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Source Of Finance Flashcards

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1
Q

What is the money market

A

Used mainly for short-term financing (less than 3 years) it consist of group of interested parties who borrow and lend amongst each other.

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2
Q

What is the capital market?

A

Used mainly for raising long-term finance( longer than 3 years

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3
Q

Difference between primary and secondary markets

A

Primary market is for new issues of finance and secondary market is for the trading of security already issued.

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4
Q

List the main types of securities listed on JSE

A
  1. Ordinary shares
  2. Preference shares
  3. Warrants
  4. Futures
  5. Options
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5
Q

What are rights issue?

A

Company invites existing shareholders to buy more share to raise more capital and if shareholders exercise their rights, their proportionate ownership of the company remains unchanged. In most cases the subscription price to rights issue will be set lower tab the current share price.

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6
Q

Reasons why companies will make increasing use of the bond as source of debt financing

A
  1. Low interest rate
  2. Use of financial leverage
  3. Low levels of gearing
  4. Credit agency ratings
  5. The tax deductibility of interest
  6. Diversification of source of debt financing
  7. Securitization and credit enhancement
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7
Q

List the equity-related instruments

A
  1. Ordinary shares
  2. Retained earnings
  3. Preference shares
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8
Q

List the types of preference shares

A
  1. Participating preference shares - fixed dividends and profit sharing
  2. Redeemable preference shares - able to redeem at specific price on particular date over given period of time
  3. Convertible preference shares - right to exchange for ordinary shares
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9
Q

What are some of the reasons to issue preference shares?

A

It enhances the balance sheet of the company as the amount is recorded under equity capital

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10
Q

Name the debts related instrument available

A
  1. Debentures and corporate bonds
  2. Long term loans
  3. Short term debts
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11
Q

What are the uses of restrictive covenants?

A
  1. Ensure that certain financial ratio remains within the agreed limits
  2. Restrict the raising of further loans
  3. Restrict the payment of dividends
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12
Q

Name the types of debentures available

A
  1. Secured - secured over certain assets
  2. Convertible - convertible into other securities
  3. Redeemable - redeemable at the option before maturity or specific date
  4. Fixed yield - interest rate is fixed
  5. Participating - receive a fixed proportion of the profit and interest
  6. Income - payable only if company has sufficient earnings to meet this commitment
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13
Q

Name the characteristics of debts and equity

A
  1. Equity has a residual right to the wealth of the firm, whereas debts has a contractual right
  2. Payments for the use of debts are usually tax deductible
  3. Debts tends to have a finite life. The life of equity tends to be the life of the firm
  4. Equity holders control the firm, debt holders do not
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14
Q

What is negative gearing?

A

The company must pay the interest agreed upon with the lender, irrespective of the performance of the company. This is an advantage when the company is doing well and earning more than the interest charged. In such circumstances the effect is to lever the profit so that the return on shareholder’s funds is higher than the return on assets. On the other hand the reverse is true when the return on assets is lower than the interest charged this is known as negative gearing.

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15
Q

Discuss the tax deductibility of interest

A

The interest charge on debt is usually tax deductible. Its effective cost to the company is therefore the after tax cost of debt. Dividends, on the other hand, aren’t tax deductible and so there is no tax relief from the companies’ point of view

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16
Q

Discuss the cost of debt

A

The cost of debt is usually less than cost of equity as a result of the lower risk to the lender and the tax deductibility of the interest. The use of debt allows the company to lever the return to shareholders, furthermore, the costs involved in issuing ordinary shares are higher than costs of issuing debts.

17
Q

Discuss the risk aspects of debt and equity

A
  1. Interest payment on debt must be met whether there are profit or not, in time of economic hardship, this can be onerous requirement. The company is not required to pay a dividend to ordinary shareholders.
  2. Debt requires a capital repayment, and ultimately all debts must be repaid this may put a strain on the liquidity of the company. Ordinary share capital is not required to be repaid.
  3. There is a limit to the amount of debt that can be raised before market reassesses the company’s risk profile, which will reflect the cost of capital. The more debt the company raises the closer it comes to this saturation point. Consequently raising debt reduces the company’s flexibility for raising future funds, this can be a disadvantage
  4. The signaling effects. The sale of new ordinary shares may be perceived as a negative signal by investors as it may indicate management’s view that the ordinary shares are overvalued
18
Q

Discuss the control aspects of debt and equity

A

Raising finance thru the issue of equity dilutes the control of existing shareholders.
Raising finance thru debt can also have control implications.

19
Q

What is spot market?

A

For immediate delivery, instruments are traded at agreed price immediately.

20
Q

What is forward market?

A

For delivery at a future date

21
Q

What is a formal market?

A

Regulated market in an exchange

22
Q

What is over the counter market?

A

Unregulated, informal trading, innovate, standardized instruments like forex

23
Q

What happens in a derivative market?

A

Settlement is deferred. Derivatives are used to manage risk, its flexible, low cost.

24
Q

What is exchange traded derivative?

A

Options and warrants traded on JSE and futures and options are traded on SAFEX. They are standardized contracts, marking to market and have high level of liquidity.

25
Q

What are non-exchange traded derivatives?

A

They area negotiated and customized, non-standardized, not traded on an exchange. Examples are forward contracts and swaps.

26
Q

What is important in terms of source of financing?

A
  1. Understand the purpose of financing
  2. Period and pattern of financing (long term/short term)
  3. Amount of finance
    - risk
    - control
    - floatation cost
27
Q

List types of debt related instrument.

A
  1. Debentures
  2. Mortgage bonds
  3. Loans
  4. Finance leases
  5. Short term loans
  6. Foreign loans
  7. Securitization
  8. Project finance
28
Q

Discuss retained earnings as source of finance.

A

It immediate source of finance for the company. Shareholders agree to forego the dividend. Expectation of future growth.
The cost of retained earnings is the cost of new equity.

29
Q

List the classification of debt.

A
  1. Fixed interest
  2. Variable interest
  3. Secured debt
  4. Unsecured debt
30
Q

Discuss venture capital and private equity.

A

Venture capital and private equity assist with launching and developing business. Venture capital and private equity markets are less efficient than the public markets.
Private equity firms will often increase the debt levels of firms.
Characteristics:
- higher transaction costs
- small number of buyer and seller
- different investment objective
- risk of failure is higher than in formal market

31
Q

Discuss ordinary shares in terms of cost, risk and control. Evaluate ordinary share as a source of finance.

A 
Cost = more expensive than debt, dividends not tax deductible
Risk = higher risk for shareholders than debt providers. Lower risk for firm than debt as dividend is not compulsory.
Control = the existing shareholders control of the company will be affected.
32
Q

Discuss debentures, mortgage bonds in terms of cost, risk and control/ evaluate debentures and mortgage bonds as source of finance.

A 
Cost = cheaper than equity and interest is tax deductible. 
Risk = lower risk for shareholders than equity. Riskier than equity for the firm as there will be fixed interest payment and capital repayment.
Control = no effect on control
33
Q

Discuss loan in terms of cost, risk and control. Evaluate loans as source of finance.

A 
Cost = cheaper than equity
Risk = lower risk for shareholders than equity but higher for the firm due to fixed interest payments and capital repayment
Control = no effect
34
Q

Discuss leases as source of finance, in terms of cost, risk and control.

A 
Cost = cheaper than equity
Risk = lower risk for shareholders than equity but higher risk for the firm due to fixed payments 
Controls = no effect

Finance (12 decks)

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