mos exam Flashcards

Question

First channel

Answer 1

Direct intermediation – the lender provides money directly to the borrower (non-market transaction)

Answer 2

Direct intermediation through a market intermediary – the borrower uses a market intermediary to help find suitable lenders. Market intermediary= an entity that facilitates the working of markets (mortgage brokers, insurance brokers, stockbrokers)

Answer 3

Indirect intermediation – the financial intermediary lends the money to the ultimate borrowers but raises the money itself by borrowing directly from other individuals

Answer 4

Banks and other deposit-taking institutions Insurance companies Pension Funds Mutual Funds- simply act as a “pass through” for individuals, providing them with a convenient way to invest in the equity and debt markets. Do not change the nature of the underlying financial security.

Answer 5

Debt and Equity

Answer 6

Legal obligations to repay borrowed funds at a specified maturity date and to provide interim interest payments. Bank loans, commercial paper, treasury bills (T-Bills), etc.

Answer 7

Ownership in a company comes in two main types: Common shares provide partial ownership and voting rights, while Preferred shares offer fixed dividends prioritized over common shareholders.

Answer 8

The common stockholders are the owners of the corporation’s equity Voting rights No specified maturity date and the firm is not obliged to pay dividends to shareholders Returns come from dividends and capital gains On liquidation of company, common stockholders are last in list for company assets, only after creditors, bondholders, and preferred shareholders are paid out

Answer 9

Equity instruments Usually entitle the owner to fixed dividend payments that must be made before any dividends are paid to common shareholders Generally do not have voting rights in the company Have characteristics of both bonds and stocks On liquidation of the company, preferred stockholders will be paid out before common stockholders (but after creditors/bondholders)

Answer 10

Involve the issue of new securities by the borrower in return for cash from investors (or lenders) [i.e. new securities are created]

Answer 11

Secondary markets facilitate the buying and selling of existing securities, ensuring investment liquidity. They are vital for the primary market's functioning, enabling investors to sell investments when needed. In equity, secondary trading surpasses primary markets, while in debt, it's the opposite.

Answer 12

short term debt instruments (maturities less than one year i.e. T-bills)

Answer 13

include debt securities with maturities greater than one year (i.e. bonds & equity securities) & equity securities

Answer 14

secondary markets that involve a bidding process that takes place in a specific location

Answer 15

secondary markets that do not have a physical location and consist of a network of dealers who trade directly with one another The distinction has become blurred in recent years because trading on most of the major exchanges in the world is now fully computerized, making the physical location of the exchange of little consequence.

Answer 16

debt that operates in the money market and is traded over the counter (like an IOU)

Answer 17

like commercial paper but the bank of the borrowing company guarantees the repayment of the debt

Answer 18

you buy a bond from a company for a certain amount of time (loan them money), then they pay you back with interest when the time is up (e.g. 10 years)

Answer 19

unsecured debt, backed only by the general assets of the issuing corporation, no collateral or belief that the company will pay except for the company's word

Answer 20

(mortgage debt) - secured by specific assets, you can take the company to court if they don't pay you back

Answer 21

in default, holders get payments only after other debt-holders get their full payment, you get paid last

Answer 22

in default holders get payment before other debt-holders get, you get paid first, will pay less interest than subordinated because subordinated debt is taking a much larger risk

Answer 23

means that you can force the company to give you your money back as an investor

Answer 24

pay face value at maturity only, sold at discount, you don't get interest throughout it, you just get paid right amount with interest at the end

Answer 25

bonds with below investment grade rating, high yield, a risk bond, really high interest, there's a risk you won't get paid back

Answer 26

you, the investor, can choose to exchange or convert or change your bond into shares of the company

Answer 27

the company can choose to take longer to pay you back, if they extend, they still have to keep sending you regular interest payments during extended period

Answer 28

the company can choose to pay you back early, the don't have to wait till the full duration

Answer 29

Preferred shares are like special stock with fixed payments, acting a bit like bonds. They can be cumulative (payments accrue if missed) or non-cumulative, and participating (get more if the company does well) or non-participating. If the company skips dividends, preferred shareholders might get voting rights. They're seen as a liability, not equity, on financial statements. Companies use them because they're sort of a cheaper alternative to regular stock, similar to debt.

Answer 30

Derivatives are like financial sidekicks, their value linked to something else. They don't have standalone value but gain it from an underlying asset. The key players are options and futures. Stock options aren't for raising funds; they're a form of compensation. Prices depend on market forces, showcasing expectations about the future from existing info.

Answer 31

can raise money by themselves, by merging with another firm, or by going public with their shares

Answer 32

Initiated by entrepreneurs rather than large corporations, the startup process involves securing "seed" money and essential resources. This early phase, lasting 1 to 2 years, sees founders relying on their own initial investments as venture capitalists or banks typically hesitate to fund. Success is gauged by providing convincing evidence to potential investors that the business concept is viable and merits financial support.

Answer 33

are individuals or firms that help new businesses get started and provide much of their early-stage financing

Answer 34

individual venture capitalists who are wealthy individuals who invest their own money in emerging businesses at the very early stages

Answer 35

are typically wealthy individuals who invest their own money in emerging businesses at the very early stages in small deals

Answer 36

The high degree of risk,Types of productive assets,Informational asymmetry problems

Answer 37

most suppliers of capital, such as banks, pension funds, and insurance companies are averse to undertaking high-risk investments, and much of their risk-averse behaviour is mandated in regulations that restrict their conduct

Answer 38

no assets to weigh risk over, most assets are not tangible, it’s easier to secure loans when tangible assets are present, so new firms whose primary assets are intangibles, like patents or trade secrets, often find it difficult to secure financing from traditional lending sources

Answer 39

Banks and investors may not fully grasp your idea like you do. In specialized or new industries, investors might struggle to tell good entrepreneurs from bad ones, making them hesitant to invest in those firms.

Answer 40

Venture capitalists invest to gain equity in a company, usually through preferred stock that can convert to common stock if they choose. How much they get involved depends on the expertise of the management team.

Answer 41

One crucial role of venture capitalists is to offer advice. Leveraging their industry expertise, they guide businesses on how to succeed, providing valuable counsel to entrepreneurs in the startup and early operational phases.

Answer 42

Bootstrap financing, Seed-stage financing, Early-stage financing, Latter-stage financing (mezzanine financing) Venture capitalists then exit by selling to a strategic buyer, selling to a financial buyer, or selling stock to the public

Answer 43

entrepreneur supplies funds, prepares business plan, and searches for initial outside funding

Answer 44

VCs provide funds to finish development of the concept

Answer 45

venture capitalists provide funds to finish development of the concept

Answer 46

typically includes 1-5 additional stages

Answer 47

why consumers find your business/product attractive

Answer 48

Funding the ventures in stages, Requiring entrepreneurs to make personal investments, Syndicating investments, Maintaining in-depth knowledge about the industry

Answer 49

not giving all of the money at once, e.g. $1 Million for 8 months, then more later if you show you are using the money properly

Answer 50

proves commitment and confidence in business VCs want your financial rewards to come from building a successful business, not from your salary

Answer 51

Venture capitalists share risk by forming groups. This reduces risk in two ways: it diversifies the investment portfolio of the original venture capitalist, as others now own part of the deal, and the initial VC has less money at stake.

Answer 52

specializing in and understanding a business field gives the VC an advantage over other lenders who may be generalists

Answer 53

Venture capitalists aren't in for the long haul; they typically exit in 3 to 7 years. Each agreement outlines key decisions for the exit, such as when to exit, the method, and the acceptable price.

Answer 54

In financial sales, firms are purchased for financial gain, not personal improvement. This often happens in leveraged buyouts by private equity firms, where the goal is to hold the company for 3-5 years and sell it at a profit. Unlike strategic buyers, financial buyers don't expect gains from operational or marketing synergies. Instead, they focus on improving operations independently to create value.

Answer 55

To get the best price in an IPO, a VC won't sell all their shares right away; selling everything might worry investors. Most VCs prefer exiting through strategic and financial sales rather than public sales (IPOs).

Answer 56

Venture capital involves high costs but offers the potential for significant returns. Typically, only 1 or 2 out of every 10 VC-backed businesses succeed. If successful, venture capitalists contribute substantially to creating value for other owners. On average, a VC fund is estimated to generate annual returns of 15-25%, surpassing the S&P 500's average annual return of 11.82%.

Answer 57

To get a lot of cash or let a venture capitalist exit, companies often go for an IPO, selling their common stock to the public. These first-time stock deals have a special name because they're crafted to attract investors as the company makes its debut in the market.

Answer 58

IPOs get big money, more than private sources. After, you can raise extra cash cheaply through follow-on public offerings because public shares are easier to trade and valued higher than private ones.

Answer 59

IPOs are costly because the stock is new, lacking an established record. Out-of-pocket expenses, like legal and accounting fees, add up. Complying with ongoing SEC disclosure rules is also pricey. Publicly sharing all company info may eliminate competitive advantages over private firms. Some investors say SEC's quarterly reporting pushes managers toward short-term profits, not long-term value.

Answer 60

A public offering is when a company sells more stocks or bonds that are already publicly traded. This means these securities are registered with the Securities and Exchange Commission, making them legally available for sale to the general public. Only registered securities can be sold to the public.

Answer 61

For an IPO, a company relies on investment bankers, specialists in introducing new securities to the market. These bankers offer three essential services in the process: origination, underwriting, and distribution.

Answer 62

Investment bankers get firms ready for an IPO, offering financial advice. BOD and shareholder approvals are needed. A preliminary prospectus provides detailed info to help investors make smart decisions about the security issue and its risks.

Answer 63

The risk-bearing part of investment banking The securities can be underwritten in 2 ways

Answer 64

In an IPO deal, the investment banker (IB) agrees to buy your shares at a set price and then sells them to the public. The underwriter takes on the risk that the resale price might be lower, known as price risk. The IB's pay is the underwriter's spread, which, in a firm-commitment offering, is the difference between the IB's purchase price and the offer price.

Answer 65

In a best-effort IPO, the investment banker aims to sell as many shares as possible at the highest price, taking a commission. They don't guarantee a price or the number of shares. Most companies prefer firm-commitment IPOs (over 95%) where the price is guaranteed. Best-effort contracts arise when underwriters avoid the risk of setting a guaranteed offering price.

Answer 66

Underwriters form an underwriting syndicate to share risk and efficiently sell a new security issue. Each participating underwriter gets a portion of the fee and an allocation of securities to sell. To expand investor outreach, syndicates may involve other IB firms in a selling group, earning commissions for each security sold without bearing underwriting risk.

Answer 67

An investment banker's challenge is to find the optimal price for a quick sale of all offered shares, ensuring a stable secondary market. This involves considering the firm's future cash flows and comparing stock prices to earnings and total firm value of similar public firms. A road show follows, with management presenting to potential investors. This helps the IB gauge how many shares investors might buy at different prices.

Answer 68

Before selling shares, the underwriting syndicate and the issuer hold a due-diligence meeting. This is to protect the underwriters and minimize the risk of investor lawsuits in case the investment faces issues later. These meetings make sure all significant details about the firm and the offering are uncovered and fully disclosed to investors.

Answer 69

After due diligence, a pricing call decides the final offer price, typically after the market closes. Management accepts or rejects the investment banker's recommendation. If accepted, an amendment is filed with the SEC, and once registered, securities can be sold to investors.

Answer 70

The syndicate's main goal is to sell securities swiftly at the offer price since it reflects the previous day's market conditions, subject to rapid changes. If the securities aren't sold within a few days, the syndicate disbands, and members sell at whatever price they can get.

Answer 71

In a firm-commitment offering, at the closing, the issuing firm hands over security certificates to the underwriter, who, in turn, delivers payment (minus the underwriting fee) to the issuer. Closings typically occur on the third business day after trading begins.

Answer 72

3 questions to consider when deciding what happens with the proceeds What are the total expected proceeds from the common-stock sale? How much money does the issuer expect to get from the offering What is the IB's expected compensation from the offering, based on the underwriter's spread

Answer 73

Underpricing is selling new securities below their true value. Investment bankers say it attracts stable long-term investors but risks damaging the IB's reputation. It's measured as the difference between the offering and closing prices on the first day of the IPO, reflecting an opportunity loss for the issuer's stockholders.

Answer 74

is the difference between the proceeds the issuer receives and the total amount raised in the offering

Answer 75

include other investment banking fees, legal fees, accounting expenses, printing costs, travel expenses, SEC filing fees, consultant fees, and taxes All of these expenses are reported in the prospectus

Answer 76

Bootstrapping and VC financing exist in the private market. Even sizable, high-quality private companies owned by entrepreneurs or family entities may choose to sell securities privately rather than accessing public markets. This is because smaller or lower-credit firms often have limited or no access to public markets, making private markets the more cost-effective source of external funding.

Answer 77

Private placements happen when a firm sells unregistered securities directly to investors like insurance companies or wealthy individuals. Private lenders are more flexible in negotiations, and financial distress is often resolved without going to court. Benefits include quick deals and flexible issue sizes. The main drawback is restrictions on resale.

Answer 78

Similar to VCs, private equity firms gather funds from various sources to invest. They focus on mature companies and often buy the entire business. Managers aim to boost acquired firms' value through close monitoring and improved management. After increasing value, they sell for a profit. Typically, private equity firms hold investments for 3 to 5 years.

Answer 79

For a public firm with a high credit rating, the most cost-effective external funding often comes from a general cash offer. This offer involves selling debt or equity and is open to all investors. It is conducted by a registered public company that has previously sold stock to the public.

Answer 80

In a specified offering, the issuer picks the securities, and an IB does the origination work. Underwriters then bid competitively to buy the issue. The winner pays the highest price, making the securities available to individual investors at the offer price.

Answer 81

In a negotiated sale, the issuer picks the underwriter at the beginning, defines the work and fees, and collaborates on issue design. After setting the offer price, the underwriter buys and sells to investors. While competitive bidding is cost-effective, negotiation can be pricier but offers benefits like reduced uncertainty and better storytelling to investors. Potential competition from other underwriters still provides advantages.

Answer 82

Shelf registration is a two-year SEC registration that lets firms register and sell securities as needed. Costs are lower, requiring only one registration statement covering multiple securities. No penalty exists for unused authorized securities, offering flexibility. Securities can be sold quickly when market conditions are favorable, allowing firms to raise money as needed instead of in a single large sale.

Answer 83

Smaller and lower-credit firms often favor the private market for cheaper funding. In unstable markets, investors go for quality over risk, impacting smaller firms in public markets. Large, high-credit companies may choose private markets to avoid regulatory costs and complex business explanations to the public.

Answer 84

the policy concerning the distribution of value from a firm to its stockholders

Answer 85

something of value distributed to a firm's stockholders on a pro-rate basis (meaning it is in proportion to the percentage of the firm's shares that they own) When a firm distributes value through a dividend, it reduces the value of the stockholders' claims against the firm

Answer 86

Dividend policy is a firm's strategy for distributing value to stockholders. Dividends are distributed proportionally and can include cash, assets, or exclusive discounts. When a firm issues dividends, it diminishes stockholders' claims and returns part of their investment.

Answer 87

The most common form is the regular cash dividend, typically paid quarterly. It's a common way for firms to share profits with stockholders. The size is usually set at a sustainable level, with a reduction viewed negatively by stock market investors.

Answer 88

Management can be cautious in setting the regular cash dividend low, as they can always pay an extra dividend if earnings exceed expectations. Extra dividends are often paid alongside regular cash dividends and ensure a minimum portion of earnings is distributed yearly, especially during prosperous years.

Answer 89

A special dividend is a one-time payment to stockholders, similar to an extra dividend but larger and less frequent. It typically occurs when a company has additional funds due to a special event, such as selling parts of the business.

Answer 90

A liquidating dividend is paid to stockholders when a firm is liquidated. It can only be paid after settling all obligations, including wages, debts, and taxes. When dividends are paid, the stock price decreases by the dividend amount. While the distribution of value to stockholders can take various forms, those not in cash, like discounts or free samples, are not considered dividends.

Answer 91

Dividends go through a process: Board votes on value and type every 3 months. Public announcement on the declaration date includes payment details. A large dividend can indicate optimism, affecting stock prices. Ex-dividend date sees stock prices drop; investors buying before get dividends. Record date determines eligibility, set after the ex-dividend date. Stock prices adjust on the ex-dividend date to exclude the dividend value.

Answer 92

Dividend process is less defined for private companies due to: Infrequent share transactions. Fewer stockholders. No involvement of a stock exchange. No public announcement. No ex-dividend date needed. Record and payable dates can be any day post board approval.

Answer 93

Stock repurchases involve a company buying its own stock, providing an alternative to distributing value to stockholders: Unlike dividends, not all stockholders participate, and it's not a pro-rata distribution. Stockholders choose participation, deciding when to pay taxes on stock gains. Investors prefer being taxed on gains from stock repurchases over dividends. When using cash, the cash account decreases, and treasury stock increases on the balance sheet. In contrast, cash dividends reduce both the cash account and retained earnings on the balance sheet.

Answer 94

Open-market stock repurchases involve a company buying shares at the current market price: Repurchases are an alternative to regular cash dividends for profit distribution. Limits exist on daily repurchases to prevent stock price manipulation. The restrictions may slow down the process of distributing a significant cash amount through open-market repurchases.

Answer 95

an open offer by a company to purchase shares Used when a company wants to distribute a large amount of cash at one time and does not want to use a special dividend

Answer 96

Company announces a buyback of X shares at a fixed price for 30 days: Firm states the number of shares it wants to repurchase. Asks stockholders to offer their shares at various prices. Management sets a price allowing the desired repurchase. Stockholders willing to sell at or below this price receive that amount for their shares.

Answer 97

Companies may announce a buyback of shares at a fixed price, valid for 30 days. Stockholders can offer their shares at various prices, and management sets a price to meet repurchase goals. Those willing to sell at or below this price receive it. This benefits non-selling stockholders, as managers may negotiate a price below the market. Yet, large stockholders' willingness to sell may signal pessimism, affecting stock prices.

Answer 98

In a scenario with no taxes, no information or transaction costs, and a fixed real investment policy, capital structure policy doesn't impact firm value. Dividends are inconsequential as stockholders can "manufacture" them at no cost, and total cash flow from real assets is unaffected by dividends. Dividends only serve as signals of fundamental changes in the firm and are byproducts of change.

Answer 99

If a company's BOD approves dividends exceeding excess cash from operations, it compels periodic equity sales in the public markets to fund the dividends. This increases costs for inefficient business operations, aligning management incentives with stockholders. Issuing equity involves rigorous auditing, potentially improving company performance and investor willingness to pay a higher stock price.

Answer 100

Dividends are taxed as ordinary income, often at higher rates than capital gains tax. Reinvesting dividends may incur brokerage fees, but some firms offer dividend reinvestment programs (DRIPs) to eliminate these costs. However, DRIPs don't impact taxes on dividends. Paying dividends reduces the total value of company assets, potentially increasing the cost of debt. With lower asset value, debt holders face higher default risk and may charge a higher interest rate on the company's debt to compensate for this increased risk.

Answer 101

Stockholders selling shares back to a company pay lower taxes on realized gains compared to dividends. Stock repurchases offer managers flexibility, allowing adjustments or halts at any time. Unlike dividends signaling confidence in long-term cash flows, repurchases distribute uncertain extra cash while preserving flexibility. Ongoing repurchase programs may lack visibility, making them less effective for signaling positive prospects to investors. Managers' knowledge advantage may lead to repurchases benefiting specific stockholders, potentially conflicting with overall stockholder interests.

Answer 102

A stock dividend is a pro-rata distribution of new shares to existing stockholders, maintaining the company's total asset value. Unlike traditional dividends, stock dividends don't increase a company's wealth; it's a reshuffling of shares. Issuing stock dividends aims to reduce stock prices. When a stock dividend is paid, each stockholder's share count increases, proportionally lowering their share value.

Answer 103

Stock splits entail substantial increases in the number of shares, often without shareholder approval. If management anticipates a stock price decline, they're unlikely to opt for a two-for-one or three-for-one split. In a stock split, stockholders receive additional shares—like getting one extra share for each share they already own.

Answer 104

Reverse stock splits may be executed to meet exchange requirements; for instance, NASDAQ mandates shares to trade at least $1. If there's concern about meeting this requirement, a company might use a reverse stock split to maintain a per-share price above the threshold. Companies may prefer lower share prices as shareholders often view stock splits positively. If stock prices become too high, fewer market participants may afford or choose to invest in them.

Answer 105

Companies may implement stock dividends or splits to bring stock prices within an optimal trading range, ensuring affordability for investors to purchase round lots (multiples of 100 shares). Odd lots (less than 100 shares) are less liquid and costlier for both investors and companies to service. Investors often prefer round lots due to their higher liquidity. By adjusting stock prices through dividends or splits, companies signal optimism about the future, as they are unlikely to split stocks if anticipating price declines. This strategy helps maintain investor interest and facilitates round-lot purchases even when prices rise.

Answer 106

Managers adjust dividends based on long-term earnings, emphasizing changes over specific amounts. They use dividends cautiously to avoid surprises and distribute excess earnings. Recent surveys show managers prefer flexible share repurchases, using leftover cash after investments. Repurchases are favored for market timing when stock prices seem low. Dividends and repurchases have little impact on investor preference, with no clear preference from institutional investors.

Answer 107

Managers must align dividend policies with the ability to sustain investments for market competition. Practical considerations include: Assessing the long-term surplus of earnings over investment needs and its certainty. Ensuring financial reserves cover dividend payouts during low earnings or high investment periods. Maintaining financial flexibility in unforeseen circumstances erasing reserves during earnings downturns. Capability to swiftly raise equity capital when needed. Considering implications for company control if financing dividends through equity leads to increased stockholders.

Answer 108

Anticipated cash flow growth signals positive future cash flows for investors, boosting stock prices. Generally, stock prices rise with announcements of increased regular cash dividends. Conversely, reductions in regular cash dividends often result in stock price declines. Special dividend announcements are also linked to average stock price increases.

Answer 109

is a transfer of control from one ownership group to another

Answer 110

the purchase of one firm by another, when one firm completely absorbs another Acquiring firm keeps identity whereas acquired firm ceases to exist

Answer 111

the combination of two or more firms into a new legal entity in which one entity keeps their identity while the others lose their identities Issues can arise if companies have announced their intent to merge as equals, but events occur that take them down a different path

Answer 112

A merger involves combining two entities into a new one, requiring approval from both sets of shareholders. In a true merger, 2/3 of shareholders from each entity must approve the amalgamation, creating a new entity. When an acquirer owns all shares in the target, the process is a formality.

Answer 113

A squeeze-out is a unique acquisition where the buyer already holds a majority stake in the target. To prevent potential abuse, safeguards include requiring a majority of minority shareholders to approve the amalgamation and obtaining a fairness opinion.

Answer 114

A fairness opinion is an external valuation by an independent expert, challenging when a controlling shareholder is involved. It assesses the true value of a firm's shares, considering factors like related businesses, expertise transfer, cost synergies, and brand name use in the amalgamation.

Answer 115

the receipt of cash for shares by shareholders in a target company Generally, when one company acquires another, the approval of the target company's shareholders is required, since they have to agree to sell their shares The shareholders of the acquiring company do not have to generally give their approval

Answer 116

A share exchange involves an acquiring company offering its shares or a mix of cash and shares to the target company's shareholders. Approval from the acquiring firm's shareholders may be required, contingent on limits set on its authorized share capital. For instance, exceeding a set limit necessitates shareholder approval.

Answer 117

In a cash transaction, shareholders in the target company receive cash for their shares. In a share transaction, the acquiring company offers its shares or a mix of cash and shares to the target company's shareholders. A going private transaction involves a purchaser, often a majority stakeholder, acquiring the remaining shares to transition a company from public to private.

Answer 118

To ensure complete and timely information be available to all parties while at the same time not letting this requirement stall the process unduly

Answer 119

Implementing takeover defenses is essential to: Prevent oppression or coercion of minority shareholders. Allow for competing bids, avoiding special rights for the first bidder and ensuring the best price for all shareholders. Limit the ability of a minority to obstruct the will of the majority, including provisions to address minority squeeze-out situations.

Answer 120

Private companies are usually exempt from provincial securities legislation. However, public companies with few shareholders in one province may be subject to the takeover laws of another province where the majority of shareholders reside, especially in the case of purchasing shares from fewer than five shareholders.

Answer 121

The "5% rule" allows for a creeping takeover, permitting the acquisition of up to 5% of outstanding shares through the exchange over a one-year period without a normal course tender offer. However, once the 20% threshold is reached, a tender offer must be made for any additional shares.

Answer 122

Authorities can reject takeovers due to: Concerns related to national security Concerns about "sensitive" industries that are seen as critical to the nation (which is why there are foreign ownership restrictions for Canadian banks) Anti-trust concerns in situations where an amalgamation of two or more businesses would create an entity that would too narrowly restrict competition

Answer 123

10% Early Warning When a shareholder hits this point a report is sent to OSC This requirement alerts other shareholders that a potential acquisisitor is accumulating a position (toehold) in the firm, and lets them know if a significant block of the company has been bought by a potential acquirer 20% Takeover Bid Not allowed further open market purchases but must make a takeover bid This allows all shareholders an equal opportunity to tender shares and forces equal treatment of all at the same price This requirement also forces the acquisitor into disclosing intentions publicly before moving to full voting control of the firm 50.1% Control Shareholder controls voting decisions under normal voting (simple majority), meeting is held and 5% ownership is required to attend the meeting Can also change the membership of the BOD 66.7% Amalgamation Can approve amalgamation proposals requiring a 2/3 majority vote (supermajority) 90% Minority Squeeze-Out Once the shareholder owns 90% or more of the outstanding stock minority shareholders can be forced to tender their shares and sell them at the takeover price This provision prevents minority shareholders from frustrating the will of the majority

Answer 124

Once an entity acquires 20% of a company's shares, any additional purchases trigger a takeover bid. This bid, seeking 50% or more of the target's shares, involves sending a comprehensive circular to shareholders, similar to a prospectus. The target's board then issues a letter within 15 days, recommending acceptance or rejection of the offer. The bid remains open for 35 days, and shareholders signal acceptance by signing authorizations.

Answer 125

Shareholders authorize takeover bids; if 80% tender, each sells 75%. Offer price can't be below the acquirer's 90-day average. Tender offer usually exceeds stock price. Prorated shares for excess tenders. Rule applies unless exempt, allowing creeping takeovers through stock exchanges up to 5% annually.

Answer 126

The acquisition of a willing target begins if the target initiates the process voluntarily, often when the founder is no longer involved. The target accommodates overtures and shares confidential information for scoping and due diligence.

Answer 127

The target engages an investment bank to create an offering memorandum, detailing the company for potential buyers to estimate fair value. If the acquirer proceeds, they sign a letter of intent outlining the acquisition terms, often including legal clauses like a no-shop provision and termination fee. This process may start with a friendly overture seeking information for valuation.

Answer 128

says that if we will start talking about prices, shares, all that stuff, you as the company being purchased cannot go out and research and try to sell to another potential buyer, need to be loyal to the company interested in buying buyer

Answer 129

A termination or break fee, typically 2.5% of the transaction value, is implemented after signing a letter of intent. If the acquiring company withdraws, this fee is paid to the target. If the withdrawal is prompted by a competing offer, it is a way of sharing some profit with the initial buyer.

Answer 130

Tax implications differ based on the acquisition method. Cash purchases result in taxable gains for target shareholders, subject to capital gains tax if share values have appreciated. In contrast, share swaps are often non-taxable, making them common in smaller acquisitions. Asset purchases, focused on obtaining specific assets (e.g., technology, equipment), are an alternative to share acquisitions but are typically not viable in hostile takeovers.

Answer 131

In an asset purchase, the acquiring company buys the target firm's assets rather than the entire firm. The target receives proceeds, which can be used to settle debts. Subsequently, the target has the choice to reinvent itself or liquidate, distributing the proceeds to shareholders.

Answer 132

A hostile takeover occurs when a target company rejects an acquirer's advances and refuses to share confidential information. The acquirer typically already owns a significant interest (e.g., 20% of outstanding shares), demonstrating their determination.

Answer 133

A creeping takeover involves gradually acquiring shares in the open market to build a toehold without attracting attention. At the 10% early warning stage, a statement is filed with the OSC. The acquirer accumulates 20% of shares through open market purchases over time. A tender offer is then made, seeking to bring ownership to the desired level, with a minimum vote percentage required. This method avoids a formal vote by target shareholders and allows the acquirer to monitor and counter defensive tactics.

Answer 134

Taxation issues arise when an acquirer uses cash for a purchase, leading to taxable cash for the target company's shareholders. Share swaps are often non-taxable, making them common in smaller acquisitions. Asset purchases involve acquiring specific assets (e.g., technology) rather than the entire corporation, and hostile takeovers may not allow this.

Answer 135

When a hostile tender offer is launched, external parties always look for certain market clues to indicate the potential outcome of a hostile takeover attempt:

Answer 136

The market's reaction to a tender offer provides key signals. A jump in the market price may signal competing offers or an undervalued bid, prompting the bidder to consider an increase. If the market price stays close to the offer, it suggests a fair price, increasing the likelihood of success. High trading activity involving arbitrageurs, who predict takeovers, is generally positive for the acquirer. Large share transfers to arbitrageurs, especially when coordinated in response to the tender offer, can enhance the deal's success for the acquirer.

Answer 137

professionally managed funds with managers who are experts in securities law and tactics designed to get the highest price for their shares

Answer 138

A "poison pill" or deal-killing strategy is a plan implemented by a target company to discourage takeovers. Typically, it allows existing shareholders to purchase additional shares at a discounted rate (e.g., 50%) during a takeover. This tactic raises the cost for the acquirer and often leads to negotiation for a friendly offer. In Canada, poison pills can only serve as a delaying tactic and cannot obstruct bids as they can in the U.S.

Answer 139

A "crown jewel" defense sells crucial assets of a target company to deter a takeover, reducing its appeal for potential acquirers. This strategy may include giving away sought-after assets or distributing a large dividend to diminish the target's attractiveness.

Answer 140

A white knight is a rescuer in a hostile takeover, where the target seeks a friendly acquirer to make a counteroffer and thwart the hostile bid. This involves encouraging others to buy shares, creating a more negotiable situation.

Answer 141

In a horizontal merger, two firms in the same industry combine, often with the aim of eliminating a competitor. A vertical merger involves a firm acquiring a supplier or another company closer to its customers, extending its competitive scope within the industry. In a conglomerate merger, two firms in unrelated businesses combine to diversify risks, reducing the overall risk of the combined company.

Answer 142

a merger or acquisition involving a Canadian and a foreign firm as either the acquiring or target company

Answer 143

This strategy involves capitalizing on a portfolio of businesses that can deliver strong financial performance. It includes actively seeking to acquire companies with undervalued assets, those facing financial distress, and those with high growth potential but limited investment capital.

Answer 144

The primary motive for Mergers and Acquisitions (M&As) should be the creation of synergy. Synergy value arises from the economies of integrating a target and acquiring company, resulting in the combined firm's value exceeding the sum of the two individual firms, often expressed as 1 + 1 = 3. Many M&A announcements emphasize the described synergies and positive gains associated with the proposed transaction.

Answer 145

Mergers and acquisitions (M&As) are strategic decisions motivated by factors such as achieving economies of scale through increased production efficiency and addressing overcapacity in industries. Geographic synergies involve consolidating fragmented markets, while economies of scope result from combining activities with shared assets. M&As may also target businesses with complementary strengths, aiming to improve overall performance. Extension M&As allow companies to expand their expertise into new areas. These motives collectively enhance efficiency, market presence, and competitiveness.

Answer 146

Mergers and acquisitions (M&As) often seek efficiency gains by utilizing excess capacity, leading to job reductions. A new management team may enhance efficiency and value. Financing synergy involves reducing cash flow variability, increasing debt capacity, and lowering average issuing costs for larger entities. Tax benefits arise from deductions, credits, and offsetting losses, providing incentives for M&As. Strategic realignments enable new strategies, skills, market connections, and product/services offerings. Overall, these factors contribute to improved financial performance and competitiveness.

Answer 147

Managers pursue M&As for personal motivations, including financial rewards and associating power and prestige with larger firms. Diversification is sought to reduce firm risk, but evidence indicates it can lead to managerial complications and lack of focus. Managers with undiversified stakes aim to use M&As for diversification geographically, across industries, or in product mix. Investors often prefer "pure play" companies focused on a single strategic plan and may pay a premium for such firms.

Answer 148

Evidence suggests that target firm shareholders gain the most in M&As, with premiums ranging from 15-20% for stock-financed takeovers and 25-30% for cash-financed takeovers. Target gains can be even higher in bidding wars and 100% cash deals, considering potential capital gains tax. Acquiring firm shareholders typically see no change or a dip in stock prices, indicating potential overpayment or misalignment of merger benefits. Share swaps show synergistic gains in non-competitive markets. Shareholder value at risk (SVAR) argues that cash deals make firms more cautious about acquisition prices compared to share swaps, spreading risk in market downturns.

Answer 149

The value of a company is shaped by buyer and seller willingness, considering supply and demand curves. The transaction price, concluding the deal, is within the range of these curves, reflecting the actual and perceived values. Limited market participation for the entire company leads to a broad spectrum of possible deal prices. Agreement between parties determines the transaction price within the range of the supply and demand curves.

Answer 150

The removal of barriers to free trade and the closer integration of national economies, often referred to as deregulation, has led to large companies generating over half of their revenue from countries other than their own. Consumers worldwide purchase goods from various countries, and production has become highly globalized, with firms seeking cost-effective components and production locations. The financial system's integration is driven by the deregulation of foreign exchange markets, money and capital markets, and banking systems in Asian and Western nations.

Answer 151

A multinational corporation (MNC) is a company based in one country but operates in multiple countries, engaging in various businesses and global activities such as manufacturing, mining, and sales.

Answer 152

A global multinational corporation (MNC) is a widely owned and managed company with a global perspective, operating without a specific allegiance to any nation or region.

Answer 153

Global business faces several challenges, including uncertainty in future exchange rates, legal and tax variations, language and cultural differences, variations in economic systems, and country-specific risks. These factors can impact financial decisions, resource allocation, and overall business operations for multinational corporations.

Answer 154

In Canada, the UK, and the USA, firms aim to maximize stockholder value. In contrast, Continental European countries like France and Germany prioritize maximizing corporate wealth, with a focus on overall stakeholder welfare alongside earning wealth for the firm.

Answer 155

The three fundamental principles of managerial finance—time value of money, valuation models for capital assets, bonds, stocks, and entire firms—remain consistent regardless of whether a transaction is domestic or international. However, certain input variables, such as required rates of return, vary across countries. Additionally, cash flows may be expressed in either home or foreign currency, and discrepancies exist in tax codes and accounting standards across countries. Please refer to the chart on the last page for a detailed comparison of domestic and international differences.

Answer 156

A global network of electronically connected markets where currencies are traded in wholesale accounts constitutes the foreign exchange market. Currency exchange rates are influenced by factors such as supply and demand dynamics, relative inflation rates, relative interest rates, and other considerations like political and economic risks. Major participants in this market include multinational commercial banks, large investment banking firms, and smaller currency boutiques.

Answer 157

the rate at which one agrees to buy or sell a currency today

Answer 158

A forward rate is the agreed-upon rate at which one commits to buy or sell a currency on a future date. This rate is set when the agreement is made, providing a predetermined exchange rate for the future transaction. Engaging in forward transactions allows companies to hedge against the risk of unfavorable exchange rate movements, providing a way to lock in the cost of foreign exchange and mitigate potential financial exposure.

Answer 159

indicates the amount of a home country's currency (CAD)needed to purchase one unit of a foreign currency You need 1.34 CAD to buy 1 USD

Answer 160

value of one currency relative to another currency

Answer 161

indicates the amount of a foreign currency needed to purchase one unit of the home country's currency

Answer 162

Capital budgeting involves evaluating and deciding on business investments. For multinational firms considering overseas capital projects, the financial manager must make company-wide decisions about which projects to accept. Accepting projects with a positive Net Present Value aligns with the fundamental goal of financial management—to maximize stockholder wealth—thus enhancing the overall value of the firm.

Answer 163

Determining cash flows from overseas capital projects is complicated by several factors. Companies may encounter challenges in estimating incremental cash flows for foreign projects. Additionally, issues may arise if foreign governments impose restrictions on repatriating, or returning, cash to the parent company.

Answer 164

Converting a project's future cash flows into another currency involves the use of projected exchange rates. However, obtaining long-term currency rate forecasts for projects with lifespans of 20 years or more can be challenging. To address this, companies may adjust their discount rate, incorporating the higher risk associated with currency fluctuations, or modify the interest rate on the investment.

Answer 165

Derivatives are electronic contracts representing rights, trading between two parties in specific markets. Unlike stocks or real estate, derivatives are ephemeral and typically have a short lifespan. The value of a derivative is highly sensitive to even small changes in the underlying asset's conditions.

Answer 166

Derivatives derive their value from an underlying security. Traders engage in these indirect claims to expand investment opportunities, lower costs, and increase leverage. Investors use derivatives for risk reduction (hedging) or speculative purposes, providing an alternative avenue to seek profits.

Answer 167

securities that derive their value in whole or in part by having a claim on the underlying common stock Gains or losses will depend on the difference between the purchase price and the sales price As derivative securities, options are innovations in risk management, not in risk itself

Answer 168

done to protect you when you own shares and you're worried about the price going down If your share today is worth $250 and you think the stock will be worth $100 in a couple years, you can buy a put option, pay premium, and then be able to legally sell it someone at a set price by a given date

Answer 169

gives holder the option or right, but not the obligation, to exercise that right or option

Answer 170

are created by investors, allowing the holder the right (but not obligation) to buy or sell a specified number of shares at a predetermined price within a set period. These claims, either calls (buy) or puts (sell), are traded between investors. The corporation whose stock underlies the option is not directly involved. If exercised, the shares are sold from the put contract owner to the writer. Investors buy puts if anticipating a stock price drop, as the put's value rises with declining stock prices. The writer, who sells the option, is obligated to provide shares to the buyer upon demand.

Answer 171

an option that gives the holder the right, but not the obligation, to buy a specified number of shares of stock at a stated price within a specified period Buyer has the right, but not the obligation, to purchase a fixed quantity from the seller at a fixed price up to a certain date

Answer 172

an option that gives the holder the right, but not the obligation, to sell a specified number of shares of stock at a stated price within a specified period Buyer has the right, but not the obligation, to sell a fixed quantity to the seller at a fixed price of particular stock up to a certain expiration date

Answer 173

Puts and calls broaden investor options, offering risk management and leverage. They enable strategies like hedging short sales and controlling stocks with minimal investment. Option buyers know their maximum loss upfront, providing a cost-effective way to participate in market movements using indices.

Answer 174

The exercise (strike) price is the cost per share for stock transactions. Options may have various exercise prices based on stock fluctuations. The expiration date determines when an option can be exercised—American options allow anytime, European only on the last day, and Bermudan on specified days. The option premium is the buyer's cost to the writer, stated per share for exchange-traded options. Long-term options (LEAPs) have maturities exceeding one year, extending up to two years or more.

Answer 175

Both puts and calls are initiated by sellers (writers), who may be individuals or institutions seeking profit based on their beliefs about the underlying stock's future price. The buyer and seller hold opposing expectations regarding the stock's performance and the option's outcome. A call buyer anticipates a stock price increase, while a call seller expects a decrease or stability. A put buyer foresees a stock price decrease, while a put seller anticipates an increase or stability. Potential outcomes include options expiring worthless, being exercised, or being sold before expiry.

Answer 176

Example: Call Options Writer sells a call option for $1.00 to you to purchase 1,000 shares at $10.00 You must expect shares to increase, writer expects shares to decrease If shares increase to$15.00 you will exercise option - buy shares at $10.00 and sell for $15.00 (you earned $4.00 profit on option contract) If shares decrease to below $10.00, you will not exercise - seller gets the $1.00 Example - Put Options Writer sells a put option for $1.00 to you to sell 1,000 shares at $10.00 You must expect shares to decrease, writer expects shares to increase If shares decrease to $5.00, you will exercise option - buy shares at $5.00 and sell for $10.00 (you earned $4.00 profit on option contract),YOU SELL THEM TO THE SELLER/WRITER OF THE OPTION If shares rise over $10.00 you will not exercise - seller gets the $1.00

Answer 177

Options exchanges like the Montreal Exchange (ME) and the Chicago Board Options Exchange (CBOE) standardize exercise dates, prices, and quantities for options contracts. A clearing corporation guarantees transactions, overcoming liquidity issues in over-the-counter markets. This standardized and guaranteed approach ensures liquidity, allowing easy buying or selling at market-driven prices. Option trades settle the next business day, and investors receive a risk disclosure statement before executing initial orders.

Answer 178

when there is little trading activity in a market because of a lack of buy or sell orders to drive up the volume

Answer 179

The Canadian Derivatives Clearing Corporation (CDCC), owned by the Montreal Exchange, guarantees all equity, bond, and stock index options in Canada. As a clearing corporation, it acts as an intermediary between buyers' and writers' brokers, ensuring contract obligations are met. The CDCC becomes the buyer for every seller and the seller for every buyer, preventing risks and problems. With a net position of zero, it randomly assigns obligations to brokers and customers who must honor the contracts. Once assigned, writers cannot offset the obligation with an opposite transaction.

Answer 180

Collateral, known as margin, is required from option writers by the Canadian Derivatives Clearing Corporation (CDCC) to secure contract fulfillment in case of exercise. Member firms holding written options for their clients must provide this collateral in cash or marketable securities. Unlike buying options, which cannot be purchased on margin, option writers must pay 100% of the collateral to the CDCC.

Answer 181

Options that are in-the-money, where the stock price exceeds the call exercise price or is less than the put exercise price, can be immediately exercised for a positive cash flow. On the other hand, out-of-the-money options, where the stock price is less than the call exercise price or exceeds the put exercise price, should not be exercised immediately. At-the-money options have exercise prices equal to the stock price, while near-the-money options have exercise prices slightly greater than the current market price.

Answer 182

when you sell options for stocks that you already own

Answer 183

when you sell options for stocks that you don't already own

Answer 184

the value of the current stock price

Answer 185

the value of the selling price that can be exercised

Answer 186

the time remaining till the expiration of the option As you get closer to the expiration date, the value of the option will keep going down

Answer 187

how rapidly does the stock price change, more volatility is good because the more it swings, the more likely it can go up within the expiration period The more volatile the stock, the higher the option cost

Answer 188

when a stock pays a dividend, on the X dividend day, the stock price goes down by the amount of the dividend As soon as the dividend is paid, the price goes down which is not good for call options, but is good for put options, good for put options because you can sell the option to the writer on that day for more than it is worth

Answer 189

Rights and warrants are financial instruments that grant the right to purchase common shares at a specified price within a specific timeframe. Corporations issue rights to existing shareholders as a way to raise additional funds, while warrants are often attached to debt or preferred shares as incentives. Rights are transferable, allowing shareholders to sell them, whereas warrants are detachable and not typically used for raising new capital. Both instruments offer benefits for investors and companies, with rights providing a means for existing shareholders to participate in fundraising, and warrants serving as incentives for bond or preferred share holders.

Answer 190

Futures contracts are designed for selling stocks for business purposes, allowing investors to manage risk and speculate in various markets. These standardized contracts simplify trading negotiations by setting features like contract size, delivery date, and item conditions. They represent an obligation to buy or sell a fixed amount of an asset on a specified future date at a predetermined price. However, a drawback exists in the fixed contract sizes, which may not align perfectly with real-world quantities, as seen in scenarios like a farmer's wheat harvest.

Answer 191

Cash markets involve immediate delivery, with the spot market offering prices for immediate delivery and the forward market for delayed delivery. Parties negotiate forward prices for future deliveries, enabling agreements months in advance, such as a wheat farmer negotiating a September delivery price in April.

Answer 192

Futures contracts are categorized into commodities (e.g., agricultural, metals, energy) and financials (foreign currencies, debt, equity). Various delivery dates are available for each contract type, with canola futures being the most active commodity in Canada. Financial futures trade on the Montreal Exchange (ME) and include bankers' acceptances, Government of Canada bonds, and equity-based contracts. While futures markets in Canada are smaller and less developed than those in the USA, the Chicago Board of Trade (CBT) serves as the center for commodity futures trading in North America.

Answer 193

In a centralized marketplace, investors trade standardized and transferable futures contracts, ensuring future exchanges of assets between buyers and sellers at specified dates and amounts. The clearinghouse guarantees performance. Futures contracts cover commodities (agricultural, metals, energy) and financials (foreign currencies, debt, equity). The agreed-upon futures price at contract maturity is determined today, and trading involves making commitments that can be eliminated by taking opposite positions in the same commodity or financial instrument for the same futures month.

Answer 194

Future exchanges are marketplaces for trading future contracts, typically voluntary, nonprofit associations. These exchanges operate under established rules and are financed by membership dues and service fees. Members, including floor traders and brokers, trade for themselves or others, with floor traders handling their own accounts and floor brokers acting as agents for clients.

Answer 195

In futures trading, "sell" and "buy" are better understood as follows: A short position obligates a trader to deliver at contract maturity by selling a contract not previously purchased. Every futures contract involves both a short position (seller) and a long position (buyer). A long position obligates a trader to purchase at contract maturity. Unlike options, futures contracts have an obligation to make or take delivery. Futures contracts can be settled by delivery or offsetting through a reverse transaction. Commissions on commodities contracts are based on completed contracts, not per individual transaction. There are no certificates for futures contracts, and open interest changes with long or liquidated positions.

Answer 196

In futures contracts, earnest money, or margin, is a small deposit ensuring contract completion. It represents the buyer or seller's equity, usually less than 10% of the contract value. Margin calls occur if the price moves against the investor, requiring additional cash or account closure. Daily marking-to-market credits or debits profits and losses to each investor's account. Net equity is the value of deposited funds plus open profits or minus open losses. Adverse market moves decrease equity. Aggregate gains and losses in futures trading balance to zero, ensuring winners' profits match losers' losses.

Answer 197

By taking a position opposite to that of one already held, at a price set today, hedgers plan to reduce the risk of adverse price fluctuations, in order to hedge the risk of unexpected price changes Used as a form of insurance Willing to forgo some profit in order to reduce risk/have someone else assume a part of the risk

Answer 198

a transaction involving the sale of futures (a short position) while holding the asset (a long position)

Answer 199

a transaction where the asset is currently not held but futures are purchased to lock in current prices

Answer 200

In financial futures, the basis is the difference between the cash price and the futures price, with the formula Basis = Cash Price - Futures Price. The basis should be zero on the maturity date. Basis risk arises from unexpected changes in basis, and investors cannot completely eliminate this risk when hedging a cash position.

Answer 201

In contrast to hedgers, Speculators: Buy or sell futures contracts in an attempt to earn a return Absorb excess demand or supply generated by hedgers Willing to assume the risk of price fluctuations that hedgers wish to avoid, hoping to profit from them Speculators contribute to the liquidity of the market and reduce the variability in prices over time

Answer 202

magnification of gains (and losses) can easily be 10 to 1

Answer 203

an investor who thinks interest rates will rise will have difficulty selling bonds short, but it is very easy to take a short position in a bond futures contract

Answer 204

these are often significantly smaller in futures markets

Answer 205

Financial futures contracts, covering equity indexes, fixed-income securities, and currencies, offer investors enhanced flexibility to fine-tune the risk-return profile of their portfolios. This flexibility is particularly crucial in the face of increased interest rate volatility and the evolving landscape of financial markets over the past 15-20 years, necessitating new instruments to address these changes.

Answer 206

Farmer grows wheat, so he goes short, he currently owns the assets Bread company needs wheat, so they go long Enter deal to buy/deliver wheat in 6 months, 100,000 bushels at $10/bushel This means there is a $1,000,000 constant In 6 months, price will probably be higher than $10 or lower than $10, so either the farmer or the company won Deal probably won’t go through, it's more to just set the price of the bread at $10 In order for contract to be valid, farmer sends $80,000 to Clearing House and company sends $80,000 to Clearing House Clearing house keeps these amounts in each party's margin Every time the spot price changes, money in the margins will exchange with one another E.g. if the price of wheat goes up to $10.25, the farmer lost So the $0.25 change times the 100,000 bushels goes from the farmer account to the company account ($25,000) Now farmer has $55,000 and company has $105,000 After this, say the price of wheat drops to $9.75, the company loses So the $0.50 change times the 100,000 bushels goes from the company account to the farmer account Now the farmer has $105,000 and the company has $55,000 If this was the last day of the contract, the farmer made a profit of $25,000 and the company made a lost of $25,000 Company goes into the market to buy the wheat, maybe from someone other than that farmer The price is $9.75 now, so 100,000 bushels is now $975,000 They write a cheque for $975,000, but they already lost the $25,000, so they lost a total of $1,000,000 (price is back to $10/bushel) Farmer takes the $975,000 and adds the $25,000 made, which totals $1,000,000, once again adding up to a value of $10/bushel