Exam 3 Flashcards
What is finance
the study of how and under what terms savings(money) are allocated between lenders and borrowers
What is the goal of a firm
to create value for the firms shareholders through maximizing the price of the existing stock
What is the role of management in a firm
management serves as an arbitrator and moderator between conflicting interest groups of stakeholders and objectives
who holds contractual claims against the firm
creditors, managers, employees, customers
who holds residual claims against a firm
shareholders
what are the three issues addressed by the study of finance
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)
what are the three principles of finance
cash flow is what matters
money has time value
Risk requires a reward
why is cash flow what matters
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
why does money have a time value
because of interest and inflation a dollar today is worth more than a dollar tomorrow
what is the present value formula
PV = FV/(1+r)^n`
how do we calculate NPV
calculate PV of inflows and outflows
subtract PV of outflows from PV of inflows
What is the common discount rate or minimum required rate of return
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
why does risk require a reward
risk is uncertainty of future payoff so a rational investor will need higher possible rewards to take on this additional uncertainty
what are real assets
tangible things owed by persons and businesses
what are financial assets
what one individual has lent to another
What are the three functions of money
medium of exchange
standard of value
store of value
what are the four main sectors of the financial system
government, businesses, non residents, households
what are the three channels of money transfer
financial intermediaries
market intermediaries
non market transactions
what are financial intermediaries
they transform the nature of the securities they issue and invest in such as banks and insurance companies
what are market intermediaries
they make markets work better such as real estate brokers and stock brokers
what are non market transactions
transaction where markets are non involved such as lending money to your family member so they can make some purchase
what is intermediation
the transfer of funds from lenders to borrowers
what is the first channel of intermediation
direct intermediation is when the lender provides money directly to the borrower(non market transaction)
what is the second channel of intermediation
direct intermediation through a market intermediary where the borrower uses a market intermediary to find suitable lenders
what is the third channel of intermediation
indirect intermediation where a financial intermediary lends money to the borrowers but raises that money by borrowing from other individuals
what are the four main financial intermediaries
banks, insurance companies, pension funds, mutual funds
which of the four main intermediaries do not change the nature of the underlying security
mutual funds
what are the two main financial instruments
debt instruments and equity instruments
what are the two main types of equity instruments
common shares and preferred shares
what are debt instruments
legal obligations to repay borrowed funds at a specific maturity date and to provide interest payments
what are equity instruments
ownership stakes in a company
what are common shares
part ownership in a company usually with voting rights
what are preferred shares
equity instruments that usually entitle the owner to fixed dividend payments that must be made before any dividends are paid to common shareholders
what are the two financial markets
primary markets and secondary markets
what are primary markets
involve the issue of new securities by the borrower in return for cash from investors or borrowers
what are secondary markets
provide trading environments that permit investors to buy and sell existing securities
how big are secondary markets
secondary markets for equities are many times the size of primary markets but it is the opposite for debt
What is bootstrapping
the process by which entrepreneurs raise seed money and obtain other resources necessary to start their business, usually lasts 1-2 years
what are some sources of bootstrap financing
personal savings, other founders, family and friends, credit cards
what is venture capital
venture capitalists are individuals or firms that help new businesses get started and provide much of their early stage financing
what are the three reasons traditional sources of funding do not work for new or emerging businesses
the high degree of risk
types of productive assets
informational asymmetry problems
how does venture capital work
VC investment gives them an equity interest in the company often in the form of preferred stock that is convertible to common stock
what are tactics used by VC’s to reduce risk
funding ventures in stages
requiring founders to make personal investments
syndicating investments
having in-depth knowledge of the industry
what is VC’ syndication
when the originating VC sells a percentage of a deal to other VC to spread out risk
How do VC exits work
VC agreements include provisions identifying who has the authority to make exit decisions such as timing, method, and price
what are the three main exit strategies for VC’s
sell to a strategic buyer
sell to a financial buyer
sell to the public through IPO
what are the five advantages of going public
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
what are the three disadvantages to going public
high cost of the IPO
costs of complying with ongoing SEC disclosure requirements
transparency that results from compliance can be costly for some firms
What do investment banks do in IPO’s
origination
underwriting
distribution
what is origination
bank helps determine if the firm is ready to IPO
firm management must obtain approvals
registration must be filed with SEC
what is underwriting
the risk bearing part of investment banking where the firm underwrites on a firm commitment basis or best efforts basis
what is firm commitment basis
the investment banker guarantees the issuer a fixed amount of money from the IPO by buying the stock and reselling it to the public
what is a best efforts basis
the investment banker makes no guarantee to sell securities at a particular price
what is underwriting syndication
when underwriters combine to underwrite an IPO so they take on less risk but also have to share the fees and profit from sale
What are the three main costs associated with an IPO
underwriting spread
out of pocket expenses
underpricing
what is a general cash offer
a sale of debt or equity by a public company that has previously sold stock to the public
what is a competitive sale general cash offer
after origination, underwriters bid competitively to buy the issue and sell to investors
what is a negotiated sale general cash offer
the issuer selects the underwriter at the beginning of origination and works closely with them to design and sell the issue
What are private placements
when a firm sells unregistered securities directly to investors such as insurance companies, commercial banks, or wealthy individuals
what are the three advantages of private placements
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
what is a disadvantage of private placements
the biggest drawback is it involves restrictions on the resale of securities
what is a dividend
something of value that is distributed to a firms stockholders on a pro-rata basis
what is the main effect of a dividend
it reduces the value of the stockholders claims against the firm by returning some of their investment to them
what are the four main types of dividend
regular cash dividend
extra dividend
special dividend
liquidating dividend
what are the steps in the dividend payment process
board vote, public announcement, ex-dividend date, record date, payable date
what are stock repurchases
not all shareholders participate in stock repurchases and they are taxed only on the capital gain not the whole amount
what are the three ways stock can be repurchased
open market repurchase
tender offer
targeted stock repurchase
what are the two types of tender offer
fixed price
dutch auction
what is a fixed price tender offer
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
what is a dutch auction tender offer
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
what is a stock dividend
does not involve distribution of value but distributes new shares on a pro-rata basis to existing stockholders
what are stock splits
a stock split involves the distribution of a larger multiple of outstanding shares
what is the benefit of stock splits
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
what should management consider when setting a dividend policy
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?
what is an acquisition
the purchase of one firm by another
what is a merger(amalgamation)
the combination of two or more firms into a new legal entity needing approval from both sets of shareholders
what is a horizontal merger
two firms in the same industry combine
what is a vertical merger
a merger where one firm acquires a supplier or another firm that is closer to its existing customers
what is backwards vertical integration
purchasing suppliers of firms before you in the trade chain
what is forward vertical integration
purchasing a firm that is closer to the end user in the trade chain
what is a conglomerate merger
a merger where two firms in unrelated businesses combine
what should the primary motivation for M&A be
the creation of synergies which is when the value of combined firms is larger than the sum of the individual firms
what are the three operating synergies
economies of scale
economies of scope
complementary strengths
what are economies of scale
spreading fixed costs and geographic synergies
what are economies of scope
the combination of 2 activities to reduce costs
what are complementary strengths
one firm is more efficient in certain areas than another
what are efficiency increases
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
what is financing synergy
reduced cashflow variability
increase in debt capacity
reduction in average issuing costs
what are tax benefits
combined firms can make better use of tax deductions and credits
what are strategic realignments
permits new strategies that were not feasible before the combination
what is the general intent of securities legislation
provide transparency and fair treatment
what are the critical shareholder percentages
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
What are the three steps in the takeover bid process
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
What is a friendly acquisition
the acquisition of a target company that is willing to be taken over
what is the timeline in a friendly acquisition
approach target with information memorandum, confidentiality agreement, sign letter of intent, main due diligence, final sale agreement, ratified
What is a hostile takeover
a takeover in which the target has no desire to be acquired and actively rebuffs the acquirer and refuses to provide confidential info
in a hostile takeover, what does a price jump above the offer price indicate
a competing offer is likely or the bid price is too low
in a hostile takeover, what does the market price staying close to the offer price indicate
the offer price is fair and the deal will likely go though
in a hostile takeover what does little trade volume indicate
a bad sign for the acquirer because shareholders are reluctant to sell
in a hostile takeover what does high trading volume indicate
shares being sold from investors to arbitrageurs who will coordinate a response to the tender offer
what are three defence tactics in a hostile takeover
shareholders rights plan
selling the crown jewels
white knight
what is a shareholders rights plan
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
what is selling the crown jewels
target company selling their key assets to become less attractive to the acquirer
what is a white knight defence
target seeks out another acquirer considered friendly to make a counter offer
what is globalization
the removal of barriers to free trade and the close integration of national economies
what is a multinational corp
a business firm that operates in more than one country but is hq in one country
what 6 factors affect international financial management
uncertainty of future exchange rates
differences in legal systems and taxes
language differences
cultural differences
economic system differences
country risk or political uncertainty
what is the FOREX market
a group of international markets connected electronically where currencies are bought and sold in wholesale amounts
what is the FOREX spot rate
the rate at which one agrees to buy or sell currency today
what is the FOREX forward rate
the exchange rate to be used when a future transaction is completed established on the present day
what are the three methods of currency rate quotes
currency exchange rate
direct quotation method
indirect quotation method
what is the currency bid rate
the rate at which the dealer will buy foreign currency
what is the currency ask rate
the rate at which the dealer will sell foreign currency
what is the dealers spread
the difference between the bid and the ask price often in percent form
(ask rate - bid rate)/ask rate
what are cross rates
exchange rates between two different currencies
what are derivatives
securities that derive all or part of their value from another underlying security
what are the three reasons to trade indirect claims
expand investment opportunities
lower cost
increase leverage
what are options
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
what are two main option exchanges
the Montreal exchange
the Chicago board options exchange
what is standardized in the options markets
exercise dates, exercise prices, and quantities
what is a clearing corp
a firm that guarantees option positions
in canada it is the Canadian derivatives clearing corporation owned by the ME
what is the intrinsic value of an option
the value of an option if it expired/was exercised today
what is an uncovered or naked option writer
a writer who does not own shares in the underlying stock to make available if exercised by the buyer
they face unlimited potential loss
what is a covered call
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
what are protective puts
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
what is the time value of an option
the actual price minus the intrinsic value
represents the premium from possible volitility
further an option is from expiration the higher the time value
what are futures derivatives
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
What is the national balance sheet accounts(NBSA
collects financial data on the major agents in the canadian financial system and tracks borrowing and lending between agents
which of the four main financial sectors are providers and which are borrowers
households and non residents are the main providers or lenders
government and businesses are the main users or borrowers
what are the categories of financial instruments
marketable and non marketable
what are the categories of marketable securities
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
what are the categories of secondary markets
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
Which methods of issuance are good for which scenarios
equity issuances should be negotiated
vanilla bonds should be competitive
complex securities should be negotiated
what is a shelf registration
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
