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Financial Management D > Financial Management D > Flashcards

Financial Management D Flashcards

1
Q

Stock Repurchase (4 methods)

A
  1. Buy Shares on the Market (.. announces the plans to buy)
  2. Tender Offer to Shareholders (.. stated number of stocks and fixed price!)
  3. Dutch Auction (.. states a series of prices at which the C is prepared to repurchase)
  4. Private Negotiation (greenmail) (..direct negotiation with a shareholder)
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2
Q

Types of Dividends

A
  • Cash dividend
  • Regular Cash Dividend (.. paid quarterly, semi-annualy or yearly)
  • Special Cash Dividend (.. one-off extra!)
  • Stock Dividend (.. dividend paid in stocks, basically equal to a stock split)
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3
Q

Information Content of Dividends

A
  • Dividend stock repurchase decisions contain information
  • Information contained in decisions vary
  • Assymetric information may be conveyed
  • Dividend increases could mean overpriced stock or increase future profits
  • Signal varies based on prior information about company
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4
Q

Accounts Payable

A
  • Goods received but not yet paid for
  • Very short-term debt
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4
Q

Unfunded Obligations

A
  • Senior debt, e.g employee pensions
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5
Q

Special-Purpose Entities (SPEs)

A
  • Raise cash through equity and debt
  • Do not show up on the balance sheet
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6
Q

Mutual Fund

A
  • A company that pools money from many investors and invests the money in securities such as stocks, bonds and short-term debt.
  • Raises money by selling shares to investors
  • Attempts to beat market
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7
Q

Money Market Fund

A

Invests in short-term safe securitites

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8
Q

Closed-End Fund

A
  • Fixed number of shares
  • Most closed-end funds are actively managed and seek to “beat the market”
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9
Q

Exchange-Traded Fund (ETF)

A

Portfolio bought or sold in single trade

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10
Q

Hedge Fund

A
  • A limited partnership of private investors whose money is managed by professional fund managers who use a wide range of strategies
  • Restricted access
  • Limited partnership
  • Performance-related fees
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11
Q

Commercial banks

A

Provide loans, safe money storage

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12
Q

Investment banks

A
  • Assist companies in raising financing
  • Advise on takeovers, mergers and acquisitions
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13
Q

Acquisitions

A

An acquisition is a business transaction that occurs when one company purchases and gains control over another company

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14
Q

Insurance companies

A

Invest in corporate stocks and bonds

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15
Q

Conglomerates

A
  • A corporation made up of several different, independent businesses
  • In a conglomerate, one company owns a controlling stake in several smaller companies, conducting business separately and independently.
  • Conglomerates often diversify business risk by participating in many different markets.
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16
Q

Crowdfunding

A

Raise funding via the net

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17
Q

Initial Public Offering (IPO)

A
  • First offering of stocks to public
  • To get a wider source of capital a firm can make its first public issue of common stock.
  • Register the offering with SEC (securities and exchange commission), underwriters buy and resell to the public.
  • Generally sold underpriced
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18
Q

Underwriter

A

Firm that buys and resells and issue of securities

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19
Q

Spread

A

Difference between public-offer price and price paid by underwriter

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20
Q

What are advantages / disadvantages of going public?

A

When a company goes public, the company initially gets all of the money raised through the IPO. When the shares trade on a stock exchange after the IPO, the company does not get any of that money. That is money that is exchanged between investors through the buying and selling of shares on the exchange. At the end of the day, the best decision is that which is best for the founders and their vision of the company.

Advantages:
- Financial benefit in the form of raising capital, can be used to fund R&D, fund capital expenditure, or pay off existing debt.
- Increased public awareness, may lead to an increase in market share for the company
- May be used by founding individuals as an exit strategy, many venture capitalists have used IPOs to cash in on successful companies that they helped
start up.
- Going public allows a company to raise significant capital and grow the business.

Disadvantages:
- Need for added disclosure for investors
- Regulation in regard to periodic financial reporting, which may be difficult for newer public companies,
Monitored by SEC, the cost of complying with regulatory requirements can be very high.
- Additional costs include the generation of financial reporting documents, audit fees, investor relation departments, and accounting oversight committees.
- The founders having to give up total control
- Remaining private allows the founders to run the company as they wish and not have to meet the
many regulatory requirements of being a public company.

Public companies also are faced with the added pressure of the market which may cause them to focus more on short-term results rather than long-term growth. The actions of the company’s management also become increasingly scrutinized as investors constantly look for rising profits. This may lead management to use somewhat questionable practices in order to boost earnings. Privately held companies have more autonomy than public ones.
Before deciding whether or not to go public, companies must evaluate all of the potential advantages and disadvantages that will arise. This usually happens during the underwriting process as the company works with an investment bank to weigh the pros and cons of a public offering and determine if it is in the best interest of the company for that time period.

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21
Q

Motives for going public

A
  • To create public shares for use in future acquisitions
  • To establish a market price/value for our firm
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22
Q

Levered firm

A

A company that has debt in its capital structure is a levered firm.

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23
Q

Unlevered firm

A

A company that has no debt is called an unlevered firm.

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24
Q

Three measures of cost of capital

A
  • The opportunity cost of capital
    The opportunity cost of capital is the cost of capital for a company or a project if it is all-equity financed
  • The company cost of capital (ra)
    Is the weighted average of the costs of equity and debt. MM tells us that in perfect markets the company cost of capital is identical to the opportunity cost for investing in the company.
  • The weighted average cost of capital (WACC)
    Is the weighted average of the cost of equity and the after-tax cost of debt.
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25
Q

Tax-Deductable Interest

A

The tax deductability of interest increases the total income that can be paid out to bondholders and stockholders

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26
Q

Cost of Financial Distress

A

Costs arising from bankruptcy or distorted business decisions before bankruptcy

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27
Q

Trade-Off Theory

A

Theory that capital structure is based on trade-off between tax savings and distress costs of debt

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28
Q

Pecking-order Theory

A

Theory stating firms prefer to issue of debt over equity if internal finances are insufficient

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29
Q

Value at risk (VAR)

A
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30
Q

Convertible Bond vs Straight Bond

A
  • A convertible bond gives the owner the option to exchange the bond for a predetermined number of shares. The convertible bondholder hope that the issuing company’s share price will zoom up so that the bond can be converted at a big profit. But if it zooms down, there is no obligation to convert, and the bondholder remains a bondholder.
  • On the contrary, a straight bond is a bond that obliges the issuer to regular, fixed interest as well as principal repayment upon maturity.
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31
Q

Special Purpose Entity (SPE) / Special Purpose Vehicles (SPV)

A

Is a subsidiary created by a parent company to isolate financial risk. Its legal status as a separate company makes its obligations secure even if the parent company goes bankrupt. For this reason, a special purpose vehicle is sometimes called a bankruptcy-remote entity. If accounting loopholes are exploited, these vehicles can become a financially devastating way to hide company debt.

  • An SPV is created as a separate company, with its own balance sheet by a corporation in order to isolate financial risk. It may be used to undertake a risky venture while reducing any negative financial impact upon the parent company.
  • Alternatively, it may be holding company for the securitization of debt
  • Also used by venture capitalists to consolidate a pool of capital to invest in a start-up
  • Have been used in the past by companies to hide financial losses.
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32
Q

Open-end funds vs Closed-end funds

A
  • Open-end fund: A mutual fund that can issue unlimited new shares, priced daily on their net asset value.
    -Closed end fund: Has a fixed number of shares that are traded on an exchange.
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33
Q

Pensions funds

A
  • Is any plan, fund, or scheme which provides retirement income
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34
Q

Internal diversification

A

Occurs when a firm enter a different, but usually related, line of business by developing the new line of business itself. Internal diversification frequently involves expanding a firm’s product or markets base and thus might be the practical way to grow.

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35
Q

The FinTech Revolution

A
  • Payment solutions, cash and checks are replaced by electronic payments
  • Person-to-person ledning. P2P lending platforms, bypass the banking system by connecting lenders and borrowers directly through the web
  • Crowdfunding, raise money directly for start-up businesses from a group of individuals
  • AI/ML Credit Scoring
  • Distributed Ledgers and Blockchains, blockchain.
  • Cryptocurrencies. Digital currency in which transactions are verified and record maintained in a distributed ledger outside the reach of governments.
  • Initial Coin Offerings. Companies developing new blockchain product and services can instead raise cash by selling tokens in an initial coin offering, ICO.
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36
Q

There are primarily three types of securities:

A
  • Equity, which provides ownership rights to holders
  • Debt, essentially loans repaid with periodic payments
  • Hybrids, which combine aspects of debt and equity

Until a company have gone public or has been sold, any estimate of its value is subjective.

37
Q

Venture capital

A
  • Is a form a private equity and financing investors provide to startups that are believed to have long-term growth potential.
  • Venture capital is disbursed in stages depending on the success of the firm. Typically firms require large amounts of capital to grow rapidly.
  • The return on venture capital varies dramatically according to the date at which the fund started to make investments.
38
Q

Security sales by public companies

A
  • Corporation face a persistent financial deficit, which they meet by selling securities
  • When companies announce a new issue of stock, the stock price generally falls. The explanation lies in the information that investors read into the announcement
39
Q

Book Building Method

A

The underwriter builds a book of likely orders and uses this information to set the issue price

40
Q

Direct share listing

A

Do not engage underwriters to buy and resell the stock, but instead register shares with SEC and sell directly to the market with no issue price available for investors. This method is not to prefer if a company wishes to raise cash.

41
Q

Open auction

A

Investors are invited to submit their bids and securities are sold to highest bidders. Most government sell their bonds by auction. There are different types of auctions:
- Discriminatory auction: Pay the price you bid
- Uniform-price auction: Pay the lowest winning bid price.

42
Q

SPAC - Special purpose acquisition vehicle

A

Special purpose acquisition vehicle, called social capital. Investors in the SPACs initial IPO
usually receive options to buy additional shares of the merged firm. In addition, the sponsor of the SPAC usually receives a share of equity of the merged firm. The advantage of this model is that once an attractive target is identified, it can be taken public much faster and at a lower cost than in a traditional IPO. On average, they outperform the post-listing returns of IPOs.

43
Q

Rights Issues

A

Is an invitation of securities offered only to current stockholders to purchase additional shares at a discount

44
Q

Preferred stock

A
  • Takes priority over common stock when receiving dividends (e.g can choose not to pay a preferred dividend, also affects the stockholder)
  • Gains som voting rights if corporation fails to pay preferred dividend
45
Q

Cash Dividend

A

Distributes dividend to its shareholders by way of cash. With cash dividends, the profits of the company are paid out instead of being reinvested in its business. This can at times become disadvantageous for a company since it cannot tap into its cash reserves for emergency purposes. If an equity shareholder of a company receives a cash dividend, it is considered to be an income and therefore the shareholders would have to disclose the income and pay tax on it.

46
Q

Stock dividend

A

distribute its own stocks to its equity shareholders in exchange for their investment
in the company, basically equal to a stock split. With stock dividends, a company doesn’t have to tap into its cash reserves or profits since it is only issuing its own stock to its equity shareholders. A company’s cash reserves stay intact. But since the company is essentially issuing more shares to its existing shareholders, it can bring about a dilution in the ownership control of the entity. Since the equity shareholder only receives more equity shares, it is not construed as an income and therefore not liable for taxation. That said, the shareholder would have to pay tax if he sells his shareholding out in the open market since that would construe as revenue.

47
Q

Difference between cash dividend and stock dividend

A

Cash dividend and stock dividend are two different methods by which a company can distribute a portion of its earnings to its shareholders. Here’s a brief explanation of the key differences between them:

Nature of Distribution:
- Cash Dividend: A cash dividend involves the distribution of actual cash to shareholders. Shareholders receive a specific amount of money for each share they own, typically expressed as a fixed amount per share (e.g., $0.50 per share).
- Stock Dividend: A stock dividend, also known as a bonus issue or scrip dividend, does not involve the distribution of cash. Instead, shareholders receive additional shares of the company’s stock. The number of additional shares received is usually expressed as a percentage of the shares the shareholder already owns (e.g., a 10% stock dividend means receiving 10 additional shares for every 100 shares owned).

Impact on Ownership:
- Cash Dividend: When shareholders receive a cash dividend, their ownership stake in the company remains the same. They receive cash but do not acquire additional shares.
- Stock Dividend: With a stock dividend, shareholders receive more shares of the company’s stock, which increases the number of shares they own. However, their proportional ownership in the company remains the same.

Company’s Financial Position:
-Cash Dividend: Paying cash dividends reduces the company’s cash reserves and retained earnings. It is a direct outflow of cash from the company’s accounts.
-Stock Dividend: A stock dividend does not involve a direct cash outflow from the company. Instead, it redistributes the value within the company by converting a portion of retained earnings into additional shares.

Tax Implications:
- Cash Dividend: In many countries, cash dividends are generally subject to taxation as income for the shareholders. Shareholders must pay taxes on the cash received.
- Stock Dividend: Stock dividends may have tax implications depending on the jurisdiction, but they often result in a lower immediate tax liability for shareholders because they do not receive cash.

Purpose:
- Cash Dividend: Companies often pay cash dividends when they want to distribute profits to shareholders as a form of income or return on investment. Cash dividends are a way to provide shareholders with liquidity.
- Stock Dividend: Stock dividends are typically used when a company wants to reward shareholders without depleting its cash reserves. They are often seen as a way to reinvest profits into the business while maintaining shareholder ownership percentages.

In summary, cash dividends involve the distribution of cash to shareholders, while stock dividends involve the distribution of additional shares of the company’s stock. The choice between the two methods depends on the company’s financial goals, cash position, and the preferences of its shareholders.

48
Q

Clinetele Effect

A

The clientele effect is a change in share price due to corporate decision-making that triggers investors’ reactions. A change in policy that is viewed by shareholders as unfavourable may cause them to sell some or all of their holdings, depressing the share price.

49
Q

Stock Repurchase

A

Instead of paying a dividend, the firm can use the cash to repurchase stock. The required shares are kept in the company’s treasury and may be resold if the company need money.

Stock Repurchase - Stocks are in the company’s treasury, 4 methods:
- Buy shares on the Markes, announces plans to buy
- Tender Offer to Shareholders, stated number of shares and fixed price
- Dutch Auction, states a series of prices at which the C is prepared to repurchase
- Private Negotiation (greenmail), direct negotiation with a shareholder

50
Q

Modigliani and Miller

A

Modigliani and Miller suggested that in a perfect world with no taxes or bankruptcy cost, the dividend policy is irrelevant. They proposed that the dividend policy of a company has no effect on the stock price of a company or the company’s capital structure.

  • Proposition 1
    When firm pays no taxes and capital markets function well, no difference if firm borrows or
    individual shareholders borrow. Hence, capital structure is irrelevant to value.

The total value of outstanding debt and equity depends on the value of the firms’ real assets,
operations, and growth opportunities, and not the proportions of debt and equity.

  • Leverage and expected returns, MM’s Proposition 2
    Financial leverage creates financial risk. When a corporation finances with more debt and less
    equity, the risk of the remaining equity goes up and its cost goes up to compensate.

MM2: Increased cost of equity exactly offset the advantage of borrowing at interest rates lower than the cost of equity.

51
Q

Limited company

A

Is fully liable for all obligations it owes to third parties who contract with it. The only limited liability is that of its shareholders. This means that the shareholders are not liable for the debts and obligations owed by the company.
- For exempel: If a person lends money to a limited company which then runs into financial difficulties, shareholders do not have any personal liability to provide their own money if the company is unable to repay the loan in full.

52
Q

Unlimited company

A

Shareholders of an unlimited company have unlimited liability. Unlimited liability menas that shareholders are responsible for all business debts and liabilities, even those that the company cannot pay. This amount can be more than the initial amount that they invested when subscribing for shares. The nature of a shareholder’s liability is set in the company’s constitution.
- For example: Suppose a person lends money to an unlimited company which runs into financial difficulties. In that case, the lender can look to the shareholders of the company for payment if the company is unable to pay its debts itself.

53
Q

Financial distress

A
  • Occurs when promises to creditors are broken or honored with difficulty.
  • Includes failure to pay interest or principal or both.
  • Formally it is defined as events preceding and including bankruptcy, such as violation of a loan or bond contract
54
Q

Financial Bootstrapping

A
55
Q

Shareholders vs Stakeholders

A
  • Shareholders are a subset of stakeholders, representing those who have a financial ownership interest in the company. Stakeholders, on the other hand, encompass a broader group of parties who have various interests in the company’s activities and outcomes, including financial, social, and environmental concerns. Modern corporate governance often involves considering the interests of both shareholders and stakeholders to achieve a balanced and sustainable approach to business operations.
  • Shareholders are always stakeholders in a corporation, but stakeholders are not always shareholders.
  • A shareholder owns a part of a public company through shares of a stock, while a stakeholder has an interest in the performance of a company for reasons other than stock performance or appreciation. These reasons often mena that the stakeholder has greater need for the company to succeed over a longer term.
56
Q

Option

A

An “option” is an instrument to do future deals. It’s a contract between two parties (buyer and seller) about deal but instead of doing it right away, you do it in the future. The one with the call option wants the stock to rise, will the one with the put option want the stock to stay stable or fall.

A stock options gives an investor the right, but not the obligation to buy or sell a stock at any agreed-upon price and date. Because inte has shares of stock (or stock index) as its underlying asset, stock options are a form of equity derivative and may be called equity options. The option payoffs depend solely on the price of the underlying asset, therefore known as derivative instruments/derivatives.

57
Q

Two types of options:

A
  • Puts, which is a bet that a stock will fall
  • Calls, which is a bet that a stock will rise. When a call option matures, the owner will exercise it only if the stock price is greater than the exercise price.
58
Q

Call option

A
  • Gives its owner the right, but not the obligation to buy a share at a specified exercise or strike price on or before a specified maturity date.
  • Option analysts often draw a payoff diagram to illustrate possible payoffs from an option.
  • Call options are typically used when an investor anticipates that the price of the underlying asset will rise. If the price indeed rises above the strike price, the call option can be profitable
59
Q

Put options

A
  • A put option gives the holder the right to sell the underlying asset at the strike price on or before the expiration date.
  • Put options are used when an investor expects the price of the underlying asset to fall. If the price does drop below the strike price, the put option can generate a profit.
60
Q

Derivatives

A

Financial instrument created from another instrument

61
Q

Option Premium

A

Price paid for option, above price of underlying security

“Utfärdaren har fått en premie för att ta på sig sin skyldighet. Om innehavaren inte utnyttjar sin rätt får utfärdaren behålla sin premie, och innehavaren har förlorat de pengar han/hon betalt.”

62
Q

Intrinsic Value

A

Difference between strike price and stock price

63
Q

Time Premium

A

Value of option above intrinsic value

64
Q

Exercise Price (Strike Price)

A

Price at which the security is bought or sold

65
Q

Expiration Date

A

Last date on which option can be exercised

66
Q

What determine option value? (Three things)

A
67
Q

Components of Option Price

A
  • Underlying stock price
  • Strike or exercise price
  • Volatility of stock returns (standard deviation of annual returns)
  • Time-to-option expiration
  • Time value of money (discount rate)
68
Q

Exercise

A

The act of using the option to buy (in the case of a call option) or sell (in the case of a put option) the underlying asset at the strike price.

69
Q

American vs European Options

A

Options can be classified as American-style or European-style. American options can be exercised at any time before or on the expiration date, while European options can only be exercised on the expiration date itself.

70
Q

Option value at maturity

A

When a call option matures, the owner will exercise it only if the stock price is greater than the exercise price. Therefore, at maturity, the value of a call is max(S-EX,0). When a pure matures, its value is max(EX-S,0)

71
Q

Put-call parity

A

In the case of European options, a strategy of buying a call and borrowing the present value of the exercise price provides an identical payoff to buying both the stock and a put. This basic relationship is called, put-call parity:

C + PV(EX) = P + S

Calls and puts are the basic building blocks that can be combined to give any pattern of payoffs

72
Q

Market capitalization

A

The market value of all shares

73
Q

Two ways to value a share of common stock

A
  • Calculate the PV of future dividends paid to holders of that share.
  • Calculate market capitalization (the market value of all shares) by forecasting and discounting all the free cash flow paid out to shareholders
74
Q

Surplus cash

A

Cash is surplus when these three criteria are met:
1. Free cash flow is reliably positive. Recall that free cash flow is the operating cash flow left after the firm has made all positive-NPV investments
2. The firm’s debt level is prudent and manageable. Otherwise free cash flow is better used to pay down debt
3. The firm has a sufficient war chest of cash or unused debt capacity to cover unexpected opportunities or setbacks.

75
Q

Capital structure

A

A corporation’s capital structure is its mix of debt and equity financing. A corporation that uses debt as well as equity employs financial leverage.

76
Q
A

Company cost of capital
Is the expected return on a portfolio of all the firm’s debt and equity securities

77
Q

Financial distress

A

When the revenues or income is not enough to cover the financial obligations of an individual or organization

78
Q

Notes vs bond

A
  • Notes
    Unsecured bonds maturing in 10 years or fewer
  • Bond
    Usually maturing in 20-30 years
79
Q

Covenants

A
  • Rules that the borrower must follow, otherwise the lender might demand that the loan should be repaid immediately
  • Restrict companies from taking actions that would increase the risk of their debt.
80
Q

Sinking fund

A
  • A fund containing money set aside for pay a debt or a bond
  • The company must set aside enough money each year to retire a specific number of bonds
  • A sinking fund reduces the average life of a bond, and it provides a yearly test of the company’s ability to service its debt. It therefore helps to protect the bondholder against the risk of default.
81
Q

Current assets

A
  • Are inventories of raw material, work in process and finished goods
  • Assets who are most likely to turn into cash in the near future
82
Q

Current liabilitites

A
  • Debts that are due to be repaid and payables
83
Q

Net working capital

A
  • Is the difference between current assets and liabilities
84
Q

Measuring Performance

A
  • Market Capitalization
    Total market value of equity, equal to the share price * number of shares outstanding
  • Market Value Added
    Market capitalization minus book value of equity.
85
Q

Economic Value Added (EVA) = Residual income

A

EVA = Residual Income = (after-tax interest + net income) - (cost of capital*capital)

86
Q

Measuring Efficiency

A
  • Asset Turnover Ratio
  • Profit Margin
  • Operating Profit Margin
  • Inventory Turnover ratio
  • Inventory period
  • Receivables Turnover
  • Accounts receivable period
87
Q

Du Pont Formula

A
88
Q

Measuring Leverage

A
  • Long-term debt ratio
  • Long-term debt-equity ratio
  • Total debt ratio
  • Times interest earned
  • Cash coverage ratio
89
Q

Measuring Liquidity

A
  • NWC to total assets = Net working capital / Total assets
  • Curren ratio = Current assets / current liabilities
  • Quick ratio = (cash + marketable securities + receivable)/ current liabilities
  • Cash ratio = (cash + marketable securities)/ current liabilities
90
Q
A

Financial Management D (4 decks)

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