Chapter 6 Capital Adjustments Flashcards
Difference between income events and capital events
Income event:
-Coupons from bonds (fixed and floating rate)
- Dividends from equities (ordinary and preference)
Capital event:
- Redemption of bonds (callable/putable, bullet issue, sinking issue)
- Shares (rights issues, bonus issue, splits and consolidation)
What is a bullet issue
Fixed repayment of capital at end
Alternatively, non-bullet issues would
repay the principal over a series of payments, rather than in a lump sum
What is a sinking fund
A sinking fund involves the issuer setting
aside a certain amount of funds toward the maturity repayment each year. The money is often paid to a
separate trustee, who will either hold the money until the scheduled maturity date, or buy back bonds
in the open market if they are trading below par. The sinking fund reduces the risk that the issuer will
not have sufficient funds to repay the entire principal on the maturity date.
What are putable and callable bonds
Callable bonds can be redeemed earlier at discretion of company
Putable bonds can be redeemed earlier at discretion of investor
What is cum and ex dividend period
Cum-div- The buyer of the security will be entitled to next dividend payment
Ex div- Entitlement of next dividend payment remains with seller- buyer not entitled
What is record date
Date which company inspects the register of members in order to establish which shareholders will be sent div
What is special ex-date trade
Takes place in cum div period but bought/sold without div. Permitted for up to 10 business days before ex div date
What is special cum-div trade
Takes place in ex div period but bought/sold with div. Permitted up to the day before the dividend payment date
Why would an investor want to trade special ex
To avoid income tax
What is claim generation
In such situations, if the dividend was paid to the wrong person in a special cum-trade, then it is the broker acting for the buyers that should make a claim for the dividend.
In contrast, when the dividend
has been paid to the wrong person, following a special ex trade, it is the seller’s broker who will have tomake the claim for their client to receive their rightful dividend payment.
Features of rights issue
A follow on issue of shares giving existing shareholders the right to subscribe to more shares in proportion to their existing holding
- Mitigates risk of diluting ownership
- Shares offered at discount to current market price
- Issues generally underwritten
Theoretical Ex Rights Calculation
eg 1:4 rights issue. 1 IS NEW SHARE AND 4 IS EXISTING SHARE ALWAYS
TERP=
(Existing share number * existing share price) +(New share number * New share price)/
(number of shares altogether new one and old)
What is an open offer
Rights issue but investor not permitted to sell rights nil-paid. Can either take rights or allow rights to lapse
What are pre-emptive rights
A pre-emption right is the right of the shareholder to be able to buy shares to maintain their existing percentage shareholding.
Possible for shareholders to waive pre-emptive rights through special resolution. Anyway should limit such issuance to 5% each year
Shares issued pro-rata to existing shareholdings
Theoretical nil paid price calculation
= TERP - Subscription price
Maximum nil-paid rights calculation
Number of rights sold = number of RIGHTS available*subscription price/ TERP
Minus this number from total number of rights available
What is a capitalization issue
Issue of new shares to existing shareholders in proportion to existing shareholding. Shareholders dont have to pay for the new shares
What is scrips/bonus issue
Follow on issue of shares to existing shareholders in proportion to existing holding
- Shares issued free of charge
- Dilutes share price alot
Theoretical ex-scrip price calculation
Current share price * existing holding/ number of shares held after scrip/bonus issue
Who is approval required from for share buy-backs
Shareholders
Reasons for buy backs
- When the company has reduced its activities (perhaps having sold a major part of its business) and
has surplus cash to return to shareholders. - When the company wants to reorganise its capital structure to include more debt and less equity (RATIONALISE CAPITAL STRUCTURE). In
these circumstances the company can borrow money (by issuing bonds or from banks), and use it to
buy back and therefore reduce the number of shares it has in issue.
Methods of buybacks
- Block trade
- Accelerated book building
- Best efforts with back stop price
- Bought deal
What is a block trade
Like placing in reverse
when an investment bank acting for the company will seek to do a small number of
large trades with investors, perhaps through an exchange.
What is a bought deal
IB guarantee you will receive number of shares you want to buy back (like underwritten)
underwriter(s) actually purchase
the shares themselves and then attempt to resell them to clients. The investment bank(s) that
provide the guarantee will retain the inventory that is not sold on.
What is accelerated book building
The correct answer is: A - An investment bank contacts larger institutional investors in the company to see if they would be willing to sell their shares at a certain price
What is FCA disclosure and transparency rules
Notifiable interest= 3% or more of shares triggers obligation to inform company. Once above 3%, notification required if holding rises or falls through a whole % point
At what % acquired is takeover successful
Above 50%
Acquire X% or more of a company then takeover/merger proceedings will be announced to market
30%
How does bonus issue affect EPS and DPS
eps and dps decrease as more shares
Look at table showing what happnes in split, consolidation etc
What capital event raises capital
Rights issue
Options when offered rights issue
Will receive provisional allotment letter then 4 choices:
- Take up rights
- Sell rights
- Split the rights
- Allow rights to lapse
How does rights issue affect net assets
Net assets increase by the amount raised
What is a dawn raid
Acquirer instructs brokers to purchase shares in target company as soon as market open to take legal control before public disclosures need to be made
Examples of indirect stakebuilding
Another possibility for keeping stakebuilding more secretive is to build a stake in an ‘indirect’ way.
Instead of buying shares in another entity directly, the stake could be established by acquiring contracts
for difference (CFDs). A CFD on a share is an agreement between the buyer and seller to exchange the
difference in the current value of the share and its value at the end of the contract. If the difference is
positive, the seller pays the buyer; if it is negative, the buyer pays the seller. CFDs enable participants to get
the economic exposure of owning a stake in another entity in a less visible and potentially leveraged way.
Examples of direct stake building
- Buying shares
What is purpose of stake building
- build strategic link
- acquire target company
Which of the following corporate actions would a company take in order to convert its reserves into new ordinary share capital?
A company converts its reserves, which may have arisen from issuing new shares in the past at a premium to their nominal value, or from the accumulation of undistributed past profits, into new ordinary shares.
These shares rank pari passu with those already in issue and are distributed to ordinary shareholders in proportion to their existing shareholdings free of charge.
Which of the following would result in an issuer of shares receiving cash?
The pre-emptive rights issue is the only one to raise capital. In a capitalisation issue the company issues shares for free. No new shares are issued in either a secondary market sale or an introduction.
How is the net asset per share affected following a 1:3 scrip?
Decreased by 1/4
What best describes the effect on the balance sheet of a 1:1 bonus issue?
Share capital increases; reserves decrease
What would the theoretical ex-rights price be, given the following?
A stock is priced 155p cum dividend. It will trade ex-dividend of 10p next week. There is a 3:5 rights issue at 110p.
The new shares rank pari passu except for the dividend.
Ex-div price = 155p - 10p = 145p 3 shares x 110p = 330p 5 shares x 145p = 725p 330p + 725p = 1,055p 1,055p / 8 shares = 131.9p
The question specifically states that ‘It will trade ex-dividend of 10p next week’. This is why the 10p dividend is stripped out of the cum-div price
What is a purpose of the rules contained in relevant legislation relating to a company buying back its own shares? It is there to:
To protect the interests of creditors
The cum-price of a share before a 5:1 capitalisation issue was 300p. What is the theoretical ‘ex’ price?
Before the scrip issue: 1 share @ 300p.
During the scrip issue: 5 shares were issued at no cost.
After the rights issue: 6 shares @ 300p.
Therefore, the theoretical ‘ex’ price = 300p/6 shares = 50p.
An individual holds 2,100 shares in X plc. The cum-rights share price is £6 when the company performs a 1:3 rights issue. The subscription price is £5. What is the maximum subscription at nil cost?
2100 SHARES, NOT RIGHTS
2,100 shares will give the shareholder 700 rights as it is 1:3 rights issue. The formula to calculate the number of rights that need to be sold is the no. of rights x Subscription price / Theoretical ex-rights price
TERP = ((£6x3)+£5)/4 shares = £5.75
700 x £5 / £5.75 =609
These rights are then deducted from the rights available to give the maximum subscription at nil cost.
700 - 609 = 91 shares
Which one of the following statements best reflects what happens with respect to the merger of two companies?
One company will exchange new shares for the shares of the other company
A firm makes a 1:10 scrip issue; you have a client whose portfolio contains 15,000 shares and was worth £50,000 before the scrip issue. Your client wants to know what his portfolio will be worth after the issue. It will be worth:
A scrip issue will not change the overall value of the portfolio. Rather than having 15,000 shares worth £50,000, the investor will have 16,500 {15,000 + (15,000 / 10) } shares worth £50,000.
