Chapter 14 Flashcards
How do firms raise money for investment? (2)
- external financing
- plow back profits and reinvest them rather than paying them out as dividends
Two types of external financing, and what they are?
1) Debt: involves borrowing money to be repaid (+interest)
2) Equity: involves raising money by selling interests in the company
See
Note on figure 14.2 top of side 1
See
14.1: balance sheet (and practice it)
What are the two ways to calculate the debt ratio?
1) Total debt to total assets (debt/assets)
2) Total LT liabilities to total capitalization (LT liabilities/LT liabilites+equity)
What do common stock/ordinary share in the UK represent?
Ownership in a corporation
This ownership is exercised by voting in appointment of board of directors and voting on corporate policy
What does it mean that common stock is a residual claim?
Means if the firm is liquidized, holders get paid only after BHs, preferred shareholders, debt holders and workers
2 ways banks protect their claim on debt?
- Borrowing allowances
- Dividend sizes
In practice, SHs only really vote on boards and key firm decisions such as mergers; if many don’t vote…?
Can lead to management getting a ‘free hand’
Explain the voting procedures wrt board of directors? And exception?
Come up for re-election every year
UNLESS classified BofD
then only 1/3 will come up each year - this has been found to increase firm value
What is the difference between book and market value?
- BV tells how much capital a firm has raised from SHs in the PAST
- MV depends on future dividends SHs expect to receive (and tf share price)
What are DCSs? Give an example of dual class shares?
Dual class shares are when there are different dividend/voting rights attached to two different types of share
They often sell at a premium (sometimes have private benefits attached eg. seat on BofD)
eg. Google when first made public, founders got 10 votes/share
What is tunnelling?
Exploitation of minority shareholders
What is preferred stock?
Stock that takes priority over common stock in regards to dividends (ie. they get paid first)
Define net worth?
Bookvalue of common shareholder’s equity + Preferred stock
What are floating-rate preferred stock?
Preferred stock paying dividends that vary with ST interest rates
Advantage of partnerships?
They avoid corporate income tax tf losses/profits are passed straight through to partners’ (investors)n tax returns
Example of a limitation to partnerships?
Limited life span (search why?)
What is a trust? Give an example of them and explain?
A trust, the owners of ‘units’ have passive ownership tf no voting rights (tf firms rarely set up like this)
Example:
REITS = Real estate investment trusts (avoid taxes as long as they pay 95% of earnings to REITS owners, but are limited to real estate) (created to encourage public investment in commercial real estate)
What does debt allow for that equity doesn’t?
Allows borrowers to walk away from obligations in exchange for assets of company
Define default risk?
Likelihood a firm will walk away from its obligations
What are bond ratings used for?
They are issued on debt instruments to help investors assess the default risk of a firm
5 questions a debt financial manager should ask?
1) LT or ST borrowing? (depends on I length)
2) Should debt be fixed/floating rate?
3) Borrow in own/other currency?
4) What promises should be made to lender?
5) Should you issue straight or convertible bonds?
See pages 357-358 for full discussion
LEARN ALL DEFINITIONS PAGE 2 SIDE 1 OF NOTES!!!
now
What is meant by ‘accounts payable’?
Obligations to pay for goods that have already been delivered (ST debt)
Method used by accountants to make the debt levels seem less/hide debt
4 types of ‘hidden’ debt?
Accounts payable
Lease payments (may have a stream of payments for foreseeable future if paying for something slowly)
Unfunded obligations (eg. senior debt such as pensions)
SPEs
Example of unfunded obligations in real world?
2011 American Airlines promised 18.5bn to pensions but only actually had 8.3bn tf 10.2bn unfunded debt
What are special purpose entities? (SPEs)
Set up to raise mixture of equity and debt, uses funds to help parent company (doesn’t show up on balance sheet!)
See
figure 14.5 is slides
What are financial markets, and what are their 3 main functions?
Market where financial assets are issued and traded
They:
-raise money through primary issues
-allow investors to trade amongst themselves
-help firms to manage risks
What do financial intermediaries do?
They raise money from investors, then provide financing to firms and make a return of it (eg. banks, insurance firms, pension funds, investment funds)
How do mutual funds work? What does their share price depend on?
They raise money by selling their shares to investors, money is then pooled and invested
Depends on Net Asset Value (NAV) of firm
They attempt to beat the market
What is a money-market fund?
Type of mutual fund, invests on in ST, safe securities (eg. US treasury bill)
Difference between an open-end and a closed-end fund?
An open end fund will buy back/issue shares as it sees fit
A closed-end fund has a fixed number of shares that are traded
What is an exchange traded fund? (ETF)`
A portfolio of stocks that can be bought/sold in a single trade
3 points defining hedge funds?
- restricted access (private investors, not any old who)
- investors are limited partners and general partner is in ‘limited partnership’
- performance related fees
Role of commercial banks? (2)
Provide loans and safe money storage
2 roles of investment banks?
- assist firms in raising finance (don’t accept deposits/make loans) by eg. underwriting stock offerings at an IPO (see book page 363)
- offer advice on takeovers, mergers and acquisitions
What do insurance companies do?
They invest in corporate stocks and bonds (LT financing) using money raised via insurance policies
4 main roles of the FM and Intermediaries?
1) Payment mechanism (allows people to pay/get paid safely and quickly over long distances)
2) Borrowing/Lending (channels savings towards those who can best use them)
3) Pooling risk (allows individual’s to share/transfer risk to those most equipped to bear it)
4) Information (allows estimation on rates of return and helps firms to summarize their success and value)
