Chapter 7 - Business finance Flashcards
How is a business
financed?
By equity from its owners in return for dividends
By debt from lenders in return for interest
Why do debt holders face lower risk but lower returns?
Receive interest before equity holders receive dividends
Debt secured by fixed/floating charges
In the event of company failure, debt holders rank higher then equity holders
Why do equity holders face higher risk but higher returns?
Any profits go to equity holders
What are a business’s immediate needs?
Pay wages and payables
What are a business’s long term needs?
Fund increases in inventory and receivables
Fund non-current assets
How are current assets financed?
Long term finance used to fund non-current assets + permanent assests + short term finance to fund fluctuating current assets.
What are the costs of short term finance?
Cheaper due to lower risks
Flexibility
Includes payables
What is are the risks to borrowers of short term finance?
Increase in risk suffered
Renewal risk
Interest rate risk
What is important when making the decision between short and long term finance?
Depends entirely on risk appetite and percieved risk/return trade off
Average companies - match maturities, less risk and return
Aggressive companies - more short term credit than equity, higher profit and risk
Defensive companies - sacrifices profitability for liquidity, low risk and return
What is the cost of holding cash?
Opportunity cost of what else could be done with the money
What influences the level of cash balances?
Transaction motive
Finance motive
Precautionary motive
Investment motive
How should surplus cash be invested?
Short term - aim to invest for a return
Long term - uses differ
What is financial intermediation?
Process of banks taking deposits from customers and lending them to other customers
What are the benefits of financial intermediation?
Small amounts can be combined to provide larger loan packages
Short term savings can be transferred into long term loans
Companies seeking loan finance can approach banks directly
Reduced risk
What are primary and secondary banks?
Primary - operate cheque accounts, deal with cheque clearing and provide internet banking
Secondary - consists of a wide range of merchant banks, don’t partake in clearing process
What is monetary policy?
BoE is banker to banks, lends at base rate set by MPC who set rates based on inflation target set by chancellor
What is financial stability?
FPC seeks to ensure stability by removing systematic risks in the UK financial system
What is the clearing mechanism?
General clearing
Electronic Funds Transfer (EFT), using EFTPOS
Banks Automated Clearing System (BACS)
Clearing House Automated Payment System (CHAPS)
Society for Worldwide Interbank Financial Telecommunication (SWIFT)
Payment gateways
Digital commerce platforms
What are examples of the bank/customer contractual relationship?
Debtor/creditor
Bailor/bailee
Principal/agent
Mortgagor/mortgagee
What is the bank/customer fiduciary relationship?
Bank the party with more relative power expected to act in good faith towards customers
What are the duties of a bank towards a customer?
Honour cheques
Credit cash/cheques paid
Comply with instructions
Respect confidentiality
What are money markets?
Covers a vast array of markets buying and selling different forms of money/marketable securities.
What are marketable securities?
Short-term highly liquid investments readily convertible into cash.
What are money market financial instruments?
Treasury bills
Deposits
Certificates of deposit (CDs)
Gilts (longer-term government debt)
Bonds
Commercial paper
