of the principles of finance to the monetary decisions of an individual or family unit. ... Credit as a financial term, used in such terms as credit card, refers to the granting of a loan and the creation of debt. ... For other uses, see Debt (disambiguation). ... An employment contract is an agreement entered into between an employer and an employee at the commencement of the period of employment and stating the exact nature of their business relationship, specifically what compensation the employee will receive in exchange for specific work performed. ... Retirement is the point where a person stops employment completely. ... A Financial Planner or Personal Financial Planner is a practicing professional who helps people to deal with various personal financial issues through proper planning, which includes but not limited to these major areas: tertiary education planning, retirement planning, investment planning, risk management and insurance planning, tax planning, estate planning and...

Public finance Tax This article does not cite any references or sources. ... “Taxes” redirects here. ...

Banks and Banking Central Bank List of banks Deposits Loan For other uses, see Bank (disambiguation). ... This is a list of banks throughout the world. ... Bank deposits are the large part of the money supply. They come in different types depending on withdrawal restrictions. ... For other uses, see Loan (disambiguation). ...

Financial regulation Finance designations Accounting scandals Financial supervision is government supervision of financial institutions by regulators. ... There are a variety of Finance designations or Accreditations that can be earned, and awarded to those in the finance industry. ... Accounting scandals, or corporate accounting scandals are political and business scandals which arise with the disclosure of misdeeds by trusted executives of large public corporations. ...

History of finance Stock market bubble Recession Stock market crash A stock market bubble is a type of economic bubble taking place in stock markets when price of stocks rise and become overvalued by any measure of stock valuation. ... In macroeconomics, a Recession is a decline in any countrys Gross Domestic Product (GDP), or negative real economic growth, for two or more successive quarters of a year. ... Black Monday (1987) on the Dow Jones Industrial Average A stock market crash is a sudden dramatic decline of stock prices across a significant cross-section of a stock market. ...

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Capital structure refers to the way a corporation finances its assets through some combination of equity, debt, or hybrid securities. A firm's capital structure is then the composition or 'structure' of its liabilities. For example, a firm that sells $20bn dollars in equity and $80bn in debt is said to be 20% equity financed and 80% debt financed. The firm's ratio of debt to total financing, 80% in this example, is referred to as the firm's leverage. For other uses, see Corporation (disambiguation). ... In business and accounting an asset is anything owned, whether in possession or by right to take possession, by a person or a group acting together, e. ... For other uses, see Stock (disambiguation). ... For other uses, see Debt (disambiguation). ... Definition A hybrid security, as the name implies, is a security that combines two or more different financial instruments. ... Leverage is related to torque; leverage is a factor by which lever multiplies a force. ...

The Modigliani-Miller theorem, proposed by Franco Modigliani and Merton Miller, forms the basis for modern thinking on capital structure, though it is generally viewed as a purely theoretical result since it assumes away many important factors in the capital structure decision. The theorem states that, in a perfect market, the value of a firm is unaffected by how that firm is financed. This result provides the base with which to examine real world reasons why capital structure is relevant, that is, a company's value is affected by the capital structure it employs. These other reasons include bankruptcy costs, agency costs and asymmetric information. This analysis can then be extended to look at whether there is in fact an 'optimal' capital structure: the one which maximizes the value of the firm. The Modigliani-Miller theorem (of Franco Modigliani, Merton Miller) forms the basis for modern thinking on capital structure. ... Franco Modigliani (June 18, 1918 – September 25, 2003) was an Italian-American economist at the MIT Sloan School of Management, and winner of the Nobel Memorial Prize in Economics in 1985. ... Merton Howard Miller (May 16, 1923 – June 3, 2000) won the Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel in 1990, along with Harry Markowitz and William Sharpe. ...

Capital Structure in a Perfect Market

Main article: Modigliani-Miller theorem

Assume a perfect capital market (no transaction or bankruptcy costs; perfect information); firms and individuals can borrow at the same interest rate; no taxes; and investment decisions aren't affected by financing decisions. Modigliani and Miller made two findings under these conditions. Their first 'proposition' was that the value of a company is independent of its capital structure. That is, you cannot change the size of a cake by cutting it into different sized pieces. Their second 'proposition' stated that the cost of equity for a leveraged firm is equal to the cost of equity for an unleveraged firm, plus an added premium for financial risk. That is, as leverage increases, while the burden of individual risks is shifted between different investor classes, total risk is conserved and hence no extra value created. The Modigliani-Miller theorem (of Franco Modigliani, Merton Miller) forms the basis for modern thinking on capital structure. ... In economics and related disciplines, a transaction cost is a cost incurred in making an economic exchange. ... Notice of closure stuck on the door of a computer store the day after its parent company, Granville Technology Group Ltd, declared bankruptcy (strictly, put into administration—see text) in the United Kingdom. ... Perfect information is a term used in economics and game theory to describe a state of complete knowledge about the actions of other players that is instantaneously updated as new information arises. ... “Taxes” redirects here. ...

Their analysis was extended to include the effect of taxes and risky debt. Under a classical tax system, the tax deductibility of interest makes debt financing valuable; that is, the cost of capital decreases as the proportion of debt in the capital structure increases. The optimal structure, then would be to have virtually no equity at all.

Capital Structure in the real world

If capital structure is irrelevant in a perfect market, then imperfections which exist in the real world must be the cause of its relevance. The theories below try to address some of these imperfections, by relaxing assumptions made in the M&M model.

Trade-off theory

Main article: Trade-off theory of capital structure

Trade-off theory allows bankruptcy costs to exist. It states that there is an advantage to financing with debt, the tax benefit of debt and there is a cost of financing with debt, the bankruptcy costs of debt. The marginal benefit of further increases in debt declines as debt increases, while the marginal cost increases, so that a firm that is optimizing its overall value will focus on this trade-off when choosing how much debt and equity to use for financing. Empirically, this theory may explain differences in D/E ratios between industries, however it doesn't explain differences within the same industry. As the Debt equity ratio (ie leverage) increases, there is a trade-off between the interest tax shield and bankruptcy, causing an optimum captial structure, D/E* The Trade-Off Theory of Capital Structure is a theory in the realm of Financial Economics about the corporate finance choices of corporations. ... Within the theory of corporate finance, Bankruptcy Costs of Debt are the increased costs of financing with debt instead of equity that result from a higher probability of bankruptcy. ... In the context of corporate finance, the Tax Benefits of Debt or Tax Advantage of Debt refers to the fact that from a tax perspective it is cheaper for firms and investors to finance with debt than with equity. ...

Pecking order theory

Main article: Pecking Order Theory

Pecking Order theory tries to capture the costs of asymmetric information. It states that companies prioritize their sources of financing (from internal financing to equity) according to the law of least effort, or of least resistance, preferring to raise equity as a financing means “of last resort”. Hence internal funds are used first, and when that is depleted debt is issued, and when it is not sensible to issue any more debt, equity is issued. This theory maintains that businesses adhere to a hierarchy of financing sources and prefer internal financing when available, and debt is preferred over equity if external financing is required. Thus, the form of debt a firm chooses can act as a signal of its need for external finance. The Pecking Order Theory was developed by Stewart C. Myers in 1984. ... In economics, information asymmetry occurs when one party to a transaction has more or better information than the other party. ...

Agency Costs

There are three types of agency costs which can help explain the relevance of capital structure. In economics, the principal-agent problem treats the difficulties that arise under conditions of incomplete and asymmetric information when a principal hires an agent. ...

• Asset substitution effect: As D/E increases, management has an increased incentive to undertake risky (even negative NPV) projects. This is because if the project is successful, share holders get all the upside, whereas if it is unsuccessful, debt holders get all the downside. If the projects are undertaken, there is a chance of firm value decreasing and a wealth transfer from debt holders to share holders.
• Underinvestment problem: If debt is risky (eg in a growth company), the gain from the project will accrue to debtholders rather than shareholders. Thus, management have an incentive to reject positive NPV projects, even though they have the potential to increase firm value.
• Free cash flow: unless free cash flow is given back to investors, management has an incentive to destroy firm value through empire building and perks etc. Increasing leverage imposes financial discipline on management.

Net present value is a form of calculating discounted cash flow. ... In corporate finance, free cash flow (FCF) is a measure of a firms financial performance. ...

Other

• The neutral mutation hypothesis—firms fall into various habits of financing, which do not impact on value.
• Market timing hypothesis—capital structure is the outcome of the historical cumulative timing of the market by managers (Baker and Wurlger).

Arbitrage

Similar questions are also the concern of a variety of speculator known as a capital-structure arbitrageur, see arbitrage. In economics and finance, arbitrage is the practice of taking advantage of a price differential between two or more markets: a combination of matching deals are struck that capitalize upon the imbalance, the profit being the difference between the market prices. ...

A capital-structure arbitrageur seeks opportunities created by differential pricing of various instruments issued by one corporation. Consider, for example, traditional bonds and convertible bonds. The latter are bonds that are, under contracted-for conditions, convertible into shares of equity. The stock-option component of a convertible bond has a calculable value in itself. The value of the whole instrument should be the value of the traditional bonds plus the extra value of the option feature. If the spread, the difference between the convertible and the non-convertible bonds grows excessively, then the capital-structure arbitrageur will bet that it will converge. A convertible bond, or convertible debenture, is a type of bond that can be converted into shares of stock in the issuing company, usually at some pre-announced ratio. ...

See also

• Financial economics
• Corporate finance

Financial economics is the branch of economics concerned with resource allocation over time. ... Domestic credit to private sector in 2005 Corporate finance is an area of finance dealing with the financial decisions corporations make and the tools and analysis used to make these decisions. ...

References

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Image File history File links Question_book-3. ...

External links

• http://www.investopedia.com/terms/c/capitalstructure.asp
• http://www.westga.edu/~bquest/2002/rethinking.htm