Corporate Finance, Derivatives, PM, Alternative Investments Flashcards
Profitability Index
Calculation of cost of debt
CAPM
Causes of beta differences
Unlevered beta for asset risk
Levering beta for a company’s financial risk
Break point WACC
Problems with leverage
- Increases volatility of a company’s earnings and cash flows
- Increases risk of lending to or owning a company (greater discount rate)
- Valuation affected by degree of leverage
- Highly leveraged companies have more risk of incurring significant losses during economic downturns
Business risk
- Sales risk: uncertainty with respect to price and quantity of goods and services
- Operating risk: risk attributed to operating cost structure, greater the use of fixed cost, the greater the operating risk
Degree of operating leverage (Operating risk)
Degree of financial leverage (financial risk)
Degree of total leverage
Break even number
Operating breakeven point
Primary sources of liquidity to firms
- Ready cash balances from payment collections, investment income and liquidation of near-cash securities
- Short-term funds: trade credit, bank lines of credit
- Cash flow management: effectiveness of a firm’s cash management systems and practices
Secondary sources of liquidity
Likely to affect the normal operations of the firm: renegotiating debt constracts, liquidating company assets, and filing for bankruptcy protection and reorganization
Drags on liquidity
When receipts lag creating pressure due to decreased availabiltiy of funds
Pulls on liquiditiy
When disbursements are paid too quickly or trade credit availability is limited
Cash conversion cycle
Forecasting short-term cash flows
Investing short-term funds
Computing yield on short-term investments
Terms of credit
Net60 - full amount is due in 60 days
1/10 net 30 - 1% discount if paid within 10 days otherwise full amount is due wihtin 30 days
Bank sources of short-term financing
Non-bank sources of short-term financing
Cost of borrowing with commitment fee
Cost of borrowing with all-inclusive interest rate
Cost of borrowing with dealer’s and other fees
Risk Governance
- Risk goals
- Top-level decisions performed at board level
Risk identification and measurement
Quantitative and qualitative analytical core of risk management
Risk Infrastructure
People, processes and technology in place to track risk exposure of the organisation
Defined Polices and Processes
Risk governance into the day-to-day operations of the company e.g. updating and protecting data, exception handling and escalation
Risk Monitoring, mitigation, and management
Putting governance, identification, infrastructure and policies togeth such that organisation can identify when risk is not aligned with organisations tolerance
Risk Communication
- Communication of risk objective, current risk position within the organisation
- Feedback is important to allow improvements and updates
Strategic Analysis or Integration
Effective risk management will imrove the performance of the organisation and increase valuations of the portfolio or organisation
Risk Governance
- The foundation for risk management that involves top-down process and guidance that aligns risk management activities of the organization with goals of overall enterprise
Elements of risk governance
- Clear Guidance in times of crisis (reactive) and normality (proactive)
- Enterprise Risk Management - Focus on the risk of the whole organisation. Narrower View unlikely to meet goal of maximising EV
- Regular Forum to discuss risk framework, best practice is to set up a risk committee
- Apportionment of responsibility - formal appointment of a responsible executive such as a CRO
Risk Budgeting
Will quantify and allocate tolerable levels of risk using specific metrics. The risk budgeting process will help implement the risk tolerance decision
Conditional VaR
Weighted average of all loss outcomes in statistical outcome that exceed the VaR loss
Value at risk
- Estimate of minimum loss from a trading position over a fixed time horizon that would be expected with a specified probability
- Subject to model risk
- Three elements: an amount in currency, a time period, a probability
Risk modification
When the acceptable level of risk has been identified in the governance stage, the risk metrics in the previous slides are used to align actual risk with acceptable risk
Risk Prevention/Avoidance
- Taking measures to avoid risk altogether
- Decision on how much risk to accept, given the trade-off between benefits and costs
Risk Acceptance
- Self-insurance: bearing a risk considered too costly to remove by external means
- Diversification accepting risk in the most efficient manner portfolio
Risk Transfer
- Passing risk from one party to another in the form of an insurance policy, surety bond or fidelity bond
- Reinsurance market
- Deductible helps to combine risk transfer with self-insurance
Risk Shifting
- Risk shifting similar to transfer but utilizes derivatives in order to modify the risk from one entity to another
- Most common method used, example is protective put
Corporate Governance and Stakeholder Management Framework
Defines rights, responsibilities and powers of each stakeholder group
- Legal infrastructure: defines rights established by law and ease of legal recourse following a breach
- Contractual infrastructure: Contractual arrangements in place with stakeholders
- Organisational infrastructure: Internal systems, governance procedures adopted to manage stakeholder relationships
- Governmental Infrastructure: REgulation. imposed on companies
Cumulative voting
Allows shareholder to accumulate and vote all of their shares for a single candidate in an election involving more than one director
Increases the likelihood that minority shareholders are represented by at least one director on the board
Policies on related party transactions
Mitigate, manage and disclose conflicts of interest regarding related-party transactions
Directors and managers required to disclose conflict they may have with company
One-tier board
Executive (internal) directors - employed by company
Non-executive directors - provide objective decision making, monitoring and performance assessment
Two-tier board
Supervisory and management board independent of each other
Increasingly CEO and chairperson separated
Staggered board
Directors are typically divided into 3 classes that are elected separately in consecutive years
Election process limits the ability to effect a major change of control in the company
Board of directors responsibilities
Duty of Care & Loyalty
- Guides and approves strategic direction
- Reviews corporate performance
- REsponsible for selecting appointing, and terminating the senior managers
- Ensure leadership continuity via succession planning
- Ensure adequate enterprise risk management in place
- Review proposals for corporate actions
Negative screening
Excludes companies based on business practices or environmental concerns
EXCLUSIONARY
Positive screening
Select companies based on ESG criteria, typically relative to peers
Key difference is hierarchy of preference
Thematic investing
Investing in themes or assets related to ESG
Engagement
Using shareholder power to influence corporate behaviour around ESG factors
Impact investing
Investments made with the intention of generating positive and measurable social and env. impact whilst at the same time making financial return
Net Cost of Carry
Benefits - Costs
-(costs) + benefits
Benefits REDUCE cost of a forward and costs increase it, a cost to carry the forward increases the compensation you pay to the counterparty for holding it
Effect of higher proportion of variable costs
Higher proportion of variable costs relative to total costs will have a higher AVC curve and closer to ARC curve, so will have a higher required price for shutdown
