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32 Cards in this Set
- Front
- Back
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Ordinary share capital (equity)
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Permanent & non-returnable. Collectively own co but last in line for rewards/greatest risk. Vote in mngt of co but managerial role prob ltd. Articles contain details of each class. Diff types of sh cap strongly discouraged by SM.
Nominal value - min at which MP would be set. Authorised - max amount may issue Issued - nominal value of sh cap allotted. |
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Preference shares
(Other types of share) |
- Pref shares - fixed % div paid before any profits distributed, only paid if suff distributable profits available. On WU receive nominal value before ord s/hs.
- Cumulative pref shs - same but unpaid divs on shares carried forward & must be paid before any divs paid to ord s/hs. - Participating pref shs - poss entitles to extra div above fixed div but only after ord s/hs received div. - Convertible pref shs - can be converted into ord shs. May issue to finance major acquisitions. Offer reasonable degree of safety w chance to make profits as a result of conversion if co prospers. - Redeemable pref shs - to be redeemed/repaid at some date in the future. |
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Other types if shares.
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Deferred shares - last in line for divs & proceeds in liquidation.
Non-voting shares - risk of equity shares but no say in running of co - not popular except in takeover bids. |
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Other parts of equity - retained profits & dividends payable
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Retained profits (part of equity) - part of s/hs' funds. Largest source of new funding for UK cos.
Dividend payable - a % return on nominal value. Div yield = dividend / MP of share. If div reduced, div yield falls, shares less attractive, demand falls, sell, supply increases, MP falls until yield is in equilibrium w returns received elsewhere. Ord shs have fluctuating service costs (divs paid out), which only increases (in theory) when co successful. |
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Newspaper info on shares
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Highest & lowest prices during yr
Closing price prev day Changes in price over previous trading day Dividends net of tax Dividend cover Gross yield P-E ratio |
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Shares categorised by volume of trading
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Alphas - prestigious cos, heavily traded & dealt in by large no of market-makers. Prices quoted immediately on SEAQ (SE automated quotations system).
Betas - large cos, not as heavily traded, must have at least 4 market-makers dealing in them, prices quoted on SEAQ are those that firm deals can be made. Gemmas - traded less freq, prices quoted for them are merely indicative. |
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Share warrants
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Rights give to lenders allowing them to buy new shares in a co at a future date ('exercise period') at a fixed, given price ('exercise price').
Value depends on market's view of future price. Theoretical value = (current price - exercise price) x no of shares that can be purchased w each warrant. If sh price is less than exercise price, the theoretical value is 0 since investor would be better off buying in the market. If co has good prospects, the warrant will be quoted at the warrant conversion premium = (cost of warrant + exercise price) - current sh price = premium premium / current sh price = premium as a % of current sh price. |
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Advantages of share warrants
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Spend less bc lower outlay tf potential loss much smaller.
Also means any increase in sh price (& thus warrant's price) will result in greater % increase in wealth of warrant-holder than of the sh. (eg increase of 25% divided by warrant price rather than sh price - known as 'gearing effect' if warrants). Profits from warrants classed as CG rather than income. Use to make debt issues more attractive & more viable. Poss offer lower rate of interest on debt. Warrants are potential future source of equity which doesn't req divs immediately or cause dilution of EPS or s/h control. |
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Raising equity via retentions
(internally generated funds - retained earnings & cash generated by bus other than profit eg provisions for depreciation) |
Reasons to prefer - GRANTS
Gearing raised by fixed-interest borrowing, poss that operating CFs may not cover interest payments Raises EPS & poss P-E ratio (bc prospective profit growth) Avoids expenses of new issue - lower immediate costs than borrowing (div yields usually much less than interest on debt capital, and no immediate add div costs ) No change in balance of equity control (new equity issue dilutes control) Third party scrutiny if bank borrowing or overdraft S/k authorisation (non-mngt) ltd if confidence maintained Factors limiting use - ICTIC Insufficient internally generated funds, esp newcos Could be an ideal mix of equity & debt in capital structure Timing of investment reqs might not match flow of funds Interest on debt attracts corporation tax relief, divs don't Cash cost of new equity may be low & retained funds nil immediately, but total cost of equity includes capital growth (sh price) as well as income. If no suitable investments available, s/hs incur opp costs by money not being paid out & used more profitably elsewhere. |
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Raising equity via retentions
(internally generated funds - retained earnings & cash generated by bus other than profit eg provisions for depreciation) |
Reasons to prefer - GRANTS
Gearing raised by fixed-interest borrowing, poss that operating CFs may not cover interest payments Raises EPS & poss P-E ratio (bc prospective profit growth) Avoids expenses of new issue - lower immediate costs than borrowing (div yields usually much less than interest on debt capital, and no immediate add div costs ) No change in balance of equity control (new equity issue dilutes control) Third party scrutiny if bank borrowing or overdraft S/k authorisation (non-mngt) ltd if confidence maintained Factors limiting use - ICTIC Insufficient internally generated funds, esp newcos Could be an ideal mix of equity & debt in capital structure Timing of investment reqs might not match flow of funds Interest on debt attracts corporation tax relief, divs don't Cash cost of new equity may be low & retained funds nil immediately, but total cost of equity includes capital growth (sh price) as well as income. If no suitable investments available, s/hs incur opp costs by money not being paid out & used more profitably elsewhere. |
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Borrowings: debt and other forms of loan capital
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Debentures and bonds (following cards)
Mortgages - secured loan placing title deeds of freehold/long leasehold property w/ a lender as security for a cash loan (usually up to 2/3s). Repayable over prearranged period & interest (fixed/floating rate) payable. Convertible loan stock (following cards) |
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Debenture and bonds
(Borrowings: debt and other forms of loan capital) |
LT, interest-paying debt = 'loan stock'. Attractive bc interest charges allowable against corp tax, status quo of s/h control maintained, & increase in gearing ratio may be ben to s/hs by improving EPS.
Limits from Articles, debenture trust deeds & market attitudes. Loan stock often issued at par, nominal value reps amount owed, and 'coupon rate' (interest rate) is based on nominal value - depends on co, credit rating & market conditions. Market value of stock fluctuates w interest rates & co results. Debenture is a multiple loan bc contributed by several ppl. Attract fixed rate of interest, holders are creditors (rank higher & must be paid even if co makes loss) n Can be permanent, but usually redeemable (10-30 yrs), often 2 dates. Date depends on whether co has suff liquid funds to redeem & current levels of interest rates compared to rate being paid on debentures. Debentures usually issued in times of low inflation & low interest rates. Redemption financed by cash reserves, fresh debt or equity capital. Issued at par, premium or discount. If large discount & redeemable at par or above = 'deep discount bonds'. Generally issued at low interest rates & true rate shown in expenses of I/S & liability increases in B/S by amount of unpaid discount. Co may purchase own debentures w/out s/h approval - if current MP makes it attractive to invest surplus funds this way or if req'd to repay existing borrowings before new issue. |
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Debentures & bonds - security
(Borrowings: debt and other forms of loan capital) |
Specific/fixed charge over particular assets
General/floating charge on assets Trust deed may contain provisions for a trustee to intercede if terms breached. A received may be app. Unsecured/naked debenture - int rate at least 1% higher to compensate for add risk. Mortgages/debentures must be registered in cos register of charges & w Registrar of Cos. |
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Debentures & bonds - types of interest
(Borrowings: debt and other forms of loan capital) |
Majority of debentures issued at fixed rates of interest. But there are 2 variations:
Floating - linked to current market interest - for issuing co ben when low interest rates & for investor ben of fair return whatever happens. Market value of debentures depends on coupon rate of interest compared w/ general market rates. Floating rates should mean value remains stable as interest payable follows that of the market. Zero - no rate of interest attached - issued at a discount. Implied rate of interest in level of discount. Borrower adv of no cash outlay until redemption & lender adv if tax advs in not receiving income in ST. |
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Debentures & bonds - return for investors
(Borrowings: debt and other forms of loan capital) |
Calculate PVs of all CFs involved - e.g. PV (x discount factor/return) of interest received and redeemable value. The investment will give the return required if market price of the debenture is the sum of all those PVs today. If it's more then not worth investment.
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Reverse yield gap
(Borrowings: debt and other forms of loan capital) |
Dividend yield - how much a co pays out in dividends each year relative to its share price. Dividend/share price. The higher the yield, the more money you will get back on your investment.
S/hs expect higher return than debenture holders bc higher risk. If return from holding equity exceeds that available to those holding fixed-interest stocks there is a yield gap. If it is vv then there is a reverse yield gap. But for most shares it is the capital appreciation/share price rather than divs (although 2 often related) that matters more & has greatest effect on s/h wealth. Variation in capital value of debentures usually less than share price. Usually, due to expectation of rising share prices, the yield gap is a reverse yield gap. |
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Convertible loan stock
(Borrowings: debt and other forms of loan capital) |
Fixed interest loan stock initially but w/ option to covert loan into equity at given price & specified period. Conversion price increases over time in line with growing expectations of co.
Conversion value = current market value of a unit of stock converted into shares. It will be below loan stock value on issue but expected to rise as conversion approaches. Investor - stands to gain stake in co while maintaining creditor status & security of fixed interest during risky period. Co - fixed interest rates, lower than those of non-c stock, plus tax relief on interest payments at time when cannot support burden of div payments. Attractiveness depends on cost of stock at time of purchase; period of time to conversion; expectations for co. Lower coupon rte reps prices paid for conversion rights. Market value of convertible stock always higher than that of non-c stock w/ make coupon rate & redemption date. If they're equal, market doesn't expect it to be worthwhile to convert. |
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Convertible loan stock - calculations
(Borrowings: debt and other forms of loan capital) |
Conversion ratio - no of ord sh obtained from each unit of loan stock (ie x shares obtained for every £1 of loan stock converted)
= no of shares stock can be converted into / amount of loan stock (£) Conversion price - amount of stock necy to obtain each ord share (ie £x.xx of stock req'd for each stock) = amount of loan stock (£) / no of shares stock an be converted into Conversion premium (%) = (market value of stock - conversion value of that stock at the date of issue) / conversion value of that stock. Or is it conversion price - share price ?? Conversion value = no of shares from loan stock (conversion ratio/nominal value of of loan stock) x market price of ord shs on day loan stock issued. Premium per share = market value of stock / no. of shares at conversion date. Current price (£ per share) = conversion premium - market price of ord shs on day loan stock issued. Issuing co wants greatest amount of conversion premium poss bc they will have to issue fewer shares for amount of original loan stock. Investor judges it on expectations of co. |
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Advantage of convertible loan stock
(Borrowings: debt and other forms of loan capital) |
To issuing co: MINES
Must be split into equity element & liability element under IAS - liability element will increase gearing but equity element reduce it Interest tax-deductible unlike divs on equity No cash outlay on redemption bc form of deferred equity Easier to issue loan stock instead of equity if share prices are depressed Stock issued at lower coupon rate - useful in times of high interest rates To investors: SIM Stockholders will be paid before shs in event of liquidation Increase in sh prices will cause value of conversion to rise bc this is amount investor will eventually receive Market value of stock cannot fall below that for similar ord stock of same coupon rate |
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Debt credit rating - agencies
(Borrowings: debt and other forms of loan capital) |
Risk of default needs to be known bc affects return req'd. Ratings agencies assess creditworthiness of bond issues. Bond markets global tf agencies are too.
Investment-grade bonds considered safest & non-investment-grade bonds ('junk bonds') used in high-risk trans (eg mngt buy-outs and by private equity groups & hedge funds who are prepared to take high risks w aim to realise investment quickly). Grade issuers of bonds as well as bonds themselves. Poor rating has large adverse effect on cost of capital. Criticism - lack of understanding of loan-based derivative instruments & also potential conflicts of interest as providing assessments for same cos that derive substantial income from by providing other forms of financial info. |
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Leasing - agreements
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Financier (lessor), usually finance house subsidiary of bank, purchases A & provides it for use by lessee. Lessor is legal owner & can claim capital allowances. Lessee makes payments to lessor.
Finance leases – lessor expected to recoup most of cost in initial period of rental (‘basic lease period’ or ‘primary term’). At end, peppercorn rent & then sold for large amount of proceeds. Servicing costs lessee’s resp. Reported on face of BS (A&L appears). Form of borrowing & increases capital gearing. Operating leases – not reported on face of BS (liability for future rental payments a note to a/cs). Do not cover economic life of A, ST rental contracts. Useful for high-tech products which quickly become obsolete. Servicing lessor’s resp. |
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Leasing – sale and leaseback
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Sells its buildings to investment co & becomes lessee, rents building back. Generally min of 50 yrs.
Adv – co can raise more money that if property used as security for a mortgage. Disadv – FRILL fewer A’s remain to support future borrowing removes sig A from BS (poss adverse reaction in market) increased real cost (v high) (esp if rents increase) loses flexibility to move/sell property loses future capital gains on the property |
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Hire purchase
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Hybrid between lending & renting – hiring w/ option to purchase. HP payments consist partly of capital & partly of interest payments. On final instalment payment, ownership passes.
HMRC permits customer to claim & retain tax relief on capital allowances provided option-to-purchase fee is less than market value at end of contract. Adv is that interest part of payment allowable against tax & capital allowances can be claimed on asset. |
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Securitisation of assets
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Rather than lending money, a bank raises finance for it by setting up an SPV to acquire co’s securities (e.g. commercial paper or rights to future income). SPV then sells bonds to investors. Co obtains receipts from bond issue. Rate of interest lower as partly offset by income obtained from securitised paper. Lower interest rates than bank lending rates.
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Government assistance
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EIS – unquoted co’s, investors obtain tax relief at 30% on amount subscribed (up to 500k/tax yr), provided keep shares for 3 yrs & paid up in full. Exemption from CGT when sell shares & claim income tax relief for capital losses.
EFG (Finance Guarantee) scheme – loan guarantee scheme to facilitate additional bank lending to viable SMEs (turnover up to 25m, loans 1k-1m) w/ insuff no security to secure normal commercial loan. Used by lenders on discretionary basis. Bus cannot withhold security lender would normally lend against & must be viable. Grants – bus project that create new jobs but need financial assistance. |
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Identifying financial needs (for LT finance)
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Project req’s – NCA (R&D, land acq); perm WC (re LT perm trends in trading activity); cyclical current asset changes (ST increases/decreases in trading activity).
Aggressive: - NCA financed by LT sources - fluctuating CAs & some perm WC from ST sources Ben if sT funds cheaper but increases likelihood of liquidity & CF probs. Conservative: - LT financing to fund all NCAs, perm WC & fluctuating CAs When CAs not large, may be surplus cash to invest – in marketable ST securities. Balanced: - NCA & perm WC from LT sources - fluctuating CAs from ST sources Suboptimal approach if restrictions in ability to raise ‘correct’ type of funds. Depends on market view re co prospects & nature of industry. |
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Methods of issuing shares (raising LT finance)
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Offers for sale – new shares, sponsored by SE member firm (ensure reqs for listing fulfilled) & issuing firm (ensure issue successful). Publish prospectus, often price at a discount to create demand. If undersubscribed then unsold shares taken up by underwriters.
Sale by tender – sometimes large, first-time issues bc uncertain re how much will be raised. Impression that can’t set rice. Subscribe by tender. Start w/ highest offer & work down until full allotted (but few apps), or price fixed at lowest tender accepts, or 2 prices fixed & prices between them scaled down. Reduces paperwork (apps lower); fixing prices usually higher than if offer for sale (forces supply & demand). Placing or selective marketing – for small first-time issue, or add finance. Acq’d by market-maker who passes them to small no. of investors. Cheap but limits no. of shares available for trading on market. ‘Bought deal’ is a variant – investment bank buys all at discounted price. Avoids undersubscribed risk & cost of discount can be less than underwriters’ fees. SE intro – intro on SE so that a quotation (price) can be fixed. Need suff no of shares to establish a market tf restricted to larger firms. Rights issue – issue add shares to existing s/hs – fright of first refusal (‘pre-emptive rights’). Price usually set at 20-40% lower (bc market prices of shares falls afterwards). Entitled to same proportion of existing holding. Can accept, renounce rights in favour of someone else/sell rights; neither & co sells and pays over surplus. Less admin, no prospectus (reduce costs) & maintains proportions. (see later card) Open offer – to existing s/hs, may be in proportion to existing shareholdings. Concessionary method of listing, approval sought in principle early on. Vendor share scheme or placing – if vendor prefers cash to shares in an acq, issuing house can place securities w/ clients for cash. Employee share schemes – incentive – chance to purchase shares in co at pre-determined price. Stock split – improve marketability of co’s shares & send signal or expected growth in EPS. Market price of split shares can be higher than simple split would be. Purpose – share more affordable & improve liquidity. Scrip issues – ‘bonus’ or ‘capitalisation issue’ – involves conversion of reserves into shares. S/hs receive add shares in proportion to holding. No add funds brought into co. Result is more equity in circulation so market value will generally fall in ST. |
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Methods of issuing shares (raising LT finance) – rights issue calculations
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Issue price – amount co wishes to raise / no. of new shares.
Ex-rights price (theoretical) = weighted average based on total value of co after rights issue (rights value of shares to be gained + amount subscribed for one new share) / no. of shares after rights issue (ie 4 if 1 for 3 rights issue). OR total value of issued shares / total no. of shares after rights issue. Actual prices after rights issue often differs from theoretical price – changes in expectations, how rights issue reacted to. Impact on s/h wealth will depends on earnings generated compared w/ existing earning rates (p189 worked example). Value of rights = diff between market price after the issue & the issue price of the new shares. (Divide by no. of shares issued per 1 share for p/share). (p190 worked examples) |
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Advisers to shares issues
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Issuing houses – advice & org most appropriate capital structure & timing of issue. Provide publicity, marketing facilities & backing.
Underwriters – usually issuing houses or investment banks – purchase any securities not taken up at issue price. Removes risk of share issue being undersubscribed. Investment banks – financial advice, also role of issuing house or sponsor. Sponsors – req’d by LRs – firm of stockbrokers to act for it & ensure all regs complied with. Solicitors – 2 firms usually – 1st to supervise issue itself, 2nd to act for co ensuring legal documentation accurate. Accountants – advice on issue & ensure legal req’s re financial info complied with. |
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Pricing of shares for a stock market quotation
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Sponsor advises on setting price. Factors that have a bearing are similar to making a judgement on what P/E is used: MICROBEAMS:
Market sentiment If quotation is to be on main market or AIM (diff) Comparable companies in same sector – their P/E ratio Reputation of co & mngt Org’s business & its prospects Business sector & its prospects Economic conditions Asset backing Matters affects stability of co & reliability of earnings - affected by business & financial risks (gearing, dependent on small no of key inds) (diff) Size of co & amount of finance req’d Estimation of issue price using P/E ratio: market share price = EPS x P/E ratio |
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Costs of shares issues
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Expensive & most are fixed. T/f more economical to issue large amounts of shares (discourages small firms). Costs involved are:
SE listing fee Advisers’ fees Underwriting costs Compulsory advertising Printing/distribution costs of details/prospectus Compliance with LRs |
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Private Finance Initiative (PFI) & Public Private Partnership (PPP)
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PFI – intro as a means of obtaining private finance for public sector LT capital projects.
PPP – to examine specific forms of partnership between private & public sector e.g. how private orgs held accountable to public. (PFI now w/in umbrella org of PPP). Advs of PFI: POPE Public sector doesn’t have to fund large capital outflows at start of project Obtain valuable planning/mngt expertise from private sector Private sector takes on risk of financing project & mnges it Expected higher value for money through PFI Disadvs: HOT High annual costs charged (build in profit, additional allowance for risk borne, higher borrowing costs) Over budget completion of many projects Transfer of assets to private sector – loss of control & accountability by public sector. |
