Corporate Financing Flashcards
What is corporate financing?
Corporations invest in long term assets (property, plant, equipment etc) and in net-working capital (current assets minus current liabilities)
Why is internal funding more convenient than external?
- Avoids costs of issuing new securities or negotiating debt
- Shareholders happy if retained profits finance positive NPV projects
Debt ratio (definition and equation)
- Proportion of debt relative to firm value
Debt ratio = value of debt/(value of debt + value of shares)
Value of debt = current liabilities + long term liabilities
Book value vs Market value
Book value = how much capital the firm has raised from shareholders in the past (accounting value)
Market value = the value that shareholders place on those shares today
Voting procedures
- Stockholders exercise their control rights by voting
- Many decisions require a simple majority vote to be approved
Classes of shares, why would there be more than one?
Usually only one but sometimes there are multiple
There are sometimes multiple with a ‘premium’ option which holds more voting power. These are usually owned by founders. This is because great control rights grant larger private benefit
Default risk
The likelihood that a firm will walk away from its obligation, voluntarily or involuntary
Secured debt
debt that has first claim on specified collateral in the event of default
Senior debt
debt a company must repay first if it goes out of business
Subordinated debt
debt that may be repaid in bankruptcy only after senior debt is repaid
Investment Grade
bonds rated Baa or above by Moody’s or BBB and above by S&P
Junk bond
bonds with a rating below Baa or BBB
Callable Bond
bonds that may be repurchased by firms before maturity at specified call price
Convertible bond
bond that give its owner the option to exchange for a predetermined number of shares
Should the company borrow short term (bank loan) or long term (issue bonds) if it needs to finance a temporary increase in inventories?
Short term
Should the interest rate on loan be fixed or floating?
bonds and bank loans
- Normally bank loans carry floating rates
- Bonds carry fixed payments
Should you borrow in domestic or foreign currency?
- Depends on whether the company has overseas operations or not
- If it needs to spend foreign currency, it makes sense to borrow it
What promises should be made to the lender?
It depends on the lenders’ concerns about the risk associated with the loan (i.e., probability of default).
Lenders may demand that their debt is senior (→ safer).
Firms may set aside some of its assets (collateral) for the protection of particular creditors.
- if firm defaults on the loan, the bank can seize the collateral and use it to help pay off the debt.
What are convertible bonds?
Depending on a change in share price, should the firm issue straight or convertible bonds?
- Convertible bonds give its owner the option to exchange the bond for a predetermined number of shares
- it depends on expectations about the firm’s share price
- Expect an increase => can convert bonds with profit
- Expect a decrease => there is no obligation to convert
Financial Markets
Markets where:
- assets are issued by corporations
- assets are traded by investors
- assets are regularly traded on organised stock exchanges
Financial intermediaries (banks)
Organisations that raise money/savings from investors and provide financing for individuals, companies and other organisations
The Role of Financial Intermediaries
- Borrowing and Lending
- Payment Mechanism
- Pooling risk
- Information about the real value of securities and commodities
Should the company borrow short term (bank loan) or long term (issue bonds) if cash is needed to pay for expansion of plant?
Long term
