Week 4
Dr. Jenne Meyer
7
Goals
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Explain short-term financing alternatives.
Compare debt and equity financing.
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line of credit
promissory note
commercial paper
leasing
BUYING ON ACCOUNT
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Accounts payable
Line of credit
Promissory note
Commercial Paper
Leasing
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Debt financing
 accounts payable
 loans
 notes
 bonds
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Equity financing - companies may seek additional
investors for a company
 no increased bankruptcy risk
 potential participation by additional owners
 increased future potential for borrowing
Bond - a certificate representing a promise to pay a
definite amount of money at a stated interest rate
on a specified maturity date
 Creditor - when you own a bond, you are lending
money to the organization issuing the bond
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 Treasury Bills - maturities vary between 91 days to one
year
 Treasury Notes - maturities vary from one to ten years
 Treasury Bonds - maturities ranging from 10 to 30 years
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U.S. Savings Bonds
 Series EE savings bonds pay interest through
discounting.
▪ The difference between the purchase price and the
payoff value is the interest earned.
 The I bond has a variable interest rate that
fluctuates with inflation.
 municipal bonds
▪ issued by local and state governments
 general obligation bond
▪ backed by the full faith, credit, and taxing power of the
government issuing the bond
 revenue bond
▪ repaid with the income from the project that the bond
was issued to finance
 Interest earned on municipal bonds is exempt
from federal and most state income taxes
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When you invest in stock, you are an owner of
the company.
When you buy a bond, you are lending money
to the company.
corporate bonds
 issued by corporations
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bond rating - a measure of the quality and
safety of a company’s debt
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Investment banker
 an individual or company that assists companies
with issuing new securities
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Advice to Company
 helps companies determine if issuing bonds is
appropriate
 helps determine how much debt might be sold
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interest is paid periodically
face value is repaid to the investor on the
maturity date
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common stock
 an equity security representing ownership in a corporation
 has voting rights
dividend
 a portion of company profits
preferred stock
 the second main class of stock issued by corporations
 has priority over common stock in dividend payment
 less risky than common stock
par value
 the minimum price for which a share can be issued
 has no relationship to the market value of a stock
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initial public offering (IPO)
 when a company offers stock to outside investors
for the first time
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public offering
 issuing additional shares of stock by a company
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What factors affect the issue value of a stock?
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stockbroker
stock exchange
market value
stock split
selling short
mutual fund
capital gain
yield to maturity (YTM)
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Investment Analysis Process
 Observe and analyze economic and social trends.
 Determine affected industries.
 Identify companies in affected industries.
 Decide whether to buy, sell, or hold the stock of those
companies.
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Economic factors
 Inflation
 Interest Rates
 Consumer Spending
 Employment
 Societal changes and other factors can have a
positive or negative influence on various types of
companies.
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Market Trends
 bull market
▪ rising stock values
 bear market
▪ declining stock market prices
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Dividend Yield
 (Dividend per Share) ÷ (Market Price per Share)
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Price-Earnings Ratio (P/E)
 the relationship between a stock’s selling price
and its earnings per share
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What factors are commonly considered when
evaluating a company’s stock?
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An investment fund set up and managed by
companies that receive money from many
investors
Some main types of mutual funds include
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aggressive growth stock funds
income funds
international funds
sector funds
bond funds
balanced funds
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capital gain
 the increase in value between the purchase price and the
maturity value
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capital loss
 the decrease in value between the purchase price and the
maturity value
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yield to maturity (YTM)
 the annual rate of return an investor would receive when a
bond is held until maturity
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2.
Why is a multimedia presentation a good way
to explain different investment options?
Why should this presentation compare and
contrast investments according to strengths
and weaknesses?
8
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Federal Reserve System
reserve requirement
discount rate
open market operations
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Federal Currency
 In 1792, the Mint Act authorized gold and silver
coins in a variety of denominations.
 In 1861, paper money was first issued by the U.S.
government.
 Prior to 1861, banknotes were issued by individual
banks.
 Bank of the United States (1791, 1816)
▪ each lasted 20 years
▪ state banks viewed these banks as a threat
 Comptroller of the Currency
▪ chartered national banks
▪ stabilized the value of U.S. banknotes
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Federal Reserve Act
 In 1913, Congress created the Federal Reserve
System.
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Federal Reserve System (Fed)
 supervises and regulates member banks to help
them serve the public efficiently
 national banks are required to join
 state banks may join
 reserve requirement
▪ the percentage of funds that a bank is required to hold
 clearing checks
▪ paying checks among different banks in different cities
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Federal Deposit Insurance Corporation
 provides a federal government guarantee of
deposits
 maintains stability and public confidence in the
nation’s banks
 insures up to $100,000 per depositor, per bank
 regulates national banks
▪ examines the loans and investments of national banks
▪ reviews the bank’s internal controls
▪ evaluates abilities of bank’s management
▪ decides whether to approve applications for changes in
the bank’s structure
▪ reviews rules and regulations regarding banking
practices
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Depository Financial Intermediaries
 commercial banks
 savings and loans
 mutual savings banks
 credit unions
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Non-depository institutions
 life insurance companies
 investment companies
 consumer finance companies
 mortgage companies
 credit card companies
How is the competitive landscape of banking
changing?
Technology?
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automatic teller machine (ATM)
debit card
safe-deposit box
trust
lock box
commercial lending
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Ancient Civilizations
 The Roman Empire developed banking
innovations (saving deposits receipts & loans)
 The Bank of Barcelona was one of the first
enterprises to offer an array of banking services.
 The Bank of France, which had a strong financial
influence in Europe, was started in 1800.
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The International Banking Act passed in 1978.
 requires foreign banks operating in the U.S. to
operate under federal banking regulations
 Deposit insurance is required to do business in the
U.S.
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Africa
 Cell phones in South Africa help
workers compensate for the lack
of convenient availability of
banks.
Asia
 The currency crisis of the late
1990s caused major banks to
downsize their scope.
 In some parts of Asia, informal
banking still takes place.
Middle East
 The Saudi Arabian Monetary
Agency was established in 1952.
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Europe
 Conflicting banking regulation in
various countries reduce the
opportunity for standardization.
 The euro has not been adopted
uniformly.
Latin America
 Brazil has three major banks.
 Brazilians usually pay bills at banks.
 Internet payments are gaining
popularity in Brazil.
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World Bank
 created in 1944 to provide loans for rebuilding
after WWII
 now provides economic assistance to lessdeveloped countries
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International Monetary Fund (IMF)
 helps promote economic cooperation by
maintaining an orderly system of international
trade and exchange rates
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Three main duties of the IMF are:
 Analyze Economic Situations
 Suggest Economic Policies
 Provide Loans
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The OECD has a commitment to
democratic government and the market
economy.
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Why have banks become more dependent on
advertising campaigns?
Why are banks using humorous commercials
as part of their advertising campaigns?
What has competition in the banking industry
done to promotions offered by banks?
Give two examples of promotions that banks
can offer potential customers.
9
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creditor
debtor
consumer credit
trade credit
credit agreement
self-managed credit plan
contracted credit plan
Careful consideration must be given to the use of
credit to ensure that the cost of the credit is not
greater than the benefits of its use to the business.
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U.S. consumers used credit cards to finance
short-term purchases of over $2 trillion in one
year.
Home mortgages account for $8.5 trillion of
consumer debt.
Extending and receiving credit is an
important activity for businesses.
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Who Should Receive Credit
 Credit should be extended when it improves the
financial position of the company.
 Credit decisions need to be based on established
standards and criteria.
▪ Anyone who meets the standards should be offered
credit.
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Does a business have to offer credit to every
customer? Why or why not?
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credit standards
credit worthy
character
conditions
factoring
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Credit has some immediate and some longterm costs to a business.
 interest
▪ from borrowing to finance the sale
▪ from lost earned interest (had the customer paid cash)
 loss of profit and product resulting from unpaid debt
Offering credit to customers also has the
potential of increasing profits for a company.
 When to Offer Credit
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 Offer credit to specific categories of customers.
 Offer credit for specific types of products.
 Offer credit during particular sales periods.
Character
 the personal qualities of the applicant that demonstrate
responsibility and dependability
 Capacity
 the ability to make the required payments
 Collateral
 the value of assets of the credit applicant that can back the
request for credit
 Conditions
 factors that are generally outside of the control of the
borrower or lender but that can affect risk
 Rating systems are sometimes developed to rate customers
based on their credit characteristics.
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 Credit terms need to be established.
▪ the length of time until credit is due
▪ the interest rate and when it is applied
▪ any early payment discounts
▪ late payment penalties
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U.S. companies that provide consumer credit
history information are:
 Equifax
 Experian
 TransUnion
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Business credit information is provided by
Dun & Bradstreet.
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The Cost of Trade Credit
 net 30
▪ the business can obtain the goods but withhold
payment until the end of the 30 days
▪ there is often an incentive for early payment
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delinquent account
charge-off
collection procedures
aging schedule
Carefully screen credit applications
Maintain complete and up-to-date account info
Ensure speedy and accurate invoicing
Monitor accounts receivable
Take immediate action following established
procedures
6. Use customer friendly but effective collection
strategies
7. Escalate collections before it is too late
8. Establish final collection and charge-off standards
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THE TRUTH IN LENDING ACT
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promotes the informed use of credit
encourages customers to compare the costs
of credit versus cash
requires businesses to disclose specific credit
terms in all credit advertising
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prohibits discrimination
All credit decisions must be based on an
analysis of financial capability related to the
credit for which the person applied.
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developed to increase the accuracy and the
privacy of information collected by credit
reporting companies
entitles consumers to free annual copies of
their credit reports
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provides a method for consumers to deal
with mistakes in credit card bills
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applies to collection agencies who deal with
family or individual debt
 prohibits debt collectors from engaging in unfair,
deceptive, or abusive practices
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recognizes that customers of financial
institutions can expect a reasonable amount
of privacy for their financial records
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requires financial institutions to give
customers privacy notices that explain
information collection and sharing practices
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Why is credit an important topic in today’s
society?
How can actual credit examples be used for
this speech?
What is one drawback of credit?
What is one advantage of credit?
10
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risk
economic risk
pure risk
speculative risk
natural risk
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There are three primary sources of risk
faced by companies.
 property risks
▪ potential damage or loss to property owned, leased
and used by a business
 personnel risks
▪ include factors that affect the health, life, or earnings
of individuals associated with the business
 liability risks
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There are four ways to deal with business
risk.
 Avoid the Risk
 Transfer the Risk
 Insure the Risk
 Assume the Risk
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insurance
policy
insured
insurer
peril
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insurable interest
premium
reinsurance
deductible
coinsurance
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Risk management procedures:
 identify each business asset
 determine the importance of each asset
 asses the financial impact of the loss of the asset
on the business operations
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insurance
 a contract providing financial protection against a
specified loss
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three principles of insurance are:
 some risk can be transferred to others
 risks are pooled among a large group
 individual risk is reduced by controlling the
uncertainty of the loss
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In order for the risk to be insurable
 A large number of individuals or businesses must be facing
the same type of risk and be willing to purchase insurance.
 The losses from the perils must be accidental and
uncertain.
 The actual loss must be identifiable and quantifiable.
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Actuaries
 trained mathematicians who gather and analyze data
 determine risk factors in order to establish premium rates
 apply the law of large numbers
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There is state and federal oversight of
insurance companies.
 licensing
 capital reserves
 rate regulation
declarations
 contains identifying
information about the
insured and the
insured property
 insuring agreement
 the basis of the
insurance contract
 conditions
 identify the conditions
that must be met in
order for the policy to
stay in effect
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Exclusions
 provide specific limitations
on the coverage provided
deductible
 an identified amount of a
loss that must be paid by
the insured before the
insurer pays
coinsurance
 the insurer and the insured
share the risk by paying a
defined amount of the costs
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Commercial Package Policy (CPP)
 a comprehensive business property insurance
package
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CPP Coverage
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buildings owned by the business
fixtures and equipment
coverage on rented buildings
personal property of the business
 business income insurance
▪ compensates the business for lost income
▪ if the business cannot operate due to a covered peril
 extra expenses
▪ incurred by the business to restore operations
 consequential damage coverage
▪ covers damages that occur after an incident
▪ that are caused by the incident
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title insurance
 protects a real estate purchaser from defects in
the title
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title
 the owner’s legal interest in the property
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lien
 a claim against the property as security for a debt
owed by the owner
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transportation insurance
 protects against damage, theft or complete loss
of goods while they are being shipped
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marine insurance
 covers shipment on oceans and inland waterways
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credit insurance
 pays off loan balances in the event of the death or
disability of a debtor
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trade credit insurance
 pays for losses suffered when payment is not
made by a business that purchased on credit
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burglary insurance
 the unlawful taking of property from inside the
business
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robbery insurance
 illegally taking property from another person
through force or violence
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theft insurance
 describes all types of stealing
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Bonds
 the company performing the work provides a bond
guaranteeing reimbursement of losses suffered by the
customer from failure to perform as agreed
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Fidelity bond
 provides protection from losses resulting from dishonest
employees
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Surety bond
 protects against losses resulting from the failure to
complete any part of a contract according to the specified
conditions
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Social Security
 provides a minimum income benefit for retirees at
retirement age
 provides financial support for disabled workers
and surviving spouses and children
 Medicare
 Medicaid
 in 2006, employers and employees contributed
6.20% of earnings for social security
 the Medicare/Medicaid contribution was 1.45%
 a contribution of 15.3% is required of selfemployed workers
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The percentage of businesses offering health
care insurance has been steadily decreasing.
health insurance
 provides payment for
▪ preventive care
▪ treatment of illness and injury
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Term insurance
 covers the insured for a specific time period
 does not accumulate any value beyond the death benefit
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whole life insurance
 provides permanent coverage for the life of the
policyholder as long as premiums are paid
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universal life insurance
 a portion or the premium pays for
▪ term insurance
▪ high-yield securities investments
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Proactively managing liability risks involves
 identifying all potential areas of liability
 taking direct action to reduce and remove any
liability
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Commercial General Liability (CGL)
 very broad coverage for activities that typically
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cause liability
the use of a company’s products and services
any business contracts
harm caused by personnel or products
advertising or other communications
 umbrella policy
▪ a separate policy providing a higher limit of coverage
over and above any other basic liability policies an
insured may have
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Any remaining questions?
Next week’s assignments