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2nd Year - Finance 1 > Lecture 5 - Share Markets > Flashcards

Lecture 5 - Share Markets Flashcards

(100 cards)

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1
Q

What are internally generated funds?

A

Cash reinvested in the firm; depreciation plus earnings not paid out as dividends.

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2
Q

What is the financial deficit?

A

The difference between the cash companies need and the amount generated internally.

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3
Q

How does a company make up a deficit?

A

Either borrow or issue new shares.

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4
Q

High debt ratios mean that more companies are likely to…

A

Fall into financial distress when a serious recession hits the economy.

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5
Q

What is treasury stock?

A

Stock that has been repurchased by the company and is held in its treasury.

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6
Q

The shares held by investors are said to be…

A

Issued and outstanding shares.

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7
Q

By contrast, treasury shares are said to be…

A

Issued but not outstanding.

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8
Q

What are issued shares?

A

Shares that have been issued by the company.

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9
Q

What are outstanding shares?

A

Shares that have been issued by the company and are held by investors.

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10
Q

What is authorised share capital?

A

Maximum number of shares that the company is permitted to issue without shareholder approval.

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11
Q

What is par value?

A

Value of security shown in the company’s account. It has little economic significance.

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12
Q

What is the additional paid in capital?

A

Difference between issue price and par value of stock. Also called capital surplus.

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13
Q

What are retained earnings?

A

Earnings not paid out as dividends. Profits that could be paid out as dividends are instead plowed back into the company (reinvested profits).

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14
Q

What are dividends?

A

Periodic cash distribution from the firm to the shareholders. It represents part of the return on the capital directly or indirectly lent to the company. They are not a liability until declared so cannot bankrupt a company - would not voluntarily bankrupt itself. They are paid out of after tax profits.

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15
Q

What is book value?

A

It is the value shown in the firm’s balance sheet. Book value records all the money that a firm has raised from its shareholders plus all the earnings that have been plowed back on their behalf. It is a backward looking measure and does not measure the value that shareholders place on those shares today. It is calculated as the difference between total assets and total liabilities. It does not capture the true value of a business.

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16
Q

What is market value?

A

This value is forward looking and depends on the future dividends that shareholders expect to receive. The market value represents the value of a company according to the stock market. It is the amount that investors are willing to pay for the shares of the firm. This depends on the earning power of todays assets and the expected profitability of future investments.

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17
Q

What is liquidation value?

A

Net proceeds that could be realised by selling the firm’s assets and paying off its creditors. The amount of cash per share a company could raise if it sold off all its assets in secondhand markets and paid off all its debts. It does not capture the value of a successful going concern.

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18
Q

The difference between a company’s actual value and its book or liquidation value is often attributed to its going concern value, which refers to what three factors?

A

Extra earning power - a company may have the ability to earn more than adequate rate of return on assets. In this case the value of those assets will be higher than their book value or secondhand value. Intangible assets - experience, expertise and knowledge are crucial assets and their values do not show up in stock prices.
Value of future investments - if investors believe a company will have the opportunity to make very profitable investments in the future, they will pay more for the company’s stock today.

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19
Q

What are the two features that determine a firms profits?

A

The earnings that can be generated by the firm’s tangible and intangible assets and the opportunities the firm has to invest in lucrative projects that will increase future earnings.

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20
Q

What is market capitalisation?

A

The total value of outstanding shares of stock. It can be calculated by multiplying a company’s outstanding shares by its current market price.

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21
Q

What is P/E ratio?

A

Ratio of stock price to earnings per share. It is the ratio of price per share to earnings per share.

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22
Q

What is dividend yield?

A

It is the forward dividend divided by previous close. It tells you how much dividend income you would receive for every $100 invested in the stock. It is like current yield of a bond. They both ignore prospective capital gains or losses.

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23
Q

Who owns a corporation?

A

A corporation is owned by its common stockholders. Some of the common stock is owned directly by individual investors but much of it is held by financial institutions such as mutual funds, pension funds and insurance companies. Stockholders are entitled to whatever profits are left over after the lenders have received their due. Usually the company pays out part of these profits as dividends and plows back the remainder into new investments. Shareholders hope that these investments will enable the company to earn higher profits and pay higher dividends in the future. Shareholders have ultimate control over how the company is run.

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24
Q

What do the board of directors do?

A

The board of directors have a duty to represent the shareholders’ interest. They appoint and oversee management and must vote to approve financial decisions including major capital investments, payment of dividends, share repurchase programs and new stock issues.

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25
What is majority voting?
Voting system in which each director is voted on separately. Each director is voted separately, and stockholders cast one vote for each they own.
26
What is cumulative voting?
Voting system in which all votes that one shareholder is allowed to cast can be cast for one candidate for the board of directors. The directors are voted on jointly and stockholders can cast all their votes just for one candidate.
27
When might a supermajority vote be needed?
For a merger to be approved.
28
What is the difference between majority voting and cumulative voting?
Cumulative voting refers to the fact that a shareholder has votes that are equal to the number of shares multiplied by the number of positions the shareholders are voting for. Meanwhile, straight voting refers to the fact that a shareholder may only cast one vote per share that the shareholder has.
29
What are classified boards?
Allow only a third of directors come up for reelection each year, which makes it more difficult for a dissident group of shareholders to replace the board, leading to entrenched management. Staggered elections appear to protect management, deter proxy contests and reduce the degree to which CEO compensation is linked to firm performance.
30
What is proxy contest/fight?
Takeover attempt in which outsiders compete with existing management and directors for shareholders' votes and control of the corporation.
31
Usually companies have how many classes of common stock?
One class of common stock and each share has one vote.
32
In some countries it is fairly common for firms to issue two classes of stock with different voting rights. What is good and bad about this?
It may be a good thing if controlling shareholders want to use their influence to improve profitability. However, if an idle or incompetent management has a large block of votes, it may use these votes to stay in control.
33
What is preferred stock?
Stock that takes priority over common stock. It promises a series of fixed payments to the investor and preferred dividends are paid in full and on time. It is legally an equity security. This is because payment of preferred dividends is within the discretion of the directors. Only obligation is that no dividends can be paid on the common stock until the preferred dividend has been paid. If the company goes out of business, the preferred stockholders get in queue after the debt holders but before the common stockholders.
34
What is net worth?
The sum of a company's common equity and preferred stock.
35
What is common stock?
Ownership shares in a publicly held corporation. Limited liability - shareholders only lose their original investment in the event of failure.
36
Does preferred stock grant voting privileges?
Preferred stock rarely confers full voting privileges. This is an advantage to firms that want to raise new money without sharing control of the firm with the new shareholders. However, if there is any matter that affects their place in the queue, preferred stockholders usually get to vote on it.
37
When are common stock and preferred dividends paid?
They are paid from after tax income. This can be a serious deterrent to issuing preferred. If on corporation buy another's stock, only 50% of the dividends it receives are taxed. This rule applies to dividends on both common and preferred stock, but it is most important for preferred, for which returns are dominated by dividends rather than capital gains.
38
What is floating rate preferred?
Preferred stock for which the dividend rate is linked to current market interest rates.
39
What is an initial public offering (IPO)?
First offering of stock to the general public.
40
What is the primary market?
Market for the sale of new securities by corporations.
41
What are primary offerings?
When a corporation sells new shares to raise additional cash.
42
What is the secondary market?
Market in which previously issued securities are traded among investors.
43
In which market does the issuer receive proceeds from the sale?
The primary market. In the secondary market the issuer does not receive proceeds from sales.
44
How do firms issue securities?
Venture capital, initial public offering, general cash offers and private placement.
45
What is venture capital?
Money invested to finance a new firm. This is usually provided to young businesses by specialist venture capital firms, wealthy individuals (known as angel investors) and investment institutions.
46
What is private equity investing?
Partnerships that provide funds for companies in distress or that buy out whole companies and then take them private.
47
When does a firm go public?
When it sells its first issue of shares in a general offering to investors.
48
What is a secondary offering?
When the company's founders and the venture capitalist cash in on some of their gains by selling some of their own shares.
49
Does a secondary offering flow to the company?
A secondary offering is no more than a sale of shares from the early investors in the firm to new investors, and the cash raised in a secondary offer does not flow into the company.
50
Are IPOs primary and secondary?
IPOs can be and commonly are primary and secondary. The firm raises new cash at the same time that some of the already existing shares in the firm are sold to the public.
51
What is an underwriter?
A firm that buys an issue of securities from a company and resells it to the public.
52
What is a typical underwriting agreement called and what does it entail?
A firm commitment. The underwrite buys the securities from the firm and then resells them to the public. The underwriters receive payment in the form of a spread. The underwriter is allowed by the company to sell the shares at a slightly higher price than they paid for it. The underwriters also accept the risk that they won't be able to sell the stock at the agreed offering price. If that happens, they will be stuck with unsold shares and must get the best price they can for them.
53
What is the spread?
The difference between public offer price and price paid by the underwriter.
54
What happens in riskier cases with underwriters?
Underwriters may not be willing to enter a firm commitment and therefore, handles the issues on a best efforts basis. In this case the underwriter agrees to sell as much of the issue as possible but does not guarantee the sale of the entire issue.
55
How is the Securities and Exchange Commission involved?
Before a stock is sold to the public, the company has to register with the SEC. This involves preparation of a detailed registration statement, which contains information about the proposed financing and the firm's history, existing business, and plans for the future. The SEC does not evaluate the wisdom of an investment in the firm but it does check accuracy and completeness. The firm must also comply with 'blue sky laws' - the firm must seek to protect the public against firms that fraudulently promise the blue sky to investors.
56
What is a prospectus?
A formal summary that provides information on an issue of securities.
57
What is the function of a prospectus?
To warn investors about the risks involved in the investment in the firm.
58
How is the issue price calculated?
To gauge how much the stock is worth, they may undertake discounted cash flow calculations. They also look at the price earnings ratio of the shares of the firm's principal competitors.
59
What is a 'roadshow'?
Gives the underwriters and the company's management an opportunity to talk to potential investors. The investors may then offer their reaction to the issue, suggest what they think is a fair price and indicate how much stock they would be prepared to buy. This allows the underwriters to build up a book of likely orders (bookbuilding method). Investors are not bound by their indications, underwriters use this as a guide to fix the price of an issue.
60
Why are underwriters likely to be cautious?
The managers of the firm are eager to secure the highest possible price for their stock but underwriters will be left with any unsold stock if they overestimate investor demand. As a result, underwriters typically try to underprice the IPO.
61
What is underpricing?
Issuing securities at an offering price set below their true value.
62
Why is underpricing needed?
It is needed to tempt investors to buy stock and to reduce the cost of marketing the issue to customers. However, underpricing represents a cost to the existing owners because the new investors are allowed to buy shares in the firm at a favourable price.
63
If an issue is underpriced...
Everybody will want to buy it and the underwriters will not have enough stock to go around.
64
If an issue is overpriced...
Other investors are unlikely to want it.
65
What are flotation costs?
The costs incurred when a firm issues new securities to the public.
66
What are the benefits of going public?
- Ability to raise new capital. - Stock price provides performance measure. - Information more widely available. - Diversified sources of finance. - Reduced borrowing costs.
67
Advantage of bookbuilding.
Allows underwriters to give preference to those investors whose bids are most helpful in setting the issue price and to offer them a reward in the form of underpricing.
68
What is a seasoned offering?
The sale of additional securities by a firm that is already publicly traded.
69
What is a rights issue?
The issue of securities offered only to current stockholders.
70
What is the result of a rights issue?
As the 'attractive' offer is shared by and limited to all existing shareholders, it has no effect on their wealth.
71
What is a general cash offer?
Sale of securities open to all investors by an already public company.
72
What is shelf registration?
A procedure that allows firms to file one registration statement for several issues by the same company.
73
What are advantages of shelf registration?
Securities can be issued in dribs and drabs without incurring excessive costs. Securities can be issued on short notice. Security issues can be time to take advantage of market conditions. The issuing firm can make sure that underwriters compete for its business.
74
What are the costs of a general cash offer?
- Incurs substantial administrative costs. - The firm needs to compensate the underwriters by selling them securities below the price that they expect to receive from investors. - Additionally, underwriters demand extra compensation for the greater risk they take in buying and reselling equity. (Issue costs are higher for equity than for debt securities)
75
What is private placement?
Sale of securities to a limited number of investors without a public offering.
76
What is a disadvantage of private placement?
The investor cannot easily resell the security.
77
What are some advantages of private placement?
- It costs less to arrange a private placement than to make a public issue. They avoid registration costs. This is more important for companies making small issues rather than for very large issues where costs are less significant. - The debt contract can be custom tailored for firms with special problems or opportunities. Also, if the firm wishes later to change the terms of the debt, it is much simpler to do this with a private placement where only a few investors are involved. This helps establish a direct relationship with the lender.
78
Example of private placement.
They occupy a particular niche in the corporate debt market, namely, loans to small and medium sized firms. These firms face the highest costs in public issue, require the most detailed investigation and may require specialised, flexible loan arrangements.
79
What is a direct search market?
Buyers are sellers locate one another on their own.
80
What is a brokered market?
Third party assistance in locating a buyer or seller.
81
What is a dealer market?
Third party acts as intermediate buyer or seller.
82
What is an auction market?
Brokers and dealers trade in one location. Trading is more or less continuous.
83
What is market order?
Buy or sell at current price.
84
What is limit order?
Buy or sell at a specific price.
85
What is stop order?
Buy or sell at current price after a specific price is reached.
86
What is limit buy order?
Buy if price falls below limit.
87
What is limit sell order?
Sell if price rises above limit.
88
What is stop loss order?
Sell if price falls below limit.
89
What is stop buy order?
Buy if price rises above limit.
90
What is a price contingent order?
A contingent order is an order that is linked to, and requires, the execution of another event. The contingent order becomes live, or is executed, when the event occurs.
91
What is commission?
Fee paid to broker for making a transaction.
92
What is bid price?
Price at which dealer will buy from you.
93
What is ask price?
Price at which dealer will sell to you.
94
What is combination?
On some trades, both are paid.
95
What is the over-the-counter market (OTC)?
Informal network of brokers/dealers who negotiate securities sales.
96
What are electronic communication networks (ECNs)?
Computer networks that allow direct trading.
97
What are specialist markets?
Share markets of one or more firms. Maintains 'fair and orderly market' by dealing personally.
98
What is algorithmic trading?
Use of computer trading programs to make rapid trading.
99
What is high frequency trading?
Computer programs that make very rapid trading decisions for very small profits.
100
What are dark pools?
ECNs where participants can buy/sell large blocks of securities anonymously. Transactions of at least 10,000 shares.

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