ADMN 201 — Ch15: Financial Decisions and Risk Management

Chapter Overview

This chapter covers how businesses fund themselves (short-term and long-term), how securities markets work, and how firms manage risk. It connects accounting, strategy, and operations.

mindmap
  root((Ch15: Financial Decisions))
    Financial Manager
      Objective: Increase Shareholder Wealth
      Cash-Flow Management
      Financial Control
      Financial Planning
    Short-Term Financing
      Trade Credit
      Secured Loans (Collateral/Factoring)
      Unsecured Loans
        Line of Credit
        Revolving Credit
        Commercial Paper
    Long-Term Financing
      Debt Financing
        Long-Term Loans
        Bonds (+ Sustainability Bonds)
      Equity Financing
        Common Stock
        Preferred Stock
        Retained Earnings
      Capital Structure
      Risk-Return Relationship
      ROI Formulas
    Securities Markets
      Primary vs Secondary
      IPO vs Private Placement
      Stock Exchanges + OTC + NASDAQ
      Market Indexes
      Buying & Selling
      Blue Sky Laws / Regulation
    Investment Vehicles
      4 Mutual Fund Types
      ETF Types
      Hedge Funds
      Commodities / Futures
    Risk Management
      5-Step Process
      Speculative vs Pure Risk
      4 Responses to Risk

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LO 15.1 — Role of the Financial Manager

Finance = the business function involving decisions about a firm’s long-term investments and obtaining the funds to pay for those investments.

Overall objective: Increase the firm’s value and shareholders’ wealth.

In sole proprietorships/partnerships: profit increases owners’ wealth directly.
In corporations: profit increases the value of common stock.

Accountants vs. Financial Managers: Accountants create data that reflects a firm’s financial status. Financial managers make decisions to improve that status.

Four Core Responsibilities

Determining a firm’s long-term investments
Obtaining funds to pay for those investments
Conducting everyday financial activities (collecting funds, paying debts, controlling cash)
Managing the risks the firm takes

Three Areas of Responsibility

1. Cash-Flow Management

Managing the pattern in which cash flows into (revenues) and out of (debt payments) the firm.

Firms must always have enough cash to buy materials and pay people.
Idle cash = lost interest income. Study found that companies with $2 M inann u a l s a l es t y p i c a ll y h o l d$ 40,000 in non-interest-bearing accounts — money that could be earning returns.
Cash-flow management requires careful planning of both inflows and outflows.

2. Financial Control

Checking actual performance against plans to ensure the desired financial status is achieved.

Budgets are the measuring stick — actual cash flows, debts, and assets are compared against budgeted amounts.
Revenue > Expected: Excess funds may go into a short-term interest-bearing account or pay off short-term debt.
Revenue < Expected: May require short-term borrowing to meet current obligations.

3. Financial Planning

A description of how a business will reach some future financial position — including projections for sources and uses of funds.

Three key questions a financial plan must answer:

What funds are needed right now?
When will the firm need more funds?
Where can the firm get those funds (short- and long-term)?

Career note: The CFO role has expanded significantly — CFOs work with people across the organization, set budgets, and deal with regulatory agencies. The CFO → CEO path is increasingly common.

LO 15.2 — Short-Term vs. Long-Term Expenditures

Type	Time Frame	Examples
Short-term (operating)	< 1 year	Payroll, inventory, utilities, accounts payable
Long-term (capital)	> 1 year	Buildings, machinery, land, equipment

Short-Term Concerns

Accounts payable — unpaid bills owed to suppliers + wages and taxes due within the year. The largest category of short-term debt for most firms.

Accounts receivable — funds due from customers who bought on credit. Temporarily tie up the firm’s cash.

Credit policy — the rules governing a firm’s extension of credit to customers.

Example terms: “2/10, net 30” = a 2% discount if paid within 10 days; full amount due within 30 days.
- On a $1, 000 in v o i ce : p a y$ 980 on days 1–10, or pay $1,000 on days 11–30.
- Sellers adjust credit terms to influence when customers pay.

Inventory — materials and goods currently held that will be sold within the year.

Type	Description
Raw-materials inventory	Basic supplies used in the production process
Work-in-process inventory	Goods partway through production
Finished-goods inventory	Items ready for sale

Too little inventory → lost sales
Too much inventory → cash tied up; may force selling at a discount to raise cash

Long-Term (Capital) Expenditures

Long-term expenditures differ from short-term in three ways:

They are not normally sold or converted to cash.
They require a large initial investment.
They represent a binding, long-term commitment of company funds.

LO 15.3 — Three Sources of Short-Term Financing

1. Trade Credit

The granting of credit by a selling firm to a buying firm — effectively a short-term interest-free loan. Accounts payable serve double duty as both an expense and a source of funds.

Form	Description
Open-book credit	Most common; informal agreement; buyer receives goods + invoice, pays later
Promissory note	Legally binding signed agreement stating when/how much will be paid, before shipment
Trade draft / trade acceptance	Document attached to shipment; buyer signs to receive goods, stating payment date. Trade drafts are common in international transactions.

2. Secured Short-Term Loans

Backed by collateral (an asset the lender can seize on default). Generally carry lower interest rates than unsecured loans because of reduced risk to the lender.

Collateral types:

Collateral	Notes
Inventory	Lender advances a portion of inventory’s stated value; more attractive if inventory can be quickly converted to cash (e.g., canned goods > unfinished lenses)
Accounts receivable (pledging AR)	Lender seizes receivables on default; especially important for service firms (accounting offices, law firms) with no physical inventory

Factoring AR — selling accounts receivable outright to a factoring company (the “factor”):

Factor pays less than face value (e.g., buys $50 Ko f A R f or$ 40K)
Factor collects the full amount from customers; profit = amount collected minus what they paid
Typical factor profit: 2–4% of receivables
$4 billion worth of goods are factored per year in Canada

3. Unsecured Short-Term Loans

No collateral required. Bank may require a compensating balance — a portion of the loan kept on deposit in a non-interest-bearing account.

Type	Description
Line of credit	Standing agreement; bank commits to lend up to a maximum on short notice
Revolving credit agreement	Guaranteed line of credit; firm pays a commitment fee (0.5–1%) on the unused portion — think of it as a business credit card
Commercial paper	Large creditworthy firms only; sell unsecured notes at a discount, repurchased at face value within 30–270 days

Commercial paper example:

Company A needs $10 M f or 90 d a ys \to i ss u es p a p er w i t h * * f a ce v a l u e$ 10.2M**
Company B buys the paper for $10M
After 90 days, Company A pays $10.2 M \to C o m p an y B e a r n s$ 200K profit

LO 15.4 — Three Sources of Long-Term Financing

Debt Financing

Long-term borrowing from outside the company. Most appealing to companies with predictable cash flows (e.g., utilities).

Long-Term Loans

Usually from chartered banks, insurance companies, pension funds, or credit companies.

Advantages	Disadvantages
Can be arranged quickly	Large borrowers may struggle to find lenders
Duration easily matched to needs	May require pledging long-term assets as collateral
Terms can be adjusted if needs change	May require agreeing not to take on more debt until repaid

Interest can be fixed or floating (e.g., “prime + 1%” — if prime = 3%, borrower pays 4%).

Bonds (Corporate Bonds)

A contract to pay the bondholder the principal on a specified maturity date + interest (coupon payments) in the interim. Governed by a bond indenture specifying interest rate, maturity date, and collateral (if any).

Bond types by security:

Type	Description
Secured bonds	Assets pledged as collateral in event of nonpayment
Debentures	Unsecured; no specific collateral; inferior claim on assets in bankruptcy. Used by financially strong corporations.
Sustainability bonds	Company provides transparent ongoing records to investors; funds allocated to social or green programs

Bond types by registration:

Type	Description
Registered bonds	Holder’s name recorded; company mails interest cheques
Bearer (coupon) bonds	Anonymous; holder clips coupons from certificate and sends them in; redeemable by anyone who holds the bond

Bond types by maturity:

Type	Description	Analogy
Callable	Issuer can call them in early (usually after 5 years) and pay a premium above face value. Called when prevailing rates drop below the bond’s stated rate.	Like a mortgage the bank can make you refinance early — but they pay you a bonus
Serial	Firm retires portions in stages (e.g., $5 M / ye a ro f a$ 100M issue)	Like monthly mortgage payments — chip away at principal over time
Convertible	Holder can convert to common stock at a specified ratio	Rent-to-own — you start as a lender but can become an owner

Example (convertible bond): Bell Canada Enterprises issued 4.5% bonds in $1,000 denominations, each convertible into 19.125 shares of common stock. If the stock rises high enough, converting is more valuable than holding the bond.

Bond ratings (default risk):

Rating Agency	High Grade	Investment Grade	Speculative	Poor / Junk
Moody’s	Aaa, Aa	A, Baa	Ba, B	Caa, C
S&P	AAA, AA	A, BBB	BB, B	CCC, D

Poor ratings → firm must offer higher interest to attract investors (risk-return relationship in action).

Bond price vs. yield:

Bond with stated rate > going market rate → sells at a premium (above face value)
Bond with stated rate < going market rate → sells at a discount (below face value)
Bond yield = annual interest / current market price

Example: Bought $1, 000 p a r b o n d in 2010 f or$ 650. Stated rate = 6% → receives $60/ ye a r . Yi e l d =$ 60 / $650 = * * 9.2$ 1,000 — extra $350 further increases effective yield.

Equity Financing

Raising money by issuing stock or retaining earnings — putting owners’ capital to work.

Common Stock

Why equity is more expensive than debt:

Bond interest is tax-deductible (reduces taxable income)
Dividends are not tax-deductible (paid from after-tax profits)
Issuing stock also creates control costs: shareholders accumulate voting rights → potential hostile takeovers

Three values of common stock:

Value	Definition
Par value	Arbitrary value set by the board; used by accountants; not meaningful to investors
Book value	Total shareholders’ equity ÷ shares outstanding
Market value	Current price on the secondary market — the “real” value

Market capitalization = outstanding shares × market value per share

Stock price influences:

Objective factors: Company profits, financial ratios
Rumors: Claims about new products, discoveries, deals
Investor relations: Publicizing positive financial news to analysts and institutions
Stockbroker recommendations: A “buy” recommendation increases demand; a “sell” decreases it

Preferred Stock (Hybrid)

Shares characteristics of both bonds and common stock:

Fixed dividend paid before common shareholders
No voting rights → firm keeps management control
Never matures (like common stock)
Dividends can be skipped if the firm has no profit
Often callable at a specified call price
Dividend expressed as % of par value (e.g., 6% × $100 p a r = * *$ 6/share/year**)

Retained Earnings

Profits not paid as dividends, reinvested in the firm. No borrowing, no interest payments. Downside: smaller dividends may reduce stock price and demand for shares.

Capital Structure

The relative mix of debt and equity a firm uses. Financial managers seek the mix that maximizes shareholders’ wealth.

Dimension	Debt	Equity
Repayment	Fixed deadline	No limit
Income claim	Regular and fixed	Only residual
Claim in liquidation	Creditors first	Shareholders last
Management control	No effect	May trigger challenge for control
Tax	Interest is deductible	Dividends are not
Management flexibility	Many constraints	Few constraints

Financing decision framework: Work through constraints first: Does ownership dilution matter? What is the credit rating? What are retained earnings? What is the market condition? Blended solutions are usually optimal.

Risk-Return Relationship

Higher-risk investments demand higher returns from investors. This applies everywhere — bonds, stocks, loans.

graph LR
    A[Low Risk] -->|Low return| B[T-Bills / Gov't Bonds]
    C[Medium Risk] -->|Medium return| D[Corporate Bonds / Preferred Stock]
    E[High Risk] -->|High return demanded| F[Common Stock / Junk Bonds / Commodities]

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Managing Risk with Diversification and Asset Allocation

Diversification — investing across many assets reduces risk because all assets are unlikely to decline simultaneously.

For stocks: invest in companies from different industries and different countries.
Diversification increases further when combining stocks, bonds, mutual funds, and real estate.

Asset allocation — the proportion of funds invested in each type of asset.

Younger investors (typical): 70% common stock, 20% bonds, 10% money market funds
Older investors: shift toward conservative assets (bonds, money market funds) and less stock

Return on Investment (ROI) Formulas

Measure	Formula	What it tells you
Current dividend yield	Yearly dividend / current market value	Annual return from dividends alone
Price appreciation (capital gain)	Sale price − original purchase price	Profit from increase in stock value
Total return (%)	(Dividend + Capital Gain) / Original Investment × 100	Full return including both income and growth

Example: Stock pays $1.80 ann u a l d i v i d e n d; c u rre n t s ha re p r i ce =$ 35.67 → Current dividend yield = $1.80/$ 35.67 × 100 = 5.05%

Time Value of Money and Compound Growth

A fundamental principle: money available today is worth more than the same amount in the future because of its earning potential.

$100 invested today compounds over time — each period, interest earns more interest (compound growth)
A person in their 20s saving $100/month can accumulate far more than someone saving much more but starting at 50
Businesses should evaluate projects based on TVM and the rate of return compared to riskless alternatives (government T-bills)

LO 15.5 — Common Stock and Preferred Stock

See LO 15.4 for full coverage of both stock types. The key secondary market facts:

Common stock is traded on stock exchanges (TSX, NYSE) and OTC markets
Preferred stock is also traded on exchanges and OTC; generally less volatile than common
Once issued in the primary market, all subsequent trading happens in the secondary market — the company receives nothing from secondary trading

Why secondary market health matters to the company:

It reflects investor confidence in the firm
A healthy stock price makes future primary market fundraising easier and cheaper

LO 15.6 — Securities Markets

Securities = stocks, bonds, and mutual funds representing secured, asset-based claims by investors.

Primary vs. Secondary Market

Market	What happens	Who gets the money
Primary	New securities issued (IPOs, private placements)	The company
Secondary	Existing securities traded between investors (TSX, NYSE)	The company receives nothing

Two ways to issue in the primary market:

IPO (public offering): Maximum capital raised; company faces ongoing public scrutiny and quarter-to-quarter performance pressure
Private placement: Sold to a small group; plans stay confidential; less regulatory burden

Investment bankers (e.g., RBC Dominion Securities, TD Securities) help companies issue new securities by:

Advising on timing and pricing
Underwriting — buying the new securities and absorbing the risk of reselling them
Distributing through a network of banks and brokers to individual investors

Stock Exchanges

A stock exchange is a voluntary organization providing an institutional setting for members to buy and sell securities. Only members (who purchase “seats”) can trade.

In Canada — TMX Group owns:

TSX (Toronto Stock Exchange) — largest in Canada; ~110 members; lists most major companies
TSX Venture Exchange — for smaller/emerging companies

Foreign exchanges:

NYSE — most well-known and most-used exchange globally
London Stock Exchange — exceeds NYSE for number of stocks listed
Tokyo, London exchanges trade trillions per year

Over-the-Counter (OTC) Market

No trading floor. Dealers hold inventories of securities not listed on major exchanges, buying and selling at their own risk. Traders are scattered in different locations connected electronically.

NASDAQ

Broadcasts trading info on an intranet to 350,000+ terminals worldwide
~3,600 companies traded
Many newer companies first appear here
Heavily tech-focused: Apple, Microsoft, Intel, Baidu, Netflix

Full-Service vs. Discount Brokers

Type	Who it’s for	What they offer
Full-service broker	Investors who want guidance	Financial planning, estate planning, tax strategies, investment recommendations — plus order execution
Discount broker	Self-directed, informed investors	Low-cost order execution, online tools, stock research, industry analysis — no personal advice

Reading Securities Quotations

Stock quotations: Company name, volume (in 100s), high, low, close price, net change.

Bond quotations:

Prices expressed as % of $1, 000 f a ce v a l u e (a q u o t eo f "85" =$ 850)
Coupon rate quoted as % of par (e.g., “6½s” = 6.5% annually, paid semi-annually)
A bond selling at 155.25 costs the buyer $1,552.50

Market Indexes

Index	Description
Dow Jones Industrial Average	30 largest US industrial firms on NYSE; “blue-chip” indicator; limited scope
S&P/TSX	246 large Canadian stocks; topped 20,000 for first time in 2021; historically volatile
S&P 500	500 US stocks (400 industrial, 40 utilities, 40 financial, 20 transport); weighted by market cap
Nasdaq Composite	All NASDAQ-listed companies; tech-heavy; historically very volatile

Bull market = rising prices (investors expect prices to rise) Bear market = falling prices (investors expect prices to fall)

Memory trick: A bull attacks by thrusting horns upward. A bear swipes downward.

Buying and Selling Securities

Order type	Description
Market order	Buy/sell at current prevailing price
Limit order	Buy only if price ≤ specified limit
Stop order	Sell if price falls to a specified level (protects against further loss)
Round lot	100 shares or multiples thereof
Odd lot	Fractions of a round lot; more expensive due to odd-lot broker fees

Margin Trading

Margin = the % of the stock’s price the buyer must put up; the rest is borrowed from the broker.

Amplifies both gains and losses:

Example (WestJet):

Buy $100 Ko f s t oc k; p u t u p$ 50K, borrow $50K at 10% interest
If stock rises to $115 K \to se ll \to p a y b ro k er$ 55K ( $50 K p r in c i p a l +$ 5K interest) → keep $60 K \to * * p ro f i t =$ 10K (20% return vs. 15% without margin)**
If stock falls to $85 K \to se ll \to p a y b ro k er$ 55K → keep $30 K f ro m$ 50K invested → loss = $20K (40% loss)

Short Selling

Selling borrowed shares expecting the price to fall, then buying them back cheaper (“covering”) to return to the lender.

Example: Borrow and sell 1,000 shares at $5 =$ 5,000. If stock falls to $3.50, b u y ba c k f or$ 3,500 → profit = $1, 500 * * . I f s t oc k r i ses t o$ 8, buy back for $8, 000 \to * * l oss =$ 3,000.

Unlike buying (maximum loss = 100%), short selling has theoretically unlimited loss potential — a stock can rise infinitely.

Short squeeze: Rising price forces many short sellers to cover simultaneously, pushing the price even higher (e.g., GameStop 2021).

Stock Options

Term	Meaning
Call option	Right to buy a stock at a set strike price until expiry
Put option	Right to sell a stock at a set strike price until expiry
Strike price	The locked-in purchase/sale price
Premium	Upfront cost of the option contract (non-refundable)
In the money	Market price > strike price (call); exercising is profitable
Underwater	Market price < strike price; let it expire; lose only the premium

Call option example: Buy a call with strike $20, p re mi u m$ 2. Stock rises to $30.

Exercise: buy at $20, se ll a t$ 30 → ( $30 -$ 20) × 100 shares − $200 p re mi u m = * *$ 800 profit**
Maximum loss = $200 premium (if stock stays flat or falls)

Securities Regulation

US vs. Canada:

USA: The SEC (Securities & Exchange Commission) is a single federal regulatory body. Consistent rules nationwide.
Canada: The only industrialized nation without a federal securities regulator. Regulation is done provincially. Canada attempted to create a federal regulator but abandoned the project after spending $30 million. This creates inconsistency and delays that reduce Canada’s international competitiveness.

Blue Sky Laws (named after a judge who ruled certain investments had about as much value as “a patch of blue sky”):

Manitoba introduced these in 1912 to protect investors from fraudulent securities
All provinces have adopted similar frameworks

What Blue Sky Laws require:

Detailed financial reporting — companies issuing securities must provide full financial disclosures
Prospectus requirement — any new security offered to the public must include a prospectus (formal document outlining the investment, risks, and financial evidence)
Licensed stockbrokers — anyone selling securities must be licensed

LO 15.7 — Investment Vehicles

Mutual Funds

A company that pools money from many investors and uses it to buy a diversified portfolio of stocks, bonds, and other securities. Gives small investors access to professional management.

36% of $4.5 trillion in Canadian financial wealth is held in mutual funds.

4 types of mutual funds:

Type	Risk	Goal
Safety fund	Low	Treasury bills and safe issues; preserves liquidity and income
Income fund	Low–medium	Seeks steady income (interest + dividends); sacrifices some safety
Aggressive-growth fund	Medium–high	Maximizes capital appreciation; sacrifices current income and safety; invests in new companies and high-risk securities
Socially responsible fund	Varies	Avoids industries like weapons or tobacco; favours strong ESG records

Key terms:

Load: Sales commission of 2–8% charged when buying into or selling out of the fund
No-load fund: No sales commission
Fund manager: The professional who decides which securities to buy and sell

Exchange-Traded Funds (ETFs)

A bundle of stocks (or bonds) that tracks an index, traded like a stock throughout the day.

	Mutual Fund	ETF
Management	Active (human picks stocks)	Passive (rules-based)
Avg. annual fee	~1.4%	As low as 0.04%
Trading	Priced once at end of day	Traded live during the day
Beats the market?	Rarely (~1/70 US funds beat S&P 500 over 3 years)	Matches the market by design
Fee difference	—	35× cheaper than mutual funds

ETF types:

Type	What it tracks
Index ETF	Market index (S&P 500, S&P/TSX) — one purchase = exposure to the whole market
Commodity ETF	A physical commodity (gold, oil, silver) without owning the physical asset
Bitcoin ETF	Bitcoin’s price. Canada’s Purpose Bitcoin ETF (BTCC) was a world first (2020) — brought crypto to mainstream investors
Thematic ETF	A specific theme (clean energy, gender equity, socially conscious) — rules filter which companies qualify

Key insight: If most actively managed funds fail to beat the index before fees, even fewer beat it after fees. This is why ETFs have grown rapidly.

Hedge Funds

Private pools of money that try to give investors a positive return regardless of market direction.

Strategies used:

Short selling — borrow and sell shares expecting prices to fall
Leverage — borrow capital to multiply position size (amplifies gains and losses)
Derivatives — options, futures, and other contracts whose value is derived from an underlying asset
Long/short equity — buy stocks expected to rise, short stocks expected to fall (market-neutral)

Historically limited to accredited investors (wealthy, knowledgeable individuals). Now marketed to average investors through:

Principal-protected notes: Guarantee the return of the original investment at a set date, but not any additional gains.

Commodities

Futures contract = an agreement to buy a specified amount of a commodity at a given price on a set future date. Frequently traded on margin, amplifying gains and losses.

Commodity categories:

Category	Examples	Price drivers
Energy (most traded)	Crude oil, natural gas, heating oil	Geopolitical events, OPEC supply decisions, wars
Agriculture (seasonal)	Corn, soybeans, wheat, coffee, sugar	Weather, harvest cycles, global food demand
Metals (store of value)	Gold, silver, copper	Gold = safe-haven asset; investors flock to it in uncertainty
Livestock (perishable)	Cattle, hogs, pork bellies	Disease, feed costs, consumer demand

Top 5 most-traded commodities by volume: Crude oil, Gold, Corn, Soybeans, Natural Gas

Every futures contract has two sides:

Hedger — seeks certainty; locks in a price to protect against unfavourable movements (e.g., a farmer locking in a wheat price)
Speculator — absorbs price risk for profit; bets on price movements with no interest in the physical good

LO 15.8 — Risk Management

Risk = uncertainty about future events. Every managerial decision creates the possibility of positive or negative outcomes.

Two Types of Risk

Type	Definition	Insurable?	Examples
Speculative risk	Gain or loss is possible	No	Investing in a new product; entering a new market
Pure risk	Only loss or no loss — no upside exists	Yes	Fire, theft, flood, employee injury, lawsuits

Key exam point: Insurance only covers pure risk. You cannot insure against a bad business decision (speculative risk).

The 5-Step Risk Management Process

flowchart LR
    A[Step 1<br/>Identify Risks<br/>& Potential Losses] --> B[Step 2<br/>Measure Frequency<br/>& Severity of Losses]
    B --> C[Step 3<br/>Evaluate<br/>Alternatives]
    C --> D[Step 4<br/>Implement Risk<br/>Management Program]
    D --> E[Step 5<br/>Monitor Results]
    E -->|Ongoing review| A

(diagram saved)

Step	What happens
1. Identify	Catalogue all sources of risk — operational, financial, environmental, legal
2. Measure	How often does each risk occur? How severe is the loss when it does? (Consider both history and current activities)
3. Evaluate	Choose from the four responses below
4. Implement	Put the chosen method in place (buy insurance, train staff, set up reserve fund, outsource the risky activity)
5. Monitor	Ongoing — risk landscape changes as business grows; revise as needed; risk management is never finished

Four Responses to Risk

These are not mutually exclusive — smart managers often combine them:

Response	What it means	Example
Risk avoidance	Stop the activity that creates the risk	Restaurant eliminates deep fryers to avoid burn injuries
Risk control	Reduce the probability or severity of loss	Driver safety training, defensive-driving routes, regular truck maintenance
Risk retention	Absorb manageable, predictable losses with company funds	Pay for minor truck vandalism out-of-pocket rather than filing insurance claims
Risk transfer	Shift risk to a third party — usually via insurance	Buy a workplace injury insurance policy

Insurance policy = a formal agreement to pay the policyholder a specified amount in the event of certain losses. Deductible = the portion of the loss the insured must absorb before the insurer pays.

Key Definitions at a Glance

Term	Definition
Finance	Decisions about long-term investments + obtaining funds to pay for them
Financial plan	Describes how a business will reach a future financial position
Financial control	Checking actual performance against plans
Credit policy	Rules governing how a firm extends credit to customers
Trade credit	Granting of credit by a selling firm to a buying firm
Factoring	Selling accounts receivable to a third party at a discount
Line of credit	Standing bank agreement to lend up to a maximum
Revolving credit agreement	Guaranteed line of credit; firm pays commitment fee on unused portion
Commercial paper	Short-term unsecured notes sold at a discount; repurchased at face value ≤ 270 days
Debt financing	Long-term borrowing (loans or bonds)
Corporate bond	Promise to pay holder principal at maturity + stated interest in the interim
Bond indenture	Legal document spelling out bond terms
Debenture	Unsecured bond; no collateral; inferior asset claim
Sustainability bond	Bond funding social or environmental programs with transparent reporting
Equity financing	Raising money via stock issuance or retained earnings
Par value	Arbitrary stock value set by board; used in accounting
Book value	Shareholders’ equity ÷ shares outstanding
Market value	Current price of one share on the secondary market
Market capitalization	Outstanding shares × market value per share
Capital structure	Relative mix of a firm’s debt and equity financing
Securities	Stocks, bonds, mutual funds = secured, asset-based investor claims
Primary market	New securities sold; company receives the proceeds
Secondary market	Existing securities traded; company receives nothing
IPO	Public offering of new shares; maximum capital, maximum scrutiny
Private placement	Shares sold to a small group; less scrutiny, less capital
Investment banker	Underwrites and distributes new securities to the public
Blue Sky Laws	Provincial laws requiring financial disclosure, licensed brokers, and prospectus filings
Prospectus	Formal legal document required when issuing new securities
Market index	Measure of price trends for an industry or the whole market
Bull market	Period of rising stock prices
Bear market	Period of falling stock prices
Margin	% of stock price the buyer puts up; rest borrowed from broker
Short sale	Selling borrowed shares expecting price to fall; unlimited loss potential
Stock option	Right (not obligation) to buy (call) or sell (put) a stock at a set price
Mutual fund	Pool of investor funds used to buy a diversified portfolio
ETF	Index-tracking bundle; traded during the day; much lower fees than mutual funds
Hedge fund	Private pool seeking positive return in any market; accredited investors
Principal-protected note	Guarantees return of original investment but not gains
Futures contract	Agreement to buy/sell a commodity at a specified price on a future date
Hedger	Uses futures to lock in a price and reduce risk
Speculator	Uses futures to bet on price movements for profit
Risk	Uncertainty about future events
Speculative risk	Gain or loss is possible; not insurable
Pure risk	Only loss or no loss; insurable
Risk avoidance	Eliminate the risky activity
Risk control	Reduce probability/severity of loss
Risk retention	Absorb the loss with company funds
Risk transfer	Shift risk to insurer

Exam Nuggets & Mnemonics

Debt vs. Equity cost: Debt (bonds) = tax-deductible interest → cheaper per dollar. Equity = dividends from after-tax profits + control risk → more expensive.
“2/10, net 30” = 2% discount if paid within 10 days; full price due by day 30. Sellers use this to accelerate cash collection.
Pure risk = insurable. Speculative risk = not insurable. You can’t insure against a bad business decision.
Short selling has unlimited downside. A stock can only fall to $0 (max gain) but can rise infinitely (unlimited loss).
Primary market = company gets the money. Secondary market = company gets nothing. But secondary market price still matters — it signals investor confidence and affects future fundraising.
ETFs vs. mutual funds: ETFs are ~35× cheaper in fees and most actively managed funds can’t beat the index anyway.
Canada has no federal securities regulator — the only industrialized nation without one. Each province regulates independently.
Blue Sky Laws (Manitoba, 1912) = financial transparency, prospectus requirement, licensed brokers. Named after a judge who said fraudulent investments were worth “a patch of blue sky.”
TVM: Money today > money tomorrow. The earlier you invest, the more compound growth works in your favour.
Risk-Return Relationship: Higher risk = higher return demanded by investors. Applies to every financial instrument.
Callable bonds are called when market rates drop below the bond’s stated rate — the company refinances at the lower rate.
Hedger vs. speculator in futures: Every futures contract has one of each — the hedger wants certainty; the speculator absorbs the risk.

ShortTermFinancing, LongTermFinancing, SecuritiesMarkets, RiskManagement, InvestmentVehicles, FinancialManager, ADMN201-Ch11, ADMN201-Ch14

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Financial Decisions and Risk Management

ADMN 201 — Ch15: Financial Decisions and Risk Management

Chapter Overview

LO 15.1 — Role of the Financial Manager

Four Core Responsibilities

Three Areas of Responsibility

1. Cash-Flow Management

2. Financial Control

3. Financial Planning

LO 15.2 — Short-Term vs. Long-Term Expenditures

Short-Term Concerns

Long-Term (Capital) Expenditures

LO 15.3 — Three Sources of Short-Term Financing

1. Trade Credit

2. Secured Short-Term Loans

3. Unsecured Short-Term Loans

LO 15.4 — Three Sources of Long-Term Financing

Debt Financing

Long-Term Loans

Bonds (Corporate Bonds)

Equity Financing

Common Stock

Preferred Stock (Hybrid)

Retained Earnings

Capital Structure

Risk-Return Relationship

Managing Risk with Diversification and Asset Allocation

Return on Investment (ROI) Formulas

Time Value of Money and Compound Growth

LO 15.5 — Common Stock and Preferred Stock

LO 15.6 — Securities Markets

Primary vs. Secondary Market

Stock Exchanges

Over-the-Counter (OTC) Market

NASDAQ

Full-Service vs. Discount Brokers

Reading Securities Quotations

Market Indexes

Buying and Selling Securities

Margin Trading

Short Selling

Stock Options

Securities Regulation

LO 15.7 — Investment Vehicles

Mutual Funds

Exchange-Traded Funds (ETFs)

Hedge Funds

Commodities

LO 15.8 — Risk Management

Two Types of Risk

The 5-Step Risk Management Process

Four Responses to Risk

Key Definitions at a Glance

Exam Nuggets & Mnemonics

Related Pages

Graph View

Table of Contents