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Financial Management > Sources of finance > Flashcards

Sources of finance Flashcards

1
Q

What is peer to peer lending? (4)

A
  • Connects established businesses looking to borrow with investors who want to lend, via a specialised online platform.
  • Potentially available for any type of lending but most loans are unsecured personal loans.
  • Platforms usually require borrowers to have a trading track record, to submit financial accounts and will perform credit checks.
  • Investors can lend small parts of individual loans, which encourages a wide range of lenders to participate.
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2
Q

Why is peer to peer lending suitable for established firms?

A

Would be able to offer security to potential investors.

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3
Q

What are the 5 advantages of peer to peer lending?

A
  • Allows customers and family or friends to share in the returns of the business.
  • Can be cheaper than using a traditional bank loan as greater competition between lenders results in a lower interest rate and lower organisation fees, which could reduce the cost of capital.
  • As P2P lending systems are typically entirely online, the application process is quick and convenient. This is valuable in competitive markets as funds can be secured quickly to commence the investment.
  • Most P2P platforms have a waiting list of investors to provide loans to borrowers which, when matched with an automated matching process, means turnaround time on accessing finance can be very quick.
  • Using external finance allows firms to proceed with investments while also paying out cash dividends with internal funds.
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4
Q

What are the 3 disadvantages of peer-to-peer lending?

A
  • Firms need to pass a credit check and other internal checks to acquire loans.
  • Borrowers who apply for P2P loans usually have low credit ratings that prevent them from obtaining conventional sources of finance.
  • The loan is likely to include an arrangement fee payable to the P2P firm, although this is likely to be cheaper than the fee attached to traditional bank borrowings.
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5
Q

What is a business’s primary objective?

A

To maximise shareholder wealth.

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6
Q

Define UK national stock markets

A

In the UK this includes the London Stock Exchange (the Stock Exchange) and the Alternative Investment Market (AIM) which not only act as markets for ‘second-hand’ securities such as shares, but also act as a primary source of new funds, via new share issues.

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7
Q

Define the banking system

A

This can be split between the retail market and the wholesale market, which service individuals/small businesses and large companies respectively.

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8
Q

Define crowdfunding

A

The use of internet-based platforms to match companies with investors (usually a large number of investors), a recent innovation in business finance.

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9
Q

Who faces more risk, debt holders or shareholders?

A
  • Shareholders face more risk.
  • Debt holders receive interest before shareholders receive any dividends, and in the event of company failure, the debt holders rank higher than the equity holders. This means that any capital amounts due to the debt holders will be repaid before the shareholders receive anything. The debt holders have a price to pay for this lower risk however; they will receive a lower rate of return on their capital.
  • Shareholders suffer the downside of any loss or fall in profits. Correspondingly, they expect a higher rate of return. Any profits go to the shareholders, not the debt holders.
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10
Q

Define equity

A

Ordinary shares. Equity shareholders are the owners of the business and through their voting rights exercise ultimate control.

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11
Q

Define preference shares

A

Form part of the risk-bearing ownership of the business but, since they are entitled to their dividends before ordinary shareholders, they carry less risk. As their return is usually a fixed amount of dividend, they are similar in many ways to debt.

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12
Q

Define loan stocks and debentures

A

Typically fixed interest rate borrowings with a set repayment date. Many are secured on specific assets or assets in general, so that lenders are protected (in repayment terms) above unsecured creditors in a liquidation.

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13
Q

Rank the 3 main sources of equity finance in terms of importance.

A
  1. Retained earnings
  2. Rights issues
  3. New issues
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14
Q

Define cum-rights price of a share

A

The share’s market value when the shareholder has the right to subscribe for new shares in the rights issue.

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15
Q

Define ex-rights price of a share

A

The price at which the shares settle after a rights issue has been made.

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16
Q

2 formulas for ex-rights price of a share

A
  1. ex-rights price = (market value of shares pre-rights issue + rights proceeds + project NPV) / number of shares ex-rights
  2. ex-rights price = present value of new total dividends / number of shares ex-rights
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17
Q

4 factors to consider when making rights issues

A
  1. Issue costs
  2. Shareholder reactions
  3. Control
  4. Unlisted companies
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18
Q

Why might it be difficult for unlisted companies to raise funds using rights issues?

A

If shareholders are unable to raise sufficient funds to take up their rights, they may not have the option of selling them as the firm’s shares aren’t listed. This could mean the firm is forced to use retained profits or obtain new loans to raise capital.

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19
Q

What are the 2 potential impacts of a rights issue on shareholder wealth?

A
  1. If the shareholder does nothing, their wealth will decrease.
  2. If the shareholder takes up the rights issue or sells their shares, their wealth will increase.
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20
Q

How does a rights issue impact the control of a company?

A

Unless large numbers of existing shareholders sell their rights to new shareholders, there should be little impact in terms of control of the business by existing shareholders.

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21
Q

What are the 2 methods of making an IPO?

A
  1. Offer for sale

2. Direct offer or offer for subscription

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22
Q

What are the 2 steps of an offer for sale?

A
  1. X plc sells shares to an issuing house or investment bank.
  2. The issuing house offers shares for sale to the general public.
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23
Q

What is the method of a direct offer or offer for subscription?

A

Shares are sold directly to the general public.

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24
Q

What procedures are used for both methods of IPO?

A
  1. Advertising such as in newspapers.
  2. Following the legal requirements
  3. Stock Exchange regulations in terms of the large volumes of information that must be provided such as listing particulars and prospectus.
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25
Q

Define underwriting

A

The process whereby in exchange for a fixed fee, usually 1% to 2% of the total finance to be raised, an institution or group of institutions will undertake to purchase any securities not subscribed for by the public.

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26
Q

2 disadvantage of underwriting

A
  1. Cost: The cost depends upon the characteristics of the company issuing the security and the state of the market and is payable even if the underwriter is not called upon to take up any securities. Hence underwriting increases the cost of raising finance.
  2. If the underwriters are required to buy the shares that other investors do not want, they will ‘hang over’ the market, and the underwriters will probably try to sell their unwanted shares as soon as there is any pick-up in demand. As a result, the share price is likely to remain depressed for some time, until the underwriters have sold all the shares they do not want to keep.
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27
Q

Define venture capital

A

Risk capital, normally provided by a venture capital firm or individual venture capitalist, in return for an equity stake.

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28
Q

6 ways venture capital is distinguished from other forms of equity finance

A
  1. More participatory as venture capitalists usually expect 20% to 49.9% of the shares of a company and so they can exert control.
  2. Provided with more regard for the long-term than the short-term, although venture capitalists’ involvement is unlikely to extend beyond the medium term.
  3. The investor provides advice and can influence management but doesn’t take on the running of the business themselves.
  4. Much of the return from providing the capital is in the form of capital gains after three to five years rather than steadily from the beginning, since by their nature companies needing venture capital will not be able to pay cash dividends in the early years.
  5. A key issue is the VC’s exit route, ie, how the VC can liquidate the investment. This is often achieved by selling the VC’s shares to another company (a trade sale) or by a stock market flotation.
  6. Failure to hit targets set by the venture capitalist can lead to extra shares being transferred to their ownership at no additional cost. This is called an equity ratchet.
29
Q

What are the features of a successful crowdfunding pitch?

A

An attractive business plan that reassures investors about the prospects for the proposed product or service, as well as about the quality of the management team.

30
Q

3 advantages of crowdfunding

A
  1. Crowdfunding is a type of finance that is available to start-up companies who often struggle to secure more regular sources of finance due to their lack of trading history.
  2. By involving a large number of investors, crowdfunding helps to attract customers and to build awareness of the company.
  3. Crowdfunding can be a quick process eg, 30 days.
31
Q

What 2 factors must a company consider when choosing a crowdfunding platform?

A
  1. Crowdfunding platforms that have experience in the company’s industry will be likely to attract investors with an interest in the company’s proposal.
  2. Companies are also more likely to want to choose a crowdfunding platform that is regulated by the Financial Conduct Authority which will provide assurance to investors that the information the business produces is clear and reasonable.
32
Q

3 costs associated with crowdfunding

A
  1. Fee payable to the crowdfunding site.
  2. Legal and advisory costs.
  3. Administrative costs of dealing with investor inquiries.
33
Q

1 advantage of IPO

A

No restriction on the amount of equity capital raised.

34
Q

1 disadvantage of IPO

A

Likely to be underwritten, which is costly and may depress share price for some time.

35
Q

1 disadvantage of venture capital

A

Failure to hit targets set by the venture capitalist can lead to extra shares being transferred to their ownership at no additional cost, which is called an equity ratchet.

36
Q

2 ways ICOs are distinguished from IPOs

A
  1. An investor receives a token, this might be for a share or it might be a utility token that gives an entitlement to use a product or service; eg, when Filecoin raised over $250million in 2017, its tokens enabled access to its decentralised cloud storage service.
  2. Payment is made in a cryptocurrency such as bitcoin.
37
Q

How has the use and regulation of ICOs changed?

A
  1. Initially, ICOs were attractive because of their simplicity. The issuer raises money by issuing a white paper, usually via their website, which provides details of the venture’s concept and of the tokens that will be issued in exchange for cryptocurrency.
  2. Increasingly, regulators are viewing ICOs as offering future revenue streams and are therefore judging them as securities, meaning that ICOs are likely to have to fulfil the related regulatory criteria for an issue of securities.
  3. Increased regulation has led to a moderation in the use of ICOs.
38
Q

1 key risk of ICOs

A

The value of cryptocurrency is highly volatile.

39
Q

Define convertible loans

A

Fixed return securities that are either secured or unsecured and may be converted into ordinary shares at a future date. Prior to conversion, the holders have creditor status.

40
Q

1 advantage of convertible loans

A
  1. The interest rate is lower than on comparable conventional fixed rate bonds because of the value of the conversion rights.
  2. Encourages possible investors with the prospect of a future share in profits.
  3. Introduces an element of short-term gearing.
  4. Avoids redemption problems if the debt is converted into equity.
  5. Can issue equity cheaply if converted.
41
Q

Define loan stock with warrants

A

Loan stocks that cannot themselves be converted into equity but give the holder the right to subscribe at fixed future dates for ordinary shares at a predetermined price. The subscription rights are issued with the loan stock and are known as warrants.

42
Q

What is the cost of loan stock with warrants?

A

The right given to holders to buy equity at a possibly reduced price at the exercise date.

43
Q

Who uses international financial markets?

A

Larger companies

44
Q

Define international money markets

A

Refer to lending and depositing funds in a foreign currency, outside the country of the currency’s origin; for example, raising a short-term US dollar loan from a London bank.

45
Q

3 forms of international money market

A
  1. Eurocurrency market
  2. International bond market
  3. International syndicated loans market
46
Q

Define eurocurrency market

A

Refers to short-term borrowing and lending by banks in currencies other than that of the country in which the bank is based.

47
Q

1 disadvantage of eurocurrency market

A

Typically only available in major currencies for which active markets exist.

48
Q

Define international bond market

A

A market in which bonds are issued by large companies and other organisations such as sovereign governments, and then sold to international investors.

49
Q

1 advantage of international bond market

A

Bonds may be denominated in any freely-convertible currency.

50
Q

Define international syndicated loans market

A

A market for medium- to long-term loans that are created when a syndicate of international banks lend money to a borrower. Some of the loan may then be marketed, enabling other investors to acquire an interest.

51
Q

2 advantages of international syndicated loans market

A
  1. Syndicated loans spread the credit risk among the participating lenders
  2. Useful when a company wants a very large loan.
52
Q

3 factors that are relevant when choosing between borrowing on the international markets or through the domestic system.

A
  1. Eurocurrency loans generally require no security, whereas borrowing on domestic markets is likely to involve fixed or floating charges on assets as securities.
  2. International bonds are attractive to investors as interest is paid gross without the deduction of withholding tax, which occurs in many domestic markets.
  3. International bonds securities can usually be sold fairly easily on the secondary market.
  4. It is often easier for a large multinational to raise large sums very quickly on the international markets than in a domestic financial market because there are more potential large investors.
53
Q

Define green finance

A

The financing of investments that provide environmental benefits as part of a broader context of encouraging environmentally sustainable development.

54
Q

4 methods of financing green

A
  1. Green loans
  2. Sustainability linked loans
  3. Green bonds
  4. Green funds
55
Q

Define sustainability linked loans

A

Loans for any purpose with an in-built pricing mechanism, meaning the loan is cheaper if the borrower achieves certain sustainability- or environmental, social and governmental-related targets.

56
Q

Define green bonds

A

A type of fixed-interest bond use to raise money for climate and environmental projects. The bonds are typically secured and have the same credit rating as a company’s other debt obligations.

57
Q

1 advantage of green bonds

A

May come with tax incentives to enhance their attractiveness to investors.

58
Q

Define green funds

A

An index of firms that satisfy social and environmental criteria.

59
Q

3 general principles relevant to financial management applicable to accountants

A
  1. Statutory and other regulatory requirements
  2. Interests of shareholders and owners
  3. Preparation of documents
60
Q

4 statutory and other regulatory requirements relevant to financial management that accountants are held to

A
  1. Professional accountants must be aware of and comply with current legislative and regulatory measures and professional guidance governing corporate finance assignments.
  2. Professional accountants are required to comply with the City Code on Takeovers and Mergers.
  3. At the outset professional accountants should draw attention to the legislative and regulatory responsibilities which will apply to the client or his employer.
  4. The professional accountant should also draw attention to his own responsibilities under professional ethical guidance.
61
Q

Define electronic share dealing platform

A

A computer software programme that can be used to buy and sell shares, currencies or derivatives over a network with a financial intermediary or directly between the participants of the trading platform.

62
Q

3 theories relevant to efficient market hypothesis

A
  1. Dividend valuation model
  2. Modigliani and Miller’s capital structure theory
  3. Dividend policy irrelevance theory
63
Q

Define efficient market hypothesis

A

Concerned with the information-processing efficiency of stock markets, particularly in terms of share prices.

64
Q

Nature of weak form efficiency

A
  1. Share prices reflect information about past price movements, which do not help investors identify profitable trading strategies.
  2. Share prices rise with good news and fall with bad news, so movement does not depend on past price movements or patterns.
65
Q

1 implication of weak form efficiency

A

Share prices cannot be predicted from past price movements.

66
Q

Nature of semi-strong form efficiency

A
  1. Share prices incorporate all publicly available information.
  2. News is very rapidly reflected in share prices.
67
Q

1 implication of semi-strong form efficiency

A

The market cannot be beaten by examining publicly available information as it’s already incorporated in share prices.

68
Q

Nature of strong form efficiency

A

Share prices reflect all available information, whether or not it’s been published.

69
Q

1 implication of strong form efficiency

A

No investor can beat the market by having superior information, as it doesn’t exist.

Financial Management (9 decks)

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