Private Equity

Question 1

Give some examples of non-traditional debt investors may seek opportunities in (also known as debt instruments).

Answer 1

1. Consumer Loans
2. Micro Loans
3. Factoring
4. Direct Real Estate Loans
5. Mortgage Backed Securities

Question 2

What are Consumer Loans?

Answer 2

Companies offer loans to borrowers accepted (Ex: Lending Club customers have DTI of: 13%, PI of $95k < )
Investors: cash provides funding to grant loans.

Question 3

What are Micro Loans?

Answer 3

Micro Loans are small loans ranging from $100 to several thousands.

Borrowers: typically small business owners not qualified for loans from banks/lenders.

Investors: may put money into these loans because of lending policies favorable to low-income borrowers.

Question 4

What is Factoring?

Answer 4

A factor is essentially a business loan that agrees to pay the company the value of the invoice minus a discount for commission and fees. Depending on creditworthiness of the debtor they may pay 60-80% of total accounts receivable .

valuable service to :

(a) companies that operate in industries where it takes a long time to convert receivables to cash, and
(b) companies that are growing rapidly and need cash to take advantage of new business growth opportunities.

Question 5

Explain Direct Real Estate Loans.

Answer 5

Financing the purchase of property directly. Seller carry a mortgage and retain title until debt is entirely paid.

Buyer Benefit: may have smaller down payment and lower interest

Seller Benefit: retention of the property title, and steady cash flow

Question 6

What is Mortgage-Backed Security (MBS)?

Answer 6

A type of asset-backed security that is secured by a mortgage or collection of mortgages.

Investor: you are essentially lending money to a home buyer or business. Yields low, but guaranteed.

Question 7

What is the definition of Entitlement?

Answer 7

The amount to which a person has a right; The fact of having a right to something.

Question 8

What is Sponsor Equity?

Answer 8

The cash investment by the owners of a project.

A financial sponsor is an individual or private equity investment firm, particularly a private equity firm that engages in leveraged buyout transactions.

Question 9

What is the Capital Stack? Explain the pyramid.

Answer 9

the legal organization of all of the capital placed into a company or secured by an asset through investment or borrowing.

1. Sponsor equity 2. Preferred equity 3. Mezzanine investors (hybrid debt and equity) 4. Second and other junior mortgages 5. Senior Secured (Investment-grade first mortgages )

Higher positions in the stack expect higher returns for their capital because of the higher risk.

Question 10

What is IRR?

Answer 10

The internal rate of return (IRR) or economic rate of return (ERR) is a rate of return used in capital budgeting to measure and compare the profitability of investments.

You can think of IRR as the rate of growth a project is expected to generate.

Question 11

What is Equity Multiple?

Answer 11

The ratio of a company’s total assets to its stockholder’s equity.

• The equity multiplier is a measurement of a company’s financial leverage.
• Gives investors an insight into what financing methods a company may be able to use to finance the purchase of new assets.

For example, a company has assets valued at $3 billion and stockholder equity of $1 billion. The equity multiplier value would be 3.0 ($3 billion / $1 billion), meaning that one third of a company’s assets are financed by equity.

Question 12

What is the role of Financial Sponsors?

Answer 12

In addition to bringing capital to an investment, financial sponsors are expected to bring a combination of capital markets expertise, various important contacts, strategies for operational improvement and experience owning leveraged companies. As the owners of the company, financial sponsors rarely manage a company directly, the CEO’s take care of day to day operations.

Question 13

What is a Paper Lot?

Answer 13

A paper lot refers to undeveloped land that exists only on paper as streets and lots. Paper means that while it was planned and sometimes the plans were recorded, the development was never completed as shown on the plan and the paper lots and street don’t really exist as such.

Question 14

What is a Twin Home?

Answer 14

Twin homes do look like duplexes, and do have a shared common wall but the main difference is the ownership interest. Twin homes are basically half- homes with with their own respective lot with a lot line landing between the two homes.

Question 15

What is a Town Home?

Answer 15

Occupied by the wealthy, a town home is a luxurious house on a small footprint in a city, but because of its multiple floors (sometimes six or more), it has a large living space, often with servant’s quarters and is within walking or mass transit distance of business and industrial areas of the city.

Question 16

What is the Lot-line adjustment process?

Answer 16

A lot line adjustment is the process that is used to change property lines of existing parcels. In every instance, the lot line adjustment process will yield the same number of parcels that you began with, or fewer. The lot line adjustment process is not used to create additional parcels.

Question 17

What is the definition of Contiguous?

Answer 17

Sharing a common border; touching: the 48 contiguous states. Next or together in sequence: five hundred contiguous dictionary entries.

Question 18

What is a Pro-forma?

Answer 18

Pro forma’s are financial statements that are designed to reflect a proposed change, such as a merger or acquisition, or to emphasize certain figures when a company issues an earnings announcement to the public.

Investors should be careful when reading a company’s pro-forma financial statements, as the figures may not comply with GAAP.

Question 19

What does GAAP stand for?

Answer 19

generally accepted accounting principles (GAAP).

GAAP are a combination of authoritative standards (set by policy boards) and simply the commonly accepted ways of recording and reporting account information.

Question 20

What is NOI?

Answer 20

Net Operating Income.

Gross Income - Operating Expenses = NOI

If this is a positive value, it is referred to as net operating income, while a negative value is called a net operating loss (NOL).

Question 21

What is DCR?

Answer 21

Debt Coverage Ratio

          net operating income DCR =     -------------------------------
                 debt service

An example of the debt coverage ratio would be a company that shows on its income statement an operating income of $200,000. The debt payments for the same period is $35,000. By dividing the $200,000 by $35,000, the company would show a debt coverage ratio of 5.71.

DCR is used to determine a companies ability to generate enough income in its operations to cover the expense of a debt.

Question 22

What is LTV?

Answer 22

Loan to Value Ratio

               Mortgage amount   LTV =         -----------------------------
       Appraised Value of the Property.

For example, Lauren needs to borrow $92,500 to purchase a $100,000 property. The LTV ratio yields a value of about 92.5%. Since bankers usually require a ratio at a maximum of 75% for a mortgage to be approved, it may prove difficult for Lauren to get a mortgage. Similar to other lending risk assessment ratios, the LTV ratio is not comprehensive enough to be used as the only criteria in assessing mortgages.

Question 23

What is Amortization?

Answer 23

• The paying off of debt with a fixed repayment schedule in regular installments over a period of time.
• Consumers are most likely to encounter amortization with a mortgage or car loan.

With auto loan and home loan payments, at the beginning of the loan term, most of the monthly payment goes toward interest. With each subsequent payment, a greater percentage of the payment goes toward principal. For example, on a 5-year, $20,000 auto loan at 6% interest, the first monthly payment of $386.66 would be allocated as $286.66 to principal and $100 to interest. The last monthly payment would be allocated as $384.73 to principal and $1.92 to interest. At the end of the loan term, all principal and all interest will be repaid.

Question 24

What is the definition of a broker?

Answer 24

A broker is an individual or party (brokerage firm) that arranges transactions between a buyer and a seller for a commission when the deal is executed. A broker who also acts as a seller or as a buyer becomes a principal party to the deal.

Question 25

What is a preferred return?

Answer 25

The preferred return, or “hurdle rate”, is basically a minimum annual return that the LP is entitled to before the GP may begin receiving carried interest. If there is a hurdle, the rate is typically around 8%.

While the preferred return of 8 - 10% is meant to compensate the investors for the longer term hold and iliquidity of the investment, good PE firms that are able to continually raise funds are expected to deliver returns in excess of 20%.

Question 26

What is carried interest?

Answer 26

Carried interest is the general partner’s share of the profits.
It can range from 5-30% of the profits.

Question 27

What is the clawback provision?

Answer 27

The clawback provision gives the LP’s the right to reclaim a portion of the GP’s carried interest in the event that losses from later investments cause the GP to withhold too much carried interest.

Question 28

What does (JV) stand for? What is it?

Answer 28

Joint Venture (JV Partner)

A business arrangement in which two or more parties agree to pool their resources for the purpose of accomplishing a specific task.

This task can be a new project or any other business activity. In a joint venture (JV), each of the participants is responsible for profits, losses and costs associated with it.

Question 29

Explain what CAP rate is.

Answer 29

Capitalization Rate:
A rate of return on a real estate investment property based on the expected income that the property will generate. Capitalization rate is used to estimate the investor’s potential return on his or her investment.

Capitalization Rate = Yearly Income
———————
Total Value

For example, if Kevyn buys a property that will generate $125,000 per year and he pays $900,000 for it, the cap rate is: 125,000/900,000 = 13.89%. What if the property’s value rises to $2 million two years later? Now the cap rate is a less favorable 125,000/2 million = 6.25%. This is because Kevyn could potentially sell the property for $2 million and use that money for an alternative investment.

Question 30

What are class A,B,C, and D properties?

Answer 30

Class A :
properties are luxury units. They are usually less than 10 years old and are often new, upscale apartment buildings. White-collar workers live in them and are usually renters by choice.

Class B: 
can be 10 to 25 years old. Generally well maintained and have a middle class tenant base of both white and blue-collar workers. Some are renters by choice, and others by necessity.

Class C:
built within the last 30 to 40 years. They generally have blue-collar and low- to moderate-income tenants, and the rents are below market. This is where you’ll find many tenants that are renters “for life.”

Class D:
properties are where you’ll find many Section 8 in the U.S. or government-subsidized housing tenants.

Question 31

What is Mezzanine debt?

Answer 31

A form of financing that is part debt and part equity typically used to finance the expansion of existing companies.

• Basically debt capital that gives the lender warrants/option rights to convert to an ownership or equity interest in the company if the loan is not paid back in time and in full.
• Generally subordinated to senior debt lenders such as banks and venture capital companies.

Mezzanine financing is usually provided to the borrower very quickly with little due diligence on the part of the lender and little or no collateral on the part of the borrower, this type of financing is aggressively priced with the lender seeking a return in the 20-30% range.

Question 32

What is a Cash on Cash Return?

Answer 32

A rate of return often used in real estate transactions. The calculation determines the cash income on the cash invested. Calculated as:

             Annual Dollar Income COC =       ----------------------------------
            Total Dollar Investment

For example when you purchase a rental property, you might put down only 10% for a cash down payment. Cash-on-cash return would measure the annual return you made on the property in relation to the down payment.

Question 33

What is a Fund of Funds?

Answer 33

Holds the shares of many private partnerships that invest in private equities. It provides a way for firms to increase cost effectiveness and thereby reduce their minimum investment requirement.

This can also mean greater diversification, since a fund of funds might invest in hundreds of companies representing many different phases of venture capital and industry sectors.
Ex: DPG

Question 34

What is an ETF?

Answer 34

Exchange-Traded Fund
You can purchase shares of an exchange-traded fund (ETF) that tracks an index of publicly traded companies that invest in private equities. Since you are buying individual shares over the stock exchange, you don’t have to worry about minimum investment requirements.

Question 35

What are (SPACs)?

Answer 35

Special-Purpose Acquisition Companies

A publicly-traded buyout company that raises money in order to pursue the acquisition of an existing company. SPACs raise blind pool money (most of which goes into a trust) from the public for an unspecified merger, sometimes in a targeted industry.

Each SPAC is typically sold at $6 per unit for one share of common stock (to be publicly-traded in the future) and two warrants that can purchase additional shares. If an acquisition is not made in two years, the money is returned to the original investors.

Also known as a “targeted acquisition company (TAC)”.

Question 36

What is the difference between Limited Partners and General Partners?

Answer 36

Limited Partners(LP):

• Usually institutional or high net worth investors interested in receiving capital gains associated with investing.
• Do NOT take part in the fund’s active management.
• Protected from losses beyond their original investment as well as any legal actions taken against the fund.

                             General Partners(GP)

• Responsible for managing the investments within the private equity fund.
• For their services, they earn a management fee and a percentage of the fund’s profits, called carried interest.
• They CAN be legally liable for the actions of the fund.

Question 37

What is Committed Capital?

Answer 37

Money that is committed by LPs to a private equity fund that is usually not invested immediately. It is “drawn down” and invested over time as investments are identified.

Question 38

What are Drawdowns?

Answer 38

Drawdowns (Capital Calls)

-issued to LP’s when the GP’s has identified a new investment and a portion of the LP’s committed capital is required to pay for that investment.

Question 39

What is the Vintage Year?

Answer 39

The first year that the PE fund draws down or “calls” committed capital.

Question 40

What is Paid-in Capital?

Answer 40

• The cumulative amount of capital that has been drawn down. Also know as contributed capital.

( Invested capital is the amount of paid-in capital that has actually been invested into the fund’s portfolio companies)

Question 41

What is Cumulative Distribution?

Answer 41

The total amount of cash and stock that has been paid out to the limited partners

Question 42

Define Residual Value.

Answer 42

Residual value is the market value of the remaining equity that the limited partners have in the fund.

Question 43

What is the Investment Multiple (also known as the TVPI Multiple)?

Answer 43

The total value to paid-in (TVPI) multiple

                                   (Cumulative Distributions + Residual Value)  Investment Multiple =          ----------------------------------------------------
                                                      Paid-In Capital

It gives a potential investor insight into the fund’s performance by showing the fund’s total value as a multiple of its cost basis. It does not take into account the time value of money.

Question 44

What is the Realization Multiple (also known as the DPI Multiple)?

Answer 44

Cumulative Distribuions
Realization Multiple = ——————————-
Paid-In Capital

The realization multiple, in conjunction with the investment multiple, gives a potential private equity investor insight into how much of the fund’s return has actually been “realized”, or paid out, to investors.

Question 45

What is the RVPI Multiple?

Answer 45

Residual Value
RVPI Multiple = ———————–
Paid-In Capital

Provides a measurement, in conjunction with the investment multiple, of how much of the fund’s return is unrealized and dependent on the market value of its investments.

Question 46

What is the PIC Multiple?

Answer 46

PIC Multiple = Paid-In Capital
————————–
Commission Capital

This ratio shows a potential investor the percentage of a fund’s committed capital that has actually been drawn down.

Question 47

Describe what an MBO is.

Answer 47

A management buyout (MBO) -

A transaction where a company’s management team purchases the assets and operations of the business they manage. A management buyout (MBO) is appealing to professional managers because of the greater potential rewards from being owners of the business rather than employees.

Question 48

What is an MBI?

Answer 48

A management buy-in (MBI)

Different than an MBO in which an external management team acquires a company and replaces the existing management team.

Question 49

What is an LMBO?

Answer 49

A leveraged management buyout (LMBO)

where the buyers use the company assets as collateral to obtain debt financing.

Question 50

Describe what a LBO is.

Answer 50

Leverage Buyout(LBO)-

The acquisition of another company using a significant amount of borrowed money (bonds or loans) to meet the cost of acquisition.

The purpose of leveraged buyouts is to allow companies to make large acquisitions without having to commit a lot of capital.

Question 51

Define Leverage.

Answer 51

Leverage is the ratio of a company’s loan capital (debt) to the value of its common stock.

” By utilizing leverage up to 50%, which is feasible in this market, the yield rises to a level that is attractive to opportunity investors.”

Question 52

What does MSA Stand for?

Answer 52

Metropolitan Statistical Area

“Used in the Atlanta MSA as equity…”

Question 53

What does a Guarantor do?

Answer 53

A person who guarantees to pay for someone else’s debt if he or she should default on a loan obligation. A guarantor acts as a co-signor of sorts, in that they pledge their own assets or services if a situation arises in which the original debtor cannot perform their obligations.

Question 54

What is REO property?

Answer 54

“Real estate owned”

REO is a class of property owned by a lender—typically a bank, government agency, or government loan insurer—after an unsuccessful sale at a foreclosure auction.T
his is commonly the case when the amount owed on the home is higher than the current market value of this foreclosure property

Question 55

Describe what a Close of Escrow (CEO) is.

Answer 55

Close of escrow means essentially that a real estate transaction has been completed and that the sale is final.

An ‘escrow’ is a common feature of standard real estate transactions. They function as an independent third party that holds all monetary funds and documents until the close of the sale.

Question 56

What does SFR stand for?

Answer 56

Single Family Residence.

Question 57

What is a Basis Point?

Answer 57

A basis point: a unit of measure used in finance to describe the percentage change in the value or rate of a financial instrument.

In most cases, it refers to changes in interest rates and bond yields.

For example, if the Federal Reserve Board raises interest rates by 25 basis points, it means that rates have risen by 0.25% percentage points. If rates were at 2.50%, and the Fed raised them by 0.25%, or 25 basis points, the new interest rate would be 2.75%. I

Question 58

What is an Earnout?

Answer 58

An earnout is a financing arrangement for the purchase of a business in which the seller finances a portion of the purchase price, and payment of this amount is contingent on achieving a predetermined level of future earnings.

An earnout will typically range between 10% to 50% of the total purchase price, and will usually not extend past three years.

Ex: Say a seller has a valuation expectation of $15 million, but the buyer thinks a purchase price of $12 million is more appropriate. The gap of $3 million might be bridged by an earnout. The seller could get paid $1 million per year.

Question 59

What is a Non Circumvention/Non Disclosure Agreement? (NCNDA)

Answer 59

An international trade instrument;

non circumvention/non disclosure agreement used in the preliminary stages of a business transaction where the Seller and Buyer do not know each other, but are brought into contact with each other by one or more intermediaries (also known as brokers or middlemen), to fulfill the transaction.

Question 60

Who is Freddie Mac?

Who is Fannie Mae?

Answer 60

Freddie Mac
The Federal Home Loan Mortgage Corporation (FHLMC)

• a public government- sponsored enterprise (GSE)
• created to expand the secondary market for mortgages in the US. Along with other GSEs, Freddie Mac buys mortgages on the secondary market, pools them, and sells them as a mortgage- backed security to investors on the open market.

                                      Fannie Mae
     The Federal National Mortgage Association (FNMA),

• established to provide local banks with federal money to finance home mortgages in an attempt to raise levels of home ownership and the availability of affordable housing.
• created a liquid secondary mortgage market and thereby made it possible for banks and other loan originators to issue more housing loans, primarily by buying Federal Housing Administration (FHA) insured mortgages

Question 61

Who is the most compassionate, helpful, funny, beautiful, intelligent, positive, forgiving, emotional yet incredible and most amazing person you know?

Answer 61

Lauren Allen Wyckoff aka White Chocolate Bunny

Question 62

What is Senior Debt?

Answer 62

Also referred to as Senior Loans

• Debt that takes priority over other unsecured or otherwise more “junior” debt owed by the issuer.
• Senior debt has greater seniority in the issuer’s capital structure than subordinated debt.
• In the event the issuer goes bankrupt, senior debt theoretically must be repaid before other creditors receive any payment.

Question 63

What does M&A stand for?

Answer 63

Mergers and Acquisitions

Question 64

Explain Sources and Uses.

Answer 64

Sources and Uses:

• Provides a summary of where the capital used to fund an acquisition will come from (the sources), what this capital will purchase (the uses).
• The sources and the uses must equal each other, and they must total the total purchase price plus transaction costs.

Typical sources of capital include: 
– Bank debt 
– Vendor financing(VTBorearnout) 
– Mezzanine debt
– Earnouts;and/or 
– Equity

Typical uses of capital include: 
– Capital assets 
– Working capital 
– Goodwill;and/or
– Transaction costs

Question 65

What are the 4 net leases ranked from strongest to weakest, beginning with the lease that gives the tenant absolute responsibility for the real estate in exchange for absolute control?

Answer 65

1. Bond Lease
2. NNN Lease
3. NN Lease
4. Modified Net (or Modified Gross) Lease

Question 66

What is a Bond Lease?

Answer 66

The tenant is fully responsible for operating expenses, maintenance, repairs, and replacements for the entire building and site, without limitation.

Question 67

What is an NNN Lease also known as a Triple-Net Lease?

Answer 67

These leases follow the bond lease definition except that capital expenditures are limited, usually in the final months of the lease.

A triple net lease (Net-Net-Net or NNN) is a lease agreement on a property where the tenant or lessee agrees to pay the three “Nets” :

• real estate taxes
• building insurance
• and maintenance on the property
  in addition to any normal fees that are expected under the agreement (rent, utilities, etc.).

Question 68

What is an NN Lease?

Answer 68

This lease follows the NNN, except the landlord is responsible for structural components, such as the roof, bearing walls, and foundation.

Question 69

What is a Modified Net Lease?

Answer 69

The tenant pays its own utilities, interior maintenance and repairs, and insurance. The landlord pays everything else, including real estate property taxes.

Question 70

Why would an Investor consider triple-net lease properties?

Answer 70

Objective may be:

• Relief from management obligations,
• Assured income,
• Pride of ownership,
• Preservation of capital.

Question 71

Name 2 lease nuances that should be avoided.

Answer 71

1. The Inflation Trap

2. Taxation burden

Question 72

What is a Pension Fund?

Answer 72

• A fund established by an employer to facilitate and organize the investment of employees’ retirement funds contributed by the employer and employees.
• The pension fund is a common asset pool meant to generate stable growth over the long term, and provide pensions for employees when they reach the end of their working years

Question 73

Explain what Family Office Partnerships are.

Answer 73

• Family offices are private wealth management advisory firms that serve ultra-high net worth investors.
• Family offices are different from traditional wealth management shops in that they offer a total outsourced solution to managing the financial and investment side of a affluent individual or family. (For example, many family offices offer budgeting, insurance, charitable giving, family-owned businesses, wealth transfer and tax services.)
• There are two types of family offices, single family offices and multi-family offices sometimes referred to as MFOs.

Question 74

What is an Equity Investment?

Answer 74

• Money that is invested in a firm by its owner(s) or holder(s) of common stock (ordinary shares) but which is not returned in the normal course of the business.
• Investors recover it only when they sell their shareholdings to other investors, or when the assets of the firm are liquidated and proceeds distributed among them after satisfying the firm’s obligations.

Also called “equity contribution.”

Question 75

What does an Exhibitor do?

Answer 75

Exhibitor: a person who displays works of art or other items of interest at an exhibition.

Question 76

What does “P&A” stand for?

Answer 76

Print and Advertising

Question 77

What is an Ancillary?

Answer 77

a person whose work provides necessary support to the primary activities of an organization, institution, or industry: the employment of specialist teachers and ancillaries.

Question 78

What is FINRA?

Answer 78

Financial Industry Regulatory Authority (FINRA)

• FINRA is dedicated to investor protection and market integrity through effective and efficient regulation of the securities industry.
• FINRA is not part of the government. They are an independent, not-for-profit organization authorized by Congress to protect America’s investors by making sure the securities industry operates fairly and honestly.

Question 79

What is inflation?

Answer 79

Inflation can mean:

• an increase in the money supply
• or an increase in price levels.

Generally, when we hear about inflation, we are hearing about a rise in prices compared to some benchmark.

If the money supply has been increased, this will usually manifest itself in higher price levels - it is simply a matter of time.

Question 80

What is GDP?

Answer 80

Gross Domestic Product

In the United States GDP represents the total aggregate output of the U.S. economy.

• It is important to keep in mind that the GDP figures as reported to investors are already adjusted for inflation.
• In other words, if the gross GDP was calculated to be 6% higher than the previous year, but inflation measured 2% over the same period, GDP growth would be reported as 4%, or the net growth over the period.

Question 81

What is an index?

Answer 81

An index is a statistical measure of the changes in a portfolio of the stick representing a portion of the overall market

Question 82

What is TTM?

Answer 82

Trailing Twelve Months (TTM)

The Trailing Twelve Months (TTM) refers to the last 12 month period for a selected financial metric such as revenue, earnings, or EBITDA. For example, the TTM revenue of a company for the month of May would include the revenue from June of the prior year to May of the current year. The trailing twelve months is also sometimes referred to as the Last Twelve Months (LTM).

Question 83

What is DIP?

Answer 83

Debtor In Possession (DIP)

Financing arranged by a company while under the Chapter 11 bankruptcy process. DIP financing is unique from other financing methods in that it usually has priority over existing debt, equity and other claims.

An individual or corporation that has filed for Chapter 11 bankruptcy protection and remains in control of property that a creditor has a lien against, or retains the power to operate a business. A debtor who files a Chapter 11 bankruptcy case becomes the debtor in possession (DIP). The DIP continues to run the business and has the powers and obligation of a trustee to operate in the best interest of any creditors. A DIP can operate in the ordinary course of business, but is required to seek court approval for any actions that fall outside of the scope of regular business activities. The DIP must also keep precise financial records and file appropriate tax returns.

Question 84

What is Coupon Rate?

Answer 84

The yield paid by a fixed income security. A fixed income security’s coupon rate is simply just the annual coupon payments paid by the issuer relative to the bond’s face or par value. The coupon rate is the yield the bond paid on its issue date. This yield, however, will change as the value of the bond changes, thus giving the bond’s yield to maturity.

                            Face Value Coupon Rate =    \_\_\_\_\_\_\_\_\_\_\_\_ 
                          Bond Par Value

A bond’s coupon rate can be calculated by dividing the sum of the security’s annual coupon payments and dividing them by the bond’s par value. For example, a bond which was issued with a face value of $1000 that pays a $25 coupon semi-annually would have a coupon rate of 5%. All else held equal, bonds with higher coupon rates are more desirable for investors than those with lower coupon rates.

Question 85

What is Arbitrage?

Answer 85

The simultaneous purchase and sale of an asset in order to profit from a difference in the price.
It is a trade that profits by exploiting price differences of identical or similar financial instruments, on different markets or in different forms.
Arbitrage exists as a result of market inefficiencies; it provides a mechanism to ensure prices do not deviate substantially from fair value for long periods of time.

Question 86

What is MOIC?

Answer 86

Multiple of Invested Capital

Question 87

Whats is Bridge Loan?

Answer 87

A short-term loan that is used until a person or company secures permanent financing or removes an existing obligation. This type of financing allows the user to meet current obligations by providing immediate cash flow. The loans are short-term (up to one year) with relatively high interest rates and are backed by some form of collateral such as real estate or inventory.

Also known as “interim financing”, “gap financing” or a “swing loan”.

Question 88

What is Unlevered Cost of Capital?

Answer 88

Unlevered Cost Of Capital

Unlevered cost of capital will be a cheaper alternative to a levered cost of capital investment, as there are higher costs associated with the issuing of debt or preferred equity. Some of these marginal costs include, but are not limited, underwriting costs, brokerage fees, and dividend and coupon payments.

Question 89

What is Levered Free Cash Flow?

Answer 89

Levered Free Cash Flow

Levered free cash flow is unlevered free cash flow minus interest and mandatory principal repayments. In other words, it shows the net cash balance a company hoards after making all debt-related remittances. Investment bankers and financial commentators pay attention to levered free cash flow to see if a borrowing entity can still be economically afloat after satisfying its commitments. This observation is important to set financially moribund companies apart from organizations with a stellar credit history and economic soundness.

Question 90

What is Unlevered Free Cash Flow?

Answer 90

Unlevered Free Cash Flow

Unlevered free cash flow is cash a company generates before paying interest. The metric equals “earnings before interest, taxes, deprecation and amortization” (EBITDA) minus capital expenditures minus changes in net working capital minus taxes. The idea is to determine how much money the organization generates on a stand-alone basis before meeting its financial commitments. Corporate leadership reviews this metric to determine how adeptly department heads are using company money, making sure they thoroughly analyze opportunities before making commercial moves.

Question 91

What is PAR value?

Answer 91

The face value of a bond. Par value for a share refers to the stock value stated in the corporate charter. Par value is important for a bond or fixed-income instrument because it determines its maturity value as well as the dollar value of coupon payments. Par value for a bond is typically $1,000 or $100.

A bond that is trading above par is said to be trading at a premium, while a bond trading below par is regarded as trading at a discount. During periods when interest rates are low or have been trending lower, a larger proportion of bonds will trade above par or at a premium. When interest rates are high, a larger proportion of bonds will trade at a discount.

If an investor buys a taxable bond for a price above par, the premium can be amortized over the remaining life of the bond, offsetting the interest received from the bond and hence reducing the investor’s taxable income from the bond. Such premium amortization is not available for tax-free bonds purchased at a price above par.

Question 92

What is Burn Rate?

Answer 92

The rate at which a new company uses up its venture capital to finance overhead before generating positive cash flow from operations. In other words, it’s a measure of negative cash flow.

Burn rate is usually quoted in terms of cash spent per month. For example, a burn rate of 1 million would mean the company is spending 1 million per month. When the burn rate begins to exceed forecasts, or revenue fails to meet expectations, the usual recourse is to reduce the burn rate (which, in most companies, means reducing staff).

Question 93

Mezzanine Capital

Answer 93

Mezzanine capital (or mezzanine debt) refers to unsecured, high-yield, subordinated debt or preferred stock that represents a claim on a company’s assets that is only senior to that of a company’s shareholders.

Question 94

Preferred Debt

Answer 94

Any obligation that has precedence over another debt. (A senior or first mortgage is an example of a preferred debt.)

Question 95

Warrants

Answer 95

A warrant is the right but not the obligation to buy or sell a certain quantity of an underlying instrument at an agreed-upon price.

The right to buy the underlying instrument is referred to as a call warrant; the right to sell it is known as a put warrant. In this way a warrant is very similar to an option. The difference is primarily that the length of time available to exercise a warrant is much longer than most option contracts. Most warrants have 5-10 years before they must be exercised or expire worthless.