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7.6: Key Terms

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    Sole proprietor is the single owner of a business and is responsible for all profits and losses.

    Partnership: a business owned jointly by two or more individuals, who share in the profits and are jointly responsible for losses.

    Corporation or company is an organization with a legal identity separate from its owners that produces and trades.

    Shareholders invest in corporations and therefore are the owners. They have limited liability personally if the firm incurs losses.

    Dividends are payments made from after-tax profits to company shareholders.

    Capital gains (losses) arise from the ownership of a corporation when an individual sells a share at a price higher (lower) than when the share was purchased.

    Real return on corporate stock: the sum of dividend plus capital gain, adjusted for inflation.

    Real return: the nominal return minus the rate of inflation.

    Limited liability means that the liability of the company is limited to the value of the company's assets.

    Retained earnings are the profits retained by a company for reinvestment and not distributed as dividends.

    Principal or owner: delegates decisions to an agent, or manager.

    Agent: usually a manager who works in a corporation and is directed to follow the corporation's interests.

    Principal-agent problem: arises when the principal cannot easily monitor the actions of the agent, who therefore may not act in the best interests of the principal.

    Stock option: an option to buy the stock of the company at a future date for a fixed, predetermined price.

    Accounting profit: is the difference between revenues and explicit costs.

    Economic profit: is the difference between revenue and the sum of explicit and implicit costs.

    Explicit costs: are the measured financial costs.

    Implicit costs: represent the opportunity cost of the resources used in production.

    Capital market: a set of financial institutions that funnels financing from investors into bonds and stocks.

    Portfolio: a combination of assets that is designed to secure an income from investing and to reduce risk.

    Risk pooling: a means of reducing risk and increasing utility by aggregating or pooling multiple independent risks.

    Risk: the risk associated with an investment can be measured by the dispersion in possible outcomes. A greater dispersion in outcomes implies more risk.

    Diversification reduces the total risk of a portfolio by pooling risks across several different assets whose individual returns behave independently.

    This page titled 7.6: Key Terms is shared under a CC BY-NC-SA 4.0 license and was authored, remixed, and/or curated by Douglas Curtis and Ian Irvine (Lyryx) via source content that was edited to the style and standards of the LibreTexts platform; a detailed edit history is available upon request.