Corporate Banking Flashcards
(230 cards)
1
Q
Who within the IB bank is responsible for making bridge financing?
A) Prime Brokerage
B) Leveraged Finance (capital market)
C) Sales and Trading
D) Private Wealth Management
A
B) Leveraged Finance Group
arrange bridge financing in connection with a stock issuance. It is not sure that this issue will be successful. Therefore, the bank engages itself into bridge financing, where if the issuance is not successful, the money will be given by the bank.
2
Q
In a best efforts transaction, the issuer will bear ___ price risk, and in a bought deal, the issuer will bear ___ price risk
A) All; all
B) No; all
C) No; no
D) All; no
A
D)
In a best-efforts transaction, the bank sells without taking any risk; it makes its best effort to sell, but if they are not successful, the issuer bears all the price risk.
In a bought deal: the bank buys the security from the issuer and resell the security to investors. i.e., they bear the entire price risk.
3
Q
Issuing securities is costly. Which of the following securities issuances incur the LOWEST direct cost?
A) Convertibles
B) Bonds
C) IPO
D) Seasoned Offering
A
B) Bonds issuance is least expensive.
Usually, this is done with a private placement (99% of bonds are sold privately to institutional investors in order to avoid filing with the supervisory board and the corresponding hassle).
4
Q
Issuing securities is costly. Which of the following securities issuances incur the HIGHEST direct cost?
A) Convertibles
B) Bonds
C) IPO
D) Seasoned Offering
A
C) IPO is the most expensive issuance since this entails huge costs connected to raising investor interest (roadshows, conference calls, individual meetings with investors)
5
Q
When might an IB decline participation in an underwriting agreement and why?
A) When perceived risks of participation outweigh the expected underwriting fees
B) If the trader believes demand for new securities from the issuer is lower than the contemplated issuance size
C) If the IB has several potential underwriting commitments at once and is limited by regulatory capital requirements
D) Because of reputational concerns or issues found during due diligence
E) All of the above
A
ANSWER: All of the above
A) if the bank cannot resell the securities, they must absorb the loss. Hence, the underwriting agreement might be rejected if the risks of participation outweigh the expected fees.
B) if supply exceeds demand of the stock issuance, the bank might not be willing to underwrite, because they bear the risk if they are not sold.
C) Whenever IBs bear risk, they must have regulatory capital to absorb potential losses. If this regulatory capital is not high enough, they might be forced to decline a mandate because it is too risky.
D) Reputational concerns or problems found during due diligence can be the reason for declining an underwriting agreement. It is the IB that writes the prospectus (the document that is given to potential investors in order for them to decide). If there are any mistakes or omission in this document, the liability is upon the bank. Hence, if the IB thinks the issuer is not truthful, they may decide not to pursue to mandate.
6
Q
What drove the need to separate research and investment banking?
A) Conflicts of interest B) Competition from foreign banks C) The credit crisis D) Research was not generating enough profits E) All of the above
A
A)
Not C: The separation of research and IB (2003) predates the financial crisis (2008).
Not D: research is paid as an indirect part of the trading contract with clients. I.e., part of the fees that the trading division received is paid to the research department
7
Q
A firm has agreed to a green shoe. The underwriter buys shares from ___ if the share price drops and from ___ if the share price increases
A) Investors; issuer
B) Investors; investors
C) The issuer; investors
D) The issuer; the issuer
A
A)
If the share price increases, the underwriter exercises its option, which entails the issuer issuing additional shares.
If the price decreases, they buy the shares from investors in the secondary market since this price is now lower than the issuing price.
8
Q
In general, strategic buyers are ___ likely to invest in an industry which is doing poorly, and ___ likely to generate synergy cost savings than financial buyer
A) Less; less
B) Less; more
C) More; less
D) More; more
A
Answer: B
Strategic buyers are LESS likely to be able to invest in an industry which is doing poorly. Usually, the strategic buyer is operating within that same industry as the target – so if the entire industry performs poorly, the buyer would not have enough money to perform acquisition.
Strategic buyers tend to invest MORE with the aim of generating synergy cost savings than financial buyers.
9
Q
Which of the following is NOT a method used by IBs to help equity issuers mitigate price risk during the marketing process?
A) Accelerated offering
B) Block trade
C) Privileged option
D) Greenshoe option
A
C) Does not exist
The longer the marketing effort period, the higher the risk that market conditions change, leading to prices deviating from those set by the IB. So, to offset that, they may (i) accelerate the offering, or they (ii) organize a block trade. Additionally, (iii) the green shoe option is also a method to mitigate price risk, because the IB gets some flexibility in terms of the quantity of stocks issues in order to stabilize the prices.
10
Q
Why are revenue synergies given less weight than cost synergies when evaluating the combined benefits of a transaction?
A) Requires more assumptions than cost synergies
B) Revenue synergies are more difficult to estimate and capture
C) key valuation multiple (EV/EBITDA) is not based on revenue
D) A and B are correct
E) B and C are correct
A
Answer: D: both A and B are correct.
Revenue synergies are much more difficult to estimate and capture than cost synergies, which is also why they require a lot more assumptions.
11
Q
As seen in the Freeport McMoRan case, what is the role of Equity Capital Market Syndicate Group in terms of underwriting?
A
Two roles:
A) to coordinate with sales force management to decide among investors when demand for the security exceeds supply
B) To ultimately decide the price range at which the security is offered and the final price at which the security will be sold
12
Q
Is it true that a fairness opinion must always be provided by a bank that is not advising the selling company?
A
it SHOULD be the case than a fairness opinion is provided by an independent third-party (bank), since this would eliminate the bias that would be present if the IB has an interest in the deal going through. BUT, typically, the IB that acts as a sell-side advisor has all the insight and information about the company, and the process would be more difficult if another independent IB was to acquire all relevant data and information itself. So, the answer is that this SHOULD be the case from a fairness POV, but the involved IB to do the fairness opinion is not legally prohibited from it.
13
Q
Is it true that a fairness opinion gives an opinion on the merits of the deal’s strategic rationale?
A
No. A fairness opinion states the fairness of the deal from a FINANCIAL POV – not strategic.
14
Q
IB clients can be categorized into two broad groups; issuers and investors. The two groups have competing objectives. Who within the IB is responsible for balancing these competing interests?
A) Prime brokerage
B) Equity capital market
C) Sales and trading department
D) Private wealth management division
A
The capital market division helps issuers of securities, while also helping investors. This department links the two groups of clients.
15
Q
Which valuation method tends to typically show the LOWEST valuation range?
A) Comparable comp
B) Comparable transaction
C) DFC with synergies
D) A, B and C typically give the same valuation
A
A) Comparable Comp:
- In comparable transaction analysis, there is control premium and synergy.
- In DCF with synergies (we have synergies).
Therefore, comparable companies valuation, which is based on stock prices and enterprise value provides the lowest valuation range since shareholders do not pay a premium for neither control nor synergies.
16
Q
In a merger, the breakup fee:
A) Is paid by the target to IB
B) Is paid by acquirer if deal does not go through
C) Is NOT paid by anyone of the deal closes
D) Is paid by target if it does not sign the merger agreement
A
C) It is not paid by anyone if deal closes
The breakup fee is paid by the target company if it walks away AFTER signing the merger agreement.
This serves as a “penalty” for walking away, e.g., if the target gets a better offer.
The REVERSE BREAKUP FEE is paid by the acquirer if it walks away AFTER signing the merger agreement.
17
Q
What is a potential risk of trying to complete a stock-based acquisition during periods of high market volatility?
A) if it is a fixed exchange ratio deal, significant fluctuations in share prices could lead to high variations in the final economic deal value.
B) If it is a floating exchange ratio deal, significant fluctuations in share prices could lead to high variations in the final economic deal value.
C) If it is a floating exchange ratio transaction, a down market (acquirer stock price decreases) could lead to more shares issued by the acquirer to pay for the transaction, thereby diluting acquirer shareholders more.
D) A + C are correct
A
Answer: D (A+C)
A) Fixed exchange ratio deal: # of shares exchanged in the deal is fixed, BUT, if the stock price of acquirer decreases significantly, target shareholders ends up getting very little economic value from the deal. Meanwhile, if the price of acquirer increases significantly, the target shareholders get higher economic value from the deal than expected.
B) Floating exchange ratio deal: not correct. A floating exchange ratio means that the economic value of the deal is fixed, and given changes in stock prices, the exchange ratio will adjust accordingly to ensure that the final economic value is equal to the predetermined deal value. (THEREFORE NOT A RISK IN TERMS OF ECONOMIC VALUE)
C) The problem with floating exchange ratio: if the acquirer stock price decreases, the acquirer must give in more shares, so the equity stake that target shareholders ends up being larger. I.e., the acquirer shareholder’s equity will dillute
18
Q
Why were pure-play IBs able to operate at much higher leverage ratios than bank holding companies?
A) IBs were able to convince SEC that they could make more accurate estimations of capital requirements by using internal models, as compared to adhering to the capital requirements, leverage, etc. laid out for deposit-taking institutions (bank holding comps).
B) The whole difference between the regulation posed on banks holding comp (commercial banks) and IBs stems from the commercial bank’s deposit-taking activity
C) both
D) none
A
Two reasons:
A: IBs were able to convince SEC that they could make more accurate estimations of capital requirements by using internal models, as compared to adhering to the capital requirements, leverage, etc. laid out for deposit-taking institutions (bank holding comps).
B) the whole difference between the regulation posed on banks holding comp (commercial banks) and IBs stems from the commercial bank’s deposit-taking activity.
19
Q
Why might a universal bank be better able to compete against a pure-play IB for M&A and other IB engagements?
A) Universal banks are better able to use their balance sheet to lend money to clients
B) Universal banks are only regulated in their country of incorporation
C) Some companies prefer doing business with a bank that can provide loans and IB products like M&A
D) A + B
E) A + C
A
E) A + C is correct.
Universal banks, with their commercial banking activities are better able to provide loans to their clients. This is likely preferred by the client that is advised in a transaction.
• Recall: Freeport McMorran: the bridge loan provided to the client was syndicated and sold to other banks, since the IB was not able to grant the loan directly.
20
Q
What is “dry powder” in PE?
A) Capital committed by LP
B) Capital invested by GP
C) Investment capital committed by LP
D) Capital committed by LP that, net of lifetime management fees, has still not been invested
A
D: Capital committed by LP that, net of lifetime management fees, has still not been invested
21
Q
What are positive consequences resulting from large increase in no. hedge funds around the world?
A) Increased market liquidity B) More efficient asset pricing C) New sources of capital for borrowers D) Increased financial innovation E) All of the above
A
E) All of the above
22
Q
PE Managers are:
A) usually paid periodic performance fees
B) usually paid a large chunk of the price coming from selling their fund’s portfolio companies when the sale occurs
C) are subject to hurdle rates when receiving performance fees
D) often paid transaction fees by their fund’s portfolio companies
E) C + D
F) B + D
A
E) C + D
C) PE funds are subject to hurdle rates when receiving performance fees
D) often paid transaction fees by their fund’s portfolio companies
Why B is Wrong: The PE fund is paid a large chunk of the PROFIT (above hurdle) from the sale of their portfolio companies, NOT a chunk of the price.
23
Q
How were senior tranches of a CDO able to obtain investment-grade ratings when some of the underlying assets were non-investment grade?
A) lower tranches absorb initial losses
B) rating agencies, issuers and investors believed that risk could be limited through diversification of assets underlying CDO
C) Rating agencies, issuers and investors believed that by slicing the CDO into tranches, the risk of the underlying pool if assets were greatly reduced for senior tranches
D) All options are correct
A
A) correct: There is a senior tranche of a CDO, a mezzanine and a junior tranche. The tranche that absorbs the first losses is the junior tranche. Then, if losses is too large, exceeding the junior tranche, losses are absorbed by the mezzanine tranche. Only when the losses are beyond absorbable for the mezzanine tranche, will the loss be absorbed by the senior tranche.
B) correct: It is true that risk can be limited through the diversification of assets underlying the CDO (e.g., geographical diversification).
C) correct: This essentially has the same meaning as A.
24
Q
Why do many large institutional investors lend their shares to IBs, who re-lends to other parties?
A) To create a bearish position in a stock
B) As a means of enhancing return coming from holding that asset
C) To hedge downside share price risk positions
D) For tax purposes
E) All of the above
A
B) As a means of enhancing return coming from holding that asset
Explanation of Wrong A: Creating a bearish position in a stock: is a position that generates the investor profit if the price goes down (bearish market)
25
HFs create leverage by:
```
A) margin loans from banks
B) fire sales whose proceeds are used as collateral for obtaining loans from banks
C) repo agreements
D) Derivatives
E) A+C+D are correct
F) All of the above are correct
```
E) A+C+D are correct
| Margin loans, derivatives & repo agreements
26
Which of the following is a strategy that HFs employ to mitigate dangers of asset/ liability mismatch?
```
A) Lock ups
B) Gates
C) Side pockets
D) Suspensions on withdrawals
E) All of the above
F) A + B + D
```
E) All of the above
In a closed-end fund, the investors have no redemption right until the fund is liquidated.
In an open-end fund, the investors may choose of withdraw their invested capital app. every quarter.
A) Lockup: investors’ capital is locked up in the initial period after the fund has been raised
B) Gates: kicks in after lock-up period. This provision limits the amount of withdrawal of investors. This limit is usually a x% of total AUM of the HF
C) Side pockets: park illiquid hard-to-value assets. Only investors who were already participants in the fund at the acquisition of the illiquid asset will participate in the ownership of this asset
D) Suspension on withdrawals: given liquidity trouble and given mismatch of assets and liabilities, HFs can suspend any withdrawals.
27
Why are average returns coming from investing in HFs an unreliable measure of HFs' ability to create value?
A) Due to high skewness of HFs' results: median return is much higher than average return, indicating top performers' create superior value than the rest
B) Low mandatory disclosure implies that the data used to track HFs' performance are biased - i.e., not all HFs' performances are incl. in data
C) Average returns do not take into account that HFs' returns might be obtained at lower risk
D) All of the above
E) Only A and B
D: all of the above are correct
A) Due to high skewness of HFs' results: median return is much higher than average return, indicating top performers' create superior value than the rest
B) Low mandatory disclosure implies that the data used to track HFs' performance are biased - i.e., not all HFs' performances are incl. in data
C) Average returns do not take into account that HFs' returns might be obtained at lower risk
28
Mutual fund managers have a ___ role and their compensation is typically based on ___ of the AUM
A) Intermediary; the amount
B) Intermediary; the performance
C) Advisory; the amount
D) Advisory; the performance
A) Mutual fund managers have a INTERMEDIARY role and their compensation is typically based on AMOUNT of the AUM
Mutual funds are paid a fee that is based on AUM.
They don’t advise, they solely trade (act as intermediary).
29
Following is TRUE about Credit Default Swaps (CDS):
A) are often used by HFs as a way to increase leverage
B) can be bought by investors who don't hold the underlying security
C) can be traded by insurance companies only
D) have been heavily used by PE firms to magnify returns in LBO deals
Answer: B
Credit Default Swap (CDS) is basically an insurance policy – you pay a premium, in exchange, if the underlying asset (whose credit risk is insured) defaults, the insurer/protection seller compensates you.
• Difference between CDS and insurance policy: if you buy protection, you don’t have to own the underlying asset insured. You can bet/speculate by buying the CDS.
30
Following is true about the (EBITDA-CAPEX)/ (Interest expense + amortization) ratio:
A) Measures firm leverage
B) Measures firm's ability to cover debt service. It must always be below 1 for an LBO deal to be sustainable from the POV of the lender
C) Measures a firm's return on investment
B)
The ratio measures a firm’s ability to cover debt service. If the ratio is above 1, it means that the CFs produced by the assets of the firm are enough to cover debt interest and amortization.
31
Funds of funds have sold themselves to investors on the basis that they offer some key benefits. Which of the following are NOT among them?
A) Diversification among HFs
B) Due diligence process of HF managers
C) Savings on cost for a result that is similar to the one delivered by direct investment in HFs
D) Access to HFs for investors who do not meet the minimum investible capital criterium
C) you have to pay for the HF fees AND, on top of this, you have to pay the FoF manager. So FoF investment is more expensive from a fee POV than direct investment in HFs.
All the others are true.
32
In the Magnetar Peleton case, is it true that:
one of the two funds would have been able to fetch a very good return to its investors during 2007 anyway because it was exploiting a price misalignment between different CDO tranches. The fund went long and short in different tranches in order to exploit price misalignment.
In one of the funds, (Peloton) the managers received a prize due to outstanding performance during 2007. But they failed miserably in 2008. When Peloton defaulted, it was investing in mezzanine tranches.
Yes or No?
Yes
33
The output of an LBO is___
| while the output of a DCF is___
The output of an LBO is IRR
| while the output of a DCF is PV of future CFs (company enterprise value)
34
```
Which of the following is an alternative asset?
A) Real estate
B) HFs
C) PE
D) All of the above
```
D) All of the above- Real estate, HFs and PE are all alternative asset classes
35
When are management fees paid to a PE fund GP?
A) Every contractually agreed upon period
B) PE funds GPs are not paid any management fee
C) When returns from investment are higher than the hurdle rate
D) When the sale of a portfolio company generates a profit
MANAGEMENT FEE is paid every contractually agreed upon period.
PERFORMANCE FEE is paid when returns from investment are higher than the hurdle rate
36
The NAV of a HF has been following the following path:
```
Inception= 100
Q1 = 90
Q2 = 120
```
What is the performance fee paid to HF given a high-water mark clause and 20% performance fee in Q2?
You always have HWM Clause in HFs. Given the high-water mark clause, HF managers are only paid a performance fee on the portion of the NAV that exceeds the highest historical NAV. So, given 20% performance fee, the performance fee to be paid in end of 2nd quarter is:
Performance Fee of 20%(HWMClause) = (120 -100)*0.2 = 4
37
Equity bridges are offered to PE fund clients with the purpose of...?
Equity bridges: in PE funds, investors have committed an amount of capital to the PE fund. Whether the investor actually has this money can be uncertain. So, as a PE fund bids on a target company, the target shareholders may, due to mistrust, not believe that the fund has the money available, and therefore reject the offer.
LPs may have problems with providing the capital they have committed to PE fund. Therefore, to reassure target shareholders, IBs can step in and provide a temporary loan (equity bridge): which is a commitment where the IB will give the money to the target shareholders if there is an issue with the payment of LPs.
38
Following is true about IBs:
A) IBs are never allowed to manage mutual funds due to conflict of interest problems
B) IBs also run HFs, even though they compete with some of their biggest clients for investors' money
C) When advising clients on managing their wealth, IBs are prohibited form recommending their own products
D) IBs systematically exploit their wealth management division clients' trust in order to have them buy securities they are underwriting and that are hard to sell
B) IBs also run HFs, even though they compete with some of their biggest clients for investors' money
39
IB Traders....
A) Cannot be involved in primary market deals
B) Are not allowed to trade outstanding securities issued by firms that are launching a public offering with the bank
C) Whenever asked, they supply sales professionals with prices for their clients
D) Have always the goal of maximizing the bank client's profits, even if that implies losses for the bank
C) Traders, whenever asked, supply sales professionals with prices for their clients
40
```
Which type of transaction has the highest probability of success?
A) Sell-side transaction
B) Buy-side transaction
C) Mergers of equals
D) Joint Venture
```
A) Sell-side assignment: the IB gets a mandate to find a buyer.
Sell-side transactions have the highest probability of deal success because the seller is often financially constrained and therefore often desperate to “get rid” of certain assets/divisions
Buy-side assignment: the buyer wants to buy assets of another firm, often for strategic reasons. The assignment is often more difficult to complete because the acquirer firm is pickier.
41
```
A transaction where two firms contribute assets and form a new entity to undertake economic activity together is called:
A) Merger of equals
B) Joint Venture
C) Sell-side assignment
D) Public market seperation
```
B) Joint Venture
42
The following is NOT true for a Public Market Separation mandate:
A) It incl. carve-out, spin-off, and tracking stock
B) Completed by the IB department in coordination with equity capital market group
C) Concerns the defense against a specific take-over proposal
D) Concerns work to deter future unsolicited take-over activity
E) A+B
F) C+D
WRONG ANSWERS:
C) Concerns the defense against a specific take-over proposal
D) Concerns work to deter future unsolicited take-over activity
Both are part of the M&A product called "hostile defense" and not "public market separation"
43
The example of Ferrari being “separated” from the rest of the group due to it being perceived as a luxury car brand and therefore its stock may be of higher value than without the separation is an example of:
A) Joint-venture
B) Sell-side assignment
C) Hostile defense
D) Public market separation
D) Public market separation
44
IBs are legally prohibited from advising hostile bidders by giving strategic and tactical advice on initiating and unsolicited take-over
TRUE/ FALSE
FALSE - It is one of the underlying products of a "hostile takeover" which is one of the businesses of IBs.
45
Which is the largest source of profits generated by an IB (on average)?
A) Stock issuance - helping issuers raise capital from the market
B) Trading - selling/ acquiring securities for investors
C) Research - providing insights to sales department
D) Helping clients raise money from various types of debt instruments (the debt capital market division)
B) Trading: the fees that the trading department in an IB gets from investors are on average higher than the profits generated from stock issuers (bc. it only issues stocks once in a while).
Trading carries extremely high weights in terms of an IB’s revenue - around 23.2% of total revenue on average
46
```
The interest of investors is typically in contrast to the interest of the issuer. Who within the IB is responsible for balancing these different interests?
A) Equity capital market group
B) Debt capital market group
C) Trading division
D) M&A group
```
A) The equity capital market group act as intermediaries between the clients of other parts of the bank: link issuer of stock to investors:
Their key role is to balance the demands of investors in the securities they offer (who want to pay as low a price as possible) vs. those of the issuing clients (who want to sell their stocks at the highest possible price).
47
```
The Fixed Income, Currencies and Commodities business is a responsibility of:
A) Trading division
B) Capital markets group
C) Debt capital market group
D) M&A division
```
A) Trading division
48
Trading refers to selling and buying securities. The trading divisions can trade either on behalf of outside clients or directly on behalf of the bank.
TRUE/ FALSE
TRUE - can trade both for clients and the bank itself
49
Legally, and IB has no limitations in terms of proprietary trading and principal investing - i.e., it is assumed that the IB can take on as much risk as they wish because they have trading professionals who are capable of selecting good investments from bad ones.
TRUE / FALSE
FALSE: Financial reform legislation limits the risk that IBs can take on through direct own investments (the bank’s own investments).
50
Following is NOT true about proprietary trading:
A) It is the one direct investment activity pursued by the IB that is not managed by the trading division
B) It may involve the trading of stocks, bonds, commodities, currencies, or other instruments
C) Focused on investments in securities, commodities and derivatives in a manner similar to the trading activities of hedge funds
D) From time to time, major trading scandals emerge due to individual “rogue traders”
WRONG: A) It is the one direct investment activity pursued by the IB that is not managed by the trading division
Proprietary trading is managed by the trading division
51
Rogue Traders typically play with high-risk investments that can produce huge losses or gains. They may take so much risk that they put the firm at risk of bankruptcy.
TRUE/ FALSE
TRUE
52
Asset managers receive fees from managing money and share these fees with Private wealth advisors. This may create a conflict of interest. How?
A) Private Wealth advisors can advise clients to invest with the IB's Asset Managers even though they might not be the best in the market
53
Mutual fund investments in an IB are managed by:
A) Trading division
B) Capital market division
C) Asset management (asset management division)
D) Private wealth management (asset management division)
C) Asset management (asset management division)
54
Alternative investment covers:
A) Fixed income, currencies, commodities
B) Private equity, mutual fund, real estate funds
C) Private equity, hedge fund, real estate funds
D) Fixed income, hedge funds, private equity
C) Private equity, hedge fund, real estate funds
55
If the ____ fund obtains a loan to invest for, the debt will be in the balance sheet of the firm to be acquired. This is different from a ____ fund leveraged investment, where the fund is the borrower. The ___ fund investments have a longest maturity.
A) PE; Hedge fund; PE
B) PE; mutual fund; HF
C) Hedge fund; PE, PE
D) PE; mutual find; mutual fund
A) PE; Hedge fund; PE
56
```
Which of the following funds is(are) an open-ended fund?
A) PE
B) Real estate fund
C) Mutual fund
D) A + B
E) B+C
```
C) mutual fund is the only "open-ended fund".
Open-end: investment is easily liquidated – investors can exit when they want.
Closed-end: you can only sell the investment by selling it to another investor who wants to enter your place. Investors don’t have the right to get the investment liquidated by the asset manager as they want
57
Which of the following funds uses the least leverage in their investment?
A) PE
B) HF
C) Mutual fund
C) Mutual fund
Both PE and HF obtain investment capital from quite handsome levels of leverage.
58
```
Provided that the cost of debt is lower than the return of the investment, leverage has ___ effect on the positive investment return:
A) amplifying
B) depends on the level of debt
C) decreasing
D) has no effect
```
A) Provided that the cost of debt is lower than the return of the investment, leverage has an amplifying effect on the positive investment return
59
```
If the cost of debt is equal to the return on investment, debt has ___ effect on the positive investment return:
A) amplifying
B) depends on the level of debt
C) decreases
D) has no effect
```
D) has no effect - I.e., return on assets will be the same as if the investment was done without leverage because the extra return made possible through debt is only just offset by the cost of debt.
NOTE: in this case, it is actually better to not take on debt, because you don't get an extra profit, plus you now have higher leverage -> higher risk
60
```
If the cost of debt is higher than the return on investment, debt has ___ effect on the negative investment return:
A) amplifying
B) depends on the level of debt
C) decreases
D) has no effect
```
A) if the cost of debt is higher than the return on investment, debt has AN AMPLIFYING effect on the negative investment return
If you are losing money, your loss is magnified by the fact that you have invested a higher monetary amount compared to no leverage, and by the fact that the lenders must be paid back.
61
```
The advisory and asset management activities of IBs imply which risk(s)?
A) liquidity risk
B) foreign exchange risk
C) reputational risk
D) interest risk
E) all of the above
```
C) The advisory & asset management activities imply no risk besides a reputational one.
62
Given the significant risks that asset-backed securities can have, why are they still an attractive business for investment banks?
A) High demand from clients for the product
B) Significant source of fees
C) Asset-backed securities are not risky because they are asset-backed
B) The business was very lucrative because of the fees. They started to buy these asset-backed securities because the return was higher than same-rating bonds.
Example of why ABS can be VERY RISKY:
When the real estate market collapsed in the U.S., the payment flows stopped and the mortgagers defaulted on their payments, leading to commercial banks not receiving payment, hereby not being able to pay investment banks, which in turn could not pay the special purpose vehicle, and ultimately, the investors did not get their money. The chain of payment stopped.
63
According to SEC (Securities act 1933),
A) Investment banks are liable for law violation if material facts are left out, or misstatements are made in the registration statements and prospectus
B) When issuing a bond, a description of the firm’s properties and business and the security to be offered for sale is required, as well as information about the management of the company and financial statements certified by independent accountants.
C) To make sure that the issuer gives all important information to the investment bank, due diligence was required to be carried out by the bank
D) All of the above
E) A+B
D) All of the above
64
The biggest impact on IBs from the Sarbanes-Oxley Act (2002) was: select 1-4
A) Research division must be separate from underwriting division (capital market)
B) Research analysts’ compensation can no longer be based on underwriting revenues in the same bank
C) Research analysts' compensation must now be a part of the trading division revenue
D) Research analysts who provide a negative report on a company are protected from retaliation from underwriters
A) Research division must be separate from underwriting division (capital market)
B) Research analysts’ compensation can no longer be based on underwriting revenues in the same bank
D) Research analysts who provide a negative report on a company are protected from retaliation from underwriters
65
Global Research Settlement (2003) had the following implications on IBs: choose 1-4
A) Restriction on communications between the research and investment banking divisions: no influence on research opinions or coverage was now allowed
B) No payment of compensation of influence promotion
C) Disclosure on potential conflicts of interest to clients: the (research) analysts have to list all the business the bank is doing on behalf of clients to those the bank is doing research reports on
D) Clients should have access to third-party independent research
E) The practice of “spinning” hot iPOs became restricted: selling stocks in “hot” IPOs to certain executive officers (with the hope of gaining future favors) was prohibited
F) All of the above
G) A, B, D, E, F
All of the above
66
The Gramm-Leach-Bliley Act (1999) was deregulation that removed the mandatory separation of commercial and investment banks. The advantages of this were:
A) Creating a more stable business model for banks (=IB+commercial): in bad times, commercial banking deposit revenues increased, while in good times, cash deposits were low, but new issuance activity would be high (IB).
B) Meet the competition from foreign banks: foreign banks were not required to follow Glass-Steagall, and they had already combined investment and commercial banking.
C) Both
D) None
C) Both
A) Creating a more stable business model for banks (=IB+commercial): in bad times, commercial banking deposit revenues increased, while in good times, cash deposits were low, but new issuance activity would be high (IB).
B) Meet the competition from foreign banks: foreign banks were not required to follow Glass-Steagall, and they had already combined investment and commercial banking.
67
The Dodd-Frank Wall Street Reform & Consumer Protection Act introduced a set of requirements. Which of the following requires large financial companies to submit plans regarding how they would shut down if they were to fail in the future?
A) Volcker rule
B) Regulation of over-the-counter derivatives
C) Funeral plan
D) Reporting requirements
C) Funeral plan
68
The Dodd-Frank Wall Street Reform & Consumer Protection Act introduced a set of requirements. Which of the following limits banks proprietary trading activity and principal investing?
A) Volcker rule
B) Regulation of over-the-counter derivatives
C) Funeral plan
D) Reporting requirements
Volcker Rule: “…restrict US banks from making certain kinds of speculative investments that do not benefit their customers.”
Volcker Rule: (1) asked banks to put their “skin in the game” for securitized products. I.e., if you want to create an ABS, you must keep a portion of the risk on your balance sheet, since this decreases the incentive of engaging in too much risk.
Volcker Rule: (2) strong limitation on proprietary trading.
69
Which of the following is NOT a service provided by the trading division?
A) execution of client trading orders
B) supplying liquidity services through market making
C) helping the bank execute proprietary trading
D) contact clients with investment proposals
E) offer prime brokerage services to e.g., hedge funds
WRONG: D) contact clients with investment proposals. This is done by the sales department
70
Traders must ensure that every trade is profitable for the bank, even if entails that the investor (client) makes a loss
TRUE/ FALSE
FALSE
If a client cannot trade profitably with an IB, he/she may eventually stop trading with the bank. Hence, with IBs being the counterparty to the investor, sometimes traders decide to accept lower trading margins (and occasional losses) to accommodate client investment objectives.
71
In primary market transactions, the trader of an IB must balance the interests of the issuer and investors. The trading price must reflect balancing. What is true about the price?
A) If the price is too low, the bank will not be given any mandate in the future by the issuer
B) If the price is too high, demand from investors will be smaller
C) If the IB underwrites, it means that they are financially engaged and will lose money if the fixed price set on the security is too high (excess supply)
D) All of the above
All of the above
72
If an IB underwrites a primary market transaction (IPO), the following is true:
A) underwriting is a risky activity since the bank is financially engaged
B) IB purchases securities from the issuer and resells them to investors at a profit while standing ready to repurchase the security
C) the pricing of the security must be high enough to satisfy the issuer, but low enough to satisfy investors and include a margin for IB
D) All of the above
D) All of the above
73
The term market maker refers to when an IB actively quotes two-sided markets in a particular security, providing bids and offers (asks) along with the market size of each. Market makers provide liquidity and depth to markets and profit from the difference in the bid-ask spread.
TRUE/ FALSE
TRUE
74
Following is NOT true about "market making"
A) Market-making services are only demanded if finding counterparties for a security trade is difficult or time demanding
B) The IB quotes a bid or offer price for securities the client wants to sell/buy
C) IB profits from this activity by capturing the bid-ask spreads
D) this activity is risk-free
D) this activity is risk-free - no.
The risk involved in capturing bid-ask spreads depends on the liquidity of the market and the complexity of the security.
75
Following is NOT true about the Proprietary trading activities of IBs:
A) They have become significant competitors to HFs who are the most important clients of the IBs client-related trading business
B) They are responsible for balancing their own profitability interest wit those of their clients (HFs)
C) The competition between IB and HFs have decreased HFs interest in trading with IBs with large proprietary trading businesses
D) Even if proprietary traders are allowed to trade with their own IB trading department, they always trade with other trading departments (including competing IBs)
WRONG: B) They are NOT responsible for balancing their own profitability interest wit those of their clients (HFs). I.e., they prioritize their own profits over that of clients' (HFs)
76
Even when proprietary traders are allowed to trade with their own firm, they always trade with others too, including competitor firms, and will execute transactions with whichever firm best enables them to achieve profits and mitigate risks.
A) TRUE
B) FALSE - the proprietary traders always prioritize to trade with the internal trading department because it allows for higher holistic profitability of the bank
TRUE
77
```
Which of the following is NOT an activity conducted in the trading division?
A) Client-related trading
B) Proprietary trading
C) Prime brokerage
D) Secures long-term financing
```
D) Secures long-term financing
78
```
Following is NOT a service offered by the prime brokerage division:
A) Trade clearing
B) Securities lending
C) Custody and settlement
D) Direct contact with clients
E) Performance measurement and reporting
```
D) Direct contact with clients
79
In a short-selling arrangement, the change of ownership of the security implies that whenever short buyers (investor buying) receive dividends, the borrower (and short-seller- e.g., HF) must pay to the lender (long-term investor initially owning the security) a cash amount that is equivalent to that dividend payout (so the original owner of the share still receives an equivalent to the dividend payout).
TRUE/ FALSE
TRUE
The short buyer receives dividends if title is held on a “record date”, and is able to vote if a shareholder election is held.
The stock loan agreement provides that whenever dividends are paid out under the ownership of short buyer (investor), the security borrower (HF) must pay to the lender (LT-owner of security) a cash amount that is equivalent to the dividends received.
I.e., the original owner of the share still receives an equivalent to the dividend payout
80
Following is NOT true about a security lending arrangement:
A) The lender of security are typically long-term institutional investors
B) Short sellers are the borrowers
C) The original owner of the security gets a cash collateral (higher than the value of the security lent)
D) In the event of borrower default, lender keeps entire collateral and interest income generated during lending period
E) If borrower doesn't default, lender gets back security + rebate
F) All are true
E) IS NOT TRUE
If borrower doesn't default, lender gets back security plus the money market rate minus rebate.
The rebate is the interest rate paid by the lender to the borrower for the cash collateral.
81
Following is NOT true about the rebate amount:
A) it is the interest rate paid by security lenders to security borrowers for the cash collateral.
B) the lower the rebate, the higher the effective cost of the security borrower (bc. receives a lower interest)
C) Rebate depends positively on attractiveness of borrowing the security and the liquidity
D) The profit of IBs for making security lending possible is a portion of the lender's profit (market rate - rebate rate)
WRONG: C)
Rebate depends NEGATIVELY on the attractiveness of borrowing the security and the liquidity.
I.e., if high attractiveness to borrow (demand), rebate is lower (cost of borrowing is higher)
82
Following is NOT true about naked shorting:
A) refers to when equities are sold short without owning the share and without borrowing the share.
B) It is an illegal practice in all manners
C) Has a short time frame (usually 2-3 days)
WRONG: B) It is an illegal practice in all manners.
It is legal if the negotiation/sale and the settlement takes place at two different times (2-3 days’ time interval usually). That means, the seller would have 2-3 days to acquire the security in question. It is banned in US unless there is a legitimate and justifiable reason to do so
83
What is a margin call?
When hedge funds borrow cash from IBs (margin loans), the use of securities as collateral is required. If the value of the collateral drops over time, banks will exercise margin calls to receive payment of a portion of the loan
84
Following is NOT true about a CDO
A) Stands for Collateralized debt obligation
B) Traded in the FICC department of trading
C) Investors purchasing CDOs receive a slightly higher coupon than similarly rated straight bonds
D) Three tranches are created in a CDO, reflecting the repayment priority
E) All are true
E) All are true
85
In a CDO, the senior debt holders are paid back first (1st. repayment priority), while they also receive the highest return (coupon rate).
TRUE/ FALSE
FALSE
It is true that senior debt holders have the 1st repayment priority BUT, they enjoy the lowest coupon (return) out of the three tranches (senior, mezzanine and equity/junior)
86
In a CDO, a very risk-averse investor would choose to invest in the ____ tranch
A) Senior
B) Mezzanine
C) Equity/ junior
A) Senior tranch
87
Asset-backed securities are of ___ risk than investing in the senior tranche of a CDO
A) Higher
B) Lower
Asset-backed securities are of HIGHER risk than investing in the senior tranche of a CDO
With ABS, if 5/100 debtors default, everyone in the chain will loose 5. If 5/100 in a CDO default, senior tranche will be the last of the three tranches to suffer any loss.
88
Consider the following:
An investor buys $10m of a 5Y $100m face value bond. He wants to protect his investment risk by entering into a ____ on a $10m notional amount. The investor will pay 2% annually of the notional amount for 5Ys. In exchange, if the bond defaults, the investor gets the right to sell the defaulted bonds to the credit protection seller at the notional value.
A) CDO
B) CDS
C) CDB
B) CDS: credit default swap
89
CDS credit protection of a company becomes ___ expensive upon completion of a PE fund takeover with LBO.
A) more
B) less
CDS credit protection becomes MORE expensive upon completion of a PE fund takeover with LBO, because the corresponding increase in riskiness of default of the portfolio company makes the CDS more expensive
90
A separately managed account (SMA) is NOT:
A) a customized portfolio of assets managed by a professional asset manager
B) allows for more customized investment strategy than pooled investment vehicles like mutual funds
C) provide tax benefits through direct ownership of securities
D) fees of a SMA is around 1-3% of AUM
E) Targets low net-worth investors who don't know how to invest
WRONG: E)
A separately managed account (SMA) is NOT targeted to low net-worth investors who don't know how to invest. Instead, they target very wealthy individuals
91
Pooled investment vehicles target only non-wealthy investors who want to invest only a small amount of capital.
TRUE/ FALSE
FALSE:
PIV does aggregate investments from individuals, providing an opportunity for investors to participate in investments otherwise available only for larger sophisticated investors or financial institutions.
But PE and HFs are also PIV, which does not grant participation to un-wealthy investors
92
Mutual funds are only open-end
TRUE/ FALSE
FALSE
Mutual funds can be either open-end or closed end.
In the former, investors can enter&exit as they want. In the latter, investors can only exit if someone else is willing to take over the position or when the life of fund ends.
93
What is NOT a reason for ETFs sometimes being more popular than mutual funds?
A) ETFs save money because it doesn't have to respond to smaller requests from investors
B) ETFs get higher returns by larger amounts of investments
C) Cost of ETF is lower than mutual funds
D) It is not more popular since it is more illiquid than mutual funds while not providing an excess return
WRONG:
D) It is not more popular since it is more illiquid than mutual funds while not providing excess return
ETF ARE MORE POPULAR THAN MUTUAL FUNDS because they generate higher returns by larger investments, while the cost of such vehicles are lower than similar mutual funds
94
```
Which of the asset classes are most popular in asset management?
A) Equity
B) Fixed income
C) Alternatives
D) Cash
E) Two of the above: but which?
```
E) Two of the above:
- Equity
- Fixed income
95
In the US, the IB and its employees cannot invest in the IB's own in-house hedge fund
TRUE/ FALSE
TRUE - it is allowed in other countries, but not in US.
It is not the same a proprietary trading - which is allowed
96
```
In asset management, fees are paid based on the given asset class. Which class has the highest fees?
A) Equity and convertible
B) Bond and convertible
C) Index
D) Alternative asset classes
```
D) Alternative asset classes
97
The following division in private wealth management targets the investors with different net worths. Rank each division from high to low network segment:
A) Retail brokerage
B) Private banking
C) Private client servicing
High: Private banking
Mid: Private client servicing
Low: retail brokerage
98
Why may a conflict of interest between the Wealth Management advisory function and the Asset Management Function in an IB arise?
Wealth Management advisors at IBs have a duty to help clients achieve the best possible returns in the context of their risk tolerance. So, in some cases, investing clients may be directed to investment products not provided by the investment bank itself, but a competing asset manager.
99
```
Which of the following is NOT an area covered by the research department? Reseach in____
A) Equity
B) Fixed income
C) Commodities
D) Economic: macroeconomic activity
E) Currencies
```
Currencies is not a research area of an IB
100
Research that is conducted within an IB for the use of
investing clients of the firm is:
A) Sell-side research
B) Buy-side research
C) Propieratry research
A) Sell-side research
101
Research that is provided to proprietary traders who trade for the account of the bank and to the bank's asset managers is:
A) Sell-side research
B) Buy-side research
C) Propieratry research
B) Buy-side research
102
Following was NOT part of the 2003 Research Settlement: Choose 1-4
A) There must be a physical separation between research and IBD
B) Research management must make all company-specific decisions to terminate coverage, and IBD can have no role in company-specific coverage decisions.
C) In addition to providing own internal research, investment banks are obliged to furnish independent research to investing clients
D) Any influence by the IBD over the research must be eliminated
All four are correct
103
A regulated market is when long-term capital market financing is obtained through the issuance of a security which is sold to ______. If it is sold through a private placement, it means it is ______. Meanwhile, the bank underwrites ____ in a private placement.
A) the general public; limited number of investors such as institutions and banks; noting
B) the general public; limited number of investors such as institutions and banks; everything
C) limited number of investors such as institutions and banks; the general public; everything
A regulated market is when LT capital market financing is obtained through the issuance of a security which is sold to the GENERAL PUBLIC. If it is sold through a private placement, it means it is LIMITED NO. INVESTORS. Meanwhile, the bank underwrites NOTING in a private placement
104
Following is NOT true about a private placement: coose 1-5
A) concerns taking a listed company off the market
B) concerns long-term funding through issuance of security
C) targets the general public - everyone can buy the security
D) the issuer is not mandated to disclose any information when doing a private placement
E) The IB does not underwrite anyting
Private placement does NOT concern taking a listed company off the market (A) AND it does NOT target the general public (C)
TRUE: D) the issuer is not mandated to disclose any information, since the large investors should be able to find out themselves
105
Securities offered in a capital market financing can be:
A) Debt: bonds & loans
B) Equity: common stock
C) Hybrid: e.g., preferred shares or convertibles
D) All of the above
E) A + B
D) All of the above
106
A capital market financing is underwritten by IBs (the bank takes on risk when purchasing securities from an issuer and then reselling those securities to investors) in a _____. In a _____, the securities are not underwritten by the IB
A) private placement; regulated market offering
B) regulated market offering; private placement
B)
A capital market financing is underwritten by IBs (the bank takes on risk when purchasing securities from an issuer and then reselling those securities to investors) in a REGULATED MARKET OFFERING. In a PRIVATE PLACEMENT, the securities are not underwritten by the IB.
107
The first time an issuer issues securities via an IB to investors is a ____. In such case, the offering must be registered with regulators or sold as a private placement to be exempted from this requirement.
A) primary offering
B) follow-up offering
C) secondary offering
D) secondary trading
A) primary offering
108
```
A subsesubsequent sale of securities to the public through an underwriter (a later issuance of a e.g., stock, but not the first time you issue stocks) is a ____
A) primary offering
B) follow-on offering
C) secondary offering
D) secondary trading
```
B) follow-on offering
109
```
When major shareholders of the firm sell their shares to the general public subject to the firm’s agreement, it is a ____
A) primary offering
B) follow-on offering
C) secondary offering
D) secondary trading
```
C) secondary offering
110
```
When investors in a security sell to another investor. This does not affect the issuer of the security. This is a ____
A) primary offering
B) follow-on offering
C) secondary offering
D) secondary trading
```
D) secondary trading
111
```
Which of the following is NOT a service provided by the capital market group?
A) bought deal
B) block trade
C) issuance of debt
D) bridge financing
E) all of them are offered by CMG
```
E) all of them are offered by CMG
Correct:
D) Bridge financing is offered by the leveraged finance division within the capital market group
112
Bridge financing "bridges" the gap between the time when a company's money is set to run out and when it can expect to receive an infusion of funds later on
TRUE/ FALSE
TRUE
113
Underwriting means that he IB buys the security from the issuer and resells to investors.
TRUE/ FALSE
TRUE
114
In an underwriting agreement, ____ is a syndicate of IBs all underwriting the same security offering. The ____ determines the marketing and pricing, and receive the highest underwriting allocation and gross spread. The rest of the syndate are ____ who don't control the process. The ____ takes no risk and receive even lower compensation.
A) co-managers; lead bookrunner; selling group; underwriters
B) underwriters; lead bookrunner; co-managers; selling group
In an underwriting agreement, UNDERWRITERS is a syndicate of IBs all underwriting the same security offering. The LEAD BOOKRUNNER determines the marketing and pricing, and receive the highest underwriting allocation and gross spread. The rest of the syndicate are CO-MANAGERS who don't control the process. The SELLING GROUP takes no risk and receive even lower compensation.
115
```
When an IB (capital market group) commits to buy the entire offering from the issuer (client) - which is very risky - is____
A) Bought deal
B) Block trade
C) Bridge financing
D) Green-shoe option
```
A) Bought deal
116
Convertible bond issuance is less expensive than straight bonds as a financing source due to investors' option to receive a number of predetermined shares in the future
TRUE/ FALSE
TRUE
117
Concerning bonds vs. loans as funding, what is NOT true?
A) Bonds have longer maturities than loans
B) Bonds have less covenants than loans
C) Bond investors accept more risk than banks issuing loans
D) Loan financing is generally more expensive than bond financing
WRONG: D)
Loan financing is generally LESS expensive than bond financing, because bonds are more risky for investors than debt is for banks
118
In a ___ bond underwriting, the issuer bears all the price risk. It is the least expensive bond underwriting types, and is a regulated market deal.
A) bought deal
B) best effort
C) backstop commitment
B) best effort
119
If a bond underwriting is a ____, the IB agrees to purchase the bond at a certain rate to resell it later. The issuer bears no risk (they will certainly get the demanded financing). It is risky for the IB because they bear the price risk. IBs do this more when markets among underwriters is competitive
A) bought deal
B) best effort
C) backstop commitment
A) bought deal
120
If a bond underwriting is a _____, the IB agrees to purchase all the remaining bonds from a offering in exchange for a fee. The price that the IB will pay is pre-committed and reflects the worst-case price for the issuer. I.e., if the market were celared, the price would have been better for the issuer (lower coupon)
A) bought deal
B) best effort
C) backstop commitment
C) backstop commitment
121
Following is NOT trues about asset-backed securities: Choose 1-4
A) are issued with the help of the capital market financing department
B) have interest and principal payments backed by underlying cash flows from other assets
C) IBs pool together several cash flows from underlying assets and sells this pool to investors
D) CDO is an ABS
All of the options are correct
122
Which of the following has the shortest maturity?
A) Bonds
B) ABS
C) Commercial paper
Commercial paper: is a short term promissory note that does not exceed 270 days. Maturities mostly ranges from a few weeks to months, with an average of around 30 days. It is an unsecured debt commonly issued by firms to finance their payrolls, payables, inventories, and other short-term liabilities.
123
The price of an IPO security is often ____ than true value of the company.
A) Higher
B) Lower
C) Depends
B) Lower
To encourage investor interest in an IPO company that does not have a track record as a public company, the price is often set below the true value of the security to tempt investors to buy stock.
124
```
Which process in an IPO is most time demanding?
A) Due diligence
B) File registration statement with SEC
C) Pre-marketing
D) Road show and book building
E) Pricing and allocation
```
A) Due diligence
| See figure on pp. 70 in notes
125
Which firms do IBs typically suggest follow-on stock issuance to? choose 1-4: Firms with:
A) strong stock performance where research suggests BUY
B) overlegeraged capital structure - to increase equity to reimburse some of its liabilities
C) going through a strategic event (e.g. acquisition) or need LARGE CAPEX
D) where there is a misunderstanding EV and a road show can help correct this
All of the above
126
In a fully-marketed stock follow-on distribution, the issuer of the stock bears ___ price risk
A) All
B) None
C) Risk is shared among IB and issuer
A) All
127
```
In a accelerated stock follow-on distribution, the isser bears ____ price risk than in a
fully-marketed
A) more
B) less
C) no
```
B)
In a accelerated stock follow-on distribution, the issuer bears LESS price risk than in a
fully-marketed because the acceleration gives less time for the share price to move around during road show period
128
Which of the three alternatives to follow-on stock distribution entails the lowest share price risk for issuer?
A) Fully marketed
B) Accelerated
C) Block trade
C) Block trade entails full elimination of market risk for the issuer since the IB bears the entire risk for share price fluctuation during road show.
129
Rank the three follow-on distribution alternatives in terms largest to smallest access to a wide pool of investors.
A) Accelerated
B) Block trae
C) Fully marketed
Widest: fully marketed
Narrower: accelerated
Exclusive targeted to few potential investors in a bid: block trade
130
Following is NOT true in a block trade follow-on distribution of stocks:
A) Investors bear no price risk, while IB bears all risk
B) Marketing is limited to sales calls to few potential investors
C) Allows the issuer to get the highest price, but still lower than market value of stocks
D) Investors participate in an auction, and highest bidder gets the shares
E) Red herring prospectus is delivered to potential investors
WRONG: E) no red herring prospectus.
Why C is correct: the block-trade follow-on distribution entails the highest price for the issuers compared to the fully marketed and accelerated distribution methods. However, the price the issuer is to receive is lower than the market stock price, taking into account the compensation paid to the IB for taking on the underwriting risk.
131
Following is NOT true about a "Red herring prospectus"
A) a propectus where information is preliminary (has a red legend on the first page)
B) delivered in connection with a block trade follow-on stock distribution
C) delivered in connection with an accelerated follow-on stock distribution
D) delivered in connection with a fully marketed follow-on stock distribution
WRONG: B) red herring is NOT delivered in connection with a block trade follow-on stock distribution
132
Which of the following options does NOT have the objective to stabilize the equity offering price and mitigate downside share price risk?
A) Overallotment option
B) Green shoe option
C) Fully marketed follow-on distribution
C) Fully marketed follow-on distribution
133
In a green-shoe option, the IB (underwriter) buys stock from _____ if the market price increases, and from ____ if the market price decreases. This stabilizes the market stock price.
A) issuer; market
B) market; issuer
In a green-shoe option, the IB (underwriter) buys stock from ISSUER if the market price increases, and from MARKET if the market price decreases. This stabilizes the market stock price.
134
The Spread is the difference between the price the underwriters pay to acquire the shares from the issuing company and the price the public pays to the underwriter for the shares. This is the fee to IBs (underwriters) from the issuer.
TRUE/ FALSE
TRUE
135
In the SPEAD (the fee that IB gets from issuer for its underwriting service), which of the following accounts for the largest part of this spread?
A) management fee: compensation for IB's role in preparing offering
B) underwriting fee: compensation for underwriting risk
C) selling concession: compensation for selling effort
A) management fee: compensation for IB's role in preparing offering: 20%
B) underwriting fee: compensation for underwriting risk: 20%
C) selling concession: compensation for selling effort: 60%
136
```
Which of the following activity of the capital market finance group generates the highest fees?
A) IPO
B) Follow-on offering
C) Convertibles
D) Bonds
```
A) IPO -> follow on -> convertibles -> bonds
137
Following is true about the time between the announcement date and the closing date of an M&A trasnaction:
A) the deal is approved by regulators
B) the deal must be approved by shareholders
C) the period can be as long as over a year for very complicated transactions
D) the period between announcement and close is extremely important for deals where stock exchange is the deal currency
E) All of the above
E) All of the above
138
Why is the period of time between announcement date and closing date of a deal risky for the parties involved?
When the deal currency is cash, the value of what Target shareholders receive does not change, but when the deal is at least partly paid with acquirer stock, the value of what the target shareholders receive might fluctuate
139
In a ____ share exchange ratio, the ratio of shares is set at announcement (e.g., 2 acquiring company shares for each target share), while for a ____ share exchange ratio, the exchange ratio moves up or down depending on share price movements
A) fixed; floating
B) floating; fixed
In a FIXED share exchange ratio, the ratio of shares is set at announcement (e.g., 2 acquiring company shares for each target share), while for a FLOATING share exchange ratio, the exchange ratio moves up or down depending on share price movements
140
A merger agreement is?
A document that establishes how the post-merger new entity will be shaped in terms of management, BoD, features, etc.
141
When the sell-side client prepares a descriptive memorandum, the wording must be very carefully directed. Why?
The memorandum should made so that a potential buyer is attracted, while making sure that significant confidentiality is not broken
142
Round 1 bids in an M&A deal is binding
| TRUE/ FALSE
FALSE - the bid is first binding after round 2
143
The legal difference between a merger and an acquisition is?
Merger: two individual entities become one new entity
Acquisition: the acquirer absorbs the target into its entity as a new subsidiary. I.e., no new entity is created
144
Following is NOT true about the corporate development group:
A) perform similar tasks as the IB
B) works for the acquiring company
C) determines the M&A strategy
D) have technical skills and knowhow in order to udnerstand fully the M&A process
WRONG: C) the corporate development investigate strategic fitting M&A activities for the acquirer, but the SENIOR MANAGEMENT and the shareholders (with recommendation from BoD) make the final decision
145
The BoD of the target firm is responsible for either recommend or reject a transaction ____ the announcement of the deal to the shareholders.
BEFORE/ AFTER
The BoD of the target firm is responsible for either recommend or reject a transaction AFTER the announcement of the deal to the shareholders.
146
Following is NOT true about a tender offer: Select 1-4
A) acquirer asks target shareholders to participate in the offer (sell their shares to the acquirer)
B) is usually an alternative to when BoD declines a merger agreement
C) is also used if the BoD approves because it is less time consuming
D) In US, the merger will fall through if not 90% of shares of target is tendered
All of the above are correct
147
What of the following is NOT the case if the target BoD does not approve a merger agreement:
A) a hostile takeover is the only option for acquisition
B) the acqurier must go through a tender offer against the will of BoD
C) the transaction goes through if 90%+ of target shareholders accept by tendering
D) the transaction goes through if 50%+ of target shareholders accept by tendering
WRONG: D) the transaction goes through if 50%+ of target shareholders accept by tendering.
The threshold is 90%, not 50%.
148
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Which of the three acquisition methods is only applicable when the target BoD disapproves the transaction?
A) merger
B) tender offer
C) proxy contest
D) asset purchase
```
Proxy contest: is a strategy that may accompany a hostile takeover. It occurs when the acquiring company attempts to convince shareholders to use their proxy votes (votes by one individual or institution as the authorized representative of another) to install new board members that are open to the takeover.
149
Tender offer is only an applicable acquisition method when it is a hostile takeover (when BoD disapproves the transaction)
TRUE/ FALSE
FALSE: tender offer is a possibility for the acquirer to acquire the target even if BoD of target disapproves. BUT, it is also sometimes used when BoD approves to make the merger process faster.
150
In a merger (an acquisition method), the approval of the transaction is usually given by BoD of both buyer and seller. Both assets and liabilities are inherited.
TRUE/ FALSE
TRUE
151
A material adverse change (MAC) clause is NOT:
A) protects target
B) often included in the M&A agreement to protect acquirer
C) comes to effect in the event of material change of the economic substance of the deal after signing but before closure
A) a material adverse change clause does NOT protect target but the acquirer
152
What is a "no shop" provision?
In a "no shop" provision is when the target is not allowed to actively look for alternative buyers. If broken, target must pay a punishment fee.
153
A break-up fee is paid by the ____ if it walks away after signing the merger agreement. A reverse break-up fee is paid by ____ if it walks away from a transaction after signing. If a material adverse change clause is triggered, a ____ is paid by target
A) target; acquirer; break-up fee
B) acquirer; target; reverse breakup fee
A break-up fee is paid by the TARGET if it walks away after signing the merger agreement. A reverse break-up fee is paid by ACQUIRER if it walks away from a transaction after signing. If a material adverse change clause is triggered, a break-up fee is paid by target
154
This ____ is designed to discourage companies from making bids without having a true intention of acquiring the target. They would, in effect, end up paying the fee if successful in their bid but wish to whitdraw.
A) break-up fee
B) reverse break-up fee
B) reverse break-up fee is paid by acquirer if it walks away from a transaction after signing the agreement
155
Merger announcement happens ____ signing of the merger agreement
A) before
B) after
C) at the same time as
C) at the same time as
156
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Which of the following techniques performed in a sell-side deal entails the highest level of confidentiality for the seller?
A) preemptive
B) targeted solicitation
C) controlled auction
D) public auction
```
A) preemptive is maintains the highest level of confidentiality for the seller
157
Following is NOT true about a preemptive sell-side technique: choose 1-4
A) only one buyer is contacted by the IB
B) only few buyers (2-5) are contacted by the IB
C) the deal value tends to be lower due to lack of competiton
D) no information leakage and quick deal execution
E) chosen as the method if the potential loss of information leakage is greater than loss from no competitive bids
WRONG: B) only one (not few) buyer is contacted by the IB.
158
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Rank the following sell-side methods from highest to lowest level of confidientiality maintained by the seller:
A) Targeted solicitation
B) Preemptive
C) Controlled auction
D) Public auction
```
Highest conf: preemptive
Mid-high conf: targeted solicitation
Mid-low conf: controlled auction
Low conf: public auction
159
What is the greatest advantage and disadvantage from a public auction as a sell-side method?
Advantage: highest possible price is obtained by the seller
Disadvantage: preliminary material is distributed to a wide range of potential buyer - a public disclosure is made, which exposes the seller to risk of business disruption and information leakage
160
_____ restructuring takes place when a company is having difficulty servicing its debt obligations and it is forced to reorganize its debt and equtiy to prevent bancruptcy liquidation.
A) corporate restructuring
B) bankruptcy restructuring
B) bankruptcy restructuring
161
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Following is NOT true about corporate restructuring:
A) when a company wants to seperate a major business line or subsidiary from its core business with the objective to optimize business portfolio and/or capital structure
B) when a company is having difficulty servicing its debt obligations and must reorganize its capital structure to prevent bankruptcy
C) examples include carve-outs, spin-offs, split-offs, tracking stock and issuance of alternative class of stock
D) can be public market or private market seperation
```
WRONG: B) when a company is having difficulty servicing its debt obligations and must reorganize its capital structure to prevent bankruptcy - this is bankruptcy restructuring
162
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In a ____ market seperation, the subsidiary is seperated to private investors or to another company. Meanwhile, in a _____ market separation, the subsidiary is seperated to public investors. The need for disclosure of company-specific information is smaller in a ____ market seperation
A) public; private; public
B) public; private; private
C) private; public: private
D) private; private; public
```
In a PRIVATE market seperation, the subsidiary is separated to private investors or to another company. Meanwhile, in a PUBLIC market seperation, the subsidiary is separated to public investors. The need for disclosure of company-specific information is smaller in a PRIVATE market seperation
163
If a subsidiary cannot survive as a stand-alone public company, a ____ market seperation is more suitable
A) private
B) public
If a subsidiary cannot survive as a stand-alone public company, a PRIVATE market seperation is more suitable
164
If the context of a corporate restructuring, a ____ market seperation is more fitting if the share of the subsidiary on a stand-alone basis is assumed to be very attractive to many investors
A) private
B) public
If the context of a corporate restructuring, a PUBLIC market seperation is more fitting if the share of the subsidiary on a stand-alone basis is assumed to be very attractive to many investors
165
If the context of a corporate restructuring, a ____ market separation is more fitting if the parent company (seller) is in a hurry to sell the subsidiary
A) private
B) public
If the context of a corporate restructuring, a PRIVATE market separation is more fitting if the parent company (seller) is in a hurry to sell the subsidiary.
This is because there is a longer process attached to a public market offering (e.g., IPO)
166
In the context of a corporate restructuring, a ____ market seperation is more fitting if there is a high damage to the company in the event of information leakage. I.e., the need for confidentiality is high.
A) public
B) private
If the context of a corporate restructuring, a PRIVATE market seperation is more fitting if there is a high damage to the company in the event of information leakage. I.e., the need for confidentiality is high.
That is because in a public market offering, the firm is legally obliged to disclose much for information to the public market (investors)
167
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Following public market seperation technique allows the parent company to retain part of the control of the seperated business/ subsidiary:
A) spin-off
B) IPO - listing the subsidiary
C) split-off
D) tracking stock
```
B) If the parent comp needs cash but still wish to maintain certain control of the subsidiary to be separated, it can go for a public market seperation through IPO
168
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In the context of public market seperation, a ____ entails that the parent comp. gives its shares of the subsidiary to be seperated to its own shareholders - the two entities are seperated and have no relationship afterwards, even thought they are both owned by the same shareholders.
A) spin-off
B) IPO - listing the subsidiary
C) split-off
D) tracking stock
```
A) spin-off
169
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In the context of public market seperation, a ____ entails that the the shareholders of the parent company must choose between either having the subsidiary's shares or the parent company shares
A) spin-off
B) IPO - listing the subsidiary
C) split-off
D) tracking stock
```
C) split-off
170
What is NOT true about a tracking stock as a seperation method?
A) a private market seperation method
B) the parent comp owns the subsidiary, but a portion of its shareholders are owning stocks that in theory are evaluated according to the performance of that single subsidiary
C) investors can choose a tracking stock that tracks either the performance of parent + other subsidiaries OR the performance of the single seperated subsidiary
D) If parent goes bankrupt, the subsidiary also goes bankrupt - i.e., owners of the tracking stocks lose money
A) a tracking stock is a PUBLIC (not private) market seperation method
171
In a sale of subsidiary for cash, (private market seperation), following happens:
A) the parent shareholders get the cash
B) the cash is received by the parent company and parent shareholders dont' receive anything directly
C) the parent shareholders own part of the sold-off subsidiary but don't get any cash
In a sale of subsidiary (private market seperation) for cash, following happens:
B) the cash is received by the parent company and parent shareholders dont' receive anything directly
172
In Private Market Separation, a Sale of Subsidiary for Stock entails NOT the following:
A) buyer (third-party) issues shares to the parent in exchange for the subsidiary
B) the parent gets an ownership of the buyer's company
C) there is no link between the parent (seller) and the buyer
WRONG: C) there IS a link between the parent (seller) and the buyer, since the parent now owns part of the buyer's corporation, which now includes the sold-off subsidiary
173
In a private market seperation in the form of joint-venture and strategic alliances, the two involved parties normally form a new entitry comprised of the assets/ cash contributed by each party. Both companies are owners of the new entity.
TRUE/ FALSE
TRUE
174
In a Private Market Separation in the form of JV and Partnership, the parent contributes stock of a subsidiary to the JV, while third party contributes stock of its own subsidiary and/or assets and/or cash to the JV. Both parent and third-party corporation receive stock in the JV or an interest in the partnership. Typically, ownership of the new JV would be 50/50
TRUE/ FALSE
TRUE
175
An important condition for a JV to succeed is mutual trust between the participating entities. A complex feature that a JV has is that a mandate should be defined in the contract, and the destiny of the alliance has to be set clearly. Who has the responsibility to help draft this contract, defining details and making sure that each partner contributes with a fair share?
A) BoD of each company
B) IB
C) shareholders of each company
B) IB helps draft the JV contract and make sure that each partner contributes with a fair share
176
A stock/ asset swap as a means for private market seperation is when:
A) the parent sells a subsidiary's stock to third party, who pays by giving the parent stocks of one of its own subsidiaries (basically exchanging a subsidiary for another)
B) the parent sells only a limited part of its own subsidiary and in exchange gets a limited part of one of the third-party's subsidiary. I.e., both companies own part of each subsidiary after the swap.
Stock/ asset swap: A) the parent sells a subsidiary's stock to third party, who pays by giving the parent stocks of one of its own subsidiaries (basically exchanging a subsidiary for another)
177
A shareholders rights plan involving the implementation of a poison pill:
A) gives non-hostile shareholdes a right to purchase shares in the company at a substantial discount (app. 50%)
B) is a defense strategy against a hostile takeover
C) hostile shareholders' ownership percentage declines as "firendly" shareholders ownership increases. This dilution effect economically compels the hostile party to give up, offer a higher price or launch a proxy contest to gain control of the target company's BoD and restrict the poison pill
D) does not require a shareholder vote and the BoD can deploy the poison pill up to a term of 10Ys
E) All of the above
F) A + B + C
E) All of the above
178
Following is true about the comparable company valuation (multiple): choose 1-4
A) most suitable for valuing minorty shareholders' willingness to pay as passive investors
B) key benefit is that the valuation is based on comparable companies current stock prices - which is indicative for what they will pay for the comp under evaluation
C) key challenges include finding a truly comparable comp set
D) valuation obtained with this method is lower than comparable transaction valuation and DCF with synergies
All are true
179
Companies that are publicly held and have ONE major business line which closely resembles one or more of the business lines composition or function of the company under evaluation is a _____. Such companies assist the valuation process greatly since little effort is required to adjust the company to make it comparable to the one under evaluation (if that company is also ____)
A) diversified company; diversified company
B) pure play company; pure play company
B) pure play company; pure play company
179
Companies that operate TWO or more major business lines are ____
A) diversified company
B) pure play company
A) diversified company
180
Companies that operate TWO or more major business lines are ____
A) diversified company
B) pure play company
A) diversified company
181
Sperating liquid anomalies based on size (done in comparable comp analysis), following is true:
A) in this step, the IB takes into consideration size differentials between comp. companies and the firm under evaluation
B) the IB separates pure play companies from diversified companies to increase comparability with company under evaluation
A) in this step, the IB takes into consideration size differentials between comp. companies and the firm under evaluation
182
In general, more traditional stable earning/stable growth companies will be valued on a ___ or ____ basis.
A) P/E; Div/P
B) EV/EBITDA; P/E
C) P/E EV/BV
In general, more traditional stable earning/stable growth companies will be valued on a EV/EBITDA or P/E basis.
183
High growth companies in industries such as technology or biotech often have low or negative CFs and/or earnings due to high R&D and start-up costs. Such companies tend to be valued on ____ multiples because earnings or EBITDA multiples would not be meaningful.
A) revenue
B) dividend
C) book value
High growth companies in industries such as technology or biotech often have low or negative CFs and/or earnings due to high R&D and start-up costs. Such companies tend to be valued on REVENUE multiples because earnings or EBITDA multiples would not be meaningful.
184
If a company's multiple is rising from e.g., 10x->12x, this is a case of _____, while if the company's multiple is falling from e.g., 12x->10x, it is a ____
A) multiple expansion; multiple compression
B) multiple compression; multiple expansion
C) multiple acceleration; multiple compression
A) multiple expansion; multiple compression
185
If a comparable comp trade at a large discount, this can be because:
A) a large percentage of the firm is held by a major shareholder: small public float and limited stock liquidity decreases the trading price of common stock
B) high debt compressing earnings and CF streams
C) a very competent management team
C) a very competent management team can be the reason that a company is traded at a premium - not discount
186
Which of the multiple-based valuation methods are mostly used in M&A valuation in investment banking?
A) comparable company analysis
B) comparable transaction analysis
B) comparable transaction analysis is one of the major pillars of M&A valuation
187
For a floating exchange ratio (acquisition currency: stock), following is NOT true:
A) number of shares to be exchanged is specified at deal closing date
B) the final exchange ratio depends on the value of the acquirer's stock price at closing
C) the shareholder of Target don't know exactly the value they will get for their shares in target
WRONG: C) the shareholder of Target DO know exactly the value they will get - not the number of shares
188
The problem with _____ exchange ratio is that the acquirer risk losing control since they risk that Target shareholders will get higher number of shares in the event of value decrease. Therefore, ceilings are often incorporated in such transactions to protect Acquirer.
A) floating
B) fixed
A) floating
189
Following is NOT true about a fixed exchange ratio:
A) a specified number of acquirer shares will be paid at closing
B) the final deal value is unknown because the stock price can still fluctuate between the time of signing/annoucement and closing where the shareholders get their part of shares
C) the shareholders dont know exactly how many shares are to be exchanged
D) If the price of acquirer shares go down, the target shareholders will receive a lower value than expected at the signing/ announcement
WRONG: C) the shareholders DO know exactly how many shares are to be exchanged in a fixed exchange ratio transaction
190
In a fixed exchange ratio transaction, the parties may apply a floor/ ceiling. Which of the following statements are WRONG?
A) if price decreases under a certain threshold at closing, no. of shares received by target will be higher than the fixed ratio defined
B) allows the parties to know the minimum/maximum no. shares to be exchanged
C) it is not often not feasible to use a floor/ceiling since it is very risky to implement
WRONG C)
191
Unless specified, it is safe to assume that an acquirer has purchased ____ of target's equity
A) 90%
B) 51%
C) 100%
C) 100%
192
_____ value refers to the price for the target's equity (the deal value per share*no. fully dilluted shares).
_____ value refers to the price paid for the entire enterprise: equity value + net debt (transaction value).
A) Equity value; Enterprise value
B) Enterprise value; Equity value
EQUITY VALUE refers to the offer price for target's equity (the deal value per share*no. fully diluted shares).
ENTERPRISE VALUE refers to the price paid for the entire enterprise: equity + net debt (transaction value).
193
In multiples valuation methods (comparable comp and comparable transaction), the IB performing the valuation should value ____ more than ____
A) mean; median
B) median; mean
In multiples valuation methods (comparable comp and comparable transaction), the IB performing the valuation should value median more than mean
194
Transaction value = ___
Deal value =___
A) EV; equity value
B) Equity value; EV
Transaction value = EV
| Deal value = equity value
195
Why does FCF used in DCF exclude any debt-related funding expenses and debt-related savings?
Because in the DCF, the WACC incorporates all the financing-related considerations, so in the FCF should exclude such consideration. E.g., we behave as if the firm was entirely funded by equity and no debt.
196
If NWC increases, it has following implications:
A) the company becomes more liquid
B) the company's operations are absorbing more cash
C) account payables have decreased relative to receivables
D) has a positive implication on the FCF
NO: A) the company becomes more liquid
YES: B) the company's operations are absorbing more cash
YES: NO: C) account payables have decreased relative to receivables
NO: D) has a positive implication on the FCF
197
```
The WACC takes into consideration:
A) cost of equity
B) cost of debt
C) capital structure
D) tax shield due to debt
E) timing - it is dynamic
```
```
YES A) cost of equity
YES B) cost of debt
YES C) capital structure
YES D) tax shield due to debt
NO E) timing - it is dynamic
```
198
The following does NOT hold for a break-up analysis
A) It is a valuation method
B) the four other methodologies are applied in a breakup analysis
C) tax consequences is an important consideration when doing a break-up analysis
D) the valuation answers the question: what is a company worth if it is broken and sold off in pieces
E) mostly applied to analyze a company with only one major business line and multiple less important lines of business
WRONG: E) mostly applied to analyse a company with MORE THAN ONE major business line
199
In the EV/EBITDA multiple, how is the market value of equity for the private company to be evaluated calculated?
After calculating the EV of the private comp using the EV/EBITDA multiple of a comparable comp, we DEDUCT net debt to get the market value of equity. THIS IS WHAT THE FINAL DEAL VALUE PER SHARE IS CALCULATED FROM
200
```
Which of the following business models of PE exist?
A) Venture capital
B) LBO
C) Growth capital
E) Mezzanine capital
F) all of the above except E
G) all of the above except C
H) all of the above
```
H) all of the above
201
```
Following type of PE refers to minority equity investment in mature companies that need capital to expand or restructure operations, finance an acquisition or enter a new market without change of control
A) Venture capital
B) LBO
C) Growth capital
E) Mezzanine capital
```
C) Growth capital
202
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Following type of PE refers to an investment in subordinated debt or preferred stock for a company, without taking voting control (even though often the stock has attached conversion rights into common stock).
A) Venture capital
B) LBO
C) Growth capital
E) Mezzanine capital
```
E) Mezzanine capital
203
What is the diference between the PE business models: growth capital and venture capital?
Growth capital: funding growth or certain activity for MATURE companies through MINORITY equity investment
Venture capital: equity investment in LESS mature nonpublic companies to fund a launch, early development or expansion
204
```
Which of the following PE business models does NOT entail any degree of control by the PE fund?
A) Venture capital
B) LBO
C) Growth capital
E) Mezzanine capital
```
E) Mezzanine capital is more of a LOAN offered by a PE fund with no control obtained
205
Why may PE funds find it attractive to engage in mezzanine capital, since they obtain no control?
Mezzanine lending are often granted to risker companies, resulting in the coupon payments being quite handsome
206
In PE, different levels of debt used comprise of:
- ____, which is usually provided by banks and secured by the assets of the target company
- ____, which is usually unsecured and raised in the high-yield capital market
A) Subordinated debt
B) Senior debt
In PE, different levels of debt used comprise of:
- SENIOR, which is usually provided by banks and secured by the assets of the target company
- SUBORDINATED, which is usually unsecured and raised in the high-yield capital market
207
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Hedge funds are big clients for the ____division of an IB, while PE funds are big clients for the _____ division in IBs
A) asset management; wealth management
B) trading; investment banking
C) capital market; investment banking
D) investment banking; trading
```
B)
Hedge funds are big clients for the TRADING division of an IB, while PE funds are big clients for the INVESTMENT BANKING division in IBs
208
Carry (part of the carried interest) is NOT:
A) paid to the PE fund GPs as performance fee
B) paid to PE GPs when the fund has been monetized
C) covers part of the management fee
D) the amount of carried interest is calculated on the basis of the profit obtained by the PE fund
NOT C) Carry does NOT cover part of the management fee - it is the performance fee in PE
209
In PE, the management fee is calculated as a percentage of:
A) committed capital
B) AUM
C) a mix of committed capital and AUM
B) AUM - the invested capital
210
What is transaction fees in PE? And where/who does it come from?
Transaction fees are paid to the PE fund by the target companies in relation to services rendered such as consulting and IB services
211
Following statement about Committed capital in PE is NOT true: choose 1-3
A) refers to capital already employed into investments
B) it is gradually "drawn down" and invested over time
C) it is the amount of capital that investors have committed to the fund - i.e., they must be available whenever a capital call is executed by the fund.
D) the performance fee is calculated based on the committed capital
NO: A) committed capital does NOT refer to capital already employed into investments, but rather the sum of lifetime management fees and investable capital
NO: D) the performance fee is NOT calculated based on the committed capital, it is calculated based on the RETURN above hurdle
212
What is lifetime management fees?
Total amount of management fees to be paid during the lifetime of a PE fund. This is a part of the committed capital
213
In a PE fund compensation scheme, in which period is the GPs paid the highest management fees usually?
A) investment phase (first 1-3Ys)
B) growth phase
C) exit phase
A) investment phase (first 1-3Ys) since this period is usually most time and resource demanding for the GP
214
Constant percentage with decreasing basis in PE management fee calculation means that at the beginning, the base is committed capital, but after a certain number of years (usually 5), the base becomes invested capital net of capital invested in exited investments (net invested capital).
TRUE/FALSE
TRUE
215
Constant percentage of committed capital is the easiest way and is the method used in the investment stage, which is very time consuming, and where the number of companies invested in is small to none
TRUE/ FALSE
TRUE
216
The ___ is a minimum annual return that LPs are entitled to before GPs may begin receiving carried interest.
A) high water-mark
B) hurdle rate
C) clawback provision
B) hurdle rate
217
The____ gives the LPs the right to reclaim a portion of GP’s carried interest in the event that losses from later investments cause the GP to withhold too much carried interest.
A) high water mark
B) hurdle rate
C) clawback provision
Clawback provision:
218
When debt principal of a loan can be paid down whenever the borrower has enough FCF, and allows the company to reborrow as needed, this is a ____ (typically issued by banks).
A) term debt
B) revolving credit facility
C) high-yield bond
B) revolving credit facility
219
A ____ refers to senior and subordinated debt with floating rates
A) mezzanine
B) revolving credit facility
C) term debt
C) term debt
220
What is NOT true about Payment in kind (PIK)?
A) a provision/guarantee in a mezzanine debt
B) allows for when the issuer is not able to pay the coupon, it can postpone this payment by adding it to the principal
C) allows investors to buy stocks of the company at the fund price (like a call option)
NO: C) PIK does NOT allow investors to buy stocks of the company at the fund price (like a call option). This is referred to as a "warrant" in a mezzanine loan.
221
What is true about covenant-lite loans?
A) they dont have the same financial triggers as normal bank loans where banks can shut off credit and force loans to become due and payable
B) entails higher likelihood for loan default
C) delays the ability of banks to intervene because it prevents banks from acting on early warning signs of a payment problem
D) fueled LBO for PE firms in 2006-2007 because it was more a favorable source of debt
NO B) entails LOWER (not higher) likelihood for loan default
222
Which dynamics fueled the PE boom in 2006-2007?
A) covenant-lite loans
B) rising asset prices due to large investment demand in general
C) abundant and cheap credit availability
D) All of the above
E) A+C
D) All of the above
223
How is "multiple of investment capital" (MOIC) calculated?
MOIC: the ratio between the value of exited deals over the value of invested capital
MOIC = sum of exit deal value/ invested capital
224
In a DCF analysis, the capital structure of the company is taken into consideration in the ____, while in a LBO analysis, capital structure of the firm is incorporated in the ____
A) FCF; WACC
B) IRR; FCF
C) WACC; FCF
In a DCF analysis, the capital structure of the company is taken into consideration in the WACC, while in a LBO analysis, capital structure of the firm is incorporated in the FCF
225
The IRR is the most important metric for a loan provider (bank) in connection with a LBO-related loan.
TRUE/ FALSE
FALSE: banks and lenders who provide the capital required to execute LBO do not care about equity returns (since that is the return to the sponsor and is quite irrelevant for the lender). Lenders care about cash flow and leverage multiples just as much as IRR in LBO
226
In the context of LBO portfolio company candidates, a _____ refers to divisions that a conglomerate may want to sell off due to lack of profitability.
A) out of favor companies
B) corporate orphans
C) family-owned companies with no succession plan
D) companies in need for operating
In the context of LBO portfolio company candidates, a CORPORATE ORPHANS refers to divisions that a conglomerate may want to sell off due to lack of profitability.
227
Following is NOT true about companies in need for operational expertise (a LBO candidate):
A) portfolio comp management is typically replaced
B) PE fund bring operational expertise needed to optimize company operations
C) new board members are usually appointed
D) portfolio comp management is typically NOT replaced
NO: A) portfolio comp management is NOT typically replaced - they stay
228
In the context of financing a LBO, what does a coverage ratio of <1 mean?
A coverage ratio of <1 means that the lender will not be able to generate enough FCF to cover the loan's interest expenses and the estimated/ actual amortization of the loan. A bank would NEVER approve such a loan.
229
In the context of financing a LBO, what does a coverage ratio of >1 mean?
A coverage ratio above 1 means that the the lender will be able to generate high enough FCFs for debt service to cover both its interest expenses and its amortization (estimated/ actual). 1 is the threshold for NOT LENDING, meaning that everything above 1 is under consideration of the bank, but a higher coverage indicate less risk for not meeting loan payments.
