Corporate Finance

Question 1

What is the consequence of financial deficit?

Answer 1

If internal cash flows are not sufficient to pay for all investments, companies can either cut back on dividends in order to increase retained earnings or raise new debt/equity capital.
However, in average internal funds (retained earnings + depreciation) cover most of the cash needed for investments.

Question 2

Equity Securities - Common Stock: Rights and Liabilities

Answer 2

Common stock represent an ownership in a publicly-held corporation.

Shareholders rights
- Cash flow rights: according to face/nominal value, but stockholders are last in line of all investors who have a claim on a firm’s assets
- Voting rights: at the corporation’s annual shareholder meeting
(Corporation can also issue common stock with limited or no voting rights; these are generally traded at a lower price)

Shareholders limited liability
In the event of failer, shareholders can lose their original investments, but they are not liable for the firm’s obligations.

Question 3

What are Preferred stocks?

Answer 3

Preferred stocks are a type of stock that typically pay a fixed dividend and have a higher claim on assets and earnings than common stock. They may also have a preference in terms of receiving dividends or being paid back in the event of a liquidation. Preferred stockholders may not have voting rights, unlike common stockholders.

These stocks are considered less risky than common stocks but more risky than bonds. Preferred stock is often issued by mature companies that want to raise capital without giving up control to common stockholders.

Question 4

How are Board of Directors (re)voted?

Answer 4

Normal companies let the entire board be up for reelection each year while classified/staggered boards let only 1/3 up for reelection.
A simple majorty of shareholder votes is normally sufficient, but the company charter may specify decisions that require a supermajortiy (75%) of those eligible to vote.

Question 5

What is the claim structure of securities in case of default?

Answer 5

1. Senior debt (in full)
2. Junior/subordinate debt
3. Preferred and common stockholders

Question 6

What is special about debt and debtholder rights (in contrast to equity)?

Answer 6

In contrast to equity, debt does not have residual Cash Flow rights an no voting rights because lenders are not considered owners of the firm.
Firm provide insurance to the lender that it will not take unreasonable risks and may even set aside some of its assets as collateral to secure debt to particular creditors.

Question 7

What is Convertible Debt?

Answer 7

Securities with option to be converted into other securities.

Convertible bonds give the owner the option to exchange the bond for a predetermined number of equity shares (at a set price before a set date= “warrant”)
Such bondholders hope that the issuing company’s share price will increase so that the bond can be converted at a profit.

Question 8

What is the role of financial markets/intermediaries?

Answer 8

• Payment mechanism (allows individuals to receive money quickly, safe, and over long distances)
• Borrowing and lending
• Pooling risk
• Information gathering (markets show what assets are worth which allows estimation of expected rates of return)

Question 9

Summarize Venture Capital (VC)!

Answer 9

VC is a type of equity investment in young, often high-tech, private firms that are difficult to evaluate but present the chance of becoing a big, public, company in a profitable market.

VC investors are investment institutions or wealthy individuals who provide these start-ups with funding (at defined milestones), ongoing managerial advice, and often play a mahor role in the recruiting of the senior management of the start-up in exchange for equity.

VC funds are organized as limited private partnerships where the management company (general partners) is responsible for making and overseeing the investments and in return receives a fixed fee (2%) and share of profits (20%) called the “carried interest”.

Question 10

What are important Terminologies for IPOs and what are motives for going public?

Answer 10

IPO= first offering of stock to the general public

Underwriter= Investment bank that buys an issue of securities from a company and resells it to the public

Spread= Difference between public offering price and price paid by underwriter

Prospectus= Formal summary that provides information on an issue of securities

Underpricing= Issuing securities at an offering price set below the market value of the security

Motives:
- create public shares for use in future acquisitions
- establish market value
- enhance reputation
- minimize cost of capital
- broaden base of ownership