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Foundations And Anaylsis > financial decison making > Flashcards

financial decison making Flashcards

1
Q

advantages and disadvantages of ‘unincorported buisiness structures such as sole trades/partnerships

A

A: cheap and easy to establish
ownership and control concentrated
no requirement to publish accounts
D: difficult to sell = finite life
business=owner= unlimited liability
dificult to raise funds as banks do not want to loan to risky businesses

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2
Q

definition of incorporated business structure

A

where the business has a separate legal identity to the owner

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3
Q

advantages and disadvantages of incorporated business structure

A

A: ownership can be transferred by selling shares= infinite life
limited liability for owners
funds can be raised publically through equity and debt markets
D: difficult and expensive to establish
tax disadvantages
management is separate from owners
requirement to publish accounts

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4
Q

what is the primary stock market

A

where companies raise new equity finance by issuing new securities/shares to new investors
Includes IPO’s + rights issued: secondary offerings

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5
Q

what is the secondary stock market
motivated by?

A

where investors buy and sell existing shares
Information and liquidity motivated
Big bang :1986 oct
Big bang 2 : 1997 oct

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6
Q

Advantages of trading in the secondary stock market

A

find opposite party that works for you
lots of liquidity due to volume of buying and selling
information of others is reflected in the stock price - gives correct valuations

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7
Q

what is an IPO

A

initial public offering

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8
Q

what is a P/E ratio

A

price earning ratio
share price/ earnings per share

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9
Q

What is EAR

A

effective annual rate, more interest compounds the more frequently interest is paid
EAR = ((1+r/m)^m)-1
When investing c for t years at a flat rate of r per year compounding m times
FV = C(1+r/m)^(mxt)

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10
Q

why raise capital

A

plan to expand
Growth - new technology, must grow otherwise will be crowded out
pay off debt - initial loans for companies are taken out at high intrest rates
More wages to pay
Mergers/acquisitions

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11
Q

how to raise capital

A

Angel finance - successful business people (capped at ~ 100k)
non - securities debt - bank loan/loan from another firm
venture capital - billionaires who own companies invest into the business on the companies behalf
listing on the stock market

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12
Q

Methods of conducting an IPO - initial public offering

A

offer for sale - all shares listed must be sold, anyone can buy, expensive as underwritter has the risk of buying unsold shares
placing - only institutional investors
offer for subscription
intermediaries offer
introductions

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13
Q

what is finance

A

finance is about the valuation of future cash flows and what effects them

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14
Q

5 elements of finance

A

time, money, risk, information, taxation

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15
Q

4 perspectives on finance

A

corporate finance : real investment, capital budgeting, financing liquidity for working capital
investments
financial markets and intermediaries: banks and pension funds
Government

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16
Q

what happens to standard dievation of risk as portfolio size increasesd

A

standard deviation goes down, risk decreases
systemtic risk
unsystematic risk is removable via diversification of portfolio

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17
Q

Role of the CFO

A

Chief financial officer
internal and external financial reporting, stewardship of a company’s assets, and ownership of cash management

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18
Q

PLC characteristics

A

Public Limited company
established by shareholders
financed by share(permanent) and debt capital (money borrowed for fixed periods)
shareholders have limited liability and establish a board of directors

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19
Q

unincorporated business definition

A

a privately owned business, often owned by one person who has unlimited liability as the business is not legally registered as a company

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20
Q

why do share prices change

A

to reflect new information about a company
new announcement

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21
Q

characteristics of informational efficiency

A

prices reflect all information available to investors
prices react immediately to reflect new information

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22
Q

how will share price react in an informationally inefficient market

A

over/underreaction and gradual adjustment to correct price
slow reaction
we can therefore predict unexpected returns
allowing us to earn returns above the level required to compensate for the risk

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23
Q

why invest in a portfolio instead of individual securities

A

unless there is perfect correlation
the standard deviation of a portfolio will be less than the weighted average of separate securities

24
Q

difference between systematic and unsystematic risk

A

systematic risk : risk that influences a large number of assets. They have a market wide influence

Unsystematic risk : risk that effects a single asset or a small group of assets, negligible by diversification

25
Q

Key elements of finance

A

Money
Time
Uncertainty/risk
Information
Taxation

26
Q

Pre big bang problems

A

Single capacity : stock jobbers , stock brokers
- increased concentration/ reduced job competition
- fixed brokerage commissions
- LSE membership restricted
- jobbers undercapitalised
- international competitiveness

27
Q

Post big bang

A

Dual capacity
- broker/dealer
- market makers
- trading floor v. SEAQ& telephone
Big bang 2 - more changes to the trading system

28
Q

Definitions of annuity and perpetuity

A

Annuity - is a series of regular and consistent cash flows for a period
PV = C (1-(1/1+r)^t)/r
Perpetuity - an annuity where cash flows continue forever
PV = C/r

29
Q

Bond features definition (face value, coupon, maturity)

A

Face value - principal, nominal value,
Coupon rate- % of face value that the bond pays in interest
Coupon - amount of interest
Maturity - the date when the issues repays face value

30
Q

Business structures in other countries

A
  • most countries have a similar structure relating to incorporated and unincorporated though some rules and regulations are different
  • a ‘partnership’ is deemed to be a corporate entry in the UK but not in Germany
  • directors of incorporated firms are elected in 2 main ways: single tier board - shareholders elect a board of directors who then select managers; 2 tier board executive managers board, and a supervisory board
31
Q

Discounting and present values

A

What is the value of £2000 now in 5 years, growing at 11% per year
2000 x 1.11^5
How much do we need to invest now at 11% per year to have £2,000 in 5 years
2000/(1.11^5)
FV = PV(1+r)^t

32
Q

Real vs nominal interest rate

A

Nominal interest rates = actual market rates
nominal - Invest £100 at 10% interest per year = £110
Real - But if inflation is 7%
110/1.07 = 102.8

33
Q

Definition of bonds and shares

A

Bonds - governments, local authorities, companies
Shares - companies

34
Q

Government gilts lengths

A

<5 years = short
5-15 years = medium
>15 years = long

35
Q

What are the different goals a firm can have

A

Maximise:
the size of the firm
Costumers satisfaction
Firms sales
Profits
Dividend growth
Shareholder wealth - occurs if product and labour markets work efficiently

36
Q

How to apply the NPV rule

A

Add up the cash flows in all the years, adjusting for the investors requires rate of return
If NPV> 0 accept the project
If NPV< 0 reject the project

37
Q

What is fishers separation theorem

A

If capital markets for borrowing and lending are well functioning
Companies can make their investment decision independently of individual shareholders consumption decisions by using the NPV rule

38
Q

Perfect capital markets

A

No transaction costs, interest rate on borrowing = interest rate on investing
Access is free and equal, no participants have the power to influence prices
All participants have the same information about prices and security/firm characteristics
No distorting taxes
Other stakeholders in the firm face competitive prices
NPV of projects = 0

39
Q

Advantages of using payback method

A

Easy to compute and understand
Encourages cash generation
Values early cash flow over late cash flow

40
Q

Disadvantages of payback

A

Adds cash flows ignoring the time value of money
Choice of cut off period is arbitrary
Ignores cash flows after the cut off period
Biased towards rejection long lived projects possibly with + NPV’s
Biased towards accepting short lived projects possibly with - NPV’s

41
Q

ARR

A

Accounting rate of return
Investments average accounting profits each year/ average book value of assets invested each year

42
Q

Advantages of ARR

A

Easy to compute because the firm collects the accounting information anyway

43
Q

Disadvantages of ARR

A

Ignores the time value of money
choice of ARR is arbitrary
Based on earrings not cash flows, uses accounting deprecation , tax charged based on accounting earnings
No standard calculation methods
Not a true return on investment

44
Q

Profitability index

A

PI = PV of future cash flows / initial investment

45
Q

How to prepare capital budgets

A
  1. Search for investment opportunities
  2. Screening:
    Is the project consistent with the strategic plan? Is it feasible?
  3. Definition of project and alternatives
  4. Evaluation
  5. Authorisation
  6. Monitoring & Post-Audit
46
Q

Definition of capital budgeting

A

Capital budgeting is the process of deciding which new project to take on behalf of the company. By project we mean any new decision that requires investment

47
Q

How does volatility of returns correlate to rate of return required

A

The greater the volatility of returns, the greater is the required rate of return.

48
Q

What does a profitability index >=1 indicate

A

That a project is profitable

49
Q

Difference between geometric and arithmetic average

A

Arithmetic - sum the returns and divide by total
Geometric ((1+r1)(1+r2)…..(1+rn))^1/n

50
Q

2 main characteristics of a return

A

Average return : measures what you expect to earn each period
Standard deviation: variability or volatility gives a measure of how far from the average you expect the return to be in any 1 period

51
Q

Implications of IE for investors

A
  • prices are the best indicator of value - prices reflect fundamentals
  • active traders, on average, perform no better than passive investors
  • uniformed investors can expect a fair return
52
Q

Why does IE imply random price changes

A

IE means prices change unexpectedly only to new information
New information, by definition, is independent of previous information
If information is already known it will already be reflected in the share price

53
Q

A bond’s coupon rate is equal to the annual interest divided by

A

face value

54
Q

what type of bond would be affected more by changes in interest rate

A

bonds with longer maturities
bonds with lower coupons

55
Q

a high interest rate on a bond =

A

more risk that it carries

Foundations And Anaylsis (4 decks)

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