Chapter 8 - Business finance Flashcards
What are the 3 sources of financing?
- by ownership: debt & equity
- by duration: short-term and long-term
- by scope: external & internal
Debt holders face ____ risk, _____ returns
lower/lower
In structuring its finances, a business must have risk-return _____ desired by potential investors
trade-off
Equity holders face _____ risk, _____ returns
higher/ higher
What range does a business need for finance?
- immediate: pay wages and day-to-day expense
- short-term: pay for goods/ services bought on credit
- medium term: pay for an increase in inventory and receivables
- long term: pay for NCA
What are the 2 approaches to finance current assets?
- permanent current assets are financed by short-term credit
- permanent current assets and some fluctuating current assets are financed by long-term source
For financing current assets, permanent current assets are financed by short-term credit is _____profitable and ____ risky
more/ less
For financing current assets, permanent current assets and some fluctuating current assets are financed by long-term sources is _____profitable and ____ risky
low/ less
What are the risks to borrowers of short-term finance?
- renewal risk: short-term financing has to be continually renegotiated as the previous relationships or the various overdraft facilities expire
- interest risk: the fluctuation in short-term interest rate
What are the 3 characteristics of choosing short-term and long-term finance?
- aggressive business: more short-term finance than equity
- 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. - defensive business: having little short-term finances and only some of the fluctuating current assets
If a business has more short-term finance than equity, it may return _____ profit but at _____ risk
higher/ greater
If a business matches its maturities, it has ____ risk and _____ return
less/ less
A defensive business will have ___ risk and ____ return
low/low
Usually, short-term finance is ____ than long-term finance due to the risks taken by lenders
cheaper
When will short-term interest rates be higher than long-term rates?
when the inverted yield curve appears (for the periods of economic recession)
What are the factors that should be considered when choosing the financing approach?
- willingness of suppliers
- extend of credit
- the risks of its industrial sector
If a business identifies a short-term surplus of cash, it should aim to invest in ___ term to earn a return
short
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.
longer term
What are the benefits of financial intermediation?
- 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
Name some types of banks in the UK and their roles
- 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
The Monetary Policy Committee (MPC) decides on ____ rate to meet a target for overall ___ in the economy to achieve the aim of monetary stability
base (rate)/ Inflation
London Inter-Bank Offer Rate (LIBOR) is the rate for what?
The rate at which banks lend and borrow money among themselves.
____ take actions or reduce systematic risks in the UK financial system as a whole
The Financial Policy Committee (FPC)
What is the secondary objective of the Financial Policy Committee (FPC)?
FPC has a secondary objective to support the economic policy of the government
How many intermediaries operate the “twin peaks regulatory regime”? Name out those
3
- half: Bank of England
- other half:
+ Prudential Regulation Authority (PRA)
+ Financial Conduct Authority (FCA)
What is the Prudential Regulation Authority (PRA) responsible for?
PRA is responsible for prudential regulation and supervision of banks, buildings, credit unions, issuers, and major investment firms
Name some of the clearing systems and other forms of money transmission.
- 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)
What are the 4 main contractual relationships between the bank and the customer? Describe their characteristics
- 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
