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Financial Managment (FM) CIPFA > Financial Management, Institutions & Sources > Flashcards

Financial Management, Institutions & Sources Flashcards

1
Q

What does the Purchasing Power Parity (PPP) theory suggest?

A

It suggests that identical goods in 2 countires should cost the same price and if inflation rates are different in the 2 countries, exchanges rates will move to bring prices back in line with eachother. This means exchange rates can be predicted based on inflation rates.

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2
Q

What is a spot rate?

A

The currency exchange rate TODAY.

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3
Q

What does the Interest Rate Parity (IRP) Theory suggest?

A

It suggests that it does not matter which country you borrow or lend money in, the return on the loan should be the same.

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4
Q

The spot rate between the £ and the $ is $/£1.5400 and annual inflation in the USA is 2.3% whilst in the UK, inflation is 1.2%. What is the forecasted exchange rate in a years time if inflation is consistent?

Where F1 = exchange rate in 1 yea

F1 ($:£) = F0 ($:£) X (1+i$) / (1+i£)

A

$/£1.5567

The same principals apply to IRP.

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5
Q

In terms of market failures, what is an externality?

A

When someone other than the parties of a transaction are affected by that transaction.

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6
Q

A company buys a plot of land from a farmer and builds a new factory on it. What externailities could arise from this?

A
  • Jobs are created for the local community
  • More business may decide to locate to the same place if they believe it oiffers good prospects.
  • Pollution
  • Noise levels
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7
Q

What is market domination?

A

When one single company or an unacceptably low number of companies can come to dominate a market.

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8
Q

What 3 disadvantages can market domination lead too?

A
  1. Inefficient use of resources - Production kept unaturally low
  2. Abusive pricing - customers paying more than is acceptable because they have no choice of supplier
  3. No incentive to improve or innovate through lack of competition.
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9
Q

What are 5 possible remedies for market domination?

A
  1. Price & profit control
  2. Removal of barriers to entry
  3. Prevention of mergers and aquistions
  4. Anti-collusion legislation
  5. Deregulation and privitisation
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10
Q

What are 2 advantages to to having a large DOMINANT company in an industry?

A
  1. They can access larger pools of resources. (expertise, finance, materials ect.)
  2. Some monopolies are socially acceptable and even preferable. (Military, police ect.)
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11
Q

What are 3 examples of green policies enacted by governments to reduce pollution?

A
  1. Taxes and duties which encourage business to cut their emissions and provide incentives to invest in cleaner production methods
  2. Subsidies for use and generation of green technology and recycling.
  3. Legislation for waste disposal. Ie, legislation on waste disposal
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12
Q

What are the 2 broad catagories of financing?

A
  • Short term financing
  • Long term financing
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13
Q

When making decisions on financing, what 6 factors should the organisation consider?

A
  1. Availability - Only listed companies can make public issues of shares
  2. Amount
  3. Timing If finance is needed quickly they should consider which financing method will provide funds in time.
  4. Maturity - Maturity should match the life of its assets
  5. Financial risk - The impact of new finance on ratios sucg as gearing and interest cover
  6. Security and Covenants - If the borrower defaults on debts the lender can seize assets.
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14
Q

What effect can offering security to a potential lender have?

A

It can reduce interest rates as there is less risk borne by the lender.

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15
Q

What is fixed charge security on an asset?

A

Security is on a specific named asset which can later be seized by the lender in the case of a default.

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16
Q

What is floating charge security on an asset?

A

Security on a class of assets. (not a specific asset)

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17
Q

What type of security is preferable for a Lender? Fixed charge or floating charge? And why?

A

Fixed charge, because the borrower cannot dispose of the asset without the permission of the lender. With a floating charge the borrower may deal in these without permission. Further more, a lender with a fixed charge has priority on liquidation.

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18
Q

Which of the following has priority in the event of liquidation?

A: Fixed charge security
B: Floating charge security

A

A: Fixed charge security

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19
Q

What is a Covenant?

A

An additional requirement put into a debt, ususally to restrict the borrower from certain practices to reduce the risk assosiated with lending money.

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20
Q

What are 5 examples of short term financing?

A
  1. Bank credit - Overdraft/short term loan
  2. Trade Credit - Purchase of goods on account
  3. Trade bills - Financial insuruments drawn by the seller as an invoice and sold to a bank at a discount for short term cash.
  4. Uk money markets - Overnight loans
  5. Externalising debt - Debt collection
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21
Q

What are the 2 main sources of long term financing for private sector organisations?

A

Equity & Debt

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22
Q

What specific types of long term financing is avaliable for private sector organisations?

A
  1. Ordinary shares
  2. Public offers
  3. Rights issues
  4. Bonus issues
  5. Preference shares
  6. Debt capital
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23
Q

In order to offer shares publicly, what type of organisation must you be?

A

A Public limited company (PLC)

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24
Q

What is an issueing house and what are they used for?

A

An issuing house is an investment bank that agrees to buy a large block of shares with the view to offer them for sale to the general public. They are used for public offers of shares.

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25
Q

What are some examples of the costs assosiated with a public offer?

A
  • Issuing house fees
  • Solicitors fees
  • Cost of preparing and issuing the prospectus
  • Advertising and marketing the shares
  • Stock market listing fees
  • Underwriters fees
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26
Q

What are underwriters in terms of share issues?

A

Financial institutions that agree to buy shares and securities which are not subscribed for by the investing public.

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27
Q

What is a rights issue of shares?

A

New shares are offered to existing shareholders, usually at a discount to encourage take up.

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28
Q

What are 2 advantages to raising finance through a rights issue?

A
  1. It is cheaper than a general public issue as admin is simpler and underwriting fees are lower.
  2. Rights issues protect the control exercised by current shareholders.
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29
Q

What is meant by the ex-rights price?

A

The share price of the company immediatly after the rights issue.

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30
Q

WHat is meant by Cum-rights price?

A

The share price of the company immediatly before the rights issue.

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31
Q

Neptune PLC has 96 million shares at a share price of £6.25. They make a share issue so that they now have 120 million shares. The total value of their share capital after the share issue is £720 million. What is the Theoretical ex-rights price?

A

£6.00

720 million / 120 million = £6.00

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32
Q

When a shareholder does not want to take up their rights issue, they decide to sell the rights on the open market. What would be the price of the rights?

A

The difference between the TERP and the issue price

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33
Q

What is the effect of a bonus issue and for what reason may a company undertake this?

A

A bonus issue does not generate any extra funds as they are free shares issued to exixting shareholders. However, as more shares will now be in circulation, the share price will decrease. The company may do this when they believe their share price is too high to attract invetment.

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34
Q

What are the benefits to preference shares?

A
  • Shareholders of these are guarnteed a fixed rate of dividend each year
  • The dividend is paid before that of ordinary shareholders
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35
Q

What are 4 sources of debt capital?

A
  1. Debentures
  2. Bonds
  3. Mortgages
  4. Bank Loans
36
Q

What is a debenture?

A

A medium to long term debt insutrument which can carry a form of security.

37
Q

What type of interest do debentures pay?

A: Variable rate interest
B: Fixed rate interest
C: Neither A or B
D: Both A and B

A

B: Fixed rate interest

38
Q

What is a bond?

A

A bond is a certificate confirming that its owner has lent money to a specified borrower and that it will be paid back at a fixed date with a fixed interest rate.

39
Q

What is the normal par value of a Bond?

A

£100

40
Q

What are government bonds refered too?

A: Debentures
B: Options
C: Government Bonds
D: Gilts

A

D: Gilts

41
Q

What are 3 advantages of using debt as long term finance?

A
  1. It creates financial disipline as the borrower must pay interest and make capital repayments when they fall due.
  2. It is cheaper than equity as lender bears a smaller risk so expect lesser returns.
  3. It is a tax deductable expense, this makes it even cheaper as dividends are not tax deductable.
42
Q

What is the difference between an operating lease and a finance lease?

A
  • With an operating lease, the risks and rewards of the ownership of the asset do not transfer and so the lessee does not capitalise the assets but instead writes them to expenses.
  • With a finance lease, the risks and rewards of ownership DO transfer and so the asset is capitalised.
43
Q

What is meant by maturity matching?

A

Matching the economic lives of asset, investments or activities with the maturity of the financial insutruments.

44
Q

When should short term financing be used and give some example.

A

Short term financing should be used for short term assets and never long term assets. Such as:
* Financing working capital shortages
* Financing assets with a short life
* providing bridging loans while making more permenant funding arrangements.

45
Q

What are 3 sources of internal financing?

A
  1. Retained earnings
  2. Working capital efficiency
  3. Dividend policy
46
Q

What is the formua for dividend per share?

A

Ordinary dividend / Number of ordinary shares in issue

47
Q

What is the formula for Dividend yield?

A

Dividend per share / share price

48
Q

What is the formula for dividend cover?

A
  • Earning attributable to ordinary shareholders / ordinary dividend or;
  • EPS / Dividend per share
49
Q

What 6 factors should a company consider when deciding how much dividend to pay out?

A
  1. Legislation
  2. Liquidity
  3. Lifecycle - companies expecting to grow need to retain a certain amount of internal finance to pay for expansion plans.
  4. Covenants - These may restrict payments of dividends in order to keep money for creditors repayments.
  5. Gearing - when a dividend is paid gearing increases
  6. Signalling effect
50
Q

What are the 5 potential dividend policies?

A
  1. Fixed/stable dividend
  2. Stable growth
  3. Fixed proportion of profits
  4. Residual dividend - profits should only be paid out if there are no viable projects to invest in to create growth.
  5. Zero-dividend
51
Q

What is a scrip dividend?

A

A dividend distribution which takes the form of newly issued shares.

52
Q

What is RIBA in islamic finance?

A

It referes to interest on a loan. This is actually illegal in sharia law to make profits just of lending.

53
Q

What are the 5 different contracts in islamic finance?

A
  1. Murabaha
  2. Ijara
  3. Sukuk
  4. Mudaraba
  5. Musharaka
54
Q

What is a Murabaha contract equivalent to?

A

A credit sale

55
Q

What is an Ijara contract equivalent to?

A

A lease

56
Q

What is a Sukuk equivalent too? and what is the difference to its non-sharia equivalent?

A

A bond.
The difference is that interest is not charged on the bond and it is instead fixed to an actual asset for which the Sukuk holder is entitled to some of the profts generated.

57
Q

What is the equivalent of a Mudaraba contract?

A

This is a partnership contract where one partner provides the finance and one provides the skills and expertise. Profits are shared according to the ratios agreed but losses are entirely attributable to the finance provider.

58
Q

What is a Musharaka contract?

A

This is a partnership contrcat in which both partners provide finance and expertise. Profits are distributed as per agreed ratioos and loses are attributed in proportion to the capital contributions.

59
Q

In which of the following islamic contracts is both finance and expertise contributed?

A:Murabaha
B:Sukuk
C:Mudaraba
D: Musharaka

A

D: Musharaka

60
Q

What is Venture capital?

A

Venture capital is capital provided to high risk projects in return for high expected returns.

61
Q

What is Crowdfunding?

A

Raising funds for a project, business or venture from a large number of people.

62
Q

What are the 3 types of crowdfunding?

A
  1. Donation crowdfunding
  2. Equity crowdfunding
  3. Debt crowdfunding
63
Q

What are the potential benefits to crowdfunding?

A
  • Raises the profile of the business
  • Combines marketing with financing and unsucessful campaigns provide useful feedback
  • Funding providers can be involved in production process.
64
Q

What are some potential risks to crowdfunding?

A
  • Reputation can suffer from unsucessful campaigns
  • Intellectual property can become more difficult to protect after entering public domain
  • Donor exhaustion can result from entering the same pool of individuals
  • Lack of regulation increases risk of fraud, embezzelment and scams
65
Q

What 3 decisions comprise the financial stratagy of an organisation?

A
  1. Investment decision
  2. Financing decision
  3. Dividend decision
66
Q

What financial return can a shareholder expect from their investment?

A: Dividends
B: Increase in value of the company which increases value of shares
C: Both
D: None

A

C: Both

67
Q

What is the formula for total shareholder return?

A

(Dividend per share + increase in share price) / share price at start of the year

68
Q

What is the formula for ROCE?

A

Operating profit / total assets less current liabilities

69
Q

What is the formula for Return on Equity?

A

Profit attributable to ordinary shareholders / Shareholder funds

70
Q

What is the formula for asset turnover?

A

Sales revenue / Capital employed

71
Q

What is the formula for Gearing %?

A

Value of debt / Value of debt & equity

72
Q

What is the formula for interest cover?

A

Operating profit / Interest expense

73
Q

WHat is the formula for dividend yield?

A

Dividend per share / share price

74
Q

What is the formula for Earning per Share?

A

Profit attributable to ordinary shares / Number of ordinary shares in issue

75
Q

What is the formula for Price/Earnings ratio?

A

Share price / EPS

76
Q

What are the 3 E’s of value for money?

A
  • Effectiveness
  • Efficiency
  • Econonmy
77
Q

What does Keynesian economics suggest?

A

That government intervention is needed in order to achieve econoomic stability and full employment.

78
Q

What government intervention did keynesian economics think should be targeted to achieve econoomic stability?

A

Aggregate demand. (The total amount of expenditure in an ecoonomy)

79
Q

In times of imbalance in the economy, what should be the focus of governemnt intervention according to monaterism?

A

The money supply

80
Q

What are the 3 policy areas of Macroeconomics?

A
  1. Fiscal policy
  2. Monetary and interest rate policy
  3. Exchange rate policy
81
Q

What is the focus of a governments fiscal policy?

A

The governments plans for taxation and spending programs

82
Q

What is an expansionary fiscal policy?

A

When government injects more money into the economy than it taxes.

83
Q

What is a contractionary fiscal policy?

A

When government withdraws more money from the economy than it injects through public expenditure programes

84
Q

What is the focus of government monetary policy?

A

Managment of the economy through control of the money supply, interest rates and the availablility of credit.

85
Q

What is an expansionary monetary policy?

A

This involves increasing spending in the economy by increasing the money supply, reducing interest rates and expansding the availability of credit.

86
Q

What is a contractionary monetary policy?

A

This involves decreasing spending in the economy by reducing money supply, increasing interest rates and restricting the availability of credit.

87
Q

What do monetarists believe inflation is caused by?

A

Excess money supply

Financial Managment (FM) CIPFA (5 decks)

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