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What is the meaning of cum div and ex div share prices?
A cum div price means that the purchaser of a share will also receive the next dividend.
An ex div price means that the purchaser of a share will not receive the next dividend (it will go to the previous owner of the share).
What is the residual theory (in respect of dividend policy)?
The residual theory argues that the timing of dividends is irrelevant – that a smaller dividend now will result in more retention and therefore more growth, leading to a larger dividend in the future.
What is the dividend irrelevancy theory?
The theory argues that shareholders are indifferent between getting dividends or capital growth and that therefore the level of dividends is irrelevant.
What is venture capital?
Venture capital is money invested in companies with high-growth potential.
The venture capital investors take shares in the company, often contibute to the management, and always intend to grow the company and to then sell their shares.
What is Ijara?
Ijara is effectively the same as lease finance.
The bank allows the customer to use the asset for a fixed period at a fixed price.
The bank is responsible for major maintenance, and the lessee is responsible for general maintenance.
What is Musharaka?
Musharaka is a relationship between two or more parties who contribute the capital of a business.
They share profits in pre-agreed ratios, but they shares losses strictly in proportion to the capital invested.
What is Muduraba?
A Muduraba is a kind of partnership where one partner provides all the capital and the other provides the management.
Profits are share in a pre-agreed ratio, but losses are sufferred only by the provider of the capital.
What is a forward exchange rate?
A forward rate is an exchange rate quoted today to apply to conversion of a fixed amount on a fixed future date.
What is meant by leading and lagging?
Leading is paying early and lagging is delaying payment – depending on the expected movement in the exchange rates.
What is meant by interest rate parity?
Interest rate parity assumes that the exchange rate between two currencies depends on the relative interest rates in the two countries.
What is meant by purchasing power parity?
Purchasing power parity assumes that the exchange rate between two currencies depends on the relative inflation rates – that identical goods must cost the same.
When using the Miller-Orr formula, what is the relationship between the variance and the standard deviation?
The variance is the standard deviation squared.
What is the Miller-Orr model of cash management?
The model sets upper and lower control limits on cash. Cash in excess of the uppoer limit is transferred to deposit or short-term investments.
When the lower limit is reached, cash is withdrawn from deposit.
What is meant by the Just in Time approach to inventory management?
The Just in Time approach aims to minimise inventory levels by improving quality and producing to customer order.
What are the three E’s in the measurement of value for money?
What are the three categories of stakeholders?
* Internal (employees and managers)
* Connected (shareholders, lenders, customers, suppliers, competitors)
* External (government, communities, regulatory bodies)
What are the determinants of shareholders wealth?
Dividends received and the market value of the shares.
What is the difference between maximising and satisficing?
Maximising is achieving maximum returns.
Satisficing is achieving enough to satisfy shareholders.
What are the three levels of market efficiency?
* Weak form efficiency
* Semi-strong form efficiency
* Strong form efficiency
What is the significance of a higher PE ratio?
A higher PE ratio suggests that investors are expecting higher future growth.
How is the PE ratio calculated?
The PE ratio is the market value per share divided by the earnings per share.
What is a scrip dividend?
A scrip dividend is where the company allows its shareholders to take their dividends in the form of new shares rather than cash.
According to Modigliani and Miller with tax, What will happen to the weighted average cost of capital as the level of gearing within the business changes?
The weighted average cost of capital will fall with higher levels of gearing.
According to Modigliani and Miller without tax, What will happen to the weighted average cost of capital as the level of gearing within the business changes?
The weighted average cost of capital will remain constant at all levels of gearing.
What is the difference between financial gearing and operating gearing?
Financial gearing measures the level of debt borrowing (and therefore interest payments) in a business.
Operating gearing measures the level of fixed operating costs (as opposed to variable costs) in a business.
Under what circumstances is it valid to appraise projects at the current weighted average cost of capital (WACC)?
When the level of gearing in the company is unchanged, and where the new project has the same level of risk as that currently in the company.
What is convertible debt?
Debt borrowing where at the date of repayment the investor has the choice of taking cash or a fixed number of shares in the company.
What is the difference between redeemable debt borrowing and irredeemable debt borrowing?
Redeemable debt is repayable at some future date, irredeemable debt is never repayable.
Assuming that there is gearing in business, which will have the higher value – the asset beta or the equity beta?
The equity beta.
Under what circumstances will the asset beta and the equity beta for a company be the same?
When there is no gearing in the business.
What is the difference between an asset beta and an equity beta for a business?
The asset beta measures the risk of the business itself, ignoring the effect of any gearing in the business.
The equity beta measures the risk of a share in the business (including the risk resulting from any gearing).
Capital asset pricing model explains the relationship between the required return from an investment and which type of risk?
What is meant by unsystematic risk?
Unsystematic risk is the risk due to factors within a particular business.
This risk can be diversified away by creating a portfolio of investments.
What is meant by the systematic risk of an investment?
Systematic risk is the risk due to general economic factors (such as the rate of inflation).
It exists in all investments but the level of systematic risk is different for different types of business (business sectors). This risk cannot be diversified away.
In the formula for Gordon’s growth approximation (g = br)
What do b and r represent?
b is the proportion of profits retained in the business
r is the return on new investment
According to the dividend valuation model, how is the market value of a share determined?
The market value of a share is the present value of future dividends, discounted at the shareholders required rate of return.
What choices are available to a shareholder who received notification of a rights issue?
They can either take up the rights or sell the rights (or any combination)
What is the main reason that a company may consider having a bonus (scrip) issue of shares?
To reduce the market value of their shares on the stock exchange and therefore make them more marketable.
What is a rights issue of shares?
A rights issue is an issue of new shares offered to existing shareholders.
What is an interest rate guarantee (IRG)?
An IRG is an agreement whereby a maximum interest rate is fixed now for a loan starting on a future date (or a minimum interest rate in the case of a deposit starting on a future date).
What is a forward rate agreement (FRA)?
An FRA is an agreement whereby the interest rate is fixed now for a loan or deposit starting on a future date.
What does an upward sloping yield curve signify about the relationship between interest rates and the length of time to maturity?
It signifies that longer periods to maturity result in higher interest rates.
What does the yield curve show?
The yield curve shows the relationship between the yield (return) on debt and the time to maturity.
What are four main reasons for differences in the interest rate quoted on loans?
* The risk
* The duration of the loan
* The size of the loan
* General interest rates (due to factors in the economy)
What is the difference between fixed and floating interest rates?
With fixed interest, the rate of interest is fixed and does not change.
With floating interest, the rate of interest changes.
For Paper FM, what methods of reducing or removing foreign exchange risk are available?
* Invoicing in home currency
* Leading and lagging
* Forward rates
* Money market hedging
What are the three types of foreign currency risk?
* Translation risk
* Transaction risk
* Economic risk
What is meant by the conservative funding of working capital?
Conservative funding is financing most of the current assets with long-term finance.
What is meant by the aggressive funding of working capital?
Aggressive funding is financing most of the current assets with short-term finance.
Name two cash management models.
* The Baumol model
* The Miller-Orr model
List three reasons for a company to hold cash.
* Transaction motive
* Precautionary motive
* Speculative motive
What is invoice discounting?
Invoice discounting is where a particular invoice (or invoices) is used as security for a loan.
What is ‘non-recourse’ factoring?
Non-recourse factoring is where the factor suffers any irrecoverable debts (i.e. the company using the factor is guaranteed to have no bad debts).
What is meant by the economic order quantity (in the context of inventory management)?
The economic order quantity is the quantity to order each time that minimises the total costs involved.
What is overtrading?
Overtrading is where a company expands rapidly but does not have enough capital to fund the required increase in the working capital. This leads to liquidity problems.
What is over-capitalisation?
Over-capitalisation is the situation where the working capital of a business is too high.
How is the operating cycle (or working capital cycle) calculated?
The operating cycle is the inventory days + receivables days – payables days.
What is meant by the sensitivity of a variable in the context of NPV decision making?
The sensitivity of a variable is the percentage change in the variable that results in the NPV of the project being zero.
What is the difference between ‘risk’ and ‘uncertainty’?
Risk is the situation where there are several possible outcomes and probabilities can be assigned to the outcomes.
Uncertainly is the situation where there are several possible outcomes but where probabilities can not be assigned.
In the situation of single period capital rationing, when the projects are divisible, on what basis are the available projects ranked?
The projects are ranked on the basis of their profitability index ( = NPV of the project divided by the amount of the initial investment)
What is meant by the term ‘profitability index’?
The profitability index for a project is the NPV of the project divided by the amount of the initial investment.
What is ‘soft’ capital rationing?
Soft capital rationing is when the company itself limits the amount that it is prepared to borrow.
What is ‘hard’ capital rationing?
Hard capital rationing is when capital availability is limited by the amount that lenders are prepared to lend.
What is meant by the term ‘capital rationing’?
Capital rationing is the situation where there is a limit on the amount of capital available for investment.
In asset replacement questions, how is the equivalent annual cost calculated?
The equivalent annual cost is the present value of the first replacement cycle divided by the annuity discount factor for the replacement period.
What is meant by the term ‘real cost of capital’?
The real cost of capital is the cost of capital ignoring any inflation. (The actual (or nominal) cost of capital is the real cost of capital as adjusted for inflation.)
What is meant by the term ‘nominal cash flows’?
The nominal cash flows are the actual cash flows after adjusting for inflation.
What is meant by the term ‘perpetuity’?
A perpetuity is an equal cash flow each year for ever.
What is meant by the term ‘annuity’?
An annuity is an equal cash flow each year.
What is the definition of the Internal Rate of Return of a project?
The Internal Rate of Return is that rate of interest at which the Net Present Value of the project is zero.
What is mean by the term ‘sunk cost’?
A sunk cost is a cost that has already been incurred and does not change as a result of the investment decision. It is therefore not relevant.
What is meant by the term ‘incremental cost’?
An incremental cost is an extra cost
What is the definition of the payback period?
The payback period is the number of years it takes, in cash terms, to get back the initial investment.
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