Chapter 1 Flashcards
What are some sources of cashflow?
Internal cashflow: retained earnings plus depreciation.
External cashflow: long term debt and stock.
Discount bond
Bond currently trading for less than its par value because the coupon rate is lower than the prevailing interest rates.
Premium bond
Bond currently trading for more than its par value because its coupon rate is higher than the interest rate.
Indenture
Contract used by creditors to protect themselves.
Interest is paid … tax
BEFORE!
What does the bond indenture state?
The face value
The coupon rate
Type of security: classification according to collateral.
Collateral trust bonds
Secured by marketable securities.
Mortgage bonds
Secured by real assets.
Debenture
Unsecured, not backed by real assets.
Sinking fund
Used to retire bonds periodically before maturity.
Callable bond
Call option to firm to retire bonds before maturity.
The purpose of this is to replace high coupon with lower rate.
Extendible bond
Call option to extend the maturity, hedge against lower rate.
Retractable bond
Put option, right to sell at par, hedge against higher rate.
Convertible bond
Call option to convert bond into common shares, exercise only if the stock price increases.
Bond with warrants
Call option to buy new shares at a fixed price.
Covenants
Restrictions that limit the actions of the borrower, the purpose of it is to avoid conflicts of interests and reduce the risk of the bond.
Loan types
Amortized loan
Interest only loan
Bullet loan
Collateral
Preferred share
- Combines the features of a bond and equity, but has preference over common shares in terms of dividends.
- Dividend can be cumulative.
- No voting rights.
Call provision
A call provision lets the company repurchase or call a bond/preferred issue at a predetermined price over a specified period.
Bond refunding
Occurs when outstanding debt is replaced.
Reasons for calling a bond
- Lower interest rate in the market
- Improved credit rating
- Reduce debt (better financial ratios)
Callable bond VS non callable bond
- Callable bond should have a higher coupon rate than a non callable bond.
- Investors hate risk, this is the compensation (premium).
Dividend is paid … tax
AFTER!
Common equity
Represents the shareholder’s stake in the company.
Rights
-Right to receive new shares
(called pre-emptive rights in case of issue of new shares).
-Right to receive dividend
-Right to vote to elect directors to the board.
Straight voting
One vote per share for each director. (doesn’t allow minority shareholders in the election)
Cumulative voting system
Use multiple votes for a single director. (allow minority to participate).
Proxy vote
Allow other party to vote a share on your behalf.
Different classes of common stock
- full voting shares
- no voting shares
- restricted voting shares
Market value
The price of the stock multiplied by the number of shares outstanding.
Book value
The sum of par value, contributed surplus, accumulated retained earnings.
Market value should always be … than Book value
HIGHER!
How could a company raise private equity financing?
- Securities not sold on the exchange
- Sold directly to a small number of investors
- Venture capital
- Private placement
From private to publicly traded firm how could you raise money?
- Initial public offering (IPO)
- Private placement
Firm commitment (bought deal)
Buy and resell securities, the dealer does not have the option to decline the issue if the selling price drops below purchase price.
Best effort
The dealer does not guarantee the amount of the issue, he can return the unsold shares to the firm.
Green shoe provision
It gives the dealer the option to buy additional shares from the issuer at the original offering price. ( It is an additional cost to the firm)
The registration statement
Provides information about the proposed uses of the funds obtained, the firm’s history and existing plans for the future.
Red Herring
Preliminary prospectus used to market the stock, this is given to potential investors.
Underpricing
Selling below the true value.
When to use underpricing?
For firms choosing the best effort deal.
POP system
It allows large firms to register files quickly.
Rights offering
One right is offered for every share owned. A rights offering gives the holder the option of buying 1 new share for N rights plus the $X (exercise price). A right is an option.
Standby underwriting
the firm uses the services of an investment banker to distribute shares and eventually buy the unsold shares.
