BANK3014 Week 2: Background Information Session
Presented by
Guangqian (Isaac) Pan
Copyright By PowCoder代写 加微信 powcoder
BANK3014 Unit Progress
Introduction Sales and Trading Financial Engineering Regulation
Global Capital Mergers and Private Banking Markets Acquisitions
Background Information Session Overview
– Understand what a corporation is and how they access financing, since they are predominantly the client(s) of an investment bank.
– Understand how these financing decisions are reflected in a corporations financial reports.
– Understand different forms of equity instruments and their function within Equity Capital Markets.
– Understand the stock exchange, its participants and its function as investment banks primarily conduct equity issuances through an exchange platform.
– Readings:
– 3 (pp 47-70) covers capital market financing (both equity and debt).
– 7 (pp 157 – 173) covers exchanges and execution.
1. The Financial Structure of Corporations
Overview of a corporation
– A corporation is a legal entity, owned by its shareholders.
– Shareholders have limited liability.
– Separation of ownership and control:
– Transfer of ownership doesn’t affect operations,
– Specialised management,
– Perpetual life,
– Agency problems.
– Incorporating provides access to capital markets allowing: pooling of resources, growth, and economies of scale.
– Goal of the firm: Maximise shareholder wealth or best serve customers (not necessarily conflicting objectives).
What are the financial decisions of a corporation?
Investment Decision
How good are your investment choices?
Reinvest back into the business
Cash available for return to shareholders
Dividend Decision
What do your shareholders prefer?
Stock Buybacks
Cashflows from Operations = After-tax Operating Income + Depreciation
How much did you borrow?
Cashflows to Debt (principal repaid, interest expenses)
Cashflows from Operations to Equity Investors
What is a reasonable cash balance?
Cash held back by the company
Cash paid out by the company
Financing Decision
What capital structure would you like?
Cash, Debt, and/or Equity
Source: – Dividends, Potential Dividends and Cash Balances
How do corporations access financing?
Debt Equity
– Debt is a liability of the issuing company. –
– Contractually obliged to repay the amount
Shareholders have a residual claim on the companies assets after all liabilities have been paid.
borrowed (principle).
– Equity claims are paid from after-tax income and therefore offer no tax benefit.
Equity shareholders are considered to be owners of the company.
– Cost of issuing debt is called interest, which has to be paid periodically until debt matures. Interest payments are tax deductible. –
– First claim on cash flows.
– Does not confer control rights to holder unless the business defaults of violates debt covenants.
– Lowest priority if firm becomes insolvent.
Capital structure overview
– The capital structure of a company comprises numerous layers which differ in relation to payment priority, the need for collateral, and their risk / return characteristics.
Payment Priority
Collateral
Corporate Capital Stucture
Risk / Return
Yes Yes No No No No No No No No
First Lien Loan
Senior Secured Debt
Senior Unsecured Debt Senior Subordinated Debt Subordinated Debt
Debt Convertible Bonds / Hybrids Preferred Equity
Common Equity
Rights and Warrants
Financial choices across the business lifecycle
Growth Stage
Stage 1 Start-Up
Stage 2 Rapid Expansion
High Growth
Stage 4 Mature Growth
Stage 5 Decline
External funding needs
Internal financing
Negative or low
Negative or low
More than funding needs
External Financing
Owner’s Equity Bank Debt
Venture Capital Common Stock
Common Stock Warrants Convertibles
Retire debt Repurchase stock
International patterns in financing
– International firms primarily rely on internal funding to finance new investment.
– Outside of the U.S. we see a greater reliance on bank loans and less willingness to raise funds
through equity issuance.
Equity Markets
(cost of equity finance and issuance)
Debt markets
(cost of borrowing and leverage limits)
(cost and availability of loans)
Internal funds (income, operating cash, and buffers
Sources: Organisation for Economic Co-operation and Development (OECD), European Central Bank (ECB), Bank of Japan, National Bureau of Statistics of China, SIFMA
2. Overview of Financial Statements
Overview of financial statements – Balance Sheet
– The financial statement that presents an entity’s current financial position by disclosing resources the entity controls (its assets) and the claims on those resources (its liabilities and equity claims), as of a particular point in time (the date of the balance sheet).
name of entity
title of the statement
specific date of the statement unit of measure
the amount of cash in the company’s bank accounts amounts owed by customers from prior sales
parts and completed but unsold widgets
factories and production machinery
land on which the factories are built
amounts owed to supplies for prior purchases’ amounts owed on written debt contracts
amounts invested in the business by shareholders past earnings not distributed to shareholders
Balance Sheet
At June 30, 2017
(in thousands of dollars)
Accounts Receivable Inventories
Plant and Equipment Land
$ 4,895 $ 5,714 $ 8,517 $ 7,154 $ 981
Total Assets $ 27,261
Liabilities
Accounts Payable $ 7,156 Notes Payable $ 9,000
Total Liabilities $ 16,156
Shareholders’ Equity
Contributed Capital $ 2,000 Retained Earnings $ 9,105
Total Stockholder’s Equity $ 11,105
Total Liabilities and Stockholder’s Equity $ 27,261
Sources: Libby, R; Libby, P; Short, D “Financial Accounting”
Overview of financial statements – Income Statement
– A financial statement that provides information about a company’s profitability over a stated period of time.
name of entity
title of the statement
accounting period unit of measure
cash and promises received from sale of widgets
cost to produce widgets sold
operating expenses not directly related to production expenses incurred to develop new products
cost of using borrowed funds
income taxes on period’s pre-tax income ($4,400 x 30%) amounts owed on written debt contracts
Income Statement
For the Year Ended June 30, 2017 (in thousands of dollars)
Sales Revenue $ 37,436
Total Revenues $ 37,436
Cost of Goods Sold Expense
Selling, General, and Administrative Expense Research and Development Expense
Interest Expense
$ 26,980 $ 3,624 $ 1,982 $ 450
Total Expenses $ 33,036
Pre-tax Income $ 4,400 Income Tax Expense $ 1,320
Net Income $ 3,080
Sources: Libby, R; Libby, P; Short, D “Financial Accounting”
Overview of financial statements – Cash Flow Statement
– A financial statement that reconciles beginning-of-period and end-of-period balance sheet values of cash; provides information about an entity’s cash inflows and cash outflows as they pertain to operating, investing and financing activities.
name of entity
title of the statement accounting period unit of measure
directly related to earning income
Statement of Cash Flows
For the Year Ended June 30, 2017 (in thousands of dollars)
Cash flows from operating activities
Cash collected from customers
Cash paid to suppliers and employees Cash paid for interest
Cash paid for taxes
$ 33,563 $ (30,854) $ (450) $ (1,190)
Net cash flow from operating acitivies $ 1,069
Cash flows from investing activities
Cash paid to purchase manufacturing equipment $ (1,625)
Net cash flow from investing actiivities $ (1,625)
Cash flows from financing activities
Cash received from bank loan $ 1,400 Cash paid for dividends $ (1,000)
Net cash flow from financing activities $ 400
Net increase (decrease) in cash during the year Cash at beginning of year
Cash at end of year
$ (156) $ 5,051 $ 4,895
purchase / sale of productive assets
from investors and creditors
change in cash during the period ($1,069 – 1,625 + 400) last period’s ending cash balance
ending cash on the balance sheet
Sources: Libby, R; Libby, P; Short, D “Financial Accounting”
Overview of financial statements – Retained Earnings
– A financial statement that reconciles beginning-of-period and end-of-period balance sheet values of retained income; shows the linkage between the balance sheet and income statement.
name of entity
title of the statement
accounting period unit of measure
last period’s ending retained earnings
net income reported on the income statement dividends declared during the period
ending retained earnings on the balance sheet
Statement of Retained Earnings For the Year Ended June 30, 2017 (in thousands of dollars)
Retained earnings, July 1, 2016 Net Income for 2017
Dividends for 2017
Retained earnigns, June 30, 2017
$ 6,805 $ 3,300 $ (1,000)
Sources: Libby, R; Libby, P; Short, D “Financial Accounting”
Relationships between financial statements
– The four key financial statements (balance sheet, income statement, cashflow statement and retained earnings) are all related:
Income Statement
Net Income
Statement of Retained Earnings
3,300 (1,000)
Beginning Retained Earnings
Net Income
Ending Retained Earnings
Statement of Cash Flows
+/- +/- +/-
1,069 (1,625)
Cash Flows from Operating Activities Cash Flows from Operating Activities Cash Flows from Operating Activities
Change in Cash
$ (156) $ 5,051
Cash at the Beginning of Period
Cash at End of Period
Balance Sheet
$ 4,895 $ 22,366
Other Assets
Total Assets
Total Liabilities
Contributed Capital
Retained Earnings
Total Liabilities & Shareholders’ Equity
Sources: Libby, R; Libby, P; Short, D “Financial Accounting”
3. Equity Instruments
Ordinary shares
– Ordinary shares represent ownership in a company and are the predominant type of equity security. Ordinary shares allow investors to:
– Share in the operating performance of the company. Companies may pay some or all of net income as a cash dividend, but it is not contractually obligated to do so.
– Participate in the governing process through voting rights. Votes are undertaken to elect board of directors, decide upon a merger or acquisition, and select external auditors.
– Have a claim on the company’s net assets in case of liquidation. Stockholders have a residual claim on assets, that is, assets remaining after holders of debt and preference shares have been repaid.
Additional ordinary shares
– Takeover issues
– During a merger or acquisition, the acquiring company often issues additional ordinary shares (scrip) to
owners of the target company as settlement of the transaction.
– This alleviates the need for the acquiring company to inject cash for the purchase of the target.
– This further allows existing shareholders of the target company ownership of the new entity and thereby claim to future cashflows.
– Dividend Reinvestment Plan (DRIP)
– This plan allows shareholders the option to reinvest dividends in additional ordinary shares.
– Shares are usually issued at a discount between 0 and 5% and there is typically no brokerage or stamp duty payable.
– In growth periods, a DRIP allows companies to pay dividends and pass on tax credits, while increasing equity.
Additional ordinary shares
– Rights Issue
– The right to subscribe to a pro rata issuance (typically 1:1) of ordinary shares to existing shareholders before
they are offered to the public.
– They are used by corporations to raise capital quickly and thus have a maximum duration of 45 days.
– Issued shares are often at a discount to current share price.
– Rights issue may be renounceable (the offer is transferable / the shareholder may sell their right) or non- renounceable (the offer is not transferable / the shareholder can not sell their right).
– Placement
– A placement is an issuance of new ordinary shares directly to selected investors (institutions and individuals)
deemed to be clients of brokers.
– The corporation does not need to register a prospectus but a memorandum of information must be prepared.
– Issued shares are often at a discount to current share price.
– Allows smaller discount and short time frame than rights issue.
– Dilutes holding of non-participating shareholders.
Preference shares (description)
– Classed as hybrid securities, possessing characteristics of both debt and equity.
– Pay a fixed dividend rate set at the issue date.
– Rank ahead of ordinary shareholders with respect to the payment of dividends and distribution of the company’s assets upon liquidation.
– Preference shares are typically sold at a premium due to their higher position in the capital structure ladder.
Preference shares (characteristics / types)
– Participating
– Participating preference shares entitle the holder to participate in the surplus assets and profits of the
company once all of the shareholders have been paid back.
– Non-participating preference shares are entitled to receive only a fixed dividend payment.
– Cumulative
– In the event that a company decides not to pay a dividend, cumulative preference shares accrue and the dividend must be paid in full at a later date before dividends on ordinary shares can be paid. Non- cumulative preferences shares have no such provision; dividends that are not paid are forfeited permanently.
– Although dividends may be deferred on cumulative preference shares and not paid on non-cumulative preference shares, failure to pay preferred dividends is looked upon unfavourably by investors.
– Redeemable
– Preference shares that a corporation can redeem.
– Convertible
– Preference shares that can be converted into ordinary shares. Such a conversion is useful for a liquidity event such as an acquisition or IPO where the new value of the ordinary shares exceeds the would-be value of liquidating preference shares before the liquidity event.
Equity derivatives
– Derivatives contracts enable risk positions related to the underlying physical market to be altered without the need to alter positions in the underlying physical market itself.
– Involves the counterparties to the transaction agreeing to exchange obligations or commitments at some future date (or number of dates) usually by reference to a market index.
– In the case of exchange traded derivatives the exchange (generally a futures exchange) often interposes itself between the counterparties following completion of the trade (novation).
– Types of equity derivatives include:
– Convertible notes / bonds,
– Warrants,
– Forwards,
– Futures,
– Options,
– Indices,
Convertible notes / bonds
– Classified as a hybrid instrument, convertible notes/bonds are issued for a fixed term at a stated rate of interest.
– Holder has the right to convert the note into ordinary shares at a specified future date and at a predetermined price.
– If share price rises, holder will exercise their conversion option to receive equity that has greater value than the notes’ cash value.
– If share price falls, holder will not exercise conversion option and will instead take the notes’ cash value.
– Advantages of convertible notes/bonds include:
– Longer terms than straight debt borrowings,
– Lower rates than straight debt borrowings,
– Interest paid is tax deductible to the corporation.
Equity warrants
– Warrants are attached options that give their holder the right to buy the underlying stock of the issuing company at a fixed exercise price until the expiration date.
– Warrants are generally attached to corporate bond issues but may be issued unattached.
– Warrants do not provide dividends to holders, but holders benefit from capital gains if share price rises are above conversion price.
Equity forwards and futures (description)
– Forwards
– Equity forward contract between two parties for the delayed delivery of financial instruments or commodities
at a fixed price or yield on an agreed future date.
– Originally used as a way to mitigate exposure to price fluctuations for commodity traders by allowing parties to fix a price in advance.
– A contract between two parties through a regulated exchange to buy or sell a defined amount and standard of a commodity at a date in the future defined by the exchange at a price agreed today.
Equity forwards and futures (characteristics)
Size on Contract
– Tailored
– Standardised
Delivery Date
– Tailored
– Standardised
Participants
– Banks, brokers, multi-national corporation
– Public speculators not encouraged
– Banks, brokers, multi-national corporation
– Public speculators encouraged
Security Deposit
– Bank balances required
– Small (5-15%) security deposit (margin) in the form of cash or Treasury bills
Clearing Operation
– Contingent on individual participant
– Exchange clearing house with daily settlement
Marketplace
– Telephone, worldwide communications platforms
– Central exchanges
Regulation
– Self-regulating (AFMA)
Liquidation
– Most settled by delivery
– Most settled by offsetting profits and losses
Transaction Costs
– Set by spread between bank’s buy (bid) and sell (ask) prices
– Negotiated brokerage fees quoted for entry and exit
Equity options (description)
– Contract that gives the buyer (a long position) the right (but not the obligation) to purchase or sell an equity security or basket of equities at an agreed price at or by a specified date.
– The seller (a short position) of the option, therefore, has the potential obligation to purchase or sell an equity security or basket of equities at an agreed price at or by a specified date in the future.
– A call option gives the owner the right to buy stock at a specified exercise price on or before a specified maturity date:
– A put option gives the owner the right to sell stock at a specified exercise price on or before a specified maturity date:
Equity options (characteristics / types)
– The exercising of options depends on their type:
– American – can be exercised any time leading up to expiry.
– European – can only be exercised on date of expiry.
– Broadly options can be exercised in two types of markets:
– Organised option market – physical place where standardised option contracts are traded.
– Over-the-counter (OTC) market offers private options that are tailored to the specific needs of the customer.
Equity swaps
– Contract between two parties to exchange sequences of payments during a specified period, where at least one sequence is tied to an equity price or an equity index.
– Assume wishes to gain $USD 100 million of S&P500 exposure while Vanguard wishes to reduce their S&P500 exposure by $USD 100 million. Vanguard enters into a swap with . The swap covers a notional principal of $100 million and calls for Vanguard to pay the return of the S&P 500 and for to make quarterly payments of 6.5%.
T = 0 (Q1)
Enter into swap
$100m * 1.625% $100m * 2.5%
(Assume S&P 500 Q2 return of 2.5%)
T = 1 (Q2)
Equity Index
– A broad equity market index represents an entire given equity market and typically includes securities representing more than 90% of the selected market.
– Equity indices can be further subdivided into sector, market capitalisation and value/growth classification. Below is the ASX breakdown of the All Ordinaries Index:
All Ordinaries Index
S&P/ASX 300
S&P/ASX Small Ordinaries
S&P All Australian
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