B. Sources of long-term funds Flashcards

Question

what is the secondary function of the stock market?

Answer 1

enable investors to sell their investments to other investors - more marketable than unlisted companies - tend to be more attractive to investors

Answer 2

has shareholders and liability of the shareholders to creditors is limited to original capital invested i.e. nominal value of the shares and and premium paid in return personal assets protected in the event of insolvency

Answer 3

when an entity obtains a listing for its shares on a stock exchange i.e. flotation or IPO

Answer 4

- once listed, the market will provide a more accurate valuation of the entity than had been previously possible - realisation of paper profits, and mechanism for buying and selling shares int he future at will - raise profile of entity, which may have an impact on revenues, credibility with suppliers and long-term providers of finance - raise capital for future investment - makes employee share schemes more accessible

Answer 5

- costly for a small entity (flotation, underwriting costs, etc) - making enough shares available to allow a market, a and hence loss of at least some control of the original owners - reporting requirements are more onerous - stock exchange rules for obtaining a quotation can be stringent

Answer 6

``` more marketable appreciation in value better reputation and profile better credit rating more access to finance ```

Answer 7

Stock Exchange for larger companies, more stringent criteria | AIM for smaller companies, more straightforward admission

Answer 8

forces of supply and demand demand drives up prices of shares

Answer 9

IPO Placing Rights issue

Answer 10

shares are offered for sale to investors through an issuing house can be fixed price or in tender offer investors are invited to at suggested price all shares are sold at best price which they would be taken up

Answer 11

shares are placed directly with certain investors (normally institutions) on a pre-arranged basis

Answer 12

selling IPO shares immediately

Answer 13

contractual restriction that prevents insiders who are holding a company's shares before it goes public, from selling the shares for a period usually lasting 90-180 days after the company goes public insiders include company founders, owners, managers, employees and venture capitalists

Answer 14

prevent the market from being flooded with a large number of shares which would depress the share price

Answer 15

they typically own a large percentage of shares

Answer 16

alternative to fixed price offer - subscribers tender for the shares at, or above, a minimum fixed price - once all prices received, a strike price is set and bidders who offered above are given shares - strike price set to make sure that the company raises the required amount of finance from the share issue - all pay strike price

Answer 17

placement or private placement

Answer 18

sale of securities to a relatively small number of select investors as a way of raising capital investors are usually large banks, mutual funds, insurance companies and pension funds

Answer 19

cheaper and quicker to arrange than most other methods but does not normally lead to a very active market for the shares after flotation

Answer 20

equity capital that is not quoted on a public exchange consists of investors and funds that make investments directly into private companies or conduct buyouts of public companies that result in a delisting of public equity try to improve financial results and prospects of a company in the hope of reselling the company to another firm or cashing out via an IPO

Answer 21

large amounts of debt are issues to fund a large purchase

Answer 22

investment banks

Answer 23

- the appointment of other specialists eg lawyers - stock exchange requirements - forms of any new capital to be made available - the number of shares to be issued and the issue price - arrangements for underwriting - publishing the offer

Answer 24

provide advice on the various methods of obtaining a listing work with IB to identify institutional investors, but usually they are involved with smaller issues and placings

Answer 25

little direct involvement other than as investors and agreeing to buy shares provide indication of take-up of shares

Answer 26

new shares are issued to existing shareholders in proportion to their existing shareholding relatively simple to arrange and do not dilute control not always suitable way of raining large amounts of finance

Answer 27

the right to buy new shares ahead of outside investors prevent dilution by new issues protected by law and can only be waived with the consent of shareholders cheaper than public issue but more expensive than placing

Answer 28

low enough to secure acceptance

Answer 29

avoids the possibility that the entity will not sell all of the shares it is issuing and so receive less funds than it expects usually financial institutions such as merchant banks agree to buy unsubscribed shares for a fee

Answer 30

through a deep-discounted rights issue reduces possibility of shareholder not taking up their rights

Answer 31

- tendency for price to fall after announcement - temporary fall due to:consequences of issue, future profits, future dividends after actual issue, price will normally fall again because: - -more shares in issue - -new shares were issues at market price discount

Answer 32

when rights issue announced, all existing shareholders have the right to subscribe for new shares and so there are rights attached to the shares and the shares are traded cum rights

Answer 33

on first day of dealings, the rights no longer exist and the old shares are now traded ex rights i.e. no rights attached

Answer 34

theoretical ex rights price is price the shares will trade on the first day of trading after issue

Answer 35

- do nothing:shares diluted - renounce the rights and sell them on the market - exercise the rights - renounce part of the rights and take up reaminder

Answer 36

- option of buying shares at a preferential price - have the option of withdrawing cash by selling their rights - able to maintain their existing relative voting position

Answer 37

- simple and cheap to implement - usually successful - provides favourable publicity

Answer 38

increases by their share of the project NPV as long as they either take up the rights or sells them

Answer 39

Issue price < Ex rights price < Cum rights price

Answer 40

in the event of a default, the lender will be able to take assets in exchange for the amounts owing

Answer 41

the debt is secured against a specific asset, normally land or buildings preferred as puts lender at front of queue

Answer 42

secured against general assets e.g inventory not as strong as fixed charge security in list of creditors

Answer 43

specific requirements or limitations laid down as a condition of taking on debt financing

Answer 44

dividend restrictions: amount they can pay financial ratios:specific levels and certain ratios financial reports:regular issue of further debt:restrictions

Answer 45

prevent excessive dividend payments which may seriously weaken the company's future cash flows and thereby place the lender at greater risk

Answer 46

lender: requiring and prohibiting activities borrower: reduce the cost of borrowing

Answer 47

state what the borrower cannot do

Answer 48

- additional long-term debt - pay cash dividends exceeding certain threshold - sell certain assets - enter into leases - combine in any way with another firm - compensate or increase salaries of certain employees

Answer 49

state what the borrower must do

Answer 50

- maintain certain minimum financial ratios - maintain accounting record in accordance with generally accepted accounting principles - provide audited financial statements - perform regular maintenance of assets used as security - maintain life insurance policies on certain key employees - pay taxes and other liabilities when due

Answer 51

net worth and current ratio

Answer 52

- waive the breach and continue the loan - waive the breach and impose additional constraints - require penalty payment - increase interest rate - demand immediate repayment of the loan - increase security needed - terminate debt agreement

Answer 53

the earlier the better can negotiate a smaller penalty give details of recovery plan, additional security or parent company guarantees

Answer 54

banks or capital markets

Answer 55

- liquidity - timescale - cost

Answer 56

accessibility latter open to all - preferred by SMEs former is costly and cumbersome for aspiring companies, need to build reputation to get higher interest rates

Answer 57

bank:submission to terms set out by the bank as well as dealing with sometimes uncertain conditions capital markets:difficult and expensive but reduced cost once in

Answer 58

money market used by a participant as a means of borrowing and lending in the short term i.e. <12m interbank lending

Answer 59

revolving credit facilities -can withdraw up to a pre-approved credit limit amount fo available credit decreases and increases as -funds are borrowed and then repaid -make repayments based on amount used or withdrawn plus interest flexible debt financing option

Answer 60

debt security in which the issuer owes the holders a debt and depending on the terms of the bond, is obliged to pay interest and repay the principal at a later date like a loan -coupon is interest

Answer 61

shareholders have an equity stake in the company and bondholders have a creditor stake -another difference is bonds usually have defined terms (maturity) but shares may be outstanding indefinitely

Answer 62

large, well-established listed companies with good credit ratings may issue short-term unsecured money market security referred to as commercial paper - generally mature within 9 months - risky if used for longer term finance as may be insufficient investor interest at one of the 3 month issue dates so need backups - can trade at any time before the maturity date

Answer 63

issues underwriters purchasers

Answer 64

sell bonds usually governments(biggest one), banks and corporations

Answer 65

investment banks and other financial institutions help sell the bonds more risk involved with this type of debt

Answer 66

medium term note programme issuer via the underwriter can issue debt securities on a regular and/or continuous basis

Answer 67

buy the bonds governments, banks

Answer 68

listing | admission to trading

Answer 69

if not already listed, must apply - listing dependent on the securities gaining admission to trading on the Main Market through satisfying the Exchange's admission and disclosure standards - can take 3 days - appointing advisers with extensive experience of listing and agreeing the timetable well in advance should help shorten the process

Answer 70

UKLA (UK Listing Authority). a division of the Financial Conduct Authority FCA responsible for approval

Answer 71

Order book for retail Bonds - launches by London Stock exchange - electronic order-driven trading service for UK government, corporate and supranational bonds

Answer 72

offer retail investor's efficient access to an on-screen secondary market in retail denominated London listed debt instruments

Answer 73

in response to demand from private investors in the UK for a cost effective and transparent mechanism fo gaining access to fixed income securities and to develop the market for retail denominated bonds in the UK

Answer 74

11 days prior to the admission date

Answer 75

an electronic copy of the base prospectus and the relevant pricing supplement/final terms document, a cope of the relevant board minutes relating to the issue, confirmation of the market maker who will be supporting the security and an indicative opening price for the security

Answer 76

to ensure that all instruments available on the ORB are tradeable and have prices available throughout the day

Answer 77

the issue or a third party broker but must be a member firm of London Stock Exchange and be authorised to deal

Answer 78

two-way prices (buy and sell) in the security throughout the continuous trading period

Answer 79

must be within maximum spread requirement determined by the trading segment and trading sector of the security also a minimum volume (equivalent to nominal value) of securities which must be quoted on either side

Answer 80

complete and submit a registration information form market maker has no obligation to quote in more than on security and there is no fee payable to register in ORB securities

Answer 81

fund a foreign investment project or foreign subsidiary

Answer 82

a hedge of the value of the project or subsidiary to protect against changes in value due to currency movements -borrowing can be serviced from cash flows arising from the foreign currency investment

Answer 83

developed country:whichever currency they prefer | developing country:in international currency e.g. USD

Answer 84

issues on the international capital markets - any major currency - listed on domestic stock exchange but cannot be traded through that exchange - bearer instruments and pay interest annually, gross of tax

Answer 85

domestic bonds are both listed and traded on the local stock exchange and are usually registered bonds, that is, registered to a named holder

Answer 86

self-regulated off-shore market self-regulation is promoted by the International Capital Market Association (ICMA) who set rules for members to follow in areas such as processing transactions and payment of comission

Answer 87

- should the entity borrow at a fixed or floating rate? - should the debt have a short-term or a long-term repayment date? - should domestic currency or foreign currency borrowings be used?

Answer 88

risk of gains or losses on assets and liabilities due to changes in interest rates -will occur for any organisation which has assets or liabilities on which interest is payable or receivable

Answer 89

the amount of interest bearing assets or liabilities that na entity holds and the type that these are (floating or fixed rate)

Answer 90

associated with interest rate risk because it looks at the risk that borrowings will not be refinanced or will not be refinanced at the same rate

Answer 91

- lenders are unwilling to lend or only prepared to lend at higher rates - the credit rating of the company has reduced making it a more attractive lending option - the company may need to refinance quickly and therefore have difficulty in obtaining the best rates

Answer 92

has to be regularly repaid and then renegotiated if additional finance is needed

Answer 93

risk that arises from possible future movements in an exchange rate 2 way risk:adverse or favourable

Answer 94

- assets and/or liabilities in a foreign currency - regular income and/or expenditures in a foreign currency - no assets

Answer 95

``` retained earnings existing cash balances sale and leaseback grants debt with warrants attached convertible debt venture capital business angels government assistance leasing ```

Answer 96

assets= equity + liability all assets are funded by equity and liabilities cost of that cash should be based on the cost of the debt and/or equity that was used to fund it this would be WACC

Answer 97

selling good quality fixed assets such as high street buildings and leasing them back over many years (25+) funds are released without any loss of use of assets any potential capital gain on assets is forgone popular for retail organisations e.g. tesco, M&S

Answer 98

often related to tech, job creation or regional policy particular important to SMEs key advantage:do not need to be paid back usually provided by government

Answer 99

option to buy shares at a specified point in the future for a specified (exercise) price often issued with a bond as a sweetener to encourage investors to purchase the bonds - potential for capital gain - can sell warrant before exercise date - can buy share on exercise date

Answer 100

finance provided to young, unquoted profit-making entities to help them expand -equity finance - accept low levels or dividends - receive most of their returns as capital gains on exit e.g IPO or flotation

Answer 101

similar to venture capitalists for smaller companies

Answer 102

schemes to assist SMEs, relocating businesses, innovators, new job creation

Answer 103

commercial agreement where an equipment owner conveys the right to use the equipment in return for payment by the equipment user of a specified rental over a pre-agreed period of time

Answer 104

- readily available form of finance so convenient - removes the need for significant capital outlay at the beginning of a project's life i.e. avoids the need to find the capital at the outset - cheaper in financial terms than conventional debt financing:asset backed finance so less risky for lender, lower rate than standard borrowing

Answer 105

only once the decision to invest in the asset has been taken

Answer 106

BOTH at the post tax cost of debt-both have similar risk

Answer 107

no as they are bearer instruments

Answer 108

lower return that it demands due to the attraction of the option of conversion to equity i.e. it is cheaper to service than ordinary debt

Answer 109

WACC falls as debt is a cheaper source of finance than equity WACC rises as the equity holders perceive more risk caused by the increase in debt so the cost of equity rises

Answer 110

interest is an obligation so less risk for lender | interest is tax deductible reducing cost

Answer 111

extra interest payments may make dividend payments less likely

Answer 112

because the entity might then be failing to exploit the benefits which borrowing can bring

Answer 113

tend to be depressing

Answer 114

will fall as debt finance is cheaper and outweighs any increases in the cost of equity required to compensate equity holders for higher financial risk

Answer 115

cost of debt will also rise as loaners will become worried about the security of their loans

Answer 116

the overall return required by investors is minimised

Answer 117

shareholder wealth is affected by changing the level of gearing there is an optimal gearing ratio at which WACC is minimised and the total value of the company is maximised financial managers have a duty to achieve and maintain this ratio while we accept that the WACC is probably U shaped for entities generally, we cannot precisely calculate a best gearing level the optimum level will differ from one entity to another and can only be found by trial and error

Answer 118

perfect capital market:no information costs and transaction costs debt is risk free and cost of debt remains constant at all levels of gearing investors are indifferent between personal and corporate gearing investors and companies can borrow at the same rate of interest

Answer 119

the two opposing forces cancel out exactly

Answer 120

future post tax (pre financing) operating income generated by its assets

Answer 121

operate in the same type of business and face similar operating risks so must have the same total value

Answer 122

any benefit from the increased proportion of cheaper debt finance (downward force on the WACC) must be exactly offset by the increase in the cost of equity (upward force on the WACC)

Answer 123

ignoring tax, a company should be indifferent between all possible capital structures

Answer 124

show that market pressures will ensure that 2 companies identical in every aspect apart from

Answer 125

mathematical analysis of a world in which a number of major assumptions have been imposed - many assumptions unrealistic - inspired further work that examines the impact of relaxing those assumptions in order to tell how gearing might affect the behaviour of capital markets

Answer 126

corporation tax system carries a distortion under which returns to debt holders (interest) are tax deductible for the company, whereas returns to debt holders equity holders are not - pay less tax - will have greater market value and lower weighted average cost of capital

Answer 127

99.9% debt

Answer 128

Vg=Vu + TB

Answer 129

that the market would not reward companies for something that could be achieved at zero cost and zero risk

Answer 130

that debt is risk free | -higher levels of debt mean higher risk for lenders and shareholders

Answer 131

- company's ability to borrow money - existing debt covenants - increasing costs of debt finance as gearing rises - views of other stakeholders and rating agencies - tax exhaustion - directors' interest

Answer 132

maximum level of borrowing that a company can comfortably support -function of creditworthiness and credit scoring

Answer 133

affect credit score or creditworthiness - reduction may be evidenced by a credit rating downgrade - reputational damage (suppliers, customers)

Answer 134

at some point interest payable will be so high that taxable profit will be reduced to zero beyond this point, there will be no further benefit of raising debt finance for tax exhaustion to apply, the company must be making a loss and will have breached any interest cover covenants -will have bigger issues than loss of tax relief

Answer 135

may be reluctant to rely too heavily on debt because their careers may be affected if they borrow responsible but company is unable to service the debt may prefer to raise equity rather than debt, even when the company has some remaining borrowing capacity

Answer 136

``` tax issues country risk type of finance provided by the parent transfer pricing thin capitalisation rules ```

Answer 137

borrowing funds in the country where it generates its net income -any servicing costs for the finance can then be paid out of the income generated without worrying about exchange rate movements

Answer 138

they are both financed by cash by the parent and therefore can be funded by the parent by either debt or equity the choice of capital structure for a subsidiary is therefore independent of the decision regarding the appropriate group capital structure

Answer 139

an adjustment if it is deemed that the interest rate charged is not set at a market rate

Answer 140

ratio greater than 50:50 interest cover < 3

Answer 141

aims to stop companies from getting excessive tax relief on interest if the have entered into a borrowing with a related party that exceed the amount a third party lender would be prepared to lend

Answer 142

- interest on the part of the borrowing that an independent third party would be prepared to lend the company is allowable - the excess is disallowed - the borrowing capacity of the individual company and its subsidiaries is considered (but not the rest of the group)

Answer 143

gearing: high debt causes thin cap issues | interest cover

Answer 144

- M&M's dividend irrelevancy argument - the interests of shareholders (the clientele and the bird-in-the-hand argument - the signalling effect or information content of dividends - the cash needs of the entity

Answer 145

says that the pattern of dividend payout should be irrelevant as long as companies continue to invest in positive NPV projects, the wealth of the SH should increase whether or not the company makes a dividend payment this year

Answer 146

1. the return on a share is determined by the share's risk 2. the return itself is delivered to shareholders in 2 parts:one part is the dividend paid and the other is the capital gain/loss in the share price 3. the dividend decision is how the return is delivered:how much of the earnings are paid as dividends vs reinvested 4. as the dividend decision does not affect the risk of the shares, it does not affect their return. All the dividend decision therefore does is to determine how the return is to be split up between dividends and capital gains 5. do shareholders ming how the returns are split? answer according to M&M is no they dont is we asusme i) there are no taxes 11) shares can be bought and sold free of any transaction costs

Answer 147

if a person is holding shares but the company withholds a dividend, the SH can sell some of the shares to replace the lost income

Answer 148

dividends delivered in the form of capital gains rather than dividends

Answer 149

if they had to incur transaction costs when realising their capital gains

Answer 150

investment policy as investors could manufacture dividends if they need to

Answer 151

clientele effect bird-in-the-hand argument

Answer 152

companies should follow a consistent dividend policy to ensure they gather clientele who like their particular policy irl, investors will have a preference for dividends or capital gains

Answer 153

a dividend is certain and some investors prefer that over the promise of future dividends even if capital gains would be more tax efficient

Answer 154

investors look at dividend decision as signal on company's financial performance and future firms will choose to keep steady, predictable dividend annually regardless of situation

Answer 155

1. reduction in the dividend per share signals that the company is in financial difficulties 2. a failure to pay out any dividend at all signals that the company is very close to receivership

Answer 156

dividend growth lagged two to three years behind earnings growth -managers reluctant to increase dividend per share until they are confident they can maintan new level

Answer 157

Apple Computers: paid no dividends for years, preferring to reinvest and reduce need for financing.Market responded positively to Apple throughout and share price rose strongly

Answer 158

poorer credit rating, struggle to raise finance from external sources so its cash needs might have to be met by restricting the amount of dividends it pays out

Answer 159

will have many potential investment opportunities. the cash needs for these new investments will have to be met by balancing dividend policy alongside external finance sources

Answer 160

might be cash rich which allows them to afford large dividends without compromising it internal cash needs

Answer 161

make a judgement on dividend policy after taking many varying factors into acocunt

Answer 162

- the clientele effect - the cash needs of the company - signalling - legal factors - debt covenants - tax implications - link to investment and financing - inflation:dividend increase needed to maintain purchasing power of last year's dividends?

Answer 163

stable dividend policy constant payout ratio zero dividend policy residual approach to dividends

Answer 164

paying out a constant or constantly growing dividend each year: - offers investors a predictable cash flow - reduces management opportunities to divert funds to non-profitable activities - works well for mature firms with stable cash flows

Answer 165

reduced earnings would force a dividend cut with all the associated difficulties

Answer 166

paying out a constant proportion of equity earnings: - maintains a link between earnings, reinvestment rate and dividend flow but - cash flow is unpredictable for the investor - gives no indication of management intention or expectation

Answer 167

all surplus earnings are invested back into the business. Such a policy: - is common during the growth phase - should be reflected in increased share price when growth opportunities are exhausted (no further positive NPV projects are available): - cash will start to accumulate - a new distribution policy will be required

Answer 168

a dividend is paid only if no further positive NPV projects available. This may be popular for firms: - in the growth phase - without easy access to alternative sources of funds

Answer 169

cash flow is unpredictable for the investor | gives constantly changing signals regarding management expectations

Answer 170

a variant on the stable dividend policy paying out a stable, but rising dividend per share: - dividends lag behind earnings, but can then be maintained even when earnings fall below the dividend level - avoids 'bad news' signals - does not disturb the tax position of investors

Answer 171

bonus shares free of charge as an alternative to a cash dividend

Answer 172

- if the company wishes to retain cash in the business - if shareholders wish to reinvest dividends in the company but avoid brokerage costs of buying shares - if there are tax advantages of receiving shares rather than cash

Answer 173

- if all shareholders opt for bonus shares, the scrip issues has the effect of capitalising reserves. Reserves reduce and share capital increases - both share price and earnings per share will fall due to the greater number of shares in issue-overall value of each shareholders' shares and share in future earning theoretically remain unchanged

Answer 174

share capital is non-distributable in the future

Answer 175

- Feb 2011 - rights issued without charge Shareholders given rights to receive additional shares and 3 options for their allotment of rights: 1) sell the rights off market to Santander and receive a fixed cash amount 2) sell the rights on market and receive cash 3) hold the rights and receive new Santander shares, 1 share for every 65 rights held

Answer 176

alternative to paying a dividend used when the company has no positive NPV projects to invest in, so it returns the cash to shareholders alternatively, a company may decide to use a one-off large dividend to return surplus cash to shareholders

Answer 177

buy back all their shares this is rare

Answer 178

- choice for investors - lower future total dividends - can change control - no change in the share price:paying dividend would lower the share price - removes the dividend policy precedent:failing to repeat a large one-off dividend can send the market a negative signal

Answer 179

- approval needed in general meeting: more time consuming - difficult to set a fair price for the repurchase:company will hope for a lower price whereas shareholders will hope for a higher price

Answer 180

both a share repurchase and a one-off large dividend have the same impact on the cash, and the gearing of the company (they reduce the value of equity, so increase the gearing and hence financial risk and cost of equity)

Answer 181

scrip dividend:EPS falls, share price falls | share repurchase: EPS rises, share price stays constant

Answer 182

total equity in SFP remains the same | capital structure and gearing ratio is the same

B. Sources of long-term funds Flashcards

(208 cards)