Finance Terms Explaination

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generated by the asset to obtain the present value. Many analysts tend to also review current liquidated value to calculate the intrinsic value. The market value of an organization is based on expectation today of the company’s future financial and operational performance. Stock market values are the sum total of the stock price multiplied by the amount of the stock outstanding.

A firm’s intrinsic value is different from its actual market value. An organization’s market value is generally driven by public or external opinions, beliefs and expectations, whereas intrinsic value is driven by private or internal opinions, beliefs and expectations. A company’s financial goal is to maximize shareholder’s wealth whether the company is private or public. This wealth refers to the intrinsic value because the market value may or may not, at any given time, fully reflect a company’s value. With private companies, fewer people hold the shares so the intrinsic value may be much higher than the market value.

(1-4) Edmund Enterprises recently made a large investment to upgrade its technology.

Although these improvements won’t have much of an impact on performance in the short run, they are expected to reduce future costs significantly. What impact will this investment have on Edmund Enterprises’s earnings per share this year? What impact might this investment have on the company’s intrinsic value and stock price?

• This year’s earnings per share should be impacted as the new investment will not earn any incremental revenue. Conversely, it may reduce earnings per share due to revenue costs such as depreciation and amortization.

• The company’s intrinsic value should not decline as the investments are made out of the funds but long-term it will increase.

• The company’s stock value should increase as there is advancement of technology that should positively attract the investors.

(1-5) Describe the ways in which capital can be transferred from suppliers of capital to those who are demanding capital.

The capital can flow from those who supply capital (lender) to those who demand it (borrower). This transfer of capital can take place in three different ways:

1. Direct transfer: The borrower sells the stocks or bonds directly to the lender, without going through any type of financial institution.

2. Investment bank: An underwriter which facilitates the issuance of securities. The borrower sells its stocks or bonds to the investment bank, which in turn sells these same securities to the lender.

3. Other financial intermediary: The intermediary obtains funds from the lender in exchange for its own securities. The intermediary uses this money to buy and hold businesses’ securities from the borrower in the market. Intermediaries create pool of capital.

(1-6) What are financial intermediaries, and what economic functions do they perform?

Financial intermediaries may include the following:

• Banks

• Broker-dealers

• Investment advisers

• Financial planners.

The functions performed by financial intermediaries are:-

• Converting risky investments into relatively risk-free ones

• Converting short-term liabilities to long term assets

• Matching small deposits with large loans and large deposits with small loans.

(1-7) Is an initial public offering an example of a primary or a secondary market transaction?

A primary market is the market in which corporations raise capital by issuing new securities. An initial public offering is a stock issue in which privately held firms go public. Hence, an initial public offering (IPO) would be an example of a primary market transaction.

(1-8) Contrast and compare trading in face-to-face auctions, dealer markets, and automated trading platforms.

In a dealer market, market participants buy and sell through dealers who are designated as market makers. A dealer market is not an actual physical space, but instead, electronic networks where market makers keep inventories from which they buy and sell stocks to customers or other dealers. They provide liquidity as well as transparency by displaying the prices at which they will buy a security (the bid) and the price at which they will sell (the offer). The bid-ask spread is the main tool market makers use to control risk.

A dealer market contrasts an auction market, where a single specialist at one physical location, like the New York Stock Exchange, matches buyers and sellers of a single security to facilitate trading. Bids and offers at auction markets must be made out in the open market giving all participants a chance to compete for the order with the best price. New bids or offers would be made if better than previous pricing for efficient price discovery. Exchanges also value positions marked to these public market prices on a daily basis.

Finally, automated trading systems, also referred to as mechanical trading systems, algorithmic trading, automated trading or system trading, allow traders to establish specific rules for both trade entries and exits that, once programmed, can be automatically executed via a computer. The trade entry and exit rules can be based on simple conditions such as a moving average crossover, or can be complicated strategies that require a comprehensive understanding of the programming language specific to the user’s trading platform, or the expertise of a qualified programmer. Automated trading systems typically require the use of software that is linked to a direct access broker, and any specific rules must be written in that platform’s proprietary language.

(1-10) What are some similarities and differences between the NYSE and the NASDAQ Stock Market?

The NASDAQ and NYSE, both located in New York City, are the two largest stock exchanges in the world. The New York Stock Exchange (NYSE) has a larger market cap than the NASDAQ, which is known for its large selection of technology stocks (e.g., Google and Facebook). While trading on the NASDAQ is fully automated, the NYSE still uses human specialists to monitor and occasionally carry out its electronic trading. It is cheaper for companies to enter and stay listed on the NASDAQ

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