FM Flashcards

1
Q

Financial Objectives (3)

A
  1. Shareholder wealth maximisation
  2. Profit maximisation
  3. Earnings per share growth
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2
Q

Total Shareholder Return

A

Divi + Change in Share Price / Price at the start of the year

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3
Q

Dividend Yield

A

Dividends per share / Share Price
If you purchased a share today, what % income
return would you expect on your investment?

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4
Q

EPS - Earnings per share

A

PAT / No of shares
The amount of earnings the company has generated
for the shareholders on each share they hold

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5
Q

P/E Ratio

A

Share Price / EPS
What is the market’s view of our future growth? A
high P/E ratio suggests high predicted growth

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6
Q

Agency Theory and Problem

A

Theory - Directors put shareholders worth first
Problem - May be tempted to act in their own interests

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7
Q

Macroeconomic policy targets (5)

A

 Strengthening business to make the economy more competitive
 Protecting the environment
 Increasing employment opportunities
 Ensuring fairness for families and communities
 Delivering macroeconomic stability to encourage long term planning and investment

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8
Q

Fiscal Policy

A

How Governments raise and spend money
Taxation and government spending. E.g. inc tax or decrease public expenditure = decrease demand and output

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9
Q

Monetary Policy

A

Governments to regulate the supply of money
Aim = achieve price stability
E.g. reduce interest rates or quantitive easing = borrowing cheaper and therefore increase demand

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10
Q

Quantitive Easing

A

Central banks can increase the supply of money by repurchasing government debt from banks

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11
Q

Money + Capital Markets

A

Money = less than 12 months
Capital = 12+ months
Both have a primary and secondary market, issues and trading

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12
Q

Role of money markets (3)

A

Providing short-term liquidity to industry and the public sector
Providing short-term trade finance
Allowing an organisation to manage its exposure to foreign currency risk and interest rate risk

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13
Q

Functions of a stock market

A

 To enable companies to raise new finance
 To enable existing investors to sell their investments
 To aid takeovers by issuing shares to finance the takeover
 To enable private company shareholders to realise part/all of their investment by floating the
company

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14
Q

Functions of a corporate bond market (4)

A

To enable companies to disintermediate i.e. to deal directly with lenders
 To enable companies to raise new debt finance
 To enable existing debt investors to sell their debt
 To aid takeovers by issuing debt to finance the takeover

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15
Q

Advantages of financial intermediaries

A

 Security
 Convenience
 Aggregation. An intermediary can take small amounts from investors and lend on in larger
packages. This is a significant benefit as lenders and borrowers do not need to find people who
want to deal with exactly the same amounts as them.
 Maturity transformation. The intermediary can provide investors and borrowers with
their desired timescales.
 Source of funds. A borrower will normally be able to find an intermediary who is prepared to
provide them with some funds even if the general market conditions are not that favourable.

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16
Q

Advantages of ROCE (4)

A

 It is simple to calculate
 As a percentage the measure is familiar to non-accountants
 It looks at the entire project
 It reflects the way external investors judge the organisation

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17
Q

Disadvantages of ROCE (6)

A

 No account is taken of the project life
 No account is taken of the timing of the cashflows/it ignores the time value of money
 The result may vary according to the accounting policy used
 It may ignore working capital
 It does not measure absolute gain
 It does not give a definite decision

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18
Q

Advantages of payback (5)

A

 It is simple to calculate
 It is easy to understand, especially for non-accountants
 It uses relevant cash flows
 It can be used as an initial screening tool on projects before undertaking a more detailed review
 It (rather crudely) allows for risk

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19
Q

Disadvantages of payback (4)

A

 It ignores returns after the payback period
 It ignores the timing of the cash flows
 It does not give a definite decision
 It ignores project profitability

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20
Q

Advantages of NPV (5)

A

 It allows for the time value of money
 It uses cash flows rather than profits
 It shows the change in shareholders’ wealth/it gives an absolute measure of return
 It can allow for risk via the cost of capital
 It looks at the entire project

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21
Q

Disadvantages of NPV (3)

A

It can be difficult to understand or explain to managers
 It requires knowledge of the cost of capital
 It is relatively complex

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22
Q

Advantages of IRR (6)

A

It allows for the time value of money
 It uses cash flows not profits
 It does not require the exact cost of funds to be known
 As a percentage, the measure is familiar to non-accountants
 It looks at the entire project
 It provides a relative measure of performance

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23
Q

Disadvantages of IRR (5)

A

 It is not an absolute measure
 Interpolation provides only and estimate and an accurate estimate requires the use of a
spreadsheet programme
 It is fairly complex to calculate
 Non conventional cash flows may give rise to multiple IRRs
 It contains the inherent assumption that cash returned from the project will be re-invested at
the project’s IRR which may not be true

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24
Q

Advantages of sensitivity analysis (4)

A

 Simple
 Provides more information to allow management to make subjective judgements
 Indicates which forecasts should be researched further
 Indicates which variables require the closest control once the project starts

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25
Disadvantages of sensitivity analysis (3)
 Assumes variables change independently of each other  Does not assess the likelihood of change  Does not lead to a definite decision
26
Objectives of working capital management (2)
Liquidity, Profitability
27
Aggressive and Conservative Working Capital
A - Low level WC, higher profit, lower liquid, higher risk C - high level WC, lower profit, higher liquidity, lower risk
28
Advantages of JIT
Reduced holding costs Increased flexibility Increased quality and efficiency Closer relationships with suppliers and increased price transparency
29
Disadvantages of JIT
Increased risk of stock-out Less opportunity for bulk discounts Low staff morale due to unpredictable production schedule Not appropriate for all organisations (e.g. NHS!)
30
Factoring, Invoice Discounting
Factoring doesn't take administration Invoice Discounting more for temporary cash shortage
31
Benefits of centralised treasury management and cash control
Allows the internal netting off of local surpluses and deficits which is cheaper  Lower bank charges due to increased volumes through a single point  Better interest rates on borrowing and lending due to increased volumes  Reduced external foreign exchange due to internal netting off  Allows the employment of experts due to the volume of work required
32
Real / Nominal Rate
Real rate (excludes inflation, compensates the lender for the time value of money) Nominal rate (includes inflation, compensates the lender for TVM and inflation)
33
Hard / Soft Capital Rationing
Hard - Organisation would like to but no shareholder will invest. E.g. returns not being high enough for risk Soft - Organisation could but chooses not to. E.g. finance too expensive
34
Venture Capital
Like dragons den Investment in ordinary shares and unsecured debt for around 5 years, look for exit route by listing or selling.
35
Private placing
Shares sold privately to clients of an issuing house at a fixed price Simple, cheap
36
Stock Exchange Listing criteria
Three year trading history Worth at least 700k At least 25% shares in the hands of the public
37
Matching of finances (3)
Duration Currency Pattern of cash flows
38
Riba
Interest / excess
39
Murabaha
Trade Credit Bank buys an asset and sells to business for a marked up price.
40
Ijara
Lease finance Lessor remains responsible of maintenance and insurance. Allowed as classed as 'rental' payments
41
Sukuk
Debt finance Business asset with a life of 3-5 years is bought, used by business to earn profits, the profits and losses are shared with the third party.
42
Mudaraba
Equity Finance Partner providing capital and partner providing time, skill and expertise. The partners share in any profits made by the business and the capital provider suffers any losses.
43
Musharaka
Venture Capital Two or more partners provide both the capital and the time, skill and expertise required by the business. These partners all share in the profits in a ratio agreed in their original contract. Losses are always shared in proportion to the capital contributions.
44
Weaknesses of dividend growth model
It is too simplistic as most companies do not pay a constantly growing dividend Identifying an ex-div share price is difficult for listed companies and very difficult for unlisted companies and so the model is based on estimates
45
Advantages of CAPM
It directly links risk and return  It can be used to calculate the cost of equity when the dividends are not growing constantly
46
Disadvantages of CAPM
 It can only be used when the investors are diversified  It assumes that all of the components will remain constant and the same as they have been historically  It assumes that investors can invest and borrow at the risk free rate  It assumes that the capital markets are perfect i.e. no transaction costs, no tax and no dominant investor  It assumes that the risk of all macroeconomic variables can be grouped into one measure
47
Creditor Heirarchy
(1) Secured Creditors e.g. fixed charge over a non-current asset (2) Preferential Creditors e.g. pension schemes and employees (3) Floating Charge Holders e.g. charge over the current assets (4) Unsecured Creditors e.g. trade payables and the Crown (5) Preference Shareholders (6) Ordinary Shareholders
48
Pecking order theory
(1) Retained earnings: this is the easiest, quickest and cheapest (in terms of issue costs) way to raise finance. (2) Debt: this is relatively cheap to service and issue and can be interpreted as a sign of management confidence. (3) Convertible debt: this offers investors the potential to benefit, at the expense of the shareholders, if the company does well. (4) Preference shares; this offers an equity stake without the uncertainty of dividend levels. (5) Ordinary shares: this is time consuming to arrange and expensive to service and if unsuccessful leads to a general loss of confidence and accompanying fall in share price of the company.
49
Financing problems for small businesses
The funding gap - higher risk, limited track record and dependency on small no of employees The maturity gap - only really able to raise short term finance which won't match investments The inadequate security - not very many non current assets as security
50
Residual theory - dividend
Dividends are paid out only after all projects with a positive NPV have been financed. Whatever cash is left (i.e. the residual amounts) is returned to shareholders as a dividend
51
Clientele Effect - Dividends
Shareholders are attracted by previous dividends, expect these to continue. If the dividend policy changes then they might sell their shares
52
Signalling
 If a company cuts its dividend, investors may interpret this as a sign of bad news and seek to sell their shares, leading to a reduction in share price If a company increases its dividend, investors may interpret this as a sign of improved future prospects and purchase shares in the company, increasing the share price.
53
Scrip dividend
A scrip dividend is a dividend paid by the issue of additional company shares, rather than by cash. It is offered pro rata to existing shareholdings
54
Warrant
Share options attached to a debt issue in order to make the debt more attractive to potential investors
55
Receivables Management (7)
Credit control - Assess credit, Manage, Collection Early Settlement Discount Factoring/Invoice Discounting Bills of Exchange - IOU Export Factoring - same as factoring but foreign Documentary Credits - Bank letter confirming Export Credit Insurance - Insurance against international customers not paying
56
Sensitivity Calc
NPV of project / PV of cashflow input
57
Equivalent Annual Cost - e.g. van
NPV of project / Annuity factor for project life
58
Business Risk
Business operations. Related to PBIT or operating profit changes as revenue or turnover changes. Assessed by calculating operational gearing - 100 × contribution/PBIT) Asset Beta
59
Financial Risk
Due to debt as finance. Related to capital structure. Variability in SH return due to paying interest. Calc - geating or interest cover
60
Specific / Systematic Risk
Both business risk Systematic - Effects everyone Specific - Specific
61
P/E Valuation
MV of all: P/E ratio x PAT Individual share: P/E X EPS
62
Earnings Yield
Earnings Yield Ratio = PAT / MV of shares or EPS / SP Value Company: MV = PAT / Earnings yield Share P = EPS / Earnings yield
63
Dividend Yield Valuation
MV of all shares = Div / Div yield
64
Translation Risk
Risk enterring short term transaction credit in diff currency
65
Economic Risk
Longer risk trading in foreign currency
66
Translation Risk
Accounting losses due to foreign currency
67
Interest Rate Parity Theory
Difference between current spot rate (S0) and current forward rate (F0) should equal the difference between interest rates in each country Investor should be indifferent between forward contract or borrowing
68
Purchasing Power Parity Theorem
Difference between current spot rate (S0) and expected future spot rate (S1) should equal difference between inflation rates in each country i.e. investor should be indifferent between buying goods in £ or converting money to $ and buying the same goods in $
69
Home currency invoicing
Invoicing in your home currency when selling abroad eliminates transaction risk
70
Leading /lagging
Bringing forward a payment or delaying a payment
71
Asset & liability management
Borrow and fund in foreign and net off
72
Forward exchange contract
Binding agreement to buy/sell an amount of currency on an agreed future date at an exchange rate agreed today. To get the FWD rate you add a discount to / deduct a premium from the spot rate
73
Currency options
The right, but not the obligation, to buy (call), or sell (put) a set amount of currency at a set price (in another currency) at a future date  If exchange rate moves against you, use the strike price on the option contract  If exchange rates move in your favour let the option lapse and use the spot rate  Pay a premium upfront in $
74
Money market hedging
Instead of using forwards and futures, you can instead use borrowing / lending on money markets + spot fx transactions to hedge your exposure.
75
Simultation
Computer based evaluation on risk and probabilities of an investment. Picture of mean EPV is built up on the results. Risk can be assessed, with most likely outcome and probability of negative NPV.
76
Risk - adjusted discount rates
Risk associated with project can be incorporated into discount rate as a risk premium over risk free rate. Can be calculated using CAPM by ungearing Equity Beta or subjectively by choosing it is riskier.
77
Cum Div - Ex Div
Cum Div - last dividend
78
When can you use the same WACC?
Same business risk No change in capital structure Project quite small Not using project specific finance e.g. gov grant
79
Miller and Modigliana - No Tax
WACC is same all levels of gearing
80
Miller and Modigliana - Tax
Gear as much as possible
81
Traditional capital structure theory
Trial and error for optimum capital structure. Debt starts off good
82
Basis Risk
Basis risk is the possibility that movements in the currency futures price and spot price will be different. It is one of the reasons for an imperfect currency futures hedge.
83