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CFA level I > Corporate issuers > Flashcards

Corporate issuers Flashcards

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1
Q

What is sole proprietorship?

A

Business owned and operated by individual, unlimited liability, only clain to net profits

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2
Q

What is business structure?

A

How business is set up from legal and organizational point of view

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3
Q

What is general partnership?

A

Two or more owners, unlimited liability, profits are distributed and taxed as personal income

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4
Q

What is partnership agreement?

A

It specifies reponsibilities and share of profit

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5
Q

What is limited partnership?

A

It has two levels: general and limited partners

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6
Q

What are general partners?

A

Owners with unlimited liability

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7
Q

What are limited partners?

A

They are liable for the amount they invest only and have claims proportionate to their investments

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8
Q

What is corporation?

A

It is legal entity separate from owners and managers, where all shareholders have limited liability. They may distribute profits and have greater access to capital

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9
Q

What is role of investor in corporation?

A

They do not directly influence day to day operations, but appoints BoD

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10
Q

What are non profit organizations?

A

They produce social benfit aor charitable goal, must reinvest all of the profits

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11
Q

What does double taxation mean?

A

It taxes profits and dividends

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12
Q

What is private placement memorandum (PPR)?

A

It gives information and risks on the company

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13
Q

How about time horizon lenght and return from private companies?

A

Longer horizon and higher return than for public companies

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14
Q

What is direct listing?

A

Stock exchange agrees to list existing shares

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15
Q

Does no listing raise new capital?

A

No

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16
Q

What is special purpose aquisition company (SPAC)?

A

It is corporate structure set up to aquire a private company in the future. It raises capital through IPO and puts the funds into trust it must use for acquisitions within specified period of time

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17
Q

What is leveraged buyout?

A

Outside investors buy all companie’s outstanding shares and revenue in stock exchange listing, if its management buyout (company mangers do so).

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18
Q

What are debt holders?

A

They have legal and contractual claim to the interest and principle payments the company promised to make

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19
Q

What are equity holders?

A

Thet have residual claim to the net assets and has unlimited upside potential

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20
Q

What is shareholder theory?

A

Primary focus is to governance interest of firms shareholders which is maximisation of the market value of firms common equity

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21
Q

What is interest of shareholders?

A

Residual interest in the corporation, have voting rights which give them effective control of the firm and the management

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22
Q

What is interest of BoD?

A

It is responsibility to protect interests of shareholders, manage senior management, set strategic direction and monitor financial performance

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23
Q

What is one-tier board?

A

Executive and non-executive members serve on single board

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24
Q

What is two-tier board?

A

Non-executive oversees management of executive

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25
Q

What is interest of senior managers?

A

To receive compensation + bonus + perqusities. Interest can include continued employment and maximising their compensation

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26
Q

What is interest of employees?

A

Interest in sustainability and success of the firm, their rate of pay, opportunity for career development, training and working conditions

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27
Q

What is interest of creditors?

A

Interest are protected by covenants and debt agreements

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28
Q

What is interest of suppliers?

A

Interest in ongoing relationship, profitability of trade and ongoing stability

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29
Q

What is principle-agent problem?

A

Agent is hired to act in the interest of principle, but agent’s interest might conflict with that of principle

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30
Q

Shareholders/managers conflict

A

Managers might choose lower level of risk as their performance depends on it

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31
Q

Groups of shareholders conflict

A

Int he aquisition majority sharehoder might have better terms than minority and might force to enter into related party transactions that benefit entities in expense of minority shareholder

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32
Q

Creditors/shareholders conflict

A

Shareholders prefer more risk because of unlmited upside potential, also risk can be increased by issuing more debt or paying dividends

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33
Q

What is corporate governance?

A

It is system of internal controls and procedures by which individual companies are managed to minimie conflict between internal and external shareholders

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34
Q

What is vote of proxy?

A

It is ability to assign a voting right to those who attend AGM if you are not able to participate

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35
Q

What is super resolutions?

A

It requires supermajority vote, 2/3 or 3/4 of the votes and is usually required in the extraordinary shareholders meeting

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36
Q

What is majority voting?

A

Candidates with most votes is elected, one is voted from in single category

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37
Q

What is cumulative voting?

A

Shareholders can cast all of their votes for a single candidate or divide among board members

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38
Q

Which voting represents minority interest?

A

Cumulative voting

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39
Q

What is activist shareholder?

A

It pressures companies for change that believe will increase shareholder value

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40
Q

What is proxy fight?

A

It seeks proxies of shareholders to vote in power of their alternative proposals

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41
Q

What is hostile takeover?

A

It is attempt to gain control over target company by sidestepping their management and BoD

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42
Q

What is bond indenture?

A

It is rights of bondholders and companys obligation, can include covenants

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43
Q

What does is mean to be backed by collateral?

A

Bond holders will have a claim over this asset in case the bond fails

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44
Q

What are creditors committees?

A

It is protection of bondholder interest in the times of financial distress

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45
Q

What is role of audit commitee?

A

Everything accounting, reporting and audit related

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46
Q

What is role of governance commitee?

A

Governance and regulations related

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47
Q

What is role of nominations commitee?

A

Everything related to elections of BoD

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48
Q

What is role of remuneration commitee?

A

Everything compensation to directors and senior managers, benefits for employees and evaluation of senior managers

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49
Q

What is role of risk commitee?

A

Everything risk policy and tolerance related

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50
Q

What is role of investment commitee?

A

Everything related to aquisitions, CAPEX and disposals

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51
Q

Which comittee is usually required by law?

A

Audit committee

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52
Q

What are employee, customers and suppliers mechanism?

A

Labor laws, employment contracts and rights to form unions, contracts

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53
Q

What are government mechanisms?

A

Is to establish agencies to regulate industries

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54
Q

What is common law system?

A

It is when judges ruling becomes law in some instances

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55
Q

What is civil law system?

A

It is when judges are bound on specifically enacted laws

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56
Q

What is responsible investing?

A

Considering ESG factors in investment decision

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57
Q

What is sustainable investing?

A

it is inveting in companies on industries based on their perceived sustainable output

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58
Q

What is socially responsible investing?

A

Choosing investment based on moral and social norms

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59
Q

What is negative screening?

A

It is excluding companies and industries based on their practices regarding human rights, environmental concerns or corruption

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60
Q

What is full integration?

A

Inclusion of ESG factors/scores in the traditional fundamental analysis

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61
Q

What is thematic investing?

A

Inveting in sectors/companies to promote ESG related goals

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62
Q

What is engagement/active ownership?

A

It is using ownership as a platforms to promote improved ESG practices

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63
Q

What is green finance?

A

It is producing economic growth in more sustainable way by reducing emissions and better resource management

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64
Q

What are green bonds?

A

Bonds for which resources raised are used for projects with positive environmental impact

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65
Q

What is business model?

A

How company proposes to make money

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66
Q

What does business model should include? (5)

A

Potential customers, product and service description, how firm will sell products, describe key assets and suppliers, explain pricing strategy

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67
Q

What is channel strategy?

A

How products will be sold and delivered

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68
Q

What is omnichannel strategy?

A

Firm usage of both digital and physical channels

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69
Q

What is value-based pricing?

A

Setting prices based on value perceived

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70
Q

What is cost based pricing?

A

Setting prices based on costs of producing + profit

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71
Q

What is price discrimination?

A

Changing different prices to different customers

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72
Q

What is tiered pricing?

A

It is based on volume of purchase

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73
Q

What is dynamic pricing?

A

It depends on tiering to a day or a week

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74
Q

What is bundling?

A

Pricing complementary products

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75
Q

What is razor-and-blades pricing?

A

Price of equipment at low prices and make profits by selling consumable goods

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76
Q

What is option pricing?

A

Options and add-ons with high margins are added after the purchase decision been made

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77
Q

What is penetration pricing?

A

Low margins or free to grow market and achieve sale of operations

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78
Q

What is freemium pricing?

A

Offer product at basic functionality at no cost, but sell/unlock other functionality for a fee

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79
Q

What is hidden revenue?

A

Online content might be free, but generate revenues through ads

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80
Q

What is fractional ownership?

A

Time share companies sell condominium ownership by the week

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81
Q

What is franchising?

A

It permits to sell in a specified area and pay % of sales to the franchiser

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82
Q

What is value proposition?

A

How customers will value the characteristics of the product giving competing products and pricing

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83
Q

What is value chain?

A

It is execution of value proposition

84
Q

What is private label manufacturer?

A

Produce products for others to market under their own brand name

85
Q

What is licencing agreements?

A

A brand is used on another product for a fee

86
Q

What are value-added resellers?

A

Offer services as support, installation etc.

87
Q

What is affiliate marketing?

A

Another company is paid commision for measurable marketing

88
Q

What is marketplace?

A

Provide platform but do not own the products

89
Q

What are aggregators?

A

Provide marketplace but you sell products and services under own brand name

90
Q

What are network effects?

A

Increase in the value of a network as its user base grows

91
Q

What is crowdsurfing?

A

It benefits from user contribution

92
Q

What are hybrid business models?

A

It is platform and traditional sales models

93
Q

What are external factors affecting risk? (3)

A

Changes in economic condition, changing in demographics, political, legal and regulatory changes

94
Q

What is macro risk?

A

It is risk arising from economic, political and legal risk factors, as well as other risks that affect all businesses within region or country

95
Q

What is competitive risk?

A

It is erosion of existing competitive advantage over time or introduction of innovative business models that disrupt the industry

96
Q

What is product market risk?

A

Expectations for growth in demand might decrease

97
Q

What is capital investment risk?

A

Investing firm assets in opportunities that do not provide returns above firm’s cost of capital

98
Q

What are ESG risk?

A

Focus on corporate governance risk, but the risk of running afront of current expectations can damage reputation

99
Q

What is operating leverage?

A

Fixed amount of the costs

100
Q

What are business maintanance investments?

A

Going concern projects and regulatory/compliance projects

101
Q

What are going concern projects?

A

They are needed to maintain business and reduce costs

102
Q

What are regulatory/compliance projects?

A

They might be required anf often include safety related and environmental concerns

103
Q

What are business growth projects?

A

They include expansion projects and other that include size and scope of the company

104
Q

What is capital allocation process?

A

Identifying and evaluating capital projects

105
Q

What is process of capital allocation process? (5)

A

Idea generation, analysing project proposals, creating firm-wide capital budget, monitoring decision and conducting post audit

106
Q

What are sunk costs?

A

Cost that cannot be avoided regardless if the project is taken or not

107
Q

What are principles of capital allocation? (5)

A

Decisions are based on incremental cashflows, CF are are based on opportunity costs, timing of CF is important, CF are analyzed on aftertax basis, financing costs are reflected in required rate of return

108
Q

What are externalities?

A

Effects of project acceptance may have on other firms cash flows

109
Q

What is cannibalization?

A

New project takes sales from an existing project

110
Q

What is conventional CF pattern?

A

If the sign on the CF changes only once

111
Q

What is unconventional CF pattern?

A

More than one sign change

112
Q

What are independent projects?

A

Projects that can be evaluated solely on their own profitability

113
Q

What are mutually exclusive projects?

A

Only one project can be accepted so profitability must be evaluated among projects

114
Q

Formula of NPV

A

CF0+sum of CF/(1+k)^t

115
Q

What is NPV rule?

A

If projects are independent, accept projects with positive NPV

116
Q

What is IRR?

A

Discount rate that makes PV just equal to initial cost of the project

117
Q

What is IRR rule?

A

If IRR>required rate of return, then accept the project

118
Q

What is hurdle rate?

A

Minimum IRR required

119
Q

What is key advantage of NPV?

A

Direct measure and best methods

120
Q

What is flaw of NPV?

A

It does not take into account size of the project

121
Q

What is key advantage of IRR?

A

It measures profitability as %, showing return and provides information on margin of safety

122
Q

What is disadvantage of IRR?

A

It may produce different rankings of mutually exclusive projects and possibility that products have multiple IRRs

123
Q

How to measure whether value for investors is created?

A

Compare return of company’s investment to cost of capital

124
Q

Formula of ROIC

A

after-tax net profit/average book value of total capital
or
net operating profit after tax/average book value of total capital

125
Q

Formula of after tax net profit

A

net income+after tax interest expense

126
Q

Formula of net operating profit after tax

A

Subtract after-tax nonoperating income

127
Q

When management is creating value for a firm?

A

ROIC>WACC

128
Q

What is effect of NPV on stock price?

A

Proportional increase in the stock price

129
Q

What are real options?

A

Future actions firm can take given they invest in project today, cannot be negative

130
Q

What are timing options?

A

Allow a company to delay making investment as more information will be available in the future

131
Q

What are abandoment options?

A

Abandon a project if PV of CF from exiting project exceeds the PV of CF for continuing the project

132
Q

What are expansion options?

A

Allows to make additional investments in the future

133
Q

What are flexibility options?

A

Gives managers choice regarding operational aspect

134
Q

What are two flexibility options?

A

Price setting and production

135
Q

What are fundamental options?

A

Projects that are options themselves because payoffs depend on the price of the underlying asset

136
Q

Formula of operating cash flow

A

Net income+D&A-dividends

137
Q

What is account receivable?

A

Amounts owed to a company from customers sales it makes on credit

138
Q

Interpretation of 2/15 net 45

A

2% discount if paid within 15 days, if not, then have to pay in full in 45 days timeframe

139
Q

What are marketable securities?

A

Liquid debt that company intends to sell within a year

140
Q

What is uncommitted line of credit?

A

Bank extends an offer of credit for a certain amount but may refuse to lend if circumstances change

141
Q

What is committed line of credit?

A

Bank extends an offer of credit that it commits to for some period of time

142
Q

What is revolving line of credit?

A

Usually for longer terms, company’s can borrow and repay funds as their needs change

143
Q

What is blank lien?

A

Claim to all current and future firms assets as collateral in case primary collateral is insufficient

144
Q

What is factoring?

A

Sale of receivable at a discount from their face value

145
Q

What is commercial paper?

A

Short-term debt security, up to one year, issued by companies with lower credit rating

146
Q

What is conservative working capital management?

A

Current assets higher as % of sales

147
Q

What is aggressive WC management?

A

Current assets lower as % of sales

148
Q

What is primary source of liquidity?

A

Sources of cash it uses in its normal day-to-day operations

149
Q

What is secondary source of liquidity?

A

Liquidating short-term or long-lived assets, renegotiating debt or filing for bankruptcy and reorganizing the company

150
Q

What are drags on liquidity?

A

Delay or reduce cash inflows or increase borrowing costs

151
Q

What are pulls on liquidity?

A

Accelerated cash outflows

152
Q

What is formula of WACC?

A

wd * (kd(1-t))+wps * kps+wce * kce

153
Q

What is after tax cost of debt?

A

Interest rate at which firms can issue new debt

154
Q

What to use for cost of debt?

A

YTM of new debt, it not available then for current debt

155
Q

Formula for cost of preffered stock

A

Dps/P

156
Q

What is cost of equity?

A

Required rate of return on firm’s common stock

157
Q

Formula of CAPM

A

rf+B(E(rmkt)-rf)

158
Q

Formula of other way of determining cost of capital

A

bond yield+risk premium

159
Q

Formula of adjusted B

A

2/3unadjusted beta+1/3

160
Q

Why individual B varies?

A

Due to financial leverage and tax rates

161
Q

What is formula of asset beta?

A

Bequity *(1/(1+[(1-t) * D/E]))

162
Q

Formula for company’s Beta

A

Basset(1+[(1-t)*D/E])

163
Q

What to do with groups B?

A

Take average

164
Q

What are floating costs?

A

Fees charged by IB when company raises external capital

165
Q

How to incorporate floating costs?

A

By adjusting selling price

166
Q

What is the best method to incorporate floating costs?

A

As cash outflow in NPV model

167
Q

What is optimal capital structure?

A

The one which minimizes WACC

168
Q

What industry characteristics allows to make on more debt? (3)

A

Non-cyclical, low fixed operating costs, subscription based

169
Q

What is debt capacity?

A

Extent to which it can finance itself with debt without risking insolvency

170
Q

What is tax rate effect on value of a company?

A

Higher tax rates gives higher tax shield hence increases value of a leveraged company

171
Q

How credit spreads move with business cycles?

A

They are narrow during expansions and widen during contractions

172
Q

What are stages of company life cycle?

A

Start-up, growth stage and mature stage

173
Q

What is start-up stage?

A

Risk is high, debt is risky requiring higher interest rate, hence mostly financed by equity

174
Q

What is growth stage?

A

Risk is somewhat reduced, up to 20% might include debt

175
Q

What is mature stage?

A

Debt might be in excess of 20% of firm’s capital structure

176
Q

What is MM assumption I?

A

Capital structure is irrelevant for firms value

177
Q

What are assumptions of MM (I)?
(5)

A

Capital markets are perfectly competitive, investors have homogenous expectations, riskless borrowing and lending, no agency costs, investment decisions are unaffected by financing decisions

178
Q

What is MM assumption II?

A

As companies increase proportion of debt financing, the risk of CF to equity holders increases, which increases cost of equity, WACC and cost of debt does not change

179
Q

MM formula of cost of equity

A

r0+D/E(r0-rd), where r0 is cost of equity with no debt

180
Q

What is MM assumption III?

A

Optimal capital structure with taxes is 100%, as proportion of debt increases, WACC decreases

181
Q

MM formula for leveraged firms value

A

leveraged firm’s value = unlevered firm + tax shield

182
Q

MM formula of cost of equity with taxes

A

r0+D/E(r0-rd)(1-t)

183
Q

What are costs of financial distress?

A

Increased costs a company faces when earnings decline to the point where the firm has trouble paying its fixed financing costs

184
Q

What is probability of financial distress?

A

Firm’s use of operating and financial leverage

185
Q

What is state (trade-off theory)?

A

Costs of financial distress balances with the tax shield benefits from using debt

186
Q

Formula of leveraged company under trade-off theory

A

Vu+t*d-PV(costs of financial distress)

187
Q

What is effect of asymmetric information on cost of debt and equity

A

Direct relationship

188
Q

What are monitoring costs?

A

Expenses of reporting to shareholders and paying BoD

189
Q

What are bonding costs?

A

Assuring managers are working the shareholder’s best interest

190
Q

What is pecking order theory?

A

Signals management send to investors through its financing choices

191
Q

What is funding preference from most to least?

A

Internally generated capital -> debt -> external equity

192
Q

Whats is cost leverage?

A

Amount of fixed costs firm has

193
Q

What is sales risk?

A

Uncertainty about the sales

194
Q

What is operating risk?

A

Uncertainty about operating earnings caused operating costs

195
Q

What is financial risk?

A

Additional risk that firm’s common stockholders must bear when firm has fixed costs financing

196
Q

What is degree of operating leverage (DOL)?

A

% change in EBIT that results from given percentage change in sales, highest at low levels of sales

197
Q

Formula of degree of operating leverage (DOL)

A

change in EBIT/change in sales
Q(P-V)/Q(P-V)-F or S-TVC/S-TVC-F

198
Q

What is degree of financial leverage (DFL)

A

% change in net income/EPS to change in EBIT

199
Q

Formula of degree of financial leverage (DFL)

A

change in EPS/change in EBIT
EBIT/EBIT-interest or S-TVC/S-TVC-I

200
Q

What is degree of total leverage (DTL)

A

Combined degree of DOL and DFL

201
Q

Formula of degree of total leverage (DTL)

A

DOL*DFL
Q(P-V)/Q(P-V)-F-I or S-TVC/S-TVC-F-I

202
Q

What is relationship between financial leverage and ROE?

A

Direct

203
Q

What is break even quantity of sales?

A

Quantity of sales for which revenue=total costs

204
Q

What is contribution margin?

A

It is difference between price and variable costs per unit

205
Q

Formula for break-even quantity of sales

A

fixed operating+fixed financing costs/price-variable costs per unit

206
Q

What is operating break even quantity of sales formula?

A

fixed operating costs/price-variable cost per unit

207
Q

What is relationship between fixed costs and break even quantity?

A

Direct

CFA level I (12 decks)

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