Chapter 4 Flashcards
What are 7 examples of capital markets?
Stock - companies can issue new shares and investors can buy or sell existing shares
Bonds (debt) markets - companies can raise funds by issuing new bonds and investors can buy/sell these
Banking system - retail market and wholesale market
Leasing - allows businesses to lease cap items instead of purchasing upfront
Debt factoring - allowing companies to borrow against the value of their receivables
Gov grants - financial assurance
International markets - available to large companies allowing them to raise finance in multiple currencies
Which kind of people face lower risk and who faces higher risk and return?
Debt holders - lower risk as debt is generally secured, returns received by debt holders are more certain(such as interest), debts may be redeemable and debt holders are paid before shareholders should the business fail
Shareholders face higher risk and return
What are the three ways of raising equity finance ?
Retentions: retaining profits is the cheapest way as there are no issue costs
Rights issues: an issue of new shares to existing shareholders in proportion to their existing holding. Second most important source of equity finance
New issues to public: least often used and the most expensive way of raising equity finance
What is value of one right?
= TERP - subscription price
What 5 factors need to be considered when making rights issues?
Issue costs -
Issuance price - issue needs to be priced at a sufficient discount to persuade shareholders to take it up
Shareholder reactions - shareholders may react badly to continually being asked for additional funds which may prompt them to sell their shares (driving down share price)
Control - if all shareholders exercise their rights there will be no change in control of the company
Unlisted companies - rights issuances may be difficult to use as shareholders may not be able to sell their rights or to raise funds to exercise them
What is an initial public offering?
When new shares are issued to the public
What are the two types of initial public offering(
Offer for sale:
Shares sold to an issuing house (investment bank)
Issue house offers shares for sale to general public
Direct offer:
Shares sold direct to the general public
What is underwriting when offering shares for sale?
In exchange for a fixed fee, an institution will undertake to purchase any securities not subscribed for by the public
Ensures total funds needed by company are raised
What is venture capital and what are the characteristics of a venture capital?
- risk capital: they want an equity stake in the firm.
Want a company with high growth potential and seek a high return understanding this is high risk.
Often invest in small companies that already have a track record of business development which need additional finance to grow or start up companies with innovative technologies and high growth potential
Characteristics:
- expect 20-49.9% of the shares- enough to exert some control but avoid being majority shareholder
- able to advice and influence management
- exit route often achieved after 3-5 years via selling shares to another company
What is crowd funding and how can it be used as a source of finance?
Using online crowdfunding gplatrform to pitch for finance from a large number of investors.
Need attractive business plan that reassures potential investors
Advantages and disadvantages of crowdfunding?
Adv:
- available to start up companies who often struggle to get more regular sources of finance
- helps to attract customers and build awareness
- can be a quick process (30 days)
Disadv:
- fee is payable to crowdfunding website
- legal and advisory costs
- administrative costs of dealing with investor requests for more info
What is an initial coin offering? What are the two key differences and what are the attractions to it? Disadvantages?
Raises finance from investors but there are two key differences to initial public offering:
- investor receives a token - this might be for a share if give it entitlement to use product or service
- payment is made in cryptocurrency.
- it is simple
- becoming judged as a security and so there is greater regulatory criteria to be met, leading to its decreased use.
What are convertible loans and the 5 benefits for the issuing company?
-fixed return securities which may be converted at the option of the holder into ordinary shares of the same company
Benefits:
- obtaining funds at lower rate of interest
- encouraging investors: with prospect of shares in future
- intriguing an element of short term gearing
- avoiding redemption problems if debt is converted into equity
- being able to issue equity cheaply if converted
What is peer to peer lending and how can it be used to raise finance?
What do the online platforms require?
What are the three advantages?
Uses online platform that connects established businesses with investors.
Good for short and long term investments and can be offered as both secured and unsecured debt.
Usually require borrowers to have a trading track record, to submit financial accounts and will perform credit checks
Advantages:
- come with lower interest rates due to greater competition between lenders
- can be quicker to arrange
- provides a more accessible source of funding for borrowers with a low credit rating
What 5 issues need to be considered when choosing between debt finance be equity finance?
Impact on financial performance: measured by EPS, return on shareholder funds
Impact on financial position: measured by gearing, interest cover, compare to historic performance or industry average
Cost of finance/impact on the WAAC: cost of debt is cheaper than cost of equity, use traditional theory/M&M to discuss expected impact on WAAC
Impact on shareholders: will their control of company be impacted? Do they have to fund new projects
Matching term/risk: will the source of finance last as long as the proposed investment?
What is greening finance?
Encompasses social, green and sustainability linked loans
Financing of investments that provide environmental benefits and encourages sustainable development.
What are the five methods of financing green?
Green loans: loans specifically to help green projects. Lenders offer better terms to borrowers that can show they are reducing envionrmentalcimpact
Sustainability linked loans: they are loans for any purpose but the pricing mechanism means that the loan is cheaper if the borrower achieves certain sustainability linked targets
Green bonds: fixed interest bond used to raise money for climate and environmental projects. Typically secured and have the same credit rating as the company’s other debt obligations but may come with tax incentives
Green funds: to help investors target I no estments in companies with higher standards of social responsibility
Social bonds: use to raise funds for projects that address or mititgate specific social issues and seek to achieve positive social outcomes
What are the four principles of green loans?
Use of proceeds: designated green projects should provide, quantifiable and measurable economic benefits that are reported by the borrower
Process of project evaluation: borrower of a green loan should communicate:
- environmental sustainability objectives
- how it appraises and selects projects
- how it identifies and manages material environmental risks
Management of proceeds: borrowers should establish an internal governance process where they can track allocation of funds
Reporting: borrowers should make available up to date information on use of proceeds
What actions should be taken where there is a conflict of interest?
Inform both clients of conflict
Notify other relevant parties of conflict
Declare that you do not have interests in one party alone
If conflict cannot be reduced, resign from one or both engagements
What controls can be put in place to mitigate threat of conflict of interest?
Use separate engagement teams
Restrict access to info
Clear guidelines for engagement team members on confidentiality and security
Use of agreements signed by employees
Regular review of the application of safeguards by senior partner or compliance team.
What 6 ethical situations are specific to FM?
- ensure that written soncent is needed for anyone to share documents prepared for client use
- take into account interests of all stakeholders unless acting for one
- avoiding advising assurance clients on takeovers
- avoiding sponsoring or underwriting securities issuances for assurance clients
-avoid undertaking management responsibilities of an assurance client
-beware of self interest and familiarity threats to objectivity during corporate finance assignments
When is a market considered efficient?
If the prices on the stock market are fair.
On the workings of the stock exchange what are the two main roles of the members (the ones who can directly buy or sell shares)
Dealers:
- will normally buy or sell irrespective of whether they actually have the securities
- hold a trading stock of securities in which they deal
Brokers:
- client contacts broker with buy or sell order
-broker determines best prices at which to transact
What are the five considerations of efficient markets?
Share prices are fair
No individual dominates the market
Transaction costs are not significant
Share prices follow random walk (rise on good news, fall on bad)
Share prices change quickly to reflect info about a company
What are the three forms of efficiency, what do the share prices reflect, how do you beat the market and when is a positive NPV project reflected in the share price?
Weak form:
- information about past price moves and past info becomes fact
- analysis of forecasts and actions of co
- when its value has been evidenced (reflected in published accounts)
Semi-strong:
- all publicably available info
-insider trading
- when the project is announced
Strong form:
- all information about a company
-luck
-when board agree to undertake a project
What does behavioural finance explain? What are the 9 tendencies of behavioural finance?
It is irrational behaviour by investors which results in share prices not moving in the expected way after the release of new information
Overconfidence: making bad investments due to lack of knowledge and high self belief
Representativeness: over reaction to news
Narrow framing: concentrating too heavily on one piece of info
Miscalculation of probabilities: over estimation of the probability of success
Ambiguity aversion: aversion to investing in new business areas
Positive feedback: assumption that rising shares will continue to rise and falling shares continue to fall
Cognitive dissonance: holding on to long held beliefs in the face of evidence to the contrary
Availability bias: paying undue attention to the latest piece of news about a company and disregarding bigger picture
Conservatism: under reaction to good news
