L3CCA 2010-2011 (Tuesdays ‘Professional’ English)
4. CORPORATE FINANCE
Bank of England 1790and Old Royal Exchange by J.M. Kernot
4/1. The development of the financial industry 4/1. A. Raising capital Alex Rodriguez works for a venture capital company: 'As you know, new businesses, called start-ups, are all private companies that aren't allowed to sell stocks or shares to the general public. They have to find other ways of raising capital. Some very small companies are able to operate on money their founders – the people who start the company – have previously saved, but larger companies need to get capital from somewhere else. As everybody knows, banks are usually risk-averse. This means they are unwilling to lend to new companies where there's a danger that they won't get their money back. But there are firms like ours that specialize in finding venture capital: funds for new enterprises. Some venture capital or risk capital companies use their own funds to lend money to companies, but most of them raise capital from other financial institutions. Some rich people, whom banks call high net worth individuals, and who we call angels or angel investors, also invest in start-ups. Although new companies present a high level of risk, they also have the potential for rapid growth – and consequently high profits – if the new business is successful. Because of this profit potential, institutions like pension funds and insurance companies are increasingly investing in new companies, particularly hi-tech ones.' Note: Venture capital is also called risk capital or start-up capital
4/1. B. Return on capital 'Venture capitalists like ourselves expect entrepreneurs – people with an idea to start a new company – to provide us with a business plan. Because of the high level of risk involved, investors in start-ups usually expect a higher than average rate of return – the amount of money the investment pays – on their capital. If they can't get a quick return in cash, they can buy the new company's shares. If the company is successful and later becomes a public company, which means it is listed on a stock exchange, the venture capitalists will be able to sell their shares then, at a profit. This will be their exit strategy. Venture capitalists generally invest in the early stages of a new company. Some companies need further capital to expand before they join a stock exchange. This is often called mezzanine financing, and usually consists of convertible bonds – bonds that can later be converted to shares (see 4/5) – or preference shares that receive a fixed dividend. (See 4/2) Investors providing money at this stage have a lower risk of loss than earlier investors like us, but also less chance of making a big profit.' BrE: preference shares; AmE: preferred stock
4/1 – E1. Complete the crossword.
Acr oss 3. A firm listed on a stock exchange is a _____ _____ (6,7) 7. Individuals who lend money to new companies are sometimes called _____ . (6) 8. Banks that are risk-_____ usually don't want to finance new companies. (6) 10. The amount of money made from an investment is its rate of _____ . (6) 11. New businesses often have to get finance from _____ _____ companies. (4,7) 12. The people who start companies. (8) Do wn 1. People who have ideas for setting up new businesses. (13) 2. _____ capital firms specialise in financing new companies. (7) 4. Many banks don't want to _____ money to new businesses. (4) 5 People who want to borrow money to start a company write a business _____ (4) 6. Money invested in a company just before it joins a stock exchange is sometimes called _____ financing. (9) 9 and 13 down. A new company is often called a _____ _____ . (5-2) 13. See 9 down.
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4/1 – E2. Match the two parts of the sentences. 1 Banks are usually reluctant 2 Start-ups often get money 3 New companies can grow rapidly 4 Risk capitalists usually expect 5 Venture capitalists need an exit strategy – a way 6 Mezzanine financing is a second round of financing
a a higher than average return on their money. b and so are potentially profitable. c before a company joins a stock exchange. d to get their money back after a few years. e to lend money to new companies. f from specialized venture capital firms.
4/1 – E3. In what ways can start-ups be risky ventures? Can you think of any start-ups which have become very successful in the mast few years? What factors do you think contributed o their success? Would you invest in startups? In which fields? If you wanted to start a business, how would you try to raise capital? 4/1 – E4. Read this article from The Financial Times.
Raising funds for schemes and dreams by Doug Richard Companies require capital. Startup companies – especially high-risk, high reward, innovation-based companies – frequently need more capital than a start-up entrepreneur can provide. This means that the entrepreneur generally has to look for outside finance. Debt finance, such as a bank loan, is generally much more readily available for the purchase of an existing company or for the management buyout of part of a large, existing company than it is for a startup, however. Essentially, the risk of these types of transactions is lower because the business in question already exists, and its trading history can be analysed. After this, another category of capital is available for innovation companies that have actually established themselves. This is due to the fact that although they have not yet hit the fast-growth curve, they have managed to reduce risk in a variety of ways. Firstly, they have already built a product or service, thereby reducing technical risk. Secondly, they have
made some sales, diminishing market risk. Thirdly, an existing effective management team lowers people risk. Although these companies are still put in the high-risk category, they present an attractive balance of risk and reward from the investor's point of view. Lack of available investment capital for start-ups, or 'start-up capital', however, means that the success of a start-up depends on how well an entrepreneur's business plan takes into account the needs of a potential investor. Investors need a healthy return on their capital investment. The return they ask for mainly depends on the amount of risk the investment presents: the greater the risk, the greater the required reward. They usually measure return using a calculation known as IRR (internal rate of return). This shows the return in terms of the annual percentage of return the investor is likely to get over the lifetime of the investment. In simplified terms, an IRR of 60 per cent means investors receive back the amount of the original capital plus 60 per cent of the capital for each year of the investment. It is also important to remember that investors are usually building a
portfolio of investments, which they view as a group. They know that most of the companies will fail completely, some will succeed, but only a few will be very successful. So every company in a portfolio needs to give a potentially high return, because the winners will eventually have to cover the losers. Therefore, the only way for entrepreneurs to interest investors is to demonstrate that they understand the risk factors, and to present a persuasive business plan, with whatever data they can find, to show that the risk will diminish. However, smart investors do not rely solely on an IRR calculation because it can be misleading. This is because most of the variables upon which IRR depends are hard to know in the early stages of investment – particularly how long the investment will last and what the selling price will be. Nevertheless, while smart investors may not entirely depend on it, smart entrepreneurs will ensure that their proposition shows the potential for an IRR of the magnitude that investors like to see before taking the big step of investing in a start-up company. Adapted from The Financial Times, 21 June 2005
A/ Choose the best option to complete each statement
1.
The problem for most entrepreneurs is that they don’t have enough… a) ideas b) money c) time
2. The riskiest type of company is… a) an established company b) a start-up c) a management buyout of part of a large company 3. The main thing that an investor looks for is a start-up company which… a) has an interesting product or service b) will pay them back within the first year c) will survive and make a healthy profit 4. The IRR (internal rate of return) …. a) indicates how risky the investment could be. b) shows how profitable the investment is expected to be. c) shows how popular the production or service will be
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B/ Decide which of these statements best describe the main idea in each paragraph.
1. 2. 3. 4. 5.
Whilst experienced investors do not rely totally on a projected IRR, it is an important factor in their investment decision-making. It is much easier to attract investment funding for a well-established business than for a start-up. The majority of start-up companies do not succeed, so an entrepreneur must show potential investors that they can minimise the risk of failure. IRR is a very important part of investment decision-making. New companies which have already started selling their product are still risky investments, but more likely to attract investment capital than a start-up.
C/ Say whether these statements are true or false. Correct the false ones. Identify the part of the article that gives this information.
1. 2. 3. 4. 5. 6.
Banks tend to prefer to lend money to low risk companies It is easier for potential investors to make investments decisions about a business which is already running. Innovation companies which have actually built a product or service are considered to be low-risk investments. Investors in start-up companies will not invest in risky ventures, however profitable they might potentially be. The IRR show the rate of return on the investment for the first year. Start-up investors expect all their investments to succeed.
D/ Complete these word partnerships with words from the article. Use the definitions to help you. a) start‐up __________ b) start‐up __________ c) start‐up __________ a) __________ risk b) __________ risk c) __________ risk
. type of enterprise that finds it more difficult to find outside financiers . person who sets up a new company . finance for a newly set‐up company . if the managers running the company do not have the right experience or ideas . if there is a fault with a new product or it does not do what it says it will do . if the product does not sell because either it is not in demand or there are too many other competing products already on sale
a) d ……… f………. . two types of money that start‐up entrepreneurs need
b) i………. c……….
E/ Find phrases in the article which complete these sentences. 1 – Projects which promise a high rate of return are often also h__________- r__________ projects, likely to fail in the early stages. (1st §) 2 – When the managers of a company decide to break away from that company and buy part of it in order to run it separately, it is known as a m__________ b__________ . ( 1st §) 3 – When the sales of start-up companies start to rise quickly, this is known as hitting a f__________- g__________ . curve. (2nd §) 4 – A company which develops a new product or service is known as an i__________ c__________. (2nd §) 5 – The i__________ r__________ of r__________ is the figure most commonly used by investors to judge whether a potential investment is a good idea or not. (3rd §) 6 – Potential investors need to study and have confidence in a start-up company's b__________ p__________ before they will take the risk of investing in it. (4th §) 7 – When investors invest in a range of companies, they are said to have a p__________ of i__________ .(4th §) 8 – Investors are only prepared to take the high risks associated with investing in start-ups if they are likely to generate a h__________ r__________ . (4th §)
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F/ Use the words in the box to complete the paragraph. fail fund investor I RR return venture worth
Some simple arithmetic illustrates the investor's decision-making process. Let us say an _______________1 intends to invest £1m into each of 10 companies for five years. The investor requires a _______________ 2 equal to the average return for early stage investors in _______________ 3 capital in the US, which is an _______________ 4 above 20 per cent. That means his total _______________ 5 must double in size in five years. Assuming six of the 10 companies _______________ 6 and two companies achieve a 20-per-cent IRR, the other two must each return an lRR of 140 per cent. In other words, they must be _______________7 £8m in five years. That is extremely fast growth! G/ Choose the best explanation for each phrase from the article.
1 'Investors need a h ealt hy ret urn on their capital investment.' (3rd§) a) large return b) safe return 2 '... the winners will eventually have to co ve r the losers.' 4th§) a) be more numerous than b) financially compensate the investor for 3 ' ... it can be m is l e adin g .' (5th §) a) inaccurate b) highly accurate 4 '... most of the v ari abl es upon which .. .' (5th§) a) individual factors b) changeable amounts 5 ' ... an I RR of the ma gni tu de that investors like to see .. .' (5th§) a) size b) magnificence H/ Use expressions from Exercises D-G to complete these sentences.
1. Last year, we added three more __________ – companies to our portfolio of __________ . 2. We think that one of the companies looks particularly promising. It claims a very high _________ __________ of __________ . 3. This is good, because obviously this company might well have to __________ the other two companies if they fail, as so many start-ups do in their first year of trading. 4. All of the __________ – __________tried to persuade us that they would all provide a return of the __________ we were looking for. 5. However, we particularly liked the __________ __________ of one of the three companies, which we finally decided to give __________ capital to. 6. We expect to see their sales hit the __________ – __________ __________ very soon. 7. If they succeed, the companies will be __________ much more to future investors. 8. All we ask from these investments is a __________ __________ !
I/ Type the word start-up into your Internet search engine. Find out about one or two newly set-up companies, or people who provide money or advice on how to succeed with a start-up company. Write a short report. J/ Imagine a new product (or product range) or service which you think would be a guaranteed success as a start-up company. Make a short presentation or 'pitch' to a panel of start-up venture capitalists. Explain your product or service, which market it would be aimed at, how much money you would need and what rate of return you would expect to make over the next five years.
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4/2. Stocks and shares 4/2. A. Stocks, shares and equities Stocks and shares are certificates representing part ownership of a company. The people who own them are called stockholders and shareholders. In Britain, ‘stock’ is also used to refer to all kinds of securities, including government bonds (see 4/5). The word equity or equities is also used to describes stocks and shares. The place where the stocks and shares of listed or quoted companies are bought and sold are called stock markets or stock exchanges. Buying a share gives its holder part of the ownership of a company. Shares generally entitle their owners to vote at companies' General Meetings, to elect company directors, and to receive a proportion of distributed profits in the form of a dividend (or to receive part of the company's residual value if it goes into bankruptcy). Some companies issue participation certificates which, like shares, grant their holders part of the ownership of a company, but usually without voting rights. Shareholders can sell their shares at any time on the secondary market, but the market price of a share - the price quoted at any given time on the stock exchange, which reflects how well or badly the company is doing may differ radically from its nominal, face, or par value.
4/2. B. Going public A successful existing company wants to expand, and decides to go public. The company gets advice from an investment bank about how many shares to offer at what price The company gets independent accountants to produce a due diligence report The company produces a prospectus which explains its financial position, and gives details about the senior managers and the financial results from previous years The company makes a floatation or IPO (initial public offering). An investment bank underwrites the stock issue
go public: change from a private company to a public limited company (PLC) by selling shares to outside investors for the first time (with floatation).
due diligence: a detailed examination of a company and its financial situation.
prospectus: a document inviting the public to buy shares, stating the terms of sale and giving information about the company. financial results: details about sales, costs, debts, profit, losses, etc.
floatation: an offer of a company’s shares to investors (financial institutions and the general pubic). Note: floatation can also be spelt flotation
underwrites a stock issue: guarantees to buy the shares if there are not enough other buyers. BrE: ordinary shares; AmE: common stock
4/2. C. Ordinary and preference shares If a company has only one type of shares these are ordinary shares. Some companies also have preference shares whose holders receive a fixed dividend (e.g. 5% of the shares’ nominal value) that must be paid before holders of ordinary shares receive a dividend. Holders of preference shares have more chance of getting some of their capital back if a company goes bankrupt – stops trading because it is unable to pay it debts. If the companies goes into liquidation – has to sell all its assets to repay part of its debt – holders of preference shares are repaid before other shareholders, but after owner of bonds and other debts. If shareholders expect a company to grow, however, they generally prefer ordinary shares to preference shares, because the dividend is likely to increase over time.
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4/2. D. Rights issues, scrip issues and treasury stock If a company wishes to raise more money for expansion it can issue new shares. These are frequently offered to existing shareholders at less than their market price: this is known as a rights issue. Companies may also turn part of their profit into capital by issuing new shares to shareholders instead of paying dividends. This is known as a bonus issue or scrip issue or capitalisation issue in Britain, and as a stock dividend or stock split in the US. American corporations are also permitted to reduce the amount of their capital by buying back their own shares, which are then known as treasury stock; in Britain this is generally not allowed, in order to protect companies' creditors. If a company sells shares at above their par value, this amount is recorded in financial statements as share premium (GB) or paid-in surplus (US).
4/2. D. Buying and selling shares After newly issued shares have been sold (usually by investment banks) for the first time – this is called the primary market – they can be repeatedly traded at the stock exchange on which the company is listed, on what is called the secondary market. Major stock exchanges, such as New York and London, have a lot of requirement about publishing financial information for shareholders. Most companies use over-the-counter (OTC) markets such as NASDAQ in New York and the Alternative Investment Market (AIM) in London, which have fewer regulations. The nominal value of a share – the price written on it – is rarely the same as its market price – the price it is currently being traded at on the stock exchange. This can change every minute during trading hours, because it depends on supply and demand – how many sellers and buyers there are. Some stock exchanges have computerised automatic trading systems that match up buyers and sellers. Other markets have market makers: traders in stocks who quote bid (buying) and offer (selling) prices. The spread or difference between these prices is their profit or mark-up. Most customers place their buying and selling orders with a stockbroker: someone who trades with the market makers.
4/2. E. Categories of stocks and shares Investors tend to classify the stocks and shares available in the equity markets in different categories, among which: • Blue chips: Stocks in large companies with a reputation for quality, reliability and profitability. More than two-thirds of all blue chips in industrialised countries are owned by institutional investors such as insurance companies and pension funds. • Growth stocks: Stocks that are expected to regularly rise in value. Most technology companies are now growth stocks, and don’t pay dividends, so the shareholder’s equity or owner’s equity increases.. This causes the stock price to rise. • Income stocks: Stocks that have a history of paying consistently high dividends. • Defensive stocks: Stocks that provide a regular dividend and stable earnings, but whose value is not expected to rise or fall very much. • Value stocks: Stocks that investors believe are currently trading for less than they are worth – when compared worth the companies’ assets. • Barometer stocks: Widely-held stocks (e.g. blue chips) that can be considered as indicators of present and future market performance. They are knows as bellwether stock in the US.
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4/2 – E1. Match the words in the box with the definitions below.
prospect us
ban kr upt goi ng p ublic flotation i nvesto rs liq ui dation ordi na ry s hare s p reference s ha res st ock exc ha nge to underw rite
1. a document describing a company and offering stocks for sale 2. a market on which companies' stocks are traded 3. buyers of stocks 4. changing from a private company to a public one, quoted on a stock exchange 5. the first sale of a company's stocks to the public 6. to guarantee to buy newly issued shares if no one else does 7. shares that pay a guaranteed dividend 8. the most common form of shares 9. insolvent, unable to pay debts 10. the sale of the assets of a failed company
4/2 – E2. Are the following statements true or false?
1. New companies can apply to join a stock exchange. 2. A company can only be floated once. 3. Banks underwrite share issues when they want to buy shares. 4. It is easier for a company to be quoted on an unlisted securities market than on a major stock exchange. 5 Investment banks sometimes have to buy some of the stocks in an IPO. 6. The due diligence report is produced by the company's own accountants. 7. The dividend paid on preference shares is variable. 8. If a company goes bankrupt, the first investors to get any money back are the holders of preference shares. 9. A scrip issue can be an alternative to paying a dividend. 10. If a company wants to issue new shares, it has to offer them to existing shareholders at a reduced price. 4/2 – E3. Make word combinations using a word or phrase from each box. Then use the correct forms of the word combinations to complete the sentences below. offer go produce underwrite
an issue a prospectus shares public
After three very profitable years, the company is planning to (1) __________ (2) __________ and we're (3) __________100,000 (4) __________ for sale. We've (5) __________ a very attractive (6) __________, and although a leading investment bank is (7) __________ the (8) __________, we don't think they'll have to buy any of the shares.
4/2 – E4. Match the words in the box with the definitions below. to capitalize rights issue
market price secondary market
primary market nominal value
own shares
1. new shares offered to existing shareholders 2. the price written on a share, which never changes 3 to turn profits into stocks or shares 4. the market on which shares can be re-sold 5. the price at which a share is currently being traded 6. shares that companies have bought back from their owners 7 the market on which new shares are sold 4/2 – E5. Are the following statements true or false? Say why. 1. Stocks that have already been bought at least once are traded on the primary market. 2. NASDAQ and the AIM have more regulations than the New York Stock Exchange and the London Stock Exchange. 3. The market price of stocks depends on how many buyers and sellers there are. 4. Automatic trading systems do not require market makers. 5. Market makers make a profit from the difference between their bid and offer prices.
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4/2 – E6. Complete the sentences.
1. A stock whose price has suddenly fallen a lot after a company had bad news could be a __________, as it will probably rise again.
5. This stock used to be considered an __________, but two years ago the company started to cut its dividend and reinvest its cash in the business.
2. The stocks of food, tobacco and oil companies are usually __________, as demand doesn't rise or fall very much in periods of economic expansion or contraction.
6. The financial director announced a forthcoming __________ of new shares to existing shareholders.
3. Pension funds and insurance companies, which can't take risks, usually only invest in __________ .
7. The company is planning a __________ of one additional share for every three existing shares.
4. The best way to make a profit in the long term is to invest in __________ .
8. We have bought back 200,000 ordinary shares, which increases the value of our __________ to € 723,000.
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4/3. Shareholders
4/3. A.. Investors Stock markets are measured by stock indexes (or indices), such as the Dow Jones Industrial Average (DJIA) in New York, and the FTSE 100 index (often called ‘Footsie’) in London. These indexes show changes in the average prices of a selected group of important stocks. There have been several stock market crashes when these indexes have fallen considerably in a single day (e.g. the Wall Street Crash of 1929, the Stock Market Crash of 1973-74, the Black Monday of 1987, the Dot-com Bubble of 2000, and the Stock Market Crash of 2008) Financial journalists use some animal names to describe investors: • bulls are investors who expect prices to rise. • bears are investors who expect them to fall. • stags are investors who buy new share issues hoping that they will be oversubscribed. This means that they hope there will be more demand than available stocks, so the successful buyers can immediately sell their stocks at a profit. A period when most of the stocks on a market rise is called a bull market. A period when most of them fall in value is a bear market.
4/3. B. Dividends and capital gains Companies that make a profit either pay a dividend to their stockholders, or retain their earnings by keeping the profits in the company, which causes the value of the stocks to rise. Stockholders can then make a capital gain – increase the amount of money they have – by selling their stocks at a higher price than they paid for them. Some stockholders prefer not to receive dividends, because the tax they pay on capital gains is lower than the income tax they pay on dividends. When an investor buys shares on the secondary market they are either cum div, meaning the investor will receive the next dividend the company pays, or ex div, meaning they will not. Cum div share prices are higher, as they include the estimated value of the coming dividend.
4/3. C. Speculators Institutional investors generally keep stocks for a long period, but there are also speculators – people who buy and sell shares rapidly, hoping to make a profit. These include day traders – people who buy stocks and sell them again before the settlement day. This is the day on which they have to pay for the stocks they have purchased, usually three business days after the trade was made. If day traders sell at a profit before settlement day, they never have to pay for their shares. Day traders usually work with online brokers on the internet, who charge low commissions – fees for buying or selling stocks for customers. Speculators who expect a price to fall can take a short position, which means agreeing to sell stocks in the future at their current price, before they actually own them. They then wait for the price to fall before buying and selling the stocks. The opposite – a long position – means actually owning a security or other asset: that is buying it and having it recorded in one's account.
A short position
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4/3 – E1. Label the graph with words from the box.
bull market
crash
bear market
1. 2. 3.
____________________ ____________________ ____________________
4/3 – E2. Answer the questions.
1 How do stags make a profit? 2 Why do some investors prefer not to receive dividends? 3 How do you make a profit from a short position? 4/3. E3. Make word combinations using a word or phrase from each box. Some words can be used twice. Then use the correct forms of the word combinations to complete the sentences below.
make own pay receive retain take
a capital gain a dividend earnings apposition a profit securities tax
1. I _______________ less _______________on capital gains than on income. So as a shareholder, I prefer not to _______________ a _______________ . If the company _______________ its _______________, I can _______________ a _______________ _______________ by selling my shares at a profit instead. 2. Day trading is exciting because if a share price falls, you can _______________ a _______________ by _______________ a short _______________ . But it's risky selling _______________ that you don't even _______________ . 4/3-E4.Would you like to be a day trader? Or would you be frightened of taking such risks?
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4/4. Share prices 4/4. A. Influences on share prices Share prices depend on a number of factors: • the financial situation of the company; • the situation of the industry in which the company operates: • the state of the economy in general; • the beliefs of investors – whether they believe the share price will rise or fall, and whether they believe other investors will think this. Prices can go up or down and the question for investors – and speculators – is: can these price changes be predicted, or seen in advance? When price-sensitive information – news that affects a company's value – arrives, a share price will change. But no one knows when or what that information will be. So information about past prices will not tell you what tomorrow's price will be.
4/4 – B. Influences on share prices There are different theories about whether share price changes can be predicted. • The random walk hypothesis. Prices move along a 'random walk' – this means day-today changes are completely random or unpredictable. • The efficient market hypothesis. Share prices always accurately or exactly reflect all relevant information. It is therefore a waste of time to attempt to discover patterns or trends – general changes in behaviour – in price movements.
• Technical analysis. Technical analysts are people who believe that studying past share prices does allow them to forecast future price changes. They believe that market prices result from the psychology of investors rather than from real economic values, so they look for trends in buying and selling behaviour such as the 'head and shoulders' pattern. • Fundamental analysis. This is the opposite of technical analysis: it ignores the behaviour of investors and assumes that a share has a true or correct value, which might be different from its stock market value. This means that markets are not efficient. The true value reflects the present value of the future income from dividends.
4/4 – C. Types of risk Analysts distinguish between systematic risk and unsystematic risk. Unsystematic risks are things that affect individual companies, such as production problems or a sudden fall in sales. Investors can reduce these by having a diversified portfolio: buying lots of different types of securities. Systematic risks, however, cannot be eliminated in this way. For example market risk cannot be avoided by diversification: if a stock market falls, all the shares listed on it will fall to some extent.
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4/4 – E1. Match the two parts of the sentences. 1 2 3 4
The random walk theory states that The efficient market hypothesis is that Technical analysts believe that Fundamental analysts believe that
a studying charts of past stock prices allows you to predict future changes. b stocks are correctly priced so it is impossible to make a profit by finding undervalued ones. c you can calculate a stock's true value, which might not be the same as its market price. d it is impossible to predict future changes in stock prices. 4/4 – E-2. Are the following statements true or false? Say why.
1 Fundamental analysts think that stock prices depend on psychological factors – what people think and feel – rather than pure economic data. 2 Fundamental analysts say that the true value of a stock is all the income it will bring an investor in the future, measured at today's money values. 3 Investors can protect themselves against unknown, unsystematic risks by having a broad collection of different investments. 4 Unsystematic risk can affect an investor’s entire portfolio. 4/4- E3. Match the theories (1-3) to the statements (a-e).
1 fundamental analysis
2 technical analysis
3 efficient market hypothesis
a Share prices are correct at any given time. When new information appears, they change to a new correct price.
b By analysing a company, you can determine its real value. This
sometimes allows you to make a profit by buying underpriced shares.
c It's not only the facts about a company that matter: the stock price also
depends on what investors think or feel about the company's future.
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4/5. Bonds 4/5. A. Government and corporate bonds Bonds are loans to local and national governments and to large companies. The holders of bonds generally receive fixed interest payments, once or twice a year, and get their money – known as the principal – back on a given maturity date. This is the date when the loan ends. Governments issue bonds to raise money and they are considered to be a risk-free investment. In Britain government bonds are known as giltedged stock or just gilts. In the US they are called Treasury notes, which have a maturity of 2-10 years, and Treasury bonds, which have a maturity of 10-30 years. (There are also short-term Treasury bills which have a different function: see 3.Banking 3/8 Money markets & 3/10 Supply & Control). Companies issue bonds, called corporate bonds, because they can usually pay less interest to bondholders than they would have to pay if they raised the same money by a bank loan. These bonds are generally safer than shares, because if a company cannot repay its debts it can be declared bankrupt. If this happens, the creditors can force the company to stop doing business, and sell its assets to repay them. In this way, bondholders will probably get some of their money back. Borrowers – the companies issuing bonds – are given credit ratings by credit agencies such as Standard & Poor's and Moody's. This means that they are graded, or rated, according to their ability to repay the loan to the bondholders. The highest grade (AAA or Aaa) means that there is almost no risk that the borrower will default – fail to pay interest or to repay the principal. Lower grades (e.g. Baa, BBB, C, etc.) mean an increasing risk of the borrower becoming insolvent – unable to pay interest or repay the capital.
4/5. B. Price and yields Bonds are traded by banks which act as market makers for their customers, quoting bid and offer prices with a very small spread or difference between them. (See 4/2) The price of bonds varies inversely with interest rates. This means that if interest rates rise, so that new borrowers have to pay a higher rate, existing bonds lose value. If interest rates fall, existing bonds paying a higher interest rate than the market rate increase in value. Consequently the yield of a bond – how much income it gives – depends on its purchase price as well as its coupon or interest rate. There are also floating-rate notes – bonds whose interest rate varies with market interest rates.
4/5. C. Other types of bonds When interest rates are high, some companies issue convertible shares or convertibles, which are bonds that the owner can later change into shares. Convertibles pay lower interest rates than ordinary bonds, because the buyer gets the chance of making a profit with the convertible option. There are also zero coupon bonds that pay no interest but are sold at a big discount on their par value, which is 100%, and repaid at 100% at maturity. Because they pay no interest, their owners don't receive money every year (and so don't have to decide how to reinvest it); instead they make a capital gain at maturity. Bonds with a low credit rating (and a high chance of default), but paying a high interest rate, are called junk bonds. Some of these are known as fallen angels – bonds of companies that were previously in a good financial situation, while others are issued to finance leveraged buyouts. (See 4/???Leverage buyouts) BrE: convertible share; AmE: convertible bond
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4/5 – E1. Match the responses on the right with the questions on the left:
1. So what exactly are bonds?
a. Because of changes in interest rates. For example, no-one will pay the full price for a 6% bond if new bonds are paying 10% b. Exactly. And the opposite, a bond whose market value is higher than its face value, is above par. c. I knew you'd finish by saying that! d. No, not at all. Bonds are very liquid. They can be sold on the ’second' market until they mature. But of course, the price might have changed. e. No, not unless it's a floating rate bond. The coupon, the amount of interest a bond pays, remains the same. But the yield will change. f. No, those are short-term (three-month) instruments which the government sells to and buys from the commercial banks, to regulate the money supply. g. That's the name they use in Britain for long-term government bonds - gilts or gilt-edged securities. In the States they call them Treasury Bonds. h. They're securities issued by companies, governments and financial institutions when they need to borrow money.
2. And how do they work? 3. So you have to keep them for a long rime? 4. Why should that happen? 5. Oh, I see. Is that what they mean by below par? 6. But the bond's interest rate doesn't change? 7. How's that? 8. And people talk about AAA and AAB bonds, and things like that. 9. And what about gilts?
i. Well, a bond's yield is its coupon payment expressed as a percentage of its price on the secondary market, so the yield changes if you buy or sell above or below par. j. Well, they usually pay a fixed rate of interest and are repaid after a fixed period, known as their maturity, for example five, seven, or ten years. k. Yes. Bond-issuing companies are given an investment grade by private ratings companies such as Standard & Poors, according to their financial situation and performance.
10. Not Treasury Bills? 11. And James Bond?
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4/5 – E2. Complete the following:
1. Companies generally use investment banks to _______________ their bonds. 2. Thereafter, they can he traded on the _______________ market. 3. The amount of interest a bond pays is often called its _______________ . 4. The majority of bonds have a _______________ rate . of interest. 5. A bond's _______________ depends on the price it was bought at. 6. A bond priced at 104% is described as being _______________ 7. Bonds are repaid at 100% at _______________. 8. AAA is the highest _______________ . 4/5 – E3. Ten of the following twenty-one words and expressions have a direct relation to bonds, and ten others are more likely to be used in relation to stocks or shares. One word logically applies to both categories. Make two lists: above par broker coupon
Bonds 1. 2. 3. 4. 5.
accounting period bull crash
6. 7. 8. 9. 10.
blue chip convertible debt
maturity redeem zero coupon
Shares 1. 2. 3. 4. 5.
dividend floating rate interest
Dow-Jones flotation investment grade
6. 7. 8. 9. 10.
equity insider junk
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4/5 – E3. In the wordbox below you should be able to find 23 words, either horizontal (left to right), vertical (top to bottom) or diagonal (top left to bottom right), including:
1. 3 types of investors, named after animals 2. 6 names of securities 3. 10 verbs related to securities 4. 4 words relating to the income investors receive from securities. B E A R E T U R N H
U U P U T R I G M E
L J Y D E A L I D D
L Q B O N D E L I G
I N T E R E S T V E
S H A R E O A N I W
S T O C K P I C D R
U E A F U T U R E I
E Z L G N I E K N T
Y I E L D O E N D E
C A L L I N V E S T
4/5 – E4. Match the words in the box with the definitions below. coupon maturity date
credit rating principal
gilt-edged stock Treasury bonds
default Treasury notes
insolvent yield
1 the amount of capital making up a loan 2 an estimation of a borrower's solvency or ability to pay debts 3 bonds issued by the British government 4 non-payment of interest or a loan at the scheduled time 5 the day when a bond has to be repaid 6 long-term bonds issued by the American government 7 the amount of interest that a bond pays 8 medium-term (2-10 year) bonds issued by the American government 9 the rate of income an investor receives from a security 10 unable to pay debts 4/5 – E5. Are the following statements true or false? Say why. T T T T
F F F F
T
F
T T T
F F F
1 Bonds are repaid at 100% when they mature, unless the borrower is insolvent. 2 Bondholders are guaranteed to get all their money back if a company goes bankrupt. 3 AAA bonds are a very safe investment. 4 A bond paying 5% interest would gain in value if interest rates rose to 6%. 5 The price of floating‐rate notes doesn't vary very much, because they always pay market interest rates. 6 The owners of convertibles have to change them into shares. 7 Some bonds do not pay interest, but are repaid at above their selling price. 8 Junk bonds have a high credit rating, and a relatively low chance of default.
4/5 – E6 Answer the questions.
1 Which is the safest for an investor? A a corporate bond B a junk bond C a government bond 2 Which is the cheapest way for a company to raise money? A a bank loan B an ordinary bond C a convertible 3 Which gives the highest potential return to an investor? A a corporate bond B a junk bond C a government bond 4 Which is the most profitable for an investor if interest rates rise? A a Treasury bond B a floating-rate note C a Treasury note
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4/6. Futures and Options 4/6. A. Commodity futures Forward and futures contracts are agreements to sell an asset at a fixed price on a fixed date in the future. Futures are traded on a wide range of agricultural products (including wheat, maize, soybeans, pork, beef, sugar, tea, coffee, cocoa and orange juice), industrial metals (aluminium, copper, lead, nickel and zinc), precious metals (gold, silver, platinum and palladium) and oil. These products are known as commodities. Futures were invented to enable regular buyers and sellers of commodities to protect themselves against losses or to hedge against future changes in the price. If they both agree to hedge, the seller (e.g. an orange grower) is protected from a fall in price and the buyer (e.g. an orange juice manufacturer) is protected from a rise in price. Futures are standardised contracts – contracts which are for fixed quantities (such as one ton of copper or 100 ounces of gold) and fixed time periods (normally three, six or nine months) – that are traded on a special exchange. Forwards are individual, non-standardised contracts between two parties, traded over-the-counter – directly, between two companies or financial institutions, rather than through an exchange. The futures price for a commodity is normally higher than its spot price – the price that would be paid for immediate delivery. Sometimes, however, short-term demand pushes the spot price above the future price. This is called backwardation. The Chicago Commodity Exchange
Futures and forwards are also used by speculators – people who hope to profit from price changes. BrE: aluminium; AmE: aluminum
4/6. B. Financial futures More recently, financial futures have been developed. These are standardised contracts, traded on exchanges, to buy and sell financial assets. Financial assets such as currencies, interest rates, stocks and stock market indexes fluctuate – continuously vary – so financial futures are used to fix a value for a specified future date (e.g. sell euros for dollars at a rate of € 1 for $1.20 on June 30). • Currency futures and forwards are contracts that specify the price at which a certain currency will be bought or sold on a specified date. • Interest rate futures are agreements between banks and investors and companies to issue fixed income securities (bonds, certificates of deposit, money market deposits, etc.) at a future date. • Stock futures fix a price for a stock and stock index futures fix a value for an index (e.g. the Dow Jones or the FTSE) on a certain date. They are alternatives to buying the stocks or shares themselves. Like futures for physical commodities, financial futures can be used both to hedge and to speculate. Obviously the buyer and seller of a financial future have different opinions about what will happen to exchange rates, interest rates and stock prices. They are both taking an unlimited risk, because there could be huge changes in rates and prices during the period of the contract. Futures trading is a zero-sum game, because the amount of money gained by one party will be the same as the sum lost by the other.
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4/6 – E1. Match the words in the box with the definitions below. backwardation to hedge
commodities over-the-counter
forwards spot price
futures
1 the price for the immediate purchase and delivery of a commodity 2 the situation when the current price is higher than the future price 3 adjective describing a contract made between two businesses, not using an exchange 4 contracts for non-standardized quantities or time periods 5 physical substances, such as food, fuel and metals, that can be bought or sold with futures contracts 6 to protect yourself against loss 7 contracts to buy or sell standardized quantities
4/6 – E2. Complete the sentences using a word or phrase from each box.
A Commodity futures allow B Interest rate futures allow C Currency futures allow
u banks v companies w farmers
x food manufacturers y importers z investors
1 _______________ _______________ to charge a consistent price for their products. 2 _______________ _______________ to be sure of the rate they will get on bonds which could be issued at a different rate in the future. 3 _______________ ________________ to know at what price they can borrow money to finance new projects.
4 _______________ _______________ to make plans knowing what price they will get for their crops. 5 _______________ _______________ to offer fixed lending rates. 6 _______________ _______________ to remove exchange rate risks from future international purchases. 4/6 – E3. Are the following statements true or false? Say Why. 1. 2. 3. 4. 5. 6. 7.
Financial futures were created because exchange rates, interest rates and stock prices all regularly change. Interest rate futures are related to stocks and shares. Financial futures contracts allow companies to protect themselves against short-term changes in exchange rates. You can only hedge if someone who expects a price to move in the opposite direction is willing to buy or sell a contract. Both parties can make money out of the same futures contract.. The price of a futures contract is determined at the moment the contract is made. Hedging is another name for speculating.
4/6 – E4. Match up the follow ing words (using them more than once if necessary) to make up at least ten two-word nouns.
call instrument primary
contract market product
financial materials raw
forward option spot
futures price strike
4/6 – E5. Match up the following words or expressions to make eight pairs of opposites. call option flood market price put option
discount futures market obligation right
drought hedging out-of-the-money speculation
exercise price in-the-money premium spot market
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4/7. Derivatives 4/7. A. Options Derivatives are financial products whose value depends on – or is derived from – another financial product, such as a stock, a stock market index, or interest rate payments. They can be used to manage the risks associated with securities, to protect against fluctuations in value, or to speculate. The main kinds of derivatives are options and swaps. Options are like futures (see 4/6) except that they give the right – give the possibility, but not the obligation – to buy or sell an asset in the future (e.g. 1,000 General Electric stocks on 31 March). If you buy a call option it gives you the right to buy an asset for a specific price, either at any time before the option ends or on a specific future date. However, if you buy a put option, it gives you the right to sell an asset at a specific price within a specified period or on a specific future date. Investors can buy put options to hedge against falls in the price of stocks.
4/7. B. In-the-money and out-of-the-money Selling or writing options contracts involves the obligation either to deliver or to buy assets, if the buyer exercises the option – chooses to make the trade. For this the seller (writer) receives a fee called a premium from the buyer. But writers of options do not expect them to be exercised. For example, if you expect the price of a stock to rise from 100 to 120, you can buy a call option giving the right to buy the stock at 110. If the stock price does not rise to 110, you will not exercise the option, and the seller of the option will gain the premium. Your option will be out-of-the-money, as the stock is trading at below the strike price or exercise price of 110, the price stated in the option. If, on the other hand, the stock price rises above 110, you are in-the-money: you can exercise the option and you will gain the difference between the current market price and 110. If the market moves in an unexpected direction, the writers of options can lose enormous amounts of money.
4/7. C. Warrants and swaps Some companies issue warrants which, like options, give the right, but not the obligation, to buy stocks in the future at a particular price, probably higher than the current market price. They are usually issued along with bonds, but they can generally be detached from the bonds and traded separately. Unlike call options, which last three, six or nine months, warrants have long maturities of up to ten years. Swaps are arrangements between institutions to exchange interest rates or currencies (e.g. dollars for yen). For example, a company that has borrowed money by issuing floating rate notes (see 4/5) could protect itself from a rise in interest rates by arranging with a bank to swap its floating-rate payments for a fixed-rate payment, if the bank expected interest rates to fall.
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4/7 - E1. Match the two parts of the sentences.
1 The price of a derivative always depends on 2 Options can be used to hedge against 3 A call option gives its owner 4 A put option gives its owner a future price changes. b the right to buy something. c the price of another financial product. d the right to sell something. 4/7 - E2. Choose the correct endings for the sentences. Some sentences have more than one possible ending.
1 If you expect the price of a stock to rise, you can a buy a call option. b sell a call option. c buy a put option. d sell a put option. 2 If you expect the price of a stock to fall, you can a buy a call option. b sell a call option. c buy a put option.
d sell a put option.
3 If an option is out-of-the-money it will a be exercised. b not be exercised. 4 If an option is in-the-money the seller will a lose money. b gain money. 5 The bigger risk is taken by a writers of options. b buyers of options. 4/7 - E3. Complete the definitions.
1.......................... are like call options, but with much longer time spans.
2 .........................give the right to sell securities at a fixed price within a specified period.
3 ......................... can be used to speculate on interest rate movements.
4/7 - E4. Complete these sentences using words from A, B and C above. 1 If your put option is out‐of‐the‐money, the seller will gain the _______________ . 2 You only exercise a call option if the market price is higher than the _______________ . 3 If I expect a stock price to go up in the short term, I buy _______________ _______________ instead of the stock. 4 If I expect a big company's stock price to go up in the long term, I sometimes buy their _______________ . 5 We needed euros and had a lot of dollars in the bank, so we did a _______________ with a German company which needed dollars.
4/7 – E5. Listen first to Peter Sinclair (formerly director of the Centre for Banking Studies at the Bank of England, whom we heard in earlier chapters), and then to Steve Harrison (who works in the compliance department of a large bank in London). Who suggests that financial institutions need to take risks – Sinclair
or Harrison?
4/7 – E6. Listen again and answer the following questions: 1. What do Sinclair and Harrison say about how long derivatives have existed? 2. What does Sinclair mean when he says derivatives ‘change the structure of risks and returns’? 3. In what situation does Sinclair say a company would want to get US dollar assets ahead of time?
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What, according to Sinclair, is the danger with derivatives? What do you think Harrison means when he says derivatives ‘have had a very bad press’? Harrison says derivatives can be used to protect positions, but ‘they can also give you exposure to areas that the bank decides that it wants to have exposure to’. What does this mean? What does Harrison mean when he says ‘Financial institutions are in the risk and reward business’? Do you agree?
4/7 – E7. Read the article and complete it using the words from the box. clients investment
contracts risk
commodities speculate
hedge underlying
instruments
4/7 – E7. Discussion 1 – Why is it possible to describe derivatives as ‘weapons of mass destruction’? 2 ‐ What do you think Buffet means by a ‘time bomb’? 3 – Do you know any examples of bankruptcies resulting from derivatives trading? What happened and why?
4/7 – E8. Before you read the article below, discuss the following questions. 1 – We generally assume that a company’s success depends on what it does in its core business market. Can you think of any other activities which can make money for a company? 2 – What do you know about the Porsche brand and its business history? 3 – The title of the article is a pun. Which famous personality’ name does it refer to? Remove three letters from the first word to get that name. Why do you think the author associated this personality with the Porsche brand?
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Porsche Spice A Daimler's very poor results yesterday show that even luxury car makers are running out of fuel. So investors in its highspeed counterpart, Porsche, must be very pleased to hear that it generated €400m liquidity last year from trading options on German companies. Its financial engineering skills, it would seem, match its automotive ones. B
But this way lies danger. Fellow German groups Schaeffler and Merckle risk losing control of their business empires due to the fact that they made some highly leveraged share acquisitions and then saw a collapse in the value of shares, which had been used as collateral against the loans for these shares.
C
Porsche's slowly-slowly takeover of Volkswagen (VW), via cash-settled call options, has so far proved extremely profitable. The short squeeze (much higher demand than supply) on VW shares dramatically pushed up its share price, when Porsche revealed its full position in October 2008. This helped it make a cool €6.8bn profit from options
trades in that year, whereas it made only €1bn from selling cars. Porsche easily took over 50 per cent of VW in January 2009. D There is an uncertain road ahead, however. Porsche probably has enough remaining options to get close to its next target: 75 per cent of VW. It also hopes that a German law, which currently allows the State of Lower Saxony to exercise a blocking minority via its 20-percent stake in VW, will be changed by a legal challenge to the European Commission. E If it is successful, Porsche could take over the rest of VW, part-financed by VW's €l0bn cash pile. However, the European case could go the wrong way. While Porsche says that it does not need a law change to buy up to 75 per cent of VW's shares, there seems little point in buying up to 75 per cent without it. F Since counterparties have hedged their exposure by buying up VW shares, for the moment, these VW options are creating a share shrotage. This has boosted the share price to a sky-high €240.
legal challenge were unsuccessful, and Porsche decided not to buy the remaining amount of shares to take its stake to 75 per cent, so closed its options position, VW's free float would increase, and the price of its shares would consequently fall. What would happen then? H Porsche says it values VW at € 117 a share in its books. Hong Kong Shanghai Banking Corporation (HSBC), however, estimates fair value of VW's shares at a much more conservative €74, on a sum-ofthe-parts basis. The bank says that this reflects VW's superior outlook compared to that of many of its competitors. What is more, if you multiply the 2010 earnings per share of €6.45 by ten times which is a common way to estimate the real value of shares - the result is even lower. I Therefore, should Porsche fail in its European Commission challenge and consequently have to write down its VW stake, investors will wish it had stuck to building sports cars, not derivatives positions. Adapted from The Financial Times, 18 February 2009
G If the European Commission
4/7 – E9. Read the article above and say whether these statements are true or false. Correct the false ones. Identify the part of the article that gives this information. At the time this performance report was written (February 2009), ... 1 … the luxury car market was doing very well. 2 … Porsche's financial trading strategies were not at all risky. 3 … the gradual takeover of Volkswagen by Porsche had helped to make Porsche a lot of money. 4 … Porsche was making more money from financial operations than it was from selling cars. 5 … Porsche would have no difficulty buying up the rest of the VW shares. 6 … there was a clear risk that VW's share price could fall in the future. 7 … HSBC agreed with Porsche's valuation of its VW shares.
4/7 – E9. Read the article again and answer these questions. 1 Which other German groups were in danger due to share trading activities? 2 How much profit did Porsche make in 2008 from trading options? 3 How much profit did Porsche make from its core activities in that year? 4 What percentage of VW shares did Porsche hope to have acquired in the near future? 5 Who was standing in the way of a full takeover? How large was their stake in VW? 6 How was Porsche trying to solve that problem? 7 How much cash did VW hold, and how could Porsche use this if it was successful in taking over VW?
T T T T T T T
F F F F F F F
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4/7 – E10. Find words or phrases in the article which fit these meanings. 1 The use of various mathematical tools to maximise profits from financial investments (paragraph A): _______________ _______________ 2 When the major part of an investment is funded by borrowed money (paragraph B): _______________ _______________ 3 Assets which are promised by a borrower to a lender if the borrower cannot repay a loan (also known as security) (paragraph B): _______________ 4 When (for example) shares that are bought on a financial market are paid for with real money (paragraph C): _______________ - _______________ 5 The number of shares in a company needed to veto certain decisions at the Annual General Meeting of shareholders (paragraph D): _______________ 6 The amount of money an investor risks losing if the investment does badly, for example on the stock market (paragraph F): _______________ 7 When there are not enough shares available on the market to supply the demand for them: a) _______________ _______________ (paragraph C) b) ________________ _______________ (paragraph F) 8 When the number of shares in supply exceed the number which are in demand, this amount of shares are said to be the company's _______________ _______________of shares. (paragraph G)
4/7 – E11. Find Match these words and phrases (1-6) with their meanings (a-f). 1 derivatives 2 option 3 option trade 4 call option 5 put option 6 to close an option position
a) the right to buy or sell shares, bonds, currencies or commodities at a particular price within a particular period of time or on a particular date in the future b) the right to sell shares at a specific price in the future, which you buy because you think prices will fall below that price c) the buying or selling of an option d) sell an option back at the current market price, or let it expire in order to reverse the original transaction or to exit the trade e) options or futures belong to this group of instruments which often offer investors an easy way to make bets in markets that would otherwise be difficult to get access to f) the right to buy shares at a specific price in the future because you think that the market price will rise above that price
4/7 – E12. Match the verbs (1-6) with the phrases (a-f). Then match each combination with a definition (ivi). 1) generate 2) pledge
a) as collateral b) exposure
3) reveal
c) its stake
4) exercise 5) hedge 6) write down
d) its position e) liquidity f) a blocking minority
i) to make cash ii) to publicly declare the number of shares you own in a company iii) when a small (but significant enough) shareholder uses its voting rights to veto a proposal at a company's AGM iv) to reduce its value on the balance sheet v) to use as security against a debt vi) to protect against financial risk
4/7 – E13. Use words and phrases from exercises 10-12 to complete these sentences. 1 Porsche had been making a larger profit out of _______________ trading than it has out of selling cars. 2 Little by little, it had bought up a large percentage of VW share _______________ . 3 The outcome of Porsche's European Commission challenge to the State of Lower Saxony's _______________. _______________ of 20% would decide whether they continued to do this. 4 Up to now, the demand for VW shares had been higher than supply. This _______________ _______________ (or _______________ _______________) had kept their price very high. 5 However, if Porsche did not win its European court case, it would probably decide not to take its stake to 75%, and would _______________ its options _______________ on the remaining VW shares. If it didn't
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continue buying their _______________ _______________ shares, their ______________ ______________would increase significantly. 6 If this happened, the share price would go down and Porsche would have to _______________ them _______________ 7 In this case, Porsche might wish that it had focused only on its core skills and had not entered into the world of _______________ _______________ . 4/7 – E14. What are the advantages and disadvantages of companies engaging heavily in stock-market trading as well as carrying out their normal business? Think of market conditions, unexpected economic and financial events and the company's investors. Explain your ideas. 4/7 – E15. The article in this unit describes the set of circumstances in 2008 and early 2009. Do an Internet search to find out what has happened to both companies in the meantime. Did Porsche win its European Commission challenge over the German state of Lower Saxony's right to exercise a blocking minority? Did it succeed in taking over VW completely? What is VW's share price valued at today? Write a short report.
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4/8. Asset management 4/8. A. Options These are a student's notes from a lecture about asset management. W HAT? Asset management is managing financial assets for institutions or individuals. W HO? Pension funds and insurance companies manage huge amounts of money. Private banks specilise in managing portfolios of wealthy individuals. Unit trusts invest money for small investors in a range of securities. HOW ? Asset managers have to decide how to allocate funds they're responsible for: how much to invest in shares, mutual funds, bonds, cash, foreign currencies, precious metals, or other types of investments. W HY? Asset allocation decisions depend on objectives and size of the portfolio (see below). The portfolio's objectives determine the returns expected or needed, and the acceptable level of risk. The best way to reduce exposure to risk is to diversify the portfolio easier and cheaper for a large portfolio than a small one.
Portfolio: all the investments held by an individual investor otr organisation Securities: a general name for shares, bonds and other tradable financial assets Allocate: to distribute according to a plan
Diversify: to buy a wide variety of different securities
BrE: unit trusts; AmE: mutual funds
4/8. B. Types of investors Investors have different goals or objectives. • Some want regular income from the investments – less concerned with size of their capital. • Some want to preserve (keep) their capital – avoiding risks. If the goal is capital preservation, the asset manager usually allocates more money to bonds than stocks. • Others want to accumulate or build up capital – taking more risks. If the goal is growth or capital accumulation, the portfolio will probably include more shares than bonds. Shares have better profit potential than bonds, but are also more volatile – their value can increase or decrease more in a short period of time.
4/8. C. Active and passive investment Some asset managers (or their clients) choose an active strategy – buying and selling frequently, adapting the portfolio to changing market circumstances. Others use a passive strategy – buying and holding securities, leaving the position unchanged for a long time. Nowadays there are lots of index-linked funds which simply try to track or follow the movements of a stock market index. They buy lots of different stocks in the index, so if the index goes up or down, the value of the fund will too. They charge much lower fees than actively managed accounts – and usually do just as well. Investors in these funds believe that you can't regularly outperform the market – make more than average returns from the market. BrE: index-linked fund; AmE: tracker fund
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4/8 - E1. Find nouns in A and B above that can be used to make word combinations with the verbs below. Then use some of the word combinations to complete the sentences. accum ul ate
diversify
alloc ate
ma nage
1 I don't want to pay a bank to _______________ my _______________ ; I can do it myself. 2 I have lots _______________
of
different
types
of
securities,
because
I
decided to
_______________
my
3 As an asset manager, I discuss clients' needs and objectives and then we decide how to _______________ their _______________ . 4 If my clients want to _______________ of stocks.
_______________, I take more risks, and buy a lot
4/8 - E2. Match the investment goals (1-3) with the statements (a—e).
1 capital preservation 2 growth 3 income
a I want to accumulate wealth, but I know that this means taking risks and buying securities with volatile prices that could go down as well as up b I want a regular return every year, because I need that money, even if this means I might have to risk losing some of my capital c I definitely don't want to risk losing any of my capital, even if this means that some years I get a very low return.
4/8 - E3. Match the two parts of the sentences.
1 The value of index-linked funds will change frequently 2 Private banks 3 Asset managers buy more bonds than shares 4 Mutual funds 5 Asset managers buy more shares than bonds
a if the client wants to avoid risks. b diversify the money of small investors. c if the whole market is volatile. d manage the investments of rich investors. e if the client hopes to accumulate capital.
4/8 – E4. Asset management and allocation. Paula Foley is an investment consultant in New York. Listen to her talking about asset management. Which three of the following things does she NOT mention?
allocation derivatives
diversification interest
liabilities objectives
portfolios risk
size style
4/8 – E5. Read the statements below, which summarize what Paula Foley says, and then listen again. In what order does she say these things? a Asset allocation means deciding how much to invest in different classes of investments: bonds, stocks and so on. b Asset management involves investing in bonds, stocks, cash, precious metals and funds. c How you manage assets depends on the client's objectives and the portfolio's size. d If you diversify too much it becomes too expensive. e It's easier to diversify a large portfolio than a small one. f Objectives can be either long term or short term. g The risk of a portfolio depends largely on the expected returns.
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4/8 – E6. Investment styles. Listen to Paula Foley talking about investment styles. How many styles does she mention? Which ones? 4/8 – E7. Read Now listen again and complete the notes below.
Growth investment means looking for…
Value investment is investing in…
Large companies are generally…
Small companies often…
Active management means you…
Passive investment means you…
Index-linked portfolios try to…
Even fund portfolios need…
4/8 – E8. Use a word from each box to make common word combinations. One word can be used twice.
asset capital conservative growth investment stable
accumulation earnings industries investment management values
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4/8 – E8. Fund management. Read the article, and answer the questions below it. This article, from The Economist, was published in 2002 after actively managed equity funds in Britain had lost over 30% (on average) in 30 months. This was only 1% less than passive, index-linked funds.
Fund management: Mug's game Anger is growing with those who manage money, particularly with those poorly performing active managers who claimed that it was precisely during tough times that they would come into their own against indexed funds. In Britain, two-thirds of active managers underperformed the index last year, even before the fees that they charged are subtracted. Those people are handsomely rewarded for losing money. Each year they pocket 1-2% of the assets they manage, on top of initial charges of as much as 5%. Indexers, by contrast, charge only 0.5% a year, with no upfront fees. An average fund manager will beat the market some of the time. Over the long run, though, the great majority of fund managers will do no better than the market average, particularly once their charges are taken into account. The chances are slim of finding one of those blessed few who can show real, sustained skill in stockpicking. Even if you find one, you may discover that what made him good in one economic period will serve him less well in the next. Believers in the so-called efficient-market hypothesis, developed by American economists in the 1960s, have tried to demonstrate the impossibility of consistent outperformance. They argue that all useful information that is available to market participants is already factored into a company's share price. Additional analysis of a share by, for instance, taking a closer look at a company's books or talking to its management - as well as all attempts at discovering
patterns in price movements - will be futile. This theory opened the door to those offering merely to track the index. Index-tracking grew hugely during the bull market of the 1980s and 1990s. In the bear market of the past two years, people have not pulled out much money from index funds - or at least, not yet. Not everybody buys the efficient-market hypothesis, however. George Soros, a well-known speculator, thinks he made his money because markets often overor undervalue things. He also challenges the view that share prices are simply a passive reflection of underlying value, or of the expected earnings of a company. A high share price might, for example, trigger certain actions: a public offering of a company's shares, or a merger or an acquisition. A low share price, meanwhile, might stop plans for an initial public offering or a merger. This is what Soros calls the market's 'reflexivity'. If knowledge of such a two-way relationship between share prices and assets can be put to good use, a fund manager might consistently do better than the market. Peter Lynch, formerly of Fidelity Investments, showed that a more old-fashioned technique - looking for good companies that the market fails for a time to appreciate - can also outperform. Yet a few examples among a cast of many thousands of fund managers offer only small consolation to the average investor, who will almost always be better off - or these days, rather worse off - putting his money in an index fund.
Mug : a person who doesn’t know very much and is easy to be taken advantage of – come into t hei r own : be successful – handsom ely r ewa rde d : well paid – upfront : paid in advance – slim (adjective) : small.
1 Why are people getting angry with active money managers? 2 Why did indexed funds develop? 3 What is the efficient-market hypothesis? Why does it suggest that it is impossible to beat the market? 4 What is George Soros's argument against the efficient-market hypothesis? 5 How did Peter Lynch beat the market? 6 Why does the article recommend that the average investor should use a passive index linked fund rather than an actively managed one? 4/8 – E9. Discussion. Do you agree with the people who say that it is impossible to beat the stock market, on average?
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4/9. Hedge funds and structured products 4/9. A. Hedge funds Hedge funds are private investment funds for wealthy investors, run by partners who have made big personal investments in the fund. They pool or put together their money and investors' money and trade in securities and derivatives, and try to get high returns whether markets move up or down. They are able to make big profits, but also big losses if things go wrong. Despite their name, hedge funds do not necessarily use hedging techniques – protecting themselves against future price changes. (See 4/6) In fact, they generally specialize in high-risk, short-term speculation on stock options, bonds, currencies and derivatives. (See 4/7) Because they are private, hedge funds do not have to follow as many rules as mutual funds.
4/9. B. Leverage, short-selling and arbitrage Most hedge funds use gearing or leverage, which means borrowing money as well as using their own funds, to increase the amount of capital available for investment. In this way, the fund can hold much larger positions or investments. Hedge funds invest where they see opportunities to make short-term profits, generally using a wide range of derivative contracts such as options and swaps. (See 4/7) They take a long position by buying securities that they believe will increase in value. At the same time, they sell securities they think will decrease in value, but which they have not yet purchased. This is called taking a short position. If the price does fall, they can buy them at a lower price, and then sell them at a profit. Hedge funds also use arbitrage, which means simultaneously purchasing a security or currency in one market and selling it, or a related derivative product, in another market, at a slightly higher price. In this way investors can profit from price differences between the two markets. Because the price difference is usually very small (and would be zero if markets were perfectly efficient), a huge volume is required for the arbitrageur to make a significant profit.
4/9. C. Structured products Investors who do not have sufficient funds to join a hedge fund can buy structured products from banks. These are customized – individualized or non-standard – over-the-counter financial instruments. They use derivative products (futures, forwards, options, warrants, etc.) in a way similar to hedge funds, depending on the customer's requirement: and changes in the markets. 4/9 - E1. Match the verbs in the box with the definitions below.
to pool
to leverage
to take a short position
to take a long position
1 to put several people's resources together for shared use 2 to purchase securities, expecting their price to rise 3 to use borrowed money as well as one's own money to increase the size of one's investments 4 to sell securities that one has not yet purchased, anticipating that their price will fall 4/9 - E2. Are the following statements true or false? Say why. 1 Hedge funds are so named because they protect against losses. 2 Hedge funds use their investors' money as well as borrowed money. 3 Hedge funds concentrate on making long-term investments. 4 The fact that investors can make a profit from arbitrage shows that markets are not perfectly efficient. 5 Structured products are individualized financial instruments offered by hedge funds.
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4/9 - E3. Read the advertisement for structured products from the UBS website, and answer the questions below. The most widely used structured products can be classified into four broad categories according to their intended purpose. Derivatives are used in order to achieve the desired structures, either in combination with the underlying securities or other derivative securities. The major groupings are: •Capital Protection – This may be in the form of hedging, utilizing forwards, futures or swaps contracts, or it could be in the form of insurance using options. •Yield Enhancement – This is usually achieved by writing (selling) options over an underlying asset. The premium from the written option provides the additional income yield. •Full Participation – These are products that have similar risk characteristics as the underlying assets, but which allow the client the convenience of being able to trade unusual baskets of assets such as foreign stock indices or a specific market sector index. •Leverage – These are generally products such as warrants, which require a low initial investment but which allow the buyer to participate in the purchase or sale of a significantly larger investment at a predetermined price in the future. N.B. These products may carry higher risks than other classes of investment. They are not suitable and are therefore not available to every investor.
Which group of structured products would you use if: 1 You wanted the chance of big returns with only a small investment now? 2 You didn't want to lose any of your money? 3 You wanted to trade in a particular combination of assets? 4 You wanted the highest return?
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4/10. Mergers and takeovers 4/10. A. Mergers. takeovers and joint ventures As business and the world economy become increasingly competitive, more and more companies are having to strengthen their operations to remain profitable. Companies can go about this in a number of ways, including the following: Merger: this is when two companies, often in the same industry, come together to form one company (e.g. Exxon and. Mobil, America Online and Time Warner). Companies merge for many reasons, for example, to increase market share and cut costs in certain areas. such as research and development. It is, in fact, a combination, where both the merging companies wish to join together, and do so on roughly equal terms. A merger may take three forms: • a pooling of interests, where the accounts are combined. • a purchase, where the amount paid over and above the acquired company's book value is carried on the books of the purchaser as goodwill. • a consolidation, where a new company is formed to acquire the net assets of the combining companies. Takeover or acquisition: this is when one company buys another one (e.g. Vodafone and Mannesmann, Daimler-Benz and Chrysler). This can happen in two ways: • Firstly, a company can offer to buy all the shareholders' shares at a certain price (higher than the market price) during a limited period of time: this is called a takeover bid. A takeover may be financed by paying cash at an offer price in excess of the market price of the shares, but more frequently by the exchange of shares or loan stock, issued by the acquiring company for the shares of the acquired company, also called target company. • Secondly, a company can buy as many shares as possible on the stock market, hoping to gain a majority: this is called a raid Investment banks have mergers and acquisitions (M&A) departments that advise companies involved in mergers and takeovers Joint venture: Companies can also work together without a change of ownership. For example, when two or more companies decide to work together for a specific project or product, this is called a joint venture. An example is Sony Ericsson, which makes mobile phones.
4/10. B. Hostile or friendly? There are two types of takeover bid: - If a company's board of directors agrees to a takeover, it is a friendly bid (and if the shareholders agree to sell, it becomes a friendly takeover). - If the company does not want to be taken over, it is a hostile bid (and if successful, a hostile takeover). An unfriendly bid is often made by a corporate raider who intends either to take control of a company by buying a controlling interest in its stock and installing new management, or to make a quick profit by threatening to take control, and then selling the stock back. This practice is called
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‘greenmail’, from ‘greenback’ (another name for the U.S. dollar), and ‘blackmail’. Greenmail profits the raider at the expense of the target company's remaining shareholders. The target company may take ‘shark repellent’ measures to try and ward off the raider: • the poison pill strategy: authorising, for example, a new series of preferred stock that gives shareholders the right to redeem it at a premium price after the takeover, thus making the stock less attractive to an acquirer. • the scorched earth defence, the company disposes of its ‘crown jewels’ ie. its most desirable properties. But this strategy may result in a permanent impairment of its earning power and value. • the company may look for a ‘white knight’, another acquirer company to rescue it (whence the expression white knight) from the unwanted bidder's control.
4/10. C. Integration Horizontal integration is when a company gets bigger by acquiring competitors in the same field of activity. Vertical integration is acquiring companies involved in other parts of the supply chain, usually to make cost savings. There are two possibilities: backward integration is acquiring suppliers of raw materials or components; forward integration is buying distributors or retail outlets. Companies can also buy businesses in completely different fields, which is known as diversification. This can be done to reduce the risk involved in operating in only one industry – but diversifying into completely different industries is a risk itself.
4/10 – E1 Complete the sentences. Look at A above to help you. 1 I want to work in the mergers and _______________ department of an investment bank in New York. 2 Beverage Partners Worldwide is a _______________ between the Coca-Cola and Nestle companies, making ready-to-drink teas and coffees. 3 After their _______________ , Union Bank of Switzerland and Swiss Bank Corporation had combined assets of $600bn. 4 We started with a _______________ , buying all the stocks available on the stock exchange. That got us 15% of their stocks. Then we made a _______________ , offering 20% above the market price, and bought another 40% of the company. 4/10 - E2. Complete the sentences. Look at B above to help you
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4/10 - E3. Match the newspaper headlines (1-5) with the processes (a-e). Look at C above to help you.
1 a horizontal integration
2
b vertical integration 3
c forward integration d backward integration
4
e diversification 5
4/10 – E4 Match up the phrasal verbs on the left with the verbs that have a similar meaning on the right:
1
1. act on advice
a. accept an offer
2. adhere to principles
b. accumulate capital
3. branch out
c. acquire a company
4. build up capital
d. await with pleasure
5.cash in on
e. collapse
6. draw up a plan
f. defeat
7. fall through
g. diversify
8. fight off
h. follow advice
9. get away with something
i. invent
10. look after
j. prepare a plan
11. look forward to
k. profit from
12. make up
l. protect
13. rely on or count on someone
m. respect principles
14. take over a company
n. succeed in doing something wrong
15. take up an offer
o. trust someone
2
3
4
5
6
7
8
9
10
11
12
13
14
15
4/10 – E5 - Use the phrasal verbs in the left-hand column to complete the text below (using each verb once only). You may need to use the past tense, the past participle or the present continuous form. When we tried to (1) _______________ MacKenzie PLC we were all (2) _______________ an easy victory. We thought that most of their shareholders would (3) _______________ the chance of a quick profit. But the directors were determined to (4) _______________ our bid. They (5) _______________ a lot of untrue stories about our company, and criticized our last Annual Report, claiming that we hadn't (6) _______________ Generally Accepted Accounting Principles, and that our accountants had (7) _______________ a lot of window dressing. They were able to convince their shareholders that they could (8) _______________ them (the current management) to (9) their interests better than we could. Over the years, they had obviously (10) _______________ a lot of respect from their shareholders, who (11) _______________ the hoard of directors' advice, and didn't (12) _______________ our offer. Thus the whole deal (13) _______________ . But we are now (14) _______________ alternative plans to (15) in a new direction.
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4/11. Leveraged buyouts 4/11. A. Conglomerates A series of takeovers can result in a parent company controlling a number of subsidiaries: smaller companies that it owns. When the subsidiaries operate in many different business areas, the company is known as a conglomerate. But large conglomerates can become inefficient. Top executives often leave after hostile takeovers, and too much diversification means the company is no longer concentrating on its core business: its central and most important activity. Takeovers do not always result in synergy: combined production or productivity that is greater than the sum of the separate parts. In fact, statistics show that most mergers and acquisitions reduce rather than increase a company's value. An inefficient conglomerate whose profits are too low can have a low stock price, and its market capitalization – the total market price of all its ordinary shares – can fall below the value of its assets, including land, buildings and pension funds. If this happens, it becomes profitable for another company to buy the conglomerate and either split it up and sell it as individual companies, or close the companies and sell the assets. This practice, common in the USA but rare in Europe or Asia, is called asset-stripping. It shows that stock markets are not always efficient (see 4/2), and that companies can sometimes be undervalued or underpriced: the price of their shares on the stock market can be too low. Some people argue that assetstripping is a good way of using capital more efficiently; others argue that it is an unfortunate activity that destroys companies and jobs.
4/11. B. Raiders If corporate raiders – individuals or companies that want to take over other companies – borrow money to do so, usually by issuing bonds, the takeover is called a leveraged buyout or LBO. Leveraged means largely financed by borrowed capital. After the takeover, the raider sells subsidiaries of the company in order to pay back the bond holders. Bonds issued to pay for takeovers are usually called junk bonds because they are risky: it may not be possible to sell the subsidiaries at a profit. But, because of the risk, these bonds pay a high interest rate, so some investors are happy to buy them. Sometimes a company's own managers want to buy the company, and re-organize it. This is a management buyout or MBO. If the buyout is financed by issuing preference shares and convertibles, this is called mezzanine financing as it is, in a sense, halfway between debt and equity. (See 4/1 for another use of 'mezzanine financing'.)
4/11 - E1. Match the words in the yellow box with the definitions below. asset‐stripping core business leveraged market capitalization parent company subsidiaries synergy
1 a company that owns or controls one or more other companies 2 the main activity of a company 3 buying a company in order to sell some of its assets 4 companies partly or wholly owned by another company 5 having a lot of borrowed money compared to one’s own funds 6 the total value of a company on the stock exchange 7 two things working together that produce an effect greater than the sum of their individual effects
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4/11 - E2. Match the two parts of the sentences. 1 Large conglomerates formed by takeovers 2 If a conglomerate diversifies and doesn't concentrate on its core business, 3 An inefficient conglomerate's stock market value 4 If a company is worth less than its assets, 5 Raiders do not need to have very much money of their own if
a can be less than the sale value of all its assets. b can become inefficient, especially if they are very diversified. c they use leverage, and issue junk bonds. d there might not be synergies among all its different activities. e you can make a profit by buying it and selling the parts.
4/11 – E3. Put the sequence of events in the correct order. The first stage is a. a Corporate raiders calculate that a large company is undervalued. b Investors buy the bonds because they pay a high interest rate. c The new owners sell some of the company's subsidiaries. d The new owners repay the bondholders. e The raiders buy the company. f The raiders issue bonds to raise capital to buy the company. a
1
2
3
4
5
6
4/11 – E4. Match the responses on the right with the sentences on the left: 1. What's the difference between a takeover bid and an LBO?
a. Exactly. And make a profit in the process.
2. Borrowed from where?
b. LBO is short for "leveraged buyout." It involves buying a company with a lot of borrowed money.
3. Ah-huh. Guess what my next question is?
c. Not an appalling joke about "elbows", I hope?
4. 0K, so you borrow money and buy a company. Then what?
d. OK. They're bonds that are considered to be fairly risky but which pay a high rate of interest. People buy them because the high returns generally compensate the risk of default.
5. Uh? 6. And then you pay back the bank or the bondholders?
e. Well, it can go wrong. If there's a recession or a stock market crash it makes it more difficult to sell the assets, and if you have less sales revenue, it becomes harder to pay the interest on the borrowed money. f. Well, you choose a large, badlymanaged, inefficient corporation or conglomerate, or a company with huge cash reserves, or whose assets are worth more than its stock market value. You buy it, restructure it, and sell the profitable bits. It's called asset-stripping.
7. Sounds easy.
8. 0h I see. So it can go wrong. Just one more thing . ..
g. Wherever you can get it. You can try to get an ordinary loan from a bank, or you can try to sell junk bonds.
9. Forget it!
h. You sell it again.
1
2
3
4
5
6
7
4/11 – E5. Add appropriate words to these sentences: 1. Leverage means using a high proportion of
_______________ money.
2. LBOs are often _______________ by junk bonds. 3. The people who try LBOs compare the value of a company's assets with its _______________ . 4. The profit in an LB0 often comes from _______________ 5. LBOs have led to several _______________ being split up.
8
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4/12. Financial Planning 4/12. A. Financing new investments Alia Rahal works in the financial planning department of a large manufacturing company: 'Financial planning involves calculating whether new projects would be profitable. We have to calculate the probable rate of return: the amount of income we'd receive each year from the investment, expressed as a percentage of the total amount invested. If we're going to finance a project with our own money, the rate of return must be at least as high as we could get by depositing the money in a bank instead, or by making another risk-free investment, like buying government bonds. If we need to borrow money to finance a new investment, its projected rate of return has to be higher than the cost of capital – the amount we have to pay to borrow the money.’
4/12. B. Discounted cash flow 'We usually calculate the discounted cash flow value of an investment. This means discounting or reducing future cash flows to get their present values – in other words, calculating the present value of money to be received in the future. This is because the value of money decreases over time. Firstly, there's nearly always inflation, so cash will have lower purchasing power in the future: you'll be able to buy less with the same amount of money. And secondly, if you had the money now, you could get income by using or investing it. The return we could get by investing the money in other ways is the opportunity cost of capital. So waiting for money is also a cost. This is the time value of money: how much more it is worth to receive money now rather than in the future.'
4/12. B. Comparing investment returns ‘If we have to choose among possible investments in the new projects, we work out the net present value (NPV) of each project by adding up all the expected cash flows, discounted to their present value, minus the initial investment.. To do this, we have to elect a discount rate or capitalisation rate. This is usually the interest rate we pay for borrowing the capital, but we could increase it if there’s a lot of uncertainty or risk Discounting sounds complicated, but it isn't. It's the opposite of compounding interest. For example, if you invest $1,000 at 10% for five years, it will yield 1.61 times its original value. So you get back $1,610, including $610 compound interest. A discount rate of 10% has a discount factor of one divided by 1.61, which is 0.62. So $620 invested now will be worth $1,000 in five years if it's invested at 10%. When we're comparing alternative investments, we also calculate the internal rate of return (IRR). That's the interest rate or discount rate that gives a net present value of zero in today's money values. In other words, the present value of the cash that we're going to receive from an investment is the same as the present value of borrowing that cash. We normally choose the investment with the highest IRR.'
4/12. C. Financial Ratios. Various financial ratios are used to measure profitability, solvency, liquidity, efficiency, etc. • The current ratio (or working capital) measures liquidity – i.e. having enough cash to meet shortterm obligations. It shows if a business can pay its most urgent debts. • The quick ratio (or acid test ratio) provides a more accurate picture of short-term solvency by considering completely liquid assets. • A company's profit margin or return on sales is the percentage difference between sales income and the cost of sales. • Productivity shows the amount of work or sales per employee. • Earnings per share relates the company's profits to the number of ordinary shares it has issued. • The price/earnings ratio (PER) reflects the market's opinion of a company's revenues, earnings and dividends: the higher it is, the more investors are optimistic about the company's future prospects. • A company's debt/equity ratio, or gearing compares the amount of debt to the firm's own capital. A highlygeared company is one that has a lot of debt compared to equity. • Interest cover or times interest earned shows whether funds are available to pay long-term debt costs.
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• Dividend cover or the dividend payout ratio shows the percentage of income paid out to shareholders (or the number of times the net profits available for distribution exceed the dividend actually paid). • Return on equity shows profit compared to shareholders' capital. • Return on total assets shows profit compared to all of a company's capital, whether debt or equity. • A company's market/book ratio is current stock market value divided by the amount invested by shareholders. (This equals the return on equity multiplied by the price/earnings ratio.) Note: the American term for gearing is leverage .
4/12-E1. Match the words in the box with the definitions below. discount rate purchasing power
discounted cash flow rate of return
internal rate of return time value of money
1 a series of future earnings converted to their value today 2 the annual percentage amount of income received from an investment 3 the interest rate an investment earns when the present value of all costs equals the present value of all returns 4 the difference between the value of money held now, and its value if it is received in the future, because it could be invested during that period 5 the value of money, measured by the quantity (and quality) of products and services it can buy
6 the interest rate used to calculate the present value of future cash flows 4/12-E2. Are the following statements true or false? Say why. 1 If a company uses its own money for a new project, there is no opportunity cost of capital. 2 A project financed by borrowed money requires a rate of return higher than the cost of capital.
T F
3 Because of inflation, money will usually be worth more in the future than at the present 4 The longer you have to wait for investment returns, the less their present value is
T F
T F
T F
4/12 - E3. Match the two parts of the sentences. 1 Future cash flows are usually discounted 2 If a project seems to be particularly risky or uncertain, 3 Money you possess now is worth more than money received in the future, because 4 The net present value of a project is the sum of all the returns it is expected to provide, 5 When choosing among potential investments, a businesses look for the one with the highest internal rate of return. b by the cost of the capital involved in the investment. c discounted to their current value. d it can earn interest in that time, and there might be inflation. e you can increase the discount rate you use in your calculations. 4/12 – E4. What are the names of the ratios? Try not to look back at the definitions above 1. ___________________________________ 2. ___________________________________ 3. ___________________________________ 4. ___________________________________ 5. ___________________________________ 6. ___________________________________ 7. ___________________________________ 8. ___________________________________ 9. ___________________________________ 10. __________________________________ 11. __________________________________ 12. __________________________________
common stock dividend net income current assets current liabilities distributable profit number of shares liquid assets current liabilities (long-term) loan capital shareholders’ equity or net assets market value of stock, per share past year’s earning per share market value x number of shares nominal value x number of shares pre-tax profit interest charges pre-tax profit owner’s equity pre-tax profit sales pre-tax profit sales sales volumes number (or wages) of employees
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4/12 – E5. Read the text below.
This article looks at the role of the credit-rating agencies in the global economic crisis started in 2007. A The Northern Rock Building Society converted into a public limited company in 1997. Over the next 10 years, the Northern Rock Bank rapidly grew into one of the largest mortgage lenders in the UK, relying on a system of securitisation repackaging most of the loans it had originated into securities and selling them on to institutional investors. B In 2007, the US subprime crisis hit Europe. That source of financing dried up, so the bank was forced to borrow emergency money from the Bank of England. When customers found out about this financial lifeline, many withdrew their savings in the first run on a bank in Britain for around 140 years.
Rating the credit agencies by Elaine Moore C In response to the Northern Rock crisis in 2007, the UK Parliamentary Treasury committee was fierce. 'You all failed,' was one member's verdict on the role of the credit-rating agencies. Admittedly, with predictions for a global economic slowdown, politicians were keen to find scapegoats. So banks, central banks and regulators all faced criticism for their failure to foresee the consequences of the US subprime mortgage lending crisis. D One group in particular was heavily criticised. The Treasury Committee interrogated representatives of the three largest credit-rating agencies: Fitch, Moody's and Standard & Poor's (S&P). E Corporate credit-rating agencies assess the creditworthiness of bonds and bond issuers. They assign different grades to corporate' bonds, using their own grading system. The highest-
ranked 'investment-grade' bonds are rated triple-A. Those at the lowest end of the spectrum, with 'junk bond' status, are rated either C or D, depending on the agency. Fund managers and other investors use the information to assess the potential return on investment. F Unfortunately, the agencies had given many assets securitised with subprime mortgages triple-A ratings. When the global credit squeeze hit, their credibility was called into question. Should these assets ever have been given the top rating? Should investors have been warned of the risks earlier? They were accused of reacting too slowly to changing situations and of facing a conflict of interest because they earned a fee from the issuers whose securities they rated. G In 2007, the US Securities and Exchange Commission (SEC) listed seven credit-rating agencies as nationally recognised statistical rating organisations. Two of these, Japan Credit Rating Agency and Rating and Investment Information, were new additions in June. H However, the much larger S&P, Moody's and Fitch still dominated the
market. This led Jean-Claude Trichet, the President of the European Central Bank, to complain about the lack of choice between global credit-rating agencies. So European Union market watchdogs started questioning the rating agencies about their role in the subprime mortgage crisis, and the International Organisation of Securities Commissions (IOSCO), representing more than 100 securities regulators, set up a taskforce to improve their regulation. I In their own defence, the rating agencies maintained that their job was to provide an opinion on the probability of a company defaulting on its debt repayments, not market performance. Added to that, they stressed that their ratings should never be used as the sole reason for an investment decision. Furthermore, S&P pointed out that it had reported the 'possible risk' for investors of 'creative financing opportunities within the residential mortgage realm' as early as April 2005. It seemed, however, that nobody had been listening. Adapted from The Financial Times, 16 November
4/12 – E6. Read the article and say whether these statements are true (T) or false (F). Correct the false ones. Identify the part of the article that gives this information. 1 At the time of its failure, Northern Rock was a building society. 2 It provided money for borrowers to buy homes and property. 3 It suddenly experienced financing problems and had to ask the Bank of England for help. 4 Northern Rock's customers feared they would lose their savings and started taking them out of the bank quickly. 5 The UK government blamed only Northern Rock for this crisis. 6 Corporate credit agencies advise investors on the riskiness of companies and investment products. 7 Standard & Poor credit-rating agency admitted that it had never warned the investor community of the danger of these 'securitisation' products. 4/12 – E7. Read the article again and answer these questions. 1 Over which period did Northern Rock increase in size very quickly? 2 Which particular financial problem made it difficult for Northern Rock to find money to finance its lending activities? 3 Which three credit-rating agencies dominated the world market at that time? 4 Which rating do they give to the safest investments? 5 Which rating do they give to the riskiest investments? 6 Who pays the credit agencies for their work? 7 What was Jean-Claude Trichet's opinion about the number of credit agencies in the market? 8 Which organisation decided to investigate and improve the credit-agency sector?
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4/13. Financial regulation and supervision 4/13. A. Government regulation Mei Lee is the compliance officer at a large US bank with subsidiaries in major financial centres: she has to make sure that everybody obeys government regulations and follows internal procedures. 'The financial services industry was deregulated in the 1980s: lots of government controls were removed to make the market freer and more efficient. But a lot of regulations still exist. We're still regulated and supervised by government agencies. For example, in Britain there's the Financial Services Authority (FSA), and here in the States there's the Federal Reserve (or the Fed) and the Securities and Exchange Commission (SEC). The Fed supervises banks, and the SEC tries to protect investors by requiring full disclosure: it makes sure that public companies make all significant financial information available. And it tries to prevent fraudulent or illegal practices in the securities markets, such as companies artificially raising their stock price by using dishonest accounting methods or issuing false information.'
4/13. B. Internal controls 'I have to make sure no one here does any insider trading or dealing – buying or selling securities when they have confidential or secret information about them. For example our mergers and acquisitions department often has advance information about takeovers. This information is usually price-sensitive: if you used it you could make the share price change. This gives the people in M&A huge opportunities for profitable insider dealing, but we try to keep what we call "Chinese walls" around departments that have confidential information. This means having strict rules about not using or spreading information. Another thing I have to deal with is conflicts of interest – situations where what is good for one department is not in the best interests of another department. For example, if banks want to win investment banking business from a company, their analysts in the research department could produce inaccurate reports exaggerating the client company's financial situation and prospects. This could lead the fund management and stockbroking departments to buy securities in that company, or recommend them to clients, because of false information.'
4/13. C. Sarbanes-Oxley 'Because of lots of serious conflicts of interest in banks, the US government passed the Sarbanes-Oxley Act in 2002. This requires research analysts to disclose whether they hold any securities in a company they write a research report about, and whether they have been paid by the company. Another outcome of Sarbanes-Oxley was the establishment of a board to oversee or supervise the auditing of public companies, and to prevent auditors doing non-audit services while they're auditing a company. That's because an auditing firm that is also doing lucrative – profitable – consulting work with a company might be tempted not to audit the accounts very carefully, and to ignore evidence of illegal practices or "creative accounting". Another part of my job is making sure no criminal organization uses us for money laundering – converting illegal or criminal funds into what looks like legitimate or legal income, by passing it through a lot of transactions, companies and bank accounts.'
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4/13 - E1. Match the words in the box with the definitions below. compliance money laundering
disclosure price-sensitive
fraudulent oversee
insider dealing
1 adjective meaning able to influence or change a price 2 behaving according to regulations, rules, policies, procedures, etc. 3 buying or selling stocks when you have confidential information about a company 4 disguising the source of money acquired from criminal activities 5 adjective meaning dishonest and illegal (intending to get money by deceiving people) 6 giving investors and customers all the information they need 7 to watch something to make certain that it is being done correctly 4/13 - E2. Match the two parts of the sentences.
1 Criminal organizations try to hide the origin of illegally received money 2 People with privileged, confidential information about a stock could make money 3 Some banks might try to get business from companies, e.g. issuing stocks and bonds, 4 Some companies might try to make their auditors less rigorous 5 Some companies try to raise their stock price a by acting on that information and buying and selling the stock. b by also paying them to do consulting work. c by moving it through lots of different companies and bank accounts. d by not following accepted accounting methods or by publishing false information. e by publishing reports that overstate the companies' financial health. 4/13 - E3. Complete the newspaper headlines with words from the box. Chinese walls deregulation
compliance officer insider traders
conflicts of interest laundering money
4/13 – E4. Conflicts of interest are situations in which what is good for one department of a financial institution and its customers is not in the best interests of another department and its customers. Such conflicts are almost inevitable in financial institutions. Read the four paragraphs below, and in each case, answer these two questions: 1 What is the potential problem arising from this situation? 2 What is done (or what could or should be done) to prevent the problem arising?
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a Banks that underwrite security issues (shares, bonds, etc.] for companies are obliged to buy the securities if they are unable to sell them to other financial institutions or to the public. b Analysts in the research departments of large banks study the financial situation of companies, and write reports about them for potential investors. In doing so, the analysts learn a great deal about companies, and so are often in a position to give them advice about raising capital, etc. However, they are usually competing with other banks to get business from these companies. c Auditors know a lot about accounting methods and acquire a lot of information about the companies whose accounts they audit. This puts them in a very good position to obtain extra - and generally very lucrative consulting work with these companies. d People working in banks' corporate finance and mergers and acquisitions departments often have information about takeover bids and other deals that are being planned but have not yet been announced. 4/13 – E5. You are going to listen to Steve Harrison, who works in the compliance department of a large bank in London, talking about financial regulation. Before you listen, check your understanding of the words and phrases in the box by matching them with their definitions (1-6). compliance counterparties mandate statutory supervision wholesale 1 according to a law or regulation 2 authorization given to an organization to carry out specific responsibilities 3 following rules and regulations 4 working with companies and institutions, and not personal or retail customers 5 other institutions in an agreement, contract or transaction 6 watching over people or an organization to make sure they are behaving correctly
4/13 – E5. The Financial Services Authority a) Steve Harrison is in regular contact with the relationship management team at the FSA that is responsible for supervising his bank. Listen to an interview with him. Which of the following points does he mention? 1 The formation of the FSA 2 How banks are changing
3 The companies that are part of the FSA
4 The objectives of the FSA 5 Regulating consumers
b) Now listen again and answer the questions below. 1 Why was the FSA created? 2 Which of the FSA's statutory objectives does Harrison mention?
3 What does the FSA want to understand when working with institutions? 4 What are a bank's 'wholesale counterparties'?
4/13 – E6. Conflicts of interest a) Listen to Steve Harrison talking about conflicts of interest. According to what he says, are the following statements true or false? 1 Conflicts of interest in financial institutions can be avoided. 2 The problem generally involves access to information. 3 Financial institutions bought shares falsely recommended by research analysts. 4 Analysts recommended investing in firms in the hope that these firms would give them investment banking work. 5 The number of recommendations to sell shares is probably too high. 6 It is legitimate for an auditing firm to do extra consultancy work. 7 Many auditing firms have been forced by law to split off their consultancy business from the auditing firm. 8 Many companies now use different auditing firms for auditing and consultancy work. b) What are the two examples Steve Harrison gives of conflicts of interest? Did you mention these in the earlier Reading activity? c) Are there any conflicts of interest that occur in the organization you work for? How are they dealt with?
4/13 – E7. Discussion The situations described below involve well-known conflicts of interest and require people to make ethical choices. What would you do in these situations, and why? Discuss them in pairs or groups. Use some of the words from the Vocabulary exercise above in your discussion.
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You get a job in a bank's mergers and acquisitions department. One of your new colleagues informs you, 'Whenever we know that Company A is going to take over Company B, and that Company B's stocks are going to rise, we go out and buy some of Company B's stocks. We make a profit, but nobody loses, because the stocks we buy
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had already been sold by somebody else. OK, this is called "insider dealing", but what's the problem? It shouldn't be a crime.' What will you do about this?
2
You are an economic advisor to a minister in a new government that has just been elected in a country where the ce.ntral bank is independent. Several members of the government want to take back control of interest rate policy. After all, the government has been elected; the central bankers have not. If the government controlled interest rate decisions it could keep rates low in the months before the next election. Consequently many voters would be paying less on their mortgages and other debts, and have more money to spend. What would you recommend?
3
You work in the research department of a bank. You have written a report which demonstrates that a local manufacturing company would be a good takeover target for the market leader in the industry. This multinational company could modernize the local company's factory and produce goods more efficiently. But it would probably also take over all the company's other functions, and close down the local marketing, sales, research and development, finance, and human resources departments, resulting in a lot of people losing their jobs. Another possibility would even be for the new owners to close down everything, and move production elsewhere. This would have a catastrophic effect on your town.
Will you still submit a report recommending a takeover?
4 You are a shareholder in a local manufacturing company. A group of shareholders wants to force the company to show more corporate social responsibility. They have proposed a motion for the Annual General Meeting, stating 'Before making decisions, this company will consider their impact on all the company's stakeholders - staff, customers, suppliers and the local community - as well as on the environment in general.' Other shareholders oppose the motion, arguing that a company's principal purpose is to maximize returns to its shareholders. How will you vote at the AGM?
4/13 – E8. Insider Dealing Inquiry Company A was planning to take over its big rival Company B, and had borrowed £20 million from a British merchant bank. The day before it announced its bid, the price of Company B's shares unexpectedly rose 10%. Stock exchange investigators suspected insider dealing: somebody in the bank was profiting from the information that a takeover was going to increase Company B's share price, and had bought a lot of them. At the end of the inquiry, the chief investigator gave journalists the following information, and told them to work out for themselves who was guilty. 1. There were five suspects, of five different nationalities, working in five different departments in a row of five neighbouring offices along the same corridor in the bank. Each banker drives a different car, and has a different expensive hobby. 2. The American collects post-impressionist paintings. 3. The banker in the middle office drives power boats. 4. The banker with the BMW is in the next office to the one who works in mergers and acquisitions (who is not necessarily guilty). 5. The banker with the Ferrari works in the office immediately between those of the Jaguar driver, and the Maserati driver, who has the right-hand office. 6. The banker with the Maserati collects expensive Bordeaux wines. 7. The banker with the Mercedes works in the office next to the one who specializes in underwriting share issues. 8. The British banker, in the left-hand office, works next door to the person with a Mercedes. 9. The Ferrari driver regularly goes on safari hunting trips. 10. The Frenchman is a bond dealer. 11. The Jaguar driver, who is German, advises customers about shares. 12. The Swiss banker has a Maserati. 13. Now, said the chief investigator, two of these people are guilty. One of them flies a helicopter in his spare time, and the other specializes in financing international trade. Who are they?
Nationality (left)
(right) Car
Hobby
Department
Culprits
?
?
?
?
?
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REFERENCE VOCABULARY THE STOCK MARKET • A stock exchange >une Bourse des valeurs is a market with its own rules and conventions, where securities are bought and sold. Securities quoted >cotées on the Stock Exchange appear in a daily Official List of buying and selling prices. • Self-regulation >l’auto-réglementation is the control and discipline of the members of an organisation by its own governing body. Such organisations are known as self-regulatory organisations. In certain countries, the stock exchanges are responsible for regulation of their own members. The Securities and Investment Board (SIB) oversees self-regulatory organisations in the UK. Other countries lean towards statutory regulation by regulatory bodies / authorities >organismes de contrôle such as the Securities and Exchange Commission (SEC) in the USA, or the Marché à terme des instruments financiers (MATIF) in France. • Deregulation >la dérégulation; déréglementation is the freeing of a market by the removal of restrictive controls and regulations which have been created by custom and practice, or by unnecessary legislation. Deregulation is aimed at increasing competition by allowing greater access to the market. The Big Bang >la déréglementation de la Bourse anglaise is the change to computerised dealing of the London Stock Exchange in 1986, owing to the pressures to compete in an increasingly international market for securities. Many dealing restrictions on foreign firms were lifted and the distinction between jobber and broker (below) abolished. The deregulation of the London market is also known as the financial services revolution >la révolution du secteur financier. • A (stock market) crash >un krach boursier; une débâcle boursière is a financial collapse of security prices on the stock exchange, i.e. when share prices plummet or nosedive >s’effondrent to unacceptable levels. The greatest crashes in history were the Wall Street Crash of 1929 and the world share slump >l’effondrement des bourses de valeurs mondiales of October 1987 (‘Black Monday’). When a recession or the price of shares bottoms out >atteint son niveau plancher / le plus bas, it has reached its lowest point and is about to improve or rise. • A (stock)broker >un courtier en Bourse; un marchand de titres is an intermediary between a buyer and a seller. On the stock market a broker was an intermediary between a jobber and the public. A jobber could only deal with the public via a broker. The broker approached various jobbers on behalf of his client and requested the most favourable buying or selling price. The distinctions between jobber and broker have now disappeared. A market maker >un faiseur / créateur de marché; un courtier en valeurs is a firm which since 1986 on the London Stock Exchange now performs the roles of both jobber and broker. Market makers give additional liquidity to the market since they take up and sell shares immediately or at short notice. • Averaging >les moyennes; faire la moyenne à la hausse ou à la baisse is the purchase of lots of the same share at different prices in order to maintain an average value for the holding >le portefeuille d’actions; l’avoir en actions, usually during a period of share instability. The purchase of additional lots of the same share when the price is rising is called averaging up >l’achat par échelons de hausse; faire une moyenne à la hausse. To average when the share price is falling is termed averaging down >faire une moyenne à la baisse. • A bull >un spéculateur à la hausse; haussier is a stock exchange dealer who buys securities speculating that the price will rise and that he can resell them with profit. Bulls operate mainly when the market is firm / firming >est ferme / soutenu; se raffermit or buoyant >actif (i.e. with active trading). When share prices are described as rallying >à la hausse; haussier or edging up >qui
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augmentent lentement they are rising slowly and constantly. A long position or bull position >une position acheteur / à découvert is a situation where a dealer has purchased shares, commodities or currencies in excess of requirements, i.e. s / he is long of shares or a commodity. Such a dealer is described as taking a long / bull position >spéculer à la hausse. A market where bulls dominate trading is described as a bullish market >un marché à la hausse. • A bear >un spéculateur à la baisse is a stock exchange dealer who sells securities anticipating a fall in their price, especially when share prices are edging down >tombent lentement. The bear later purchases back the securities at a lower price, and pockets the price difference >empoche la différence. A short / bear position >une position vendeur is a situation where a dealer has sold shares or commodities that s / he does not yet possess, i.e. s / he is short of shares. Such a dealer is described as taking a short / bear position >spéculer à la baisse. A market where bears dominate trading is described as bearish >à la baisse, baissier. • A stag >un chasseur de prime; “un loup”; spéculateur d’émissions is a speculator in new share-issues. The stag buys new shares when he anticipates a quick rise in their value, usually due to oversubscription of the issue, and then resells them with profit. • A chartist or technical analyst >un chartiste; conjoncturiste; opérateur sur graphique is a share analyst who attempts to predict the future price movements of securities on the statistical basis of their past performance. The term ‘chartist’ is derived from the use of share graphs and charts to plot >représenter graphiquement the price fluctuations. • A listed company >une société admise à la cote officielle is a company whose shares may be bought or sold on the stock exchange. To obtain this authorisation or listing >la cote officielle, the company must furnish detailed information about its activities and meet stock-exchange listing requirements. • The share (price) index or index of stocks [US] >indice boursier des actions is an index number of a basket or sample of shares >indice d’un panier d’actions taken as an average or indicator of share price movements on a particular stock market. In the UK the index of the London Stock Exchange is the Financial Times Stock Exchange Index-100 (the ‘Footsie’). Other indexes include the DAX (Deutsche Aktien Index – Frankfurt), the Dow Jones Averages (New York), the Hang Seng (Hong Kong), the Nikkei Average (Tokyo) and the CAC-40 (Compagnie des Agents de Change – Paris). • Settlement >le règlement; le jour de la liquidation; jour du terme is the procedure or date for making share deals officially complete. Settlement involves payment of shares, delivery of share certificates and the balancing of books with other brokers. • Backwardation >déport is the premium or surcharge >surcote; prime that a seller must pay to a prospective purchaser >client potentiel if he is short of the necessary shares on the settlement day and wishes to delay (prolong) the delivery of these shares in the hope that their price will have fallen when he buys them in. Backwardation is usually paid by a ‘bear’ speculator for the prolongation of a transaction >prolongation d’une opération. (See also ‘backwardation of commodities’ below). • Contango or the contango rate >report is the premium or surcharge that a buyer of shares must pay to a seller to defer payment >différer / reporter le paiement (i.e. defer settlement) in the hope that the value of these shares will rise and cover not only the purchase price and the contango, but also yield an immediate profit. Contango (the contango rate) is usually paid by a ‘bull’ speculator for the prolongation of a transaction. (For contango with respect to commodities, see below. • Program(med) trading >échanges programmés is the use of computer programs in computerised dealing to determine the moment at which shares should be bought or sold. These trigger
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points >points de déclenchement are programmed into the computer, and buy or sell commands may be issued automatically as soon as these points are reached. Program trading can give rise to a ‘herd instinct’ >provoquer un instinct grégaire. Largescale panic-selling caused by program trading was partly blamed >en partie responsable for the crash on Black Monday (see above). • To discount the market >anticiper le marché is to anticipate future share movements before they occur. The share-trading related to a specific event often occurs long before the event itself, owing to the stock market discounting it. This is yet another meaning of ‘discount’. STOCKS AND SHARES • A (financial) security >valeur mobilière; titre is a document of a government or company given against a loan, guaranteeing that the loan is secured against assets >garanti sur les actifs. These documents, which may be fixed-interest securities / stock >valeurs à taux fixe, floating-rate securities >valeurs à taux variable (i.e. securities whose interest-rate changes) or profitsharing securities / shares >valeurs / actions avec participation aux bénéfices can be bought and sold on the open market (a market with few restrictions where price is determined by supply and demand). Shares, debentures (see below) and Treasury bills >bons du Trésor à court terme are all securities. Securitisation >titrisation; la conversion d’un emprunt monétaire en valeurs is the issue of securities by a company or government in return for a loan. Securitisation allows companies to borrow money from investors directly without using the banks as intermediaries >intermédiaires. • Stock >actions; effets is any fixed-interest securities >titres à taux d’intérêt fixe of a company or central government, i.e. government stock >titres d’État (see ‘gilts’ below). With reference to a company, stocks, like shares, are a unit of ownership in the company. They are however usually issued in larger numbers and unlike shares, they do not have an identifying number. The plural form can be ‘stocks’ or more usually just ‘stock’. • Shares or stock [US] >actions are units of ownership in a company, issued as a means of raising long-term capital >se procurer des capitaux / actions, termed share capital or capital stock [US]. Ordinary shareholders (stockholders) >actionnaires ordinaires are legal owners of the company. Certain categories of shares called voting shares / stock >actions avec droit de vote carry the right to vote at company meetings. Shares in public companies are transferable >négociables and can be sold on the open market. The market for shares in private companies is often restricted by legislation >limité par la loi or by the articles of association >les statuts d’une société. • The maturity (of a security) >date d’échéance is the length of time which a security runs before it can be repaid (e.g. a security has three months’ maturity, or matures after three months), or the date on which a loan expires and becomes repayable. Long-dated securities or longs >valeurs à longue échéance are fixedinterest (fixed-rate) securities >valeurs à taux fixe that mature after more than 15 years. • To redeem a security >amortir / rembourser un titre / une obligation is to buy back or repurchase a security from the holder. Some securities are redeemed automatically after a fixed period (i.e. redeemed on maturity) by the company or government which issued them, others can be redeemed at any time. The process of repurchase is called redemption. Securities which can be repurchased are termed redeemable securities >titres remboursables / amortissables. Irredeemable securities >titres non-remboursables cannot be repurchased. • A bond >obligation; titre de rente is any fixed-rate security issued by the government, banks or companies for a period of years to raise long-term capital. Bonds are usually part of a large loan for a
specific purpose and unlike shares, do not confer ownership in >ne donnent pas un droit de propriété sur a company. They are part of the loan capital >capital d’emprunt and are a recognition of debt which may be traded on the securities’ market. The coupon >coupon is the rate of interest on a security or bond, or the slip attached to a security entitling >donne droit à the holder to receive the interest payment. • A debenture >obligation d’entreprise is a long-term fixed-interest loan issued by a company in large numbers like shares and repayable at a fixed date. A debenture is a formal and fairly safe form of bond secured against the assets of the company, and entitling the holder to payment of interest. Unlike shareholders, debenture holders are only creditors >créanciers and not owners of the company. They are neither entitled to vote at shareholders’ meetings, nor do they receive dividend payments out of profits. A debenture is a more formal and more secure form of loan than a bond. Debentures may be fixed debentures, i.e. a fixed charge on a specific asset >charge / sûreté fixe sur un actif spécifique of the company, or floating debentures, i.e. a floating charge >charge / sûreté fixe sur l’entreprise on all fixed assets >immobilisations and current / circulating assets >actif circulant such as stock (inventory [US] >stock. In the United States debentures are known as debenture bonds >obligations non garanties par gage and they are not secured against the assets of the company. • Listed securities >valeurs admises à la cote officielle are securities which may be bought or sold on the Stock Exchange >la Bourse. Listed securities are considered safer investments than unlisted securities >valeurs non admises à la cote because of the disclosure of information >divulgation d’information necessary to obtain the listing. The most-traded shares of the larger companies are termed alpha shares / stocks >actions fréquemment négociées. Most shares indexes (indices) or listings include 200 to 300 alpha shares. • Gilt-edged securities or gilts >valeurs de père de famille; les valeurs de tout repos; les emprunts d’État are government bonds with a fixed rate of interest, which are traded on the stock exchange and are considered a very sound investment >investissement sûr because they are secured against national assets, but which offer a lower interest rate than securities with a higher risk. • Consolidated stock or consols >rentes consolidées are fixedinterest securities issued by the UK government with no repayment date. These securities or bonds are used to repay different debts which have been consolidated or merged >consolidées. Consols offer a secure long-term interest, but since they are irredeemable (i.e. have no repayment date) their trading price depends only on the prevailing interest-rate >taux d’intérêt en vigueur. • Convertible loan stock >titres convertibles are fixed-interest stock of a government or company which can be converted into stock or shares of a different nature at a specified date, e.g. certain debentures which may be converted into ordinary shares when they mature. • A Eurobond >Euro-obligation is a bond with a foreign-currency denomination issued by a company or government institution in return for a long-term foreign currency loan which is underwritten >garanti by an international bank or group of companies. Eurobonds are bearer securities >valeurs au porteur (i.e. they are not named and are payable to the holder) which are traded not only in Europe, but throughout the world. Companies wishing to borrow money often resort to the Eurobond market as a result of national credit-restrictions or high domestic interest rates >taux d’intérêt intérieurs hauts. • Junk bonds [US] >obligations spéculatives à haut risque; obligations ‘camelote’ / ‘pourries’ are high-interest bonds usually issued in large amounts by companies whose credit-rating >degré / réputation de solvabilité has fallen dramatically. This is often a result of a takeover bid >OPA by another company, that takes the
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target company >entreprise cible out of the safe investment category of many investment firms. This formal loss of credit-rating, which may not reflect the true state of the affairs, obliges companies to raise capital from other sources by these highinterest loans. Although the markets view junk bonds as high-risk, they can make a very good investment in certain cases. • A premium bond >un bon à lot is a UK government security of fixed value which bears no interest but allows the holder to participate in a regular prize lottery. The bonds must be held for a minimum period but are then redeemable at their face value or nominal value >valeur nominale. TYPES OF SHARES • Ordinary Shares or equities or common stock [US] >les actions ordinaires are a type of share which entitles its holders (ordinary shareholders or common stockholders [US]) to any dividend >dividendes (from the net profits. The amount of share dividend, which is determined by the company directors, can rise or fall dramatically depending on the profits of the company. Ordinary shareholders are legal owners of the company. Equity capital >capital social; capital de participation; financement sur fonds propres is the amount raised by the issue of ordinary shares. The term share capital or stock capital [US] >capital actions is much wider and consists of all issued shares, i.e. ordinary shares and preference shares >actions privilégiées, together with any reserves or retained profit. Loan capital >capital d’emprunt, which includes preference shares, bonds and debentures is a debt which has to be repaid. Loan capital may be contrasted with equity capital, which is not a debt. The owners’ equity (also termed shareholders’ equity or the net worth, or in the US – the net equity or proprietors’ capital) >valeur / situation nette; les fond.s / capitaux propres is the amount owed by the business to its owners or shareholders after all debts been paid , i.e. total assets minus all liabilities >actif moins le passif. Ordinary shares (common stock) are termed equities because they entitle the holder to a share of the owners’ equity (net worth) of the business. • The par value or parity value >pair des actions is the nominal value of the share (i.e. the value written on the share), or in countries where there is no nominal value of shares, the value at which a share is issued. In subsequent trading, the value of the shares may fall or rise. In these cases, the shares are said to be trading below par >au-dessous du pair, or above par >au-dessus du pair respectively. Price fluctuations on the securities’ and currency markets are measured in points, where 100 basis points = 1 percentage point, e.g. ‘the shares rose / fell 150 basis points’ >ont monté / reculé / baissé de 50 points. • A share premium >surcote; prime d’émission is the difference between the issue value of a share and its lower par value. Shares sold at a premium are sold above their par value and the difference must usually be credited to a share premium account >portée sur un compte de primes d’émission. Severe legal restrictions are placed on the use of funds in this account. A share discount >une décote is a reduction in the selling price of shares, for example when shares are issued at below market value. The difference between the purchase price (or offer price) and the selling price (or bid price) of a share in trading is known as the share spread >marge; différentiel. • The share dividend >dividende d’actions is a payment made from profits to the shareholders of a company. Depending on the level of profits, the company directors have the discretion to increase, reduce, or even to not distribute dividends >distribuer des dividendes. An interim dividend >dividende provisoire is a dividend based on a profit-estimate for the whole year, which is usually paid half-yearly. The remaining final dividend >solde de dividende is paid at the end of the year when the overall profits of the company are known. Dividends are unearned income >revenus du capital (non-salariaux) (i.e. interest or income from
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invested capital) for the shareholders. Companies that pay attention to shareholder value >intérêt financier des actionnaires pay good dividends regularly rather than retain the profits. • Ex-dividend shares or dividend-off stock [US] >actions exdividende are shares sold without the right to the coming dividend. If shares are sold ex dividend (i.e. without dividend), then the seller of the shares retains the right to receive the next dividend due. Sales of shares ex-dividend occur mainly in the period of one month before dividend date, when the transfer of dividend rights is suspended to allow the staff of companies to assess both the identity of shareholders, as well as the exact dividends due to them. Any sales of shares during this period are usually quoted exdividend and their price is adjusted downwards to reflect this fact. Cum-dividend shares or dividend-on stock [US] >actions coupon attaché /avec le dividende are sold (i.e. shares sold cam dividend) together with the right of the purchaser to receive the next dividend due on the shares. • Preference shares or preferred stock [US] >actions privilégiées; actions de préférence / priorité are shares which received a fixed rate of any dividend due and which entitle the holder to payment of this dividend before the holders of ordinary shares. If a dividend is not paid in one year, the dividend may become cumulative. In this case the shares are termed cumulative preference shares >actions privilégiées cumulatives, i.e. they accumulate the right to dividend until such time as they are paid. Preference shares which are repurchased by the company after a fixed period are called redeemable preference shares >actions privilégiées amortissables. Although preference shares are more secure, ordinary shareholders can receive much higher dividends in years of profit to compensate them for the greater risk. Preference shares are part of the share capital (capital stock [US]) but not part of the equity capital, since they do not entitle the holders to a proportionate share of the profits. On the liquidation >liquidation / dissolution of a company, holders of preference shares are repaid their capital before holders of ordinary shares. • Preferred ordinary shares >actions ordinaires privilégiées are a category of shares that gives a right to a dividend only after the preference shareholders (preferred stockholders) have been paid, but before the ordinary shareholders. (Do not confuse with ‘preference shares’ or ‘preferred stock’ – above) • Deferred shares >actions différées are shares which entitle the holder to a specific share of the profit only after all other classes of shareholders (including preference and ordinary / common shareholders) have received their dividends. Deferred shares usually entitle the holder to a larger share of the profit than ordinary shares, making them very lucrative in profitable years. Founder’s shares or management shares >parts de fondateur are a class of deferred share given (as a reward or part payment) to the founder or initiator of a company on its sale to another party. • Blue chips >titres de premier ordre / de tout repos; les valeurs vedettes are ordinary shares (equity shares) in established public companies with a good performance record, which are considered a safe or low-risk investment. Established companies >compagnies bien implantées with shares of this nature are known as blue-chip companies >compagnies de premier ordre. • Industrials >actions d’entreprises are shares in manufacturing companies, as opposed to trading companies. ISSUING SHARES • A share flotation >émission / un lancement d’actions is the raising of capital by a share issue (i.e. sale of shares) to the public for the first time. Shares may be floated >lancées; émises by a newly formed company or by an existing company seeking to raise extra capital. A company floating shares for the first
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Reproductions effectuées par l’Université Paris Dauphine avec l’autorisation du CFC (20, rue des Grands Augustins, 75006 Paris)
time is said to go public >s’introduire en bourse; être admise à la cote (i.e. the company has been floated). Shares are usually offered to the public in a document known as a share prospectus >prospectus. A share issue is not only the process of issue, but can refer to the actual number of shares sold to the public. To place shares >placer des actions is to sell shares to certain selected investors rather than to the public in general. Such a sale is known as a placement of shares >placement. • The primary market >marché d’émissions is that part of the share market which is concerned with the purchase and sale of new share issues (i.e. share floatations). The secondary market >marché secondaire d’actions is that part of the share market which is concerned with the purchase and sale of existing shares. • To underwrite a share issue >garantir / souscrire une émission is to guarantee to buy any shares of a share issue which are not bought by the public. The underwriting of a share issue by an underwriter >soumissionnaire; compagnie de soumissionnaires that is usually a merchant bank >banque d’affaires or other financial institution, creates public confidence in the issue. • A share subscription >souscription d’actions is an agreement between a company and an individual (termed a subscriber) to purchase part of the share issue of that company. The buyer is said to ‘subscribe to a share issue’ or ‘subscribe for shares’ >souscrire à des actions. Oversubscription >dépassement de souscriptions occurs where the number of shares applied for exceeds the number of shares to be issued. The issue is then said to be oversubscribed >sursouscrite; couverte de façon excédentaire. At the discretion of the directors, each subscriber usually receives an allotment >attribution of only a proportion of the shares for which s / he has subscribed. The opposite case, where shares are left without subscribers, is undersubscription or an undersubscribed issue >émission non entièrement souscrite. • Paid-up capital >capital versé is that proportion of a share issue which has actually been paid for by its subscribers. In share issues, it is common for shares to be purchased in two or more instalments, e.g. one instalment immediately after the issue, and the rest over a period of months. Shares that have been fully paid are known as fully-paid shares >actions entièrement libérées. Called-up capital >capital appelé is that proportion of a share issue where payment has been requested from the subscribers. The remaining portion to be paid at a later date is uncalled capital >capital non-appelé. • A rights issue >émission de droits de souscription is an issue of new shares at a discount >avec décote to existing shareholders in proportion to the number of shares they already hold. In a one-toone issue >émission d’actions une contre une, shareholders are invited to purchase one new share for every share already held. Shares sold ex rights >ex-droits do not allow the buyer to profit from any future rights issue. • A bonus issue or scrip issue or capitalisation issue or stock split [US] >émission d’actions gratuites is an issue of bonus shares >actions gratuites for the sole purpose of converting accumulated revenue reserves >réserves fiscales into share capital. Revenue reserves are temporary reserves used to hold profit that has not been distributed to shareholders, with the intention of ploughing it back >réinvestir into the business. New bonus shares, paid for out of reserves, are created and issued free to existing shareholders in proportion to the number of shares already held. This process is known as capitalisation >capitalisation. The main reason that companies capitalise reserves is that they desire the value of shares to reflect the rue asset value of the company, without the shares becoming overvalued as a result of excessive reserves. The high share price may also discourage some investors, and the bonus shares dilute (reduce) the price and increase marketability >commerciabilité; négociabilité, since high-value shares do not trade as easily as low-value ones. Capitalisation issues are technical issues
>émissions à des fins comptables (i.e. shares issued for bookkeeping purposes), since the new shares will reduce both the market price of each existing share as well as the dividend, making the holders theoretically no better off. The term ‘capitalisation’ also refers to the nature or make-up of the total shares and stocks that constitute a company’s finances, i.e. the relative proportions of common stock, preferred stock, debentures etc. held. TYPES OF TRANSACTIONS • A share portfolio or an investment portfolio >un portefeuille d’actions is a list of the total investment in shares or securities held by an investor. Portfolios usually spread the risk over a range of investments that are both long- and short-term, as well as highand low-risk. • Venture capital or risk capital >le capital-risque; capital à risque is speculative capital which is attracted to high-risk, but potentially high-earning investments. Firms making such investments are known as venture capitalists >investisseurs à risque. Venture capitalists also fund projects and advance seed capital >capitaux / financement d’amorgage to allow the foundation of promising new companies. Top-down investment >démarche descendante pour investir is an investment strategy that focuses on securities in market sectors that are doing well (e.g. shares in information technology companies or the leisure industry). Bottom-up investment >approche pyramidale d’investissement (de bas en haut); la démarche ascendante pour investir concentrates more on the performance of the individual companies, regardless of the market sector in which they are operating. • Ethical investment >investissement éthique / selon des principes éthiques is the application by investors of environmental and socially-responsible criteria to a company before investing in it. Corporate investors >compagnies d’investissements specialising in this type of investment attract money from small investors who want to invest with a good conscience. • A unit trust or mutual fund [US] >une société d’investissement à capital variable (SICAV); un fonds commun de placement is a financial institution which spreads the risk of investment, mainly in ordinary shares, over a wide range of companies and which sells units based on all these investments. The units give a return >un rendement reflecting their aggregate (i.e. overall or total) performance. These investments also determine the price at which the units are bought and sold. The holders of investments in unit trusts (mutual funds) are not shareholders (i.e. not the owners of the company) but only creditors. An investment trust >une société d’investissements is an investment company similar to a unit trust where the investors are shareholders and not creditors. Fund management >la gestion des fonds which is the management of investors’ money by fund managers is often subject to >soumise à government controls. • A personal share investment plan >un plan d’épargne en actions is a planned share-investment portfolio of a small personal investor, on which the dividends usually attract tax reduction or tax exemption >dégrèvement d’impôts. In the UK, one such scheme is termed a personal equity plan (PEP). Such schemes are used by governments to encourage the smaller investors into the stock market. In the UK in April 1999, PEPs became absorbed into a more general private savings scheme >plan d’épargnecapitalisation personnel called an individual savings account (ISA) that allows both personal tax-free savings as well • A share / stock option >option de souscription à des actions nouvelles; stock option is a right which is purchased from a company or share dealer to buy or sell certain shares at a fixed price after or within a limited period of time (usually one or more months). A share warrant >bon de souscription is a form of share option that allows the holder to purchase ordinary shares from a company at a fixed date. Options are a type of speculation on the price-fluctuation >la variation des prix of shares; the buyer
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speculates that the market value of the shares will rise (or fall) enough to cover not only the cost of the option and the agreed price, but also give a profit. Share options are classed as a form of derivatives >instruments financiers spéculatifs since their value is only remotely derived >dérive de façon éloignée from the underlying shares >des actions sous-jacentes. • A call option or a buyer’s option >une option d’achat d’actions nouvelles is an option or right to buy shares in the future at an agreed price, termed the strike price or striking price or exercise price >prix d’exercice, in the hope that the share price will rise. The buyer of a call option speculates that the market value of the shares on that future date will have risen so far above the strike price that it will cover not only their purchase price (at that future date) and the cost of the option, but also yield a profit >dégager un bénéfice. • A put option or a seller’s option >une option de vente is an option or right to sell shares in the future at an agreed price, in the hope that the share price will fall. The buyer of a put option calculates that the striking price will cover not only the purchase price of the shares (which will hopefully have fallen by that future date) and the cost of the option, but also yield a profit. • Switching >une opération simultanée d’achat ou de vente de titres is the frequent short-term selling of one stock and the purchase of another to take advantage of better interest rates. •A consolidation of the market >consolidation du marché is a readjusting of share prices to reflect the fundamentals of the market >tendances fondamentales du marché (i.e. the basic underlying realities or trends), especially after a period of rising and falling prices based on speculation. • A player (on the market) >spéculateur is a (large) buyer or seller who is actively trading on the share and security markets. Such traders are said to ‘play the market’. • A ‘bed and breakfast’ deal >la vente puis le rachat immédiat d’actions pour dégager une moins-value fiscale is a sale of shares and securities on one day, and the repurchase of them on the same or next day in order to create a profit or loss for the purposes of taxation, usually capital gains tax >impôt sur les plus-values. The term alludes to a short overnight stay in a boarding house or hotel. • Insider dealing >délit d’initié is the dealing in stocks and shares by persons with privileged or special knowledge (insider-dealers) obtained by way of connection with a particular company. The information may relate share issues or takeover bids >OPA, etc., and in most countries, individuals who are party to this information are prohibited from dealing in the shares of the company concerned until this information becomes public knowledge. • Chinese walls >limitations sur la circulation interne d’informations en vue de prévenir les délits d’initié are a convention >convention; pratique in large financial institutions for the prevention of insider dealing, whereby departments are segregated by an invisible wall through which they cannot pass certain categories of information. One department may be advising a company about its take-over bid for a firm which is a client of another department. In such a case, it would be unethical >contraire à la morale to use the confidential information from one client to advise another. FOREIGN CURRENCY TRANSACTIONS • The bullion market >marché des métaux précieux is the market for gold and silver. •A basket of currencies >panier de devises is a representative sample >échantillon représentatif of currencies taken as a means of comparison with other such samples. A basket of goods >panier de produits is a similar representative sample of commodities or goods, often used to measure inflation.
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• The currency spread >marge is the difference between the buying and selling price of a currency. Distinguish from a ‘currency spread’ in relation to an exchange-rate mechanism • The interest rate differential >écart des taux d’intérêt is the difference in international interest rates that attracts investors to a particular country. More particularly, it is also the difference between the spot price and the forward price >différence / marge entre le prix au comptant et le prix à terme for foreign currencies. The spot rate for a foreign currency will exceed the forward rate if the interest rate in the country of the currency is higher than the domestic rate >taux intérieur in the country of the purchaser. These prices reflect the interest rate differential, since the purchaser of currency forward will have lost the opportunity to profit from the higher rates in the intervening period, whereas spot purchasers can profit immediately from the foreign rates. If foreign interest rates are lower than domestic rates, then the forward price will exceed the spot price, since purchasers of spot currency will have lost the opportunity to invest at the higher domestic rates. • Arbitrage is the short-term buying and selling of foreign currencies on different markets to profit from exchange-rate differentials. Currency arbitrage is practised mainly by large banks and investment houses (arbitrageurs), who make use of the differentials caused by time zones and global trading (See also ‘arbitrageur’ above • The agio >prime de change; agio is the commission for converting one foreign currency into another. • Hot money or funk money [US] >capitaux spéculatifs / fébriles is the funds of speculators attracted to a country or an institution by high rates of interest. These funds are highly volatile and can disappear quickly if the rates in another country become more attractive. Hot money is a major means of speculation and can cause turbulence on the currency exchanges >provoquer des perturbations / turbulences sur les bourses de devises. • Eurocurrency >eurodevises is currency which is held outside the country of origin, e.g. yen in London (Euroyen), US dollars in Switzerland (Eurodollars). Eurocurrency arises as a result of paying a foreign exporter with domestic currency which does not return to the country of origin, but circulates abroad. (See also ‘Eurobond’ above) • Petrodollars >pétrodollars are dollar revenue from the sale of oil by OPEC countries which is in excess of their needs and which is invested in US and European financial institutions. • A parallel loan or back-to-back loan >emprunt de monnaies adossé is an exchange or swap of currency loans. A company may be able to borrow money on the domestic market at much more advantageous interest rates than a foreign company. If two foreign companies need each others currencies, it may be in their interests to take out loans for domestic currencies at advantageous rates and then swap these currency loans, usually via a bank. It is usual to swap both the loans and their interest payments. Distinguish from a back-to-back credit or countervailing credit >un accréditif / crédit adossé which is a credit granted by a bank or finance house to an exporter, who has exported goods to a middleman >intermédiaire, who in turn resells or reexports them. • A currency swap >échange de monnaies; un ‘swap’ de devises is a purchase of foreign currency on the spot market >marché au comptant combined with a simultaneous sale >lié à une vente simultanée of the same amount of currency on the forward market. This transaction allows firms who are to receive currency in the future, to calculate exactly what they will receive in terms of domestic currency, by excluding any exposure to excessive exchange-rate fluctuation >exclure les risques d’exposition à des fluctuations excessives du taux de change. A spot sale combined with a forward purchase allows firms who owe foreign currency at a future date to ensure that they can purchase it at a known rate. Currency swaps are a form of derivatives or futures trading.
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Reproductions effectuées par l’Université Paris Dauphine avec l’autorisation du CFC (20, rue des Grands Augustins, 75006 Paris)
(Distinguish from ‘currency swap arrangement / facility’ between central banks). THE COMMODITY EXCHANGE A commodity exchange >Bourse des matières premières et denrées is a centre for wholesale trading in commodities such as metals, foodstuffs and other raw materials. Fungibles >fongibles are perishable commodities that can be numbered or weighed (grain, milk etc.). The ring >le parquet; le marché officiel is a term for the trading floor of a commodity exchange where groups of dealers negotiate together in circles to buy and sell commodities. • The spot market >marché au comptant is the buying and selling for cash of commodities and securities for immediate delivery. The market price for this type of dealing is known as the spot price or spot rate >prix au comptant. • The futures market or forward market >marché à terme is the market for forward dealing >opérations à terme, i.e. the purchase and sale of commodities, foreign currencies and securities for delivery at a future date at a fixed price. This price is termed the forward / futures rate or forward / futures price >cours / prix à terme; taux de change à terme. Both buying forward >achat à terme and selling forward >vente à terme are means of protecting a manufacturer against future price fluctuation in raw materials. They are also methods of speculation, since the commodity can be sold again immediately at a profit if the market price rises between the date of the forward contract >contrat à terme and the agreed date of delivery. Futures contracts are a form of derivatives (below). • The derivatives market >marché d’instruments financiers dérivés is a generic term for the trade in future changes in the value of a commodity, currency or security. Derivatives are speculative financial instruments >instruments financiers spéculatifs whose value is remotely derived >dérivée de façon éloignée from the future trade in an underlying commodity or security >de la matière première ou valeur sous-jacente. Futures contracts (above), options (both share options and commodity options – see below) and currency swaps (see below) are the three main forms of derivatives. Both physically and temporally >dans le temps, derivatives transactions are often many stages removed from the actual underlying commodity >très éloignées de la marchandise sous-jacente, and for this reason they can become very complicated in nature. • A commodity option >droit d’option is a right, acquired by payment of a fee to sell a commodity, securities or foreign currency
– a put option or to buy the same – a call option -, at a fixed price within a limited period of time in the future. The options themselves rather than the commodities to which they relate can also be bought and sold, in which case they are known as traded options >options négociables. • Margin dealing >transactions / opérations sur provision is futures trading that involves cash deposits covering a proportion of the contract. A margin >marge; provision; couverture is the value of any property or money deposited by a buyer as security in futures trading, or / the difference between this amount and the actual value of the contract. • Backwardation (of commodities) >déport is the difference between the lower forward price and higher spot price. If the forward price is greater than the spot price, this difference is known as contango. (See above where ‘backwardation’, and ‘contango’ are payments made to defer the settlement of share deals.) • Hedging >mesures de couverture / protection contre un risque is an attempt to avoid large losses in forward dealing caused by unexpected price fluctuations. A dealer who has sold forward a large quantity of goods may decide that the market is too risky and reduce part of his potential loss by buying forward that commodity to cover part of his forward sales. S / he is then said to hedge >se protéger, or ‘hedge against the risk’. Hedging as a form of risk management occurs also in share and currency dealing. • Valorisation >maintien artificiel; valorisation is the artificial fixing and maintaining of a commodity or currency at a specific price level, usually by a government or government body in order to encourage producers to decrease or increase supply. • Profit-taking >prise de bénéfices is the sale of commodities and securities that have increased in value in order to make a profit. Profit-taking on a large scale can temporarily halt any rise in commodity prices. • The opportunity cost or alternative cost >coûts de substitution / d’opportunité is the cost of holding commodities which might otherwise be invested productively to earn interest. It is a measure of the value of a missed alternative investment. The opportunity cost of holding commodities will be high if the profit on the commodity falls far short of the interest that could be earned by investing the money. Adapted from English Business Practice, Ralph APPLEBY & Franck MICHEL, coord. Ronald LISTER, Ellipses, Paris, 1999.