Problem Areas Flashcards
What are the three types of standards as per the Global Reporting Initiative Sustainability Reporting Standards?
Universal Standards
Sector Standards
Topic Standards
What would be considered domestic tax implications when setting financial strategy?
Availability of tax allowable depreciation
Income tax rules relating to dividends
Availability of tax relief on debt finance
What are some examples of political risk?
Enforced nationalisation of company assets
High tariff on imports
According to M&M why would the cost of equity rise with increased gearing?
Return to shareholders becomes more variable
When is an assets based value method use?
Likely to be more useful for capital intensive businesses than for service businesses
When is a dividend valuation model used?
Appropriate if valuing a minority shareholding
When is a cash flow based model used?
Relevant where significant growth is expected
Does group relief cease to be available once arrangement are in place to sell the shares of a company in the group?
YES
What are the advantages of making an acquisition through a share for share exchange?
Improves financial gearing as the shareholders of the acquired company become shareholders in the post-acquisition company
It reduces the risk of a taxable chargeable gain arising when compared with a cash offer
What is an interest rate guarantee?
A right but not an obligation to buy or sell forward rate agreements
What is a characteristic of standard forward exchange contracts?
Binding obligation to buy or sell an agreed amount of foreign currency
What is M&M’s dividend irrelevancy theory?
Pattern of dividend payout should be irrelevant
As long as companies continue to invest in positive NPV projects, the wealth of shareholders should increase.
What is the stable dividend policy?
Paying a constant or constantly growing dividend each year:
Offers investors a predictable cash flow
Reduces management opportunities to divert funds to non-profitable activities
Works well for mature firms with stable cash flows
What is the constant pay-out ratio method?
Paying out a constant proportion of equity earnings:
Maintains a link between earnings, reinvestment rate and dividend flow buy
Cash flow is unpredictable for the investor
Gives no indication of management intention or expectation
What is the zero dividend policy?
All surplus earnings invested back into the busines. Such a policy:
Is common during the growth stage
Should be reflected in increased share price
What is the residual dividend policy?
A dividend is paid only if no further NPV positive projects are available. This may be popular for firms:
In the growth phase
Without easy access to alternative sources of funds
What is the ratchet pattern of payments?
Paying out a stable, buy rising divend per share
What is the basis of purchasing power parity theory?
Law of one price
What is arbitrage with PPPT?
Buying at the lower price, selling at the higher price
What is a forward rate?
future exchange rate, agreed now, for buying or selling an amount of currency on an agreed future date. It is, in effect, the market’s prediction of what the exchange rate will be at a particular date in the future.
What is arbitrage?
Simultaneous purchase and sale of a security in different markets with the aim of making a risk-free profit through the exploitation of any price differences between the two markets.
Who uses arbitrage?
mainly used by speculators rather than as a hedging tool
What are the benefits of hedging?
hedging can provide certainty of cash flows which will assist in the budgeting process
risk will be reduced, and hence management may be more inclined to undertake investment projects
reduction in the probability of financial collapse (bankruptcy)
managers are often risk-averse since their job is at risk. If a company has a policy of hedging it may be perceived as a more attractive employer to risk-averse managers.
What are the arguments against hedging?
shareholders have diversified their own portfolio, thus further hedging by the business may harm shareholders’ interests
transaction costs associated with hedging can be significant
lack of expertise within the business, particularly with regards to use of derivative instruments
complexity of accounting and tax issues associated with the use of derivatives.
What is a derivative?
financial instrument whose value depends on the price of some other financial asset or underlying factor
How do we hedge internally?
Invoice in home currency
Leading and lagging payments
Offsetting
Countertrade
What are the external types of hedging?
Netting centres
Forward contracts
Money market hedges
Futures
Options
Swaps
What is a forward contract?
agreement to buy or sell a specific amount of foreign currency at a given future date using an agreed forward rate.
What are the advantages of a forward contract?
Are simple, and so have low transaction costs
Can be purchased from a high street bank
Fix the exchange rate exactly
Are tailored, so are flexible to amount and delivery period
What are the disadvantages of a forward contract?
A potential credit risk since the company is contractually bound to sell a currency, which it may not have received from its customer
No upside potential, even if rates move favourably
What is a money market hedge?
markets for wholesale (large-scale) lending and borrowing, or trading in short-term financial instruments. Many companies are able to borrow or deposit funds through their bank in the money markets.
What is a currency option?
right, but not an obligation, to buy or sell a currency at an exercise price on a future date
What is a call option?
gives the holder the right to buy the underlying currency.
What is a put option?
gives the holder the right to sell the underlying currency.
What does it mean if you are in the money?
exercise price for an option is more favourable to the option holder than the current ‘spot’ market price
What does it mean if you are out of the money?
option is less favourable to the option holder than the current ‘spot’ market price
What is a cross currency swap?
allows a company to swap a currency it currently holds for a different currency for a fixed period, and then swap back at the same rate at the end of the period.
What is an interest rate swap?
agreement whereby two parties agree to swap a floating stream of interest payments for a fixed stream of interest payments and vice versa. There is no exchange of principal.
If a comapny wanted to pay a fixed rate in exchange for a receipt of the RFR (swap floating to fixed) would they pay higher or lower amount?
Higher
If company wanted to pay RFR in exchange for a fixed rate would they pay higher or lower amount?
Lower
If we need to convert EUR to dollars what do we sell and what do we buy?
Sell EUR to buy USD
How do you calculate market capitalisation?
Share price x number of shares
What is the conclusion of M&M on the relevance of dividend policy?
The value of the shareholder’s equity is determined solely by the firm’s investment selection criteria
What is included in social disclosures?
Labour practices and Decent work
Human rights
Product Resposibility
Training and Education
Diversity and Equal Opportunity
What is a white knight defence?
Appeal to a third party to acquire you instead
What are three examples of Topic Standard Disclosures?
Table showing proportion of spending with local suppliers
Summary of financial donations to political parties
Chart showing the breakdown of the workforce by ethnic background
If a perfect capital market exists how does this impact Ke, WACC and total market value?
Ke increases
WACC decreases
Total market value increases
What is an example of financial capital?
Gov grant received by company to enable it to invest in emissions reduction technology
What is an example of manufactured capital?
Buses owned by company
What is an example of social and relationship capital?
Companys brand and logo
What is an example of intellectual capital?
Copyright relating to bus timetables operated by company
Features of cross currency swaps
Company entering the cross currency swap will end up with the type of interest rate it prefers
Cross currency swaps can be used to reduce interest costs
Cross currency swaps can be ‘fixed for fixed’, ‘floating for floating’ or ‘fixed for floating’
What is an example of systematic risk?
Worldwide oil and energy prices rise, increasing costs for a company
