Corporate financing

Question 1

What are two ways companies fund investment?

Answer 1

• Internal funds

- External funds

Question 2

What are forms of internal funds

Answer 2

• Profits

- Depreciation

Question 3

What are forms of external funds?

Answer 3

• New equity

- Borrowing

Question 4

What proportion of corporate financing in the UK is taken up by internal funding?

Answer 4

2/3

Question 5

Why is internal funding more convenient than external funding?

Answer 5

• Avoids costs of issuing new securities
• Avoids cost of negotiating debt
• Shareholders happy if dividends are used to increase stock value

Question 6

When do managers usually rely too much on internal funds?

Answer 6

When they are averse to external funding and risk

Question 7

What is the debt ratio?

Answer 7

Proportion of debt relative to the firm value

Question 8

What is the formula for debt ratio?

Answer 8

Value of debt / (value of debt +Value of shares)

Question 9

What is the calculation for the value of debt?

Answer 9

Current liabilities + Long term liabilities

Question 10

What is book value?

Answer 10

Tells us how much capital the firm has raised from shareholders in the past

Question 11

What is market value?

Answer 11

The value that shareholders place on those shares today

Question 12

The market value of equity is often much larger than:

Answer 12

The book value of equity

Question 13

The market debt ratio is often much lower than:

Answer 13

The book debt ratio

Question 14

A corporation is owned by:

Answer 14

Its common stockholders

Question 15

Corporations can raise new cash by issuing:

Answer 15

New stock

Question 16

Stocks/shares held by investors are called:

Answer 16

Issued and outstanding

Question 17

Stocks/shares that are bought back from investors are called:

Answer 17

Issued but not outstanding

Question 18

What is the difference between stocks and shares?

Answer 18

Shares refer to ownership of one company, stocks refers to any company or more than one company

Question 19

What type of rights do shareholders have?

Answer 19

Cash flow rights

Question 20

Who do the privileged rights of shareholders go to?

Answer 20

Lenders of the firm

Question 21

What types of the firm’s actions do shareholders have control over?

Answer 21

• Investment decisions
• Recruitment policy
• Decision to merge

Question 22

Stockholders exercise their control rights by:

Answer 22

Voting

Question 23

What type of vote do most decisions require to be approved?

Answer 23

Simple majority

Question 24

What kind of vote result do some big decisions require?

Answer 24

Supermajority (75%)

Question 25

Some shares can have the same cash flow rights, but different:

Answer 25

Control rights

Question 26

Stocks with superior voting power sell at a:

Answer 26

Premium

Question 27

What are the benefits of greater control rights?

Answer 27

- Prevent challenge to a position - Extra bargaining power - Business advantage - Toss out bad management

Question 28

The dividend rate on preferred stocks is fixed:

Answer 28

At the time of their issue

Question 29

Preferred stock gives priority over common stock when:

Answer 29

Receiving dividends

Question 30

When companies borrow money, their liability is:

Answer 30

Limited

Question 31

Borrowers can walk away from debt obligations in exchange for:

Answer 31

Assets of the company

Question 32

Borrowers are usually only willing to exchange assets in return for freedom of debt if:

Answer 32

Asset value < Debt value

Question 33

What is the default risk?

Answer 33

Likelihood that a firm will walk away from its debt obligation

Question 34

Bond ratings are issued on debt instruments to help investors assess the:

Answer 34

Default risk of a firm

Question 35

Debt offers no control rights unless:

Answer 35

The firm defaults

Question 36

Debt can be disguised as a:

Answer 36

Tax subsidy

Question 37

Interest is paid on:

Answer 37

Pre tax income

Question 38

Dividends are paid on:

Answer 38

After tax income

Question 39

What is secured debt?

Answer 39

Debt that has first claim on specified collateral in the event of default

Question 40

What is senior debt?

Answer 40

Debt a company must repay 1st if it goes out of business

Question 41

What is subordinated debt?

Answer 41

Debt that must be paid in bankruptcy after senior debt is repaid

Question 42

What classifies as Investment grade debt?

Answer 42

Bonds rated Baa or above by Moody's or BBB or above by S&P

Question 43

What's a junk bond?

Answer 43

Bonds with a rating below Baa or BBB

Question 44

What is a Callable bond?

Answer 44

Bonds that may be repurchased by the firm before maturity at a specified call price

Question 45

What are convertible bonds?

Answer 45

Bonds that give its owner the option to exchange for shares

Question 46

What do financial intermediaries do?

Answer 46

- Raise money from investors | - Provide financing for companies

Question 47

What are the roles of financial markets?

Answer 47

- Payment mechanism - Borrowing/lending - Pooling risk - Information

Question 48

Debt ration measures the reliance on:

Answer 48

Debt vs Equity financing