finance lec 10 - sources of finance Flashcards
financing decision relate to how to
raise appropriate finance
at the right time required
for the lowest cost
(As maxes vaye of firm)
whar are internal sources of finance
ertained earnin
what ar external sources of finance
equity/debt
finacial instuments are not the same as
assets
what is diffrence between financial instruwment and finccial asset
assets are more general
in return for what you oay you keep recieveign something for it
???????
finacial instryments are
asssets that are regulat traded
check if it is are or aren’t
whar are 3 finacnial instruments
shares
bond/debt
loans
example of bond/debt
gilt treasury, bills?
what are loans in terms of finaicalinstrument/asset
assets but not regulary traded no liquid mkt but at same time we have a debt collection business where whoole premse is they buy loans
retained earnigns
cash available to company to invest in real assets generated from operations
retained earnigns are available to do what 2 things
distribute/retain
retained earnigns are a rimary source of finance for new investments in whic 4 coutnies
US UK GERMANY JAPAN
Who has full control over retained earnings
managers and directors
what we dont pay to sh we
reinvest in retained earnigns
more div = what to things / what thing and then what happens as a result
less retained earnings (+ less retained for investment)
more reliant on external finance
what descisions do we make
-how much
- is it best
how much will we pay out to S
is it best source
how much will we pay out to SH
-the more paid out
- some ompanies do what instead of issuin dividends
- where can we get the rest of finance from
the more paid out ass dividen the less retained for reinvestment
some companies buy back shares instead of issiuin dividends
get the rest from debt and equity to make i ? LOL CHECK THIS ON
is it best source (retained earnings)what 3 things do we consider
is it avaiable
no issuing costs therfore don’t incur costs to use retained earnings
easy to access
as long as you got retained earnign what dont you need to explain
anything to anyone else
as long as got retained earnings dont need to explain anything to anyone else but
what does this avoid and why
what position may you end up in
what do managers avoid
aviods market discipline as if you dont got to justify or persuade this is a foos incestment
may end up in a position where you take on bad invesment doe selfish descsion
managers avoud having to explain and promo a project of raise funds exterrnally
debt is
borrowing or issuing boonds
borrowing from a bank is
a contract between a copmay and bank
setting out terms and afreement
oat interst annual the repay the principal
generally not tradebale
may be secured on assets
in debt the interst can be
fixed/fotaing
expand on a fixed/floatinginterest rate
prespescified payment is areed
LIBOR - cost of funding
diff commercial banks agreed when borrow from each other
5.3% + preimium on otp
change over time based on base rate
how does bank protect its position
by mposing covenants - restritions on waht the company can do
what can’t a copmany do in terms of imposed restrictios, we talking about
- dividends
- debt
- assets
pay dividends - till paid off loan
issue new debt - dont want to dilute securiteis
can’t sell asset on wcich loans are secrured
who are restrictoins especially imposed on
small firm
restrictions are imposed as it minimses
chances of company failing to pau loan back
in terms of teh ratio to ratio thing that the ank may imposed what’s the poitn
they dont care whats borrowed as long as it is below threshold
i
what happens if you go above the threshold
breached covenant
got right to call in loan for it to be paid earlier
bank loan is used as st borrowing what is the period of year
3-5 years
long term debt finance
what are the 2 types
fixed interest securities
debenture
what are fixed interst securities
borrow money and in echange secure/use a number of ordinary shares as collateral
if they fail to pau they seize stocks and get moeny
give example of fixed interst securtieis
loan stock
debentures
bulle tpoitns for fixed interest securities
may be conertible
pat value in uk typically £100
market value - depends on D and S in bond mkt
repaid b4 SH in event of liquidation
less risky than shares - so lower return required by debt hilders
what is debentrue
secured corporate bond - UK
unsecured - US
written acknowldegement of indebtness
debeentures are secured agaisnt
corporate assets
- fixed charge on speciifed asets
assets can’t be disposed of whilst debt is outstanding
if don’t got NCA mmay impose flotaing charge on WC items such as inventory (floating charge on a class of asset)
are debentures ore or less risky and why
less risky than unsecured debt
as all you can do in this situation is take company into liquidation and then get moeny that is leftover(unsecured debt)
(secured debt) usually secured against asset that is mor valuable than actual value fo debt
can be engineered to suit needs of company and investors - coupon , issue price, redemption price
warrants , convertible debt
restrictive covenants
conditions attached to loan/bond
restrictive conventans used to
ptotect debt holder
RC restricy
managments ower
examples of coventnats
limit amount of other debt to anyone
have a target for gearing/current ratio
what is intention of RC
Prevent risk profile of company being changed
safeguard against any unexpected change to company risk profile
what do we mena when we say change company risk profile
dont borrow from anayoe les/above cetain threshold - cause if you do you no longer the copany that borrowed money in 1st place
don’t increase div payout bby certian rate otherwise you deviate from circumnstances/situation you went in intially when you borrowed money
what haooens in breahc of contract / not being able ti pay
BOC - lead to forced early repayment
if dont got £ - take emminto liquidation (game over for SH , wealth wiped out dont get anytgubg
bond rting is a key feature of
bond / debenture
bond rating is measure of
investment risk
- how liekly company will pay interst
- how liekly is it cop will repay principla
bond rating is rated by
commerial organisations e.g. Moodys
bond ratings are basedon
company’s finaical perfomance
economic environment
ubvesmtent risk an limit investments in bonds to
‘investment grade’
a dowgrading of a bond rating can trigger
a reuiremtn to sell
causing a fall in the bond once and an increase in its yield
our 2 types of risk
interst
default
what are the number bond ratin
AAA - prime , best quality, high risk
all the way to
D = default
anything below what is thought of as non ivnestment grade
BBB
THERE AER LEGAL REQUIREMTNS ESPECIALLY IF - bruh idk what this links to
you are a institutional investor
BBB doesnt necessarily mean .. and expand (what does it take)
low quality investents
all it takes is for a company to over leverafe meaing they theri bond rating falls
sum - anythig below triple be is non inesmtnet grad ebut dont mean low quality investment
new issues of ond finance
issued via an IB in new issue
lead bank will sell blocks of debentures to clients prior to isse#ue fate
book building - ms wants to raise 10m in bonds so they hire IB who find investoes for ya
- attractive bonds may be oversubscribed
-companies can increase the bonds on offer if t lots od demand
where are new issues of bond finance done
in primary market
equity finace is
extenal lon term finace
= ownerhsip = ordinary shares
holders of equit finance are
owener sof the copnay
equity finacne can be
listed/unlisted
we mostly consider isted here
equity finance holders have a right to
residual cash factors
for a company to be a copany it needs to have
equity base and shareholders
- residual claimants of assets of the firm
what are optional elements of capital
debt
preference shares
bank loan
ordinary shrea
issued by copmany
hekd by inesotrs /sh
shareholders on london stock exchange
- used to be primary uk priv industry
now mainly financial institutions and international investors e.g. pension funds
sh
whi are they
what is control limited to
where can they attend and vote
owners of company
control limited to entitlement vote
can attend and vote at AGM - in person/proxy and many do not vote
waht can sh vote on
appointmentof directos
appointment/remuneratino and removal of audotrs
approval of the dividend declared by directors
what do SH recieve
annual report
dividends if declared and approved
a share of residual assets on winding up ? - huh
what di sh participate in
new issue of share
have pre emption rights
sh generally do not run company what does this give scope for
principal agent risk
sh ahe a riht to claim
residual assets of copamny
voting is the only powet they have they dnt get to nominate direcorss but
they dont get to vote on dividends but
can pick whos beeing nominated
can vote on proposal of dividend
although retained not maangemnts money why do they have full control over it
casue SH dont have a say on how copany uses resours
pre emptio rights ar erelated to
a rights issue
what are pre empritio rights
got to offer new shares to eisting sh first
offered on pro rata basis
cheaper than public offering
mans there is not a diultion of control - still have chance to keep the % of control they had before
usually offerd at discount to encourage ivnesmtnet
in terms of pre eption rights - only if you decline you can go to … and why
public
if own 10%must be five opp to retain 10% ‘
directors are a key part of
corporate goernance
maangmetn act as wha for SH
agnetw
who represents SH
independent directors
direcotrs are appointed for
fixed terms
what dpecifc requirements does the UK corporate goernance coode give
annyal reappointment for FTSE 350 companies
for others every 3 years
teh most teffective channl for magment to keep SH in check is and through and expand
independent directoes
represent interst of aSH in a company
preference share soffer
a series of fixed patent to investors
company can choose not to
pay prpeference divided
if opany dot pay prefernce dividend it cant
pay orfinaty dividend
if preference dividedn not pad prefernce share hold may gain
votign rights
preference shares may be
cumulative
what do you ahev to do befre orfinary div can be paid
cleat all past dividends
preference shares cna only get div if
moeny is abaiable
prefernce shar sdont get
voting rights
but if not paid cna exxchange prefernce shares for voting rights
when faced w liquidation if voluntary there is a chance sh may end up with xxx but
suttin
bt sh rwealth wied out
lay out the order of entitlement in event of liquidatio
secured debt holders i.e loans, debentures bonds paid 1st
then nsecured ebt holders
unsecured creditors paid e.g suppliers
prefernce SH
only aftereveryonebeen paid ordinary SH get paid wgat left
signi
in terms of order of settlemt in liquidation there is a significant risk
OS get paid nothing
secuured creditoes fet paid 1st htereofre they are hte least rriskiest invetsment so
rend to have lowest ror
riskand return on equity
who bears residual risk
and what otehr risk
OS
+ RISK FROM INSUDSTY company operates in
breat dinaicla risk arising form how compan finced
as OS got the greates risk they expect
biggest retunr
return required by SH is
cost of equity for copmany
cost of equity highe rhtna cost of waht 2 thing
cost of rpefernce shares
csot of debt
sh take all risk arising from invesmtent as hgihest ROR os TEND TO AHEV
Highest cost of capital for company
how does a company decided(on what pls) - guessng sof
amount of finance required
period finance required for
cash flow avaiable to repay
alternative use of internal resourdes
cost of raising finance - ussue cost s, arrangemnt fees etc
availablity of finnce
cost of finance
dividend policy
pros of being lsited via IPOS
exit route for current owners
access t fince
use share sto acquire other copanies
increased and iporved opmany profile
cons of listing via IPOS
Cost of listing
SH expectations
short termism
public scrutiny
open to takeover bids
explain acces to fiace
lets sya i want 10 m for new investment as a priv firm me cyant do tha but id puublic an big not oo hrd
explain increased and improvevd compettive profile
exposed to pbulic so reputation increases
explain use dshares to acquire otehr companies
being lsited qcuires you t enable/emere or be involed in acquisiton o fother comp by buying and offering stocks
explain exit route for current owners
if sh want to get out jsut need to get shares ot market and sell tehm
but if in a priv company got to negotiate with other investors and owners and sell shre of asets which can get ugly q
explain short termisnis
if lsited sh may expect yu to anoucne good earnings every 6 m mky lead to M taking bad investment decisions just to satisfy and meet SH expectation
ST decision may not be in line w LT benefits of company or overall strat of copm in otfer to avoid disappointemnt to sh
explain pblic scrutiny
everyone may know everything about finances - issue for exectuvive level officers cause if get 10k in bonys dont want eveyone to know
explain costs of lisitng
big cost pay anuual fees also
open to take voer bids - expalin
maangment can loose jobs
equity v debt
equity
controls company
has a vote
owns retained profit
reciees dividends
dividends paid from profit afte tax
debt
conotract w compnay
recives interst
reccievers erpayment of principal
interst is a bsuiness cost and is tax deductible
equity is last to receieve x but what gets proirty
payment
dividend gets priority
equity beenfoits from profitablity but no amtter who profitbale ….
debt is capped
