1-3 slides Flashcards
What is the role of financial intermediaries?
Size Transformation- Small sums from lenders are parcelled into large amounts for borrowers
Maturity Transformation- By pooling short term deposits they are able to lend at longer rates; does increase risk of ‘credit crunch’ and hence strict capital adequacy requirements required.
Risk Transformation- Able to ‘smooth’ risks of lending to risky ventures by pooling, diversification, monitoring and hedging.
What does the yield curve plot the relationship between?
Yield curve describes the relationship between bond yields and bond maturity
What is reinvestment risk?
Uncertainty concerning rates at which cash flows can be reinvested.
Short-term bonds have more reinvestment rate risk than long-term.
High coupon rate bonds have more reinvestment rate risk than low coupon rate bonds.
Characteristics of debt
Not an ownership interest (Creditors do not have voting rights), Interest is considered a cost of doing business and is tax deductible, Debt has a specific term after which capital must be repaid or rolled over, Under normal conditions, debt holders know cash flows in advance, Debt Payments are an obligation.
Creditors have legal recourse if interest or principal payments are missed
Characteristics of equity
Ownership interest (Common stockholders vote on board of directors and other issues), Dividends are not considered a cost of doing business and are not tax deductible, Equity is infinitely lived so capital is effectively loaned in perpetuity, Equity holders receive a share of profits which is unknown in advance, Dividends are not a liability of the firm and stockholders have no legal recourse if no dividends are not paid
Preferred stock dividends
Stated dividend that must be paid before dividends can be paid to common
stockholders. Taxed like dividends.
Dividends are not a liability of the firm and preferred dividends can be deferred indefinitely
Most preferred dividends are cumulative – any missed preferred dividends have to be paid before common dividends can be paid
Preferred stock generally does not carry voting rights
In the event of liquidation preferred stocks are more senior. They get their face value repaid before common shareholders are paid – hence preferred.
Used in start-ups to protect investor
Reasons why a company might want to go public
To release capital that’s invested in the company
To give the company more access to capital
To increase the value of the company
Drawbacks of going public
Expense of going to market one-off cost of listing Greater transparency required Increased accounting costs More emphasis on short term transparency distracting attention from the longer term Less monitoring of management More vulnerable to takeovers
What service do underwriters provide?
Formulate method used to issue securities
Involved in Prospectus writing and marketing road shows
Price the securities
Sell the securities
Price stabilization by lead underwriter
Syndicate?
Spread?
Syndicate – group of investment bankers that market the securities and share the risk associated with selling the issue
Spread – difference between what the syndicate pays the company and what the security sells for initially in the market
What is firm commitment underwriting?
Issuer sells entire issue to underwriting syndicate
The syndicate then resells the issue to the public
The underwriter makes money on the spread between the price paid to the issuer and the price received from investors when the stock is sold
The syndicate bears the risk of not being able to sell the entire issue for more than the cost
Most common type of underwriting in the United States and UK
Steps in a rights issue?
Issue of common stock offered to existing shareholders
Allows current shareholders to avoid the dilution* that can occur with a new stock issue
“Rights” are given to the shareholders
Specify number of shares that can be purchased
Specify purchase price
Specify time frame
Rights may be traded OTC or on an exchange
List the areas of key differences Between Debt and Equity
Ownership, Tax, Longevity, Return Risk and Credit Risk
