Brainscape's Knowledge GenomeTM

Browse over 1 million classes created by top students, professors, publishers, and experts.


See full index

Business, Technology and Finance > Chapter 8: Business Finance > Flashcards

Chapter 8: Business Finance Flashcards

You may prefer our related Brainscape-certified flashcards:
Series 65 flashcards Series 63 flashcards Series 66 flashcards Series 7 Top-off Exam flashcards SIE Exam flashcards CFA flashcards Series 79 Top-Off Exam flashcards
1
Q

What is a financial intermediary?

A

Financial intermediaries bring together investors/lenders with borrowers/users of funds

They mirror the ‘real world’ by providing a relatively risk-free lending environment and easily accessible funds for borrowing

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
2
Q

What are the roles of the financial intermediary?

A
  • Risk diversification: e.g., one lender not lending all money to one borrower
  • Aggregation: e.g., pooling lots of deposits together to get better returns
  • Maturity Transformation: loans and deposits mature at different times
  • Making a market: putting lenders and borrowers ‘in touch’
  • Advice: e.g., on best rates available
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
3
Q

What is a fiduciary relationship?

A

Banks have a fiduciary relationship which means that they are expected to act in good faith in its relationship with the customer

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
4
Q

What is the mortgagor/mortgagee relationship?

A

If the customer defaults on a loan, the bank has rights to the assets of the customer

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
5
Q

What is the principal/agent relationship

A

Where the bank acts as the agent for the customer. When a customer receives funds into their account, the bank with whom they have the account acts as the customer’s agent. For example, when the bank pays a third party sums promised on a customer cheque

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
6
Q

What is the bailor/bailee relationship?

A

When the bank safeguards property e.g. title deeds as collateral on a mortgage

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
7
Q

What is the receivable/payable relationship?

A

The bank and the customer contractually ‘owe’ each other dependent on whether overdrawn or in credit

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
8
Q

What are the three main components of the UK banking system?

A
  • Primary banks
  • Secondary banks
  • Bank of England
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
9
Q

What is a primary bank?

A

Those banks which deal with day-to-day money transmission, e.g., clearing banks like Barclays, Natwest or LLoyds

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
10
Q

What is a secondary bank?

A

These offer tailored advice to large commercial clients usually in raising considerable sums e.g., merchant banks like Rothschild

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
11
Q

What is the Bank of England?

A

They act as a banker to the banks by lending money to the banking sector through its financial market operations

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
12
Q

What are the roles of the Bank of England?

A
  1. Carrying out monetary policy

2. Ensuring financial stability

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
13
Q

What is monetary policy?

A

The Bank of England lends money to the banking sector at the base rate which is set by the Monetary Policy Committee

Banks then lend and borrow money among themselves at rates such as the London Intern Bank Offered Rate (LBOR) which then in turn affects the rates offered to customers when combined with other determining factors

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
14
Q

How do the Bank of England achieve Financial stability?

A
  • The Bank of England’s Financial Policy Committee (FPC) is responsible for taking action to remove systemic risks in the UK financial system as a whole
  • The Prudential Regulation Authority (PRA) is also part of the Bank of England and is responsible for prudential regulation and supervisions of banks, building societies, credit unions, insurers and major investment firms
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
15
Q

What is the Financial Conduct Authority?

A

Financial service firms which are not supervised by the PRA are regulated by the Financial Conduct Authority (FCA) which is an independent body that is also responsible for:

  • Promoting effective competition
  • Ensuring that relevant markets function well
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
16
Q

What is contractionary monetary policy? What about expansionary monetary policy?

A

If the Monetary Policy Committee increase the base rate of interest this encourages savings, otherwise known as contractionary monetary policy.

If they decrease the base rate, this stimulates spending and so is an expansionary monetary policy

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
17
Q

What is contractionary monetary policy? What about expansionary monetary policy?

A

If the Monetary Policy Committee increase the base rate of interest this encourages savings, otherwise known as contractionary monetary policy.

If they decrease the base rate, this stimulates spending and so is an expansionary monetary policy

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
18
Q

What is Fintech?

A

A combination of finance and technology = PayPal

These disrupt the traditional banking sector and include:

  • Crowd Funding
  • Peer to Peer lending - e.g., Zopa
  • Online currency conversion
  • Digital Wallets: e.g., Apple Pay
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
19
Q

What are some cash transmission techniques? (GC, EFT, BACS, CHAPS)

A
  • General Clearing: mainly cheques, costly and takes up to 4 days to clear
  • Electronic Fund Transfers (EFT): any computer based system used to transfer money electronically
  • Bank Automated Clearing System (BACS): deals with salaries, standing orders and direct debits. Same day clearing
  • Clearing House Automated Payments System (CHAPS): covers items greater than or equal to £10,000 and provides same day clearing in the UK in GBP
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
20
Q

What are some cash transmission mechanisms part 2? (SWIFT, FPS, PG, DCP)

A
  • Society for Worldwide Interbank Financial Telecommunication (SWIFT): Similar to CHAPS but for international transfers
  • Faster Payments Scheme: same day clearing for amounts less than or equal to £250k, for some customers of some banks, using phone or internet instruction
  • Payment gateways: system for payment authorisation when using credit cards online
  • Digital commerce platforms - e.g., Paypal - payments made just using e-mail address. Very low cost
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
21
Q

What are money markets?

A
  • Covers a vast array of markets buying and selling different forms of money or marketable securities
  • The money markets provide short-term (less than a year) borrowing and investing to companies, banks, and the public sector
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
22
Q

What is the capital market?

A
  • This is the national and international market in which a business may obtain the finance it needs for its short-term and long-term plans
  • The capital market deal in longer-term borrowing and investing, mainly via a stock exchange. In the UK London Stock Exchange and Alternative Investment Market (AIM)
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
23
Q

What are marketable securities?

A

Marketable securities are short term highly liquid investments that are readily convertible into cash

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
24
Q

What are treasury bills?

A

These are issued by the BoE on behalf of the government. They have a minimum investment of £500,000, last up to a maximum of twelve months. Whilst they are very secure, they offer low returns

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
25
Q

What are deposits?

A

These are usually placed in accounts with banks for period from overnight to five years. Yields usually higher than Treasury Bills

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
26
Q

What are certificates of deposit? CDs

A

These are issued for deposits of £50,000 or more for a fixed term. They can be traded in the CD market. These are fully negotiable and attractive the investor.

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
27
Q

What is a gilt?

A

These offer a range of maturities and rates based on money market rates

These are longer-term government debts and they guarantee a fix cash payment every 6 months till the maturity date

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
28
Q

What is a bond?

A

Debentures and loan stock of companies quoted on the Stock Exchange
These are readily tradable and offer good liquidity

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
29
Q

What are commercial papers?

A

IOUs issued by large companies which can be held to maturity or sold to third parties beforehand.
Usually arise from large, listed companies trying to raise money - these have HIGH issue costs

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
30
Q

What are National Stock Markets?

A

In the the UK this includes the London Stock Exchange and the Alternative Investment Market (AIM). They act as:

  • primary markets i.e a source of new finance via new share issues
  • secondary markets for securities such as shares that are already in issue
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
31
Q

How can businesses access finance within the capital market?

A
  • National Stock markets
  • The banking system (the retail market and the wholesale market)
  • Bond markets (generally for very large organisations to raise very large amounts of money)
  • Leasing
  • Debt factoring (normally for small businesses to help their working capital requirements)
  • International Markets: typically available to larger companies, these allow finance to be raised in different currencies, typically in very large amounts
How well did you know this?
1
Not at all
2
3
4
5
Perfectly
32
Q

What does raising new, long-term finance involve?

A

Raising new long-term business finance invariably involves issuing securities in the form of shares (equity) or bonds (debt)

How well did you know this?
1
Not at all
2
3
4
5
Perfectly
33
Q

What are the three main types of capital market instruments available for business to use as finance?

A
  • Equity/Shares
  • Preference Shares
  • Loan stocks and debentures
34
Q

What is equity/shares?

A

Ordinary shares in the business

Equity shareholders are the owners of the business and exercise ultimate control

35
Q

What are preference shares?

A

Preference shareholders are entitled to dividends before ordinary shareholders, therefore they carry less risk
-They usually receive a fixed percentage dividend

36
Q

What are loan stocks and debentures?

A

Those with these entitlements usually receive a fixed rate of interest

They are usually secured on specific assets such that lenders are protected in liquidation

37
Q

How are businesses financed?

A

By a combination of:

  • Equity: supplied by owners who want a dividend in return
  • Debt: supplied by lenders who want interest in return
38
Q

What is the key difference between equity holders and debt holders?

A

Debt holders face lower risk but less returns

  • they receive interest before dividends are paid
  • they often secure the debt with fixed/floating charges
  • if the company fails, they are paid in preference to equity holders

Equity holders face higher risk but enjoy higher returns in the form of profits distributed as dividends

39
Q

What two items must you manage within treasury management?

A
  • Liquidity: Being able to pay debts as they fall due

- Profitability: minimising the holding of cash - an idle asset

40
Q

What are the costs of holding cash?

A

Lost interest on deposits or other investments

41
Q

What can influence the level of cash balances? (4 motives)

A
  • Transaction motive - to meet current day to day financial obligations
  • Precautionary motive - to cushion against unplanned expenditure
  • Investment motive - to take advantage of opportunities
  • Finance motive - to cover major transactions
42
Q

What are the costs of running out of cash?

A
  • loss of settlement discounts
  • loss of supplier goodwill
  • poor industrial relations if wages are not paid
  • winding up of business, liquidation
43
Q

What is the classic rule for financing?

A
  • Short term needs should be financed by short term funds. This is basically working capital (the balance of inventories, payables, receivables, and cash) and overdrafts
  • Long term assets should be financed by long term funds, essentially debt and equity
44
Q

What are the advantages and disadvantages of short term finance?

A

Advantages:

  • Relatively cheap: shorter period of risk exposure for lenders. Trade payables are interest free. Although unsecured overdrafts are expensive
  • Flexible: a bank overdraft, for example, is only used when needed

Disadvantages:

  • Renewal risk: an overdraft may be recalled on demand at the lenders discretion
  • Interest rate risk: short term interest rates can fluctuate
45
Q

What are the advantages and disadvantages of long-term finance?

A

Advantages:
- More predictable and assured, presenting lower operational risk

Disadvantages:

  • Equity finance will expect high returns due to the risk of business failure
  • Debt finance i.e. money lent from banks, will be expensive for long-term loans as there is increased uncertainty and a longer period of risk-exposure, therefore higher interest rates will be charged
46
Q

How do you approach balancing long-term and short-term finance?

A

Three broad approaches:

Aggressive: sees a business use more short term finance over debt and equity; offers greater probability as it is cheaper but higher risk

Defensive: the business is risk averse and will use a portion of long term finance for its short term needs; less risk but expensive (e.g. long bank loan with longer interest payments)

Average: looks to strike a balance between the risk and reward in its financing approachh

47
Q

What are retained earnings?

A

A means of raising equity finance:

  • Internally generated funds that are easy and important
  • Profits can be paid as dividends or reinvested to the business
  • Shareholders expect a return on the funds re-invested in the business (i.e an increase in their welath)
  • Profits reinvested may lead to growth = growing share price
48
Q

What are rights issues of shares?

A

A means of raising equity finance.

A rights issue is an issue of new shares for cash to existing shareholders in proportion to their existing holdings.

  • must be legally made before a new issue to the public (unless shareholders agree otherwise)
  • Existing shareholders have rights of first refusal (pre-emption rights) on the new shares
  • Can be waived by selling shares to others
49
Q

What factors should you consider when making a rights issue?

A
  • Issue costs
  • Shareholder’s reactions - if they react badly, they may sell their existing shares, driving down the market price
  • Control - as long as large numbers of existing shareholders do not sell their rights to new owners
  • Unlisted companies - often find rights issues difficult to use, as shareholders may not have sufficient funds to take up their rights but are not able to sell them
50
Q

What is a new issue of shares?

A

A means of raising equity finance.

Usually done for listed companies or if they are listing for the first time.

  • Expensive
  • Time consuming

Can take the form of placings or public offers.

51
Q

What are placings?

A

Placings are the most common method of issuing shares when a company first comes onto the market.

  1. Shares are sold to an issuing house (investment bank)
  2. Issuing house ‘places’ shares with its clients (sells them the shares)

The investor base in a placing is made up of institutional investors, contacted by the issuing house

52
Q

What are the benefits of placings?

A
  • Benefit: lower transaction costs (e.g. advertising, admin) than public offers
  • Disadvantage: by only offering to a narrow pool of institutional investors which reduces the efficiency of the market in the shares
53
Q

What are public offers?

A

Can take place in two different ways:
So the company goes through an issuing house to offer shares for sale to the general public OR the company directly offers shares to the general public

The offer for sale (issuing house route) is far more common. The issue in both methods is likely to be underwritten. There is no restriction on the amount of capital raised by public offer.

54
Q

What are some problems with the pricing of new issues?

A

If priced too high then the issue fails

If priced too low, then too many shares are issued

These can be managed by underwriting or using an offer for sale by tender

55
Q

What is underwriting?

A

Underwriting is the agreement for another company or bank to buy any unsold shares

56
Q

What is offer for sale by tender?

A

Selling shares to the public and inviting them to set a price. The company will then issue new shares at the highest price that will generate the funds that they need. This is the minimum price that tenders must be at or above the minimum. Does not normally need to be underwritten

57
Q

What are the benefits of preference shares?

A

Preference shares have no voting rights and no right to share in excess profits.

  • Benefits: attractive if looking to raise new capital but want to avoid additional debt or dilute the ordinary shareholder’s influence
  • Drawbacks: Preference shares offer a fixed rate of dividend each year. Most preference shares are ‘cumulative’, so all arrears have to be paid before equity dividends can be paid. Expensive to issue and finance
58
Q

What are the advantages and disadvantages to ‘going public’?

A

This means to ‘go public’ or ‘float’ on the Official List of the Stock Exchange

Adv:

  • Access to a large source of finance
  • Improves the marketability of shares which in turn increases the value of the company
  • Raises the profile of the company

Disad:

  • Can be very expensive
  • Dilution of control (at least 25% of the company has to be in public hands)
  • Need to have traded for three years
  • Having to answer to other investors
  • Greater scrutiny of the affairs of the company and the actions of the directors
  • Listing might not be successful unless the business is worth at least £50m
  • Possibility of being taken over
  • Extra costs of control and reporting systems to meet the increased demands on the company due to listing rules
  • Risk of failure: share price immediately drops
59
Q

What is involved in the process of going public?

A

Lots of specialist advisors:

  • Sponser: usually an investment bank, can also be a stockbroker, accountant etc. They assess whether flotation is appropriate, helps draft prospectus, co-ordinates all advisors, prices and underwrites the issue
  • Accountant: involved in long-form report
  • Corporate broker: advises on market conditions and likely demand, generates interest with investors, helps with issue method and pricing, may organise sub-underwriting
  • Registrar: record ownership of sales
  • Solicitors: deal with legal aspects
  • Investing public
60
Q

What are the advantages and disadvantages of an overdraft?

A

Adv:

  • Flexible: can be used and repaid as desired
  • Cost: overall interest cost can be lower as interest is only paid when overdrawn

Disadv:

  • Risk: as it is repayable on demand it is not suitable as a long-term source of capital, since banks can - and do - demand immediate repayment
  • Cost: if permanently in overdrawn, the overall interest cost is higher as the interest rate is generally higher
  • Control - the bank may require security on assets of the business
61
Q

What is an overdraft?

A

Source of debt finance.

An overdraft is a short-term loan of variable amount up to a limit from a bank, typically repayable on demand. Interest is charged on a day-to-day basis at a variable rate

Used by businesses to meet their short-term cah deficits. They are repayable on demand,

Despite this, many companies have a permanent overdraft used as a long-term source of finance

62
Q

What is debt factoring?

A

Debt factoring is when the business receives loan finance and insurance, known as non-recourse factoring, so that, in the event that a customer does not pay, the business does not have to repay the loan. If it is with recourse, the business is liable to the factoring company if the customer never pays

Services typically offered:

  • Financing the credit taken by customers
  • Insuring receivables
  • Managing the running of the receivables ledger
63
Q

What is a term loan?

A

A term loan, usually a bank loan, is where the repayment date is set at the time of the borrowing. They are not repayable on demand, unless the borrower defaults on repayment.

  • Interest rates can be fixed or variable
  • Relatively small arrangement fees are usually payable on term loans
  • Term loans are usually secured against assets
  • Repayment schedules are flexible. Interest ‘holidays’ of up to two years can be negotiated to allow new ventures to be become established before loan repayments are made
64
Q

What is loan stock?

A

Loan stock is debt capital (called bonds or debentures) in the form of securities issued by companies, the government and local authorities

65
Q

What are key considerations of loan stock in regard to coupon rate and redemption value?

A
  • Coupon (interest) rate: Can be fixed or variable. Annual interest is the coupon rate x nominal value of the stock
  • Redemption Value: Loans can be repaid at par, at a premium or at a discount to the par (nominal) value. If repaid at a premium, investors will find the stock more attractive and will be happier to accept a lower or zero coupon rate which eases company’s cash flow
66
Q

What are key considerations of loan stock in regard to redemption date and recipient?

A

Redemption date:

  • Loan stocks are normally medium to long term
  • Some bonds are undated (perpetual or irredeemable)
  • On undated bonds, must sell the loan stock to get capital back

Recipient:

  • With UK domestic bonds issued on the Stock Exchange, the bond holder’s name is recorded on a register, as with shares
  • Some bonds e.g., Eurobonds, are ‘bearer’ bonds. The holder of the bond will receive the payments due.
67
Q

What is leasing?

A
  • A finance lease is a lease that transfers substantially all the risks and rewards of ownership of an asset from the lessor (the finance company or bank) to the lessee (the business)

An operating lease is any other lease

68
Q

What are the differences between a finance lease and an operating lease?

A

Finance:

  • Long-term debt finance: a purchase of the asset by the lessee, financed by the lessor
  • Lease exists for the majority of the asset’s useful life
  • Ownership passes to the lessee at term end or a cheap secondary lease period
  • Lessee bears the liability of ownership
  • Cannot be cancelled or charge early cancellation charges = liability for all payments

Operating:

  • Short-term rental of an asset
  • Lease period usually less than asset’s useful life
  • Ownership remains with the lessor
  • Lessor usually responsible for repairs and maintenance
  • The lease can sometimes be cancelled at short notice
69
Q

What are business angels?

A

Means to financing a growing business.

These are experienced, wealthy individuals investing in start-ups, early stage or expanding businesses. Tend to invest at a much earlier stage. Equity rather than debt as they want money for shares. High risk as want high returns

70
Q

What is crowdfunding?

A

A means of financing a growing business by raising a specific sum of money from individuals, usually via the internet.

  • Can contribute money as loans, equity or simply donations
  • Can pre-buy a product or service not yet launched
  • Peer-to-peer lending and equity-based investment are the largest sectors of crowdfunding and are regulated by the FCA
  • Other forms of crowdfunding are still largely unregulated
71
Q

What is crowdfunding?

A

A means of financing a growing business by raising a specific sum of money from individuals, usually via the internet.

  • Can contribute money as loans, equity or simply donations
  • Can pre-buy a product or service not yet launched
  • Peer-to-peer lending and equity-based investment are the largest sectors of crowdfunding and are regulated by the FCA
  • Other forms of crowdfunding are still largely unregulated
72
Q

What are venture capitalists? (VC)

A

Means of financing a growing business.
i.e. Dragon’s Den

VC is the provision of risk-bearing capital, usually in the form of in equity to companies with high growth potential

High risk so VCs expect high returns (25%-40% annually), often requesting a presence on the board

  • Medium term source of finance
  • Not a management role but they offer advice and are able to influence management
  • Return in the form of capital gains after 3-5 years
  • Key issue = exit route: can be by a trade sale (shares or the whole company), flotation, buy-back of shares on re-financing
73
Q

Aside from Business Angel’s, crowdfunding or VCs, how can a growing business acquire finance?

A

Through the Alternative Investment Market. The AIM has less stringent regulations than the full Stock Exchange and is available to companies with a value of at least £1m with relatively low-entry costs

74
Q

What risks exist for companies who export goods?

A
  • Physical risk: lost or stolen in transit
  • Trade risk: customer refusal to accept goods on delivery or cancellation in transit
  • Cultural and Political Risks
  • Credit risk: default by the customer
  • Liquidity Risk: inability to finance the credit given to customers
75
Q

How do you reduce export risks?

A

With the help of banks, insurance companies, credit reference agencies and government agencies such as the UK’s Export Credits Guarantee Department

76
Q

How do you combat Credit Risk as an exporter?

A

Bills of Exchange: A document drawn up by the exporter (seller) and sent to the overseas buyer’s bank. The bank accepts the obligation to pay the bill by signing it and therefore payment is guaranteed. Can then sell or discount to third party for cash.

  • Letters of credit
  • Export Credit Insurance
77
Q

What are letters of credit?

A

Letters of credit provide a method of payment in international trade which is risk-free. The arrangement between the exporter, the buyer and participating banks must take place before the export sale takes place

  • the exporter receives immediate payment of the amount due to him, less the discount from the banks
  • the buyer is able to get a period of credit before having to pay for the imports

But this is slow to arrange and administratively cumbersome. Good for a business with new-buyers with no credit history

78
Q

What is Export credit insurance?

A

Export credit insurance is insurance against the non-payment by foreign customers for export debts

Some private companies provide credit insurance for short-term export credit business, and the UK government’s Export Credits Guarantee Department (ECGD) provides long-term guarantees to banks on behalf of exporters

Also covers political differences or losses due to changing exchange rates

79
Q

What is green finance?

A

Green finance is any source of finance that is used specifically to finance projects or activities that lead to environmental benefits:

green bonds, green loans, grants and venture capital funds that specialise in investing in green projects

These fulfill corporate sustainability and responsibility goals

80
Q

What are green bonds?

A

Green bonds are any type of bond instrument where the proceeds will be exclusively applied to eligible green projects and which are aligned with the four core components of the GBP

81
Q

What are the Green Bond Principles?

A
  1. Proceeds must only be used for projects with clear environmental benefits
  2. Must be a defined process for project evaluation and selection
  3. Proceeds must be kept in a separate account (or tracked by issuer)
  4. Use of proceeds should be reported to the investor

Business, Technology and Finance (15 decks)

Brainscape helps you reach your goals faster, through stronger study habits.
© 2024 Bold Learning Solutions. Terms and Conditions