Below are the most frequently used Corporate Finance Terms and their meanings; please provide your feedback to improve this further. There will be a separate post for a more general list of investment and finance both on this blog.

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1. DEBT

Debt represents money owed by the company to its creditors(i.e. those who have provided loan). Creditors expect the company to repay debt, with interest, at some specified future date. Hence, a company can obtain source of money through Equity or Debt

2. BOND

Bond is a long-term debt instrument in which the issuer of the bond (i.e. borrower of money) is obligated to pay the investor of the bond (i.e. lender of the money) a specified amount of money, usually at specific intervals, and to repay the principal amount of the loan at maturity. The periodic payments are based on the rate of interest agreed upon at the time the instrument is sold.

3. FACE(PAR) VALUE

Face(Par) Value represents the principal in the loan agreement, which is the amount the issuer pays at maturity of the bond. It is the amount printed on the bond certificate and is also called as the Nominal Value of the Security

4. COUPON RATE

Coupon Rate is the rate of interest paid on a debt security (e.g. Bond). Generally stated on an annual basis, even if the payments are made at some other interval.

5. MATURITY DATE

Maturity Date is the date until a security is due to be paid or a loan is to be repaid.

6. COUPON (S)

Coupon (s) are the periodic interest payment(s) made by the issuer of a bond (debt security). Calculated by multiplying the face value of the security by the coupon rate.

7. BOOK VALUE

Book Value is the value of an asset as carried on the balance sheet of a company. In reference to the value of a company, it is the net worth (equity) of the company.

8. LIQUIDITY

Liquidity is the ease with which assets or securities can be sold for cash on short notice at a fair price

9. MONEY MARKET

Money Market is a market that specializes in trading short-term, low-risk, very liquid debt securities

10. CAPITAL BUDGETING

Capital Budgeting is the process of selecting and ranking investment alternatives and capital expenditures.

11. ASSETS

Assets are investments made by the company in different items like Machinery, Securities, and Inventories, which are directly or indirectly, used to produce the products or generate the services that are sold by the company.

12. LIABILITY.

To acquire assets, it is necessary for the company to raise capital to pay for them. Any capital which is owed by the company to its creditors or owners is a Liability. Capital, as said earlier, comes in two basic forms: debt and equity.

13. BALANCE SHEET

The Balance Sheet is a record of assets held by a business and capital used (liability) to pay for those assets. It is a snapshot of conditions at a specific point in time, generally at the end of a quarter or a year.

14. INCOME STATEMENT

The Income Statement provides a summary of a company's operations and profitability over a given period of time (at the end of a month, quarter, or year). It shows the value of the products and services sold by the company for the reporting period, the costs incurred in achieving those sales, and the distribution of the residual income. Since the Income Statement provides an analyst with clues about the profitability of a company's operations, it is also called the Profit and Loss Statement.

15. CASH FLOW STATEMENT

Cash Flow Statement is the financial statement shows the sources and uses of a company's funds. It also may be called the "Statement of Changes in Financial Position" or the "Sources and Uses Statement" or "Funds Flow Statement".

16. FIXED ASSETS

Fixed Assets are the long-term investments made by the company in property, manufacturing plants, and equipments etc.

17. CURRENT ASSETS

Current Assets are the short-term investments made by a company in Marketable Securities, Inventories, Cash etc.

18. ANNUITY

Annuity is a series of payments or deposits of equal size spaced evenly over a specified period of time

19. ANNUITY DUE

Annuity Due is the annuity where the payments are to be made at the beginning of each period

20. YIELD TO MATURITY

Yield to Maturity (a.k.a YTM) is the measure of the average rate of return that will be earned on a debt security that is held until it matures.

21. PERPETUITY

Perpetuity is a special case of an annuity with no set maturity. Payments are made forever.

22. RATIO ANALYSIS

Ratio Analysis is the process of using financial ratios, calculated from key accounts found in a company's financial statements, to make judgments concerning the finances and operations of the firm.

23. CATEGORIES of RATIOS

The most common financial ratios can be grouped into five broad categories:

Liquidity Ratios
Asset Management Ratios
Debt Management Ratios
Profitability Ratios
Market Value Ratios

24. LIQUIDITY RATIOS

Liquidity Ratios attempt to measure the extent to which the short-term creditors of the company are covered by assets, that are expected to be converted to cash in roughly the same time period.

Liquidity Ratios include:

Current Ratio
Quick (Acid-Test) Ratio

25. CURRENT RATIO

The Current Ratio is calculated by dividing CURRENT ASSETS by CURRENT LIABILITIES. For e.g. In the attached balance sheet, the Current Ratio of XYZ corporation is calculated as:

Total Current Assets = $153.0 Million

Total Current Liabilities = $ 61.4 Million

Current Ratio = 153.0 / 61.4 = 2.49 times

Recall that CURRENT ASSETS accounts include CASH, MARKETABLE SECURITIES, INVENTORIES, and PREPAID EXPENSES. The CURRENT LIABILITIES include ACCOUNTS PAYABLE, NOTES PAYABLE, and ACCRUED WAGES AND TAXES. The Current Ratio means that, if necessary, the company could use its current assets to pay off its current liabilities 2.49 times. If a company is experiencing financial difficulty, it may pay its bills more slowly. This causes an increase in bank loans and similar activities. If CURRENT LIABILITIES are rising more quickly than CURRENT ASSETS, the Current Ratio will fall. This could indicate trouble in the company.

26. ACID-TEST RATIO

The Quick (Acid-Test) Ratio is computed by subtracting INVENTORIES from CURRENT ASSETS, then dividing the remainder by CURRENT LIABILITIES. XYZ Corporation's Quick Ratio can be calculated as follows:

Quick Ratio = (Current Assets - Inventories) / (Current Liabilities)

= ($153.0 - $88.7) / ($61.4)

= 1.05 times

Inventories(i.e. Raw Materials, Work in Progress and Finished Goods = Inventory) usually are the least liquid (recall the term Liquidity??!) of the current assets. They are the most difficult to convert to cash and most likely to incur losses in the course of a liquidation. The Quick Ratio gives an indication of the firm's ability to meet short-term obligations without relying on the sale of inventories. XYZ Corporation can use its most liquid current assets to pay off the current liabilities 1.05 times.

27. ASSET MANAGEMENT RATIOS

Asset Management Ratios are the ratios that attempt to measure how effectively the company is managing its assets. They tell if the amount of each type of asset, reported on the Balance Sheet, is reasonable (given the current and anticipated operations of the firm)

Asset Management Ratios include:

· Inventory Turnover Ratio

· Average Collection Period

· Fixed Assets Turnover Ratio

· Total Assets Turnover Ratio

28. INVENTORY TURNOVER RATIO

The Inventory Turnover (Inventory Utilization) Ratio is calculated by dividing the Net SALES of the firm by its INVENTORIES.

Inventory Turnover = (Net Sales) / (Inventories)

= ($287.6) / ($88.7)

= 3.24 times

This means that the firm's inventory is roughly sold out and restocked, or "turned over," a little more than three times per year. Obsolete, unnecessary, or excess products held in inventories cause the Asset Turnover Ratio to fall, which may indicate a need for management action.

The analyst should consider two weaknesses of the Inventory Turnover Ratio.

· Overstating of Turnover Rate: The first concern is that sales are stated at market prices, whereas inventories are usually carried at cost. In an environment with rapidly changing prices, the ratio would overstate the inventory turnover rate. When market prices are volatile, a more accurate calculation may be made using Cost of Goods Sold in the numerator.

· Allow for seasonal Trends: The other weakness is that sales occur over the entire year, whereas the inventory is valued at a point of time. A business with highly seasonal trends may calculate the ratio using an average inventory figure.

29. AVERAGE COLLECTION PERIOD

The Average Collection Period (ACP) is often used to appraise ACCOUNTS RECEIVABLE (i.e. Money that the company has to receive from its debtors or those who have purchased goods sold by the company on credit.) It is computed by dividing AVERAGE DAILY SALES by the ACCOUNTS RECEIVABLE. Average daily sales are found by dividing the total year's SALES by 360 (the number of days in the year). For XYZ Corporation, the calculation is:

ACP = (Accounts Receivable) / (Average Daily Sales)

= ($50.9) / ($287.6/360 days)

= 63.7 days

The Average Collection Period represents the number of days the company must wait after a sale is made before receiving cash. If XYZ Corporation gives its customers credit terms of 30 days, this ratio indicates that the company is inefficient in collecting its receivables.

30. FIXED ASSETS TURNOVER RATIO

Fixed Assets Turnover Ratio : To measure the utilization of the firm's plant and equipment, the Fixed Assets Turnover (Fixed Asset Utilization) Ratio can be used. It is the firm's SALES divided by its FIXED ASSETS.

Fixed Assets Turnover = (Sales) / (Net Fixed Assets)

= ($287.6) / ($133.9)

= 2.15 times

This gives the an idea of how well the fixed assets are being utilized. XYZ Corporation's fixed assets are generating slightly more than two times their value in sales for the company. Unnecessary or underutilized fixed assets that do not increase sales cause this ratio to become lower.

In a period of rapidly changing prices, the value of fixed assets on the Balance Sheet may be seriously understated. This causes a firm with older equipment to report a higher turnover than a firm with more recently purchased plants and equipment.

If the industry average for Fixed Assets Turnover is 2.98 times, a manager of XYZ Corporation may begin to investigate how other companies in the industry are able to generate more sales from their fixed assets.

31. TOTAL ASSETS TURNOVER RATIO

The Total Assets Turnover Ratio measures the utilization of the company's assets. To compute the Total Assets Turnover Ratio, divide SALES by TOTAL ASSETS.

For XYZ Corporation, it is:

Total Assets Turnover = (Sales) / (Total Assets)

= ($287.6) / ($286.9)

= 1.00 times

Like the Fixed Assets Turnover Ratio, this ratio gives an indication of how well a company is utilizing its assets. The Total Assets Turnover Ratio indicates how many times the value of all ASSETS is being generated in SALES. The same concerns about understated assets also are applicable to the Total Assets Turnover Ratio.

32. DEBT MANAGEMENT RATIOS

Debt Management ratios help to determine the extent of the use of borrowed funds to finance assets and to determine how many times the income generated by those assets can be used to make interest payments. These ratios include:

· Total Debt to Total Assets Ratio

· Times Interest Earned (TIE) Ratio

· Fixed Charge Coverage Ratio

33. TOTAL DEBT TO TOTAL ASSETS RATIO

The Total Debt to Total Assets Ratio measures the percentage of total funds provided by the use of debt. It is calculated by dividing TOTAL DEBT (LIABILITIES) by TOTAL ASSETS.

For XYZ corp.,

Debt Ratio = (Total Debt) / (Total Assets)

= ($61.4 + $107.4) / ($286.9)

= 58.8%

Notice that TOTAL DEBT includes CURRENT LIABILITIES and LONG-TERM DEBT. This Debt Ratio is used by creditors to help decide if they will

loan money to the company.

34. TIMES INTEREST EARNED RATIO

The Times Interest Earned Ratio gives the an idea of how far operating income can decline before the company is unable to meet its interest payments on currently held debt. The TIE Ratio for XYZ Corporation is computed by dividing EARNINGS BEFORE INTEREST AND TAXES (EBIT) by the INTEREST CHARGES.

Times Interest Earned = (EBIT) / (Interest Charges)

= ($22.5) / ($6.0)

= 3.8 times

The calculation uses earnings before interest and taxes in the numerator because interest payments are tax deductible in many countries, and the ability to pay current interest is not affected by taxes. The TIE Ratio indicates how many times the company can make interest payments with the earnings generated by the firm.

35. FIXED CHARGE COVERAGE RATIO

The Fixed Charge Coverage Ratio has one important difference from the TIE Ratio. Many companies enter long-term lease agreements for assets. This ratio recognizes those leases as obligations and includes the LEASE PAYMENTS as fixed charges along with INTEREST PAYMENTS on loans. The Fixed Charge Coverage Ratio is computed by dividing EBIT plus LEASE PAYMENTS by INTEREST CHARGES plus LEASE PAYMENTS.

Fixed Charge = (EBIT + Leases) / (Interest Charges + Leases)

= ($22.5 + $2.1) / ($6.0 + $2.1)

= 3.0 times

This ratio is used more often than the TIE ratio, especially in industries where leasing of assets is common. It tells how many times all fixed payments incurred by the company can be made by using all the earnings of the firm.

36. PROFITABILITY RATIO

All policies and decisions made by a company are driven by the company's profitability goal. The previous ratios were designed to provide information about the operations of a company. Another group of ratios, Profitability Ratios, highlight the combined effects of liquidity, asset management, and debt management. These ratios include:

· Profit Margin Ratio

· Basic Earnings Power Ratio

· Return on Total Assets Ratio

· Return on Common Equity Ratio

37. PROFIT MARGIN RATIO

The Profit Margin Ratio shows the percentage of sales that is left for distribution to the common shareholders. The calculation is NET INCOME AVAILABLE TO COMMON SHAREHOLDERS divided by SALES for the period.

For our XYZ Corporation example, the calculation is:

Profit Margin = (Net Income to Common) / (Sales)

= ($6.2) / ($287.6)

= 2.16%

The Profit Margin Ratio reveals how much profit the company is generating for each dollar of sales.

38. BASIC EARNINGS POWER RATIO

The Basic Earnings Power Ratio is used to help compare firms with different degrees of financial leverage and in different tax situations. It provides with an idea of how effectively the assets are used to generate earnings. The computation is EARNINGS BEFORE INTEREST and TAXES (EBIT) divided by TOTAL ASSETS.

Basic Earnings Power = (EBIT) / (Total Assets)

= ($22.5) / ($286.9)

= 7.84% of Total Assets

EBIT is used in the Basic Earnings Power Ratio to eliminate any interest payments or tax considerations of the firm. The Basic Earnings Power Ratio indicates the percentage of TOTAL ASSETS generated as EARNINGS.

39. RETURN ON TOTAL ASSETS RATIO

The Return on Total Assets (ROA) Ratio is used to determine the return generated by the company on its assets. By taking NET INCOME AVAILABLE TO COMMON SHAREHOLDERS and dividing it by the value of all the ASSETS, one calculates the return on those assets. For XYZ Corporation, the calculation is:

Return on Total Assets = (Net Income to Common) / (Total Assets)

= ($6.2) / ($286.9)

= 2.16% of Total Assets

ROA is a common measure of the profitability of a company's ASSETS.

40. RETURN ON COMMON EQUITY RATIO

The Return on Common Equity (ROE) Ratio is a measure of the rate of return on stockholders' investments. It is calculated by dividing NET INCOME AVAILABLE TO COMMON SHAREHOLDERS by the TOTAL COMMON EQUITY capital in the firm.

Return on Common Equity = (Net Income to Common) / (Common Equity)

= ($6.2) / ($105.8)

= 5.86% of Common Equity

The ROE Ratio tells the return that common shareholders had on their investments

41. MARKET VALUE RATIOS

Market Value Ratios relate the company's stock price data with the earnings and capital structure of the company. This information gives an idea of the view investors have of the company's past performance and also their view of the firm's future prospects. These ratios include:

· Price / Earnings Ratio

· Market / Book Ratio

42. PRICE / EARNINGS RATIO

Price / Earnings (P/E) Ratio shows how much investors are willing to pay for every dollar of the company's reported profits. It is calculated by dividing the market price per share of Common Stock by EARNINGS PER SHARE (EPS).

The Earnings per Share calculation is NET INCOME AVAILABLE TO COMMON divided by the Number of Shares Outstanding. The Number of Shares can be found next to the COMMON EQUITY figure on the Balance Sheet. Be sure to check the units on the Number of Shares; they may not always be the same as the other figures on the Balance Sheet. On XYZ Corporation's Balance Sheet, all figures are in millions.

Earnings per share = (Net Income to Common) / (Number of shares)

= ($6.2) / (8.0 shares)

= $0.775 per share

For our XYZ Corporation example, if the price of XYZ stock is $12.70 per share, the P/E Ratio is:

Price / Earnings = (Market price per share) / (Earnings per share)

= ($12.70) / ($0.775)

= 16.4 times

The P/E Ratio indicates that the common shares are selling for 16.4 times the EARNINGS of XYZ Corporation.

43. MARKET / BOOK RATIO

The Market / Book Ratio shows how much investors are willing to pay relative to the value of the company as shown on its books. The total market value of a company is the value that investors in the stock market (where the shares are being traded) think the company is worth. This value is derived from the stock price at which the shares are trading. For example, the market value for XYZ Corporation is $101.6 million (8 million shares times $12.70 per share).

To calculate the Market / Book Ratio, one must first compute the Book value per Share. This computation is the value of COMMON EQUITY divided by the Number of Shares.

Book value per share = (Common Equity) / (Number of shares)

= ($105.8) / (8.0 shares)

= $13.225 per share

The Market / Book Ratio is calculated by dividing the market price per share by the book value per share.

Market / Book = (Market price per share) / (Book value per share)

= ($12.70) / ($13.225)

= 0.96 times

The Market / Book Ratio indicates how many times above (or below) the book value of the company investors are paying for an equity position. In our XYZ Corporation example, investors are not quite willing to pay the book value for the equity of the company. (1.00 times means that the market price and the book price are the same.)

44. USING RATIO ANALYSIS

The ratios we have so far been analysing, provide us with information about a company's liquidity, asset management, debt management, and profitability. They also indicate how market investors value the company's efforts. These ratios also provide additional insights when compared to the ratios of other companies and when trends are mapped over a period of time.

Industry Comparisons

An astute analyst will first calculate a company's ratios and then make comparisons with other similar companies in that industry or with the

industry as a whole. Any significant discrepancies will signal that closer inspection may be needed. For example, if most of the industries competing with XYZ Corporation have Profit Margin Ratios of over 4% and XYZ has a Profit Margin Ratio of 2.16%, the analyst will begin to look for reasons why XYZ is performing so poorly. It is important to compare companies within the same industry to gain useful observations. An automobile manufacturer will have a much different structure than a consulting company.

Trend analysis

Trend analysis can also provide insights into the conditions of a company. By calculating ratios over a period of several years, an analyst can uncover potential problems within the firm. For example, if XYZ Corporation has an Inventory Turnover Ratio of 3.24 times in 1993, 3.86 times in 1992, and 4.56 times in 1991, an analyst will begin to look for reasons why it is taking longer for XYZ Corporation to sell its products. These trends give clues as to whether the financial condition is improving or deteriorating. By using industry comparisons and trend analysis, the analyst can focus the investigation on areas of a company that may need attention.

45. FUTURE VALUE

The term Future value (FV) refers to the value of a cash flow at a specified rate of interest at the end of a stated length of time. A cash flow that is received today is worth more than the same amount received in the future. Cash in hand today may be invested to earn a return over a period of time.

For example, an investor receiving $100 today may have the opportunity to invest the $100 for one year at 10% per annum (p.a.). With a risk-free investment in an environment free from inflation, the investor will have $110 value at the end of the one year. If the receipt of the $100 is delayed for one year, the investor will have only $100 at that time; the opportunity to earn the 10% will have been lost. The principal plus the return on the investment over time represents the future value of the investment.

46. PRESENT VALUE & DISCOUNTING

Discounting is the process we use to equate a future cash flow to its Present Value.The Present Value refers to the value of the investment at the present time. Similar to the Interest rate that is used to calculate Future Value, there is a Discount rate that is used to calculate the Present Value of an investment. The Discount Rate represents the opportunity cost of money, which is the rate of return that could have been earned on the best alternative investment.

The logic is to estimate the next best return scenario if a different investment decision had been made. Applying this concept to discount rates, it is said that, given approximately equal time frames and levels of risk, the appropriate rate to discount cash flows is the rate of return that represents the next best alternative in the list of investment choices. The discount rate or opportunity cost is also called the investor's required rate of return.

In short, Present Value is the dollar value at the present time (year zero) of a single cash flow or a stream of future cash flows. The present value is calculated by discounting the future cash flows.

DEBT FINANCE

47. BASIS POINT

Basis Point is one-hundredth of one percent (0.01%). Fifty basis points equal 1/2 of one percent. A basis point is sometimes referred to as a "tick." e.g. Any type of cost for the Company which is issuing Bonds i.e. Interest cost, Commitment Fees or Upfront cost for issuing a debt are all denoted in Basis points. For e.g. if we say that Bond A will give investors LIBOR (London Inter Bank Offered Interest Rate) + 100 Basis points, that means if LIBOR is 4% then the interest paid by the bond will be 4 + 1 % = 5 %

48. NOTE

Note is a debt agreement in the form of a security issued by a company or unit of government with a maturity of one to five years. Because notes are similar to bonds in every aspect except maturity, they are often grouped together with Bonds when referring to debt securities.

49. BANKER’S ACCEPTANCE

Banker's Acceptance is a Marketable security, issued on a discount basis, that represents a time draft that a bank has agreed to pay unconditionally on the maturity date

50. EUROMARKET

The international debt markets may be referred to as the external debt markets or offshore markets. However, the most common name for the international markets is Euromarket. International market issues can take place in any location, although London is the most important issuing market. Most Euromarket issues are listed on the London or Luxembourg exchanges. These markets are not subject to the direct control of any government.

The Euromarket is divided into groups based on the currency in which the issue is denominated. For example, a Eurobond denominated in Japanese yen is referred to as a Euroyen bond issue; dollar-denominated bonds are called Eurodollar bonds. Eurodollar bonds represent the largest share of this market, but other important currencies include the Deutschemark, British pound sterling, Dutch guilder, Swiss franc, Japanese yen, Canadian

dollar, and European Currency Unit (ECU).

51. CALLABLE BOND

Callable bond is a bond that gives the issuer the option of repurchasing it from investors before maturity. Some bonds have a provision that gives the issuer an option to repurchase the bonds from investors at a specified price. The price is referred to as the "call" price. Let's use an example to explain the process. If a company issues bonds when interest rates are relatively high, the debt is considered expensive to the company when interest rates move to lower levels. A callable bond allows the issuer to repurchase the old bonds at a price that is usually lower than market price. Thus, investors may not get the full market value for the bonds as they would in an open market transaction. Investors require issuers to compensate them for the possibility that the bonds may be called or bought back. Issuers compensate investors in callable bonds most often by paying a higher interest rate than they would pay on bonds of similar risk without the call provision. In some callable bond situations, the borrower issues lowerpriced debt, then uses the proceeds to call/buy the higher-priced bonds.

52. CREDIT RATING

Credit Rating is an evaluation, by independent sources, to determine the ability of an issuer to repay its debt obligations.

53. GUARANTEED BOND

Guaranteed Bond is a bond backed by the guarantee of repayment by an entity other than the issuer. In many cases, the guarantor is the parent company of the issuer i.e., a parent company will guarantee the bonds of a subsidiary. The guarantee may be for the interest payments on the bonds, the principal repayment, or both. This arrangement provides security for the investors buying the bond and lowers the interest rate the issuer pays. In case of default, the guarantor provides the necessary funds to satisfy the investors.

54. BULLET PAYMENT

Bullet Payment is a loan repayment convention in which the entire principal is repaid at the end of the loan agreement. During the course of the loan, the borrower pays only interest and makes no payment on principal until the loan matures. At maturity, the borrower repays the investor the entire face value of the loan. Most government securities and many corporate bonds use a bullet payment.

55. MORTGAGE BOND

A Mortgage Bond gives the bondholders a lien, or claim, against the pledged assets (generally property owned by the firm). In other words, the bondholder has a legal right to sell the mortgaged property to satisfy unpaid obligations to the bondholders. Even though the bondholders have a right to this asset, it is unusual for the assets to be sold. In most default cases, the company undergoes a financial reorganization that provides a settlement of the debt for the bondholders. The mortgage provides a strong bargaining position for the bondholders in the reorganization negotiations. Generally, mortgage bonds pay the lowest rate of interest, all other factors being equal.

56. ZERO-COUPON SECURITIES

Zero-coupon Securities require no interest payments during the time of the agreement. The borrower receives less than the face value of the loan at the time of the agreement (i.e., the bonds are sold at a discount). A zero-coupon security charges an implied interest rate that is represented by the rate of return earned by the investor.

Example For example, an issuer sells a $1,000 bond at a discount and receives an amount that is less than $1,000 from the investor at the time of the transaction. During the time the loan agreement is in force, the borrower makes no interest payments. When the loan is due at maturity, the borrower repays the investor $1,000.

57. COLLATERAL TRUST BONDS

Some companies do not own any fixed assets (such as property or equipment) to which a mortgage can be attached. Many of these companies are holding companies that own the securities of other companies. These holding firms can satisfy their debt holders' demands for backing by issuing Collateral Trust Bonds. The issuer pledges whatever assets (stocks, notes, bonds) are necessary to provide security and collateral for investors. These investors have claim on the collateral assets in the case of default. Once again, default generally results in some type of reorganization rather than a direct sell-off of the assets.

58. DEBENTURES

Debentures are not secured by any specific assets owned by the issuer. Only the earnings potential of the issuer backs these debt instruments. The investor in debentures is a general creditor of the company. In the event of default or bankruptcy, debenture holders have a claim on the assets of the defaulting firm only after all of the secured bondholders have been satisfied. In a financial reorganization, these bondholders have relatively little bargaining power. Debenture holders do have claim on assets before equity holders. To compensate investors for these disadvantages, debentures typically pay a higher rate of interest, all other factors being equal.

59. ASSET BACKED SECURITIES

Lending institutions pool high-quality loans that they have made and use them as collateral for raising capital through the sale of Asset-backed Securities. Investors buying these securities receive their earnings from the interest and principal payments generated by the loans in the pool. There are many types of asset-backed securities. The most common assets being securitized include automobile loans, credit card receivables, residential and commercial mortgages, and computer and truck leases.

60. SECURITIZATION

The term "Securitization" refers to the process of packaging groups of small, illiquid assets into a marketable security with an active secondary market.

The participants of the process of Securitization are:

· The party who creates the loans to be pooled is called the originator. This is typically a lending or financing institution that wishes to sell its claim on a future set of cash flows (interest on the loans or leases plus principal repayment), for an immediate cash payment.

· The issuer of the asset-backed security is usually a trust created by the originator for this special purpose. The issuer acquires the assets from the originator and pools them together as marketable securities. The issuer raises money for this purchase by selling the securities to investors.

· One party acts as the servicer to look after the day-to-day details of the loans. Most often, the originator fills this role to maintain its relationship with its customers.

· The investment bank acts as the trustee for the transaction. Its role is essentially a policing one to ensure that the security holders are being treated fairly, that the assets are being collected, and that investors are paid on time.

· The enhancer serves to guarantee against default for the underlying assets. This ensures that the investors will receive interest and principal payments in a timely manner. An investment bank or insurance company fulfills the role of enhancer.

· Finally, the investment bank that assists in the issue of the assetbacked securities helps provide liquidity in the secondary market. This allows investors to buy and sell the securities on the secondary market in a timely manner and at fair prices.

61. SENIOR AND SUBORDINATED DEBT

An alternative method for classifying debt securities is by the priority of the claim on the assets of the issuer in case of a reorganization or bankruptcy.

The terms "Senior debt" and "Subordinated debt" refer to the relative position of the bondholders in a reorganization or bankruptcy. Senior debt has the highest priority. Generally, secured debt is senior; however, the prospectus specifies the claims to which the investor is entitled. Subordinated bonds are usually last in the line of creditors for a claim on the assets of the issuer. The terms "senior" and "subordinated" are sometimes used with the classification system that describes claims on assets. For example, a subordinated debenture has claim after senior debentures. The issuer pays a higher rate of interest to compensate investors for relinquishing their claims on specific assets.

62. PUBLIC OFFERING AND PRIVATE PLACMENT

Two methods for issuing debt securities are Public offering and Private placement.

In a public offering, a company offers its debt securities to all participants in the market.

In a private placement, a company places its debt directly with private investors without a public registration of the offering

63. CURRENT YIELD

Current yield relates the annual coupon interest to the market price of the security. The formula for calculating current yield is:

Current yield = Annual coupon interest / Market price

The current yield is always higher than the coupon rate for bonds selling at a discount to par value. For bonds selling at a premium, the current yield is always less than the coupon rate. Many secondary market bond quotations list a bond's current yield as well as its pricing information.

One weakness of the current yield calculation is that it includes only one of the three sources of potential income: the periodic interest payment. It does not account for the reinvestment of interest payments or for any capital gains or losses.

64. FULL COUPON BOND

Full Coupon Bond A bond with a coupon rate above, at or just slightly below current market interest rates. The bond is thus selling at around its par value (provided that the applicable required rate of return is almost the same as the coupon rate). If the market interest rate rises, and the bond's coupon rate is fixed, then the bond's price will decline. If the market interest rate falls and the bond's price stays fixed, then the bond's price will rise.

65. TREASURY BILLS

Treasury bills (or T-Bills ) are short-term securities that are issued by the Treasury Department of the government of a country and backed by the full faith and credit of the Government. The Treasury Department holds a monthly auction to issue three-month, six-month, and 52-week securities. Treasury bills are zero-coupon instruments; therefore, they are quoted on a discount basis. Treasury bill quotes are based on a 360-day year. Other Treasury securities are quoted on a price basis, which makes it difficult to directly compare Treasury bills with other Treasury instruments.

The market for Treasury bills is large and very liquid. The backing of the government makes these instruments popular for risk adverse investors. Most investors in Treasury bills are institutional; however, some large individual investors participate in the Treasury bill market.

66. COMMERCIAL PAPER

Commercial paper (CP) is an unsecured promissory note issued for a specific amount that matures on a specific date. It is sold on a discount basis, with the investor receiving face value at maturity. Most commercial paper is issued with 30-day maturities. Companies that issue commercial paper usually do not have sufficient funds in 30 days to repay the loan and, therefore, they expect to "roll over" the paper (issue new commercial paper to pay off the maturing securities). The interest rates paid on commercial paper depend on:

· Maturity

· Amount the borrower wishes to raise

· General level of interest rates

· Credit rating of the issuer

Due to the possibility of default, rates generally are slightly higher than the rate paid on the Treasury bills. Many issuers back their securities with a bank line of credit. Since investors typically hold commercial paper until maturity, liquidity is a problem in the secondary market. This also causes rates to be higher.

Issuers of commercial paper are generally companies with high credit ratings. Most investors will not purchase the commercial paper of companies with lower ratings. Traditionally, large, well-established industrial and manufacturing firms issued commercial paper. Today, financial companies are large issuers; banks, foreign companies, government agencies, and sovereigns also have begun to enter the market. Many financial companies sell their paper directly to investors, while manufacturing and other companies use dealers.

Investors The majority of investors in commercial paper are institutional investors, including money market funds, pension funds, commercial bank trust departments, and some non-financial firms seeking short-term investments.

67. CERTIFICATE OF DEPOSIT

A Certificate of Deposit (CD) is a certificate issued by a bank that indicates a specified sum of money has been deposited at the issuing depository institution. Financial institutions use CDs to raise funds to finance their activities. CDs have a minimum maturity of 14 days, with most tenors in the one- to six-month range. Some five-year and seven-year CDs exist, but they are not common.

Certificates of deposit are issued at face value. Shorter-term instruments (less than one year) pay interest at maturity, while longer instruments make semiannual interest payments. CD rates are quoted on a 360-day year basis. Yields on CDs are determined by the:

· General level of interest rates

· Credit rating of the issuer

· Supply and demand for the securities

Interest Rates are higher for CDs than for Treasury bills because of the credit risk associated with the issuer and the lower level of liquidity in the secondary market. Because most CDs have high face values, they usually attract institutional investors.

68. MEDIUM-TERM NOTES

Medium-term Notes (MTNs) began as an extension of commercial paper, providing longer maturities for issuers and investors who wanted the characteristics of commercial paper for longer investment periods. A medium-term note program usually offers securities with a range of maturities and a different rate associated with each tenor. An investment banker, acting as a dealer for the issuer, posts rates for the different maturities and sells the paper "off the shelf" to investors. The notes are sold on a best efforts basis and continuously offered to investors during the time specified by the registration. Investors choose which maturity and rate best meet their investment needs and buy the selected securities from the dealer. The issuer may encourage investors to buy a particular maturity by offering it at a better yield than other tenors.

Interest rates Most MTNs are interest-bearing securities, paying a semiannual coupon. The interest rate is quoted on a 360-day year basis. The notes sell at par, with the interest rate fixed at the time of purchase. The maturity of the security, the overall level of interest rates, and the credit rating of the investor determine the rate. Usually, the rate is quoted as a spread over Treasury instruments of similar tenor.

Innovations Floating rate MTNs (with rates reset monthly, quarterly, or semiannually) have become more common. Other innovations include credit-supported MTNs, collateralized MTNs, and multicurrency MTNs.

Issuers Typical issuers are companies with high credit ratings. The process for rating MTNs is the same as that used for rating corporate bonds The wide investor base for MTNs includes both institutions and individuals. Investors in MTNs are fairly sophisticated and require a variety of features being offered in the market.

69. TREASURY NOTES

Treasury Notes are coupon-paying securities (with maturities of two to ten years) issued by the country's Treasury Department. The full faith and credit of the government backs these securities. The Treasury Department issues the notes through a monthly or quarterly auction, depending on the maturity of the security. Treasury notes pay semiannual interest and repay the face value at maturity. The market for Treasury notes is large and very liquid. Investors can easily buy and sell securities at fair prices. Most investors are institutional; however, there are some individual participants.

70. MEDIUM, LONG TERM & COMPLEX DEBT SECURITIES

Last week, We saw the various short-term market instruments like

· T-Bills

· Banker's Acceptance

· Commercial Paper

· Certificate of Deposits

· Repurchase Agreements

and the various Medium-Term market instruments like

· Treasury Notes

· Medium-Term Notes

In the coming weeks, we shall see the various Long-Term market Instruments like

· Treasury Bonds

· Corporate Bonds

· Municipal Bonds

· Eurobonds & Brady Bonds (already discussed!)

and other Complex Debt Securities like

· Equity Linked Debt

- Convertible Debt

- Warrants

· Dual Currency Debt

71. REPO

A Repurchase Agreement (or "repo") is a common investment vehicle for lenders with funds available for very short-term investments. A repo involves the sale of a security with a commitment to repurchase the same security at a designated date and price. It is actually a collateralized loan, with the collateral being the security that is sold and repurchased. The difference between the sale price and the purchase price is the interest cost of the loan. Repo interest rates closely follow the interest rates being paid on other money market securities. Interest rates for repos are quoted on a 360-day year basis. From the borrower's point of view, the rate paid on a repo is usually less than the rate paid on bank financing. For the investor, repos provide an attractive rate of return on a short-term secured loan with a highly liquid secondary market.

Repo Issuers Primary users of repurchase agreements are government securities dealers who need short-term funds. For example, consider a government securities dealer who needs $10 million to purchase a particular Treasury security that the dealer plans to hold overnight. To obtain financing for the purchase, the dealer can arrange a bank loan, use the dealer's own funds, or enter a repo using other securities in the dealer's portfolio as the collateral.

Repo Investors The lender in the repurchase agreement may be any entity with excess funds for short-term investment. Common lenders in the repo market are municipal governments, other securities dealers, and government agencies. Corporations with excess cash also enter the repo market to earn interest on their holdings, even if the investment period is only one day. One-day repurchase agreements are called "overnight repos." Repos that are arranged for longer periods are referred to as "term repos."

72. TREASURY BONDS

The Treasury Department of any country for e.g. U.S., issues bonds with maturities of 10, 20, and 30 years. It offers the securities at a monthly or quarterly auction, depending on the maturity of the instrument. Treasury bonds are coupon-paying instruments, with semiannual interest payments, that repay the face value at maturity. The bonds are backed by the full faith and credit of the U.S. government. The secondary market for Treasury bonds is large and very liquid. Most investors are institutional, although there are some individual participants in the long-term market.

73. CORPORATE BOND

The Corporate Bond market is very large and includes a wide variety of instruments. We have discussed several methods for paying off debt (Bullet Payment, Callable Debt etc.) and for providing security for debt instruments. In the corporate bond market, these features are combined to form an almost endless number of different debt securities that meet the needs of both issuers and investors. The overall level of interest rates and the issuer's credit rating generally determine the interest rates paid on corporate bonds. Most domestic corporate bonds make semiannual coupon payments;Most corporate bond issues are underwritten.

o Plain Vanilla Debt

The terms "straight debt" and "plain vanilla debt" refer to simple bonds that make periodic interest payments and repay the entire face value at maturity. These bonds are the easiest to evaluate.

o Floating rate notes

Another common type of corporate bond is the floating rate note (FRN). As the name suggests, these securities have a floating interest rate payment, usually benchmarked against a market rate such as LIBOR or Treasuries plus a spread. The spread is determined by the credit rating of the company, the maturity of the instrument, plus a possible liquidity premium. FRNs have a wide range of maturities that fall into both the medium-term and long-term markets. FRN rates can be set either before the coupon payment period (predetermined) or at the time the coupon is due (postdetermined or "back-end" set).

74. MUNICIPAL BONDS

Municipal bonds are securities issued by government entities other than the country’s government. They include state, county, district and city governments. The distinguishing feature of municipal bonds is that interest payments are not subject to taxation by the government, which makes them attractive to many investors with tax concerns. Local governments issue most municipal bonds to finance capital projects. Two types are general obligation bonds and revenue bonds.

1. General obligation bonds (GOBs) are backed by the full faith and credit of the local government. The ability of the government entity to collect taxes to repay the bonds provides security for investors.

2. Revenue bonds are backed by the income generated by the project for which the bonds provided funding. For example, the expected revenue from a toll bridge may be used to provide security for the bond.

Complex Debt Securities

75. EQUITY LINKED DEBT

Equity Linked Debt: Companies with lower credit ratings often need to provide investors with incentives to purchase their debt securities at reasonable rates. One common incentive links the debt to the company's equity by providing investors with an opportunity to participate in the earnings of the company. Companies use two basic methods to link debt with equity: convertible debt and warrants.

Convertible Debt

Convertible debt gives a bondholder the option of exchanging the bond for a predetermined number of shares in the issuing company. Sometimes the bondholder can convert the debt into the shares of another company. This may occur when another company provides a guarantee for the bonds of the issuer. Some bonds are convertible into other assets, such as commodities like gold or oil. Other convertible bonds may allow conversion from fixed-rate debt to floating debt. Most of these conversions occur at a time that is most advantageous for the bondholders. Usually the conversion rates, regardless of the asset being converted, are preset at the time the bonds are issued.

Warrants

The other type of equity-linked debt instruments have warrants attached. A warrant is a negotiable certificate that gives the owner the right to purchase a predetermined number of shares of the issuing company at a specified price during a specified period. Warrants have value as stand alone securities, and often are separated from the bonds to which they were originally attached. This "detachability" provides investors with greater flexibility than investors in convertible bonds. Investors can detach the warrants and sell either the bonds or the warrants as their investment needs change. The secondary market for some warrants is very active and liquid. A company also may issue warrants that are not attached to bonds. These are called "naked warrants."

The purpose of attaching warrants is to lower the interest rate the issuer pays on the debt. When warrants are removed, bonds often trade at deep discounts to face value because the interest rate is much lower than the prevailing rate for bonds of similar maturity and risk. Most investors will value warrants and bonds separately, even if they do not plan to detach them. Typically, investors exercise the warrants when the market price of the stock is greater than the exercise price. Many warrants expire with no value because the stock price never exceeds the exercise price during the life of the warrant. Companies issue most convertible bonds or bonds with warrants as straight debt. Typically, they pay semiannual coupons with the face value repaid at maturity.

76. DUAL CURRENCY DEBT

Some debt instruments are linked to other assets or securities to create hybrid securities. One common hybrid is the dual currency bond. Dual currency bonds make interest payments in one currency and repay the principal in another currency. This structure is designed to meet expected cash flows the company will generate from the use of capital raised by the bonds. Companies with operations in more than one country and earnings in more than one currency are typical issuers of dual currency bonds. These bonds allow issuers to take advantage of the relatively low level of interest rates associated with strong currencies which, in turn, lowers their overall costs of borrowing. The redemption rate usually is set at the time the bonds are issued, so that exchange rates are known to the investors. The bonds are usually straight debt instruments, with semiannual coupon payments.

77. YIELD TO CALL

Yield-to-call is conceptually similar to yield-to-maturity. The major difference is that yield-to-call assumes the issuer will call (Recall the word Call?? Repurchase...)the bond at the first opportunity. The yield-to-call calculation is the same as the yield-to-maturity calculation except that the number of interest paying periods until the first opportunity to call is used instead of the number of periods until maturity. Yield-to-call, like yield-to-maturity, assumes that interest payments are reinvested at the same rate as the yield-to-call rate. Another weakness of yield-to-call is that it does not consider what happens to the proceeds of the bond if it is called. The bond purchaser often has an investment horizon that is longer than the period until first call. This measure does not allow a direct comparison with investment opportunities for such an investor.

78. REALIZED COMPOUND YIELD

The final measure, Realized Compound Yield, adjusts for interest payments that are reinvested at a different rate than the yield-to-maturity. One problem with realized compound yield is that one may not know the reinvestment rate. When comparing investments, one can use the same arbitrary reinvestment rate for all investment alternatives. Usually, its best to use the yield-to-maturity for comparison purposes if the reinvestment rate is not known.

EQUITY FINANCE

79. REGISTERED SHARES

Equity securities may be issued in one of three forms:

1. Registered shares

2. Bearer shares

3. Depository receipts

Registered Shares

If a company records and maintains a current list of shareholders who own its stock certificates, then the shares are said to be registered. Each transaction involving the shares of a company is reported to the company so that the registration list may be updated. Several countries, including the United States and United Kingdom, require companies to register their shares. Tax collection is the most common reason for this requirement

80. DEPOSITORY RECEIPT

A Depository Receipt is a negotiable certificate representing a certain number of shares of a company traded on an exchange other than the exchange where the issuer resides. Depository receipts offer advantages to investors and issuers.

Advantage to investors

Investors can participate in foreign markets without having to be concerned with the regulations of that market or the complexities associated with trading in a foreign currency.

Advantage to issuers

Issuers avoid many of the costly and time-consuming regulations found in some countries. Usually, the host country's regulating agency will have only minimum requirements concerning the size of the issuing company and the size of the issue.

81. BEARER SHAREHOLDERS

Bearer shareholders are not recorded by the issuing company. Possession of the actual stock certificates is the only proof of ownership. Bearer shares are common on most European stock exchanges (except in the United Kingdom).

82. COMMON STOCK

A company usually issues equity to investors as a security in the form of shares of stock in the company. Each share represents a claim of ownership on the assets of the firm. Publicly-held companies issue two types of equity:

o Common stock and

o Preferred stock.

Each type of equity has specific characteristics and functions.

Common stock represents an ownership claim on the assets of a company. A prospectus is a document that details the ownership rights of common

stockholders. The prospectus also specifies the voting rights of the shares.

Shareholder rights An owner of a company's common stock is entitled to share in the profits of that company. This participation usually takes place in two ways:

1. A dividend (distribution of earnings) paid by the company to the share owners

2. An appreciation in the price of the stock (capital gain) generated by the future prospects of the company Common stock has no maturity date; the shareholders are entitled to these earnings for as long as they own the shares and the company is in business.

Voting rights The common shares of many firms also give shareholders the right to vote. Shareholders vote to determine the directors of the company or to approve broad strategy and policy choices presented by the directors. Usually, each share represents one vote; however, some common shares have no voting rights or they may have multiple voting rights. A recent common stock innovation is super-voting shares that represent a higher number of votes. Companies issue these shares to select investors to ensure that the majority ownership remains with the

designated shareholders. To meet different capital needs, a company may issue several types (or classes) of common stock. Each class possesses different rights and voting privileges. Companies use a different letter classification, such as "class A shares," "class B shares," to distinguish shares with different voting powers.

Preemptive purchase of new issues Owners of common shares also may enjoy a preemptive power, which gives existing shareholders the right to purchase newly-issued shares before they are offered to other investors. This right is usually proportional to the amount of shares currently owned by each investor in order to protect the dilution of value for current stockholders.

83. PREFERRED STOCK

Preferred Stock, often called a hybrid (mixed) source of capital, preferred stock is similar to common stock in some respects and to bonds (debt capital) in other respects.

Shareholder rights

Like common stockholders, preferred stockholders participate in the earnings of a company. Like bond holders, preferred stockholders receive a regular dividend payment based on the shares' face (par) value. This payment is usually determined when the shares are issued and is generally stated as a percentage of the par value. The dividend may be based on a fixed percentage rate of par or at a floating percentage rate that is tied to some market interest rate. For this reason, many analysts believe that the price of preferred stock behaves like bonds in response to changes in interest rates. A company must pay a dividend to preferred shareholders before it pays a dividend to the common shareholders, hence the term "preferred." The par value establishes the amount due to the preferred stockholders in the event of liquidation of the company. Thus, preferred stock has a priority claim on both earnings and assets. A company may decide not to pay preferred dividends at certain times (such as periods of financial distress or large internal growth). However, these "passed" dividends must be paid before any common stock dividend may be paid. Financial analysts often consider preferred shares as a liability because shareholders receive their dividends before any earnings distribution to common shareholders. Most accountants classify preferred stock as equity and list it in the equity section of the balance sheet.

Voting rights Preferred stock also may have other ownership provisions. Generally, preferred shareholders do not have voting rights. However, some preferred stocks grant a voting right if the company fails to pay the preferred dividend for a specified period (such as four or eight quarters). This provides incentive for the directors to make great efforts to pay the preferred dividend.

Buy Back rights Many newer issues of preferred stock allow for a sinking fund. This entitles the company to retire (buy back from investors) a certain percentage of the preferred shares each year. Some preferred shares may have a call provision that allows the company to repurchase the shares at a set price, usually at a premium over the par value.

Conversion rights Finally, many preferred stock issues include a conversion feature that allows the shareholders to exchange the preferred stock for common stock at a set rate. This conversion is usually at the option of the shareholder.

84. INITIAL PUBLIC OFFER (IPO)

If a privately held company decides to raise capital by selling equity to investors, it does so through an initial public offering. This is often called "taking a company public." There are two major types of IPO: a firm commitment offering and a best efforts offering. These two offerings are distinguished by the role that the investment bank plays in the process of bringing the issue to investors.

Bank as underwriter

In a firm commitment offering, the investment bank serves as the underwriter of the issue. The investment bank actually purchases the shares from the issuer at a discount, then resells them to investors. This is called underwriting the issue.

Bank as sales representative

In a best efforts offering, the investment bank agrees to use its "best efforts" to sell the shares; but the bank does not actually purchase the shares from the company. In most cases, the issuer does not choose the type of offering it prefers; the nature of the company and the type of deal dictate which offering will bring the best results. We will describe the process for both types of offerings in the coming days.....

85. FIRM COMMITMENT OFFERING

Firm Commitment Offering

There are several steps in the process of issuing a firm commitment IPO.

· Select investment bank

An issuing company begins the process by selecting an investment bank to manage the underwriting. The company and the underwriter then discuss the financing requirements of the company. The two groups draft a "letter of intent" that outlines the proposed terms of the stock issue and the underwriter's compensation for participating in the issue.

· Draft a Registration Statement

Next, the underwriter assists the issuer in drafting a registration statement. The company submits the registration to the appropriate government regulatory agency for examination and approval. In the United States, the Securities and Exchange Commission (SEC) is the agency responsible for regulating securities markets. In the United Kingdom, the Securities and Investments Board is responsible for regulation; in Japan, the Ministry of Finance is the appropriate agency and in India its SEBI (Securities Exchange Board of India). The registration statement contains all the information a potential investor needs to make an educated decision about the offering, including:

_ Description of the business, its operations, and its current capital structure

_ Terms of the offering and proposed use of the proceeds

_ Set of audited financial statements

_ Description of the future prospects of the firm, including potential risks

_ Background of the management group and current major shareholders in the company

_ Identity of the underwriter

_ Disclosure of the underwriting agreements to which the offering company is party

· Generate investor interest

Underwriters show the informational section of the registration statement to potential investors in the form of a preliminary prospectus, sometimes referred to as a "red herring." This gives the underwriter an idea of how much investor demand there is for the issue. The preliminary prospectus gives an estimated price per share because the final price is determined just prior to issue. Representatives of the company and the bank may also conduct information meetings with prospective investors to generate interest in the issue. These meetings are often called "road shows" or "dog and pony shows."

· Finalize price of issue and number of shares

A day or two after receiving approval from the appropriate regulatory agency, the issuer and the underwriter (or syndicate) meet to finalize the issue - including the number of shares to be issued and the price of the shares. It is not unusual for the number of shares and the price figures to be drastically different from the figures on the preliminary prospectus. The official prospectus is then prepared and sent to the government agency for a routine acceptance.

· Underwriter sells stock

After the pricing meeting, the underwriter (or syndicate) sells the stock to investors. This sale takes place a few hours, or perhaps the next morning, after the last meeting between the issuer and the underwriters. The sale occurs quickly because the underwriter has identified potential investors prior to the actual sale. In a firm commitment offering, the underwriter has essentially guaranteed that the issuer will receive the net proceeds (amount received from the sale of the stock less the underwriter's expenses and fees) agreed upon at the pricing meeting. The underwriter prepares a simple, boxed advertisement called a tombstone to be placed in the financial section of an appropriate newspaper. The tombstone is released on the day following the offering to advertise that the stock issue has taken place.

· Issuer risk

Substantial proceeds risk exists for the issuer from the time of the registration statement filing to the issue. During that time, market conditions may weaken which can reduce the demand for the new issue. This will affect the amount of capital the company can raise through the offering.

86. BEST EFFORTS OFFERING

Best Efforts Offering

In a best efforts offering, the investment bank does not underwrite the issue, although the bank is still often referred to as the underwriter. Instead, the bank agrees to use its "best efforts" to sell the shares.

· More risk for issuer

This arrangement exposes the issuer to more risk than the firm commitment. In a best efforts offering, the investment banker essentially acts as an advisor and a marketing agent. The company and the investment bank agree on an issuing price and a minimum and maximum number of shares to be sold. The investment bank tries to generate interest in the issue so that the issuing company can sell enough shares to meet its capital needs. Best efforts offerings are more common with smaller issues.

· Issuing process

The registration process for best efforts offerings is the same as for the firm commitment offering. Following approval by the appropriate government regulatory agency, the investment bank sets up an escrow account for potential investors. These investors deposit money in the account to reserve their shares.

· Direct costs

The investment bank typically charges a commission (between 8% and 11%) on the shares sold in the offering, in addition to the other fees and expenses. This commission is often higher than the spread in a firm commitment offering. In some best efforts agreements, if the minimum number of shares is not sold in the prescribed amount of time, the offering is withdrawn and the investors' money is returned. The issuer does not receive any capital. This arrangement is similar to an all-or-nothing agreement, but the minimum number of shares to be sold in the best efforts agreement is much smaller. Other best efforts agreements specify that the investment bank sell as many shares as possible (up to the maximum number specified).

87. ALL OR NOTHING OFFERING

Although firm commitment and best efforts are by far the most common types of IPOs, investment bankers and issuers sometimes use other, less common types as well.

An all-or-nothing offering is a contract specifying that the investment bank will withdraw the offer if it is unable to place (sell) the issue. This is similar to a best efforts offering with a minimum acceptable percentage of shares to be sold. Some variations of the all-or-nothing offering will set a minimum acceptable percentage (such as 90%).

88. OPEN PRICE OFFERING

An open-price offering is an arrangement where investors bid on the shares. The investment bank then places the offering with the investors who make the highest bids and work down until enough capital has been raised. Most open-price offerings will specify a minimum bid by investors. Open-price offerings are more common for companies that issue shares in several different markets at the same time.

For e.g. i-flex IPO was an open-price offering where the minimum bid price was kept at Rs.530

89. SEASONED OFFERING

Suppose that a company has successfully placed an IPO, and those shares are being traded in the equity market. Now, the company needs more capital and wants to raise it through an additional equity offering called a Seasoned Offering. The process of issuing additional shares is similar to an initial public offering. There are two types of seasoned offerings:

o a general cash offering and

o a rights offering.

90. GENERAL CASH OFFERING

If a company offers the additional shares to all potential investors (not just current stockholders), the offering is called a General Cash Offering. The shares are sold to investors using the same methods as for the initial public offering.

Direct costs Typical general cash offerings incur direct administrative expenses of approximately 1.5% of the offering, and the investment banker's spread averages about 5%. A lower percentage of the total issue amount is charged for larger issues, indicating economies of scale in the costs of issuing the equity.

Indirect costs An indirect cost of a seasoned offering results from the tendency of the stock price to fall when the offering is announced. This price change may range from 2% to 6% of the total value of the firm. Two theories have been proposed to explain this phenomenon.

One theory is that company is more likely to issue additional stock when the current stock is overvalued - they try to take advantage of the mispricing in order to maximize the capital raised by the firm. Investors believe that a general cash offering is a signal that the shares are overpriced.

Another theory is based on the idea that a stock issue announcement indicates that the company is having cash flow problems and needs to raise capital that doesn't require interest payments. Since equity issues do not require any interest payments (and debt issues do), investors view the stock issue as a sign of problems.

91. RIGHTS OFFERING

The second type of seasoned offering is a Rights Offering, which gives the existing shareholders a preemptive right to buy the new equity

securities. Companies allow current shareholders the first right to purchase the new equity so that their holdings are not diluted.

Let's look at an example that illustrates the concept of diluting shares of current stockholders.

Consider a company with 4 million outstanding shares of common equity. One particular investor, a mutual fund, owns 200,000 shares of the company, which represents a 5% ownership share in the firm. The company issues 500,000 new shares and the mutual fund is not able to purchase any. Therefore, after the issue, the fund's 200,000 shares represent only a 4.44% ownership in the firm. This is referred to as "dilution of ownership in the firm."

The direct costs of a rights offering are usually much less than those of a general cash offering because the existing shareholders are already familiar with the company and its operations. The investment bank may only serve as a standby underwriter in case the shares are not all sold.

The indirect costs for a rights offering are similar to a general cash offering. Most issue announcements are met with a 3% to 4% fall in the share price of the existing shares. Theories explaining price decreases are much the same as for the general cash offering.

92. VALUATION OF SECURITIES

We have seen different methods of offering securities. Now, having issued securities on the equities markets, companies must track the value of their stock. Investors also need to estimate the value of equity securities to make educated investment decisions. A variety of techniques are available for estimating the value of equity securities. We shall now see the most commonly used methods for estimating the value of equity and discuss their relative strengths and weaknesses.

93. VALUATION OF COMMON EQUITY

Three valuing methods

There are three standard methods for estimating the value of common equity. They are:

1. Ratio valuation

2. Relative valuation

3. Discounted cash flow valuation

Most investment analysts consider the discounted cash flow method to be the best method for estimating the value of a company or for estimating the value created by a potential project. By focusing on cash flows rather than net income or other values, one can eliminate the bias incurred by various accounting conventions. Discounted cash flow analysis also attempts to account for risk, whereas other methods do not. Many managers, especially those without a strong analytical background, still use ratio and relative valuation methods. While not as comprehensive as discounting cash flows, these methods can be good "first-cut" types of analyses (a quick, back-of-the-envelope calculation) that will give you a beginning point for comparison. Let's see one by one in the next few days.....

94. RATIO VALUATION

Using price-to-characteristics ratios to estimate the value of common stock is very popular. You can find the data needed to calculate ratios in the financial statements of the company, which are published in the annual report. Most of the calculations are simple and straightforward. This is the same as the RATIO ANALYSIS that we discussed in Corporate Finance.

_ Price / earnings ratio

_ Market / book ratio

_ Dividend valuation

_ Other price-to-characteristics ratios

95. PRICE / EARNINGS RATIO

The Price / Earnings ratio gives information about the value the market attaches to the earnings of a company. The formula for calculating the price / earnings (P/E) ratio is:

P/E = (Market price per share) / (Earnings per share)

Description and uses of P/E ratio

The P/E ratio shows how much investors are paying for each dollar of income generated by the firm. High P/E ratios indicate that investors are very optimistic about the future prospects of the company. They are willing to pay more for the current earnings of the firm because they feel that the future earnings will be even higher. Likewise, lower P/E ratios indicate less optimism for the company by investors. P/E ratios are often used to compare companies as potential investment opportunities. It is appropriate to compare companies within the same industry because of their similar structure and operations. For example, one would compare the P/E ratios of Ford Motor Company and General Motors as part of their analysis. They would not compare the P/E ratio of Ford with the P/E ratio of IBM.

Disadvantage of P/E ratio

The problem with using P/E ratios to make investment decisions is that the analysis is short-sighted. For example, some investors believe that by choosing companies with lower P/E ratios, they are getting a bargain. If two similar companies are being considered and one has a P/E ratio of 8, and the other has a P/E ratio of 12, investors probably will choose the company with a P/E of 8 because they will pay less for each dollar of income generated by the company. However, the company with a P/E of 12 may still be a better investment because of its future earnings potential. The P/E ratio is based on the most recent earnings figure, not the future earnings potential; therefore, it can be short-sighted when used as the only investment criterion.

96. MARKET/BOOK RATIO

The market / book ratio relates the market price of the shares with the book value of the company on a per share basis. The formula is:

Market / Book = (Market price per share) / (Book price per share)

Description and uses of market / book ratio

This ratio describes how much investors are paying for the company divided by the value of the company according to accounting methods. In other words, the market / book ratio gives a multiple of the market price of the company in relation to its book value. Some investors consider the book value as the floor for the market price of the company. They feel that if the market value ever falls below the book value, the company can sell off its assets at book value to maintain its price. Those investors may also argue that low market / book ratios indicate the company is a safer investment; but the book value may not be the price the company could get by selling off its assets.

Disadvantage of market / book

The market / book ratio is even less useful as a stand-alone tool than the P/E ratio. Problems occur even when comparing companies in the same industry. Most accounting conventions require that assets be carried at their historical cost on the books. It can be difficult to find a company with similar operations and similar assets to serve an appropriate point of comparison. Companies with older, less-costly assets will have lower market / book ratios than similar companies with newer, more modern assets (all other factors being equal). However, some less-sophisticated investors continue to use the market / book ratio as a major investment decision-making tool.

97. DIVIDEND VALUATION

If a company pays a regular dividend, analysts can estimate the firm value based on those dividend payments using the dividend valuation ratio. There are two ways to estimate the value, depending on whether we assume that the dividends paid on the common stock are a perpetuity or a growing perpetuity. The ratio for estimating the value of common stock as a perpetuity is:

V = D / R

Where:

V = Value of common stock

D = Recent dividend payment

R = Estimated discount rate

The growing perpetuity formula is:

V = D1 / (R - G)

Where:

V = Value of common stock

D1 = Expected dividend in the next period, calculated as D1 = D x (1 + G)

R = Estimated discount rate

G = Estimated dividend growth rate

Notice that both ratios require an estimated discount rate. That rate is the investor's required rate of return or the earnings an investor expects to make on an equity investment.

Disadvantages If a company does not pay dividends, or if our assumptions concerning future dividends do not fit a perpetuity, then this method is of little value. For example, if a company is very erratic in its dividend payments, then the assumption of dividend perpetuity may not be valid.

98. OTHER PRICE-TO-CHARACTERISTICS RATIOS

There may be other price-to-characteristics ratios that can help one understand a company or industry. For example:

· A price-to-revenues ratio may provide insight into how much investors are paying for the revenues being generated by the company.

· The price-to-EBITD (Earnings Before Interest, Taxes, and Depreciation) ratio shows how much value market investors place on the earnings (without interest payments, taxes, and depreciation) of the company.

The price-to-cash flow ratio relates the price of the firm to the cash flow generated by the firm. The calculation of these ratios is similar to the P/E ratio (price per share divided by EBITD or cash flow).

99. RELATIVE VALUATION

Relative valuation methods provide information about a company relative to other companies in the same industry. Most of these valuation methods provide an estimate of the entire firm value. By dividing the firm value by the number of shares outstanding, one can find per share value estimates. These methods of valuation often require that one should be very familiar with the operations of a particular company and its industry. The information needed to make these kinds of estimates is usually not readily available to most investors.In this section, we shall see:

- Liquidation value

- Asset-based valuation

100. LIQUIDATION VALUE

Description and uses

If a company sells all of its assets and uses the proceeds to pay its creditors, the liquidation value is the amount left to distribute to shareholders. Analysts often consider the liquidation value to be the floor price of the stock. If the stock price falls below this value, investors are better off having the company liquidated. Corporate raiders often use liquidation value as a criterion to evaluate potential takeovers. They may notice that a stock price is less than the liquidation value on a per share basis and will make an offer for all of the stock of the company. The raider then gains control, sells off the assets, and pays the creditors. The value remaining represents the raider's gain (less the original investment).

Disadvantages However, it may be very difficult to estimate the liquidation value of a company. This is especially true if there is little or no market for the assets of the company. One must have a thorough understanding of the company and its industry to make an accurate estimate of the company's liquidation value.

101. ASSET BASED VALUATION

Description and Uses

Some may want to value the individual assets of a company at a market price according to the cash flow generated by the asset groups. They often use the asset-based valuation method for companies with several different operations. For example, consider a media company that owns television stations, radio stations, some newspaper publishers, and a book publisher. The market most likely will value earnings from each business at a different P/E ratio. One with access to a breakdown of the cash flow generated by each unit may discover that one unit is undervalued. This unit will be worth more to other investors as either a stand-alone entity or as part of another company. Spin-offs, mergers, and acquisitions are often motivated by this type of asset valuation.

102. DISCOUNTED CASH FLOW VALUATION

The discounted cash flow method involves a more detailed analysis than ratio and relative valuation methods. It requires the investor or analyst to make several assumptions about the future prospects of the company being analyzed. We will briefly describe the four-step process:

Four-step process

1) Forecast cash flows

2) Estimate cost of capital

3) Estimate residual value

4) Discount cash flows

103. FORECAST CASH FLOWS

The first step in discounting cash flow is to develop a set of projected cash flows for an appropriate time frame based on certain assumptions. Usually one's sense of the accuracy of the estimates and assumptions will dictate the time frame used for the analysis. That may be somewhere between three and twenty-five years. Figure 1 is an example of how assumptions for five years may be organized for XYZ Corporation.

ASSUMPTIONS:

		Year		1		2		3		4		5
(A)		Sales Growth		4.00%		4.00%		4.00%		4.00%		4.00%
(B)		Profit Margin Incremental Net		12.00%		12.00%		12.00%		12.00%		12.00%
(C)		Cash Income Tax		35.00%		35.00%		35.00%		35.00%		35.00%
(D)		Incremental Working Capital Investment		13.00%		13.00%		13.00%		13.00%		13.00%
	(E)	Fixed Asset Investment (% of Sales Increase)	18.00%		18.00%		18.00%		18.00%		18.00%

Figure 1: Assumptions for Forecasting Cash Flows

The most common procedure for estimating cash flows begins with the most recent sales figure. First, one estimates future sales based on an assumed revenue growth rate (A). Next, one makes assumptions about the projected profit margin of the firm (B) and estimates a future cash tax rate (C). You can also make assumptions about the company's future investment in working (D) and fixed (E) capital assets. One with access to this information will use the company's actual projected figures. Else, you can make an estimate based on the investment rates as percentages of incremental sales. Having completed the set of assumptions, one is ready to forecast future cash flows for XYZ Corporation. Based on the assumptions in Figure 1, estimated cash flows for each of the five years are shown in Figure 2.

ESTIMATES:

Year (Figures in Millions)	1	2	3	4	5
Sales	$104.00	$108.16	$112.49	$116.99	$121.67
Operating Profit	12.48	12.98	13.50	14.04	14.60
Cash Income Taxes	4.37	4.54	4.72	4.91	5.11
EBIAT	8.11	8.44	8.77	9.12	9.49
Fixed Capital Investment	0.72	0.75	0.78	0.81	0.84
Working Capital Investment	0.52	0.54	0.56	0.58	0.61
Free Cash Flow	6.87	7.15	7.43	7.73	8.04

Figure 2: Five-year Cash Flow Forecast

Let's look at how to use the assumptions to calculate the cash flow for Year 1.

Sales for the past year (Year 0) totaled $100 million.

Sales = Sales for Year 0 (1 + Forecast growth rate)

= $100 million x (1.04)

= $104 million

Operating Profit = Sales x Expected profit margin

= $104 million x 0.12

= $12.48 million

Income Tax = Operating profit x Tax rate

= $12.48 million x 0.35

= $4.37 million

EBIAT (Earnings before interest after taxes ) = Operating profit - Taxes

= $12.48 million - $4.37 million

= $8.11 million

If we do not have access to exact figures from the company's fixed capital and working capital investment plans, then we must make estimates. As mentioned earlier, a common method is to assume a certain investment rate based on the incremental increase in sales. We can base our assumptions on a careful study of the company's past investment patterns.

In our example, the Year 1 sales increase is $4 million ($104 million - $100 million). One expects the firm to invest 13% of each year's sales increase in working capital and 18% in fixed capital assets. This is the investment net of depreciation. The calculations for investments in Year 1 are:

Fixed Capital Investment

= Incremental sales increase x Fixed asset investment rate

= $4 million x 0.18

= $0.72 million

Working Capital Investment

= Incremental sales increase x Working capital investment rate

= $4 million x 0.13

= $0.52 million

Now we calculate the cash flow.

Projected Cash Flow

= EBIAT - (Fixed + Working capital investment)

= $8.11 million - ($0.72 million + $0.52 million)

= $6.87 million

The estimated cash flow for XYZ Corporation for Year 1 is $6.87 million.

We shall see step 2 - Estimation of Cost of Capital in tomorrows mail.........

104. COST OF CAPITAL

The next step in the discounted cash flow valuation is to estimate the cost of capital for the firm. This is the required rate of return that the firm must earn for its investors to properly reward them for the risk they take by investing in the company. It is the rate that will be used to discount the projected cash flows to calculate the present value of the company.

The best method for estimating the cost of capital is by using the weighted average cost of capital. This method accounts for each source of capital (debt, preferred stock, and common equity) and the cost associated with its use. The formula for calculating the weighted average cost of capital is:

ka = Wd kd (1 - T) + Wp kp + We ke

Where:

ka = Weighted average cost of capital

Wd = Percentage of capital using debt

kd = Cost of debt

T = Marginal tax rate of company

Wp = Percentage of capital using preferred stock

kp = Cost of preferred stock

We = Percentage of capital using equity

ke = Cost of equity

Debt : The formula multiplies the cost of each source of capital by its relative weight in the capital structure of the firm. It adjusts the cost of debt for the tax-deductibility of interest payments by multiplying k by one minus the tax rate. One estimates the cost of debt as the interest rate that the company will pay on new debt.

Preferred stock : Preferred dividends are divided by the price of the preferred shares to calculate the cost of preferred shares. This gives an estimate of the rate of return that preferred shareholders are earning on their investment.

Common equity :To estimate the cost of common equity, many analysts use the capital asset pricing model. Another method commonly used is dividend valuation, which we discussed last week.

To continue our example of XYZ Corporation, suppose that the cost of debt is 6.0%, the cost of preferred stock is 8.5%, and the cost of common equity is 13.0%. The expected capital structure is 40% debt, 10% preferred equity, and 50% common stock. The cash tax rate is expected to be 35%. You can estimate the weighted average cost of capital as follows:

ka = Wd kd (1 - T) + Wp kp + We ke

ka = (0.40)(0.06)(1 - 0.35) + (0.10)(0.085) + (0.50)(0.13)

ka = 0.0891 or 8.91%

The required rate of return for investors (discount rate) is 8.91%.

We shall discuss the Step 3 - Estimate Residual Value in tomorrow's mail

105. ESTIMATE THE RESIDUAL VALUE

The third step in the discounted cash flow valuation is to calculate the residual value. Residual value is the estimated value of the company at the end of the forecasted periods.

Based on liquidation value

There are several methods that can be used to make this estimate. If one knows that the company will be terminated at the end of the forecast, then you may want to use an estimated liquidation value of the assets or an estimated price at which the company may reasonably be sold at that time.

Based on returns matching cost of capital

If one expects that the company will continue to operate and generate cash flows for the investors, the analyst will want to make a different estimate. One method is to assume that the company will continue to earn a rate of return that matches the cost of capital invested in the company. Under this assumption, the value of the company is:

Residual value = (EBIAT) / ka

Where:

ka = Weighted average cost of capital (which we saw in yesterday's mail)

The convention is to use the earnings before interest after taxes (EBIAT) for the last forecasted year, divided by the average cost of capital (discount rate) for that year. By using this method, one makes the implicit assumption that the company is not creating (or destroying) any value for the shareholders of the company. All investors (debt, preferred, and common) are earning their expected rates of return by investing in the company.

Based on returns above cost of capital

Some companies may anticipate that they will continue earning returns above their cost of capital after the forecast period. In these cases, a growing perpetuity method may be appropriate for estimating the residual value. The formula for placing value on a growing perpetuity is:

Residual value = [EBIAT x (1 + g)] / (ka - g)

Where:

g = Expected growth rate

ka = Weighted average cost of capital

One important thing to remember when using this method is that the cost of capital must be larger than the expected growth rate.

Example We want to estimate the residual value of XYZ Corporation at the end of five years. Let's assume that the residual value is a perpetuity of $9.49 million (Year 5 earnings before interest after tax). We can use our formula to estimate the residual value with a weighted average cost of capital of 8.91%.

Residual value = ($9.49 million) / (0.0891)

= $106.51 million

106. DISCOUNT THE CASH FLOWS

The final step is to discount the projected cash flows, including the residual value, to a present value using the weighted average cost of capital (discount rate). In Figure 3, we discount the cash flows of XYZ Corporation and calculate the firm's present value:

Year	Cash Flow (Millions)	Present Value Factor*	Present Value (Millions)
1	6.87	1/(1.0891)1	6.31
2	7.15	1/(1.0891)2	6.03
3	7.43	1/(1.0891)3	5.75
4	7.73	1/(1.0891)4	5.49
5	8.04	1/(1.0891)5	5.25
Residual Value	106.51	1/(1.0891)5	69.51
		Total Firm Value	98.34

* Present Value Factor = 1 / (1 + Weighted Average Cost of Capital)T T = Year

Figure 3: Present Value of XYZ Corporation

This discounting process gives us the total present value of the company - based on our earlier assumptions concerning growth, investment, and cost of capital. To find the value of the common equity, we deduct the value of the debt and the value of the preferred stock.

In our example, the company has approximately $35 million in debt and $8 million in preferred stock on its books. Thus, the value of the common equity is $55.34 million ($98.34 million - $43 million). If the company has 2.5 million shares of common stock outstanding, we can divide the value of the equity by the number of shares to get the firm value on a per share basis ($55.34 million / 2.5 million = $22.14 per share).

107. VALUATION OF PREFERRED SHARES

Perpectuity Method

The most common method for estimating the value of preferred shares is to use a perpetuity method. The dividend paid on each share is considered a perpetuity. We can estimate the value of the preferred shares by dividing the dividend by the investors' required rate of return. The formula is:

Value = Dividend / Discount rate

Example If we know that a company pays a yearly dividend of $6.25 on its preferred shares and that an investor can earn an 8.5% rate of return on investments with similar risk, then we can estimate the value of the preferred shares.

Value = $6.25 / 0.085

= $73.53

This means that an investor with a required rate of return of 8.5% would be willing to pay $73.53 for a preferred share that pays a $6.25 yearly dividend.

Estimating cost of preferred shares

Analysts use this same relationship to estimate the cost of preferred shares when trying to find the weighted average cost of capital. The analyst will have access to the dividend and price per share information, and will solve the equation for the discount rate (which represents the cost of the preferred stock to the company).

For example, suppose that a company has preferred shares that are currently selling for $43.50 and pay a yearly dividend of $4.80. The cost of the preferred shares can then be estimated.

Discount rate = Dividend / Share price

= $4.80 / $43.50

= 0.1103 or 11.03%

TRADE FINANCE

108. TARIFFS

Tariffs are taxes that are placed on imported goods to:

· Protect domestic businesses from foreign competition

· Discriminate, if they apply unequally to products of different countries

· Retaliate, if they are designed to compel another country to remove artificial trade barriers

The tariff imposed on Japanese motorcycles is an example of a protective tariff. In 1983, Harley-Davidson, a US manufacturer, was having difficulty competing with the heavyweight bikes imported from Japan by Honda and Kawasaki. The US Government imposed a five-year tariff on Japanese bikes imported into the United States. This gave Harley-Davidson management time to reorganize the company and become competitive again - without pressure from the Japanese imports. By 1987, Harley-Davidson had regained its share of the market in the heavyweight class of bikes and requested that the tariff be lifted a year early.

109. NON-TARIFF BARRIERS

Nontariff barriers consist of a variety of measures that restrict imports. These measures include testing, certification, or bureaucratic hurdles. Example An interesting example of bureaucratic hurdles occurred in France in 1983. The French government decided to reduce the importation

of foreign video recorders and mandated that all recorders had to be sent to the customs station at Poitiers - which was far from the normal transportation routes. Because the station was understaffed, operated only a few days per week, and each individual package had to be opened, the import of video recorders was effectively stopped. Meanwhile, the French were able to assert their adherence to international agreements.

110. QUOTAS

Quotas are restrictions on the quantity of specific products that can be imported and exported. Sometimes import quotas are imposed to prevent damage to a domestic industry, e.g. clothing and textiles. Occasionally, this action has unexpected results.

Example For example, in the early 1970s, quotas placed on tuna fish packed in oil from Japan prevented the tuna from entering the US market. This forced the Japanese to concentrate on packing tuna in water even though, at that time, only 7% of tuna was packed in water. The Japanese became quite successful and created a niche for themselves in the tuna-packed-in-water market. Export quotas are set for reasons of national defense, economic stability, and price support. For example, it is United States government policy to control the export of weapons and high technology that may have an adverse effect on national security. Tariffs, non-tariff barriers, and import and export quotas all function to restrict or limit foreign trade. There also are several methods that serve to promote global trade.

111. TRADE AGREEMENTS

A trade agreement is an agreement between two or more countries concerning the buying and selling of each country’s goods and services. Countries enter into trade agreements to facilitate trade among the member countries. Their objectives are to:

· Diversify export markets

· Create or explore trade opportunities without barriers

· Protect products from other markets

· Encourage economic development of the region

While there are many trade agreements in different parts of the world, one plays a major role in Europe (the European Community [EC]), and three of them directly influence trade in Latin America: North American Free Trade Agreement (NAFTA), MERCOSUR, and Pacto Andino.

112. EXPORT CREDIT AGENCIES

Export Credit Agencies are national organizations that support and expand local exports to benefit the country’s balance of payments and, as a result, create jobs in the local market. The ECA programs enable the Bank’s customers (exporters) to remain competitive with businesses from other countries. Importers also benefit from access to preferential rates and terms for loans from programs of the exporting countries.

ECA programs ECA assistance is provided in the form of guarantees or insurance as well as direct lending. ECA programs include:

· Insurance to national exporters and commercial banks against commercial (credit) and/or country risks

· Payment guarantees to commercial banks involved in export financing

· Preferential fixed interest rate loans to foreign importers

113. MULTILATERAL AGENCIES

Governments working together have established institutions whose purpose is to maintain orderly international financial conditions and to provide capital and advice for economic development, particularly in those countries that lack the resources to do it themselves. These institutions or multilateral agencies play an increasing role in the financing of large export contracts and projects. We shall discuss first the globally-oriented World Bank, its entities and affiliates, and then examine the role of regional development banks.

114. ROLE OF WORLD BANK GROUP

The World Bank Group is comprised of the International Bank for Reconstruction and Development (IBRD) and the International Development Association (IDA) and two affiliates, the International Finance Corporation (IFC) and the Multilateral Investment Guarantee Agency (MIGA). Let’s examine their specific roles.

World Bank

The World Bank is a multilateral development agency. Its purpose is to help member countries progress economically and socially so that their people may live better and fuller lives. The World Bank is the primary source of funding for projects in emerging-market countries when private capital cannot be raised. In addition to lending medium and long-term funds directly to governments in the emerging markets, the World

Bank provides technical and financial aid to private-sector companies for direct investments.

World Bank entities: IBRD and IDA

The term “World Bank” refers to two legally and financially distinct entities: the International Bank for Reconstruction and Development (IBRD) and the International Development Association (IDA). The IBRD and IDA have three related functions:

· Lend funds

· Provide economic advice and technical assistance

· Serve as a catalyst to investment by others

Both the IBRD and the IDA provide training and technical advice to help developing countries address their own problems. However, the IBRD makes market-rate loans to newly industrialized countries (e.g. Korea, Brazil) by borrowing in the world capital markets. The IDA extends

assistance to the poorest countries on easier terms (e.g., interest-free loans), largely from resources provided by its wealthier members.

Funds from such other sources as governments, commercial banks, export credit agencies, and other multilateral institutions are increasingly being paired with World Bank funds to co-finance projects.

SEDOL stands for Stock Exchange Daily Official List, a list of security identifiers used in the United Kingdom and Ireland for clearing purposes. The numbers are assigned by the London Stock Exchange, on request by the security issuer. SEDOLs serve as the NSIN for all securities issued in the United Kingdom and are therefore part of the security's ISIN as well.

Although SEDOL was to have been superseded by ISIN, problems with the ISIN system have since forced a reversal of this decision. In particular, a single ISIN is used to identify the shares of a company no matter what exchange it is being traded on, making it impossible to specify a trade on a particular exchange or currency. For instance, Chrysler trades on twenty-two different exchanges worldwide, and is priced in five different currencies. An expanded ISIN standard is currently being formulated to address this problem.

[edit] Description

SEDOLs are seven characters in length, consisting of two parts: a six-place alphanumeric code and a trailing check digit. SEDOLs issued prior to January 26, 2004 were composed only of numbers. For those older SEDOLs, those from Asia and Africa typically begin with 6, those from the UK and Ireland (until Ireland joined the EU) typically begin with 0 or 3 those from Europe typically began with 4, 5 or 7 and those from the Americas began with 2. After January 26, 2004, SEDOLs were changed to be alpha-numeric and are issued sequentially, beginning with B000009. At each character position numbers precede letters and vowels are never used. All new SEDOLs, therefore, begin with a letter. Ranges beginning with 9 are reserved for end user allocation.

The check digit for a SEDOL is chosen to make the total weighted sum of all seven characters a multiple of 10. The check digit is computed using a weighted sum of the first six characters. Letters are converted to numbers by adding their ordinal position in the alphabet to 9, such that B = 11 and Z = 35. While vowels are never used in SEDOLs, they are not ignored when computing this weighted sum (e.g. H = 17 and J = 19, even though I is not used), simplifying code to compute this sum. The resulting string of numbers is then multiplied by the weighting factor as follows:

First   1

Second  3

Third   1

Fourth  7

Fifth   3

Sixth   9

Seventh 1 (the check digit)

The character values are multiplied by the weights. The check digit is chosen to make the total sum, including the check digit, a multiple of 10, which can be calculated from the weighted sum of the first six characters as (10 - (this sum modulo 10) modulo 10.

For British and Irish securities, SEDOLs are converted to ISINs by padding the front with two zeros, then adding the country code on the front and the ISIN check digit at the end.

An International Securities Identifying Number (ISIN) uniquely identifies a security. Its structure is defined in ISO 6166. Securities for which ISINs are issued include bonds, commercial paper, equities and warrants. The ISIN code is a 12-character alpha-numerical code that does not contain information characterizing financial instruments but serves for uniform identification of a security at trading and settlement.

Securities with which ISINs can be used include debt securities, shares, options, derivatives and futures. The ISIN identifies the security, not the exchange (if any) on which it trades; it is not a ticker symbol. For instance, DaimlerChrysler stock trades on twenty-two different stock exchanges worldwide, and is priced in five different currencies; it has the same ISIN on each, though not the same ticker symbol. ISIN cannot specify a particular trade in this case, and another identifier, typically the three-letter exchange code, will have to be specified in addition to the ISIN. The SEDOL board of the London Stock Exchange is currently revising their own standards to address this issue.

[edit] Description

ISINs consist of three parts: a two letter country code, a nine character alpha-numeric national security identifier, and a single check digit. The country code is the ISO 3166-1 alpha-2 code for the country of issue, which is not necessarily the country in which the issuing company is domiciled. International securities cleared through Clearstream or Euroclear, which are Europe-wide, use "XS" as the country code.

The nine-digit security identifier is the National Securities Identifying Number, or NSIN, assigned by governing bodies in each country, known as the national numbering agency (NNA). In North America the NNA is the CUSIP organization, meaning that CUSIPs can easily be converted into ISINs by adding the US or CA country code to the beginning of the existing CUSIP code and adding an additional check digit at the end. In the United Kingdom and Ireland the NNA is the London Stock Exchange and the NSIN is the SEDOL, converted in a similar fashion after padding the SEDOL number out with leading zeros. Most other countries use similar conversions, but if no country NNA exists then regional NNAs are used instead.

The procedure for calculating ISIN check digits is similar to the "Modulus 10 Double Add Double" technique used in CUSIPs. To calculate the check digit, first convert any letters to numbers by adding their ordinal position in the alphabet to 9, such that A = 10 and M = 22. Starting with the right most digit, every other digit is multiplied by two. (For CUSIP check digits, these two steps are reversed.) The resulting string of digits (numbers greater than 9 becoming two separate digits) are added up. Subtract this sum from the smallest number ending with zero that is greater than or equal to it: this gives the check digit which is also known as the ten's complement of the sum modulo 10. That is, the resulting sum, including the check-digit, is a multiple of 10.

ISINs are slowly being introduced worldwide. At present, many countries have adopted ISINs as a secondary measure of identifying securities, but as of yet only some of those countries have moved to using ISINs as their primary means of identifying securities.

[edit] Examples

Apple Inc.: ISIN US0378331005, expanded from CUSIP 037833100 The main body of the ISIN is the original CUSIP, assigned in the 1970s. The country code "US" has been added on the front, and an additional check digit at the end. The check digit is calculated in this way...

Convert any letters to numbers:

U = 30, S = 28. US037833100 -> 3028037833100.

Collect odd and even characters:

3028037833100 = (3, 2, 0, 7, 3, 1, 0), (0, 8, 3, 8, 3, 0)

Multiply the group containing the rightmost character (which is the FIRST group) by 2:

(6, 4, 0, 14, 6, 2, 0)

Add up the individual digits:

(6 + 4 + 0 + (1 + 4) + 6 + 2 + 0) + (0 + 8 + 3 + 8 + 3 + 0) = 45

Take the 10s modulus of the sum:

45 mod 10 = 5

Subtract from 10:

10 - 5 = 5

Take the 10s modulus of the result (this final step is important in the instance where the modulus of the sum is 0, as the resulting check digit would be 10).

5 mod 10 = 5

So the ISIN check digit is five.

TREASURY CORP VICTORIA 5 3/4% 2005-2016: ISIN AU0000XVGZA3

Convert any letters to numbers:

A = 10, G = 16, U = 30, V = 31, X = 33, Z = 35. AU0000XVGZA -> 103000003331163510.

Collect odd and even characters:

103000003331163510 = (1, 3, 0, 0, 3, 3, 1, 3, 1), (0, 0, 0, 0, 3, 1, 6, 5, 0)

Multiply the group containing the rightmost character (which is the SECOND group) by 2:

(0, 0, 0, 0, 6, 2, 12, 10, 0)

Add up the individual digits:

(1 + 3 + 0 + 0 + 3 + 3 + 1 + 3 + 1) + (0 + 0 + 0 + 0 + 6 + 2 + (1 + 2) + (1 + 0) + 0) = 27

Take the 10s modulus of the sum:

27 mod 10 = 7

Subtract from 10:

10 - 7 = 3

Take the 10s modulus of the result (this final step is important in the instance where the modulus of the sum is 0, as the resulting check digit would be 10).

3 mod 10 = 3

So the ISIN check digit is three.

Conversion table for characters is :

A = 10	F = 15	K = 20	P = 25	U = 30	Z = 35
B = 11	G = 16	L = 21	Q = 26	V = 31
C = 12	H = 17	M = 22	R = 27	W = 32
D = 13	I = 18	N = 23	S = 28	X = 33
E = 14	J = 19	O = 24	T = 29	Y = 34

BAE Systems: ISIN GB0002634946, expanded from SEDOL 0263494

The main body is the SEDOL, padded on the front with the addition of two zeros. The country code "GB" is then added on the front, and the check digit on the end as in the example above.

The Non-Profit Partnership “National Depository Centre” became a member of the Association of National Numbering Agencies (ANNA). The admission decision was made at the General Members’ Meeting of the Association in New York on 15 November 1999.

ANNA comprises 61 organizations handling the functions of national numbering agencies assigning international securities identification numbers (ISINs) to securities and other financial instruments in their countries.

The purpose of ISIN assignment is to ensure the standardized identification of issue-grade securities and other financial instruments within a uniform system and the distribution of data to securities market participants. ISINs and standard descriptions of securities are used in all sectors of the securities industry, and are important in performing precise and effective settlement and clearing.

In the period of non-existence of such organization in Russia its functions were temporarily carried out by Wertpapier-Mitteilungen Company (Germany), responsible for assigning ISINs to all Russian securities, with which NDC entered into the Service Agreement on the delivery of ISIN assignment services.

In accordance with the Articles of Incorporation of ANNA, the functions of NDC are as follows:

· assigning ISINs to domestic securities and other financial instruments

· facilitating the application of provisions of ISO 6166

· making available for the members of ANNA and all securities market participants information on ISINs and their assignment within the uniform ISIN structure for different securities trading and management purposes under international securities transactions

participation in creating an effective international securities identification system.

The acronym CUSIP typically refers to both the Committee on Uniform Security Identification Procedures and the 9-character alphanumeric security identifiers that they distribute for all North American securities for the purposes of facilitating clearing and settlement of trades. The CUSIP distribution system is owned by the American Bankers Association and is operated by Standard & Poor's. The CUSIP Services Bureau acts as the National Numbering Association (NNA) for North America, and the CUSIP serves as the National Securities Identification Number for products issued from both the United States and Canada.

In the 1980s there was an attempt to expand the CUSIP system for international securities as well. The resulting CINS (CUSIP International Numbering System) has seen little use as it was introduced at about the same time as the truly international ISIN system. CINS identifiers do appear in the ISIDPlus directory, however.

Contents

[hide]

1 Description

2 Examples

3 See also

4 External links

[edit] Description

The first six characters are known as the "base" (or "CUSIP-6"), and uniquely identify the issuer. Issuer codes are assigned alphabetically from a series that includes deliberate built-in "gaps" for future expansion. The last two characters of the issuer code can be letters, in order to provide more room for expansion. The numbers from 990000 up are reserved, as are xxx990 and up within each group of 1000 (ie, 100990 to 1009ZZ).

The 7th and 8th digit identify the exact issue, the format is dependent on the type of security. In general, numbers are used for equity and letters are used for fixed income. For commercial paper the first issue character is generated by taking the letter code of the maturity month, the second issue character is the day of the maturity date, with letters used for numbers over 9. The first security issued by any particular issuer is numbered "10". Newer issues are numbered by adding ten to the last used number up to 80, at which point the next issue is "88" and then goes down by tens. The issue number "01" is used to label all options on equities from that issuer.

Fixed income issues are labeled using a similar fashion, but due to there being so many of them they use letters instead of digits. The first issue is labeled "AA", the next "A2", then "2A" and onto "A3". To avoid confusion, the letters I and O are not used to avoid confusion with the digits 1 and 0.

The 9th digit is an automatically generated check digit using the "Modulus 10 Double Add Double" technique. To calculate the check digit every second digit is multiplied by two. Letters are converted to numbers by adding their ordinal position in the alphabet to 9, such that A = 10 and M = 22. The resulting string of digits (numbers greater than 10 becoming two separate digits) are added up. The ten's-complement of the last number is the check digit. In other words, the sum of the digits, including the check-digit, is a multiple of 10. Some clearing bodies ignore or truncate the last digit.

CINS adds a single country code letter to be the beginning of an otherwise similar CUSIP. These are not standard country codes, for instance Norway is "R". A table of the country codes appears on the CUSIP web site.

[edit] Examples

Apple Inc: 037833100

The low-numbered issuer number, 037833, is a side effect of the company name starting with the letter "A". Their stock is the first issue they released, and is thus numbered "10".

The check digit is calculated by first collecting the even and odd digits, converting any letters to numbers if need be (not in this case):

(0, 7, 3, 1), (3, 8, 3, 0)

The second set is then multiplied by two:

(6, 16, 6, 0)

The individual digits are then added together:

(0 + 7 + 3 + 1) + (6 + (1 + 6) + 6 + 0) = 30

The check digit is the ten's complement of the last digit of 30, which is 0, so the check digit is 0. The ten's complement of a digit is the result of subtracting that digit from 10, except that the ten's complement of 0 is 0.

Wal-Mart: 931142103

Similar to the Apple example, but with a name appearing near the end of the dictionary. The check digit is (9 + 1 + 4 + 1) + (6 + 2 + 4 + 0) = 27, the ten's complement of 7 is 3.

A National Securities Identifying Number or NSIN is a generic nine digit number which identifies a fungible security. The NSIN is issued by a national numbering agency (NNA) designated for that country. Regional substitute NNAs have been allocated the task of functioning as NNAs in those countries where NNAs have not yet been established. NSINs are used as part of the makeup of a product's ISIN.

Sunday, 29 March 2015

1. DEBT

2. BOND

3. FACE(PAR) VALUE

4. COUPON RATE

5. MATURITY DATE

6. COUPON (S)

7. BOOK VALUE

8. LIQUIDITY

9. MONEY MARKET

89. SEASONED OFFERING

101. ASSET BASED VALUATION

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