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Unformatted text preview: SELF-TEST PROBLEMS 1. What is the price of a 180¢day bill of exchange, with a face value of$500 000, if the yield is 6.50 per cent per annum? If the purchaser in the previous problem sells the bill 60 days later, at which time it is priced to yield 6.30 per cent per annum, what effective annual interest rate has been earned? Solutions to self—test problems are available in Appendix B, page 803. EFERENCES 1‘ Australian Bureau of Statistics, Australian National Accounts, ustralian Financial Markets Association, 2010 Australian inancial Markets Report, AFMA, Sydney, 2010. askin, ].B. & Miranti, R}, A History of Corporate Finance, ambridge University Press, 1997, pp. 151—7. attellino, R., ‘Why do so many Australian borrowers ssue bonds offshorei’, Reserve Ban/e ofAustralia Bulletin, December 2002, pp. 19—24. lack, S., Brassil, A. 86 Hack, M., ‘Recent trends in Australian banks’ bond issuance’, Reserve Bank of Australia, Bulletin, March 2010, pp. 27—33. Brown, A., Davies, M., Fabbro, D. 86 Hanrick, T., ‘Recent developments in banks’ funding costs and lending rates’, Reserve Ban/e ofAusiralia Bulletin, March 2010, pp. 35—44. Bruce, R., McKern, B., Pollard, 1. 8C Skully, M. (eds), Handbook ofAustralian Corporate Finance, 5th edn, Butterworths, Sydney, 1997, Chapters 9, 13 and 14. } FinancialAccounts, cat. no. 5232.0, Table 27, June quarter 2010. Carew, E., FastMoney 4, Allen 86 Unwin, Sydney, 1998. Davis, K., (Converting preference shares: an Australian £1. capital structure innovation), Accounting and Finance, , November 1996, pp. 213—28. ,1 Fitzpatrick, P. & Hardaker, R., ‘Finance company finance’, - {1'1 in R. Bruce, B. McKern, I. Pollard 86 M. Skully (eds), , : Handbook ofAustralian Corporate Finance, 5th edn, 1% Butterworths, Sydney, 1997. GE Capital, Guide to Asset Based Lending, 1999, GE Capital Commercial Finance, Stamford, wwwsecuritization.net/ pdf/asset_guide.pdf. Hunt, B. 56 Terry, (3., Financial Institutions anilMar/e'ets, 5th edn, Thomson Learning, Melbourne, 2008. Institute for Factors and Discounters of Australia and New Zealand lnc., [FD Update, March 2010, wwwfactorsanddiscountersxom. Jen, F.C., Choi, D. 86 Lee, S., ‘Some new evidence on why companies use convertible bonds’, journal oprpliecl Corporate Finance, Spring 1997, PP. 44453. WWW Montague, B., ‘Swaps’, in R. Bruce 86 D. Morrison (eds), Handbook ofAustralian Corporate Finance, 5th edn, Butterworths, Sydney, 1997, Chapter 13. Reserve Bank of Australia, Tables D2, D4, D7, D8, F 1, F4 ———— and F5, September 2010 . WWW , "The global financial environment’, Financial Stability Review, September 2010, pp. 3—14. ~—, (Central bank market operations’, Bulletin, September 2007, pp. 19—26. —, ‘Australian banks’ global bond funding’, Bulletin, August 2006, pp. 1—6. ——, ‘Australian financial markets’, Bulletin, June 2002, pp. 6—21. Smithson, CW, Managing Financial Ris/e, 3rd edn, McGraW—Hill, New York, 1998. W W W W W W Standard 86 Poor’s, 2006 Corporate Criteria Boo/e, WWW. corporatecriteria.standardandpoors.com. -——, Hybrid Capital Handbook: September 2008 edn, WWW. corporatecriteria.standardandpoors.com. Viney, C., McGrat/o’s Financial Institutions, Instruments and Mar/eets, 6th edn, McGrawvHill, Sydney, 2009. Yescombe, E.R., Principles ofProject Finance, Academic Press, San Diego, 2002. QUESTIONS 1. [L0 2] A debt contract will always include specifications about casb flows. Outline the forms that these specifications may take. Identify the nature of other specifications usually included in a debt contract. 2. [L0 2] Distinguish between: (a) secured debt and unsecured debt (b) subordinated debt and unsubordinated debt (c) indirect and direct debt finance. 3. [L0 2] The financial risk associated with borrowing involves two separate effects. Outline these effects. 4. [L0 2] Lenders usually bar/e no control over a company’s operations but tbey bar/e considerable potential control. Explain. 5. [L0 2] The forms of security available to commercial lenders include fixed charge, floating charge and negative pledge. What are the main similarities between these three forms of security? What are the main differences between them? 6. [L0 3] Discuss the factors that affect the terms of a bank overdraft negotiated by a borrower. 7. [L0 3] A ban/e overdraft provides a company witb a flexible source of funds. Discuss the significance of this flexibility for the financial manager and the difficulties it may cause for the bank. 8. [L0 4] Distinguish between ‘with recourse debtor finance’ and ‘without recourse debtor finance’. 9. [L0 4] Identify the basic feature that is common to all the types of debtor finance shown at . (a) Critically evaluate the advantages of debtor finance that are shown at the above website. (b) Use information available at the Oxford Funding website to compare debtor finance with an overdraft. 10. [IO 3] Only small companies ever need bridging finance. Do you think this statement is likely to be true or untrue? Why? 11. [L0 3] Describe the major types of bank lending other than bank overdraft. 12. [L0 3, 5] (a) Select one of the four major Australian banks (ANZ, CBA, NAB or Westpac) and, from the bank’s website, identify the types of business loans offered by the bank. Record the current interest rates on these business loans and on overdrafts offered by the same bank. Explain the differences between these rates. (b) In January 2008, Federal Treasurer Wayne Swan criticised a decision by the ANZ bank to lift interest rates on variable—rate mortgages by 0.2 per cent. The Treasurer said: ‘We believe the rise is excessive, and over and above anything that could be justified by the increase in costs flowing to those organisations from the fallout from the US sub—prime [mortgage] crisis’. What aspects of the rate increase announced by the ANZ bank were unusual? Evaluate the reasons put forward by the AN Z to justify the rate increase. 13. [L0 5] What are the terms of the typical mortgage agreement? ‘ 14. [L0 5] Variable—rate term loans bane mucb greater flexibility tbanfixed—rate term loans. Explain. 15. [L0 5] Ban/e loans provide mac/a greater flexibility tban borrowing by issuing debt securities. Discuss. 16. [L0 5] Define a mortgage loan. What are the similarities between a debenture and a mortgage loan? How do they differ? 17. [L0 7] Describe the main features of commercial paper. Why do issues of commercial paper generally involve large—scale borrowing? 18. [L0 7] How does commercial paper differ from a bill of exchange? 19. [L0 7] From the viewpoint of a potential purchaser, what are the advantages and disadvantages of a bank bill compared with commercial paper? 20. [L0 7] What are the advantages of issuing commercial paper rather than bills of exchange? 2.1. [L0 7] Describe the usual roles of the drawer, acceptor and discounter of a bill of exchange. 22. [L0 8] Ingrid deposits $40 000 with a fund that invests mainly in bank bills and commercial paper. The next day the Reserve Bank of Australia announces an increase in the cash rate. Three days later Ingrid withdraws her deposit and is stunned to find that she has lost money. (Interest rates have gone up! How can I have lost money?’ Enlighten her. . [LO 7] Distinguish between a ‘fully drawn bill facility’ and a ‘revolving credit bill facility’. . [LO 9] Discuss the term ‘security’ as it relates to the difference between debentures and unsecured notes. . [L0 9] What are the functions of the trustee and the trust deed to a debenture issue? . [LO 9] Corporate bonds and debentures have many similarities. What are these similarities? What are the main differences between them? . [LO 9] Debt securities secured by a cbarge over intangible assets may be described as notes or band: but not as debentures. Explain. . [LO 9] Many commentators have suggested that it would be desirable to encourage the growth of the corporate bond market in Australia. Outline the regulatory changes introduced by ASIC during 2010 to reduce the cost of issuing corporate bonds. Identify other measures that might stimulate further development of the corporate bond market. . [L0 10] Outline the main features of project finance. What distinguishes project finance from other types of long—term finance? Explain why ‘completion’ is of critical importance to the project sponsors and the lenders of funds to the project. . [L0 11] Explain Why interest rate swaps are popular with corporate borrowers and also many traditional lenders. . [L0 12] It has been suggested that preference shares offer advantages over ordinary shares and bonds ' in three areas: (a) the control of the original shareholders; (b) the ability of relatively uninformed investors to value the securities; and (c) the bankruptcy risk of the company (Baskin 8C Miranti 1997, pp. 151—7). ’ Consider each of these three areas in turn and compare the issue of new preference shares with the alternatives of issuing new ordinary shares or issuing new bonds. 32. [L0 12] Most companies regard preference sbares a5 a firm aflong~term debt. What causes them to hold such a View? How does this affect their use of preference shares to raise funds? 33. [L0 12] 77aere is evidence tbat tbeprice of a company’s ordinary sbare: apicallyfalir wben an issue of convertible notes is announced. Discuss this statement. Does it follow that issuing convertible notes is never in the best interests of shareholders? 34. [L0 12] Hybrid securities may be classified as either debt or equity for tax purposes. What is the main criterion for this classification? 35. [L0 12] Identify the main differences between a reset preference share and a step—up preference share. Why have reset preference shares been largely replaced by step—up preference shares in Australia? 36. [L0 12] In October 2007, Sydney Properties Ltd, which has assets valued at more than $5 billion, raised $200 million by issuing step—up preference shares (SPS) that pay quarterly distributions at a floating rate equal to the 90-day bank bill swap rate plus a margin of 2 per cent per annum for a period of 5 years. The SPS have a face value of $100 each and their current price on the ASX is $95. The step—up date is 30 November 2012 and if the shares are not redeemed on that date the interest margin will increase to 4.5 per cent per annum. What factors should the directors of Sydney Properties take into account when considering whether to redeem the SP8 on the step—up date? PROBLEMS 1. Calculating price lof commercial paper [LO 8] Calculate the price of commercial paper With a face value of $1 million and 180 days to maturity if the yield is 8.9 per cent per annum. 2. Calculating yield on bill of exchange [LO 8] To raise $485 000, a company draws up a bill of exchange with a face value of $500 000, payable in 180 days. What is the implicit simple annual interest rate (yield) on the bill? What is the implicit effective annual interest rate on the hill? 5. Calculating bill prices [LO 8] Calculate the bill prices needed to complete the table overleaf. Assume in every case that the face value is $1 million. 331 in] ii w 20?; M w): Hi‘fi‘xim Hi 53] CHAPTER 10 2..., «mandamus5.«Wn..w.wwimawwmmnkwnwwtmwmmm—WMMWWM»W,WW~WMM «w... ...,., .. TERM YIELD = YIELD = YIELD = 5.1% p. a. 5.2% p. a. 5.3% p. a. 30 day: 7 "9611217573 5 7 7 "19639. What patterns are there in the table? 4. Bank bill prices and returns [LO 8] On 8 March 2012, JDF Investments Ltd purchased a bank bill maturing on 7 May 2012 at an annual yield of 6.95 per cent per annum. The bill had a face value of $1 million. On 23 March 2012, ]DP sold the bill at a yield of 6.80 per cent per annum. Calculate: (a) the purchase price paid by JDF (b) the sale price received by JDF (c) the dollar return earned by JDF (d) the simple annual interest rate earned by JDF (e) the effective annual interest rate earned by JDF. 5. Bank bill prices and returns [LO 8] An investor buys a 90—day bank bill priced at a yield of 12.55 per cent per annum and sells it a week later priced at a yield of 13.60 per cent per annum. What effective annual interest rate has the investor earned? Explain your result. 6. Bank bill prices and returns [LO 8] An investor bought a 90~day bank bill priced at a yield of 7.45 per cent per annum. Three weeks later the market yield on the bill had fallen slightly to 7.35 per cent per annum. The RBA then unexpectedly announced that it had reduced the target cash rate by 0.5 per cent per annum. As a result, short—term interest rates and bill yields rapidly adjusted downwards and the bill’s yield fell to 7.05 per cent per annum. The investor then sold the bill. Calculate the effective annual interest rate the investor earned. What effective annual interest rate would the investor have earned if the RBA had not announced a new target cash rate? 7. Fixed—rate term loans [LO 5] Sealex Ltd has a‘fixedaate term loan of $2 million at an interest rate of 8.75 per cent per annum. The company has earnings before interest and tax (EBIT) of $1.4 million per annum. A covenant in the term loan agreement specifies that EBIT must be at least 3. 5 times greater than the total interest paid on the company’s debt. The directors of Sealex are planning to raise additional debt by borrowing at a variable rate, initially 7.5 per cent per annum. What is the maximum amount that Sealex can borrow on these terms? Calculating annual repayments and interest rates [LO 5] Cominco Ltd needs to borrow approximately $2 million to finance the purchase of a gem»sorting machine for its diamond mine. lts financial manager is considering the following alternatives: (i) Cominco’s bank will lend $2 million, repayable in four annual payments at an interest rate of 8.5 per cent per annum. (ii) The equipment supplier has offered to finance the gem sorter with an initial payment of $500 000, followed by annual instalments of $460 000 at the end of each of the next 4 years. (iii) A finance broker can arrange a $2 million loan repayable in a lump—sum payment of $2 761 513 in 4 years’ time. The broker will charge an up—front fee of 1 per cent of the loan principal. (a) What are the annual repayments on the bank loan? (b) What is the interest rate (ignoring the up—front fee) on the finance broker’s loan? (c) Which of the three alternatives provides the lowest cost finance? Converting preference shares [L0 12] XYZ Ltd converting preference shares have a face value of $1 5 and are due to convert to ordinary shares on 31 July 20X1. Each converting preference share will convert to a number of ordinary shares that is determined by dividing $15 by: (i) an amount equal to the price ofXYZ ordinary shares on 31 July 20X1, less 5 per cent; or (ii) $15, whichever yields the greater number of ordinary shares. How many ordinary shares will be received by the holder of one converting preference share if the price of XYZ ordinary shares is: (a) $5? (b) $7.50? (c) $10? ((1) $15? (e) $20.> 332 HUSH]:mull/19M, \ 10. Analysis of conversion terms [L0 12] (a) to (e). Based on your results, suggest an alternative Using the information in Problem 9, calculate the name that describes the nature of converting preference value of the ordinary shares that will be received on shares. conversion of each converting preference share in cases Test yourself further with Connect Plus online! Ask your lecturer or tutor for your course’s unique URL. SOURCE 1:; m I Ill/am; mm CHAPTER 10 333 “W“ - 'v \ 3% £79357 , law 1. Herbert, A, Australian Private Equity 2 venture Capital Guide 2010, 17th edn, Private Equity Media, Brighton, 2010. How, ]., Izan, H. 86 Monroe, G., ‘Differential information and the underpricing of initial public offerings: Australian _ evidence’, Accounting and Finance, May 1995, pp. 87—105. How, J., 86 Yeo, ]., "th pricing of underwriting services in the Australian capital market’, Pacific—Basin Finance journal, July 2000, pp. 347—73. - Ibbotson, R., Sindelar, J. 86 Ritter, J., ‘The market’s problems with the pricing of initial public offerings’, journal - (y‘Applied Corporate Finance, Spring 1994, pp. 66—74. Ilcenberry, D., Rankine, G. 86 Stice, 13., ‘What do stock splits really signal?’, journal ofFinancial and Quantitative Analysis, September 1996, pp. 357—75. 188 Governance Services, Equity Capital Raising in Australia during 2008 and 2009, ISS Governance Services, August 2010. Lakonishok, J. 86 Vermaelen, T., KTax induced trading around eX—dividend days’, journal ofFinancial Economics, 1986, pp. 287—319. Lee, R, Taylor, S. 86 Walter, T., ‘Australian IPO pricing in l the short and long run', journal ofBanking and Finance, August 1996, pp. 1189—210. L Lee, R, Taylor, S. 86 Walter, T., ‘IPO underpricing explanations: implications from investor application and allocation schedules’, journal of Financial and Quantitative Analysis, December 1999, pp. 425—44. Lipton, P., Herzberg, A. 86 Welsh, M., Understanding Company Law, 15th edn, Lawbook Co., Sydney, 2010. Loughran, T. 86 Ritter, ]., (The new issues puzzle’, journal of Finance, March 1995, pp. 23—51. Loughran, T. 86 Ritter, ]., (Why don’t issuers get upset about leaving money on the table in IPOs?’, Review ofFinaneial Studies, 2002, vol. 15, no. 2, pp. 413—43. Loughran, T. 86 Ritter, ]., ‘Why has IPO underpricing changed over time?’, Financial Management, Autumn 2004, pp. 5—37. Marsh, P., ‘Equity "rights issues and efficiency of the UK stock market’, journal ofFinance, September 1979, pp. 839—62. Muscarella, C. 86 Vetsuypens, M., KStock splits: signaling or liquidity? The case of ADR “solo—splits”, journal of Financial Economics, September 1996, pp. 3~26. Pham, R, Kalev, P. 86 Steen, A, ‘Underpricing, stock allocation, ownership structure and post—listing liquidity ) ‘51, +551, "2“" of newly listed firms), journal of Banking and Finance, May 2003, pp. 919—47. Reserve Bank of Australia, ‘Australian corporates’ sources and uses of funds’, Bulletin, October 2009, pp. 1—12. Ritter, ]., (The long—run performance of initial public offerings; journal ofFinance, March 1991, pp. 3—27. Ritter J. 86 Welch, 1., ‘A review of IPO activity, pricing and allocations), journal ofFinance, August 2002, pp. 1795—828. Rock, K, (Why new issues are underpriced’, journal of Financial Economics, January—February 1986, pp. 187—212. Sloan, R.G., ‘Bonus issues, share splits and ex—day share price behaviour: Australian evidence', Australian journal of Management, December 1987, pp. 277—91. Smith, CW Jr, ‘Raising capital: theory and evidence’, Midland Corporate Finance journal, Spring 1986, pp. 6~22. Smith, R.L. 86 Smith, ].K., Entrepreneurial Finance, Wiley, New York, 2000. Stradwick, R., Employee Snare Plans, Pitrnan Publishing, Melbourne, 2nd edn, 1996. Viney, C., McGrat/a’s Financial Institutions, Instruments and Markets, 6th edn, McGraw—Hill, Sydney, 2009, Chapter 5. Welch, 1., ‘Seasoned offerings, imitation costs and the underpricing of initial public offerings’, journal ofFinanee, June 1989, pp. 421~49. QUESTIONS 1. [L0 1] 777e interest held by ordinary shareholders is a residual claim. Explain the meaning and significance of this statement. 2. [L0 1] What are the most important rights of shareholders in a company? 3. [L0 1] What are the main similarities between contributing shares and instalment receipts? How do they differ? 4. [L0 2] What are the main advantages of raising equity rather than borrowing? 5. [L0 2] Distinguish between limited liability and no liability companies. Why are no liability companies confined to exploration and mining companies? 6. [L0 3] Define private equity. \What are the main features that distinguish private equity from other forms of equity finance? 281 f-Elllilx’lllfi 0i llNANlllz l‘lHJll‘i CHAPTERQ 7. [L0 3] Private equity funding for new ventures is typically provided in stages. What are the main reasons for this approach? 8. [L0 5] Listed public companies have the advantage of greater access to the capital market than private or unlisted companies. However, this advantage also involves significant costs. ...
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