Financial instruments

Question 1

Loan capital .

Answer 1

is a method of raising funds from investors by issuing debt instruments.
1.1. Loan capital is issued to investors who receive interest payments and a return of capital in return

Question 2

how is Interest and capital calculated loan capital

Answer 2

Interest and capital payments are specified at the outset or calculated through a formula.

Question 3

Loan capital

Answer 3

is often referred to as bonds or bills.

Question 4

Loan capital may be listed on a__________

Answer 4

stock exchange.

Question 5

. Holders of loan capital are

Answer 5

. Holders of loan capital are creditors of the company and do not have voting rights.

Question 6

state Features of loan capital

Answer 6

Features of loan capital include nominal value, interest payments as a proportion of the par value, issue price, redemption at par, and market price fluctuations.

Question 7

state Features of loan capital

Answer 7

Features of loan capital include nominal value, interest payments as a proportion of the par value, issue price, redemption at par, and market price fluctuations.

Question 8

Most loan capital is redeemed at _______after a set date.

Answer 8

Most loan capital is redeemed at par after a set date.

Question 9

Variations in loan capital include

Answer 9

capital repayment at the company’s option, variable rate issues, index-linked bonds, stepped bonds, call option, put option, and sinking funds.

Question 10

The rights of bondholders are set out in a

Answer 10

loan agreement drawn up when the loan is issued, and a trustee is appointed to act on behalf of the loan stockholders.

Question 11

loan capital benefits

Answer 11

Loan capital is a significant source of finance for UK listed companies.
2.1. Companies often raise more finance each year by borrowing from investors by issuing loan capital than by issuing shares.

Question 12

Long-term loan capital instruments are often referred to as________and short-term instruments as _______.

Answer 12

Long-term loan capital instruments are often referred to as “bonds” or “corporate bonds”, and short-term instruments as “bills”.

Question 13

Loan capital is a cost to the company, not a distribution of profits, true or false

Answer 13

Loan capital is a cost to the company, not a distribution of profits, and holders of loan capital rank equally with, or above other creditors on a winding-up.

Question 14

The price of a bond is fixed true or false

Answer 14

The price of a bond varies with supply and demand for the bonds, and there is a see-saw relationship between interest rates and the price of a bond.

Question 15

Loan capital variations include

Answer 15

capital repayment at the company’s option, variable rate issues, index-linked bonds, stepped bonds, call option, put option, and sinking funds.

Question 16

is Loan capital different from shares explain

Answer 16

Loan capital is different from shares as shareholders receive dividends at the discretion of the company’s directors, whereas holders of loan capital receive specified interest payments and a return of capital.

Question 17

Question 4.1
What is the total amount of cash you would receive if you purchased £200 nominal of a
6% government bond redeeming on 31 December 2025, and purchased on 1 January
2015?

Answer 17

Solution 4.1
In each of the years 2015 to 2025 inclusive, you would receive 6% of £200 = £12. This
would normally be paid in two semi-annual payments of £6. This amounts to £132. At
the maturity of the bond you would get £200 back in addition to the final coupon
payment we have included above. Total cash received = £332

Question 18

Question 4.2
Suppose interest rates rise in the economy, what would happen to the demand for a
fixed-coupon bond and hence what would happen to the price of the bond?

Answer 18

Solution 4.2
If interest rates rise general in the economy, the fixed interest on the bond compares
unfavourably with that received elsewhere. The demand for such bonds will therefore
fall and the price will fall. As the price falls, the fixed interest becomes a higher
percentage of the market price and the capital gain (if any) on redemption increases
until equilibrium is restored.

Question 19

What details might you expect to find in the trust deed of a bond issued by a company?

Answer 19

Solution 4.3
Typical issues covered in a trust deed:
 Description of any assets of the company that might be set aside to cover the
particular loan in the event that the company winds up.
 Details of exactly how the assets should be used to repay the bondholders in the
event of a winding-up and how surplus cash should be treated.
 The rights of the company to issue further bonds that rank above or alongside
this particular issue.
 Covenants that describe how much the company’s profit must remain above the
amount of the interest payments on the bond. This is a form of protection for
bondholders to ensure that their interest payments are easily met by the company
in future.
 Arrangements for changing the trustees.
 A description of circumstances under which bondholders must be consulted. For
example if covenants are breached or about to be breached.

Question 20

What details might you expect to find in the trust deed of a bond issued by a company?

Answer 20

Solution 4.3
Typical issues covered in a trust deed:
 Description of any assets of the company that might be set aside to cover the
particular loan in the event that the company winds up.
 Details of exactly how the assets should be used to repay the bondholders in the
event of a winding-up and how surplus cash should be treated.
 The rights of the company to issue further bonds that rank above or alongside
this particular issue.
 Covenants that describe how much the company’s profit must remain above the
amount of the interest payments on the bond. This is a form of protection for
bondholders to ensure that their interest payments are easily met by the company
in future.
 Arrangements for changing the trustees.
 A description of circumstances under which bondholders must be consulted. For
example if covenants are breached or about to be breached.

Question 21

what are Debentures stocks

Answer 21

are loans secured by some or all of a company’s assets, and the stockholders have various actions available to them in case the company fails to make one of the coupon payments or the capital repayment.

Question 22

two types of Debentures

Answer 22

Debentures come in two types: Mortgage debenture (fixed charge) and Floating charge debenture.

Question 23

whats a fixed charge debenture

Answer 23

A fixed charge means that specific secured assets are mentioned in the legal documentation for the mortgage debenture, and the company can sell or make significant alterations to the secured asset only with the mortgage debenture holders’ permission.

Question 24

whats A floating charge debenture

Answer 24

A floating charge debenture allows the company to change the secured assets in the normal course of business, but if the company fails to make an interest or capital payment, the debenture holders can apply to the courts to make the floating charge become a fixed charge, which is called “crystallising.”

Question 25

Debentures are used to raise _______ amounts of funds and have a fixed _______ and carry a fixed rate of interest, making the borrower have a known debt servicing commitment.

Answer 25

Debentures are used to raise large amounts of funds and have a fixed redemption date and carry a fixed rate of interest, making the borrower have a known debt servicing commitment.

Question 25

Debentures are used to raise _______ amounts of funds and have a fixed _______ and carry a fixed rate of interest, making the borrower have a known debt servicing commitment.

Answer 25

Debentures are used to raise large amounts of funds and have a fixed redemption date and carry a fixed rate of interest, making the borrower have a known debt servicing commitment.

Question 26

Debentures carry the risk that

Answer 26

Debentures carry the risk that coupon payments or capital repayment may not be made, but the stockholders have security in respect of the secured assets. However, payments on debentures are a legal obligation on the company, making debentures more secure than ordinary or preference shares.

Question 27

The total return on debentures will reflect

Answer 27

all the risks such as default risk, inflation risk, and marketability risk.

Question 28

Describe marketability of debentures

Answer 28

Debentures may not be readily marketable, and marketability is usually worse than for government bonds, with bigger spreads between buying and selling prices, and lower volumes traded.

Question 29

The existence of a fixed and/or floating charge, together with the appointment of a trustee, is designed to reduce the risk to the debenture holder,

Answer 29

but the security ultimately depends on the company’s continuing profitability to meet the required payments, and failing that, on the market value of the charged assets.

Question 30

Unsecured loan stock

Answer 30

Unsecured loan stock is a loan for which there is no specific security.

Question 31

If the company defaults on the loan, the only remedy for the loan stockholders is to

Answer 31

sue the company. In practice, this means asking the courts to wind up the company.

Question 32

unsecured loan stockholders rank after debenture holders. True or false

Answer 32

Debenture holders have a prior claim to the assets of the company on which there is a charge. Therefore, unsecured loan stockholders rank after debenture holders.

Question 33

Other creditors of the company rank equally with unsecured loan stockholders.True or False

Answer 33

Other creditors of the company rank equally with unsecured loan stockholders.

Question 34

Some banks issue subordinated loan stock,

Answer 34

so the loan stockholders rank after the bank’s depositors in the event of a winding-up.

Question 35

If there is insufficient money generated from the liquidation of the company’s assets to meet all claims, available money is

Answer 35

shared out in proportion to the amount owed.

Question 36

High-ranking claimants (e.g. debenture holders) may get all their capital returned on a winding-up, while low-ranking claimants (e.g. shareholders)

Answer 36

may get nothing.

Question 37

At the highest level of ranking where the total money available is insufficient (e.g. unsecured creditors),

Answer 37

a proportionate payment will be made.

Question 38

Question 4.4
Why don’t companies always issue unsecured loan stocks rather than debentures?

Answer 38

Solution 4.4
Debentures are secured upon the assets of a company. This security means that the
company can offer a lower rate of coupon (ie interest) to investors. The company will
therefore find it cheaper to borrow using debentures than using unsecured loan stock

Question 39

Corporate bonds behave much like government bonds, but there are major differences between the two types of bonds. Some of the differences are as follows:

Answer 39

Security: Corporate bonds are generally less secure than government bonds. The level of security varies depending on the type of security, the company that has issued it, and the term.

Marketability: Corporate bonds are much less marketable than government bonds, mainly because the sizes of issues are much smaller.

Question 40

Subordinated debt rank:

Answer 40

Subordinated debt: In the event of default, the holder of subordinated debt ranks below the firm’s general creditors (but ahead of preference shareholders and the ordinary shareholders). The subordinated lender holds a junior debt and is paid after all senior debt holders are satisfied.

Question 41

Eurobond loan capital: Eurobonds give borrowers access to international _______. A Eurobond is a bond issued in the Euromarket and is marketed internationally, mainly by the London branches of international banks.

Answer 41

Eurobond loan capital: Eurobonds give borrowers access to international investors. A Eurobond is a bond issued in the Euromarket and is marketed internationally, mainly by the London branches of international banks.

Question 42

Eurobond issues can be made in almost any _______, and the majority of Eurobond issues are denominated in ________.

Answer 42

Eurobond issues can be made in almost any currency, and the majority of Eurobond issues are denominated in dollars.

Question 42

Eurobond issues can be made in almost any _______, and the majority of Eurobond issues are denominated in ________.

Answer 42

Eurobond issues can be made in almost any currency, and the majority of Eurobond issues are denominated in dollars.

Question 43

Eurobonds are “bearer form” documents, and to claim interest payments, holders must

Answer 43

cut out coupons from the certificates and send them to the company (or its paying agent).

Question 44

Trading: Although most Eurobond issues are listed on a stock exchange (often in London), most trading in them occurs through

Answer 44

the banks rather than through a stock exchange.

Question 45

Minimum acceptable issue: Eurobonds are used to raise large sums, and the minimum acceptable issue is $75m or more. They are not secured against the assets of

Answer 45

the issuing company.

Question 46

Underwriting: The key difference between Eurobonds and unsecured loans is that

Answer 46

Eurobonds are marketed in a different way.

Question 47

A Eurobond is an issue underwritten by

Answer 47

an international syndicate of banks and typically (but not exclusively) sold in countries other than the country of the currency in which it is denominated.

Question 48

Issues are often marketed in several countries simultaneously. Eurobonds are not fully within the legal control of any________

Answer 48

Issues are often marketed in several countries simultaneously. Eurobonds are not fully within the legal control of any government.

Question 49

Floating-rate notes (FRNs) are

Answer 49

medium-term debt securities issued in the Euro market.

Question 50

The interest payments on FRNs _____ with short-term interest rates.

Answer 50

The interest payments on FRNs “float” with short-term interest rates.

Question 51

FRNs may have a stipulated minimum rate, which is commonly known as an

Answer 51

interest-rate floor.

Question 52

An interest-rate floor ensures that the coupons on FRNs will not

Answer 52

fall below the minimum rate, even if the benchmark interest rate falls lower.

Question 53

FRNs are attractive to investors when

Answer 53

interest rates are expected to rise, as the interest payments will increase.

Question 54

FRNs are less attractive to investors when interest rates are expected

Answer 54

to fall, as the interest payments will decrease.

Question 55

FRNs are less attractive to investors when interest rates are expected to fall, as the interest payments will decrease.

Answer 55

FRNs are less attractive to investors when interest rates are expected to fall, as the interest payments will decrease.

Question 56

Companies may issue FRNs when interest rates are high, as they can still access financing while avoiding fixed interest rates that may become unaffordable during periods of high interest rates.

Answer 56

Companies may issue FRNs when interest rates are high, as they can still access financing while avoiding fixed interest rates that may become unaffordable during periods of high interest rates.

Question 57

FRNs provide investors with some protection against interest rate risk, as their interest payments adjust to changes in the benchmark interest rate.

Answer 57

FRNs provide investors with some protection against interest rate risk, as their interest payments adjust to changes in the benchmark interest rate.

Question 58

FRNs may offer lower yields than fixed-rate bonds with similar credit ratings, as investors pay for the flexibility provided by the floating interest rates.

Answer 58

FRNs may offer lower yields than fixed-rate bonds with similar credit ratings, as investors pay for the flexibility provided by the floating interest rates.

Question 59

Share capital; Ordinary shares give rights to

Answer 59

a share of the residual profits of the company, and to the residual capital value if the company is wound up, together with voting rights and various other rights.

Question 60

A company may or may not have loan capital and/or preference shares, but to exist it must have

Answer 60

ordinary share capital (unless it is “limited by guarantee”).

Question 61

Shareholders are the _______of the business and have _____rights at meetings in proportion to the number of _______held.

Answer 61

Shareholders are the owners of the business and have voting rights at meetings in proportion to the number of shares held.

Question 62

are “dividend” payments a legal obligation

Answer 62

Shareholders receive “dividend” payments made from a company’s profits, which are not a legal obligation of the company and are only paid at the discretion of the directors.

Question 63

Dividends are paid net of tax with an attaching tax credit for the recipient, which is termed

Answer 63

“franked” investment income.

Question 64

Ordinary shares are the ______ranking form of finance issued by companies and rank after all ________, including preference shareholders, on winding-up.

Answer 64

Ordinary shares are the lowest ranking form of finance issued by companies and rank after all creditors of the company, including preference shareholders, on winding-up.

Question 65

Ordinary shares are almost always ______, meaning there is no fixed date when the company has to _______.

Answer 65

Ordinary shares are almost always irredeemable, meaning there is no fixed date when the company has to repay the share capital.

Question 66

All shares have a “par” or

Answer 66

“nominal” value, often 25p, which has no relevance to the market value of the share.

Question 67

Shareholders have a ________up to the fully paid value of the shares, and partly paid issues are allowed.

Answer 67

Shareholders have a ________up to the fully paid value of the shares, and partly paid issues are allowed.

Question 68

The figure shown in the accounts for issued share capital is the

Answer 68

nominal value.

Question 69

The total nominal value of authorized share capital is the maximum amount that the directors can issue without calling for a vote from the shareholders. The issued share capital is the nominal amount actually issued, and it cannot be greater than the authorized share capital.

Answer 69

The total nominal value of authorized share capital is the maximum amount that the directors can issue without calling for a vote from the shareholders. The issued share capital is the nominal amount actually issued, and it cannot be greater than the authorized share capital.

Question 70

Ordinary shares give an equal right to share in residual profits, give

Answer 70

one vote per share, give an equal share to any assets left over following a winding-up after all other creditors have been paid, are fully paid, and give various other minor rights.

Question 71

The low ranking of ordinary shares in terms of payment of dividends and upon winding-up makes ordinary shares a more

Answer 71

risky investment than other types of capital.

Question 71

The low ranking of ordinary shares in terms of payment of dividends and upon winding-up makes ordinary shares a more

Answer 71

risky investment than other types of capital.

Question 72

Ordinary shareholders have the right to attend and

Answer 72

speak at company meetings, or appoint a proxy to attend and vote on their behalf, vote to reduce dividends, appoint directors, forego the “pre-emptive” right to be offered any new shares to be issued, and change the company’s borrowing powers.

Question 73

Question 4.5
What does “bearer” mean? What form will a security be if it is not “bearer”?

Answer 73

Solution 4.5
This means that the issuing company does not keep a register of holders, unlike share
capital and traditional loan capital. So, holding the Eurobond loan certificate is proof of
ownership. Rather like a pound note – if you lose it, you’ve lost it.
If a certificate is not bearer, it is normally “registered” which means that your name is
on a computer list somewhere, and if you lose your certificate, the registrars can issue
you with another one. Dividends can be transferred directly to your bank account.