Undertake Theory Questions

Question 1

Discuss the benefits and drawbacks of using equity as a means of raising finance

Answer 1

• equity contracts indicate that the holders of these contracts will be entitled to some proportion of the cash flows of the company
• equity holders are the owners of the institution and provides a large source of finance
• can be cheaper than debt but forgoing ownership and control
• types of equity (preference and ordinary)

Question 2

Explain the concept of the capital asset pricing model CAPM as a measure of the cost of equity

Answer 2

• the CAPM suggests that the expected return (cost of equity) is comprised of two elements- risk free return and risky return.
• the risky element only has one component in that it is purely a simple measure of market risk
• whilst theoretical elegant, the CAPM is very narrow in its conceptualisation of the risk- return relationship