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Corporate Financne > Corporate Financing & the Issuance of Securities > Flashcards

Corporate Financing & the Issuance of Securities Flashcards

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1
Q

What are the two main ways firms can raise funds?

A

From external sources (debt/equity) or by plowing back profits (retained earnings)

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2
Q

When do shareholders generally accept plowback decisions?

A

When the firm invests in positive-NPV projects that increase shareholder value

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3
Q

What is a financial deficit?

A

It occurs when internal cash flows are not sufficient to pay for all investments

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4
Q

How can a company cover a financial deficit?

A

By cutting dividends or raising new capital (debt or equity)

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5
Q

What are two key financial management questions?

A

What fraction of profits should be plowed back?

What fraction of a deficit should be financed with debt or equity?

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6
Q

What typically covers most investment needs for firms?

A

Internal funds (retained earnings plus depreciation)

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7
Q

Why might managers avoid issuing new equity for a risky positive-NPV project?

A

Because new equity announcements often lead to negative stock price reactions (signaling)

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8
Q

Does the mix of debt and equity financing remain the same across firms or time?

A

No, it varies by industry, firm, and over time

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9
Q

Is there a constant or target debt ratio for firms?

A

No, and even if there were, it would vary over time

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10
Q

What does a common stock represent?

A

An ownership share in a publicly-held corporation

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11
Q

What rights does a share of common stock typically include?

A
  • Cash flow rights (based on face/nominal value)
  • Voting rights on corporate governance, M&As, etc
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12
Q

When do shareholders exercise their voting rights?

A

At the corporation’s annual shareholder meeting

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13
Q

What are two class of common stocks?

A

one with voting rights and one without or with different voting rights

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14
Q

How do non-voting shares typically trade compared to voting shares?

A

At a lower price

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15
Q

What is meant by the “residual claim” characteristic of common stock?

A

Stockholders are last in line to claim the firm’s assets and income, after all other claims are settled

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16
Q

What does “limited liability” mean for shareholders?

A

They can lose their original investment but are not personally liable for the firm’s debts or obligations

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17
Q

Where can common stocks of large corporations typically be bought and sold?

A

On stock exchanges

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18
Q

What is the primary market?

A

The market where new securities are issued (e.g., IPOs and SEOs)

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19
Q

What is Secondary market ?

A

previously issued securities

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20
Q

What does it mean when a public firm’s stock is “closely held”?

A

Stocks of public firms which are not publicly traded

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21
Q

How is preferred stock similar to both equity and debt?

A

It pays a fixed income like debt but represents ownership like equity

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22
Q

Does preferred stock convey voting power?

A

No, preferred stock typically does not have voting rights

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23
Q

Is a firm contractually obligated to pay dividends on preferred stock?

A

No, but unpaid dividends accumulate and must be paid before common stock dividends

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24
Q

What is the priority of preferred stock in bankruptcy?

A

It ranks after bonds but above common stock in claims on assets

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25
Are preferred stock dividends tax-deductible for the firm?
No, unlike interest on bonds, preferred dividends are not tax-deductible
26
How often are the boards of many U.S. companies up for reelection?
Annually, the entire board is up for reelection each year
27
What is a classified (or staggered) board?
A board where only one-third of directors are reelected each year
28
What voting threshold is usually required for shareholder decisions?
A simple majority, unless the company charter specifies a supermajority
29
What is a supermajority vote, and when is it used?
A higher threshold (e.g., 75%) required for major decisions like mergers or charter changes
30
What is a proxy contest?
the firm’s existing management and directors to compete with outsiders for effective control of the corporation
31
What do activist investors typically seek through proxy contests?
- A growing number of activist investors campaign for changes in management policy - If they gain sufficient shareholder support, the firm may get the message without entering a proxy figh
32
What does debt have a first claim on?
Cash flows but only up to interest payments and the repayment of face value
33
What is the order of repayment in a debt waterfall during default?
1. Senior debt 2. Junior/subordinated debt 3. Preferred stockholders 4. Common stockholders
34
When are junior (subordinated) debtholders repaid?
Only after all senior debtholders are fully paid
35
Who ranks ahead in the claim structure—debtholders or equity holders?
All debtholders rank ahead of both preferred and common stockholders
36
Do debt holders have residual cash-flow rights or benefit from business growth?
debt does not have residual cash-flow rights and does not participate in the upside of a business
37
Do lenders have voting power in the firm?
No, because they are not considered owners
38
When do debt gain control rights over a firm?
debt offers no control rights unless the firm defaults or violates debt covenants
39
How are owners protected in the context of debt financing?
By bankruptcy laws and credit covenants
40
What are examples of debt covenants that limit firm behavior?
Restrictions on taking excessive debt, engaging in mergers, or other risky activities
41
What is collateral in the context of lending?
Assets set aside by the firm to secure the debt, protecting particular creditors
42
The firm also provides insurance to the lender why ?
it will not take unreasonable risks, e.g., the borrower may agree to limit the extra amount of debt that it can issue, accept limitations on mergers
43
What are convertible securities?
Securities that give the owner an option to convert them into other securities
44
What is a warrant?
gives the right to purchase a set number of the company’s shares at a set price before a set date. Warrants and bonds are often sold together as a «package».
45
What is a convertible bond?
gives the owner the option to exchange the bond for a predetermined number of equity shares
46
When is converting a bond into shares profitable for the bondholder?
If the company's share price increases, allowing conversion at a gain
47
What happens if the share price falls with a convertible bond?
The bondholder is not obligated to convert
48
Some obligations are similar to debt, but treated differently in the accounts:
- Accounts payable - Rents and leases - Unfunded obligations - Special-purpose entities (SPEs)
49
What are accounts payable?
Goods or services received but not yet paid for—essentially short-term debt
50
How are leases similar to debt?
Firms make lease payments instead of borrowing to purchase assets—economically similar to loan repayments
51
What are unfunded obligations?
Future obligations similar to senior debt, such as employee pension obligations
52
What are special-purpose entities (SPEs)?
Separate entities used to raise funds via equity and debt but kept off the company’s balance sheet
53
Flow of savings to investment
page 22
54
What is venture capital (VC)?
A type of funding (equity investments) in young, growing private companies
55
Who are the typical investors in venture capital?
Investment institutions or wealthy individuals who finance firms before they can obtain debt or go public
56
How do venture capital firms pool funds?
They pool funds from a variety of investors to build high-risk financial portfolios (VC funds
57
What do venture capitalists provide to startups?
Funding, and often managerial services/advice, in exchange for equity
58
How is funding provided by venture capitalists?
In stages or milestones, not all upfront, with funding given as the company reaches each milestone
59
How are most VC funds organized?
As limited private partnerships with a fixed life of about 10 years
60
Who are the "limited partners" in a VC fund?
The investors, such as pension funds.
61
Who manages the VC fund and what do they receive in return?
The management company (general partner) is responsible for making and overseeing investments and receives a fixed fee and a share of the profits called carried interest
62
What is a typical fee arrangement for a management company in a VC fund?
2% fee plus 20% of the profit (if any
63
What types of firms do VC firms typically specialize in?
Young, high-tech firms that are difficult to evaluate but have the potential to become large, profitable public companies
64
How do VC firms support the companies they invest in ?
They monitor closely, provide ongoing advice, and often play a major role in recruiting senior management team
65
How do venture capitalists "cash out" their investment?
1. Sell out to a larger firm. 2. Go for an IPO (Initial Public Offering), allowing the VC fund to exit while the entrepreneurs retain control
66
What percentage of companies going public have been backed by VC firms?
About 50% of companies going public have been backed by a VC company
67
Why is it difficult to estimate market-based risk for VC funds?
There is only one observation per fund, which does not allow the use of factor models or other market-based risk estimation methods
68
Why can't the beta(s) of a VC fund be derived from its portfolio?
The portfolio firms are not listed, so their individual betas cannot be used to calculate the weighted average beta of the fund
69
What is an Initial Public Offering (IPO)?
The first offering of stock to the general public by a company
70
Who is the underwriter in an IPO?
The investment bank that buys the issue of securities from the company and resells it to the public
71
What is the spread in an IPO?
The difference between the public offer price and the price paid by the underwriter
72
What is a prospectus in the context of an IPO?
A formal summary that provides information on an issue of securities
73
What does underpricing mean in an IPO?
Issuing securities at an offering price below the market value, often reflected as the first-day stock price at the exchange
74
Who are the typical underwriters in an IPO?
The leading investment banks, such as Goldman Sachs, JP Morgan, Bank of America/Merrill Lynch, UBS, Deutsche Bank, etc
75
What is a firm commitment in an IPO?
Underwriters buy the securities from the firm and then resell them to the public
76
What is a best-efforts commitment in an IPO?
Underwriters agree to sell as much of the issue as possible, but they do not guarantee the sale of the entire issue
77
What are flotation costs in an IPO?
The costs incurred when a firm issues new securities to the public
78
What are some specific costs incurred when a firm issues new securities?
Key costs include the spread, underpricing, and other fees related to issuing securities
79
What is underpricing in an IPO?
Setting the IPO offer price below the market value, often leading to a price jump on the first trading day
80
Why might underpricing be used to compensate for risk?
Riskier IPOs are harder to value, so underpricing compensates early investors for taking on uncertainty
81
How does underpricing help avoid reputational damage?
A strong first-day stock performance creates positive momentum and avoids the perception of a failed IPO
82
How are star analysts related to underpricing?
Underwriters may offer underpricing in exchange for favorable coverage by influential analysts.
83
What is "spinning" in the context of IPOs?
Allocating underpriced IPO shares to executives or VCs as a reward for future business deals
84
Who benefits most from underpricing?
Early investors (e.g., institutional clients of underwriters), not the issuing company.

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