Final Exam Flashcards
(201 cards)
1
Q
Finance is…
A
The science or study of the management of funds
2
Q
What is the goal of the firm?
A
The goal of the firm is to create value for the firm’s shareholders.
3
Q
How is the goal of the firm achieved?
A
By maximizing the price of the existing common stock.\
Good finance decisions will help increase stock price and poor financial decisions will lead to a decline in stock price.
4
Q
What is the role of management?
A
Management serves as an arbitrator and moderator between conflicting interest groups or stakeholders and objectives
5
Q
Contractual claims
A
Creditors, managers, employees and customers have contractual claim against the company
6
Q
Residual claim
A
shareholders have residual claim against the company (meaning left over)
7
Q
What is the role of finance in business?
A
There are three basic issued addressed by finance?
- What long-term investments should the firm undertake (capital budgeting decision)
- How should the firm raise money to fund these investments? (capital structure decision)
- How to manage cash flows arising from day-to-day operations (operating decisions)
8
Q
What is the function of financial manager?
A
1 a) Raising funds 1 b) Obligations (stocks, debt securities) 2. Investment 3. Cash from Operational activities 4. Reinvesting 5.Dividends or interest payments
Finance function- managing cashflow
9
Q
Principle 1 of Finance: Cash flow is what matters
A
Accounting profits are not equal to cash flows
- Cash flow drive the value of a business
- We must determine additional cash flows when making financial decisions
10
Q
Principle 2 of Finance: Money has a time value
A
1$ received today is worth more than a dollar received in the future
- we can earn interest on money we received today, it is better to receive money sooner than later
- inflation
11
Q
Computation of present value
A
an investment can be viewed in two ways-its future value or its present value (check slide 11 of lec 6)
12
Q
Present Value
A
P= Fn/(1+r)^n
13
Q
The net present value method
A
To determine net present value we
- Calculate the present value of cash inflows
- Calculate the present value of cash outflows
- subtract the present value of the outflows from the present value of the inflows
14
Q
Positive Net present value
A
the project is acceptable since it promises a return greater than the required rate of return
15
Q
Zero Net Present value
A
the project is acceptable, since it promises a return equal to the required rate of return
16
Q
Negative Net Present value
A
Project is not acceptable since it promises a return less than the required rate of return
17
Q
What are some typical outflows?
A
Initial investment (cash need to be purchases asset), Incremental operating costs repairs and maintenance of new equipment, additional investment in inventory
18
Q
What are some typical inflows?
A
Incremental revenues, reduction of operating costs , salvage value
19
Q
Cost of capital
A
average rate of return the company must pay to its long term creditors and stockholders for the use of their funds (Q: No short-term then?)
20
Q
Choosing a discount rate?
A
The firm’s cost of capital is usually regarded as the minimum required rate of return.
21
Q
Principle 3 of Finance: Risk requires a reward
A
Risk is the uncertainty about the outcome or payoff of an investment in the future
Rational investors would choose a riskier investment only if they feel the expected return is high enough to justify the greater risk
22
Q
Diversification of investments
A
all investment is not the same
- some risk can be removed or diversified by investing in several different securities
- firm specific (unsystematic)
- market (systematic)
23
Q
Principle 4 of Finance: Market prices are generally right
A
A financial market is “information efficient” if at any point in time the prices of securities reflect all information available to the public.
When new info. becomes available, prices quickly change to reflect that information.
Information efficient markets provide liquidity and fair prices
However, there are inefficiencies in the market that distort the market prices from value of assets (caused by behavioural biases)
24
Q
Principle 5 of Finance: Conflicts of interest cause agency problem
A
The separation of management and the ownership of the firm creates an agency problem
owners or equity investors want to maximize the returns on their investments
25
Principal-Agent problem
Managers may make decisions that are not in the best interest of the shareholder.
Managers may seek to emphasize the size of the firm, sales, assets, or other perks
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Oversight
Board of directors to oversee management
27
Managerial
to run the company
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Compliance
Laws, regulations and standards
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Internal audit
assurance and consulting acitivities
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legal and advisory
advice
31
External audit
lend credibility
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Monitoring
elect or remove directors and management
33
Principle 6 of Finance: Ethics and Trust in Business
Ethical behaviour is doing the right thing
- Sound ethical standards are important for business and personal success
- unethical decisions can destroy shareholder wealth
34
Real Asset
Tangible things owned by persons and businesses
- residential structures and property
- major appliances and automobiles
- office towers, factories and mines
- machinery and equipment
35
Financial Asset
What one individual has lent to another
- consumer credit
- loans
- mortgages
36
Function 1 of Money: Medium of Exchange
How transactions are conducted:
Something that is generally acceptable in exchange for goods and services.
In this function, money removes the need for double coincidence of wants by separating sellers from buyers
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Function 2 of Money: Standard of Value
How the value of goods and services are denominated:
| Something that circulates and provides a standardized means of evaluating the relative prices of goods and services
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Function 3 of Money: Store of Value
How the value of goods and services are maintained in a monetary terms:
-the ability of money to command purchasing power in the future
39
Financial intermediaries
is an institution or individual that serves as a conduit for parties in a financial transaction.
-Act as a bridge between government, business,non-residents and households
40
Market Intermediaries
refers to resellers, physical distribution firms, marketing services agencies, and financial intermediaries.
41
Examples of Financial system (Financial intermediaries)
- Banks and other deposit-taking institutions
- insurance companies
- pension funds
- mutual funds
42
Direct claims
A payment made that is not backed up by a purchase order.
43
Indirect claims
A claim made by a shareholder seeking compensation for damages resulting from an action directed solely against the rights of the company in which it holds shares. The assertion is that the shareholder's rights were indirectly affected by the actions against the rights of the company.
44
Intermediation
Brokerage function which brings together seekers and providers of goods, information, money, etc. Need for intermediation occurs due to the imperfect nature of markets and everyday situations where the complete ('perfect') knowledge about providers and seekers (and about what they seek) is not available to everyone.
45
Financial market
Markets for sale and purchase of stocks (shares), bonds, bills of exchange, commodities, futures and options, foreign currency, etc., which work as exchanges for capital and credit.
46
Primary Market
1. Market in which buyers and sellers negotiate and transact business directly, without any intermediary such as resellers.
2. Financial market in which newly issued securities are offered to the public.
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Secondary market
1. Customers other than those to whom a product was originally offered. For example, tools designed and priced for professionals may also be bought by serious hobbyists.
2. Financial market where previously issued securities (such bonds, notes, shares) and financial instruments (such as bills of exchange and certificates of deposit) are bought and sold. All commodity and stock exchanges, and over-the-counter markets, serve as secondary markets which (by providing an avenue for resale) help in reducing the risk of investment and in maintaining liquidity in the financial system.
48
Money Market
Network of banks, discount houses, institutional investors, and money dealers who borrow and lend among themselves for the short-term (typically 90 days). Money markets also trade in highly liquid financial instruments with maturities less than 90 days to one year (such as bankers' acceptance, certificates of deposit, and commercial paper), and government securities with maturities less than three years (such as treasury bills), foreign exchange, and bullion. Unlike organized markets (such as stock exchanges) money markets are largely unregulated and informal where most transactions are conducted over phone, fax, or online.
49
Capital market
A financial market that works as a conduit for demand and supply of debt and equity capital. It channels the money provided by savers and depository institutions (banks, credit unions, insurance companies, etc.) to borrowers and investees through a variety of financial instruments (bonds, notes, shares) called securities.
A capital market is not a compact unit, but a highly decentralized system made up of three major parts: (1) stock market, (2) bond market, and (3) money market. It also works as an exchange for trading existing claims on capital in the form of shares.
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Organized exchanges
A securities marketplace where purchasers and sellers regularly gather to trade securities according to the formal rules adopted by the exchange.
51
Over-the counter
Describing a security or trade that does not occur on an exchange. Very often, the OTC market includes securities that are very small and do not trade on an exchange because they do not meet market capitalization requirements. OTC securities may theoretically be traded informally (one may stand on a street corner and sell his/her stocks), but the term usually refers to securities traded through a dealer network.
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Corporate bonds: Debentures
Unsecured debt, backed only by the general assets of the issuing corporation
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Corporate bonds: Secured debt (a.ka. mortgage)
Secured by specific assets
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Corporate bonds: Subordinate debt
In default, holders get payments only after other debtholders get their full payment
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Corporate bonds: Senior debt
In default holders get payment before other debtholders get
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Corporate bonds: Zero coupon
pay face value at maturity only, sold at discount
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Corporate bonds: Junk bonds
bonds with below investing grade rating
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Retractable bond
A bond that features an option for the holder to force the issuer to redeem the bond before maturity at par value. An investor may choose to shorten the maturity on a bond because of market conditions or if he or she requires the principal sooner than expected.
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Convertible bond
bond that can be converted into a predetermined amount of the company's equity at certain times during its life, usually at the discretion of the bondholder.
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Extendable bond
A long-term debt security that includes an option to lengthen its maturity period. Depending on the specific terms of the extendable bond, the bond holder and/or bond issuer may have one or more opportunities to defer the repayment of the bond's principal, during which time interest payments continue to be paid. Additionally, the bond holder or issuer may have the option to exchange the bond for one with a longer maturity, at an equal or higher rate of interest. Because these bonds contain an option to extend the maturity period, a feature that adds value to the bond, extendable bonds sell at a higher price than non-extendable bonds.
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Callable (Redeemable) bond
A callable bond is a bond that can be redeemed by the issuer prior to its maturity. If interest rates have declined since the company first issued the bond, the company is likely to want to refinance this debt at a lower rate of interest. In this case, the company calls its current bonds and reissues them at a lower rate of interest.
62
Equity instrument issued by corporations: common stocks
The common stockholders are the owners of the corporation's equity
- voting rights
- no specific maturity date and the firm is not obliged to pay dividends to shareholders
- returns come from dividends and capital gains
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Equity instrument issued by corporations:Preferred stock
Have face value, predetermined periodical (dividend) payments with priority over common stockholders
-No voting right but if dividend payment is not paid, preferred stockholders may get voting rights
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Cumulative preferred stock
type of preferred stock with a provision that stipulates that if any dividends have been omitted in the past, they must be paid out to preferred shareholders first, before common shareholders can receive dividends.
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Non-cumulative preferred stock
refers to the preferred stock shares which usually have dividends starting all over in every year. In case the company fails to pay dividends in one year, the dividends will not accumulate in arrears. The company is only expected to pay the dividends for the current year before the remaining amount is paid to the common shareholders.
66
Participating preferred stock
Type of preferred stock that gives the holder the right to receive dividends equal to the normally specified rate that preferred dividends receive as well as an additional dividend based on some predetermined condition.
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Non-participating preferred stock
is a preferred share in a corporation with a feature that limits the dividends that can be issued per year. This maximum limit is usually written or stated on the face of the stock certificate as a percentage of the par value. It can also be stated in real dollars.The reason why non-participating preferred stockholders have maximum dividend limit each year is because preferred shareholders receive their dividends before any common shareholders. This secures that if the corporation declares dividends, the preferred shareholders will get paid no matter what. After the preferred dividends are paid off, the common stock shareholders will get whatever is left.
68
Derivative securities
Securities whose value is derived from the value of some underlying asset- most important derivatives are options and futures
69
Stock options
A privilege, sold by one party to another, that gives the buyer the right, but not the obligation, to buy or sell a stock at an agreed-upon price within a certain period of time
-Not a tool of fundraising, but a method of compensation
70
How are prices of financial instruments determined?
In equilibrium by demand and supply forces
| -reflect market expectations regarding the future as inferred from currently available information
71
Bootstrapping
The process by which many entrepreneurs raise "seed" or start-up money and obtain other resources necessary to start their businesses
- Initial seed money from the entrepreneur or other founders
- Other cash may be from personal savings, sale of personal assets, loans from family and friends, use of credit cards
- seed money spend on developing a prototype of the product or service and a business plan
- 1-2 years
72
Venture capital
v. capitalists are individuals or firms that help new businesses get started and provide much of their early-stage financing
- individual v. capitalist or angel investors are typically wealthy individuals who invest their own money in emerging businesses at very early stages in small deals
73
Three Reasons why traditional sources of funding do not work for new or emerging businesses
1. The high degree of risk
2. Types of productive assets
3. information asymmetry problems
74
What do Venture capitalists' investment give them?
1. equity interest in the company often in a form of preferred stock that is convertible into common stock at the discretion of the venture capitalist
75
What do Venture capitalists provide?
involvement depends on the experience of the management team
-because of their industry and general knowledge about what it takes for a business to succeed, they provide counsel for entrepreneurs when a business is being started and during early stage of operation
76
How doe Venture Capitalists reduced their risks?
Some tactics to reduce risk are:
- funding the ventures in stages
- requiring entrepreneurs to make personal investments
- syndicating investments
- in-depth knowledge about the industry
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Syndication
Occurs when the originating venture capitalist sells a percentage of a deal to other venture capitalist
78
How does syndication reduce risk?
1. It increases the diversification of the originating venture capitalist's investment portfolio
2. willingness of other venture capitalists to share in the investment provides independent corroboration that the investment is a reasonable decision
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The exit
Venture capitalists are not long-term investors in the companies, but usually exit over a period of three to seven years
-Every venture capital agreement includes provisions identifying who has the authority to make critical decisions concerning the exit process: timing, the method of exit, and what price is acceptable
80
What are the principal ways in which venture capital firms exit venture-backed companies?
1. sell to a strategic buyer in the private market
2. sell to financial buyer in the private market
3. initial public offering: selling common stock in an initial public offering
81
Initial public offering
It is one way to raise larger sums of cash or to facilitate the exit of a venture capitalist is through IPO of the company's common stock
-first time stock issues are given a special name bc the marketing and pricing of these issues are distinctly different from those of seasoned offering
82
What are some advantages of going public?
The amount of equity capital that can be raised in the public equity markets is typically larger than the amount that can be raised through private sources
Once an IPO has been completed, additional equity capital can usually be raised through follow-on seasoned public offerings at a low cost
83
What are some disadvantages to going public?
- High cost of the IPO itself
- The costs of complying with ongoing SEC disclosure requirements
- The transparency that results from this compliance can be costly for some firms
84
Investment-banking services
To complete an IPO, a firm will need the services of investment bankers, who are experts in bringing new securities to the market
85
What are the three basic services investment bankers provide which bring securities to market?
- Origination
- Underwriting
- distribution
86
Origination of IPO
Includes giving the firm financial advice and getting the issue ready to sell
- the investment banker helps the firm determine whether it is ready for an IPO
- Once the decision to sell stock is made, the firm's management must obtain a number of approvals
- file a registration statement with the securities exchange commissions
87
Underwriting of IPO
The risk-bearing part of investment banking
- the securities can be underwritten in two ways:
- on a firm-commitment basis
- on a best-efforts basis
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Underwriting syndicates
To share the underwriting risk and to sell a new security issue more efficiently, underwriters may combine to form a group called an underwriting syndicate
-participating in the syndicate entitles each underwriter to receive a portion of the underwriting fee as well as an allocation of the securities to sell to its own customers
89
Underwriting: determining the offer price
One of the investment banker's most difficult tasks is to determine the highest price at which the bankers will be able to quickly sell all of the shares being offered and that will result in a stable secondary market for shares
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Underwriting: Due diligence meeting
Before the shares are sold, representatives from the underwriting syndicate hold a due-diligence meeting with rep. of the issuer..
-investment bankers hold due-diligence meetings to protect their reputations and to reduce the risk of investors' lawsuits in the event the investment goes sour later on
91
Distribution
Once the due-diligence process is complete, the underwriters and the issuer determine the final offer price in a pricing call
- The pricing call typically takes place after the market has closed for the day
- By either accepting or rejecting the investment banker's recommendation, management ultimately makes the pricing decisions
92
IPO pricing and cost: three basic costs associated with issuing stock in an IPO
1. Underwriting Spread- the difference between the proceeds the issuer receives and the total amount raised in the offering
2. Out of pocket expenses- include other investment banking fees, legal fees, accounting expenses, printing costs,....taxes
3. Underpricing- defined as the difference between the offering price and the closing price at the end of the first day of the IPO
93
Private vs. Public Markets
1. Because many smaller firms and firms of lower credit standing have limited access, or no access, to the public markets, the cheapest source of external funding is often the private markets
2. When market conditions are unstable, some smaller firms that were previously able to sell securities in the public markets no longer can
3. Bootstrapping and venture capital financing are part of the private market as well
94
Private Markets
Many private companies that are owned by entrepreneurs, families, or family foundations, and are sizable companies of high credit quality, prefer to sell their securities in the private markets even though they can access public markets
95
Private Placements
Private lenders are more willing to negotiate changes to a bond contract
- If a firm suffers financial distress, problems are more likely to be resolved without going to a bankruptcy court
- Speed of private placement deals and flexibility in issue size
- The biggest drawback of private placements involves restrictions on the resale of the securities.
96
Private equity firms
LIke venture capitalists, private equity firms pool money from wealthy investors, pension, funds, insurance companies and other sources to make investment
-Private equity firms invest more mature companies and they often purchase 100 percent of a business
97
What Private equity firm managers seek to increase?
They want to increase the value of the firms they acquire by closely monitoring their performance and providing better management
- Once value is increased, they sell the firms for a profit.
- Private equity firms generally hold investments for 3-5 years
98
Dividends
Term is generally used to refer to a firm's overall policy regarding distributions of value to a stockholders
A dividend is something of value that is distributed to a firm's stockholders on a pro-rate
-A dividend can involve the distribution of cash, assets, or sth else, such as discounts on the firm's products that are available only to stockholders
99
What happens when value is distributed through a dividend?
1. Reduces the value of the stockholder's claims against the firm
2. Reduces the stockholders' investment in a firm by returning some of that investment to them
100
Regular cash dividend
The most common form, it is the cash dividend that is paid on a regular basis.
Are generally paid on a quarterly basis and are a common means by which firms return some of their profits to stockholders.
The size of a firm’s regular cash dividend is typically set at a level that management expects the company to be able to maintain in the long run, barring some major change in the fortunes of the company.
101
Extra dividends
Management can afford to err on the side of setting the regular cash dividend too low because it always has the option of paying an extra dividend if earnings are higher than expected.
Extra dividends are often paid at the same time as regular cash dividends
102
Special dividend
A special dividend, like an extra dividend, is a one-time payment to stockholders.
larger than extra dividends and to occur less frequently.
103
Liquidating dividend
Is a dividend that is paid to stockholders when a firm is liquidated.
104
Process of dividend payment
1. Board vote
2. public announcement
3. ex- dividend date
4. record date
5. payable date
105
Dividend payment process at private companies
It is not as well defined for private companies because
- shares are bought and sold less frequently,
- fewer stockholders and,
- no stock exchange is involved in the dividend payment process.
It is easy to inform all stockholders of the decision to pay
it is easy to actually pay it.
There is no public announcement,
no need for an ex-dividend date.
The record date and payable date can be any day on or after the day that the board approves the dividend.
106
Stock repurchase
they do not represent a pro-rata distribution of value to the stockholders, because not all stockholders participate.
when a company repurchases its own shares, it removes them from circulation.
stock repurchases are taxed differently than dividends.
107
Open Market Repurchase
A firm will announce that it will repurchase some shares in the open market from time to time as market conditions dictate and maintains the option of deciding whether, when, and how much to repurchase. Open-market repurchases can span months or even years. There are, however, daily buy-back limits which restrict the amount of stock that can be bought over a particular time interval again ranging from months to even years. Per SEC Rule 10b-18, The issuer can't purchase more than 25% of the average daily volume.
108
Tender Offer: Fixed price
This offer specifies in advance a single purchase price, the number of shares sought, and the duration of the offer, with public disclosure required. The offer may be made conditional upon receiving tenders of a minimum number of shares, and it may permit withdrawal of tendered shares prior to the offer's expiration date. Shareholders decide whether or not to participate, and if so, the number of shares to tender to the firm at the specified price.
109
Tender offer: Dutch auction
A Dutch auction offer specifies a price range within which the shares will ultimately be purchased. Shareholders are invited to tender their stock, if they desire, at any price within the stated range. The firm then compiles these responses, creating a demand curve for the stock. The purchase price is the lowest price that allows the firm to buy the number of shares sought in the offer, and the firm pays that price to all investors who tendered at or below that price.
110
Targeted stock repurchase
A targeted repurchase is a technique used to thwart a hostile takeover in which the target firm purchases back its own stock from an unfriendly bidder, usually at a price well above market value.
111
Stock dividend
- does not involve distribution of value
- When a company pays a stock dividend, it distributes new shares of stock on a pro-rata basis to existing stockholders.
- Value of company does not change'
- The stockholder is left with exactly the same value as before.
112
Stock splits
similar to stock dividend, but it involves the distribution of a larger multiple of the outstanding shares
-can think of a stock split as an actual division of each share into more than one share
113
benefits of stock splits
Real benefit of stock splits is that they can send a positive signal to investors about the outlook that management has for the future and this, in turn, can lead to a higher stock price
**Management is unlikely to want to split the stock of a company two-for-one or three-for one if it expects the stock price to decline
114
Reverse stock split
opposite of stock split
115
Practical considerations in seeing a dividend policy
is about how the excess value in a company is distributed to its stockholders
-It is extremely important that managers choose their firms' dividend policies in a way that enables them to continue to make investments necessary for the firm to compete in its product markets
116
What kind of practical questions when selecting a dividend policy?
1. Over the long term, how much does the company's level of earnings (cash flows from operations) exceed its investment requirements? how certain is this level?
2. Does the firm have enough financial reserves to maintain the dividend payout in periods when earnings are down or investment requirements are up?
3. Does the firm have sufficient financial flexibility to maintain dividends if unforeseen circumstances wipe out its financial reserves when earnings are down?
4. Can the firm quickly raise equity capital if necessary?
5. If the company chooses to finance dividends by selling equity, will the increased number of stockholders have implications for the control of the company?
117
Acquisition
The purchase of one firm by another
118
Merger
The combination of two or more firms into a new legal entity in which one entity keeps their identity while the others lose their identities
119
Amalgamation
A blending together of two or more entities where both lose their identities and a new separate entity is born. Both (all) sets of shareholders must approve the transaction
120
Horizontal Integration
is the acquisition of additional business activities that are at the same level of the value chain in similar or different industries. This can be achieved by internal or external expansion. Because the different firms are involved in the same stage of production, horizontal integration allows them to share resources at that level. If the products offered by the companies are the same or similar, it is a merger of competitors. If all of the producers of a particular good or service in a given market were to merge, it would result in the creation of a monopoly. Also called lateral integration.
121
Vertical Integration
Extends a firm's competitive scope within same industry
Backward into sources of supply
Forward toward end-users of final product
Can aim at either full or partial integration
122
Unrelated Diversification
Favors capitalizing on a portfolio of businesses that are capable of delivering excellent financial performance
Entails hunting to acquire companies:
- Whose assets are undervalued
- That are financially distressed
- With high growth potential but are short on investment capital
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Motivations for mergers and acquisition
The primary motive should be the creation of synergy.
Synergy value is created from economies of integrating a target and acquiring a company; the amount by which the value of the combined firm exceeds the sum value of the two individual firms.
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Economies of Scale
Economies of scale is the cost advantage that arises with increased output of a product. Economies of scale arise because of the inverse relationship between the quantity produced and per-unit fixed costs
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Economies of Scope
Economies of scope is an economic theory stating that the average total cost of production decreases as a result of increasing the number of different goods produced.
126
Complementary strengths
used of two things when each adds something to the other or helps to make the other better
127
Value Creation Motivation 1: Efficiency Increases
New management team will be more efficient and add more value than what the target now has.
The combined firm can make use of unused production/sales/marketing channel capacity
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VCM 2 M&A: Financing Synergy
Reduced cash flow variability
Increase in debt capacity
Reduction in average issuing costs
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VCM 3 M&A: Tax Benefits
Make better use of tax deductions and credits
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VCM 4 M&A: Strategic Realignments
Permits new strategies that were not feasible prior to the acquisition. The acquisition of new management skills, connections to markets or people, and new products/services.
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Managerial Motivation for M&A: Increased firm size
more highly rewarded financially for building a bigger business
Many associate power and prestige with the size of the firm.
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Managerial Motivation For M&A: Reduced firm risk through diversification
Managers have an undiversified stake in the business and so they tend to dislike risk
M&As can be used to diversify the company and reduce risk that might concern managers.
133
How deal is financed:
Cash Transaction
-The receipt of cash for shares by shareholders in the target company.
Share Transaction
-The offer by an acquiring company of shares or a combination of cash and shares to the target company’s shareholders.
Going Private Transaction (Issuer bid)
-A special form of acquisition where the purchaser already owns a majority stake in the target company
134
Intent of the legislation
1. Transparency- To ensure complete and timely information be available to all parties while at the same time not letting this requirement stall the process unduly
2.Fair Treatment
To avoid oppression or coercion of minority shareholders.
To permit competing bids during the process and not have the first bidder have special rights. (In this way, shareholders have the opportunity to get the greatest and fairest price for their shares.)
To limit the ability of a minority to frustrate the will of a majority. (minority squeeze out provisions)
135
Exempt Takeovers
Private companies are generally exempt from provincial securities legislation.
Public companies that have few shareholders in one province may be subject to takeover laws of another province where the majority of shareholders reside.
Purchase of shares from fewer than 5 shareholders
136
Creeping Takeover: The 5% rule
Normal course tender offer is not required as long as no more than 5% of the outstanding shares are purchased through the exchange over a one-year period of time.
This allows creeping takeovers where the company acquires the target over a long period of time.
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10%: Early warning
When a shareholder hits this point a report is sent to OSC
| This requirement alters other shareholders that a potential acquisitor is accumulating a position (toehold) in the firm.
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20%: Takeover bid
Not allowed further open market purchases but must make a takeover bid
This allows all shareholders an equal opportunity to tender shares and forces equal treatment of all at the same price.
This requirement also forces the acquisitor into disclosing intentions publicly before moving to full voting control of the firm.
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50.1%: Control
Shareholder controls voting decisions under normal voting (simple majority)
Can replace board and control management
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66.7%: Amalgamation
can approve amalgamation proposals requiring a 2/3s majority vote (supermajority)
141
90%: Minority squeeze-out
Once the shareholder owns 90% or more of the outstanding stock minority shareholders can be forced to tender their shares.
This provision prevents minority shareholders from frustrating the will of the majority.
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Takeover bid process: Moving beyond the 20% threshold
Takeover circular sent to all shareholders.
Target has 15 days to circulate letter to shareholders with the recommendation of the board of directors to accept/reject.
Bid must be open for 35 days following public announcement.
Shareholders tender to the offer by signing authorizations.
A Competing bid automatically increases the takeover window by 10 days and shareholders during this time can withdraw authorization and accept the competing offer.
143
The takeover bid process: Prorated settlement and price
Takeover bid does not have to be for 100 % of the shares.
Tender offer price cannot be for less than the average price that the acquirer bought shares in the previous 90 days. (prohibits coercive bids)
If more shares are tendered than required under the tender, everyone who tendered shares will get a prorated number purchased.
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Friendly Acquisition
The acquisition of a target company that is willing to be taken over.
Usually, the target will accommodate overtures and provide access to confidential information to facilitate the scoping and due diligence processes.
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Friendly Acquisition: The friendly takeover process
1. Normally starts when the target voluntarily puts itself into play.
- Target uses an investment bank to prepare an offering memorandum
- May set up a data room and use confidentiality agreements
- A signed letter of intent (usually includes a no-shop clause and a termination or break fee)
- Legal team checks documents.
2. Can be initiated by a friendly overture by an acquisitor seeking information that will assist in the valuation process.
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Friendly Takeovers: Structuring the Acquisition
In friendly takeovers, both parties have the opportunity to structure the deal to their mutual satisfaction including:
1. Taxation Issues
2. Asset purchases rather share than share purchases.
3. Earn outs where there is an agreement for an initial purchase price with conditional later payments depending on the performance of the target after acquisition.
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Hostile Takeover
A takeover in which the target has no desire to be acquired and actively rebuffs the acquirer and refuses to provide any confidential information.
The acquirer usually has already accumulated an interest in the target (20% of the outstanding shares) and this preemptive investment indicates the strength of resolve of the acquirer.
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Hostile takeover: the typical process
The typical hostile takeover process:
1. Slowly acquire a toehold by open market purchase of shares at market prices without attracting attention.
2. File statement with OSC at the 10% early warning stage while not trying to attract too much attention.
3. Accumulate 20% of the outstanding shares through open market purchase over a longer period of time
4. Make a tender offer to bring ownership percentage to the desired level (either the control (50.1%) or amalgamation level (67%)) - this offer contains a provision that it will be made only if a certain minimum percentage is obtained.
During this process the acquirer will try to monitor management/board reaction and fight attempts by them to put into effect shareholder rights plans or to launch other defensive tactics.
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Hostile Market reactions and other dynamics
Market clues to the potential outcome of a hostile takeover attempt:
1. Market price jumps above the offer price
- -A competing offer is likely or
- -The bid price is too low
2. Market price stays close to the offer price
- -The offer price is fair and the deal will likely go through
3. Little trading in the shares
- A bad sign for the acquirer because shareholders are reluctant to sell.
4. Great deal of trading in the shares
- Large numbers of shares being sold from normal investors to arbitrageurs (arbs) who are, themselves building a position to negotiate an even bigger premium for themselves by coordinating a response to the tender offer.
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Hostile Takeovers: Defensive Tactics
Shareholders Rights Plan
- Known as a poison pill or deal killer
- Can take different forms but often:
- --Gives non-acquiring shareholders get the right to buy 50 percent more shares at a discount price in the event of a takeover. Makes acquisition more expensive.
Selling the Crown Jewels
- The selling of a target company’s key assets that the acquiring company is most interested in to make it less attractive for takeover.
- Can involve a large dividend to remove excess cash from the target’s balance sheet.
White Knight
-The target seeks out another acquirer considered friendly to make a counter offer and thereby rescue the target from a hostile takeover
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Globalization of the World Economy
- Globalization refers to the removal of barriers to free trade and the closer integration of national economies.
- Consumers in many countries buy goods that are purchased from a number of countries other than just their own.
- The production of goods and services has also become highly globalized.
- the financial system has also become highly integrated.
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Rise of Multinational corporations
- A multinational corporation is a business firm that operates in more than one country but is headquartered or based in its home country.
- Multinationals are owned by a mixture of domestic and foreign stockholders.
- Transnational corporations, regardless of the location of their headquarters, are managed from a global perspective rather than the perspective of a firm residing in a particular country.
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Factors affecting international financial management
1. The uncertainty of future exchange rate movements
2. Differences in legal systems and tax codes
3. While English is the official business language, it is not, however, the world’s social language.
4. Cultural views also shape business practices and people’s attitudes toward business.
5. An economic system determines how a country mobilizes its resources to produce goods and services needed by society, as well as how the production is distributed.
6. Country risk refers to political uncertainty associated with a particular country.
- ---At the extreme, a country’s government may even expropriate business’s assets within the country.
- ---Other actions include; change in tax laws, restrictive labour laws, local ownership, tariffs and quotas, disallow any cash from subsidiary to parent
- -----These types of actions clearly can affect a firm’s cash flows
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Goals of International Finance Management
-Stockholder value maximization is the accepted goal for firms in Canada, the United Kingdom and the United States
The European manager’s goal is to earn as much wealth as possible for the firm while considering the overall welfare of all stakeholders.
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Country differences
In Japan, companies form tightly knit, interlocking business groups and the goal of the Japanese business manager is to increase the wealth and growth of the group
--As a result, they might focus on maximizing market share rather than stockholder wealth.
In China, which is moving from a command or central economy to a market-based economy, there are sharp differences between state-owned companies and emerging private-sector firms.
--large staThe te-owned companies have an overall goal that can best be described as maintaining full employment in the economy while the new private-sector firms fully embrace the Western standard of stockholder value maximization.
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Basic Principles
- The basic principles of managerial finance remain the same whether a transaction is domestic or international.
- The basic principles of managerial finance remain the same whether a transaction is domestic or international.
- the same models are used for valuing capital assets, bonds, stocks, and entire firms
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Foreign Exchange Markets
The foreign exchange market is a group of international markets connected electronically where currencies are bought and sold in wholesale amounts.
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Supply and demand relationships
Supply and demand is perhaps one of the most fundamental concepts of economics and it is the backbone of a market economy. Demand refers to how much (quantity) of a product or service is desired by buyers. The quantity demanded is the amount of a product people are willing to buy at a certain price; the relationship between price and quantity demanded is known as the demand relationship. Supply represents how much the market can offer. The quantity supplied refers to the amount of a certain good producers are willing to supply when receiving a certain price.
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factors affecting currency
supply and demand relationship,Relative inflation rates, relative interest rate, and other factors
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The major participants in the foreign exchange markets are
- Multinational commercial banks
- large investment banking firms
- and small currency boutiques
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Foreign Currency quotation
The spot rate is the rate at which one agrees to buy or sell a currency today
The forward rate is the rate at which one agrees to buy or sell a currency in some future date
Note that the forward rate is established at the date on which the agreement is made and defines the exchange rate to be used when the transaction is completed in the future.
By contracting now to buy or sell foreign currencies at some future date, can lock in the cost of foreign exchange and do not have to worry about the risk of an unfavorable movement in the exchange rate in the future.
--Companies can use forward transactions to lock in (hedge) the cost of foreign exchange
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CURRENCY EXCHANGE RATE:
Value of one currency relative to another currency
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DIRECT QUOTATION METHOD:
Indicates the amount of a home country’s currency needed to purchase one unit of a foreign currency
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INDIRECT QUOTATION METHOD:
Indicates the amount of a foreign currency needed to purchase one unit of the home country’s currency
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International Capital Budgeting
When a multinational firm wants to consider overseas capital projects, the financial manager faces the decision of which capital projects should be accepted on a company-wide basis.
The decision to accept projects with a positive Net Present Value increases the value of the firm and is consistent with the fundamental goal of financial management, which is to maximize stockholder wealth.
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Determining Cash Flows
A number of issues complicate the determination of cash flows from overseas capital projects.
companies find it more difficult to estimate the incremental cash flows for foreign projects.
problems with cash flows can arise when foreign governments restrict the amount of cash that can be repatriated, or returned, to the parent company.
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Exchange rate risk
Financial managers have to deal with foreign exchange rate risk on international capital investments.
To convert the project’s future cash flows into another currency, we need to come up with projected or forecast exchange rates.
One of the problems with obtaining currency rate forecasts for use in analysis of capital projects is that many projects have lives of 20 years or more.
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Financial derivatives securities
derive all or part of their value from another (underlying) security
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Why trade these indirect claims?
- Expand investment opportunities
- lower cost
- increase leverage
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Options
Created by investors, sold to other investors
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Call
Buyer has the right but not the obligation to purchase a fixed quantity from the seller at a fixed price up to a certain date
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Put
Buyer has the right but not the obligation, to sell a fixed quantity to the seller at a fixed price up to a certain date
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Exercise (Strike) price:
the per-share price at which the common stock may be purchased or sold
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Expiration date
last date at which an option can be exercised
- American (up to due date)
- European (on the due date)
- Bermudan (certain points till the date)
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Option premium
the price paid by the option buyer to the writer of the option, whether put or call
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How do options work?
- Call buyer expects the price of the underlying security to increase
- Call seller expects the price of the underlying security to decrease or stay the same
- Put buyer expects the price of the underlying security to decrease
- Put seller expects the price of the underlying security to increase or stay the same
- Possible courses of action
- -------Options may expire worthless, be exercised, or be sold prior to expiry
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Options exchanges
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Montreal Exchange (ME)
Chicago Board Options Exchange (CBOE)
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Options trading: Standardized exercise dates, exercise prices, and quantities
Facilitate offsetting positions through a clearing corporation
Clearing corporation is guarantor, handles deliveries
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Options characteristics
In-the-money options have a positive cash flow if exercised immediately
Call options: Stock price (S) > Exercise price (E)
Put options: S E
If S = E, an option is at the money
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Stock price
price of a single share of a number of saleable stocks of a company, derivative or other financial asset. In layman's terms, the stock price is the highest amount someone is willing to pay for the stock, or the lowest amount that it can be bought for.
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Exercise price
the price per share at which the owner of a traded option is entitled to buy or sell the underlying security.
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Time to maturity
Term to maturity is the remaining life of a debt instrument. In bonds, term to maturity is the time between when the bond is issued and when it matures (its maturity date), at which time the issuer must redeem the bond by paying the principal (or face value).
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Stock volatility
It is a rate at which the price of a security increases or decreases for a given set of returns. Volatility is measured by calculating the standard deviation of the annualized returns over a given period of time.
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Interest rates
he proportion of a loan that is charged as interest to the borrower, typically expressed as an annual percentage of the loan outstanding.
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Cash dividend
A cash dividend is money paid to stockholders, normally out of the corporation's current earnings or accumulated profits. All dividends must be declared by the board of directors, and they are taxable as income to the recipients.
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Right
to purchase a stated number of common shares at a specified price with a specified time (often a few months)
- Issued by the corporation
- Are transferrable
- Option to purchase shares a price often lower than the market price
- Certificates mailed to current shareholders on pro rata basis
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Warrant
to purchase a stated number or common shares at a specified price with a specified time (often several years)
- Often attached to debt or preferred shares as a sweetener
- Are detachable
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Spot or cash market
Price refers to item available for immediate delivery
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Forward market
Price refers to item available for delayed delivery
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Futures market
Sets features (contract size, delivery date, and conditions) for delivery
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Futures market characteristic
Centralized marketplace allows investors to trade with each other
Performance is guaranteed by a clearinghouse
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Commodities
agricultural, metals, and energy related
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Financials
foreign currencies as well as debt and equity instruments
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Future exchanges
Where futures contracts are traded
Voluntary, nonprofit associations, typically unincorporated
Organized marketplaces where established rules govern conduct
-----Financed by membership dues and fees for services rendered
Members trade for self or for others
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The clearing corporation
A corporation separate from, but associated with, each exchange
Exchange members must be members or pay a member for these services
---Buyers and sellers settle with clearing corporation, not with each other
Helps facilitate an orderly market
Keeps track of obligations
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The mechanics of trading
Through open-outcry, seller and buyer agree to take or make delivery on a future date at a price agreed on today
Like options, futures trading is a zero-sum game
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short-position (seller)
commits a trader to deliver an item at contract maturity
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long-position (buyer)
commits a trader to purchase an item at contract maturity
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Futures margin
Good faith deposit made by both buyer and seller to ensure completion of the contract
--Not an amount borrowed from broker
Each clearing house sets its own requirements
--Brokerage houses can require higher margin
Initial margin usually less than 10% of contract value
Margin calls occur when price goes against investor
-Must deposit more cash or close account
-Position marked-to-market daily
-Profit can be withdrawn
Each contract has maintenance or variation margin level below which the investor’s net equity cannot drop
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Hedgers
At risk with a spot market asset and exposed to unexpected price changes
Buy or sell futures to offset the risk
Used as a form of insurance
Willing to forgo some profit in order to reduce risk
-Hedged return has smaller chance of low return but also smaller chance of high return
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Speculators
Buy or sell futures contracts in an attempt to earn a return
Absorb excess demand or supply generated by hedgers
Assuming the risk of price fluctuations that hedgers wish to avoid
Speculation encouraged by leverage, ease of transacting, low costs
