Financial Markets and Instruments Flashcards

1
Q

Equity Finance

A

The process of raising capital through the sale of shares in an enterprise. Selling of ownership interest to raise funds for business purposes

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2
Q

Primary & Secondary Market

A

Primary: where new shares and bonds are issued

Secondary: where previously owned shares are traded

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3
Q

Ways of Issuing Shares in the Primary Market

A

Private placing - shares issued only to financial institutions or bank’s private clients

Offers for sale - biz sells shares to a bank who then take on the risk of selling them to investors

Public issue - invitation to purchase is issued to the public using prospectuses

Rights issue - existing shareholders given the option to buy more shares

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4
Q

Market Capitalisation

A

The value of a business, as determined by the total market price for all of a businesses shares

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5
Q

Capital Markets Instruments

A

Ordinary shares - equity shares that carry rights to a div and voting rights

Preference shares - get a set dividend before ordinary shares but no voting rights

Company bond/debenture holders - a type of loan in which the shareholder does not own any part of the company

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6
Q

Money Markets

A

Firms can also raise firms through the money market which is where short term borrowing and lending occur. Designed for large transactions between financial institutions and companies or governments

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7
Q

Calculating Returns on Financial Instruments

A

Shareholders receive returns as dividends. When expressed as a % it’s known as the dividend yield

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8
Q

Dividend Yield

A

Dividend paid per share
———————————— x 100
Market price of the share

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9
Q

Bond Returns

A

3 formulas are needed:

  • The bill rate
  • The running rate or interest yield
  • The gross redemption yield
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10
Q

Bill Rate

A

Equivalent to the coupon rate:

Yield = bond value x coupon rate

Doesn’t take into account the market price

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11
Q

Running Yield

A

Takes into account a bond’s market value

Interest (coupon rate)
——————————– x 100%
Market rate

Fails to take into account the gain in MV

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12
Q

Gross Redemption Yield

A

Takes a bond’s MV and gains in MV into account, therefore it’s the best estimate.

The investor can compare the result of the calculation to their required yield, the interest rate, and the level of risk being undertaken to make their decision to invest

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13
Q

Risk

A

Affects the rate of return and the market price for bonds. An investor will have a certain rate of return in mind based on the perceived risk taken on. This is therefore the required value of their net dividend yield

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14
Q

Net Dividend Yield

A

Annual dividend
———————— x 100%
Market value

Formula can be rearranged to get the MV

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15
Q

Market Value Formula

A

Net dividend yield

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16
Q

The Effects of Risk

A

The higher the perceived risk, the lower the market price will fall so as to maintain the yield

The lower the perceived risk, the higher the market price will be

17
Q

Loans and their relationship with Interest Rates

A

Loans with high fixed interest rates: guaranteed returns, used when market price is falling

Loans with arrangement fees: size of arrangement fees could mean any savings due to low interest rates are offset

18
Q

Mitigating Risk

A

Risk is significant in determining the market price of a company so businesses use credit rating agencies: organisations which provide some indication of how likely it is a company will default on their debt

19
Q

Credit Rating

A

Rating is calculated by taking into account:

  • Ratio of debt to assets
  • Size and strength of a co’s cashflow
  • Stability of a co’s asset value
  • How long the debt is due to be outstanding
20
Q

Credit Spread

A

An amount charged over and above the rate of a government bond; the no risk rate. This amount acts as compensation for the lender for taking on the risk

21
Q

No-Risk Rate

A

The rate charged on bonds is considered to be the no-risk rate as governments always pay back their debts

22
Q

Yield on a Corporate Bond

A

Yield on gov bond + spread

23
Q

Interest Rates: Base Rate

A

The rate around which all rates are set and used by central banks to determine the rates at which they lend money to companies

24
Q

Nominal Return Rate

A

Rates often advertised by banks which do not factor in inflation

25
Q

Real interest Rate

A

Rates which do factor in inflation

26
Q

Hedging

A

When companies take action to reduce risk

27
Q

Interest Rate Hedging

A

Forward rate agreement - a contract between 2 parties that determines the rate of interest on a future obligation

Interest rate guarantees - option on a FRA that allows a co to have the option of taking out a FRA in future for an up-front fee

Interest Rate Futures - similar to FRA as it fixes future a rate, unlike FRA it is an exchange traded agreement

Interest rate options - grants buyer the right, not obligation, to deal in IR futures, is exchange traded and a premium is payable