P2B.3 Raising Capital Flashcards
Different Types of Financial Markets
- Capital Markets: Stock & Bond
- Money Markets
- Commodity Markets
- Derivative Markets
- Insurance Markets
- Foreign Exchanges
Capital Market Definition
- Allows buyers and sellers to trade debt and equity securities.
- Stock: Equity buyer and sellers trade newly issued shares (primary) and existing shares (secondary)
- Bond: Provides debtors and creditors access to buying and selling bonds.
Money Market Definition
Specializes in short-term and highly liquid financial instruments; CD’s, treasury bills, commercial paper, etc.
Commodity Market Definition
Trading commodities; gold, oil, rubber and corn.
Derivative Market Definition
- Options, swaps, futures and forwards are traded in this market.
- Generally a subcategory of the underlying asset.
Insurance Market Definition
Allows parties seeking insurance and insurers to negotiate deals to transfer risk.
Foreign Exchange Definition
Currencies traded on the market. No central exchange exists.
Why Financial Markets have been established.
- Transferring funds: from depositors to investors
- Provide liquidity: giving investors a means of converting securities into cash
- Provide economic signals: security sales can signal a change in the economy
Efficient Capital Market
- New info is quickly reflected in stock prices.
- Large number of securities can be exchanges without affecting the price significantly.
- Successive trades are made at prices that are fairly close to prices of previous trades.
Market Efficiency
The degree to which market prices accurately reflect the true value of investments.
Strong Form - Market Efficiency
- Current price of security accounts for all public and private information.
- No investor has an unfair advantage over the average investor.
Semi-Strong Form - Market Efficiency
- Current price of security accounts for all public information.
- Investor with private knowledge has advantage over average investor.
- Market adjusts quickly to new public information.
Weak Form - Market Efficiency
- Current price of security accounts for all past price information.
- Investor can’t analyze past prices to predict future performance.
Credit Rating Agencies
Assigns credit ratings; Aaa, A, B on securities.
Investment Banks
- Investment banks provide underwriting services, and assist with mergers and acquisitions.
- Investment banking firms must keep advisory services and the firm’s trading department separate, in order to comply with ethical standards.
Underwriting
- Process which an investment bank raises capital for a firm by placing securities on its behalf, typically through IPOs.
- Risk of unsold securities is held by underwriter as is reward for higher placement costs.
Advice & Trading
- Advice: investment banks advise individuals on financial topics.
- Trading: departments within the investment bank execute transaction.
- Advice and trading must be kept separate.
Net Advantage to Leasing (NAL)
- Compares PV of cash flows under leasing to PV of cash flows under borrowing to see which is more advantageous.
- Positive NAL = lease
- Negative NAL = borrow funds
Net Advantage to Leasing Calculation
- Begin with cost of asset
- Subtract PV of after-tax lease payments: discount rate is after-tax cost of borrowing
- Subtract PV of depreciation tax shield: PV of depreciation multiplied by tax rate. Discount rate is after-tax cost of borrowing
- Add PV of after-tax operating costs: cost if asset was owned; property tax, insurance, etc.
- Subtract PV of after-tax salvage value of asset: discounted by target rate of return.
Stock Price Valuation Model Formula
Stock price is based on expected future cash flows.
r = D1 + (P1 − P0) / P0 P0 = D1 + P1 / 1 + r
P0 = price of stock today P1 = price of stock future D1 = dividend per share r = required rate of return
Cost of Debt Formula
Measures the amount of interest incurred relative to amount of debt redeemed.
= Interest expense / Cash received from sale of bond
Cost of Newly Issued Preferred Stock Formula
Measures the proportion of annual dividend relative to amount of net cash received from new preferred stock.
= Yearly dividend / Net proceeds of issue
= Annual dividend / (Current market price of stock - underwriting fee)
Stock Dividends
Treated as such when shares issued as part of dividend is <25% of total number of previously outstanding shares.
Stock Splits
Treated as such when corporations issues a number of shares >25% of previously outstanding shares.
Repurchase
- Treated as treasury stock.
- Company uses as equity incentives for management.
- Other reasons: mergers and acquisitions, retirement plans and options.
SEC Requirements
Securities Act of 1933: ensures that investors receive sufficient financial disclosures from companies that issue securities to the public.
Securities Act of 1934: governs securities that trade in the secondary market between investors, and governs brokers and dealers of securities.
Cost of Equity Calculation
= (Current dividends per share / Current market price per share) + Expected growth in dividends per share
= (Total dividends per share / Total market value of all shares outstanding) + Expected growth in total dividends paid to common shareholders
Leases
Operating: service/maintenance lease
Finance;
- Ownership transfers to lessee at end of lease.
- Bargain purchase option at the end of lease.
- Term exceeds 75% of useful life.
- Discount PV is greater than or equal to 90% of FMV.
Dividend Policy
Stable: pays dividends quarterly and payout corresponds with quarterly earnings.
Passive: decides whether of not to pay dividends or reinvest retained earnings. Doesn’t keep excess cash on hand.
Constant: pays dividends as a constant percentage of earnings and can fluctuate.
Regular: pays dividends every year and is a set amount.
