E Rote Flashcards
1
Q
What are unsecured bonds likely to require? (yield)
A
A higher yield to maturity than equivalent secured bonds
2
Q
What do convertible bonds give the borrower the right to?
A
To turn the bind into a predetermined number of ordinary shares
3
Q
What is a eurobond?
A
A bond that is denominated in a currency which is not native to where bond itself is issued
4
Q
Who has the rights in a convertible bond (borrower or investor)
A
Investor
5
Q
Are trade payables unsecured or secured?
A
Typically unsecured
6
Q
Is ordinary or preference shares riskier?
A
Ordinary
7
Q
What is meant by a coupon rate for bonds?
A
Annual interest received as a % of nominal value of the bond
8
Q
What is meant by redemption yield?
A
Return received taking into account capital repayment as well as interest payments
9
Q
What is meant by interest yield?
A
Annual interest received as a percentage of the ex interest market price of the bond
10
Q
What is meant by sukuk?
A
A bond in islamic finance where lender owns the underlying asset and shares in the risks and rewards of ownerships
11
Q
What is meant by mudaraba?
A
Equity in islamic finance where profits are shared according to a pre-agreed contract - dividends are not paid as such
12
Q
What is meant by murabaha?
A
Trade credit in Islamic finance where a pre-agreed mark-up is agreed in advance for the convenience of paying later
13
Q
What is meant by ijara?
A
A lease in islamic finance where lessor retains ownership and risk and rewards of ownership of the underlying asset
14
Q
What does MM model assume in regards to capital markets?
A
Assume perfect capital markets so there is no information content in dividend policy
15
Q
Assumptions for MM model? (taxes)
A
No taxes or tax preferences
16
Q
Assumptions for MM model? (transaction)
A
No transaction costs
17
Q
Why does MM assume no transaction costs?
A
Investors can switch between income and capital gains without cost
18
Q
What is a residual dividend geared to?
A
Geared to financing investments that will give capital gains
19
Q
What is meant by manufacturing dividends?
A
Investors selling some shares to realise some capital gains
20
Q
What can a share repurchase scheme increase ratios?
A
EPS and gearing
21
Q
What is a bonus issue>
A
When a company offers free additional shares to existing shareholders
22
Q
What are shareholders entitlied to receive (dividends)
A
To receive a share of any agreed dividends but directors decide on amount and frequency of dividend payments
23
Q
Are currency futures suitable for trades in small amounts of currency?
A
No, as they are standard contract sizes
24
Q
Is peer-to-peer lending equity or debt finance?
A
Debt finance
25
Is corwdfunding equity or debt finance?
Equity finance
26
Is peer-to-peer lending available to startup companies?
No, only to investors with an established trading history
27
Why do SMEs have a funding gap?
Due to them being seen as a higher risk investment than a larger company
28
What do founding shareholders of an SME often have to sacrifice?
Limited liability to obtain bank finance
29
Are medium-term or longer-term loans for SMEs harder to obtain?
Medium-term loans due to mismatching of the maturity of assets and liabilities
30
What is meant by a funding gap?
Shortfall in capital needed to fund ongoing operations
31
What is business angel financing?
Private individuals or group of individuals can invest directly into a small business
32
What does supply chain finance (SCF) allow?
A buyer to extend the time in which it settles its accounts payable
33
What does supply chain finance allow for a lower interest rate?
Allows an SME to raise finance at a lower interest rate than would normally be available for it
34
What is meant by systematic risk?
Residual risk associated with investing in a well-diversified portfolio
35
What is total risk?
Risk associated with investing in equity
36
Issue with an increase in cost of equity?
Leads to a fall in share price
37
What is risk-return trade-off?
Investors faced with increased risk will expect increased return as compensation
38
Is cost ode bt usually lower than the cost of preference shares?
YES
39
Why should capital structure remain unchanged for the duration of a project? (if current WACC used as appraisal)
As this affects the WACC
40
What is the business risk of the project the same as? (if current WACC used as appraisal)
The current business operations
41
Size of project? (if current WACC used as appraisal)
It is relatively small in size
42
What does higher gearing increase?
The cost of equity
43
Are interest payments tax deductible?
Yes
44
What does MM assume with financial risk?
MM assumes financial risk is consistently proportionate to gearing across all levels
45
What does the asset beta only effect?
The business risk
46
Which will be lower, asset beta or equity beta?
Asset beta
47
What is the difference between an asset beta and an equity beta?
The impact of financial risk
48
When is financial risk higher (debt beta)
If a debt beta is assumed to be zero
49
What does an asset beta only reflect?
Business risk
50
What does an equity beta reflect?
Both business and financial risk
51
Does tax being zero mean asset beta is greater than an equity beta?
No
52
Do asset and equity beta contain the same business risk?
YES
53
Do bonus issues raise cash?
No
54
Why is dividend decision irrelevant in M&M?
As shareholders would be happy with capital gains or dividends
55
What can a share repurchase scheme increase?
Both EPS and gearing
56
Issue with offering new shares for tender?
May mean that not enough funding is raised from the share issue
57
What should an offer for tender ensure?
All shares on offer are taken up
58
Share price and an increase in cost of equity?
Leads to a fall in share price
59
What is lower, the cost of debt or cost of preference shares?
Cost of debt as risk is lower
60
Profits and a decrease in company's operating gearing ratio?
Company has profits which are less sensitive to changes in sales volume
61
Fixed costs and a decrease in gearing ratio?
Implies a lower proportion of fixed costs
62
WACC and traditional theory of gearing?
There must exist a minimum WACC
63
What happens when there's a scrip issue with perfect information?
Decreases market price and EPS, as there is no misinterpretation by investors
64
A company incorporates increasing amounts of debt finance into its capital structure, while leaving its operating risk unchanged. Assuming a perfect capital market, effect on company's cost of capital and total market value (cost of equity)?
Increases
65
A company incorporates increasing amounts of debt finance into its capital structure, while leaving its operating risk unchanged. Assuming a perfect capital market, effect on company's cost of capital and total market value (WACC)?
Decreases as there's increased gearing
66
A company incorporates increasing amounts of debt finance into its capital structure, while leaving its operating risk unchanged. Assuming a perfect capital market, effect on company's cost of capital and total market value (total market value)?
Increases due to market value
67
What is financial risk depedent on?
Debt/equity (gearing) ratio
68
When there's a lower the value of debt in the ratio?
Financial risk is lower
69
What is operating risk dependent on?
Ratio of variable costs to fixed costs
70
When the lower of proportion of variable costs and higher the proportion of fixed costs?
The higher the operating risk
71
Changes due to sales effect on fixed and variable costs?
Fixed: None
Variable: Fluctuations
72
What is risk that cannot be diversified away?
Systematic risk
73
What is risk that increases as a company gears up?
Financial risk
74
An all equity company issues some irredeemable loan notes to finance a project that hasthe same risk as existing projects. The company operates in a tax-free environment underconditions of perfect capital markets
What happens with cost of equity?
Increases
75
An all equity company issues some irredeemable loan notes to finance a project that hasthe same risk as existing projects. The company operates in a tax-free environment underconditions of perfect capital markets
What happens with WACC?
No change
76
What is most likely to result in a company's financial gearing being high? (tax)
High tax rates
77
What is most likely to result in a company's financial gearing being high? (intangible)
Intangible assets being a low proportion of total assets
78
How do oridinary secured loan notes compare to convertible secured loan notes?
Less expensive because if their equity component as investors are willing to accept a lower coupon rate on the debt
79
How does M&M determine the relevance of dividend policy?
Value of shareholders' equity is determined solely by the firm's investment selection criteria (as it's a perfect market)
80
Gordon growth model and relevance on dividend policy?
Increase in retentions results in a higher growth rate
81
If a company that currently pays its workforce on a piece rate system were to automate itsproduction line, which of the following responses would it expect of operating gearing?
Increase as fixed cost increases but variable cost decreases
82
What does ROCE measure?
How efficiently the company is using the funds available
83
What does interest cover measure?
A company's financial risk
84
Are preference shares a form of equity/debt capital?
Equity capital
85
Are preference shares more risky than ordinary shares from a company point of view?
Yes, as they carry out a requirement to pay dividends
86
Are preference shares more risky than ordinary shares from an investor point of view?
No, but higher risk than debt
87
What is meant by interest yield?
The interest or coupon rate expressed as a percentage of themarket price and this is a measure of return on investment for the debt holder
88
What does total shareholder return ratio measure?
The returns to the investor by taking accountof dividend income and capital growth
89
What does dividend per share ratio measure?
Helps individual shareholders see how much of the overall dividend payout they are entitled to
90
What does the dividend cover ratio measure?
How many times the company’s earnings could pay the dividend
91
Long-term leases (agreement)
The lease agreement cannot be cancelled
92
Long-term leases (lessee)
Lessee is responsible for repairs and maintenance
93
Long-term leases (lessor)
Lessor does not retain the risks or rewards of ownership
94
Long-term leases (quantity)
Usually one lease that covers the majority of the useful life of the asset, not many
95
In relation to an irredeemable security paying a fixed rate of interest, what happens when risk rises?
The market value of the security will fall to ensure that investors receivean increased yield
96
What is meant by maturity gap?
Using its non-current assets an SME may find it easierto secure long-term finance when it may actually need short- or medium-term finance
97
What is meant by a funding gap?
The difference between the finance required to operate an SME and the amount obtained
98
What is an advantage to existing shareholders of listing the company on a major stock market?
Shares become more marketable
99
What is an introduction defined as?
The listing of existing shares without any new finance being raised
100
Who is offered a rights issue first?
Existing shareholders
101
What does a rights issue spread?
A company’s value over an increased number of shares
102
What is the main purpose of a rights issue?
To raise finance
103
How are shares issued in a bonus issue?
At nominal value
104
Do bonus shares carry voting rights?
Yes
105
What is crowdfunding?
The practice of funding a project or business venture by raising monetary contributions from a large number of people, typically using the internet
106
Why are SMEs seen as a igher trading risk?
Due to a lack of trading history as well as fewer assets to provide security
107
What do SMEs often experience?
A funding gap
108
What increases the funding gap problems for SMEs?
A lack of suitable, sufficient, non-current assets
109
How is the value of a company is determined in dividend irrelevance theory?
Solely by the earnings of its investment decisions
110
How are transaction costs incurred in dividend irrelevance theory?
In selling shares
111
Shareholders in bird-in-the-hand theory?
Shareholders may prefer a current dividend to future capital gains (or deferred dividends) because the future is more uncertain
112
Does a bonus issue raise any cash?
No
113
What are good methods to raise equity finance for a listed company?
Rights issue
Private placing
114
What is the advantage of financing using long-term debt?
The reduction in profit before tax. Interest payments on debt are tax deductible, creating a tax shield for the company
115
When issuing new loan notes, what would be the primary reason for a debt covenant limiting the company’s future level of debt?
To reduce the annual interest rate
116
Why do ordinary shares decrease the debt to equity ratio?
They increase equity while having no effect on debt
117
Do ordinary shares commit company to a fixed dividend?
No
118
Do ordinary shares need to be redeemed?
No
119
Do both debt and equity holders have an ownership interest in the company?
Equity does, debt no
120
Payments in debt obligations?
A periodic interest payment
121
Payments in equity securities?
Pay income to their holders when dividends are proposed at the discretion of the board of directors
122
What do variable interest rate loan notes automatically adjust?
Their interest payment in line with an agreed market benchmark
123
Which of the following types of loan note is most likely to maintain a constant market value?
Variable interest rate
124
What is a warrant?
Share options attached to a debt issue in order to make the debt more attractive to potential investors
125
Is selling a sales invoice to a customer’s bank for immediate payment an example of SCF?
Yes
126
What is P2P lending?
A method of debt financing that enables individuals to lend money to other individuals or small businesses without the use of an official financial institution as an intermediary
127
What are other terms of P2P lending?
Can be referred to as “microfinance” or “debt-based crowdfunding”
128
Benefit to selling a sales invoice to a customer’s bank for immediate payment?
The customer’s bank would only deduct a small fee when buying the invoice.
129
Allows a small company to take advantage of a large customer’s high credit rating relates to which source of finance?
Supply chain finance
130
Converts illiquid assets into liquid assets relates to which source of finance?
Securitisation
131
Particularly appropriate for early stage “seed” finance relates to which source of finance?
Crowdfunding
132
Payment by installments relates to which source of finance?
Ijara
133
What is a participating preference share?
Gives the holder the right to receive an additional dividend (if certain conditions are met) in addition to a fixed percentage of the share’s nominal value
134
What elements are needed to estimate the cost of equity using the dividend growth model? (market)
Current market price per share
135
What elements are needed to estimate the cost of equity using the dividend growth model? (dividend)
Current dividend per share
136
What elements are needed to estimate the cost of equity using the dividend growth model? (growth rate)
Expected growth rate in dividend per share
137
What usually determines the optimal capital structure for an organisation?
Lowest WACC as PV of company's future operating cash flows is maximised, thereby maximising the value of company
138
What does any increase in financial gearing create for shareholders?
An additional financial risk, thereby pushing up the cost of equity
139
What does pecknig order theory state for managers?
Managers prefer to use internal equity rather than issue external finance
140
What does MM show when gearing rises?
Increase in the cost of equity (due to financial risk) is perfectly offset by the increased use of relatively cheap debt, leaving the WACC unchanged.
141
Which capital structure theory suggests that the weighted average cost of capital (WACC) will initially decrease, reach a minimum and then increase?
Traditional view of capital structure
142
What does a company's asset beta (ungeared beta) measure?
The underlying risk of the company’s operations
143
Does volatility of operating profit measure business risk?
Yes
144
Does equity beta measure business risk?
No
145
Does volatility of net income measure business risk?
No
146
Does CAPM make assumption on a perfect market?
Yes
147
Does CAPM make assumption on dividend growth?
No
148
Does CAPM make assumption on linear relationship between risk and required return?
Yes
149
Effect of bonus issue on EPS?
Decreases as there is a larger number of shares
150
Dividends and clientele theory?
A company should maintain a stable dividend policy or risk losing investors
151
Dividends and bird-in-the-hand theory?
Shareholders prefer higher dividends and lower potential capital gains because a dividend today is without risk whereas future share price growth is uncertain
152
Dividends and dividend irrelevance theory?
The pattern of dividends does not affect shareholder wealth
153
In order to invest, a venture capitalist would normally expect?
Board representation
154
What do venture capitalists usually want?
They usually want 25% to 49% of the equity, a dividend policy that promotes growth and an exit route.
155
What is the minimum amount for an IPO?
A minimum of £700000
156
is a business angel available for an SME?
No
157
is crowdfunding available for an SME?
No
158
Are government grants available for an SME?
No
159
What is an advantage of convertible debt?
The lower required interest rate due to the attraction of the option of conversion to equity
160
Rollover risk and short-term financing?
Higher rollover risk
161
Cost and long-term financing?
High cost
162
Why does long-term financing have a higher cost?
As long-term investors require higher compensation for deferring their liquidity.
163
What is the coupon rate for a loan note?
The coupon rate gives the annual interest based on the nominal value of the loan note
164
Debt/equity on security over company assets?
Debt may require security over company assets. Equity isn't
165
What is an acknowledgement of debt to be paid on a stated date?
Bill of exchange
166
How can bill of exchange be held?
To maturity or discounted with a bank
167
Which source of finance usually has lowest cost to the company?
A.Bank loan
B.Loan notes
C.Preference shares
D.Ordinary shares
Loan notes
168
What further reduces the risk of loan note financing?
The company issuing loan notes receives a tax deduction for interest paid
169
Effect of an increase in the corporate income tax rate?
Might cause a firm to increase the debt in its financial structure because interest is tax deductible, while dividends are not tax deductible
170
Are dividends tax deductible?
No
171
Is interest tax deductible?
Yes
172
How can unsystematic risk be eliminated?
By investors building a diversified portfolio
173
Traditional capital structure theory (cost of equity)
Cost of equity is higher when there is a high proprotion of debt capital
174
Traditional capital structure theory (WACC)
Point at which WACC is minimised
175
What is the optimal capital structure made up of?
Almost entirely of debt
176
What may debt holders do about market imperfections?
May impose restrictive covenants in loan agreements
177
A company's gearing creates what in market imperfections?
Creates a high risk of bankruptcy as the WACC will be higher
178
DGM assumes what for shareholders?
Have the same required rate of return
179
DGM assumes a constant share price?
No
180
Does equity finance represent cash?
No
181
Are preference shares a source of equity capital?
No
182
Are retained earnings equity or debt?
Equity capital
183
What does Mudarana involve?
An investing partner and a managing or working partner
184
What is Murabaha similar to?
Trade credit
185
Who do leasing companies pass the obligation back to?
The lessee as everything is negotiable
186
If the PV of leasing is cheaper than the PV of purchasing (NPV)
A project NPV will increase through the use of a lease as opposed to purchasing an asset, so could potentially rise from negative to positive
187
Why is the existence of a lease will represent extra risk for shareholders that may be perceived by them?
Due to legal commitments for cash payments that come with the lease
188
What would be the effect on the TERP value if the new shares were offered at a 20%discount level whilst raising the same total amount of finance?
The TERP would fall
189
What is shareholder more likely to accept if the discount on a rights issue gets bigger?
To accept the rights offer
190
What is the worst thing shareholders could do in relation to a rights issue as far as shareholder wealth is concerned?
Save their investment and do nothing
191
What action shareholders could do that results in the least dilution of control for existing shareholders?
Accept the rights offer without negotiation
192
Assuming the business wants to retain control in the hands of the existingshareholders, how should it seek to raise the new finance?
issue new debt
193
What is meant by the tax shield?
The amount of tax saved due to the payment of interest on debt
194
What happens to tax shield if the higher the value of interest paid?
Becomes larger
195
What is the main driver for risk premium?
Systematic risk
196
What is meant by the signalling effect?
Where changes in dividend patterns can affect the investors’ view of the business
197
What is meant by dividend irrelevancy theory?
States that shareholders wish to increase their wealth but are indifferent as to whether it comes from dividends received or through a rise in the share price.
198
What does dividend dependency suggest?
Investors have invested because of the currentpattern of dividends and a change in that pattern will upset that and negate theirreasons for investing
199
How to resolve company liquidity issues?
The company should only pay out what it canafford or offer a non-cash alternative instead
200
What does a scrip issue give?
More shares to shareholders but since the overall market value isnot affected then the share price falls
201
Example of systematic risk (recessionary)
Recessionary pressures in the country in which the bank operates
202
Example of systematic risk (election)
A change in government after a general election
203
What is meant by a beta value of 1?
The investment has the same level of systematic risk as the market
204
Why is having fixed costs in a cost structure risky?
Since they have to be paid and are oftenunavoidable in the short run if the business starts to turn downwards
205
What do more fixed costs mean for profitability?
More volatility in profits
206
How do equity holders respond to the increased risk when a company includes more debtin its capital structure?
By increasing the return they demand from the company
207
What happens to WACC in M&M no tax?
It does not change
208
What happens to WACC in M&M with corporation tax introduced?
WACC brought down as gearing increased
209
What is the traditional theory of gearing on how modest amounts of debt are treated?
Amounts of debt often went unnoticed by shareholders and this lack of response (in the form of increased demands for higher return) meant the WACC fell
210
What do shareholders given M&M assumptions do with risk inherent of extra debt?
Compensate themselves by a commensurate increase in required return to leave the company WACC unaltered and withoutany inherent gain
211
What does the rising tail represent?
An increased risk to debt holders
212
What does tax exhaustion increase?
The cost of borrowing at high levels of gearing
213
Do banks lend to high risk businesses?
Generally no
214
What does CAPM assume?
All shareholders of a company have thesame required rate of return
215
Dividend growth model assumption (share price)
A constant share price and a constant dividend growth for company
216
Dividend growth model assumption (interim dividend)
That the company's interim dividend is equal to the final dividend
217
Is cutting dividend debt or equity finance?
Equity finance
218
Preference shares debt or equity finance?
Debt
219
What does traditional capital structure theory state for WACC?
It is minimised
220
What does traditional capital structure theory state for cost of equity?
Will be higher when there is a high proportion of debt capital
221
M&M model with no tax treat value of company?
The value of the company remains unchanged with increased gearing
222
M&M model with no tax recognise structure?
There is no optimal capital structure
223
Optimal capital structure with M&M with tax model?
Optimal capital structure is made up almost entirely of debt
224
Debt holders and market imperfections?
Debt-holders may impose restrictive covenants in loan agreements
225
Company's gearing and market imperfections?
When a company's gearing creates a high risk of bankruptcy the WACC will be higher
226
When does tax exhaustion occur?
When there is a high proportion of debt rather than equity capital
227
Agency costs, tax exhaustion and bankruptcy risk discourage what? (gearing)
Very high gearing levels
228
What is meant by a placement?
A sale of shares to new investors
229
What does pecking order theory state?
Managers prefer to use internal finance (i.e. retained earnings) rather than external finance
230
What if external finance is required in pecking order theory?
Debt issues are preferable to share issues
231
What is meant by financial disintermediation?
Borrowing directly from investors rather than through a financial intermediary such as a bank
232
Debt secured vs unsecured debt (cost)
Tend to have a lower cost than unsecured debt
233
What does the redemption price influence?
Influences the dollar market value of a loan note rather than the cost of debt
234
Why does a longer period to redemption tends to increase the cost?
A normal yield curve is upward sloping
235
Who are loan notes a liability for?
The issuer
236
Who are loan notes an asset for?
The buyer
237
What happens to the market value of a fixed interest loan note if the general level of interest rates in the economy rises?
The market value of the loan note falls as it reduces PV of a loan note's future cash flows
238
What does the dividend growth model assume?
All shareholders of Tulip Co have the same required rate of return
239
What does Mudaraba involve?
An investing partner and a managing or working partner
240
When are convertible loans repaid in a creditors' hierarchy on liquidation?
First, then followed by preference shares and ordinary shares
241
What risk does an asset beta only measure?
Business risk
242
When assuming the beta of debt is zero?
It will understate business risk when ungearing an equity beta to find an asset beta.
243
What is true with traditional capital structure theory (cost of equity)
The cost of equity is higher when there is a high proportion of debt capital
244
What is true with traditional capital structure theory (WACC)
There is a point which WACC is minimised
245
Optimal capital structure with M&M with-tax model?
Made up almost entirely of debt
