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finals (2 year) > Corporate finance > Flashcards

Corporate finance Flashcards

1
Q

Liquidation

A

All company assets are sold
The proceeds from the liquidation are used to pay the firms creditors and the firm ceases to exist

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2
Q

Reorganization:

A

It is the more common form of bankruptcy for large corporations

the firms existing management is given the opportunity to propose a reorganization plan

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3
Q

What happens to the expected costs of financial distress when leverage increases

A

They increase

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4
Q

Three key factors determine the present value of financial distress costs

A

1) The probability of financial distress

2) The magnitude of financial distress costs

3) The discount rate for financial distress costs

1) distress costs have negative CAPM beta (costs are high when the firm (the market) does poorly
2) So the beta of the financial distress costs is negative

2) This makes the expected costs of financial distress even higher

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5
Q

Total value of a company VL =

A

V^L = VÛ + PV(interest tax shield) - PV(Financial distress costs)

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6
Q

Value of a levered firm:

A

V^L = Vû + PV(interest tax shield) - PV(Financial distress costs) - PV(Agency costs of debt) + PV(Agency Benefits of Debt)

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7
Q

What happens when you have too little leverage

A

Lost tax benefits
Excessive perks
Wasteful investment
Empire building

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8
Q

Too much leverage

A

Excess interest
Financial distress costs
excessive risk taking
under-investment

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9
Q

How can we mitigate agency

A

The structure of the debt can help:
Short term debt is associated with more oversight of managerial actions by creditors

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10
Q

capital structure

A

The relative proportions of debt, equity, and other securities that a firm has outstanding

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11
Q

Cost of capital

A

The return required by the investors who provide capital to the firm

Cost of capital for the entire firm
Cost of equity capital
Cost of debt capital

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12
Q

Leverage ratio

A

D/D+E

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13
Q

Debt-to-equity ratio

A

D/E

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14
Q

Perfect capital markets (assumptions)

A

Investors and firms can trade the same set of securities at competitive market prices equal to the present value of the future cash flows

There are no taxes, transaction costs, or issuance costs associated with security trading

A firms financing decisions do not change the cash flows generated by its investments, nor do they reveal new information about them

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15
Q

Cost of equity

A

Re= Ru + D/E(Ru -Rd)

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16
Q

Cost of equity definition

A

Cost of equity is the return that a company requires for an investment or project, or the return that an individual requires for an equity investment.

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17
Q

EPS Fallacy

A

If you increase the leverage of the firm, the earnings per each share (EPS) will increase

Since the value of a share is discounted value of future earnings, and these earnings go up for each share, then the price of a share must go up

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18
Q

Earnings per share (Formula)

A

Earnings/Number of shares

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19
Q

Equity issuance fallacy
“an unlevered company is currently worth 1000$ and issues 200$ in equity

A

Having collected the new cash makes the price of equity increase WHICH IS NOT TRUE

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20
Q

Payout policy

A

The way a firm chooses between the alternative ways to distribute free cash flow to equity holders

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21
Q

Special dividend

A

A one time dividend payment a firm makes, which is usually much larger than a regular dividend

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22
Q

Stock dividend

A

Instead of cash, shareholders get more shares

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23
Q

Share repurchases

A

An alternative way to pay cash to investors is through a share repurchase or buyback. The firm uses cash to buy shares of its own outstanding stock

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24
Q

Open market Repurchase

A

When a firm repurchases shares by buying shares in the open market

Open market share repurchases represent about 95% of all repurchase transactions

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25
Q

Greenmail

A

When a firm avoids a threat of takeover and removal of its management by a major shareholder by buying out the shareholder, often at a large premium over the current market price

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26
Q

cost of capital

A

the minimum rate of return or profit a company must earn before generating value.

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27
Q

Effective dividend tax rate T*d (weird looking t)

A

T*d = (Td -Tg)/(1-Tg)

Tg is the capital gains rate tax, and Td is the dividend tax rate

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28
Q

MM payout irrelevance

A

In perfect capital markets, if a firm invests excess cash flows in financial securities, the firms choice of payout versus retention is irrelevant

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29
Q

Agency costs of retaining cash

A

When firms have excessive cash, managers may use the funds inefficiently by paying excessive perks, over-paying for acquisition, etc

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30
Q

Why is retaining cash bad

A

The firm invests and it incurs corporate taxes

Managers can appropriate (steal) cash more easily

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31
Q

Issuance and distress costs

A

Generally, firms retain cash balances to cover potential future cash shortfalls, despite the tax disadvantage to retaining cash

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32
Q

Dividend smoothing

A

The practice of maintaining relatively constant dividends

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33
Q

Dividend signaling hypothesis

A

The idea that dividend changes reflect managers views about a firms future earning prospects

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34
Q

Advantages of venture capital firms

A

Limited partners are more diversified

They also benefit from the expertise of the general partners

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35
Q

Disadvantages of venture capital firms

A

General partners usually charge substantial fees

Most firms charge 20% of any positive return they make

They also generally charge an annual management fee of about 2% of the funds committed capital

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36
Q

Pre-money valuation

A

The new valuation of the firms outstanding shares before the infusion of capital and the issuance of new shares

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37
Q

Post-Money valuation

A

The value of the whole equity (old plus new shares) at the price at which the new equity is sold

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38
Q

Liquidation preference

A

Specifies a minimum amount that must be paid to these shareholders before any payment to common stakeholders

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39
Q

Seniority

A

In case of liquidation investors get paid as long as every investor with higher seniority has already been paid

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40
Q

Participation rights

A

Holders of convertible shares without participation rights must choose between demanding their liquidation preference or converting their share to common stock. Participation rights allow investors to “double dip”

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41
Q

Initial public offering

A

The process of selling stock to the public for the first time

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42
Q

Advantages of IPO

A

Greater liquidity

Better access to capital

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43
Q

Disadvantages of IPO

A

The equity holders become momre widely dispersed

The firm must satisfy all the requirements of public companies

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44
Q

Best effort basis

A

For smaller IPOs, a situation in which the underwriter does not guarantee that the stock will be sold, but instead tries to sell the stock for the best possible price

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45
Q

Firm commitment

A

An agreement between an underwriter and an issuing firm in which the underwriter guarantees that it will sell all of the stock at the offer price

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46
Q

Auction IPO

A

A method of selling new issues directly to the public. The underwriter in an auction IPO takes birds from investors and then sets the price that clears the market

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47
Q

Two ways to value a company

A

Compute the present value of the estimated future cash flows

Estimate the value by examining comparable IPOS

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48
Q

A roadshow

A

In a roadshow, the firm and the underwriter pitch the idea behind the firms plans to a set of large institutional investorss, aiming at gaining insight into the demand that these large investors have for the stock, and these investor reservation price for the stock

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49
Q

Lockup (managing risk)

A

A restriction that prevents existing shareholders from selling their shares for some period, usually 18ß days after an IPO

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50
Q

Over-Allotment allocation (risk management)

A

An option that allows the underwriter to issue more stock, usually 15% of the offer size, at the IPO price

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51
Q

Green shoe provition

A

Underwriters initially market both the initial allotment and the allotment in the green shoe provision by short selling the green shoe allotment

If the issue is a success: the underwriter exercises the green shoe option

If not: the underwriter covers the short position by repurchasing the green shoe allotment in the aftermarket, thereby supporting the price

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52
Q

4 IPO puzzles

A

Underpricing: the price at the end of the first trading day is often substantiall higher than the IPO price

The number of issues are highly cyclical

The costs of an IPO are very high and it is not clear why firms willingly incur them

The long-run performance of a newly public company (2-5 years) is poor

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53
Q

Underpricing (IPOs)

A

The underwriters benefit from the underpricing because it allows them to manage their risk. The pre-IPO shareholders bear the cost of underpricing

Although IPO returns are attractive, all investors cannot earn these returns.

When an IPO goes well, the demand for thestock exceeds the supply. Thus the allocation of shares for each investor is rationed

When an IPO does not go well, demand at the issue price is weak, so all initial orders are filled completely

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54
Q

The winners curse (underpricing + long-term reversal)

A

Refers to a situation in competitive bidding when the high bidder, by virtue of being the high bidder, has very likely overestimated the value of the item being bid on. You “win” (get all the shares you requested) when demand for the shares by others is low and the IPO is more likely to perform poorly

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55
Q

Debt (everything)

A

investor provides refundable money. She is called debt-holder or creditor

Legal obligation for debtor to repay creditor

If you have debt in sufficiently profitable firm, it is not risky but bankrupcy can happen. When a frim goes bankrupt, not even creditors can be repaid in full Creditors may get a haircut

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56
Q

Equity (everyting)

A

Investor provieds non-refundable money. She is called shareholder

Residual claim on future cash flows

Risky:
Return from stocks is volatile

It is the type of volatility equity holders cannot diversify away

in the event of bankrupcy, equity may be worth nothing

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57
Q

Yield of a bond

A

The required return from investing in the bond

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58
Q

Bond at a premium

A

This happens when coupon-rate>bond yield

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59
Q

yield to maturity of a bond

A

the percentage rate of return for a bond assuming that the investor holds the asset until its maturity date. It is the sum of all of its remaining coupon payments.

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60
Q

coupon rate

A

the annual amount of interest that the owner of the bond will receive. To complicate things the coupon rate may also be referred to as the yield from the bond.

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61
Q

Bond at par

A

(this happens when coupon-rate = bond yield)

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62
Q

Bond at discount

A

(this happens when coupon-rate < bond yield)

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63
Q

Leverage buyout

A

When a group of private investors purchase all the equity of a public corporation and finances the puchase primarily with debt

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64
Q

Indenture

A

Included in a prospectus (public bond issue), it is a formal contract between a bond issuer (a corporation) and a trust company

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65
Q

Senior debt

A

In the event of a liquidation, senior debt has the highest priority in repayment

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66
Q

Asset backed debt

A

In the event of brankruptcy/liquidation, the asset that was used as “collateral” for the loan is used to repay the creditor

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67
Q

Unsecured debt

A

In the event of bankruptcy/liquidation, unsecured bondholders are paid from the sale of assets of the firm that are not already pledged as collateral on other debt

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68
Q

A bond issuer typicall repays its bonds by making coupon and principal payments as specified in the bond contract. However, the issuer can:

A

Repurchase a fraction of the outstanding bonds in the market

Make a tender offer for the entire issue

Exercise a call provision

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69
Q

What happens when a frim sells a callable bond

A

It is “short” a bond

It is “long” an option to buy back the debt “before” maturity

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70
Q

Sovereign debt

A

government debt

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71
Q

Term loan

A

A bank loan that lasts for a specific term

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72
Q

Revolving line of credit

A

A credit commitment for a specific time period, typically two or three years, which a company can use as needed

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73
Q

Private placement

A

A bond issue that is sold to a small group of investorsrather than the general public; tradable among institutional investors

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74
Q

Morgage-backed security

A

Largest sector of the asset-backed security market

Backed by home mortgages

Largest issuers are U.s. government agencies and sponsored enterprises, such as the government national mortgage association

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75
Q

Covenants

A

Restrictive clauses in a bond contract that limit the issuers from undercutting their ability to repay the bonds

For example covenants may:
Restrict the ability for management to pay dividends
Restrict the level of further indebtedness
Specify that the issuer must maintain a minimum amount of working capital

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76
Q

Convertible bond

A

A corporate bond with a provision that gives the bondholder an option to convert each bond owned into a fixed number of shares of common stock

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77
Q

Conversion ratio

A

The number of shares received upon conversion of a convertible bond, usually stated per $1000 of face value

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78
Q

Conversion price

A

The face value of a convertible bond divided by the number of shares received if the bond is converted

79
Q

Value of an investment (at time 0) with the WACC method

A

V0^L = E(FCF1)/(1+rwacc) + E(FCF2)/(1+rwacc)^2 + E(FCF3)/1+rwacc)^3 + …

80
Q

Wacc method procedure summary

A

Determine the expected FCF stream of the investment (unlevered)

Compute the weighted average cost of capital

Compute the value ofthe investment, including the tax benefit of leverage, by discounting the expected FCF stream using the WACC

81
Q

Debt capacity (Dt)

A

The amount of debt at a particular date that is required in order to maintain the firms target debt ratio (=debt/value), given the firms rwacc

82
Q

APV method (market value)

A

1) Determine the FCF stream of the investment (unlevered)

2) Determine the unlevered cost of capital from the pre-tax weighted average cost of capital

3) Obtain the unlevered value by discounting the FCF stream at the unlevered cost of capital

4) Determine the present value of the interest tax shield
(determine the expected interest tax shield amounts, Determine the appropriate discount rate to use for the interest tax shield amounts and discount the interest tax shield amounts to obtain PV(ITS)

Add the unlevered value to the present value of the interest tax shield in order to determine the value of the investment with leverage

83
Q

Target leverage ratio

A

When a firm adjusts its debt proportionally to a projects value or its cash flows

The proportion need not remain constant over time, as long as it is a proportion

A constant debt-equity ratio is a special case of a target leverage ratio

(it can be shown that the interest tax shield will have the same risk as the firm if the firm maintains a target leverage ratio)

84
Q

FTE method valuing an investment

A

1) Determine the free cash flow to equity (FCFE) of the investment

2) Determine the relevant equity cost of capital

3) Compute the equity value by discounting the FCFE stream using the equity cost of capital

4) This gives the NPV of the project, since this is exactly what accrues to equity holders

85
Q

FCFE formula

A

FCFE = (net income) - (non cash operational items) + (net inflow from borrowing) = (EBIT-interest)(1-Tc) + (Depreciation - deltaNWC - CapEx) + delta(debt capacity) = FCF - (1-Tc)Interest + delta(debt capacity)

86
Q

Advantages of the FTE method

A

May be simpler to use when calculating the value of equity for the entire firm
If the firms capital structure is complex
The market values of the other securities in the firms capital structure are unknown

It may be viewed as a more transparant method for discussing a projects benefit by emphasizing a projects implication for equity holders

87
Q

FTE method disadvantages

A

We must compute the projects debt capacity in order to determine the interest and net borrowing before we can make the capital budgeting decision

We must know the future market value of debt in the project before we can assess the projects addition to market value

This is also a disadvantage of the APV method. The WACC method doees not suffer from this limitation

88
Q

Predetermined debt levels

A

No targe debt-equity ratio, leverage ratio or interest coverage ratio. The firm adjusts its debt according to a fixed schedule that is known in advance

89
Q

Issuance costs

A

Intermediaries such as banks charge underwriting fees. These should be included as part of the projects required investment

90
Q

Security mispricing

A

If management believes that securities are being mispriced by outsiders, hten it should exploit this in the interest of existing shareholders
Thhe gains from eg issuing overpriced securities hould be included in the NPV of the project

On the other hand, issuing underpriced securities reduces the NPV

91
Q

Call (put) option

A

A contract that gives its owner the right to purchase (sell) an underlying asset at a fixed price during a fixed period of time

92
Q

At-the-money

A

Exercise price approximately equal to the current underlying asset price

93
Q

In-the-money

A

If immediately exercised, option would yield a positive amount

94
Q

Out-of-the-money

A

Immediate exercise would yield a negative amount

95
Q

Underlying value

A

Mostly some stock, but also stock indices and a variety of other financial assets

96
Q

Speculating motive

A

When investors use options to place a bet on the direction in which they believe the price of the underlying asset is likely to move

97
Q

Hedging motive

A

In order to reduce risks by holding contracts or securities whose payoffs are negatively correlated with some risk exposure

98
Q

Call option value (C) at expiration

A

C = max(S-K,0)
S = underlying stock price at expiration
K = exercise price of the option

99
Q

Option returns are highly levered for two reasons

A

1) For a small fraction of the current stock price, you are entitled to the full upward potential above the strike price (call option)

2) Option positions normally have a multiplier, i.e. they can only be engaged in for (usually) 100 stock equivalents

100
Q

Law of one price

A

Two positions with exactly the same future payoff must have the same price today

101
Q

Credit default swaps

A

Is the put option P in the previous formulation of debt

Risk-free debt = risky debt + put option on the firms assets

102
Q

The value of a call (put) option increases as …

A

The stock price increases (decreases) (and vice versa)

103
Q

Why is the valuation of call and put options important?

A

It allows traders in options markets to benchmark actual prices

It enables developing valuation tools for more complex derivative securities

It contributes to corporate finance theory through the option analogy of equity finance

It opens up ways to quantify the value of strategic flexible alternatives in investment projects (i.e. real topic of chapter 22)

104
Q

Binomial price model

A

Stock price follows a binomial tree with a given number of periods

In every oeriod the stock price may either go up or down by a known amount or percentage

The one-period risk-free interest rate is given

105
Q

Replicating portfolio

A

Portfolio consisting of
1) A number delta of stocks
2) a number b of risk-free bonds maturing at the end of the period

Such that this portfolio has exactly the same payoff as the call option at the end of the period

106
Q

Parameters of the black-scholdes model

A

S = current stock price
K = exercise price of the option
T= time of maturity of the option
rf = risk-free interest rate
PV(K)= present value of K = K/1+rf)^T
omega = annualized volatility

107
Q

Volatility

A

The annualized standard deviation of stock returns

108
Q

N(d) function

A

The N(d) function is the standard normal cumulative density function

109
Q

What is the beta of a (call ) option

A

Equal to that of its replicating portfolio:
beta = (sdelta/sdelta + B) *betas + (B/sdelta + B) *betaB

110
Q

Leverage effect

A

We see that the beta of a call option is (much) larger than the beta of its underlying stock

111
Q

Leasing contract

A

contractt allowing the firm to use specific assets for several years in exchange for periodic payments

112
Q

Lessee/lessor definition

A

Lessee: the party in a lease using the asset and liable for the periodic payments

Lessor: the party that lends the asset and is entitled to the lease payments

113
Q

Typical lease contract

A

Involves litttle or no upfront payment by the lessee

The lessee just commits to make regulr lease payments for the term of the contract

At the end of the contract term, the lease specifies who will retain ownership of the asset and at what terms

114
Q

Operational lease

A

Firm uses the asset during the contract term, after which it is returned to the lessor

115
Q

Financial lease

A

Firm has the obligation/right to buy the asset after the contract term

116
Q

Sales-type lease

A

The lessor is the manufacturer of the asset, offering lease financing services

Usually through a financial service subsidiary

117
Q

Direct lease

A

The lessor is an independent company that specializes in purchasing assets and leasing them to customers

Very often subsidiaries of commercial banks

118
Q

Sale and lease-back

A

Firm already owns the asset but would prefer to lease it

Firm sells the asset to the lessor in return for cash

Leases it back to continue using the asset

119
Q

Leverage leases

A

The lessor borrows from a bank or other lender to obtain the initial capital to purchase the asset

The lessor uses the lease payments from the lessee to pay interest and principal on the loan

120
Q

Special-purpose entity/vehicle (SPE or SPV)

A

Separate business partnership created by the lessee for the sole purpose of obtaining a lease

121
Q

synthetic lease

A

Lease that uses an SPE for lease constructions that are targeted to obtain specific favorable accounting and/or tax treatments

122
Q

Leasing is an alternative for

A

Purchasing + financing + servicing/maintainging + finally selling the asset (whether by lessor or lessee)

123
Q

Primary determinant of lease payments

A

Residual value at the end of the leasing period, since (purchase price - residual value) will be depreciated, and may differ for lessor and lessee

Other costs such as servicing and maintenance are:

1) not that large
2) usually not very different for lessor/lessee

124
Q

Ignoring servicing/maintenance costs

A

Competitive pricing in perfect capital markets implies that the lessor sets the lease payments such that

PV(lease payments) = purchase price - PV(residual value)

125
Q

Fair market value (FMV) lease

A

Lessee has the option to purchase the asset at its fair market value at the end of the lease term

In perfect capital markets, there is no difference between an FMV lease and an operational lease

126
Q

Fixed price lease

A

Lessee has the option to purchase the asset at the end of the lease term for a fixed price that is set upfront

Very common for consumer leases
Since the lessee has an option to purchase, he will buy the asset elsewhere if the fair MV is lower than the fixed price

The lessor will set a higher lease payment to compensate for the value of this option

127
Q

Fair market value cap lease

A

The lessee can purchase the asset at the minimum of its fair market value and a fixed price (or “cap”)

Similar to the fixed price lease, but the lessee is not likely to go elsewhere to buy the asset at the end of the lease term

128
Q

Operating lease (viewed as rental of the asset)

A

Lessee includes the lease payments as operational costs

Lessor depreciates the asset on its balance sheet

Lessee does not carry the asset on its balance sheet, and so does not depreciate it

Sessee discloses the lease obligations in the footnotes of its financial statements

129
Q

Capital lease (viewed as acquisition with longterm financing

A

Lessee carries the asset on its balance sheet and depreciates it

Lessee deducts the interest part of the lease payments as an interest expense

Lessee lists the present value of the future lease payments as a liability on the balance sheet

130
Q

True tax lease

A

Lessor receives the depreciation deduction associated with the ownership of the asset

Lessee can deduct the full amount of the lease payments as an operating expense

Lease payments are treated as revenue for the lessor

131
Q

Non tax lease

A

Lessee receives the depreciation deduction for tax purposes

Lessee can also deduct the interest portion of the lease payments as an interest expense

The interest portion of the lease payment is interest income to the lessor

132
Q

Tax authorities will classify a lease as a non-tax lease if it satisfies any of :

A

◦ Lessee obtains equity in the leased asset
◦ Lessee receives ownership of the asset on completion of all lease payments
◦ Total amount that the lessee is required to pay for a relatively short period of use constitutes an
inordinately large portion of the value of the asset
◦ The lease payments greatly exceed the current fair rental value of the asset
◦ The property may be acquired at a bargain price in relation to the fair market value of the asset at
the time when the option may be exercised
◦ Some portion of the lease payments is specifically designated as interest or its equivalent

133
Q

security interest

A

The firm is regarded to have effective ownership of the asset and the asset is protected against seizure by the lessor

The lessor is treated as any other secured creditor and must await the firms reorganization or ultimate liquidation

134
Q

True (tax) lease

A

The lessor retains ownership rights over hte asset

The firm must decide, within a limited period of time, whether it assumes or rejects the lease

If it assumes, it must settle all pending claims and continue to make all promised lease payments

If it rejects the lease, the asset must be returned to the lessor

135
Q

Cash conversion cycle (CCC)

A

CCC is a measure of the cash cycle

Reflects the “habits” of the industry the firm is in

136
Q

Inventory days formula

A

Inventory / Average daily COGS

137
Q

Accounts receivable days formula

A

Accounts receivable / Average daily sales

138
Q

Accounts payable days formula

A

Accounts payable / average daily COGS

139
Q

Cash conversion cycle formula

A

CCC = inventory days + Accounts receivable days - accounts payable days

140
Q

Trade credit

A

The credit that the firm extends to its customers, or receives from its suppliers

141
Q

Accounts receivable days

A

Average number of days that it takes the firm to collect its sales

Compare this to the overall credit terms

See if a trend can be identified

142
Q

Payment pattern

A

Provides information on the percentage of monthly sales tha tthe firm collects in each month after sale

If e.g. it is normal that 10% of sales are usually collected in the same month, 25% in two months, etc…, it can be compared with the current payment pattern

143
Q

stretching accounts payable

A

= ignoring a payment due period and deliberately pay later

144
Q

Seasonal patterns and/or positive/negative cash flow shocks cause short-term financing needs since:

A

Extra investment in fixed assets and working capital is needed in order to accomodate these

Increased earnings follow these investments with a time delay

And this must be (temporarily) financed

145
Q

it can be argued that the short-term financing needs are due to

A

Increased fixed asset investment

Extra (net) working capital investment

146
Q

Permanent working capital

A

The amount that the firm must keep invested in its short-term assets to support its continuing operations

147
Q

Temporary working capital

A

The difference between the actual level of working capital needs nad its permanent working capital requirements

148
Q

Golden financing rule

A

Fixed assets + permanent NWC should be financed with long-term capital (mix of equity and long term debt)

149
Q

Line of credit

A

Bank agrees to lend a firm any amount up to a stated maximum

Firm decides to what extent to use this credit falicy

150
Q

Bridge loan

A

Short-term bank loan that is used to “bridge the gap” until the firm has arranged long-term financing

151
Q

Discount loan

A

Loan requiring the borrower to pay the interest at the beginning of the period

The lender deducts the interest from the loan proceeds

152
Q

Commercial paper

A

Short-term unsecured debt issued by large corporations directly to the investing public

-Usually a cheaper source of funds than a short-term bank loan

-Mostly uses in US

-Face value in the order of 100 000

-Average maturity is 30 days, maximum maturity is 270 days

-rated by credit rating agencies

153
Q

Trust receipt loan

A

Distinguishable inventory items are held in a trust as security for the loan

When these items are sold, the firm remits the proceeds from their sale to the lender as repayment

154
Q

Horizontal merger

A

Target and acquirer are in the same industra

155
Q

Vertical merger

A

Targets industry buys from or sells to acquirers industry

156
Q

Conglomerate merger

A

Target and acquirer operate in unrelated industries

157
Q

stock swap

A

Target shareholders are swapping old stock for new stock in either the acquirer or a newly created merged firm

158
Q

Reasons to acquire (firms)

A

Cost reductions: such as layoff of overlapping employees and elimination of redundant resources, are more common and easier to achieve

Revenue enhancements: Such as increased revenues from increased market share, are much harder to predict and achieve

159
Q

Economies of scale

A

Larger companies enjoy savings from producing goods in high volume that are not available to small companies

160
Q

Economies of scope

A

Savings large companies can realize that come from combining the market and disribution of different types of related products

161
Q

Synergies: expertiese

A

Buying new technologies (patents) and experienced workers directly may be more efficient than inventing/hiring them

162
Q

Synergie: monopoly gains

A

Buy your competitor in order to substantially reduce competition and increase profits

163
Q

Synergies: efficient gains

A

Acquirers often claim that they can run the target organization more efficiently than existing management

164
Q

Synergies : Tax savings from operating losses:

A

Conglomerate merger may enjoy losses in one division being offset against profits in another division

165
Q

Takeover process

A

Tender offer, sometimes in several rounds with higher prices (offer may be in cash, stock or combination)

166
Q

US differential taxation

A

Cash receipts by target shareholders are immediately taxed since it triggers capital gains realization

Stock swaps allow target shareholders to defer capital gains realization

167
Q

Friendly takeover

A

Targets board of directors supports the merger and negotiates with potential acquires

168
Q

Proxy fight takeover defence mechanism

A

The acquirer attempts to convince the targets shareholders to remove the target board by using their proxy votes and support the acquireres candidates

169
Q

poison pills (takeover defenses)

A

A rights offering giving target shareholders the opportunity to buy shares in either the target or an acquirer at a deeply discounted price

Existing shareholders of the acquirer effectively subsidize these purchases, making the takeover so expensive that they choose to pass on the deal

170
Q

White knight/squire (takeover defense)

A

some other (friendly) entity shows up that acquires the company

171
Q

golden parachute

A

incumbent management receives an extremely lucrative and guaranteed package in the event that the firm is taken over and the managers are let go

172
Q

Free rider problem

A

If the target firm is poorly managed, this results in a low share price

After taking over control in the target (not necessarily 100%) by the acquirer, the value of any sharefolder will be increased if the acquirer succeeds in its strategy

173
Q

Leverage buyout (LBO) usually hostile takeover by a corporate raider, where the raider announces a tender offer for a controlling interest in the target firm instead of using his own cash to pay for these shares he borrows and pledges the shares as collateral on the loan. AFTER taking control of the target:

A

Us legislation allows that the loans can be directly attached to the acquired company, so the company has borrowed, not the raider. The raidr owns half of the shares, while the company is responsible for repaying the loan with interest. The corporate raider has effectively obtained half the shares without paying for them!

174
Q

Insurance covers the costs/losses due to specific events e.g.

A

Property insurance: fire storm earthquakes etc.

Business liability insurance: the comapny is liable for a third party claim

Business interruption insurance: loss of earnings due to fire, accident, product recall, etc.

Key personnel insurance: copensates the firm for the loss or unavoidable absence of crucial employees in the firm

175
Q

Insurance premium & actually fair insurance premium

A

The fee a firm pays to an insurance company for the purchase of an insurance policy

When the NPV from selling insurance is zero ie. when:

Insurance premium = present vlaue of the expected payment

176
Q

Actually fair insurance premium formula

A

SUMPr(loss at time t) x E(payment in the event of loss at time t)/(1+rL)^t

177
Q

Tax rate fluctuations

A

If the corporate tax code has different bracket, insurance can provide a tax saving if the firm is in a higher tax bracket when it pays the premium compared to the tax bracket it is in when it receives the insurance payment in the event of a loss

178
Q

Debt capacity

A

Insurance reduces the risk of financial distress, so the tradeoff between leverage and financial distress costs is relaxed, allowing the firm to increase its use of debt financing

179
Q

Risk assessment

A

Insurance companies specialize in assessing risk and will often be better informed about the extent of certain risks faced by the firm than the firms own managers

180
Q

Two types of exposure management

A

Vertical integration and/or storage
Hedging this exposure in commodity or financial markets

181
Q

Vertical integration

A

Refers to a merger of a firm with its supplier

Commodity price increase raises the firms costs and the suppliers revenues, so that they may offset each other

May add value if combining the firms results in important synergies

Vertical integration is not a perfect hedge

182
Q

Long term storage

A

E.g. airliner could purchase a large quantity of fuel today and store it until it is needed, so that he cost of fuel is locked in

183
Q

Disadvantages of supply contracts

A

They expose each party to the risk that the other party may default and or will fail to live up to the terms of the contract

The cannot be entered into anonymously: the buyer and seller know each otehrs identity

the market value of the contract at any future time may be difficult to determine

A lot of investors are only interested in the commodity price movement, and do not want any actual delivery of commoditites

184
Q

Future contract

A

Agreement to trade an asset on some future date at a price that is locked in today

185
Q

Exchange rate risk

A

Exchange rate fluctioations

186
Q

Importer-exporter consideration

A

If the supplier sets its prices in GBP then the euro firm faces the risk that the euro may fall, making the GBP and therefore the parts more expensive

187
Q

Hedging instruments include

A

Currency forward contracts

Currency futures contracts

Loosely defined: a forward contract is the same as a futures contract, with two differences:

Actual delivery of the underlying value occurs at the expiration date
There is no marking-to-market feature

188
Q

CIRP definition + formula

A

States that the difference between the forward and spot exchange rates is related to the interest rate differential between the currencies

Ft = S*(1+r$)^T/(1+reuro)^T

189
Q

Interest rate risk

A

Interest rate risk is commonly measured in terms of duration

190
Q

A securities duration is computed as D =

A

SUM(t*PV(Ct)/P

P= security price = SUM PV(Ct) = SUM(Ct/(1+r)^t)

Ct = cash flow of the security at date t

PV() = present value at the yield to maturity (r)

Duration measures the security price sensitivity

191
Q

Interest rate sensitivity (risk)

A

dP/P = D*dr/1+r = percentage change in the bond given yield to maturity r and duration D

192
Q

Duration-based hedging

A

Managing/hedgin interest rate risk
Try to make the interest rate sensitivites of assets and liabilities more or less the same

This translates directly into matching of the durations of assets and liabilities

193
Q

Duration of a portfolio of securities =

A

Market value weighted average of the individual durations

In other words

D1+2 = P1/P1 + P2 *D1 + P2/P1 + P2 * D2

194
Q

In order to protect its equity from overal small increases or decreases of interest rates, the firm needs an equity duration of zero this is acomplished how?

A

On balance hedging:
Reduce the duration of the assets and/or increase the duration of the liabilities

Easy to understand but usually difficult to execute

Off balance hedging:
Use financial derivatives to immunize equity, leaving balance sheet items intact

Although this entails complex analysis, it is by far the most used immunization strategy for fixed-income portfolios

finals (2 year) (27 decks)

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