Chapter 8 - Business finance

Question 1

What are the 3 sources of financing?

Answer 1

1. by ownership: debt & equity
2. by duration: short-term and long-term
3. by scope: external & internal

Question 2

Debt holders face ____ risk, _____ returns

Answer 2

lower/lower

Question 3

In structuring its finances, a business must have risk-return _____ desired by potential investors

Answer 3

trade-off

Question 4

Equity holders face _____ risk, _____ returns

Answer 4

higher/ higher

Question 5

What range does a business need for finance?

Answer 5

1. immediate: pay wages and day-to-day expense
2. short-term: pay for goods/ services bought on credit
3. medium term: pay for an increase in inventory and receivables
4. long term: pay for NCA

Question 6

What are the 2 approaches to finance current assets?

Answer 6

1. permanent current assets are financed by short-term credit
2. permanent current assets and some fluctuating current assets are financed by long-term source

Question 7

For financing current assets, permanent current assets are financed by short-term credit is _____profitable and ____ risky

Answer 7

more/ less

Question 8

For financing current assets, permanent current assets and some fluctuating current assets are financed by long-term sources is _____profitable and ____ risky

Answer 8

low/ less

Question 9

What are the risks to borrowers of short-term finance?

Answer 9

1. renewal risk: short-term financing has to be continually renegotiated as the previous relationships or the various overdraft facilities expire
2. interest risk: the fluctuation in short-term interest rate

Question 10

What are the 3 characteristics of choosing short-term and long-term finance?

Answer 10

1. aggressive business: more short-term finance than equity
2. average business: matches its maturities
   eg: permanent current assets are financed by long-term debt
   eg: fluctuating current assets are financed by short-term trade credit and overdrafts.
3. defensive business: having little short-term finances and only some of the fluctuating current assets

Question 11

If a business has more short-term finance than equity, it may return _____ profit but at _____ risk

Answer 11

higher/ greater

Question 12

If a business matches its maturities, it has ____ risk and _____ return

Answer 12

less/ less

Question 13

A defensive business will have ___ risk and ____ return

Answer 13

low/low

Question 14

Usually, short-term finance is ____ than long-term finance due to the risks taken by lenders

Answer 14

cheaper

Question 15

When will short-term interest rates be higher than long-term rates?

Answer 15

when the inverted yield curve appears (for the periods of economic recession)

Question 16

What are the factors that should be considered when choosing the financing approach?

Answer 16

• willingness of suppliers
• extend of credit
• the risks of its industrial sector

Question 17

If a business identifies a short-term surplus of cash, it should aim to invest in ___ term to earn a return

Answer 17

short

Question 18

If the surplus is of a longer-term nature, it should be invested in _____ projects to increase shareholder wealth or returned to shareholders as dividends.

Answer 18

longer term

Question 19

What are the benefits of financial intermediation?

Answer 19

• larger loan packages made by the combination of small amounts deposited by savers
• short-term savings can be transferred into long-term loans
• reduce search costs
• reduce risks of finding potential individual borrower

Question 20

Name some types of banks in the UK and their roles

Answer 20

• primary banks: operating money transmission or clearing system
• secondary banks (made up of merchant banks and other banks): do not take part in the clearing system
• bank of England (UK - BOE): carry out monetary policy & ensure financial stability

Question 21

The Monetary Policy Committee (MPC) decides on ____ rate to meet a target for overall ___ in the economy to achieve the aim of monetary stability

Answer 21

base (rate)/ Inflation

Question 22

London Inter-Bank Offer Rate (LIBOR) is the rate for what?

Answer 22

The rate at which banks lend and borrow money among themselves.

Question 23

____ take actions or reduce systematic risks in the UK financial system as a whole

Answer 23

The Financial Policy Committee (FPC)

Question 24

What is the secondary objective of the Financial Policy Committee (FPC)?

Answer 24

FPC has a secondary objective to support the economic policy of the government

Question 25

How many intermediaries operate the “twin peaks regulatory regime”? Name out those

Answer 25

3
- half: Bank of England
- other half:
+ Prudential Regulation Authority (PRA)
+ Financial Conduct Authority (FCA)

Question 26

What is the Prudential Regulation Authority (PRA) responsible for?

Answer 26

PRA is responsible for prudential regulation and supervision of banks, buildings, credit unions, issuers, and major investment firms

Question 27

Name some of the clearing systems and other forms of money transmission.

Answer 27

• general clearing
• electronic funds transfer (EFT)
• bank automated clearing system (BACS)
• clearing house automated payment system (CHAPS)
• faster payment scheme
• society for worldwide interbank financial telecommunication (SWIFT)

Question 28

What are the 4 main contractual relationships between the bank and the customer? Describe their characteristics

Answer 28

• receivable/payable relationship: a contract
• bailor/ bailee relationship: accepting the customer’s property for storage in its safe deposit
• principal/agent relationship: acts on behalf of another party - the principal
• mortgagor/mortgagee relationship: asks the customers to secure the loan with a charge over its assets