Topic 1:

Question 1

Goal of the firm

Answer 1

Maximise shareholders’ wealth by maximising share price.

Question 2

5 principles of finance

Answer 2

1. Cash flow is what matters.
2. Money has time value.
3. Risk requires reward.
4. Market prices are generally right.
5. Conflict of interests causes agency problems.

Question 3

Principle 1: Cash flow is what matters

Answer 3

Accounting profits =/ cash flows.

Cash flows, not profits, drives company’s value.

Determine incremental increase in cash flow.

Question 4

Principle 2: Money has time value

Answer 4

Money today worth more than money tomorrow because:

1. Dividends/interest if we invest in savings etc.
2. Inflation impact on purchasing power.

Question 5

Principle 3: Risk requires rewards

Answer 5

Investor won’t take additional risks unless they are compensated with additional rewards.

Investor expects to be compensated for “DELAYING CONSUMPTION” & “TAKING RISKS” (expect more in stocks than in FD).

Question 6

Principle 4: Market prices are generally right

Answer 6

Efficient market hypothesis:
Market prices fully reflect all available information at any point of time.

Stock prices good indicator of value of firm because reflects on future cash flow changes.

Inefficiencies such as behavioural biases may distort market prices from value of assets.

Question 7

Principle 5: Conflict of interest causes agency problems.

Answer 7

Separation of management and the ownership of firm.

Management not consistent with firm’s goals.

Reduced through:

1. Monitoring.
2. Compensation.
3. Market mechanism.

Question 8

Decisions in corporate finance.

Answer 8

1. Capital budgeting decisions.
2. Capital structuring decisions.
3. Working capital decisions.

Question 9

Function of Financial Markets

Answer 9

Facilitate transfer of funds from “saving surpluses” to “saving deficits”.

Question 10

Ways to transfer capital

Answer 10

1. Direct transfer.
2. Indirect transfer through IB.
3. Indirect transfer through FI.

Question 11

Direct transfer

Answer 11

Saving deficits looks for saving surpluses directly.

Startups looking for VC.

Question 12

Role of VC

Answer 12

Provide funding to startups. Very risky, high return potential.

Startups: small sized, no profit records, uncertain future growth prospects.

Question 13

Public offering

Answer 13

Securities initially sold by managing IBs to retail and institutional investors.

Issuing firm never meets final purchaser.

Question 14

Private/Direct offering

Answer 14

Sold directly by company to selected investors.

Question 15

Primary market

Answer 15

Market of which new securities are sold to initial buyers.

Only time the company receive fresh funds.

Question 16

Seasoned equity offering/RI

Answer 16

Sales of additional shares of company already public to existing shareholders at a discount to market price.

Question 17

Secondary market

Answer 17

Market of which previously issued securities are traded.

Company does not received any fresh funds from shares traded in this market.

Question 18

Money market

Answer 18

Market for short-term debt instruments.

Notes, bills.

Question 19

Capital market

Answer 19

Market for long-term financial securities.

Bonds, shares, T-bonds, term loans.

Question 20

Futures market

Answer 20

Market for derivatives trading.

Question 21

OTC Markets

Answer 21

Over-the-counter. All markets except organised markets.

For companies:

1. Fail to meet listing requirements of secondary market.
2. Wishes to avoid higher reporting listing requirement and fees of exchanges.

Question 22

Underwriters’ spread

Answer 22

Differences between IB paid price and IPO price.

Question 23

Functions of IB

Answer 23

1. Underwriting.
2. Distributing.
3. Advising.

Question 24

Underwriting/distribution methods

Answer 24

UNDERWRITING

1. Negotiated purchase.
2. Competitive bid.

DISTRIBUTING

1. Best efforts.
2. Privileged subscription.