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FM - Financial Management > Chapter 15 - Sources of Finance > Flashcards

Chapter 15 - Sources of Finance Flashcards

1
Q

Why do firms need finance?

A

to provide working capital
to invest in non-current assets

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2
Q

What is the criterial for choosing a source of finance?

A
  • cost
  • duration
  • term structure of interest rates
  • Gearing
  • accessibility
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3
Q

What is risk?

A

the variability of potential returns

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4
Q

Investment risk arises because of what?

A

returns are variable and uncertain

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5
Q

An increase in the risk taken on by an investor generally requires what?

A

an increase in returns provided by the investment

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6
Q

shareholders provide what to the business?

A

provide equity funding to the business

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7
Q

lenders provide what to a business?

A

provide debt finance

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8
Q

Lenders lend money in return for what?

A

interest receipts and capital repayment

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9
Q

Is debt or equity more protected when lending to companies in risk industries?

A

debt providers will be more protected than equity providers. This provides therefore take on less risk on their investment than shareholders

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10
Q

What is one principle of raising finance in regards to the duration?

A

duration of the funding should match the duration of the need for it

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11
Q

What are the some negatives and positives of bank overdrafts?

A
  • flexible and only used when needed
  • bank can call them in at any time, making them risky to use in the long-term
  • interest rates high
  • if used intermittently only when needed can be cheaper than arranging a loan
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12
Q

What are bank loans?

A
  • can be arranged quickly and put in place for a number of years
  • may not always be available and company may need to provide security
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13
Q

IN the short term a company can aim to?

A
  • collect their receipts in faster
  • delay payments to suppliers
  • have a more efficient inventory system in place
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14
Q

Who are equity shareholders?

A

Ordinary shareholders - the owners of the business and exercise ultimate control through their voting rights

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15
Q

What is equity finance?

A

the investment in a company by the ordinary shareholder, represented by the issued ordinary share capital plus reserves

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16
Q

What are preference shares?

A

their characteristics bear more resemblance to debt finance and so far for the purposes of such calculations as gearing they are considered part of debt than equity

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17
Q

How can we raise finance?

A
  • internally generated funds
  • rights issues
  • new external share issues
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18
Q

what are internally generated funds?

A

retained earnings not already paid out as dividends or used for prior investment. Quick and cheap source of finance if available

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19
Q

what are rights issues?

A

the issue of new shares to existing shareholders in proportion to their existing shareholdings at a discount to the current market value

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20
Q

What are new external share issues?

A

placings, offers for sale etc

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21
Q

what would happen to the share price after a rights issue?

A

expected to fall

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22
Q

What is the formula for the theoretical ex-rights price (TERP)?

A

(Market value of shares already in issue + proceeds from new share issue) / no. of shares in issue after the rights issue

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23
Q

What is another reason for the affect in TERP value?

A

if funds raised from the rights issue are being used to undertake a positive NPV project, the value of that NPV with be theoretically added to the value of the company and therefore would increase the TERP

24
Q

What is the value of a right calculation?

A

TERP - issue (subscription) price

25
Q

What is the value of a right per existing share price?

A

(TERP-issue price) / no. of shares needed to obtain a right

26
Q

What are the different shareholder options in regards to a rights issue?

A
  • take up the rights by buying the specified proportion of shares at the price offered
  • renounce the rights and sell them in the market
  • renounce part of the rights and take up the remainder
  • do nothing
27
Q

What are the characteristics of new external share issues?

A
  • expensive and may fail if investors cannot be found to purchase enough shares to raise the required total cash
28
Q

What is underwriting?

A

when company chooses to have the issue insured

29
Q

Some companies do what to raise enough cash for new external share issues?

A

may require business to become quoted - stringent criteria to adhere to

30
Q

What is a bond/ loan note?

A

a written acknowledgment of a debt by a company, normally containing provisions as to payment of interest and the terms of repayment of the principal

31
Q

What are features of long term finance?

A
  • traded on the stock market
  • usually denominated in blocks of $100 nominal value
  • interest (coupon) paid as percentage of nominal value
  • secured or unsecured
  • may be redeemable or irredeemable
32
Q

What are the advantages for an investor for long-term debt?

A

low risk, low return

33
Q

What are the advantages for a company for long-term debt?

A

cheap, predictable, doesn’t dilute control

34
Q

What are the dis-advantages for an investor for long-term debt?

A

No voting rights (no control) - debt investors do not have equity shares they cannot influence the direction of the company

35
Q

What are the dis-advantages for a company for long-term debt?

A

inflexible, increase risk at high levels of gearing, must be repaid

36
Q

What are examples of other types of loan notes?

A

Deep discount loan notes
Zero coupon loan notes
Hybrid loan notes - convertibles
Hybrid loan notes - with warrants

37
Q

What are deep discount loan notes?

A

issued at a discount to nominal value and redeemable at nominal value and above

38
Q

What are zero coupon loan notes?

A

like deep discount but zero interest is paid whilst in issue. Investors entire return is in the form of a capital gain from the difference between the issue and redemption prices

39
Q

What are hybrid loan notes - convertibles?

A

these give the loan note holder the right to convert (if they choose at the time) the debt into other securities, normally ordinary shares, at a future date

40
Q

What are hybrid loan notes - with warrants?

A

these give the loan note holder the right to subscribe at a fixed future date for a certain number of ordinary shares at a predetermined price

41
Q

Long term lease arrangements would be used when?

A

as debt finance for assets that have a useful life over the mdeium to long-term period

42
Q

What are characteristics of leasing?

A
  • The lease generally covers the whole useful life of the asset.
  • The lessor does not usually deal directly in this type of asset.
  • The risks and rewards of ownership are generally passed to the lessee.
  • The lease agreement cannot be cancelled.
43
Q

What are venture capital investors?

A

take up shares in small, fast growing companies that have significant growth potential

44
Q

What do venture capital investors provide?

A

the funds to help the business grow, and often take an active role in advising the company too

45
Q

Venture capitalists usually aim to do what?

A

grow the company to the point at which it can be floated on the stock market. This allows them to sell their shares, all being well at a huge profit on their original stake

46
Q

SMEs tend to be unquoted and can have difficulty raising finance due to what?

A
  • small number of owners with limited capital available between them
  • lack of business history or proven track record
  • lower level of public scrutiny over accounts and records
  • lack of internal controls and governance over owner-manager decisions
  • lack of tangible assets to use as security for lending.
47
Q

What is the funding gap?

A

the gap between the finance that SMEs could product

48
Q

What are the different options for an SME to raise finance from different sources?

A
  • seed capital
  • high street bank
  • government grant
  • business angel
  • venture capitalist
49
Q

What is the maturity gap?

A

SME find easier to obtain long-term finance compared to small to medium term.

50
Q

Islamic finance operates in accordance to what principles of sharia law?

A
  • sharing of profits and losses
  • no interest (riba) allowed
  • restricted to islamically acceptable transactions, i.e., no investment in alcohol, gambling etc
51
Q

What is Murabaha?

A

Trade credit, similar to equity finance.

52
Q

What is Ijara?

A

Lease finance. The investor owns the asset and makes it available for use by the borrower in return for rental/purchase payments

53
Q

What is Sukuk?

A

similar to debt finance. Instead of owning a bond, the investor owns a share of an asset that the sukuk is linked to

54
Q

What is Mudaraba?

A

Provision of finance (by the rab ul mal) and management of the venture (by the mudarib) are separate.

55
Q

What is musharaka?

A

The investor and investee contribute capital to a joint venture. Both may be involved in management of the venture.

FM - Financial Management (19 decks)

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