Chapter 14

Question 1

How do firms raise money for investment? (2)

Answer 1

• external financing

- plow back profits and reinvest them rather than paying them out as dividends

Question 2

Two types of external financing, and what they are?

Answer 2

1) Debt: involves borrowing money to be repaid (+interest)

2) Equity: involves raising money by selling interests in the company

Question 3

See

Answer 3

Note on figure 14.2 top of side 1

Question 4

See

Answer 4

14.1: balance sheet (and practice it)

Question 5

What are the two ways to calculate the debt ratio?

Answer 5

1) Total debt to total assets (debt/assets)

2) Total LT liabilities to total capitalization (LT liabilities/LT liabilites+equity)

Question 6

What do common stock/ordinary share in the UK represent?

Answer 6

Ownership in a corporation

This ownership is exercised by voting in appointment of board of directors and voting on corporate policy

Question 7

What does it mean that common stock is a residual claim?

Answer 7

Means if the firm is liquidized, holders get paid only after BHs, preferred shareholders, debt holders and workers

Question 8

2 ways banks protect their claim on debt?

Answer 8

• Borrowing allowances

- Dividend sizes

Question 9

In practice, SHs only really vote on boards and key firm decisions such as mergers; if many don’t vote…?

Answer 9

Can lead to management getting a ‘free hand’

Question 10

Explain the voting procedures wrt board of directors? And exception?

Answer 10

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

Question 11

What is the difference between book and market value?

Answer 11

• 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)

Question 12

What are DCSs? Give an example of dual class shares?

Answer 12

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

Question 13

What is tunnelling?

Answer 13

Exploitation of minority shareholders

Question 14

What is preferred stock?

Answer 14

Stock that takes priority over common stock in regards to dividends (ie. they get paid first)

Question 15

Define net worth?

Answer 15

Bookvalue of common shareholder’s equity + Preferred stock

Question 16

What are floating-rate preferred stock?

Answer 16

Preferred stock paying dividends that vary with ST interest rates

Question 17

Advantage of partnerships?

Answer 17

They avoid corporate income tax tf losses/profits are passed straight through to partners’ (investors)n tax returns

Question 18

Example of a limitation to partnerships?

Answer 18

Limited life span (search why?)

Question 19

What is a trust? Give an example of them and explain?

Answer 19

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)

Question 20

What does debt allow for that equity doesn’t?

Answer 20

Allows borrowers to walk away from obligations in exchange for assets of company

Question 21

Define default risk?

Answer 21

Likelihood a firm will walk away from its obligations

Question 22

What are bond ratings used for?

Answer 22

They are issued on debt instruments to help investors assess the default risk of a firm

Question 23

5 questions a debt financial manager should ask?

Answer 23

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

Question 24

LEARN ALL DEFINITIONS PAGE 2 SIDE 1 OF NOTES!!!

Answer 24

now

Question 25

What is meant by ‘accounts payable’?

Answer 25

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

Question 26

4 types of ‘hidden’ debt?

Answer 26

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

Question 27

Example of unfunded obligations in real world?

Answer 27

2011 American Airlines promised 18.5bn to pensions but only actually had 8.3bn tf 10.2bn unfunded debt

Question 28

What are special purpose entities? (SPEs)

Answer 28

Set up to raise mixture of equity and debt, uses funds to help parent company (doesn’t show up on balance sheet!)

Question 29

See

Answer 29

figure 14.5 is slides

Question 30

What are financial markets, and what are their 3 main functions?

Answer 30

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

Question 31

What do financial intermediaries do?

Answer 31

They raise money from investors, then provide financing to firms and make a return of it (eg. banks, insurance firms, pension funds, investment funds)

Question 32

How do mutual funds work? What does their share price depend on?

Answer 32

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

Question 33

What is a money-market fund?

Answer 33

Type of mutual fund, invests on in ST, safe securities (eg. US treasury bill)

Question 34

Difference between an open-end and a closed-end fund?

Answer 34

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

Question 35

What is an exchange traded fund? (ETF)`

Answer 35

A portfolio of stocks that can be bought/sold in a single trade

Question 36

3 points defining hedge funds?

Answer 36

• restricted access (private investors, not any old who)
• investors are limited partners and general partner is in ‘limited partnership’
• performance related fees

Question 37

Role of commercial banks? (2)

Answer 37

Provide loans and safe money storage

Question 38

2 roles of investment banks?

Answer 38

• 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

Question 39

What do insurance companies do?

Answer 39

They invest in corporate stocks and bonds (LT financing) using money raised via insurance policies

Question 40

4 main roles of the FM and Intermediaries?

Answer 40

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)