7) Sources of Finance [15]

Question 1

..What are some of the factors to consier when choosing between sources of finance?

Answer 1

Cost
Duration
Term structure of interest rates
gearing
accessibility/availability 
lending restriction from the bank
Impact of the financing on the financial statements

Question 2

what is the term structure of interest rates

Answer 2

The term structure of interest rates describes the relationship between interest rates charged for loans of differing maturities.

The term structure of interest rates, also called the yield curve, is a graph that plots the yields of similar-quality bonds against their maturities, from shortest to longest. The term structure of interest rates shows the various yields that are currently being offered on bonds of different maturities. It enables investors to quickly compare the yields offered on short-term, medium-term and long-term bonds. Generally, the term structure of interest rates is a good measure of future economic growth expectations.

Types include:
-Normal; ST yields < long term yield. it is a signal investors believe future economic growth to be strong and inflation high.

• Inverted; ST yields> long term yields- If there is a highly negative inverted curve, it is a signal investors believe future economic growth to be sluggish and inflation low.

-Flat; Little to no variation betwen short and long-
A flat yield curve means investors are unsure about the future.

Question 3

What is gearing

describe an effect of too little debt

Answer 3

Gearing is the ratio of debt to equity finance.

although high gearing involves the use of cheap debt finance, it does bring with it the risk of having to meet regular repayments of interest and principal on the loans. If these are not met, the company could end up in liquidation.

On the other hand, too little debt could result in earnings dilution. For example, the issue of a large amount of equity to fund a new project could result in a decrease in earnings per share (EPS) due to the volume of shares issued, despite an increase in total earnings.

Question 4

What are short term sources of finance

Answer 4

bank overdrafts
bank loans
better management of working capiatal
squeezing trade credit
leasing
sale and lease back

Question 5

What are the three types of share capital

Answer 5

Ordinary shares
Cumulative shares
non cumulative shares

Question 6

explain characterisitcs of ordinary shares

Answer 6

Voting rights in general meetings. Rank after all creditors and preference shares in rights to assets on liquidation.

Dividends payable at the discretion of the directors out of undistributed profits remaining after prior claims have been met.

The right to all surplus capital funds after prior claims have been met.

Question 7

explain characterisitcs of cumulative preference shares

Answer 7

Limited right to vote at a general meeting (only when dividend is in arrears or when it is proposed to change the legal rights of the shares)

Rank after all creditors but usually before ordinary shareholders in liquidation.

A fixed amount of dividend per year at the discretion of the directors. Arrears accumulate and must be paid before a dividend on ordinary shares may be paid.

A fixed amount of capital per shares

Question 8

explain characterisitcs of non cumulative preference shares

Answer 8

ypically acquire some voting rights if the dividend has not been paid for three years. Rank as cumulative in liquidation.

A fixed amount of dividend per year, as above. Arrears do not accumulate.

A fixed amount of capital per shares

Question 9

What are the sources of equity finance

Answer 9

rights issue
external share issues
retained earnings

Question 10

how are internally generated funds created?

Answer 10

They are generated as a result of increased working capital management efficiency and from successful short- and long-term projects.

Question 11

What is a rights issue and advantages

Answer 11

A rights issue is an offer to existing shareholders to subscribe for new shares, at a discount to the current market value, in proportion to their existing holdings.

 it is cheaper than a new share issue
 it is made at the discretion of the directors, without consent of the shareholders or the Stock Exchange

 it rarely fails.
 allow existing shareholders to retain the same proportion of ownership of the company as they did prior to the rights issue

Question 12

what is the theoretical ex rights price?

Answer 12

The new share price after the issue is known as the theoretical ex-rights price and is calculated by finding the weighted average of the old price and the rights price, weighted by the number of shares.

Question 13

what is the formula for terp

Answer 13

(MV of shares currently in issue)+(proceeds from new share issue)
÷
Number of shares in issue after the rights issue

Question 14

what is the value of a right and the formula

Answer 14

To make the offer relatively attractive to shareholders, new shares are generally issued at a discount on the current market price.

Value of a right = theoretical ex rights price – rights issue price

Question 15

what is the value of a right per existing share formula

Answer 15

Value of a right = (theoretical ex rights price – rights issue price ) / number of shares bought

e.g. 1 for 2 issue means 2 shares needed to obtain a right to buy 1 share

so Value of a right per existing share = ($0.40/2)x1 = $0.20

Question 16

how do you calculate the wealth of someone who takes up the share rights issue

Answer 16

wealth after taking up issue=TERP * total shares now owned (old +new)
Cost of purchase= issue price x shares bought

=Total weath

Question 17

what are the methods of new issue of shares to NEW shareholders (when existing shareholders forgo their rights)

and describe the process for each and advantage and disadvantage

Answer 17

1) offer for sale at a fixed price

• Shares that are sold either directly to the general public or via an issuing house.
• An offer for sale is usually underwritten. This leads to high issue costs, and therefore is expensive.
• Leads to dilution of control of the existing shareholders.
• Pricing of the shares can prove difficult.

2) Offer for sale by tender

• Investors will bid for shares at a price of their choice
• All of the shares will then be sold or issued at the maximum price at which all of the shares will be purchased.
• This will maximise the proceeds arising from the issue of new shares.
• Again, there will be a dilution in control for current shareholders.

3) Placing

• The shares are not offered to the public, but instead placed on a sponsoring market whereby the shares are sold to a small number of institutional investors
• Quick and cheap from an administration point of view
• Again, there will be a dilution in control for current shareholders.

Question 18

What are the methods of issue for unquoted company and what type of investors are interested? the company wants to finance without an immediate stock market quotate

Answer 18

Placing or Enterprise investment scheme (EIS)

Investor: Individuals, merchant banks, finance corporations

Question 19

What is placing?

Answer 19

Unquoted companies can arrange for a placing of shares with an institution. The bank advising the company selects institutional investors to whom the shares are ‘placed’ or sold. If the general public wish to acquire shares, they must buy them from the institutions.

• The shares are not offered to the public, but instead placed on a sponsoring market whereby the shares are sold to a small number of institutional investors
• Quick and cheap from an administration point of view
• Again, there will be a dilution in control for current shareholders.

Question 20

What are the methods of issue for quoted or unquote company and what type of investors are interested?

The company wants to finance with an immediate stock market quotation. Finance with a new issue

Answer 20

Method of issue: Stock exchange OR Small firm market placing

: Public offer (IPO) fixed price or offer for sale by tender

Investors: The investing public, pension funds, insurance companies and other institutions.

Question 21

what is a public offer?

Answer 21

A public offer is an invitation to apply for shares in a company based upon information contained in a prospectus, either at a fixed price or by tender.

Question 22

what is fixed price offer?

Answer 22

• Shares that are sold either directly to the general public (including institutions).
• Details of the offer document are published in a prospectus for the issue. The prospectus contains information about the company’s past performance and future prospects
• An offer for sale is usually underwritten. This leads to high issue costs, and therefore is expensive.
• Leads to dilution of control of the existing shareholders.
• Pricing of the shares can prove difficult.

Question 23

what is offer for sale by tender?

Answer 23

Shares are offered to the general public (including institutions) but no fixed price is specified. Potential investors bid for shares at a price of their choosing. The ‘strike price’ at which the shares are sold is determined by the demand for shares.

• Investors will bid for shares at a price of their choice
• All of the shares will then be sold or issued at the maximum price at which all of the shares will be purchased.

OR a price lower than in (a), but with tenders at or above this lower price receiving only a proportion of the shares tendered for, so as to avoid the concentration of ownership in the hands of a few.

• This will maximise the proceeds arising from the issue of new shares.
• Again, there will be a dilution in control for current shareholders.

Question 24

what are the methods of obtaining a stock market listing?

Answer 24

1) IPO- typically when a company becomes listed a large public offering is made. Shares can be at fixed price or offering shares for sale by tender
2) Placing- when obtaining a listing on a stock market- it’s unlikely that all of the shares will be placed. At least some of the shares will need to be offered for sale at a fixed price or offered for sale by tender in order to create a proper market for buying and selling shares
3) Introduction

Question 25

What is introduction?

Answer 25

• An introduction normally happens when a company already has a listing on one stock market but wants to also make its shares available for sale on a different stock market. By listing on a different stock market the company may gain access to a large amount of additional potential investors

This refers to a situation where a company has its shares listed on a stock market without the company issuing new shares in order to raise new finance.

It is used where the public already holds at least 25% of the shares in the company (the minimum requirement for a stock exchange listing). The shares become listed and members of the public can buy shares from the existing shareholders.

Question 26

what must be considered when choosing between sources of equity?

Answer 26

accesibility of the finance 
amount of finance
costs of the issue procedure
pricing of the issue
control 
dividend policy- using RE could impact share price

Question 27

what are the type of bonds?

Answer 27

Deep discount bonds
zero coupon
Hybrids- convertibles
Hybrids- warrants

Question 28

what are deep discount bonds?

Answer 28

100 bond issued at par $50 and redeemable at 100. Very low interest e.g. 1%

▪ The bonds are issued at a price below nominal value
▪ Redeemable at par or above nominal at maturity
▪ This will assist short term cash flow
▪ Deep discount bonds carry a low rate of interest

Much of the return gained by the investor comes from the capital gain when the bond is redeemed.

Question 29

what are zero coupon bonds?

Answer 29

$ 40 issue and 100 redemption. 0% interest

▪ These are bonds that are issued at a discount to their nominal/redemption value
▪ However, no interest is charged on the bond.
▪ For lenders this means the original rate of discount must offer a high yield to be worthwhile.

Question 30

what are hybrid convertible and why is it attractive to companies issuing them

Answer 30

▪ These are bonds that give the holder the right to convert the bond to other securities, (normally ordinary shares) at a pre-determined price/rate and time with predetermined ratio

▪ Prospect of capital gain on shares in the future may attract a lower coupon rate today. also means you don’t have to secure it against anything

Question 31

what is bond Conversion premium and the premium

Answer 31

The conversion premium measures the difference between the market value of a convertible bond and the value of the shares if conversion takes place immediately into ordinary shares.

When issuing convertible bonds, companies aim to maximize the conversion premium so will try to keep this premium high when they issue bonds because they know the price will increase in value between the date of bond issue and conversion

Stock trading at $102, to be converted into 10 shares currently trading at $9 each,

conversion premium of:

102 – (10 × 9) = $12 or $1.20 per share.

Question 32

what are hybrids- loan notes with warrants

Answer 32

Warrants give the holder the right to subscribe at a fixed future date for a certain number of ordinary shares at a predetermined price.

NB: If warrants are issued with loan notes, the loan notes are not converted into equity. Instead, bond holders:
 make a cash payment for the shares
 retain the loan notes until redemption.

Question 33

what are the advantages of convertibles and warrants

Answer 33

Immediate finance at low cost due to conversion option so loans are raised with less security

Attractive if share prices are depression as you don’t want to sell your shares for low brice

self liquidating- problem of repayment disappears as loans will be converted into shares

exercise of warrants related to need for finance- e.g. if the options involve the payment of extra cash to the company, this creates extra funds when they are needed

Question 34

What are the financial impact of sources of finance for small and medium enterprises

Answer 34

The funding gap

The maturity gap

Question 35

What is the funding gap

explain how normally sme try to manage and how this also fails

Answer 35

Smaller companies tend to be unquoted, it is more difficult for equity investors to liquidate their investment. therefore Typically small firms rely on finance from retentions, rights issues and bank borrowings.

Bank borrowing doesn’t always provide a solution either. To control their exposure, banks will often use credit scoring systems, effectively creating competition amongst SMEs for the available funds.

Lenders will want more information such as business plans, additional security which owners may be unwilling to give and also will want to monitor their investment more closely

As a result, a funding gap often arises when they want to expand beyond these means of finance but are not yet ready for a listing on the Stock Exchange or Alternative Investment Market (AIM).

Question 36

how is the funding gap closed

Answer 36

Financial investors: Business Angels & Venture capitalist

Government solution: Tax incentive, marketability of shares

Other practice: Crowd funding, peer to peer lending, supply chain financing

Question 37

what is the maturity gap

Answer 37

often, with smaller businesses, longer-term loans are easier to obtain that medium term loans because the longer loans are easily secured with mortgages against property. The fact that medium term loans are hard to obtain is a well-known feature of SMEs and is known as the maturity gap. Its main problem arises in a mismatching of assets and liabilities.

Question 38

why are small firms more risky?

Answer 38

lack proper financial control systems
have inexperienced management teams
not have an established track record
lack sufficient good quality assets to offer as security (it is common for the owners of the business to be asked for personal guarantees).

Question 39

What is a venture capital

• who
• what they look for
• how they benefit

Answer 39

▪ Venture capital is a type of private equity typically from institutional investors or high net worth individuals.

▪ Venture capitalists seek to invest cash in return for shares in private companies with high growth potential.

▪ They seek a high return which is often realised through a stock market listing.

Although venture capital companies are the main providers of equity finance to small businesses, they are highly selective and normally do not invest amounts under £100,000 in the UK

Question 40

What is a business angels

• who
• what they look for
• how they benefit

Answer 40

think of dragons den

Wealthy individuals who invest in an SME, who are prepared to take high risks for high returns.

Business angels are willing to make investments in small businesses in return for an equity stake. They can also offer the businesses the benefits of their own management expertise. A number of business angel networks operate in the UK to match businesses seeking equity finance with potential investors.

Question 41

..

Answer 41

..

Question 42

what are the strategies that government use to increase the attractiveness of SME

Answer 42

increasing marketability of shares

tax incentives for investors.

Question 43

A number of SMEs that have good business ideas and growth potential do not fulfil the profitability/track record requirements to obtain a full stock exchange listing.

Whats the solution

Answer 43

The development of small firm capital markets, such as the AIM (alternative investment market) in the UK and the Growth Enterprise Market (GEM) in Hong Kong, is designed to bridge this gap and provide both an exit ground and a venue for further fund-raising for investments.

Question 44

what are the examples of tax incentives

list 3

Answer 44

The Enterprise Investment Scheme (EIS)
Venture capital trusts
share incentive schemes

Question 45

what is the Enterprise Investment Scheme (EIS)

Answer 45

Offers tax relief on investments in new ordinary shares in qualifying unlisted trading companies, including those traded on the AIM for up to £1m and the investment qualifies for 20% income tax relief.

Any gain on disposing of EIS shares after 3 years is exempt from capital gains tax (CGT).

Income tax or CGT relief is available on losses.

Question 46

what is the Venture capital trusts?

Answer 46

VCTs are companies listed on the London Stock Exchange and are similar to investment trusts.

The aim is to encourage individuals to invest indirectly in a range of small higher-risk trading companies whose shares and securities are not listed on a recognised stock exchange. By investing through a VCT, the investment risk is spread over a number of companies.

Income tax relief is available at 30% on new subscriptions by individuals for ordinary shares in VCTs, to a maximum of £200,000 pa.

In addition, subject to certain conditions, CGT relief is available on disposal of the shares.

Question 47

What are share incentive schemes

Answer 47

In the UK, there are schemes designed to encourage employees to hold shares in companies by which they are employed. All such schemes require HM Revenue and Customs (HMRC) approval.

Question 48

what are the types of specific forms of assistance

Don’t need to know each in detail; basic

Reverse-REERSE

Answer 48

Regional selective assistance
Enterprise finance guarantee
enterprise grants
regional innovation grants
small firms training loans
European investment bank (EIB) and european investment fund schemes (EIF)

Question 49

what is Enterprise finance guarantee

Answer 49

Replacing the Small Firms Loan Guarantee Scheme since 2008,

this provides a government guarantee for loans by approved lenders. Loans are made to firms or individuals unable to obtain conventional finance because of a lack of security. The guarantee generally covers 75% of the risk of default on the outstanding loan. The borrower pays a fee to the government as well as the interest and repayment amounts to the lender.

Question 50

what is Regional selective assistance

Answer 50

discretionary scheme available in those parts of the UK designated as Assisted Areas. It takes the form of grants to encourage firms to locate or expand in these areas. Projects must either create new employment or safeguard existing jobs.

Question 51

what is enterprise grants

Answer 51

selective scheme for firms employing fewer than 250 people. It is available for high quality projects in designated areas. Businesses may only receive one such grant.

Question 52

what are regional innovation grants

Answer 52

available in certain areas of the UK to encourage the development of new products and processes. It is available to individuals or businesses employing no more than 50 people. The scheme provides a fixed grant of up to 50% of eligible costs up to a maximum of £25,000.

Question 53

what are small firms training loans

Answer 53

These are available through the Department for Education and Employment and eight major banks in the UK. The scheme helps businesses with up to 50 employees to pay for vocational education or training, by offering loans on deferred repayment terms:

Question 54

what are European investment bank (EIB) and european investment fund schemes (EIF)

Answer 54

The EIB provides loans to banks and leasing companies to help provide finance to small and medium-sized companies. The operators of EIB – supported schemes include finance organisations such as Barclays Mercantile, Lombard Business Finance and Forward Trust.

The EIF provides loan guarantees in conjunction with some finance organisations’ own environmental loan facilities. These facilities are designed to assist business to finance investments that produce a quantifiable environmental benefit (energy usage, raw material usage, etc.).

Question 55

what are some other practice to bridge the funding gap:

Answer 55

Crowd funding, peer to peer lending, supply chain financing

Question 56

what is crowd funding

Answer 56

Crowdfunding is a way of raising finance by asking a large number of people each for a small amount of money. using the internet to talk to thousands – if not millions – of potential funders. Typically, those seeking funds will set up a profile of their project on a website. They can use social media, alongside traditional networks of friends, family and work acquaintances, to raise money.

Question 57

what is peer to peer lending

Answer 57

Peer-to-peer financing is the practice of borrowing and lending money between unrelated individuals, or ‘peers’, There is no necessary common bond or prior relationship between borrowers and lenders.

Intermediation takes place by a peer-to-peer lending company and all transactions take place online, with a view to the lender making a profit.

Lenders may choose which borrowers to invest in and the loans are unsecured. The emergence of new intermediaries has proven to save time and expenses.

Question 58

what is supply chain financing

Answer 58

Supply chain finance (or SCF) is a form of supplier finance in which suppliers can receive early payment on their invoices. Supply chain finance reduces the risk of supply chain disruption and enables both buyers and suppliers to optimize their working capital. It’s also known as reverse factoring.

supply chain finance is set-up by the buyer instead of by the supplier. Another key difference is that suppliers can access supply chain finance at a funding cost based on the buyer’s credit rating, rather than their own. As a result, suppliers are typically able to receive supply chain finance at a lower cost than they can otherwise access.

In 2012 the Supply Chain Finance Scheme was introduced which provides cheaper finance for small and medium sized businesses.

The scheme allows large organizations to vouch for their suppliers’ incomes. In return, banks will allow the small and medium sized businesses access to credit to improve cash flow and lower costs within the supply chain.

banks will be notified by the larger company that an invoice is being approved; the bank is then able to offer a 100 per cent immediate advance to the supplier (SME) at lower interest rates based upon their customer’s credit rating knowing the invoice will be paid.

The scheme helps smaller businesses in two key areas – improving their working capital and tackling the issue of late payments.

Question 59

what are the basic principles of islamic finance

Answer 59

 No interest (riba) allowed.
 Wealth must be generated from legitimate investment in assets- not just lending money and charging interest

 Finance is restricted to Islamically accepted transactions. i.e. No investment in alcohol, gambling etc.

 Speculative activity is not allowed- using futures and options to make speculative gain is not allowed.

Instead of interest being charged, returns are earned by channelling funds into an underlying investment activity, which will earn profit. The investor is rewarded by a share in that profit, after a management fee is deducted by the bank.

Question 60

what are the sources of finance within the islamic banking model and also what they are similar to

Answer 60

equity like:

Mudaraba (equity finance)
Musharaka (venture capital).

debt like:

Murabaha (trade credit)
 Ijara (lease finance)
Sukuk (debt finance)

Question 61

what is murabaha

Answer 61

Murabaha is a form of trade credit finance.

The company/supplier needs finance so they will sell to the bank. The bank will take actual constructive or physical ownership of the asset. The asset is then sold onto the ‘borrower’ or ‘buyer’ for a profit but they are allowed to pay the bank over a set number of instalments.

The period of the repayments could be extended but no penalties or additional mark-up may be added by the bank.

▪ Bank buys asset from supplier – therefore bears risk of not being able to sell on or customer defaulting

▪ Bank sells to customer but allows payment in instalments – amount cannot be changed even if customer is late paying i.e. no charge for late payment therefore bank bears risk

▪ A type of short-term debt finance

Question 62

what is Ijra

Answer 62

Ijara is an Islamic equivalent of an operating lease.

▪ the Bank uses/buys a tangible asset (use of assets or equipment such as plant, office automation, or motor vehicles for a fixed period and price) e.g. plane from boeing and lesses it to a customer who needs to use the asset such as emirates in exchange for a regular rental payment whilst retaining ownership throughout the period of the lease contract.

▪ Lessor bears risks and rewards of ownership – lease can be cancelled by company using the asset

▪ Lessor builds a return into lease payments

▪ Major maintenance and insurance are the responsibility of the lessor, while minor day to day maintenance is the responsibility of the lessee.

Question 63

what is Sukuk

Answer 63

Type of long term debt finance

Conventional loan notes are not allowed under Sharia ’a law because there must be a link to an underlying tangible asset and because interest (riba) is forbidden by the Quran. Islamic bonds (or sukuk) are linked to an underlying asset, such that a sukukholder is a partial owner in the underlying assets (E.g. SPV) and profit is linked to the performance of the underlying asset.

E.g. Investors invest money into the SPV and receive certificate (own the bond). The SPV uses the $$ to buy an asset e.g. plance. The asset is leased to a company and so receives annual rental payments to SPV. The return is also distributed to investors from renting the asset.

Since the sukuk holders take on the risks and rewards of ownership, sukuk also has an equity aspect. As owners, sukuk holders will bear any losses or risk from the underlying asset. In terms of rewards, sukuk holders have a right to receive the income generated by the underlying asset and have a right to dismiss the manager of the underlying asset, if this is felt to be necessary

for example, a sukukholder will participate in the ownership of the company issuing the sukuk and has a right to profits (but will equally bear their share of any losses).

▪ Investor (Sukuk holder) receives periodic distributions of income generated by SPV

▪ SPV owns the asset – therefore if company using the asset gets into financial difficulty and defaults then the SPV (and hence bondholders who ‘own’ SPV) will not receive any money and may have to sell the asset or find another company to lease it to

▪ The bondholders therefore bear risk and reward i.e. get a share of the profits generated but also bear the risk of the user of the asset getting into financial difficulty and defaulting

▪ Type of long-term debt finance (with elements of equity in that the investor bears significant risk)

Question 64

what is mudaraba

Explain the nature of a mudaraba contract and

One central principle of Islamic finance is that making money out of money is not acceptable, i.e. interest is prohibited.

Answer 64

A mudaraba contract, in Islamic finance, is a partnership between one party that brings finance or capital into the contract and another party that brings business expertise and personal effort into the contract. The first party is called the owner of capital, while the second party is called the agent, who runs or manages the business.

The mudaraba contract specifies how profit from the business is shared proportionately between the two parties. Any loss, however, is borne by the owner of capital, and not by the agent managing the business. It can therefore be seen that three key characteristics of a mudaraba contract are that no interest is paid, that profits are shared, and that losses are not shared.

▪ Profits shared between the partners based on a signed agreement

▪ Losses are borne by the investor alone, as the provider of finance, up to the limit of the capital provided

▪ Considered to be similar to a ‘rights’ issue type of equity finance

Question 65

what is Musharaka

Answer 65

Musharaka is a form of equity where a partnership exists and profits and losses are shared (A).

Musharaka is a relationship between two or more parties, who contribute capital to a business, and divide the net profit and loss pro rata. It is most closely aligned with the concept of venture capital. All providers of capital are entitled to participate in management, but are not required to do so.

▪ All partners bring a share of the capital, as well as the expertise to the business/project. These do not have to be provided in equal proportions.

▪ Profits are shared in accordance with the original contract between the partners. Losses are shared in proportion to capital invested.

▪ Similar to joint venture equity finance

Question 66

what is the ex div market value of the shares if:

1 for 5 rights issue at price $2.3
Current cum rights price of shares is 3.35

Answer 66

The new ex-div market value per share = (5 × $3.35 + $2.30)/6 = $3.18

Question 67

what is the coupon rate?

Answer 67

The coupon rate gives the annual interest based on the nominal (face) value of the loan notes.

Question 68

Explain the differences between islamic finance and other conventional finance

Answer 68

Wealth creation in Islamic finance requires that risk and reward, in terms of economic benefit, are shared between the provider of finance and the user of finance. Economic benefit includes wider economic goals such as increasing employment and social welfare. Conventonal finance does not require sharing of risks and rewards.

Islamic finance can only support business activities which are acceptable under Sharia law. Murabaha and sukuk are forms of Islamic finance that can be compared to conventional debt finance. Unlike conventional debt finance, however, murabaha and sukuk must have a direct link with underlying tangible assets

Question 69

what is operating lease

Answer 69

A lease in which all risks and rewards related to asset ownership remain with the lessor for the leased asset is called an operating lease. In this type of lease, the asset is returned by the lessee after using it for the agreed-upon lease term.

The ownership of the asset remains with the lessor for the entire lease period. An operating lease is generally treated like renting. That means the lease payments are treated as operating expenses and the asset does not show on the balance sheet.

Since an operating lease is as good as renting, the lease payment is considered an expense. No depreciation can be claimed.

In an operating lease, no running or administration costs are borne by the lessee, including registration, repairs etc., since this lease gives only the right to use the asset.

Question 70

what is Finance lease

Answer 70

In a financial lease, running costs, insurance, maintenance, administration expenses and taxes are higher and are born by the lessee. The ownership transfer option at the end of the lease period is available to the lessee.

A financial lease is generally treated like loan. Here, asset ownership is considered by the lessee, so the asset appears on the balance sheet.

The lease term is generally the substantial economic life of the asset leased.

The lessee can claim both interest and depreciation, as a financial lease is treated as a loan.

Question 71

what are the considerations when issuing debt

Answer 71

1) Security - fixed or floating charge
2) term of loan - redeemable or not
3) interest- fixed of floating

Question 72

what are the advantages of a stock market listing

Answer 72

▪ Access to a wider pool of finance
▪ Easier to seek growth by acquisition
▪ Original owners can realize their investment
▪ Enhanced public image
▪ Improved Marketability of Shares

Question 73

what are the disadvantages of a stock market listing

Answer 73

▪ Significantly greater public regulation, accountability & scrutiny e.g. publish interim accounts in addition to final

▪ Additional costs in regard to new share shares

Question 74

what are Euro bond

Answer 74

any bond issued in a currency outside it’s country of origin

e.g. in London if you were to issue USD bond then it’s called a euro bond

Question 75

what is the minimum requirement for a stock exchange listing

Answer 75

It is used where the public already holds at least 25% of the shares in the company (the minimum requirement for a stock exchange listing).