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Finance > Sources of finance and financial markets > Flashcards

Sources of finance and financial markets Flashcards

1
Q

what is the primary role of a manager?

A

use a blend of quantitative tools and analyses to make financial decisions that create value for owners of the firm.

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2
Q

what is managerial finance all about

A

maximizing value for owners of the firm or maximizing value

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3
Q

how does the firm generate inflow

A

selling goods and services produced by human capital and productive assets

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4
Q

what is residual cash flow

A

remaining cash - usually paid to shareholders or reinvested in business

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5
Q

failure to generate sufficient cash flow may result in

A

bankruptcy
rescue plan
insolvent

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6
Q

name the three fundamental decisions (financial)

A

capital investment/budgeting
financing/capital structure plan
Working capital management

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7
Q

What is the capital budgeting/investment decision?

A

aka CAPEX decision
involves deciding what productive assets to buy
the rule of this decision: Accept an investment project if the value of future cash inflows exceeds the cost of the project (thus creating firm value)

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8
Q

what does CAPEX stand for

A

capital expenditure decision

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9
Q

why is CAPEX decision considered to be the most important?

A
  • productive assets that generate most of the firm’s cacsh inflows
  • long term
  • involve huge cash outlays
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10
Q

what is the financing/capital structure decision?

A
  • determines how the productive assets are financed
  • involves selecting the optimal capital structure - good mix of debt and equity
  • Firm value comes mainly from the investment rather than the financing decision. However, a bad financing decision can destroy value.
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11
Q

what are some advantages and disadvantages of debt

A

+ interest is tax deductible - reduces the amount of tax that is paid
- more debt is more risk to share holder

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12
Q

what is the working capital management decision

A

determines how current assets and current liabilites are managed
maximize value create and minimize or avoid destroying value

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13
Q

examples of WCM decisions

A

how much inventory to buy or maintain
where to invest idle cash
whether or not to sell goods on credit or whether or not to offer settlement discounts

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14
Q

effects of debt on the capital structure

A

–When profits are high or are increasing, the ROE is greater for firms with debt than those without debt, thus benefiting shareholders.•Shareholders benefit due to the tax benefit of interest –less tax paid.

–When profits are low or are decreasing, the ROE is worse for firms with debt than those without debt, thus disadvantaging shareholders (or destroying shareholder value).•Shareholders are disadvantaged because (unlike dividends), interest on debt is paid whether or not the firm is making a profit.

Companies with highly uncertain and variable operating income should make minimum use of debt.

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15
Q

trade off between risk and return

A

higher risk higher return

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16
Q

what are the two main categories of long term finance?

A

Equity or share capital

Long term debt (liabilities)

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17
Q

what is equity/share capital?

A

normally comprising of ordinary shares (class A shares), preference shares (class B shares) and retained income (undistributed profits). The two primary ways of raising equity finance are: new issue of shares (ordinary or preference shares) and retained income (or profits).

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18
Q

forms of long term debt

A

loans, debentures, bonds

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19
Q

what does the convention say about financing long term assets?

A

they should be financed with long term debt

This ensures that the costs of borrowing are matched with the benefits arising from the use of the assets.

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20
Q

From the point of view of the investor, investing in long-term debt (bonds/debentures) is much safer than investing in ordinary shares – why?

A

This is because (a) both the periodic interest payments and repayment of the capital sum on maturity are guaranteed; and (b) the debt can be secured against assets of the firm.

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21
Q

disadvantages of long term borrowing

A

higher interest rates - due to greater uncrtainty
impose conditions - managers decisions are less
Failure to pay periodic interest and/or to repay the capital sum could result in liquidation or bankruptcy.

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22
Q

what are ordinary shares(class A shares)

A
  • ordinary shareholders are the effective owners of a company
  • Ordinary shares confer rights to ordinary shareholders to: attend and vote at the company’s AGM, elect directors of the board, share in the company’s profits through dividends, and to share in any surplus assets on liquidation of the company
  • are not tax deductible
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23
Q

what are the benefits of listing shares on a stock exchange include

A
  • easier for shareholders to sell their shares - the price is readily available
  • increased ability to raise large new capital
  • enhanced public image and greater exposure in the media
  • enables a company to facilitate BEE or BBBEE deal
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24
Q

what is IPO

A

initial public offering - when company offers shares to public for the first time

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25
Q

from the point of the investors which carry the greatest risk

A

ordinary shares
preference shares
debt

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26
Q

preference shareholders have preferential rights over ordinary shares with respects to

A

payment of dividends - their dividends are fixed and must be paid before that of ordinary shareholders’
repayments of capital sum investment if the company is liquidated

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27
Q

what are preference shares?

A

class B shares

  • regarded as an equity instrument except when they are redeemable on a specific date - hybrid between equity and debt
  • Unlike interest on debt, preference share dividends are only payable when declared by directors, subject to available profits.
  • no voting rights except when dividends are in arrears
  • most pref shares dividends are cumulative
  • are not tax deductible
28
Q

what is retained income

A

residual cash flows
This source of finance is derived from operating profits earned in previous years which was not distributed to ordinary shareholders as dividend.

29
Q

what are bonds/debentures?

A

A bond or debenture is a fixed income instrument that represents a loan received by the borrower (company or municipality or government) from investors (bondholders).

30
Q

what does the bond specify?

A

interest rate
when interest is paid
when the capital amount will be repaid

31
Q

what does it mean for something to be bonded or mortgaged

A

Most bonds issued are secured against the an immoveable property of the company
In the event of the company being liquidated, the immovable property would be sold and cash received would first be used to repay fully bondholders before other parties are paid.

32
Q

why do companies use debt finance instead of equity finance?

A

its cheaper because:
- There is less risk for bondholders than shareholders –their investment is secured.–Interest on debt is tax deductible, thus reducing tax paid by the company.

33
Q

what are long term loans

A
  • A company may enter into a loan agreementwith any other party (usually a bank) willing to lend it funds.
  • The loan agreement would specify whether or not the loan is secured, the interest rate and when the loan will be repaid.
  • The interest rate is normally variable. However, it may be fixed for an agreed period of time (usually done with a home loan).
34
Q

what is leasing finance

A
  • A company can acquire an asset either through leasing or through borrowing and buying. This makes leasing another source of long-term finance used by companies (e.g., SAA).
  • Legally, ownership of the leased asset remains with the lessor.
35
Q

what is sale and leaseback

A
  • This agreement allows a company that owns an asset (e.g., a building) to (a) raise finance by selling the asset to a third party; and (b) lease the same asset from the new owner.
  • This arrangement allows a company to raise finance by selling its assets, while it continues to use the same assets.
36
Q

summary - what are the major sources of long term finance

A 
ordinary shares
preference shares
retained earnings
bonds/debentures
long term loans
leasing finance
sale and leaseback
37
Q

what are short term finances usually used for?

A

finance working capital requirements

38
Q

what are the 3 most popular short term finances

A

trade payables
bank overdrafts
factoring accounts receivables

39
Q

why is trade payables a good form of short term finance

A

This is a very popular source of short-term finance, especially with retail companies like Shoprite and Pick n Pay.
–This is because trade credit comes without cost (no interest is charged by creditors). The supplier benefits from the ability to sell more goods.

40
Q

what are bank overdraft and why are they good form of short t finance

A

These enable companies to borrow easily from the overdraft facility with a bank. Their advantages are: –They are very convenient
–the facility is available for use when needed.–When not being used, no interest is charged.

•A common mistake is to depend on overdraft finance on a permanent basis
–contrary to the principle of financing short-term needs with short-term finance.

41
Q

what does it mean to factor trade receivables?

A

company sells its trade receivables at a discount in order to receive cash immediately

42
Q

what is an advantage of factoring TR

A

An advantage of factoring is the use of experts to collect company debts, especially SME -small market enterprise- that lack the ability to manage their accounts receivable.

43
Q

what is an disadvantage of factoring TR

A

company may still be liable for uncollected debts

44
Q

what are financial markets?

A

where financial assets are traded - JSE, Altx, BESA

45
Q

what are financial institutions

A

these invest their funds in financial assets - banks, insurance firms, asset management firms

46
Q

what is the role of the financial system?

A

o gather money from lender-savers and channel it to borrower-spenders and enable firms to raise the finance they require.

47
Q

what are the two basic mechanisms by which funds flow through the financial system?

A

directly through financial markets -Borrower-spenders sell financial instruments (shares and bonds) to lender-savers in exchange for money.

indirectly through financial institutions - which collect money from individuals (e.g., from depositors, or for insurance or pension) and use the money to either buy shares and bonds issued by borrower-spenders or lend the money directly to borrower-spenders.

48
Q

what is the primary market?

A

–A financial market where new shares or bonds are sold by companies to investors for the first time.

–A financial market where companies raise finance.

49
Q

what is the secondary market?

A

–Enables owners of outstanding securitiesto sell them to other investors.

–Provides a value (or price) for securities already issued, thus increasing a security’s liquidity/marketability –the ease of converting the shares into cash

50
Q

dealers vs stock brokers?

A

SB - bring buyers and sellers together in secondary market for a fee and bear no risk of ownership of security
dealers - buy securities in their own right and sell from their own securities inventory - they bear the price risk

51
Q

what are money markets?

A

short term debt instruments are traded - no central location

52
Q

define short term debt instuments?

A

instruments with maturities of less than one year

53
Q

what are the characteristics of MM instruments?

A

short-term maturities, are highly marketable, have relatively low risk and low returns

54
Q

example of MM instruments

A

treasuray bills, NCD, bank acceptances and commercial papers

55
Q

who are the key players in the MM

A

investment and commercial banks

56
Q

what is the capital market?

A

where shares and long term debt instruments are traded

57
Q

examples of capital markets

A

jse
altx
besa

58
Q

difference between CM and MM

A

cm - higher risk and higher return, long term stuff

59
Q

what is the stock market?

A

where shares or stocks are traded

60
Q

what is the stock market index?

A

is a measure of stock market performance –whether stock prices have, on average moved up or down.

61
Q

what are some examples of most popular national indices?

A

–ASIA:The All Ordinaries Index(Australia), Nikkei225 (Japan), Hang Seng(Hong Kong).
–EUROPE:The DAX(Germany), CAC40 (France), FTSE100 (UK).
–AMERICA:The Dow Jones Industrial Average, Nasdaq Composite, and S&P 500(USA)

62
Q

what are some examples of JSE stock market indices

A

–All Share Index, Industrials Index,Financials Index,

Top40Index, ShariaTop40Index, the mining index, and Socially Responsible Investment Index.

63
Q

what is the main goal of an IPO

A

Obtain capital for expansion (notes) (1)
A return for the original founders (notes) (1)
Ensure succession because shares will be owned by other outsiders (from video shown in class) (1)

64
Q

functions of the IPO underwriter

A

drives the entire process- marketing and documenting

Guarantees that the company will raise the capital – they will take up shares if the public does not buy them

65
Q

In an IPO what is the process to check the integrity ad validity of the information.

A

Due diligence

66
Q

Why do some investors prefer to invest in bonds (1 mark)

b. Name one category of investors who would prefer bonds (1 mark)

A

bonds pay a fixed rate of interest and provide income b.pension funds or retired person

67
Q

what is the repo and prime lending rate?

A

repo - 6.50 - from 6.25

prime lending - 10% from 10.25

Finance (12 decks)

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