This OpenStax ancillary resource is © Rice University under a CC BY 4.0 International license; it may be reproduced or modified but
must be attributed to OpenStax, Rice University and any changes must be noted.
CHAPTER SIXTEEN
Understanding Financial Management and Securities
Markets
CHAPTER SUMMARY
This chapter focuses on the financial management of a firm and the securities markets
in which firms raise funds. The chapter begins with an overview of the role of finance
and of the financial manager in the firm’s overall business strategy.
Financial management is the art and science of managing a firm’s money so that it can
meet its goals. The financial manager must decide how much money is needed and
when, how best to use the available funds, and how to get the required financing. The
financial manager’s responsibilities include financial planning, investing (spending
money), and financing (raising money).
A firm invests in short-term expenses to support current production, marketing, and
sales activities. The financial manager manages the firm’s investment in current assets
so that the company has enough cash to pay its bills and support accounts receivable
and inventory. Long-term expenditures are made for fixed assets such as land, buildings,
machinery, and equipment.
Firms raise money by borrowing money, selling ownership shares, and retaining
earnings. The financial manager must assess all these sources and choose the one most
likely to help maximize the firm’s value. Finance managers must match the term of the
financing to the period over which benefits are expected to be received from the
associated outlay. Short-term items should be financed with short-term funds, and long-
term items should be financed with long-term funds.
Equity refers to the owners’ investment in the business. In corporations, the preferred
and common stockholders are the owners. A firm obtains equity financing by selling
new ownership shares, by retaining earnings, or for small and growing, typically high-
tech, companies, through venture capital.
September 17, 2018 1
,This OpenStax ancillary resource is © Rice University under a CC BY 4.0 International license; it may be reproduced or modified but
must be attributed to OpenStax, Rice University and any changes must be noted.
LEARNING OUTCOMES
1. How do finance and the financial manager affect the firm’s overall strategy?
Finance involves managing the firm’s money. The financial manager must decide
how much money is needed and when, how best to use the available funds, and
how to get the required financing. The financial manager’s responsibilities
include financial planning, investing (spending money), and financing (raising
money). Maximizing the value of the firm is the main goal of the financial
manager, whose decisions often have long-term effects.
2. What types of short-term and long-term expenditures does a firm make?
A firm incurs short-term expenses — supplies, inventory, and wages — to
support current production, marketing, and sales activities. The financial
manager manages the firm’s investment in current assets so that the company
has enough cash to pay its bills and support accounts receivable and inventory.
Long-term expenditures (capital expenditures) are made for fixed assets such as
land, buildings, equipment and information systems. Because of the large
outlays required for capital expenditures, financial managers carefully analyze
proposed projects to determine which offer the best returns.
3. What are the main sources and costs of unsecured and secured short-term
financing?
Short-term financing comes due within one year. The main sources of unsecured
short-term financing are trade credit, bank loans, and commercial paper.
Secured loans require a pledge of certain assets, such as accounts receivable or
inventory, as security for the loan. Factoring, or selling accounts receivable
outright at a discount, is another form of short-term financing.
4. What are the key differences between debt and equity and the major types
and features of long-term debit?
Financial managers must choose the best mix of debt and equity for their firm.
The main advantage of debt financing is the tax-deductibility of interest. But
debt involves financial risk because it requires the payment of interest and
principal on specified dates. Equity — common and preferred stock — is
considered a permanent form of financing on which the firm may or may not pay
dividends. Dividends are not tax-deductible. The main types of long-term debt
are term loans, bonds, and mortgage loans. Term loans can be unsecured or
secured and generally have maturities of 5 to 12 years. Bonds usually have initial
maturities of 10 to 30 years. Mortgage loans are secured by real estate. Long-
September 17, 2018 2
, This OpenStax ancillary resource is © Rice University under a CC BY 4.0 International license; it may be reproduced or modified but
must be attributed to OpenStax, Rice University and any changes must be noted.
term debt usually costs more than short-term financing because of the greater
uncertainty that the borrower will be able to make the scheduled loan
payments.
5. When and how do firms issue equity, and what are the costs?
The chief sources of equity financing are common stock, retained earnings, and
preferred stock. The cost of selling stock includes issuing costs and potential
dividend payments. Retained earnings are profits reinvested in the firm. For the
issuing firm, preferred stock is more expensive than debt because its dividends
are not tax deductible and its claims are secondary to those of debtholders but
less expensive than common stock. Venture capital is often a source of equity
financing for young companies.
6. How do securities markets help firms raise funding, and what securities trade
in the capital markets?
Securities markets allow stocks, bonds, and other securities to be bought and
sold quickly and at a fair price. New issues are sold in the primary market. After
that, securities are traded in the secondary market. Investment bankers
specialize in issuing and selling new security issues. Stockbrokers are licensed
professionals who buy and sell securities on behalf of their clients. In addition to
corporate securities, investors can trade U.S. government Treasury securities and
municipal bonds, mutual funds, futures, and options. Mutual funds are managed
by financial-service companies that pool the funds of many investors to buy a
diversified portfolio of securities. Investors choose mutual funds because they
offer a convenient way to diversify and are professionally managed. Exchange-
traded funds (ETFs) are like mutual funds but trade on stock exchanges similar to
common stock. Futures contracts are legally binding obligations to buy or sell
specified quantities of commodities or financial instruments at an agreed-on
price at a future date. They are very risky investments because the price of the
commodity or financial instrument may change drastically. Options are contracts
that entitle the holder the right to buy or sell specified quantities of common
stock or other financial instruments at a set price during a specified time. They,
too, are high-risk investments.
7. Where can investors buy and sell securities, and how are securities markets
regulated?
Securities are resold in secondary markets, which include both broker markets
and dealer markets. The broker market consists of national and regional
securities exchanges, such as the New York Stock Exchange, that bring buyers
and sellers together through brokers on a centralized trading floor. Dealer
markets use sophisticated telecommunications networks that link dealers
September 17, 2018 3
must be attributed to OpenStax, Rice University and any changes must be noted.
CHAPTER SIXTEEN
Understanding Financial Management and Securities
Markets
CHAPTER SUMMARY
This chapter focuses on the financial management of a firm and the securities markets
in which firms raise funds. The chapter begins with an overview of the role of finance
and of the financial manager in the firm’s overall business strategy.
Financial management is the art and science of managing a firm’s money so that it can
meet its goals. The financial manager must decide how much money is needed and
when, how best to use the available funds, and how to get the required financing. The
financial manager’s responsibilities include financial planning, investing (spending
money), and financing (raising money).
A firm invests in short-term expenses to support current production, marketing, and
sales activities. The financial manager manages the firm’s investment in current assets
so that the company has enough cash to pay its bills and support accounts receivable
and inventory. Long-term expenditures are made for fixed assets such as land, buildings,
machinery, and equipment.
Firms raise money by borrowing money, selling ownership shares, and retaining
earnings. The financial manager must assess all these sources and choose the one most
likely to help maximize the firm’s value. Finance managers must match the term of the
financing to the period over which benefits are expected to be received from the
associated outlay. Short-term items should be financed with short-term funds, and long-
term items should be financed with long-term funds.
Equity refers to the owners’ investment in the business. In corporations, the preferred
and common stockholders are the owners. A firm obtains equity financing by selling
new ownership shares, by retaining earnings, or for small and growing, typically high-
tech, companies, through venture capital.
September 17, 2018 1
,This OpenStax ancillary resource is © Rice University under a CC BY 4.0 International license; it may be reproduced or modified but
must be attributed to OpenStax, Rice University and any changes must be noted.
LEARNING OUTCOMES
1. How do finance and the financial manager affect the firm’s overall strategy?
Finance involves managing the firm’s money. The financial manager must decide
how much money is needed and when, how best to use the available funds, and
how to get the required financing. The financial manager’s responsibilities
include financial planning, investing (spending money), and financing (raising
money). Maximizing the value of the firm is the main goal of the financial
manager, whose decisions often have long-term effects.
2. What types of short-term and long-term expenditures does a firm make?
A firm incurs short-term expenses — supplies, inventory, and wages — to
support current production, marketing, and sales activities. The financial
manager manages the firm’s investment in current assets so that the company
has enough cash to pay its bills and support accounts receivable and inventory.
Long-term expenditures (capital expenditures) are made for fixed assets such as
land, buildings, equipment and information systems. Because of the large
outlays required for capital expenditures, financial managers carefully analyze
proposed projects to determine which offer the best returns.
3. What are the main sources and costs of unsecured and secured short-term
financing?
Short-term financing comes due within one year. The main sources of unsecured
short-term financing are trade credit, bank loans, and commercial paper.
Secured loans require a pledge of certain assets, such as accounts receivable or
inventory, as security for the loan. Factoring, or selling accounts receivable
outright at a discount, is another form of short-term financing.
4. What are the key differences between debt and equity and the major types
and features of long-term debit?
Financial managers must choose the best mix of debt and equity for their firm.
The main advantage of debt financing is the tax-deductibility of interest. But
debt involves financial risk because it requires the payment of interest and
principal on specified dates. Equity — common and preferred stock — is
considered a permanent form of financing on which the firm may or may not pay
dividends. Dividends are not tax-deductible. The main types of long-term debt
are term loans, bonds, and mortgage loans. Term loans can be unsecured or
secured and generally have maturities of 5 to 12 years. Bonds usually have initial
maturities of 10 to 30 years. Mortgage loans are secured by real estate. Long-
September 17, 2018 2
, This OpenStax ancillary resource is © Rice University under a CC BY 4.0 International license; it may be reproduced or modified but
must be attributed to OpenStax, Rice University and any changes must be noted.
term debt usually costs more than short-term financing because of the greater
uncertainty that the borrower will be able to make the scheduled loan
payments.
5. When and how do firms issue equity, and what are the costs?
The chief sources of equity financing are common stock, retained earnings, and
preferred stock. The cost of selling stock includes issuing costs and potential
dividend payments. Retained earnings are profits reinvested in the firm. For the
issuing firm, preferred stock is more expensive than debt because its dividends
are not tax deductible and its claims are secondary to those of debtholders but
less expensive than common stock. Venture capital is often a source of equity
financing for young companies.
6. How do securities markets help firms raise funding, and what securities trade
in the capital markets?
Securities markets allow stocks, bonds, and other securities to be bought and
sold quickly and at a fair price. New issues are sold in the primary market. After
that, securities are traded in the secondary market. Investment bankers
specialize in issuing and selling new security issues. Stockbrokers are licensed
professionals who buy and sell securities on behalf of their clients. In addition to
corporate securities, investors can trade U.S. government Treasury securities and
municipal bonds, mutual funds, futures, and options. Mutual funds are managed
by financial-service companies that pool the funds of many investors to buy a
diversified portfolio of securities. Investors choose mutual funds because they
offer a convenient way to diversify and are professionally managed. Exchange-
traded funds (ETFs) are like mutual funds but trade on stock exchanges similar to
common stock. Futures contracts are legally binding obligations to buy or sell
specified quantities of commodities or financial instruments at an agreed-on
price at a future date. They are very risky investments because the price of the
commodity or financial instrument may change drastically. Options are contracts
that entitle the holder the right to buy or sell specified quantities of common
stock or other financial instruments at a set price during a specified time. They,
too, are high-risk investments.
7. Where can investors buy and sell securities, and how are securities markets
regulated?
Securities are resold in secondary markets, which include both broker markets
and dealer markets. The broker market consists of national and regional
securities exchanges, such as the New York Stock Exchange, that bring buyers
and sellers together through brokers on a centralized trading floor. Dealer
markets use sophisticated telecommunications networks that link dealers
September 17, 2018 3
