CH:36 Capital Management

Question 1

Capital is needed by companies to?

Answer 1

• deal with financial consequences of adverse events
• provide a cushion against fluctuating trading volumes
• finance expansion
• finance stock and work in progress
• obtain premises, hire staff, purchase equipment

Question 2

What are the sources of capital for financial product providers

Answer 2

• retained profits
• equity capital
• debt capital

Question 3

Why do financial product providers require additional capital?

Answer 3

• meet benefits before sufficient premiums are received
• meet development expenses
• hold a cushion against unexpected events
• meet statutory/solvency requirements
• invest more freely
• sell product guarantees
• demonstrate financial strength to attract business
• smooth profits
• achieve strategic aims

Question 4

how can mutual insurance companies raise capital

Answer 4

• at start-up they require someone to lend the intial capital with no requirement to be repaid unless there are profits
• raise capital through subordinated debt

mutual companies don’t have s/holders, they can’t raise equity capital

Question 5

What are the capital management tools available

Answer 5

• reinsurance - to reduce the amount of capital required
• financial reinsurance - reinsurance arrangement that provides capital, typically through exploiting some form of regulatory, solvency or tax arbitrage
• securitisation - converting an illiquid asset into tradable instruments
• subordinated debt
• banking products - including liquidity facilities, contigent capital and senior unsecured financing
• derivatives
• equity capital
• internal restructuring - including merging funds, changing assets, weakening the valuation basis, deferring surplus distribution and retained profits