Finance Terminology

1. Finance--is the study of how people and businesses evaluate investments and raise capital to fund them. Finance is conceptualized, structured, and regulated by a complex system of power relations within political economies across state and global markets.

Thus, there are three basic questions that are addressed by the study of finance:

1. What long-term investments should the firm undertake? This area of finance is generally referred to as capital budgeting.

2. How should the firm raise money to fund these investments? The firm's funding choices are generally referred to as capital structure decisions.

3. How can the firm best manage its cash flows as they arise in its day-to-day operations?

This area of finance is generally referred to as working capital management.

2. Efficient Market-- hypothesis states that securities prices accurately reflect future expected cash flows and are based on all information available to investors.

An efficient market is a market in which all the available information is fully incorporated into securities prices, and the returns investors will earn on their investments cannot be predicted. Taking this concept a step further, we can distinguish between weak-form efficient markets, semi-strong form efficient markets, and strong-form efficient markets, depending on the degree of efficiency:

1. The Weak-Form Efficient Market Hypothesis asserts that all past security market information is fully reflected in securities prices. This means that all price and volume information is already reflected in a security's price.

2. The Semi-Strong Form Efficient Market Hypothesis asserts that all publicly available information is fully reflected in securities prices. This is a stronger statement because it isn't limited to price and volume information, but includes all public information. Thus, the firm's financial statements, news and announcements about the economy, industry, or company, analysts' estimates on future earnings, or any other publicly available information is already reflected in the security's price. As a result, taking an investments class won't be of any value to you in picking a winner.

3. The Strong-Form Efficient Market Hypothesis asserts that all information, regardless of whether this information is public or private, is fully reflected in securities prices. This form of the efficient market hypothesis encompasses both the weak-form and semi-strong form efficient market hypotheses. It asserts that there isn't any information that isn't already embedded into the prices of all securities. In other words, even insider information--that is, material information that isn't available to any other investor--is of no use.

3. Primary Market--securities trade in the primary market (IPO) currently outstanding securities trade in the secondary market. It is a market in which new, as opposed to previously issued, securities are bought and sold for the first time. In this market, firms issue new securities to raise money that they can then use to help finance their businesses. The key feature of the primary market is that the firms selling securities actually receive the money raised.

4. Secondary Market--currently outstanding securities trade in the secondary market. It is where all subsequent trading of previously issued securities takes place. In this market the issuing firm does not receive any new financing, as the securities it has sold are simply being transferred from one investor to another. The principal benefit of the secondary market for the shareholders of firms that sell their securities to the public is liquidity.

5. Risk--is the potential that