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Finance and Accounting > Exam 3 > Flashcards

Exam 3 Flashcards

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1
Q

What is finance

A

the study of how and under what terms savings(money) are allocated between lenders and borrowers

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2
Q

What is the goal of a firm

A

to create value for the firms shareholders through maximizing the price of the existing stock

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3
Q

What is the role of management in a firm

A

management serves as an arbitrator and moderator between conflicting interest groups of stakeholders and objectives

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4
Q

who holds contractual claims against the firm

A

creditors, managers, employees, customers

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5
Q

who holds residual claims against a firm

A

shareholders

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6
Q

what are the three issues addressed by the study of finance

A

what long term investments should the firm make(capital budgeting)
how should the firm raise money(capital structure)
how to manage cashflows from day to day ops(operating decision)

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7
Q

what are the three principles of finance

A

cash flow is what matters
money has time value
Risk requires a reward

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8
Q

why is cash flow what matters

A

accounting profits are not cashflows meaning a profitable company can be generating no or even negative cash flow
cash flow is what drives the value of a business

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9
Q

why does money have a time value

A

because of interest and inflation a dollar today is worth more than a dollar tomorrow

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10
Q

what is the present value formula

A

PV = FV/(1+r)^n`

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11
Q

how do we calculate NPV

A

calculate PV of inflows and outflows
subtract PV of outflows from PV of inflows

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12
Q

What is the common discount rate or minimum required rate of return

A

the firms cost of capital which is the average rate of return the firm must pay to long term creditors and shareholders to use their funds

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13
Q

why does risk require a reward

A

risk is uncertainty of future payoff so a rational investor will need higher possible rewards to take on this additional uncertainty

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14
Q

what are real assets

A

tangible things owed by persons and businesses

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15
Q

what are financial assets

A

what one individual has lent to another

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16
Q

What are the three functions of money

A

medium of exchange
standard of value
store of value

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17
Q

what are the four main sectors of the financial system

A

government, businesses, non residents, households

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18
Q

what are the three channels of money transfer

A

financial intermediaries
market intermediaries
non market transactions

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19
Q

what are financial intermediaries

A

they transform the nature of the securities they issue and invest in such as banks and insurance companies

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20
Q

what are market intermediaries

A

they make markets work better such as real estate brokers and stock brokers

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21
Q

what are non market transactions

A

transaction where markets are non involved such as lending money to your family member so they can make some purchase

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22
Q

what is intermediation

A

the transfer of funds from lenders to borrowers

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23
Q

what is the first channel of intermediation

A

direct intermediation is when the lender provides money directly to the borrower(non market transaction)

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24
Q

what is the second channel of intermediation

A

direct intermediation through a market intermediary where the borrower uses a market intermediary to find suitable lenders

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25
Q

what is the third channel of intermediation

A

indirect intermediation where a financial intermediary lends money to the borrowers but raises that money by borrowing from other individuals

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26
Q

what are the four main financial intermediaries

A

banks, insurance companies, pension funds, mutual funds

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27
Q

which of the four main intermediaries do not change the nature of the underlying security

A

mutual funds

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28
Q

what are the two main financial instruments

A

debt instruments and equity instruments

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29
Q

what are the two main types of equity instruments

A

common shares and preferred shares

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30
Q

what are debt instruments

A

legal obligations to repay borrowed funds at a specific maturity date and to provide interest payments

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31
Q

what are equity instruments

A

ownership stakes in a company

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32
Q

what are common shares

A

part ownership in a company usually with voting rights

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33
Q

what are preferred shares

A

equity instruments that usually entitle the owner to fixed dividend payments that must be made before any dividends are paid to common shareholders

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34
Q

what are the two financial markets

A

primary markets and secondary markets

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35
Q

what are primary markets

A

involve the issue of new securities by the borrower in return for cash from investors or borrowers

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36
Q

what are secondary markets

A

provide trading environments that permit investors to buy and sell existing securities

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37
Q

how big are secondary markets

A

secondary markets for equities are many times the size of primary markets but it is the opposite for debt

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38
Q

What is bootstrapping

A

the process by which entrepreneurs raise seed money and obtain other resources necessary to start their business, usually lasts 1-2 years

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39
Q

what are some sources of bootstrap financing

A

personal savings, other founders, family and friends, credit cards

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40
Q

what is venture capital

A

venture capitalists are individuals or firms that help new businesses get started and provide much of their early stage financing

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41
Q

what are the three reasons traditional sources of funding do not work for new or emerging businesses

A

the high degree of risk
types of productive assets
informational asymmetry problems

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42
Q

how does venture capital work

A

VC investment gives them an equity interest in the company often in the form of preferred stock that is convertible to common stock

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43
Q

what are tactics used by VC’s to reduce risk

A

funding ventures in stages
requiring founders to make personal investments
syndicating investments
having in-depth knowledge of the industry

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44
Q

what is VC’ syndication

A

when the originating VC sells a percentage of a deal to other VC to spread out risk

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45
Q

How do VC exits work

A

VC agreements include provisions identifying who has the authority to make exit decisions such as timing, method, and price

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46
Q

what are the three main exit strategies for VC’s

A

sell to a strategic buyer
sell to a financial buyer
sell to the public through IPO

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47
Q

what are the five advantages of going public

A

amount of equity is larger
addition equity can be raised at low cost
can fund growing business without giving up control
creates secondary market
easier to attract top management

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48
Q

what are the three disadvantages to going public

A

high cost of the IPO
costs of complying with ongoing SEC disclosure requirements
transparency that results from compliance can be costly for some firms

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49
Q

What do investment banks do in IPO’s

A

origination
underwriting
distribution

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50
Q

what is origination

A

bank helps determine if the firm is ready to IPO
firm management must obtain approvals
registration must be filed with SEC

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51
Q

what is underwriting

A

the risk bearing part of investment banking where the firm underwrites on a firm commitment basis or best efforts basis

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52
Q

what is firm commitment basis

A

the investment banker guarantees the issuer a fixed amount of money from the IPO by buying the stock and reselling it to the public

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53
Q

what is a best efforts basis

A

the investment banker makes no guarantee to sell securities at a particular price

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54
Q

what is underwriting syndication

A

when underwriters combine to underwrite an IPO so they take on less risk but also have to share the fees and profit from sale

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55
Q

What are the three main costs associated with an IPO

A

underwriting spread
out of pocket expenses
underpricing

56
Q

what is a general cash offer

A

a sale of debt or equity by a public company that has previously sold stock to the public

57
Q

what is a competitive sale general cash offer

A

after origination, underwriters bid competitively to buy the issue and sell to investors

58
Q

what is a negotiated sale general cash offer

A

the issuer selects the underwriter at the beginning of origination and works closely with them to design and sell the issue

59
Q

What are private placements

A

when a firm sells unregistered securities directly to investors such as insurance companies, commercial banks, or wealthy individuals

60
Q

what are the three advantages of private placements

A

private lenders are more willing to negotiate changes to a bond contract, if a firm suffers financial distress, the problems are more likely to be resolved without going to bankruptcy court, private placement deals are fast and flexible

61
Q

what is a disadvantage of private placements

A

the biggest drawback is it involves restrictions on the resale of securities

62
Q

what is a dividend

A

something of value that is distributed to a firms stockholders on a pro-rata basis

63
Q

what is the main effect of a dividend

A

it reduces the value of the stockholders claims against the firm by returning some of their investment to them

64
Q

what are the four main types of dividend

A

regular cash dividend
extra dividend
special dividend
liquidating dividend

65
Q

what are the steps in the dividend payment process

A

board vote, public announcement, ex-dividend date, record date, payable date

66
Q

what are stock repurchases

A

not all shareholders participate in stock repurchases and they are taxed only on the capital gain not the whole amount

67
Q

what are the three ways stock can be repurchased

A

open market repurchase
tender offer
targeted stock repurchase

68
Q

what are the two types of tender offer

A

fixed price
dutch auction

69
Q

what is a fixed price tender offer

A

management announces the price that will be paid for shares and the max number of shares to be purchased then interested stockholders tender their shares with how many they are willing to sell at that price

70
Q

what is a dutch auction tender offer

A

management announces the number of shares it will purchase and offers a series of prices to see which price gets the proper amount of shares tendered

71
Q

what is a stock dividend

A

does not involve distribution of value but distributes new shares on a pro-rata basis to existing stockholders

72
Q

what are stock splits

A

a stock split involves the distribution of a larger multiple of outstanding shares

73
Q

what is the benefit of stock splits

A

sends a positive message about the stock value as management is unlikely to split the stock if they thing the price is going to decline

74
Q

what should management consider when setting a dividend policy

A

long term how much does the firms earnings exceed investment needs?
does the firm have enough reserves to maintain dividends in low earning periods?
does the firm have sufficient flexibility to maintain dividends in unforeseen circumstances?
can the firm quickly raise capital?
if the firm chooses to finance dividends with equity will the increased number of shareholders affect the control of the firm?

75
Q

what is an acquisition

A

the purchase of one firm by another

76
Q

what is a merger(amalgamation)

A

the combination of two or more firms into a new legal entity needing approval from both sets of shareholders

77
Q

what is a horizontal merger

A

two firms in the same industry combine

78
Q

what is a vertical merger

A

a merger where one firm acquires a supplier or another firm that is closer to its existing customers

79
Q

what is backwards vertical integration

A

purchasing suppliers of firms before you in the trade chain

80
Q

what is forward vertical integration

A

purchasing a firm that is closer to the end user in the trade chain

81
Q

what is a conglomerate merger

A

a merger where two firms in unrelated businesses combine

82
Q

what should the primary motivation for M&A be

A

the creation of synergies which is when the value of combined firms is larger than the sum of the individual firms

83
Q

what are the three operating synergies

A

economies of scale
economies of scope
complementary strengths

84
Q

what are economies of scale

A

spreading fixed costs and geographic synergies

85
Q

what are economies of scope

A

the combination of 2 activities to reduce costs

86
Q

what are complementary strengths

A

one firm is more efficient in certain areas than another

87
Q

what are efficiency increases

A

new management will be more efficient and add more value than what the target now has
the combined firm can make use of unused production, sales, and marketing capacity

88
Q

what is financing synergy

A

reduced cashflow variability
increase in debt capacity
reduction in average issuing costs

89
Q

what are tax benefits

A

combined firms can make better use of tax deductions and credits

90
Q

what are strategic realignments

A

permits new strategies that were not feasible before the combination

91
Q

what is the general intent of securities legislation

A

provide transparency and fair treatment

92
Q

what are the critical shareholder percentages

A

10% is early warning
20% needs a takeover bid
50.1% gives control
66.7% can approve amalgamation proposals
90% allows for minority squeeze out

93
Q

What are the three steps in the takeover bid process

A

takeover circular sent to all shareholders
target has 15 days to circulate letter to shareholders with eh recommendation of the board of directors to accept or reject
bid must be open for 105 days following public announcement subject to board ability to reduce the bid period to at least 35 days

94
Q

What is a friendly acquisition

A

the acquisition of a target company that is willing to be taken over

95
Q

what is the timeline in a friendly acquisition

A

approach target with information memorandum, confidentiality agreement, sign letter of intent, main due diligence, final sale agreement, ratified

96
Q

What is a hostile takeover

A

a takeover in which the target has no desire to be acquired and actively rebuffs the acquirer and refuses to provide confidential info

97
Q

in a hostile takeover, what does a price jump above the offer price indicate

A

a competing offer is likely or the bid price is too low

98
Q

in a hostile takeover, what does the market price staying close to the offer price indicate

A

the offer price is fair and the deal will likely go though

99
Q

in a hostile takeover what does little trade volume indicate

A

a bad sign for the acquirer because shareholders are reluctant to sell

100
Q

in a hostile takeover what does high trading volume indicate

A

shares being sold from investors to arbitrageurs who will coordinate a response to the tender offer

101
Q

what are three defence tactics in a hostile takeover

A

shareholders rights plan
selling the crown jewels
white knight

102
Q

what is a shareholders rights plan

A

aka the poison pill or deal killer
gives non acquiring shareholders the right to buy 50 percent more shares at a discount price to make the acquisition more expensive

103
Q

what is selling the crown jewels

A

target company selling their key assets to become less attractive to the acquirer

104
Q

what is a white knight defence

A

target seeks out another acquirer considered friendly to make a counter offer

105
Q

what is globalization

A

the removal of barriers to free trade and the close integration of national economies

106
Q

what is a multinational corp

A

a business firm that operates in more than one country but is hq in one country

107
Q

what 6 factors affect international financial management

A

uncertainty of future exchange rates
differences in legal systems and taxes
language differences
cultural differences
economic system differences
country risk or political uncertainty

108
Q

what is the FOREX market

A

a group of international markets connected electronically where currencies are bought and sold in wholesale amounts

109
Q

what is the FOREX spot rate

A

the rate at which one agrees to buy or sell currency today

110
Q

what is the FOREX forward rate

A

the exchange rate to be used when a future transaction is completed established on the present day

111
Q

what are the three methods of currency rate quotes

A

currency exchange rate
direct quotation method
indirect quotation method

112
Q

what is the currency bid rate

A

the rate at which the dealer will buy foreign currency

113
Q

what is the currency ask rate

A

the rate at which the dealer will sell foreign currency

114
Q

what is the dealers spread

A

the difference between the bid and the ask price often in percent form
(ask rate - bid rate)/ask rate

115
Q

what are cross rates

A

exchange rates between two different currencies

116
Q

what are derivatives

A

securities that derive all or part of their value from another underlying security

117
Q

what are the three reasons to trade indirect claims

A

expand investment opportunities
lower cost
increase leverage

118
Q

what are options

A

when the buyer has the right but not the obligation to buy or sell the underlying security at a fixed price upon a certain date

119
Q

what are two main option exchanges

A

the Montreal exchange
the Chicago board options exchange

120
Q

what is standardized in the options markets

A

exercise dates, exercise prices, and quantities

121
Q

what is a clearing corp

A

a firm that guarantees option positions
in canada it is the Canadian derivatives clearing corporation owned by the ME

122
Q

what is the intrinsic value of an option

A

the value of an option if it expired/was exercised today

123
Q

what is an uncovered or naked option writer

A

a writer who does not own shares in the underlying stock to make available if exercised by the buyer
they face unlimited potential loss

124
Q

what is a covered call

A

when you write or sell a call option while owning the underlying stock
limits gains if stock price rises but also cushions loss by the amount of the call premium

125
Q

what are protective puts

A

a strategy involving the purchase of a put option as a supplement to a long position in an underlying asset
put acts as insurance against a decline in the underlying price guaranteeing a minimum price the stock can be sold

126
Q

what is the time value of an option

A

the actual price minus the intrinsic value
represents the premium from possible volitility
further an option is from expiration the higher the time value

127
Q

what are futures derivatives

A

forwards contracts with set contract size, delivery date, and conditions for deliver
futures represent an obligation to buy or sell a fixed amount of an asset on a specified date at a price set today

128
Q

What is the national balance sheet accounts(NBSA

A

collects financial data on the major agents in the canadian financial system and tracks borrowing and lending between agents

129
Q

which of the four main financial sectors are providers and which are borrowers

A

households and non residents are the main providers or lenders
government and businesses are the main users or borrowers

130
Q

what are the categories of financial instruments

A

marketable and non marketable

131
Q

what are the categories of marketable securities

A

money market securities which are short term debt instruments
capital market securities which are debt securities with maturities greater than one year and equity securities

132
Q

what are the categories of secondary markets

A

exchanges or auctions where traders bid on securities at a specific location
OTC markets where there is no set location and consist of a network of dealers who trade with each other

133
Q

Which methods of issuance are good for which scenarios

A

equity issuances should be negotiated
vanilla bonds should be competitive
complex securities should be negotiated

134
Q

what is a shelf registration

A

allows company to register shares for the next two years without selling them so they can issue them as needed without the extra cost of a new issuance

135
Q
A

Finance and Accounting (3 decks)

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