notes on corporate finance

8/12/2019 Notes on Corporate Finance

1/32

Corporate repurchase

A corporation's repurchase of stock or bonds it has issued. In the case of stocks , thisreduces the number of shares outstanding , giving each remaining shareholder a largerpercentage ownership of the company. This is usually considered a sign that the company's management is optimistic about the future and believes that the current share price isundervalued . Reasons for buybacks include putting unused cash to use, raising earnings pershare , increasing internal control of the company, and obtaining stock for employee stockoption plans or pension plans . hen a company's shareholders vote to authori!e a buyback,they aren't obliged to actually undertake the buyback. also called corporate repurchase.

Read more" http"##www.investorwords.com#$%buyback.html i(!!%)*+ k-nT
http://www.investorwords.com/1140/corporation.htmlhttp://www.investorwords.com/1140/corporation.htmlhttp://www.investorwords.com/8682/repurchase.htmlhttp://www.investorwords.com/521/bond.htmlhttp://www.investorwords.com/4725/stock.htmlhttp://www.investorwords.com/10842/reduce.htmlhttp://www.investorwords.com/10438/number.htmlhttp://www.investorwords.com/10438/number.htmlhttp://www.investorwords.com/4533/shares_outstanding.htmlhttp://www.investorwords.com/16088/ownership.htmlhttp://www.investorwords.com/16088/ownership.htmlhttp://www.investorwords.com/992/company.htmlhttp://www.investorwords.com/2931/management.htmlhttp://www.investorwords.com/2931/management.htmlhttp://www.investorwords.com/10481/optimistic.htmlhttp://www.investorwords.com/9809/future.htmlhttp://www.investorwords.com/9809/future.htmlhttp://www.investorwords.com/5959/share_price.htmlhttp://www.investorwords.com/5130/undervalued.htmlhttp://www.investorwords.com/9996/include.htmlhttp://www.investorwords.com/9996/include.htmlhttp://www.investorwords.com/747/cash.htmlhttp://www.investorwords.com/1623/Earnings_per_Share.htmlhttp://www.investorwords.com/1623/Earnings_per_Share.htmlhttp://www.investorwords.com/1623/Earnings_per_Share.htmlhttp://www.investorwords.com/10073/internal.htmlhttp://www.investorwords.com/1696/employee.htmlhttp://www.investorwords.com/4745/stock_option_plan.htmlhttp://www.investorwords.com/4745/stock_option_plan.htmlhttp://www.investorwords.com/4745/stock_option_plan.htmlhttp://www.investorwords.com/3653/pension_plan.htmlhttp://www.investorwords.com/4527/shareholder.htmlhttp://www.investorwords.com/11466/vote.htmlhttp://www.investorwords.com/332/authorize.htmlhttp://www.investorwords.com/11408/undertake.htmlhttp://www.investorwords.com/639/buyback.html#ixzz32VDJkMnThttp://www.investorwords.com/639/buyback.html#ixzz32VDJkMnThttp://www.investorwords.com/1140/corporation.htmlhttp://www.investorwords.com/8682/repurchase.htmlhttp://www.investorwords.com/521/bond.htmlhttp://www.investorwords.com/4725/stock.htmlhttp://www.investorwords.com/10842/reduce.htmlhttp://www.investorwords.com/10438/number.htmlhttp://www.investorwords.com/4533/shares_outstanding.htmlhttp://www.investorwords.com/16088/ownership.htmlhttp://www.investorwords.com/992/company.htmlhttp://www.investorwords.com/2931/management.htmlhttp://www.investorwords.com/10481/optimistic.htmlhttp://www.investorwords.com/9809/future.htmlhttp://www.investorwords.com/5959/share_price.htmlhttp://www.investorwords.com/5130/undervalued.htmlhttp://www.investorwords.com/9996/include.htmlhttp://www.investorwords.com/747/cash.htmlhttp://www.investorwords.com/1623/Earnings_per_Share.htmlhttp://www.investorwords.com/1623/Earnings_per_Share.htmlhttp://www.investorwords.com/10073/internal.htmlhttp://www.investorwords.com/1696/employee.htmlhttp://www.investorwords.com/4745/stock_option_plan.htmlhttp://www.investorwords.com/4745/stock_option_plan.htmlhttp://www.investorwords.com/3653/pension_plan.htmlhttp://www.investorwords.com/4527/shareholder.htmlhttp://www.investorwords.com/11466/vote.htmlhttp://www.investorwords.com/332/authorize.htmlhttp://www.investorwords.com/11408/undertake.htmlhttp://www.investorwords.com/639/buyback.html#ixzz32VDJkMnT


2/32

Definition of 'Sinking Fund'

A means of repaying funds that were borrowed through a bond issue. The

issuer makes periodic payments to a trustee who retires part of the issue by

purchasing the bonds in the open market.

Investopediaexp ains'SinkingFund'

!ather than the

issuer repaying

the entire

principa of a

bond issue on thematurity date"

another company

buys back a

portion of the

issue annua y

and usua y at a

fixed par va ue or

at the current

market va ue of

the bonds"

whichever is ess.

Shou d interest

rates dec ine

fo owing a bond

issue" sinking#

fund provisions

a ow a firm to

essen the interest

rate risk of its

bonds as it

essentia y

rep aces a portion

of existing debt

with ower#

yie ding bonds.

From the

investor's point of

view" a sinking

fund adds safety


3/32

ooks like Company profits both ways/

01 Interest rates rise 2 bonds less e(pensive. Company buys back the low price bonds.

)1 Interest rates fall 2 bonds more e(pensive. Company pays slightly more than facevalue

Definition of '$referred Stock'

A class of ownership in a corporation that has a higher claim on the assets and earningsthan common stock. 3referred stock generally has a dividend that must be paid outbefore dividends to common stockholders and the shares usually do not have votingrights.

The precise details as to the structure of preferred stock is specific to each corporation.4owever, the best way to think of preferred stock is as a financial instrument that hascharacteristics of both debt 5fi(ed dividends1 and e6uity 5potential appreciation1. Alsoknown as 7preferred shares7.

Definition of 'Treasury Stock %Treasury Shares&'

The portion of shares that a company keeps in their own treasury. Treasury stock may have comefrom a repurchase or buyback from shareho ders or it may have never been issued to the pub icin the first p ace. These shares don't pay dividends" have no voting rights" and shou d not beinc uded in shares outstanding ca cu ations.

Treasury stock is often created when shares of a company are initially issued. In thiscase, not all shares are issued to the public, as some are kept in the company's treasuryto be used to create e(tra cash should it be needed. Another reason may be to keep acontrolling interest within the treasury to help ward off hostile takeovers.

Alternatively, treasury stock can be created when a company does a share buyback andpurchases its shares on the open market. This can be advantageous to shareholdersbecause it lowers the number of shares outstanding. 4owever, not all buybacks are agood thing. 8or e(ample, if a company merely buys stock to improve financial ratiossuch as 93: or 3#9, then the buyback is detrimental to the shareholders, and it is done

without the shareholders' best interests in mind.

-ortgage backed security

A type of asset/backed security that is secured by a mortgage or collection ofmortgages. These securities must also be grouped in one of the top two ratings asdetermined by a accredited credit rating agency, and usually pay periodic payments thatare similar to coupon payments. 8urthermore, the mortgage must have originated from aregulated and authori!ed financial institution.


4/32

hen you invest in a mortgage/backed security you are essentially lending money to ahome buyer or business. An -;: is a way for a smaller regional bank to lend mortgagesto its customers without having to worry about whether the customers have the assets tocover the loan. Instead, the bank acts as a middleman between the home buyer and theinvestment markets.

This type of security is also commonly used to redirect the interest and principalpayments from the pool of mortgages to shareholders. These payments can be furtherbroken down into different classes of securities, depending on the riskiness of differentmortgages as they are classified under the -;:.

Conversion 3rice

The price per share at which a convertible security, such as corporate bonds orpreferred shares, can be converted into common stock.

6uotient of the principal value of the convertible security divided by the conversion price

The conversion price is determined when the convertible security is issued and can befound in the bond indenture 5in the case of convertible bonds1 or in the securityprospectus 5in the case of convertible preferred shares1. The conversion price isessential in determining the number of shares to be received, by computing the 6uotientof the principal value of the convertible security divided by the conversion price.


5/32

cost, not because of the 6uality of the bond but because of the attractiveness of theconversion feature for this 7growth7 stock. hen money is tight and stock prices aregrowing, even very credit/worthy companies will issue convertible securities in an effortto reduce their cost of obtaining scarce capital. -ost issuers hope that if the price of theirstocks rise, the bonds will be converted to common stock at a price that is higher than

the current common stock price. ;y this logic, the convertible bond allows the issuer tosell common stock indirectly at a price higher than the current price. 8rom the buyer'sperspective, the convertible bond is attractive because it offers the opportunity to obtainthe potentially large return associated with stocks, but with the safety of a bond

0. Reduce cost of borrowing money

). Reduce the dilution of 93:

%. Reduce the high coupon payments on the straight bonds. Reduce the financial

burden on the payment of big interests 5reducing the burden of debt service1@. ess negative signal than issuing the straight e6uity

. +elayed action 2 delayed e6uity. 4ence less native reaction.

+isadvantages

There are some disadvantages for convertible bond issuers, too. =ne is that financing with convertible securities runs the risk of diluting not only the 93: of the company'scommon stock, but also the control of the company.

93: can go down because of dilution/ conversion increases the of outstanding shares

4edging

et's see how this works with an e(ample. :ay you own shares of Cory's Te6uilaCorporation 5Ticker" CTC1. Although you believe in this company for the long run, youare a little worried about some short/term losses in the te6uila industry. To protectyourself from a fall in CTC you can buy a put option 5a derivative1 on the company,

which gives you the right to sell CTC at a specific price 5 strike price 1. This strategy isknown as a married put . If your stock price tumbles below the strike price, these losses

will be offset by gains in the put option. 58or more information, see this article on marriedputs or this options basics tutorial .1

8utures Contract

The futures market is a centrali!ed marketplace for buyers and sellers from around the world who meet and enter into futures contracts. s3ricing can be based on an open crysystem, or bids and offers can be matched electronically. The futures contract will statethe price that will be paid and the date of delivery

The profits and losses of a futures contract depend on the daily movements of themarket for that contract and are calculated on a daily basis. 8or e(ample, say the futures
http://www.investopedia.com/terms/p/put.asphttp://www.investopedia.com/terms/s/strikeprice.asphttp://www.investopedia.com/terms/m/marriedput.asphttp://www.investopedia.com/articles/optioninvestor/080101.asphttp://www.investopedia.com/articles/optioninvestor/080101.asphttp://www.investopedia.com/university/options/http://www.investopedia.com/terms/f/futuresmarket.asphttp://www.investopedia.com/terms/b/bid.asphttp://www.investopedia.com/terms/b/bid.asphttp://www.investopedia.com/terms/p/put.asphttp://www.investopedia.com/terms/s/strikeprice.asphttp://www.investopedia.com/terms/m/marriedput.asphttp://www.investopedia.com/articles/optioninvestor/080101.asphttp://www.investopedia.com/articles/optioninvestor/080101.asphttp://www.investopedia.com/university/options/http://www.investopedia.com/terms/f/futuresmarket.asphttp://www.investopedia.com/terms/b/bid.asp


6/32

contracts for wheat increases to B per bushel the day after the above farmer and breadmaker enter into their futures contract of B@ per bushel. The farmer, as the holder of theshort position, has lost B0 per bushel because the selling price ?ust increased from thefuture price at which he is obliged to sell his wheat. The bread maker, as the longposition, has profited by B0 per bushel because the price he is obliged to pay is less than

what the rest of the market is obliged to pay in the future for wheat.

=n the day the change occurs, the farmer's account is debited B , 5B0 per bushel D, bushels1 and the bread maker's account is credited by B , 5B0 per bushel D, bushels1. As the market moves every day, these kinds of ad?ustments are made

accordingly.


7/32

-argin Account

A margin account is an account offered by brokerages that allows investors to borrowmoney to buy securities . An investor might put down F of the value of a purchase andborrow the rest from the broker. The broker charges the investor interest for the right to

borrow money and uses the securities as collateral .

The specific calculations as to how margin works get a little more complicated, but youcan learn about this in our Margin Trading tutorial.

The important thing to understand about margin is that it has conse6uences. -argin isleverage , which means that both your gains and losses are amplified. -argin is great

when your investments are going up in value, but the double/edged sword of leveragereally hurts when your portfolio heads south. ;ecause margin e(poses you to e(tra risks,it's not advisable for beginners to use it. -argin can be a useful tool for e(periencedinvestors, but until you get to that point, play it safe.

8loating Rate 3referred :tock

A type of preferred stock where the dividends issued will vary with a benchmark, mostoften a T/bill rate. The value of the dividend from the preferred share is set by apredetermined formula to move with rates, and because of this fle(ibility preferred pricesare often more stable then fi(ed/rate preferred stocks.

The preferred category of stocks are more secure as they will be one of the first of thee6uity holders to receive dividend payments in the event of the company's li6uidation.There is often a limit to the amount the rate can change on the dividend, adding furthersecurity to the issue.

Convertible 3referred :tock

3referred stock that includes an option for the holder to convert the preferred shares intoa fi(ed number of common shares, usually anytime after a predetermined date.

-ost convertible preferred stock is e(changed at the re6uest of the shareholder, butsometimes there is a provision that allows the company 5or issuer1 to force conversion.The value of convertible common stock is ultimately based on the performance 5or lackthereof1 of the common stock.

Similarities between preferred stocks and convertible bondsThe market value of both instruments is affected by changes in interest rates. When

interest rates go up, prices for these investments (both with fixed payments) go down. Theeffect is often less marked on preferred stock however.
http://www.investopedia.com/terms/m/marginaccount.asphttp://www.investopedia.com/terms/s/security.asphttp://www.investopedia.com/terms/c/collateral.asphttp://www.investopedia.com/terms/c/collateral.asphttp://www.investopedia.com/university/margin/http://www.investopedia.com/terms/l/leverage.asphttp://www.investopedia.com/terms/p/portfolio.asphttp://www.investopedia.com/terms/m/marginaccount.asphttp://www.investopedia.com/terms/s/security.asphttp://www.investopedia.com/terms/c/collateral.asphttp://www.investopedia.com/university/margin/http://www.investopedia.com/terms/l/leverage.asphttp://www.investopedia.com/terms/p/portfolio.asp


8/32

oth exist in ! callable " versions. #or instance, when a preferred stock$s fixed dividend isgreater than prevailing interest rates, a company may !call" the preferred stock and pay theinvestor a pre%defined redemption price.

&referred stock has priority over common stock for any payments due, and so do bonds.'owever, bonds also have priority over preferred stock.

&referred stock can often be converted into common stock, like convertible bonds can beconverted into common stock. n both cases, investors have a safety net of a minimumincome while the opportunity remains open for investors to profit from an upturn in theoverall worth of the issuing company.

redit ratings apply to preferred stocks as to bonds. *atings are lower for preferredstocks, because they do not have the same guarantees as bonds .

urrent yields for preferred stock are calculated as for bonds. +xample with a fixeddividend of - ./0 and a market price of -10, a preferred stock has a current yield of 23(- ./04-10). 5s stock presents higher risk than bonds, the yield on preferred stock may beset higher than for convertible bonds issued by the same company.

6ifferences between preferred stocks and convertible bonds 5t the end of the day, preferred stock is still e7uity, while convertible bonds are still debt.n other words, a company is not obligated to pay the preferred stock holders a dividend.

'owever, preferred stock holders must be paid all their dividends before common stock

holder receive a dividend.&ayments to investors holding preferred stocks cost the issuing company more per dollar

paid out, but are also sub8ect to board approval by the company. ond interest is paid out before tax, making it less expensive, and is also an obligation that a company must respect.

&referred stock may be more accessible to investors than bonds, because they tend tohave lower face values, compared to bonds with face values of around - ,000 andminimum purchase re7uirements.

6ebt is tax efficient than &referred Stock

% See more at http 44www.learnbonds.com4convertible%bonds%vs%preferred%stocks49sthash.h: nnb*h.dpuf

hat is a Convertible 3referred :tockG

In most cases, convertible preferred stocks are similar to convertible bonds and respond accordingly in themarket place. However, there are some differences between the two.

In most instances, a preferred stock is a perpetual instrument and, as such, does not mature. Its liquidation value the stated value of the preferred stock at redemptionis an option of the issuing company. Preferred stocksrank ahead of common stocks, but below more senior obligations of the company, that is debt obligations.Therefore, holders of preferred shares will be paid before common shareholders. Dividends on preferred stocksare usually paid in quarterly amounts. However, dividends on preferred stocks are not secured and may be
http://www.learnbonds.com/lesson/callable-bonds-and-sinking-funds/http://www.learnbonds.com/bond-credit-ratings/http://www.learnbonds.com/bonds-vs-stocks/http://www.learnbonds.com/bonds-vs-stocks/http://www.learnbonds.com/bonds-vs-stocks/http://www.learnbonds.com/how-to-read-a-bond-quote/http://www.learnbonds.com/convertible-bonds-vs-preferred-stocks/#sthash.hKCnnbRh.dpufhttp://www.learnbonds.com/convertible-bonds-vs-preferred-stocks/#sthash.hKCnnbRh.dpufhttp://www.learnbonds.com/convertible-bonds-vs-preferred-stocks/#sthash.hKCnnbRh.dpufhttp://www.learnbonds.com/lesson/callable-bonds-and-sinking-funds/http://www.learnbonds.com/bond-credit-ratings/http://www.learnbonds.com/bonds-vs-stocks/http://www.learnbonds.com/how-to-read-a-bond-quote/http://www.learnbonds.com/convertible-bonds-vs-preferred-stocks/#sthash.hKCnnbRh.dpufhttp://www.learnbonds.com/convertible-bonds-vs-preferred-stocks/#sthash.hKCnnbRh.dpuf


9/32

omitted. While corporations are required to pay interest on convertible bonds, they are not required to paypreferred dividends. Dividend payments are voted at the convenience of the company. But many preferred issuesprovide provisions for cumulative payments. That is, the corporation is obliged to make up omitted paymentsbefore it may distribute dividends to common stock holders. Furthermore, missed dividend payments givepreferred shareholders the right to elect directors to the companys Board of Directors. In general, preferreddividends are paid regularly.

If a convertible preferred stock trades on an exchange, its notation will be similar to a common stock.Convertibility is not generally indicated. However, prices shown are actual prices at which the preferred hastraded, and not a percentage of par. Also, dividends shown are actual dollar amounts and not a percentage ofpar. For example, the Newell Financial $2.625 preferred pays an annually dividend of $2.625.

Whereas convertible bonds are debt instruments for a corporation, preferreds are considered equity. Convertiblepreferreds are generally protected against dilution. In addition, some preferreds may enjoy several addedfeatures. For example, the dividend on the common is increased above a certain level, if the preferred dividendwould also be increased.

What is the difference between forward and futures contracts?

8undamentally, forward and futures contracts have the same function" both types ofcontracts allow people to buy or sell a specific type of asset at a specific time at a givenprice.

4owever, it is in the specific details that these contracts differ. 8irst of all, futurescontracts are e(change/traded and, therefore, are standardi!ed contracts. 8orwardcontracts , on the other hand, are private agreements between two parties and are not asrigid in their stated terms and conditions. ;ecause forward contracts are privateagreements, there is always a chance that a party may default on its side of theagreement. 8utures contracts have clearing houses that guarantee the transactions,

which drastically lowers the probability of default to almost never.

:econdly, the specific details concerning settlement and delivery are 6uite distinct. 8orforward contracts, settlement of the contract occurs at the end of the contract. 8uturescontracts are marked/to/market daily, which means that daily changes are settled day byday until the end of the contract. 8urthermore, settlement for futures contracts can occurover a range of dates. 8orward contracts, on the other hand, only possess onesettlement date .

astly, because futures contracts are 6uite fre6uently employed by speculators , who beton the direction in which an asset's price will move, they are usually closed out prior tomaturity and delivery usually never happens. =n the other hand, forward contracts aremostly used by hedgers that want to eliminate the volatility of an asset's price, anddelivery of the asset or cash settlement will usually take place.

The right of a stockholder to vote on matters of corporate policy and who will make upthe board of directors. *oting often involves decisions on issuing securities, initiatingcorporate actions and making substantial changes in the corporation's operations.

:hareholders do not necessarily need to be physically present at the site of thecompany's annual meeting in order to e(ercise their right to vote. It is common forshareholders to voice their vote by pro(y by mailing in their response.


10/32

vote right that individuals commonly possess in democratic governments, the number ofvotes that a shareholder has corresponds to the numbers of shares that he owns. 8ore(ample, a shareholder that owns 0 shares will have a 0 times more sway than ashareholder that owns a single share.

8utures and forward contracts are linear 5!ero sum game1. =ptions are not.

Depository share

A


11/32

takeovers, since key insiders can maintain ma?ority voting control of their company without actually owning more than half of the outstanding shares .

*oting issues aside, different share classes typically have the same rights to profits andcompany ownership. Thus, even though retail investors may be limited to purchasing

only inferior classes of common stock for a given company, they still en?oy aproportionally e6ual claim to the company's profits. In these cases, investors see theirfair share of a company's returns on e6uity , although they do not en?oy the voting powertheir shares would normally provide in the absence of dual classes. 3rovided the largestakeholders who own the disproportionate voting shares are successful in running thecompany, this should be of little concern to investors / especially the typical retailinvestor who has a very tiny stake in the company anyway. Hormally, the e(istence ofdual class shares would only be a problem if an investor believed the disproportionatevoting rights were allowing inferior management to remain in place in spite of the bestinterests of shareholders.

';id/Ask :pread'

The amount by which the ask price e(ceeds the bid. This is essentially the difference inprice between the highest price that a buyer is willing to pay for an asset and the lowestprice for which a seller is willing to sell it.

8or e(ample, if the bid price is B) and the ask price is B)0 then the 7bid/ask spread7 isB0.

The si!e of the spread from one asset to another will differ mainly because of thedifference in li6uidity of each asset. 8or e(ample, currency is considered the most li6uidasset in the world and the bid/ask spread in the currency market is one of the smallest5one/hundredth of a percent1. =n the other hand, less li6uid assets such as a small/capstock may have spreads that are e6uivalent to a percent or two of the asset's value.

The Two :ides =f +ual/Class :haresWhat Are Dual-Class Shares?

hen the Internet company Joogle went public, a lot of investors were upset that it

issued a second class of shares to ensure that the firm's founders and top e(ecutivesmaintained control. 9ach of the Class ; shares reserved for Joogle insiders would carry

0 votes, while ordinary Class A shares sold to the public would get ?ust one vote. 5To

learn more, see When Insiders Buy, Should Investors Join Them? 1

+esigned to give specific shareholders voting control, une6ual voting shares are

primarily created to satisfy owners who don't want to give up control, but do want the

public e6uity market to provide financing. In most cases, these super/voting shares are

not publicly traded and company founders and their families are most commonly the

controlling groups in dual/class companies.
http://www.investopedia.com/terms/o/outstandingshares.asphttp://www.investopedia.com/terms/o/outstandingshares.asphttp://www.investopedia.com/terms/r/retailinvestor.asphttp://www.investopedia.com/terms/r/retailinvestor.asphttp://www.investopedia.com/terms/r/returnonequity.asphttp://www.investopedia.com/terms/i/insider.asphttp://www.investopedia.com/articles/02/121002.asp#axzz1iJWkopEghttp://www.investopedia.com/articles/02/121002.asp#axzz1iJWkopEghttp://www.investopedia.com/terms/e/equitymarket.asp#axzz1iJWkopEghttp://www.investopedia.com/terms/e/equitymarket.asp#axzz1iJWkopEghttp://www.investopedia.com/terms/o/outstandingshares.asphttp://www.investopedia.com/terms/r/retailinvestor.asphttp://www.investopedia.com/terms/r/returnonequity.asphttp://www.investopedia.com/terms/i/insider.asphttp://www.investopedia.com/articles/02/121002.asp#axzz1iJWkopEghttp://www.investopedia.com/terms/e/equitymarket.asp#axzz1iJWkopEg


12/32

Who Lists Them?

The Hew ork :tock 9(change allows


13/32

that while large ownership stakes in managers' hands tend to improve corporateperformance, heavy voting control by insiders weakens it. :hareholders with super/voting rights are reluctant to raise cash by selling additional shares//that could dilutethese shareholders' influence. The study also shows that dual/class companies tend tobe burdened with more debt than single/class companies. 9ven worse, dual/class stocks

tend to under/performs the stock market.

The Bottom LineHot every dual/class company is destined to perform poorly//;erkshire 4athaway, forone, has consistently delivered great fundamentals and shareholder value. Controllingshareholders normally have an interest in maintaining a good reputation with investors.Insofar as family members wield voting power, they have an emotional incentive to votein a manner that enhances performance. All the same, investors should keep in mind theeffects of dual/class ownership on company fundamentals.

:hort :elling" hat Is :hort :ellingG8irst, let's describe what short selling means when you purchase shares of stock. In

purchasing stocks, you buy a piece of ownership in the company. The buying and selling

of stocks can occur with a stock broker or directly from the company. ;rokers are most

commonly used. They serve as an intermediary between the investor and the seller and

often charge a fee for their services.

LCM hen using a broker, you will need to set up an account. The account that's set up is

either a cash account or a margin account . A cash account re6uires that you pay for

your stock when you make the purchase, but with a margin account the broker lends you

a portion of the funds at the time of purchase and the security acts as collateral.

hen an investor goes long on an investment, it means that he or she has bought a

stock believing its price will rise in the future. Conversely, when an investor goes short ,

he or she is anticipating a decrease in share price.

:hort selling is the selling of a stock that the seller doesn't own. -ore specifically, ashort sale is the sale of a security that isn't owned by the seller, but that is promised to

be delivered. That may sound confusing, but it's actually a simple concept. 5To learnmore, read Bene'it (rom Borro"ed Se%urities .1

:till with usG 4ere's the skinny" when you short sell a stock, your broker will lend it toyou. The stock will come from the brokerage's own inventory, from another one of thefirm's customers, or from another brokerage firm. The shares are sold and the proceedsare credited to your account. :ooner or later, you must 7close7 the short by buying backthe same number of shares 5called covering 1 and returning them to your broker. If theprice drops, you can buy back the stock at the lower price and make a profit on thedifference. If the price of the stock rises, you have to buy it back at the higher price, andyou lose money.
http://www.investopedia.com/terms/d/debt.asp#axzz1iJWkopEghttp://www.investopedia.com/terms/m/marginaccount.asphttp://www.investopedia.com/terms/l/long.asphttp://www.investopedia.com/terms/s/short.asphttp://www.investopedia.com/articles/stocks/08/borrowed-securities.asphttp://www.investopedia.com/terms/b/broker.asphttp://www.investopedia.com/terms/s/shortcovering.asphttp://www.investopedia.com/terms/d/debt.asp#axzz1iJWkopEghttp://www.investopedia.com/terms/m/marginaccount.asphttp://www.investopedia.com/terms/l/long.asphttp://www.investopedia.com/terms/s/short.asphttp://www.investopedia.com/articles/stocks/08/borrowed-securities.asphttp://www.investopedia.com/terms/b/broker.asphttp://www.investopedia.com/terms/s/shortcovering.asp


14/32

-ost of the time, you can hold a short for as long as you want, although interest ischarged on margin accounts, so keeping a short sale open for a long time will cost more4owever, you can be forced to cover if the lender wants the stock you borrowed back.;rokerages can't sell what they don't have, so yours will either have to come up withnew shares to borrow, or you'll have to cover. This is known as being called away . It

doesn't happen often, but is possible if many investors are short selling a particularsecurity.

;ecause you don't own the stock you're short selling 5you borrowed and then sold it1,you must pay the lender of the stock any dividends or rights declared during the courseof the loan. If the stock splits during the course of your short, you'll owe twice thenumber of shares at half the price. 5To learn more about stock splits, read &nderstanding Sto%# S)lits $1

:hort selling

Short se ing %or (se ing short)& is a techni*ue used by peop e who try to profit from thefa ing price of a stock. Short se ing is a very risky techni*ue as it invo ves precise timingand goes contrary to the overa direction of the market. Since the stock market hashistorica y tended to rise in va ue over time" short se ing re*uires precise market timing"which is a very difficu t feat.

+ere,s how short se ing works. Assume you want to se short - shares of a company because you be ieve sa es are s owing and its earnings wi drop. /our broker wi borrow theshares from someone who owns them with the promise that you wi return them ater. /ou

immediate y se the borrowed shares at the current market price. 0hen the price of theshares drops %you hope&" you (cover your short position) by buying back the shares" and your

broker returns them to the ender. /our profit is the difference between the price at which youso d the stock and your cost to buy it back" minus commissions and expenses for borrowingthe stock. 1ut if you,re wrong" and the price of the shares increase" your potentia osses areun imited. The company,s shares may go up and up" but at some point you have to rep acethe - shares you so d. In that case" your osses can mount without imit unti you coveryour short position.

ebate

0. In a short/sale transaction, the portion of interest or dividends earned bythe owner 5lender1 of shares that are paid to the short seller 5borrower1 ofthe shares.

). In an options transaction, the amount paid to the holder of the option ifthe option e(pires worthless.

Short S!uee"e

A situation in which a heavily shorted stock or commodity moves sharply higher, forcingmore short sellers to close out their short positions and adding to the upward pressure
http://www.investopedia.com/terms/c/calledaway.asphttp://www.investopedia.com/terms/d/dividend.asphttp://www.investopedia.com/terms/d/dividend.asphttp://www.investopedia.com/terms/r/right.asphttp://www.investopedia.com/terms/s/stocksplit.asphttp://www.investopedia.com/articles/01/072501.asphttp://www.investopedia.com/terms/c/calledaway.asphttp://www.investopedia.com/terms/d/dividend.asphttp://www.investopedia.com/terms/r/right.asphttp://www.investopedia.com/terms/s/stocksplit.asphttp://www.investopedia.com/articles/01/072501.asp


15/32

on the stock. A short s6uee!e implies that short sellers are being s6uee!ed out of theirshort positions, usually at a loss. A short s6uee!e is generally triggered by a positivedevelopment that suggests the stock may be embarking on a turnaround. Although theturnaround in the stockNs fortunes may only prove to be temporary, few short sellers canafford to risk runaway losses on their short positions and may prefer to close them out

even if it means taking a substantial loss.

-argin Call

A broker's demand on an investor using margin to deposit additional money or securitiesso that the margin account is brought up to the minimum maintenance margin. -argincalls occur when your account value depresses to a value calculated by the broker'sparticular formula.

This is sometimes called a 7fed call7 or 7maintenance call.7

;lack :wan event

An event or occurrence that deviates beyond what is normally e(pected of a situationand that would be e(tremely difficult to predict. This term was populari!ed by HassimHicholas Taleb, a finance professor and former all :treet trader.

8ire :ale

Se ing goods or assets at heavi y discounted prices. Fire sa e origina y referred to the discountsa e of goods that were damaged by fire it may now refer to any sa e where the se er is infinancia distress. In the context of the financia markets" fire sa e refers to securities that aretrading we be ow their intrinsic va ue" such as during pro onged bear markets.

':9C 8orm +98 0@A'

A filing with the :ecurities and 9(change Commission 5:9C1 that must be filed by or onbehalf of a registrant when a shareholder vote is re6uired. :9C 8orm +98 0@A is mostcommonly used in con?unction with an annual meeting pro(y. The form should providesecurity holders with sufficient information to allow them to make an informed vote at anupcoming security holders' meeting or to authori!e a pro(y to vote on their behalf. Itincludes information about the date, time and place of the meeting of security holders>revocability of pro(y> dissenter's right of appraisal> persons making the solicitation> director indirect interest of certain persons in matters to be acted upon> modification ore(change of securities> financial statements> voting procedures> and other details.

8orm +98 0@A, which is also known as 7definitive pro(y statement7, is re6uired under:ection 0@5a1 of the :ecurities 9(change Act of 0&%@. This form is filed with the :9C

when a definitive pro(y statement is given to shareholders and helps the :9C ensurethat shareholders' rights are upheld.


16/32

There are both differences and similarities between capital and money markets . 8romthe issuer or seller's standpoint, both markets provide a necessary business function"maintaining ade6uate levels of funding. The goal for which sellers access each market

varies depending on their li6uidity needs and time hori!on. :imilarly, investors or buyershave uni6ue reasons for going to each market" Capital markets offer higher/riskinvestments, while money markets offer safer assets> money market returns are oftenlow but steady, while capital markets offer higher returns. The magnitude of capitalmarket returns is often a direct correlation to the level of risk, however that is not alwaysthe case.

Although markets are deemed efficient in the long run, short/term inefficiencies allowinvestors to capitali!e on anomalies and reap higher rewards that may be out ofproportion to the level of risk. Those anomalies are e(actly what investors in capitalmarkets try to uncover. Although money markets are considered safe, they haveoccasionally e(perienced negative returns. Inadvertent risk, although unusual, highlightsthe risks inherent in investing / whether long or short term, money markets or capitalmarkets.

Cyclical Industry

A type of an industry that is sensitive to the business cycle, such that revenues aregenerally higher in periods of economic prosperity and e(pansion, and lower in periods

of economic downturn and contraction.

Companies in cyclical industries can deal with this type of volatility by implementing cutsto compensations and layoffs during bad times, and paying bonuses and hiring enmasse in good times. Cyclical industries include those that produce durable goods suchas raw materials and heavy e6uipment. A type of an industry that is sensitive to thebusiness cycle, such that revenues are generally higher in periods of economicprosperity and e(pansion, and lower in periods of economic downturn and contraction.

Companies in cyclical industries can deal with this type of volatility by implementing cutsto compensations and layoffs during bad times, and paying bonuses and hiring enmasse in good times. Cyclical industries include those that produce durable goods suchas raw materials and heavy e6uipment.

8or e(ample, the airline industry is a fairly cyclical industry> in good economic times,people have more disposable income and, therefore, they are more willing to takevacations and make use of air travel.

Conversely, during bad economic times, people are much more cautious aboutspending. As a result, they tend to take more conservative vacations closer to home 5ifthey go at all1 and avoid e(pensive air travel.
http://www.investopedia.com/university/moneymarket/http://www.investopedia.com/university/moneymarket/http://www.investopedia.com/university/moneymarket/


17/32

-e!!anine 8inancing

A hybrid of debt and e6uity financing that is typically used to finance the e(pansion ofe(isting companies. -e!!anine financing is basically debt capital that gives th:inceme!!anine financing is usually provided to the borrower very 6uickly with little due

diligence on the part of the lender and little or no collateral on the part of the borrower,this type of financing is aggressively priced with the lender seeking a return in the ) /% F range.e lender the rights to convert to an ownership or e6uity interest in thecompany if the loan is not paid back in time and in full. It is generally subordinated todebt provided by senior lenders such as banks and venture capital companies.

-e!!anine financing is advantageous because it is treated like e6uity on a company'sbalance sheet and may make it easier to obtain standard bank financing. To attractme!!anine financing, a company usually must demonstrate a track record in the industry

with an established reputation and product, a history of profitability and a viablee(pansion plan for the business 5e.g. e(pansions, ac6uisitions, I3=1.

Standstill A#reement

0. A contract that stalls or stops the process of a hostile takeover. The target firmeither offers to repurchase the shares held by the hostile bidder, usually at alarge premium, or asks the bidder to limit its holdings. This act will stop thecurrent attack and give the company time to take preventative measures againstfuture takeovers.

). An agreement between a lender and borrower in which the lender stops

demanding the repayment of the loan. A new deal is negotiated, usually alteringthe loan's original repayment schedule. This is used as an alternative tobankruptcy or foreclosure when the borrower can't repay the loan.

$ri%ate $lacement

The sale of securities to a relatively small number of select investors as a way of raisingcapital. Investors involved in private placements are usually large banks, mutual funds,insurance companies and pension funds. 3rivate placement is the opposite of a publicissue, in which securities are made available for sale on the open market.

-anagement ;uyout

A transaction where a companyNs management team purchases the assets andoperations of the business they manage. A management buyout 5-;=1 is appealing toprofessional managers because of the greater potential rewards from being owners ofthe business rather than employees. -;=s are favored e(it strategies for largecorporations who wish to pursue the sale of divisions that are not part of their corebusiness, or by private businesses where the owners wish to retire. The financingre6uired for an -;= is often 6uite substantial, and is usually a combination of debt ande6uity that is derived from the buyers, financiers and sometimes the seller.

An -;= is different from a management buy/in 5-;I1, in which an e(ternal managementteam ac6uires a company and replaces the e(isting management team. It also differs


18/32

from a leveraged management buyout 5 -;=1, where the buyers use the companyassets as collateral to obtain debt financing.

An -;=Ns advantage over an -;I is that as the e(isting managers are ac6uiring thebusiness, they have a much better understanding of it and there is no learning curve

involved, which would be the case if it were being run by a new set of managers. Theadvantage of an -;= over an -;= is that the companyNs debt load may be lower,giving it more financial fle(ibility.

4owever, there are several drawbacks to the -;= structure as well. hile themanagement team can reap the rewards of ownership, they have to make the transitionfrom being employees to owners, which re6uires a change in mindset from managerialto entrepreneurial. Hot all managers may be successful in making this transition.

Also, the seller may not reali!e the best price for the asset sale in an -;=. If the e(isting

management team is a serious bidder for the assets or operations being divested, themanagers have a potential conflict of interest. That is, they could downplay ordeliberately sabotage the future prospects of the assets that are for sale to buy them at arelatively low price.

-;=s are viewed as good investment opportunities by hedge funds and large financiers, who usually encourage the company to go private so that it can streamline operationsand improve profitability away from the public eye, and then take it public at a muchhigher valuation down the road. hile private e6uity funds may also participate in -;=s,their preference may be for -;Is, where the companies are run by managers they knowrather than the incumbent management team.

8ree Cash 8lows to 96uity

The formula for free cash flow to equity is net income minus capital expenditures minuschange in working capital plus net borrowing.The free cash flow to equity formula is used to calculate the equity available toshareholders after accounting for the expenses to continue operations and future capitalneeds for growth.

sNet Income is found on a firm's income statement and is the firm's earnings afterexpenses, including interest expenses and taxes. Net income may also be found on thecash flow statement which may save time considering other factors of the free cash flowto equity formula are on there as well. Net income may be referred to as the bottomline .! firm's prior capital expenditures can be found on its cash flow statement andrepresents capital used for long term or fixed assets.! firm's working capital is current assets minus current liabilities. The term currentimplies that the assets and liabilities are liquid, generally representing less than one


19/32

year, and used for short term operations. "urrent assets and current liabilities can befound on a firm's balance sheet.sNet borrowing is the difference between the amount a company borrows and what debtit repays. It is important to not include interest as this is already figured into net income#interest expense$. Net borrowing can be found by comparing changes on a company'sbalance sheet.

Use of the FCFE Formula

The free cash flow to equity formula may be used by investors and analysts in replace ofdividends when analy%ing a company. &ne of the most notable examples of this is in thefree cash flow to equity model for valuing a stock. The free cash flow to equity modeldiffers from the dividend discount method only in that it uses free cash flow to equityinstead of dividends.To understand the use the free cash flow to equity formula, one must understand thecomponents of it and how it differs from dividends. ! company's net income is alsoreferred to its earnings. ! company pays some of the earnings out to investors in theform of dividends and the amount retained is used for future growth. The formula forcash flow to equity starts with the company's earnings. "apital expenditures issubstracted to account for the amount needed for assets used for growth. The nextvariable, change in working capital, is subtracted to account for an increase in capitalneeded for short term operations. astly, net borrowing is added, or subtracted ifnegative, to account for any capital received from taking new debt, or lost due torepayment of debt. These factors all resolve to the amount available to equity, orshareholders.!lthough the free cash flow to equity may calculate the amount available toshareholders, it does not necessarily equate to the amount that is paid out toshareholders


20/32


21/32

&C&& ' C&( ) After ta* interest - C&+

&C&, ' et +ncome . /Cape* . Depreciation0 . WC ) et Borrowin#s

C&( ' + ) Depreciation ) Deferred Ta*es . WC

C&+ ' CA$,1

2xamp es of Investing activities are


22/32

$urchase or Sa e of an asset %assets can be and" bui ding" e*uipment" marketab esecurities" etc.&

3oans made to supp iers or received from customers

$ayments re ated to mergers and ac*uisition.

"(( ) "ash flow from financing

4FF 5 6et 1orrowings 7 Dividends

Financing activities inc ude the inf ow of cash from investors such as banks and shareho ders"as we as the outf ow of cash to shareho ders as dividends as the company generates income.8ther activities which impact the ong#term iabi ities and e*uity of the company are a so

isted in the financing activities section of the cash f ow statement.

9nder IAS :" 3ayments of dividends 3ayments for repurchase of company shares

8or non/profit organi!ations, receipts of donor/restricted cash that is limited to long/term purposes

Items under the financing activities section inc ude; +ividends paid :ale or repurchase of the company's stock

Het borrowings

3ayment of dividend ta(

Repayment of debt principal, including capital leases

23 Ta* Benefits elated to ,mployee Stoc4 (ptions 5:ee 0 on Amgen C8= statement1AmgenO's C8= was boosted by almost & million because a company gets a ta( deduction

when employees e(ercise non/6ualified stock options . As such, almost PF of AmgenO's C8=is not due to operations and is not necessarily recurring, so the amount of the PF should beremoved from C8=. Although AmgenO's cash flow statement is e(ceptionally legible, somecompanies bury this ta( benefit in a footnote.To review the ne(t two ad?ustments that must be made to reported C8=, we will consider*eri!onO's statement of cash flows below.53 6nusual Chan#es to Wor4in# Capital Accounts 5receivables, inventories and payables15Refer to ) on *eri!onO's C8= statement.1Although *eri!onO's statement has many lines, notice that reported C8= is derived from netincome with the same two sets of add backs we e(plained above" non/cash e(penses areadded back to net income and changes to operating accounts are added to or subtractedfrom it"
http://en.wikipedia.org/wiki/Investorhttp://en.wikipedia.org/wiki/Bankhttp://en.wikipedia.org/wiki/Bankhttp://en.wikipedia.org/wiki/Shareholderhttp://en.wikipedia.org/wiki/Dividendhttp://en.wikipedia.org/wiki/Dividendshttp://en.wikipedia.org/wiki/Dividendshttp://en.wikipedia.org/wiki/Stockhttp://en.wikipedia.org/wiki/Debthttp://www.investopedia.com/terms/n/nso.asphttp://en.wikipedia.org/wiki/Investorhttp://en.wikipedia.org/wiki/Bankhttp://en.wikipedia.org/wiki/Shareholderhttp://en.wikipedia.org/wiki/Dividendhttp://en.wikipedia.org/wiki/Dividendshttp://en.wikipedia.org/wiki/Stockhttp://en.wikipedia.org/wiki/Debthttp://www.investopedia.com/terms/n/nso.asp


23/32

Hotice that a change in accounts payable contributed more than B).$ billion to reported C8=.In other words, *eri!on created more than B).$ billion in additional operating cash in ) % byholding onto vendor bills rather than paying them. It is not unusual for payables to increase asrevenue increases, but if payables increase at a faster rate than e(penses, then the companyeffectively creates cash flow by 7stretching out7 payables to vendors. If these cash inflows areabnormally high, removing them from C8= is recommended because they are probablytemporary. :pecifically, the company could pay the vendor bills in anuary, immediately afterthe end of the fiscal year. If it does this, it artificially boosts the current/period C8= bydeferring ordinary cash outflows to a future period.

*ivident +ayout Total *iv - Net Income )note the denominator is net income

&perating margin /IT - sales


24/32

0

3oison put0

Coattail +n%estin#

An investment strategy in which investors mimic the trades of well/known and historicallysuccessful investors.


25/32

A bond that allows bondholders to redeem before maturity at a high price should certain, namedevents take place. These events commonly include restructuring , a leveraged buyout , an attemptedhostile takeover , or paying dividends in excess of a certain amount or percentage. Poison-put bondscan act as an anti-takeover measure ; they help management discourage takeovers by raising theirexpense . n the other hand, when the company is going through a difficult time, poison-put bondscan limit management!s restructuring options for the same reason.

0. In bond trading , a bond indenture that gives the bondholder the right to demand redemption before maturity at its high par value in case certain event happen. :uch pre/designated events include restructuring of the bond issuing company , e(cessive dividend distribution to its stockholders , a leveraged buyout , or a hostile takeover attempt. A poisonput helps the management of the target company to deter the takeover attempt by making itvery costly for the bidder. In times of low li6uidity, however, this put works against themanagement as the bond holders can pressure the company into a reorgani!ation or toincrease its borrowing costs .

). In stocks trading, the rights assigned to common stockholders that sharply escalates theprice of their stockholding, or allows them to purchase the company's shares at a veryattractive fi(ed price, in case of a hostile takeover attempt. also called event risk covenant

Risk based haircut

A reduction in the recogni!ed value of an asset in order to produce an estimate for thelevel of margin or financial leverage that is acceptable to use when purchasing orcontinuing to own the asset. An analyst undertaking a risk/based haircut of an assetattempts to determine the chances of the asset's value falling below its current level, sothat a sufficient buffer can be established to protect against a margin call.

A risk/based haircut is important to do in order to provide a margin of safety to protectagainst the possibility of a margin call or similar type of over/leveraged position in asecurity. ;y artificially reducing the recogni!ed value of an asset before undertaking aleveraged position in it, the actual market value of the asset must fall by an increasedamount than if no haircut was applied in order for a margin call to take place. Thisdecreases the chances of an ill/time margin call or forced sale of the security for a lowprice taking place in the investors account.

+ebt/for/e6uity swap

In a debt#for#e*uity swap" a company's creditors genera y agree to cance some or a of thedebt in exchange for e*uity in the company.

Debt for e*uity dea s often occur when arge companies run into serious financia troub e"and often resu t in these companies being taken over by their principa creditors. This is

because both the debt and the remaining assets in these companies are so arge that there is noadvantage for the creditors to drive the company into bankruptcy. Instead the creditors preferto take contro of the business as a going concern . As a conse*uence" the originashareho ders' stake in the company is genera y significant y di uted in these dea s and may

be entire y e iminated" as is typica in a 4hapter -- bankruptcy .
http://financial-dictionary.thefreedictionary.com/Bondhttp://financial-dictionary.thefreedictionary.com/Bondhttp://financial-dictionary.thefreedictionary.com/Bondholdershttp://financial-dictionary.thefreedictionary.com/Bondholdershttp://financial-dictionary.thefreedictionary.com/Bondholdershttp://financial-dictionary.thefreedictionary.com/Redeemhttp://financial-dictionary.thefreedictionary.com/Redeemhttp://financial-dictionary.thefreedictionary.com/Redeemhttp://financial-dictionary.thefreedictionary.com/Maturityhttp://financial-dictionary.thefreedictionary.com/Pricehttp://financial-dictionary.thefreedictionary.com/Pricehttp://financial-dictionary.thefreedictionary.com/Restructuringhttp://financial-dictionary.thefreedictionary.com/Restructuringhttp://financial-dictionary.thefreedictionary.com/Leveraged+Buyouthttp://financial-dictionary.thefreedictionary.com/Leveraged+Buyouthttp://financial-dictionary.thefreedictionary.com/Hostile+Takeoverhttp://financial-dictionary.thefreedictionary.com/Dividendshttp://financial-dictionary.thefreedictionary.com/Dividendshttp://financial-dictionary.thefreedictionary.com/Anti-Takeover+Measurehttp://financial-dictionary.thefreedictionary.com/Expensehttp://www.investorwords.com/521/bond.htmlhttp://www.investorwords.com/521/bond.htmlhttp://www.investorwords.com/5025/trader.htmlhttp://www.investorwords.com/529/bond_indenture.htmlhttp://www.investorwords.com/529/bond_indenture.htmlhttp://www.investorwords.com/528/bondholder.htmlhttp://www.investorwords.com/1396/demand.htmlhttp://www.investorwords.com/4103/redemption.htmlhttp://www.investorwords.com/3017/maturity.htmlhttp://www.investorwords.com/2306/high.htmlhttp://www.investorwords.com/3611/par_value.htmlhttp://www.investorwords.com/9996/include.htmlhttp://www.investorwords.com/9996/include.htmlhttp://www.investorwords.com/5952/restructuring.htmlhttp://www.investorwords.com/2654/issuer.htmlhttp://www.investorwords.com/2654/issuer.htmlhttp://www.investorwords.com/992/company.htmlhttp://www.investorwords.com/9619/excessive.htmlhttp://www.investorwords.com/9619/excessive.htmlhttp://www.investorwords.com/1509/dividend.htmlhttp://www.investorwords.com/1495/distribution.htmlhttp://www.investorwords.com/1495/distribution.htmlhttp://www.investorwords.com/4735/stockholder.htmlhttp://www.investorwords.com/4735/stockholder.htmlhttp://www.investorwords.com/4735/stockholder.htmlhttp://www.investorwords.com/2787/Leveraged_Buyout.htmlhttp://www.investorwords.com/2787/Leveraged_Buyout.htmlhttp://www.investorwords.com/2344/hostile_takeover.htmlhttp://www.investorwords.com/2344/hostile_takeover.htmlhttp://www.investorwords.com/2931/management.htmlhttp://www.investorwords.com/2931/management.htmlhttp://www.investorwords.com/15097/target_company.htmlhttp://www.investorwords.com/4868/takeover.htmlhttp://www.investorwords.com/4868/takeover.htmlhttp://www.investorwords.com/2925/maker.htmlhttp://www.investorwords.com/9319/costly.htmlhttp://www.investorwords.com/2837/liquidity.htmlhttp://www.investorwords.com/8787/against.htmlhttp://www.investorwords.com/12802/bond_holder.htmlhttp://www.investorwords.com/5765/reorganization.htmlhttp://www.investorwords.com/5765/reorganization.htmlhttp://www.investorwords.com/5765/reorganization.htmlhttp://www.investorwords.com/10007/increase.htmlhttp://www.investorwords.com/7518/borrower.htmlhttp://www.investorwords.com/1148/cost.htmlhttp://www.investorwords.com/4725/stock.htmlhttp://www.investorwords.com/4725/stock.htmlhttp://www.investorwords.com/4282/right.htmlhttp://www.investorwords.com/11084/sharply.htmlhttp://www.investorwords.com/11084/sharply.htmlhttp://www.investorwords.com/3807/price.htmlhttp://www.investorwords.com/8807/allow.htmlhttp://www.investorwords.com/8807/allow.htmlhttp://www.investorwords.com/3952/purchase.htmlhttp://www.investorwords.com/3952/purchase.htmlhttp://www.investorwords.com/4525/share.htmlhttp://www.investorwords.com/8877/attractive.htmlhttp://en.wikipedia.org/wiki/Creditorhttp://en.wikipedia.org/wiki/Debthttp://en.wikipedia.org/wiki/Shareholder's_equityhttp://en.wikipedia.org/wiki/Shareholder's_equityhttp://en.wikipedia.org/wiki/Going_concernhttp://en.wikipedia.org/wiki/Going_concernhttp://en.wikipedia.org/wiki/Chapter_11_bankruptcyhttp://financial-dictionary.thefreedictionary.com/Bondhttp://financial-dictionary.thefreedictionary.com/Bondholdershttp://financial-dictionary.thefreedictionary.com/Redeemhttp://financial-dictionary.thefreedictionary.com/Maturityhttp://financial-dictionary.thefreedictionary.com/Pricehttp://financial-dictionary.thefreedictionary.com/Restructuringhttp://financial-dictionary.thefreedictionary.com/Leveraged+Buyouthttp://financial-dictionary.thefreedictionary.com/Hostile+Takeoverhttp://financial-dictionary.thefreedictionary.com/Dividendshttp://financial-dictionary.thefreedictionary.com/Anti-Takeover+Measurehttp://financial-dictionary.thefreedictionary.com/Expensehttp://www.investorwords.com/521/bond.htmlhttp://www.investorwords.com/5025/trader.htmlhttp://www.investorwords.com/529/bond_indenture.htmlhttp://www.investorwords.com/528/bondholder.htmlhttp://www.investorwords.com/1396/demand.htmlhttp://www.investorwords.com/4103/redemption.htmlhttp://www.investorwords.com/3017/maturity.htmlhttp://www.investorwords.com/2306/high.htmlhttp://www.investorwords.com/3611/par_value.htmlhttp://www.investorwords.com/9996/include.htmlhttp://www.investorwords.com/5952/restructuring.htmlhttp://www.investorwords.com/2654/issuer.htmlhttp://www.investorwords.com/992/company.htmlhttp://www.investorwords.com/9619/excessive.htmlhttp://www.investorwords.com/1509/dividend.htmlhttp://www.investorwords.com/1495/distribution.htmlhttp://www.investorwords.com/4735/stockholder.htmlhttp://www.investorwords.com/2787/Leveraged_Buyout.htmlhttp://www.investorwords.com/2344/hostile_takeover.htmlhttp://www.investorwords.com/2931/management.htmlhttp://www.investorwords.com/15097/target_company.htmlhttp://www.investorwords.com/4868/takeover.htmlhttp://www.investorwords.com/2925/maker.htmlhttp://www.investorwords.com/9319/costly.htmlhttp://www.investorwords.com/2837/liquidity.htmlhttp://www.investorwords.com/8787/against.htmlhttp://www.investorwords.com/12802/bond_holder.htmlhttp://www.investorwords.com/5765/reorganization.htmlhttp://www.investorwords.com/10007/increase.htmlhttp://www.investorwords.com/7518/borrower.htmlhttp://www.investorwords.com/1148/cost.htmlhttp://www.investorwords.com/4725/stock.htmlhttp://www.investorwords.com/4282/right.htmlhttp://www.investorwords.com/11084/sharply.htmlhttp://www.investorwords.com/3807/price.htmlhttp://www.investorwords.com/8807/allow.htmlhttp://www.investorwords.com/3952/purchase.htmlhttp://www.investorwords.com/4525/share.htmlhttp://www.investorwords.com/8877/attractive.htmlhttp://en.wikipedia.org/wiki/Creditorhttp://en.wikipedia.org/wiki/Debthttp://en.wikipedia.org/wiki/Shareholder's_equityhttp://en.wikipedia.org/wiki/Going_concernhttp://en.wikipedia.org/wiki/Chapter_11_bankruptcy


26/32

:ub/prime mortgage crisisQ edit

Debt#for#e*uity swaps are one way of dea ing with sub#prime mortgages. A househo derunab e to service his debt on a


27/32

A line of credit where the customer pays a commitment fee and is then allowed to usethe funds when they are needed. It is usually used for operating purposes, fluctuatingeach month depending on the customer's current cash flow needs.

Roll up

"rite down all of you debt balances and the minimum monthly payment for each. Then,

divide the balances by the minimum monthly payment. This gives you a number called the

#divisor# which is assigned to each debt.

$ext, order your debts starting with the one with the largest divisor, working your way down

the list. %f two debts have e&ual divisors, list the one with the lowest interest rate first.

$ow, for every debt except the bottom debt, you only make the absolute minimum payment

for each. 'or the bottom debt however, you pay the minimum plus whatever extra amount

that you have. (ou do this each month until that bottom debt is fully paid off.

$ext, you roll up the amount that you had been paying on the bottom debt, and start

applying it to the next debt above it on the list. (ou keep doing this until all the debts are

gone.

+I3 financing

8inancing arranged by a company while under the Chapter 00 bankruptcy process. +I3financing is uni6ue from other financing methods in that it usually has priority overe(isting debt, e6uity and other claims.

Chapter 00 gives the debtor a fresh start, which is, however, sub?ect to the debtor'sfulfillment of its obligations under its plan of reorgani!ation.

An individual or corporation that has filed for Chapter 00 bankruptcy protection andremains in control of property that a creditor has a lien against, or retains the power tooperate a business. A debtor who files a Chapter 00 bankruptcy case becomes thedebtor in possession 5+I31. The +I3 continues to run the business and has the powersand obligation of a trustee to operate in the best interest of any creditors. A +I3 canoperate in the ordinary course of business, but is re6uired to seek court approval for anyactions that fall outside of the scope of regular business activities. The +I3 must alsokeep precise financial records and file appropriate ta( returns.

After filing for Chapter 00 bankruptcy, new bank accounts are opened that name the

debtor in possession on the account. A debtor in possession can be terminated and thecourt will appoint a trustee in the event that assets are improperly managed or the debtor


28/32

in possession is not following court orders. The


29/32

A type of loan issued by a company that can be converted into stock by the holder and,under certain circumstances, the issuer of the bond. ;y adding the convertibility optionthe issuer pays a lower interest rate on the loan compared to if there was no option toconvert. These instruments are used by companies to obtain the capital they need togrow or maintain the business.

Convertible debentures are different from convertible bonds because debentures areunsecured> in the event of bankruptcy the debentures would be paid after other fi(edincome holders. The convertible feature is factored into the calculation of the diluted per/share metrics as if the debentures had been converted. Therefore, a higher share countreduces metrics such as earnings per share, which is referred to as dilution.

arrant

A derivative security that gives the ho der the right to purchase securities %usua y e*uity& fromthe issuer at a specific price within a certain time frame. 0arrants are often inc uded in a newdebt issue as a CsweetenerC to entice investors.

The main difference between warrants and call options is that warrants are issued andguaranteed by the company, whereas options are e(change instruments and are notissued by the company. Also, the lifetime of a warrant is often measured in years, whilethe lifetime of a typical option is measured in months.

Cash from 8inancing Activities

Cash received from Issuing 96uity 2 +ividends 3aid out 2 Interest payments

A positive number for cash f ow from financing activities means more money is f owing into thecompany than f owing out" which increases the company,s assets. 6egative numbers can meanthe company is servicing debt" but can a so mean the company is retiring debt or making dividend

payments and stock repurchases" which investors might be g ad to see. Investors can a so getinformation about cash f ow from financing activities from the ba ance sheet,s e*uity and ong#term debt sections and possib y the footnotes. 4ash f ow from financing activities is one of thethree main sections of a company,s cash f ow statement" the other two being cash f ow fromoperations and cash f ow from investing. This section of the cash f ow statement measures themovement of cash between a firm and its owners and creditors.

Financing activities that generate positive cash f ow inc ude receiving cash from issuing stockand receiving cash from issuing bonds. Financing activities that generate negative cash f ow

inc ude spending cash to repurchase previous y issued stock" to pay down debt" to pay interest ondebt and to pay dividends to shareho ders.


30/32

Total Capital /

Total capital E :hareholderNs e6uity STotal +ebt

The debt/to/capital ratio gives users an idea of a company's financial structure, or how itis financing its operations, along with some insight into its financial strength. The higherthe debt/to/capital ratio, the more debt the company has compared to its e6uity. Thistells investors whether a company is more prone to using debt financing or e6uityfinancing. A company with high debt/to/capital ratios, compared to a general or industryaverage, may show weak financial strength because the cost of these debts may weighon the company and increase its default risk.

Jross 3rofit E :ales 2 C=J:

9;IT E Jross 3rofit 2 :J A / +epreciation

3ercent of sales method

Inventory E F of sales

C=J: E F of sales

:J A E F of sales

CA39D E F of sales

+epreciation E F of CA39D

+eferred Ta(es E F of CA39D

HI E F of sales

+ividend E F of HI

Ta( E marginal ta( rate

Addition to R9 E F of HI

Incremental investment rate 2investment in fi(ed asset 5fi(ed 3391 re6uired per dollarincrement in sales

1995 1996 1997 1998 1999


31/32

%ncremental'ixed)apital%nvestments

-*+. -+ . - +. - /./ - 0+.+

1ales ,232. 0 +,0 +. 0 2, * .30 3,423.*0 /,24+.20

%ncremental1ales

*3+. , +/.*0 , +/.+0 , 34. 0 , 33.20

%ncremental'ixed)apital%nvestment5ate

*.336 .* 6 /.306 0.*36 3.4+6

Net New Financing 7 Pro8ected Assets - Pro8ected 9iabilities and :&uity

igh :P1 < investors are more willing to pay for the share

%f revenue tells us how much money is flowing into the company, :P1 tells us how much ofthat money is flowing down to stock holders. :P1 tells you how much money the company ismaking in profits per every outstanding share of stock. The higher the :P1 is, the moremoney your shares of stock will be worth because investors are willing to pay more forhigher profits.

5ead more= http=>>www.nasda&.com>investing>do?en>earnings-per-share.aspx@ix?? 4b/ +l2

igh P>: < has positive upside. arket thinks that share price will rise in future. 9ow P>: is Bvote of noconfidenceC

0hat does +- tell you1 The +- gives you an idea of what the market is willing to pay for thecompany2s earnings. The higher the +- the more the market is willing to pay for the company2searnings. 3ome investors read a high +- as an overpriced stock and that may be the case,however it can also indicate the market has high hopes for this stock2s future and has bid up theprice.

+3 Net Income- 4 "3 outstanding

So looking at the EPS ratio, you should go buy Company A with an EPS of 10, right? EPS is not theonly basis of comparing two companies, but it is one of the methods used.

Note that there are three types of EPS numbers:

Trailing EPS last years numbers and the only actual EPSCurrent EPS this years numbers, which are still projectionsForward EPS future numbers, which are obviously projectionsEPS doesnt tell you whether its a good stock to buy or what the market thinks of it.

PE Ratio :
http://www.nasdaq.com/investing/dozen/earnings-per-share.aspx#ixzz334b8M5l6http://www.nasdaq.com/investing/dozen/earnings-per-share.aspx#ixzz334b8M5l6http://www.nasdaq.com/investing/dozen/earnings-per-share.aspx#ixzz334b8M5l6http://www.nasdaq.com/investing/dozen/earnings-per-share.aspx#ixzz334b8M5l6http://www.nasdaq.com/investing/dozen/earnings-per-share.aspx#ixzz334b8M5l6


32/32

If there is one number that people look at than more any other number, it is the Price to Earning Ratio(P/E). The P/E is a ratio that investors throw around with confidence as if it told the complete story.Of course, it doesnt tell the whole story (if it did, we wouldnt need all the other numbers.)

The P/E looks at the relationship between the stock price and the companys earnings. The P/E is themost popular stock analysis ratio, although it is not the only one you should consider.

You calculate the P/E by taking the share price and dividing it by the companys EPS (Earnings PerShare that we saw above)

P/E = Stock Price / EPS

For example: A company with a share price of Rs.40 and an EPS of 8 would have a P/E of: (40 / 8) =5

What does P/E tell you?Some investors read a high P/E as an overpriced stock.

However, it can also indicate the market has high hopes for this stocks future and has bid up theprice.

Conversely, a low P/E may indicate a vote of no confidence by the market or it could mean that themarket has just overlooked the stock. Many investors made their fortunes spotting these overlookedbut fundamentally strong stocks before the rest of the market discovered their true worth.

In conclusion, the P/E tells you what the market thinks of a stock. It tells you whether the market likesor dislikes the stock.

notes on corporate finance

Documents