Ebook Business finance Theory and practice (8E) Part 2

(BQ) Part 2 book Business finance Theory and practice has contents The secondary capital market (the stock exchange) and its efficiency; cost of capital estimations and the discount rate, the dividend decision, management of working capital, international aspects of business finance,...and other contents.

BUSF_C09.qxd 11/19/08 10:14 Page 252 www.downloadslide.com Chapter The secondary capital market (the stock exchange) and its efficiency Objectives In this chapter we shall deal with the following: ‘ the role of the capital markets in their secondary function ‘ the mechanisms of the London Stock Exchange ‘ the efficiency of the secondary capital market ‘ tests of efficiency ‘ the implications of capital market efficiency 9.1 Introduction The capital market is a title given to the market where long-term finance is raised by businesses and by local and national governments Businesses raise this type of finance through the issue of equity (shares) and debt (loan notes, debentures or bonds) to members of the public and to investing institutions (unit trusts, insurance businesses and so forth), usually in exchange for cash It is also a market where holdings of equity or debt (securities) may be transferred from one investor to another The new finance market is known as the primary capital market, whereas the market in which second-hand securities are traded is referred to as the secondary capital market We have already considered this primary role in Chapter In this chapter we shall confine ourselves to consideration of the secondary aspect Secondary capital markets The most important secondary capital markets throughout the world tend to be the official stock exchanges or stock markets They are not the whole of the secondary capital market, however – certainly not in the UK, as we shall see later in the chapter Nonetheless, the world’s official stock exchanges are the major forums for trading local, and increasingly international, securities Most of these official stock exchanges fulfil a primary function as well as a secondary one 252 BUSF_C09.qxd 11/19/08 10:14 Page 253 www.downloadslide.com The London Stock Exchange The existence of a secondary capital market is vital to businesses wishing to raise long-term finance Potential long-term investors will not generally be prepared to take up issues of shares or loan notes unless the opportunity exists to liquidate their investment at any time Since it is not practical for businesses themselves constantly to hold cash in readiness to redeem the securities, it is necessary for there to be a secondary capital market where security holders may sell their investments The absence of secondary market facilities tends to make the raising of long-term finance impossible or, at best, very expensive in terms of returns demanded by investors It is thought by some observers that underdeveloped countries are often restrained in their industrial and commercial development by the lack of an established secondary capital market and therefore by the lack of long-term investment finance Price efficiency Potential investors will not only require the existence of the opportunity to liquidate their securities as and when they wish; they will also be interested in whether their investment is efficiently priced Efficiency in the context of pricing implies that, at all times, all available information about a business’s prospects is fully and rationally reflected in that business’s security prices That is to say, the market price of a particular security is the present (discounted) value of the future economic benefits that the security will bestow on its owner This will interest investors as they would generally prefer that the price at any particular moment be set rationally and not be a matter of sheer chance Perhaps more important is the fact that, as the capital market is the interface between managers and investors, efficiency means that financial decisions made by managers will reflect in the business’s security prices and so have a direct effect on shareholders’ wealth As maximisation of shareholders’ wealth is generally accepted as the principal criterion for management decisions, this reflection of management action is a significant matter, with several implications In this chapter we shall look briefly at the mechanisms of the London Stock Exchange (LSE) in its secondary role before going on to see that it seems to be efficient to a large extent Lastly we shall consider the implications for investors and for financial managers of the efficiency (or otherwise) of the LSE 9.2 The London Stock Exchange As with all capital markets in their secondary role, the LSE is basically a marketplace where securities of private businesses and public bodies may be bought and sold LSE members Whereas in many types of markets members of the public may directly buy and sell on their own behalf, in the LSE they are barred from entry Only members of the LSE have direct access to buy and sell securities When members of the public wish to buy or sell securities through the LSE, they can so only by using a member as an agent The rules governing the conduct of the members are laid down and enforced by a Council elected by the membership One of the functions of the Council is to authorise specific securities as suitable to be dealt in on the LSE Authorised (listed) securities are those that satisfy a number of criteria established by the Council The object of 253 BUSF_C09.qxd 11/19/08 10:14 Page 254 www.downloadslide.com Chapter • The secondary capital market and its efficiency screening securities before authorising them is to try to avoid members of the investing public from losing money by buying very hazardous securities There are currently about 1,130 UK businesses whose shares are listed by the LSE, with about 120 of these accounting for about 85 per cent of the total value of the shares of all 1,130 businesses (London Stock Exchange 2007) LSE members have two roles The first is as market makers or dealers, equivalent in principle to a trader in a street market Each dealing business specialises in a particular group of securities, in much the same way as traders in street markets tend to specialise in fruit, or meat, or fish The second role is as agents of the public who wish to buy or sell through the LSE (brokers) Dealing on the LSE Dealers Dealers will usually be prepared to buy or sell irrespective of whether they are immediately able to close the deal Thus dealers will normally be ready to sell securities that they not at the time possess (short sell) or to buy those for which they have no immediate customer It is only with very rarely traded securities and with exceptionally large orders that dealers may not be prepared to deal either as a buyer or seller Any unwillingness on a dealing business’s part to make a market in a particular security on a particular occasion may damage the dealer’s reputation This could have an adverse effect on the future trade of that dealer There is therefore a sanction against dealers who fail properly to fulfil their function as market makers At any given time, a particular dealing business will typically hold trading inventories, either positive or negative, of some of the securities in which it deals Where the inventories position is a positive one it is said to hold a bull position in that security, and where securities have been sold that the dealer has yet to buy in, it is said to hold a bear position Dealers are risk-taking market makers When dealers buy some securities they judge that they can subsequently sell them at a higher price Similarly, when they sell securities that they not possess (where they take a bear position), their judgement is that they can buy the securities that they have an obligation to deliver, at a lower price If they are wrong in this judgement it could be an expensive mistake, as they may have to offer a very high price to encourage a seller into the market Members who act only as dealers make their living through profits from trading The dealing process Until the mid 1980s virtually all LSE transactions were conducted on the floor of the LSE Here, each dealer business would have its own ‘stall’ to which brokers could go to deal on their clients’ behalf To deal at the most advantageous prices it would have been necessary for the broker to call at the stalls of all, or at least a good sample of, dealers who dealt in the particular security concerned, to compare prices Now the ‘floor’ of the LSE is, in effect, a computerised dealing system, though in essence the dealing process remains the same The Stock Exchange Automated Quotations system (SEAQ) allows dealers to display their prices to interested parties, both members and non-members, and constantly to update those prices It also enables LSE members to deal directly using a terminal linked to SEAQ, without leaving their offices 254 BUSF_C09.qxd 11/19/08 10:14 Page 255 www.downloadslide.com The London Stock Exchange When members of the investing public wish to buy or to sell a particular security, they typically e-mail or telephone their broker The broker can immediately access the display of the prices at which various dealers are prepared to trade These prices will normally differ from one dealer to another This is because estimates of the value of the security concerned will vary from dealer to dealer The ‘inventories holding’ position of the particular dealer at that particular moment will also influence the prices on offer A dealer with a bear position may well be prepared to pay a higher price to buy the particular securities than one with a bull position In respect of a particular security and a particular dealer, the SEAQ screen will display two prices At the lower of these the dealer is prepared to buy and at the higher one to sell The same information is available to all members and to others who wish to subscribe The broker can tell the client what is the best price in the security according to whether the client is a potential buyer or a potential seller The client can then immediately instruct the broker to execute the trade at this best price or to nothing If the client wishes to go ahead with the deal, the broker executes the transaction immediately and without any direct contact with the relevant dealer business (using the SEAQ terminal) The effective contact between the broker and the dealer is through SEAQ The system automatically informs the dealer concerned that the trade has taken place and provides a record of the details of the transaction Although anyone can be provided with the SEAQ information, only LSE members can use that information directly to trade through SEAQ The ‘quote-driven’ approach, of which SEAQ is the modern embodiment, has long been the standard way that the LSE operates This approach has, however, been criticised by investors on the grounds that, since dealers seek to make a profit from each transaction, additional and unnecessary costs have to be borne by investors It is argued that, since ultimately, each sale of securities by an investor leads by way of the market maker to a buying investor, it would be cheaper for buyers and sellers to deal directly with one another, without a dealer being involved In 1997 the LSE introduced an ‘order-driven’ system, the Stock Exchange Electronic Trading System (SETS), which now runs alongside SEAQ Here would-be buyers and sellers of the shares of a particular business enter (through their individual brokers) information about their wishes on an electronic screen for that particular share This information, which does not show the identity of potential buyers and sellers, includes the number of shares that they wish to buy or sell and the maximum and minimum prices, respectively, at which they are willing to trade Where SETS can match two entries, it will automatically effect the transaction Naturally, a particular would-be seller may not wish to sell the same quantity of the shares as a would-be buyer wishes to buy Here SETS would carry out the transaction for the lower of these two quantities and leave the outstanding balance displayed on the screen Critics of the SETS approach argue that the intervention of dealers ensures that there is always a buyer or seller for particular shares, i.e a dealer It has been argued, however, that in practice it can be difficult to buy or sell particular shares at certain times, despite the existence of dealers Irrespective of whether the transaction has been effected through SEAQ or SETS, brokers must be involved Only members of the LSE can trade Brokers charge their clients a commission, which is their source of income These dealing costs tend to be significant, particularly on small transactions, though they typically become proportionately lower on larger ones Brokers offer their clients a range of professional services related to investment, rarely viewing their role in the narrow sense of buying and selling agents They are, of 255 BUSF_C09.qxd 11/19/08 10:14 Page 256 www.downloadslide.com Chapter • The secondary capital market and its efficiency course, competing with each other for investors’ business Those giving the best service, in terms of advice and guidance, are likely to attract most dealing commissions Derivatives Not only can investors buy and sell securities, they may also buy and sell derivatives linked to security prices Investors may, for example, buy and sell security options They can buy the right (but not the obligation) to buy or sell specified securities at predetermined prices before a stated date If, for example, an investor believes that Vodafone Group plc’s shares are due to rise in price, an option to buy a certain quantity at a specified price before a stated date can be bought This would be known as a ‘call’ option, and the price of such an option would depend on the quantity, the call price and the exercise date If, by the exercise date, the market price of Vodafone Group shares were above the call price, the investor would take up the option to buy the shares An option giving the right to sell is known as a ‘put’ option In certain securities the option itself may even be bought and sold (traded options) Share options are another example of derivatives (see Chapter 1), and just one of many derivatives linked to security prices The place of the LSE in the UK secondary market There is no legal requirement in the UK that all secondary market activities must be carried out through the LSE While it has long been and still remains the case that the LSE dominates the UK secondary market in terms of business transacted, there are other markets, albeit limited ones There are, for example, commercial organisations that operate over-the-counter (OTC) markets, where the organisations act as market makers in a range of securities Securities are bought from and sold to the investing public, in much the same way as second-hand furniture is bought and sold by dealers, without an agent being involved There is some evidence – for example, the emergence of the OTC market – that suggests that members of the investing public will readily look elsewhere if they feel that the LSE is not providing the service they need, at a price they are prepared to pay 9.3 Capital market efficiency When security prices at all times rationally reflect all available, relevant information, the market in which they are traded is said to be efficient This implies that any new information coming to light that bears on a particular business will be incorporated into the market price of the security quickly, and rationally in terms of size and direction of security price movement To say that a secondary capital market is efficient is not necessarily to imply that the market is ‘perfect’ in the economists’ sense, although to be efficient the market has to display most of the features of the perfect market to some degree It is also important to note that efficiency does not mean perfect powers of prediction on the part of investors All it means is that the current price of a security is the best estimate of its economic value on the basis of the available evidence Note that ‘efficient’ in the 256 BUSF_C09.qxd 11/19/08 10:14 Page 257 www.downloadslide.com Capital market efficiency current sense is not related to ‘efficient’ in the sense of having no specific risk (see Chapter 7) It is unfortunate that the same word has become the standard term to describe two different concepts Why should capital markets be efficient? Prices are set in capital markets by the forces of supply and demand If the consensus view of those active in the market is that the shares of a particular business are underpriced, demand will force the price up In a secondary capital market such as the LSE, security prices are observed by large numbers of people, many of them skilled and experienced, and nearly all of them moved to so by that great motivator – financial gain Information on the business comes to these observers in a variety of ways From the business itself come financial statements, press releases and leaks (deliberate or otherwise) Information on the industry and economy in which the business operates will also be germane to assessment of the value of a particular security, and this will emerge from a variety of sources Where observers spot what they consider to be an irrational price, in the light of their assessment of, say, future projected dividends, they tend to seek to take advantage of it or to advise others to so For example, an investment analyst employed by a unit trust might assess the worth of a share in Tesco plc at £3.50 but note that the current share price is £3.00 The analyst might then contact the investment manager to advise the purchase of some of these shares on the basis that they are currently underpriced and there are gains to be made The increase in demand that some large-scale buying would engender would tend to put up the price of the shares Our analyst is just one of a large number of pundits constantly comparing the market price of Tesco shares with their own assessment of their worth Most of these pundits will take action themselves or cause it to be taken by those whom they advise if they spot some disparity The market price of the shares at all times represents the consensus view If people feel strongly that this price is irrational, they will take steps to gain from their beliefs: the greater they perceive the irrationality to be, the more dramatic the steps that they will take Efficiency and the consensus: predicting American football results – ask the audience or phone a friend Efficiency has been interpreted by some people as requiring that there is at least one person active in the market who has great knowledge, skill and judgement This need not be the case Beaver (1998) points out that all that is needed for efficiency is many observers with most having some rational perceptions even if their other perceptions about the security are misguided He argues that the misguided perceptions will be random and probably not held by others The rational perceptions, on the other hand, will be common, perhaps not to all, but nonetheless to a large number of observers As the security price reflects a weighted average of the perceptions of all of those active in the market for that particular security, the misconceptions, because they are random, will tend to cancel each other out and so have no overall effect on the price The correct perceptions will not be random and so will not cancel each other and will therefore be reflected in the share price Beaver illustrates and supports this point with what is at first sight an irrelevant account of some predictions of results (win, lose or draw) of American football games 257 BUSF_C09.qxd 11/19/08 10:14 Page 258 www.downloadslide.com Chapter • The secondary capital market and its efficiency The Chicago Daily News, on each Friday over the period 1966 to 1968, reported the predictions of each of its 14 or 15 sports staff of the outcome of the games to be played over the forthcoming weekend The newspaper also published the consensus view of the sports staff, that is, the single most popular view on each game When the success of the predictions was summarised for the three years, the results were as shown in Table 9.1 Table 9.1 Performance of forecasters of American football games 1966 Number of forecasters (including the consensus) Number of forecasts per forecaster Rank of leading forecasters: J Carmichael D Nightingale A Biondo H Duck Rank of the consensus 15 180 (tie) (tie) (tie) 1967 1968 15 220 16 219 11 10 16 Source: Chicago Daily News It is interesting to note that the consensus view outperforms all individuals over the three years and indeed outperforms all but one or two in any particular year (it tied with two individuals in 1966 and was beaten by one individual in 1967 and 1968) It is clear from the table that the performance of the successful individuals is inconsistent, suggesting some element of luck in their successful year Luck may not be the only reason for the success, since Biondo performed better than average in all three years Yet despite the possible presence of skill in one individual, over the three years the consensus easily beat them all It would appear that some forecasters are more skilled than others It also seems that the consensus performs even better than the best individual This is despite the fact that the consensus combines the forecasts of all the individuals, skilled and not so skilled Far from having the effect of dragging down the quality of the forecasts of the best individuals, combining the forecasts, to find the consensus, actually improves the quality of forecasting Beaver suggests that this is because idiosyncratic factors (such as personal loyalties to a particular football team), which might influence the forecasts of even the best forecaster, tend to cancel out when a reasonably large number of different individuals is involved in forming the consensus Thus the consensus represents a rather more clear-sighted and objective forecast than any individual can provide, on a consistent basis This is rather like the portfolio effect of equity investing that we met in Chapter Random factors (specific risk, in the case of investing) cancel out, leaving only the common factor (systematic risk) Beaver (1998) also refers to a similar effect with predictions of UK gross domestic product by 30 economists Here the consensus beat 29 and tied with one of the economists Another example of this seems to arise in the context of the TV quiz show Who Wants To Be A Millionaire? According to Surowiecki (2004), the ‘friends’ (who are selected by the contestant for their expertise) answer correctly 65 per cent of the time, whereas the audiences (each one a random selection of quite a large number of people) supply the correct answers to 91 per cent of the questions asked of them This 258 BUSF_C09.qxd 11/19/08 10:14 Page 259 www.downloadslide.com Tests of capital market efficiency is again explained by the portfolio effect It may be that contestants choose to ask the audience the easier, more obvious questions, but this difference in success rate is still striking Efficiency and speed of reaction Efficiency requires not only that prices react rationally to new information, but also that they react speedily Certainly, the rate at which data can be transmitted, received, and analysed, and the analysis transmitted, received, and acted upon by buying or selling, is very rapid, particularly in this era of cheap electronic data communication and processing Since there are large numbers of informed, highly motivated observers who are capable of quick action, we have good reason to believe that a sophisticated secondary capital market like the LSE would be efficient in its pricing of securities The question now becomes: is it efficient in practice? 9.4 Tests of capital market efficiency Forms of efficiency Attempts to assess efficiency have addressed themselves not so much to whether the capital markets are or are not efficient but rather to what extent they are efficient Roberts (1967) suggested that efficiency and tests of it should be dealt with under three headings: ‘ l Weak form If the market is efficient to this level, any information that might be con- tained in past price movements is already reflected in the securities’ prices ‘ l Semi-strong form This form of efficiency implies that all relevant publicly avail- able information is impounded in security prices ‘ l Strong form If present this would mean that all relevant information, including that which is available only to those in privileged positions (for example, managers), is fully reflected in security prices These are ascending levels of efficiency such that, if a market is strong-form efficient it must, therefore, also be semi-strong and weak-form efficient Approach taken by the tests Propositions such as that relating to capital market efficiency are not directly testable How can we test whether all available information is reflected in security prices? The researcher may not personally have all of the available information or even know that some of it exists We can, however, test whether or not security price behaviour seems consistent with efficiency Generally, the tests that have been carried out have tried to this The tests have sought to assess whether or not it seems possible to make abnormal returns by exploiting any possible inefficiency Abnormal returns in this context means returns in excess of those that could be made, over the same period in which the test was conducted, from securities of similar risk Returns typically means capital 259 BUSF_C09.qxd 11/19/08 10:14 Page 260 www.downloadslide.com Chapter • The secondary capital market and its efficiency gain plus dividend received over a period, expressed as a percentage of a security’s price at the start of that period Tests of this type pose several methodological problems Such is the number of factors acting simultaneously on the price of a particular security that it is difficult to know to what extent prices are affected by the specific factor in which the researcher is interested and to what extent other factors are involved For our present purposes, let us accept what most qualified observers believe, that the major researchers in this area, some of whose work we shall consider, have sufficiently well overcome the practical problems for their results to be regarded as providing significant insights Where this seems not to be the case, we shall discuss it Readers who are interested in looking at the methodological problems in detail should take up some of the references given during and at the end of this chapter Tests of weak-form efficiency Technical analysis ‘ It has long been popularly believed that security prices move in cycles or patterns that are predictable by those who study the matter closely enough Many feel that past patterns of security price behaviour repeat themselves, so that spotting a repeat starting to occur can put the investor in a position to make abnormally large investment returns Not surprisingly, adherents to this philosophy use graphs and charts of past security prices to facilitate recognition of the pattern early enough to benefit from it These people are often referred to as chartists Others seek to develop trading rules that are perhaps easier to apply than those of the chartists For example, it is believed by some that the price of a particular security tends to hover around a particular value, rarely deviating from it by more than a small percentage If the price starts to break out from the ±x per cent band, they believe that this implies a large movement about to occur This they feel can be taken advantage of by buying or selling according to the direction of the breakout Such dealing rules are usually called filter rules More generally, the use of techniques such as filter rules and charts is known as technical analysis If the market is efficient this should mean that no gains could be made from technical analysis because there are so many observers at work that if any information were contained in past price movements it would be impounded in the current price as a result of buying and selling Only new information would affect share prices As new information is random, security prices would be expected to follow a random path or random walk New information must be random or it would not be new information That the sales of a Christmas card manufacturer were greater towards the end of the year than at other times during that year is not new information because this pattern tends to occur every year and is predictable Spotting repeating patterns Let us suppose that the price of a particular security has followed the cyclical pattern shown in Figure 9.1 over a number of years There is obviously a regular pattern here What should we if we spotted this pattern at time t? Surely we should buy some of the securities and hold them until the next peak, sell them and buy some more at the following trough and so on until we became bored with making money! It seems too good to be true and, of course, it is In real life we should not be the only ones to spot 260 BUSF_C09.qxd 11/19/08 10:14 Page 261 www.downloadslide.com Tests of capital market efficiency this repetition of peaks and troughs; in fact there would be a very large number of us who would notice it As we try to sell at the peak, so would the others Since few potential buyers would be interested at the peak price, the price would drop Realising this, we should all try to sell earlier to try to beat the drop in price, which would simply cause it to occur still earlier The logical conclusion of this is that the price would not in fact ever rise to the peak Expecting the trough to be reached and eager not to miss it, we should be buying earlier and earlier, thus keeping the price up and ensuring that the trough is never reached either The net result of all this is that if there are sufficient investors following past price patterns and seeking to exploit repetitions of them, those repetitions simply will not occur In practice, the more likely price profile of that security would approximate to the horizontal broken line shown in Figure 9.1 Figure 9.1 Graph of the daily share price against time for a hypothetical security If this pattern were expected to occur, investors, by their buying and selling actions, would cause the pattern not to occur Weak-form efficiency test results The first recorded discovery of randomness in a competitive market was by Bachelier when he observed it as a characteristic of commodity prices on the Paris Bourse as long ago as 1900 His discovery went somewhat unnoticed until interest in the topic was rekindled some years later Kendall (1953), accepting the popular view of the day that LSE security prices move in regular cycles, tried to identify the pattern, only to discover that there was none; prices seemed to move randomly Efficiency and randomness imply that there should be no systematic correlation between the price movement on one day and that on another For example, it seems to be believed by some observers that if the price of a security rises today then it is more 261 BUSF_Z04.qxd 11/19/08 10:34 Page 504 www.downloadslide.com Glossary of its effective life It is a means of raising finance (p 244) Satisficing A business objective that seeks to provide all stakeholders with satisfactory returns, rather than promoting the interests of any single one of them (p 23) Scenario building A decision-analysis tool where various feasible combinations of input data are combined in an attempt to assess possible outcomes In effect, an extension of sensitivity analysis (p 158) Scrip dividend The issue of bonus shares to certain shareholders as an alternative to a cash dividend The expression usually applies only where there is a choice for the shareholders between the shares and cash (p 448) Seasoned equity offering A public issue of shares by a business that has already made at least one previous offering of shares to the public (p 225) Secondary capital market A market in which ‘second-hand’ securities issued by businesses (for example, shares) and other organisations are traded (p 218) Secured creditors People or organisations owed money under a contract that links the obligation with a particular asset of the borrower (p 15) Securities Shares and loan notes of businesses and other organisations (p 184) Securitisation Turning an expected future stream of positive cash flows into a security and selling it as a means of raising finance (p 241) Security market line The straight line on a graph of return against risk (as measured by beta) (p 199) Sell-offs Divestment devices where one business sells part of its undertaking to another business (p 402) Semi-strong-form capital market efficiency A situation where security prices, at all times, rationally reflect all publicly known information about the securities concerned (p 259) Sensitivity analysis An examination of the key variables affecting a project, to see how changes in each input might influence the outcome (p 154) Separation theorem The notion that business financing and investment decisions are strictly separate (p 31) Servicing (of finance) The cost of providing returns to suppliers of finance (for example, interest and dividends) (p 218) Share repurchase Where a business buys some of its own shares from existing shareholders, usually to cancel them (p 334) Shareholder value analysis A method of measuring and managing business value based on the long-term 504 cash flows generated It identifies various factors that are seen as the key ‘value drivers’ (p 137) Short-termism A tendency for managers to make decisions that will provide benefits in the short term, while possibly jeopardising the long-term future of the business (p 27) Signalling A business indicating, through its behaviour (such as having a particular level of capital gearing or paying a particular level of dividend), something about itself to the outside world (p 308) Soft capital rationing This arises where a business’s capital rationing is caused by a self-imposed unwillingness to provide funds to meet all desirable potential investments (p 126) Specific risk That aspect of total risk that arises from factors that are related to the particular investment concerned as opposed to general/macroeconomic factors It can, in theory, be eliminated by diversification of investments (p 165) Spin-off Where a business takes part of its operations and turns it into a separate business Shareholders of the old business are issued with shares in the new business in proportion to the size of their investment in the old business (p 402) Spot (foreign exchange) rate The rate of exchange between two currencies where the foreign exchange transaction is to be completed immediately (p 412) Standard deviation A statistical measure of the dispersion of individual outcomes about their mean or expected value; it is the square root of the variance (p 186) Strategic planning The act of establishing the best area of activity and style of approach for the business (p 135) Strong-form capital market efficiency A situation where security prices, at all times, rationally reflect all publicly and privately known information about the securities concerned (p 259) Subjective probabilities Probabilities based on opinion rather than past data (p 160) SWOT analysis A framework in which many businesses set a position analysis Here the business lists its strengths, weaknesses, opportunities and threats (p 136) Synergy The name given to the phenomenon that when two or more businesses combine, the combined business is more effective and valuable than the sum of the constituent businesses (p 391) Systematic risk That aspect of total risk that arises from general/macroeconomic factors as opposed to factors that are related to the particular investment concerned (p 166) BUSF_Z04.qxd 11/19/08 10:34 Page 505 www.downloadslide.com Glossary Takeover A business amalgamation where one business buys sufficient shares in another business to control it Also known as merger (p 388) Tax shield The value of the asset of the tax benefit of using loans in the long-term finance of the business (p 305) Technical analysis The use of technical rules and charts of past security price movements to spot profitable investment opportunities (p 260) Term loans Loans, typically by a bank or similar institution, usually for a specified period of time (p 241) Trade-off theory A theory of capital/financial gearing that holds that determining the optimum level of gearing requires that a balance is struck between the value of the tax shield, on the one hand, and potential bankruptcy cost, on the other (p 313) Transaction risk The risk that buying or selling a product or service priced in a foreign currency will lead to losses because of an adverse shift in exchange rates between the time of the transaction and the payment or receipt of the foreign currency (p 419) Translation risk The risk that the value of assets held overseas may reduce, in terms of the home currency, as a result of an adverse shift in the exchange rate (p 424) Two-fund separation The notion that all rational risk-averse investors will choose to invest only in a risk-free investment and the market portfolio (p 197) Unadjusted rate of return See Accounting rate of return (p 97) Unsecured creditors People or organisations owed money under a contract that links the obligation with the general assets of the borrower, rather than with a particular one (p 15) Utility Personal satisfaction from some desirable factor (p 36) Value drivers The factors that are seen in shareholder value analysis as being key in generating shareholder value (p 138) Variance A statistical measure of the dispersion of individual outcomes about their mean or expected value; it is the square of the standard deviation (p 186) Venture capital Equity finance provided to support new, expanding and entrepreneurial businesses (p 442) Warrants Options, granted by a business, that entitle the holder to subscribe for a specified quantity of (usually) ordinary shares, for a specified price, on or after a specified date (p 240) Weak-form capital market efficiency A situation where security prices, at all times, reflect all information about the securities concerned implied by their past price movements (p 259) Weighted average cost of capital The average cost of capital for a business, being the average of the costs of the various constituents of capital (such as shares and loan notes), weighted by the market value of each constituent (p 274) Working capital Short-term assets, net of short-term liabilities (p 113) Z-score A measure of the potential for a business to survive rather than fail due to financial inadequacies (p 57) 505 BUSF_Z05.qxd 11/19/08 10:34 Page 506 www.downloadslide.com References Aharony, J and Swary, I (1980) Quarterly dividends and earnings announcements and stockholders’ returns: an empirical analysis Journal of Finance (March) Akbar, S and Stark, A (2003) Deflators, net shareholder cash flows, dividends, capital contributions and estimated models of corporate valuation Journal of Business Finance and Accounting (December) Al-Ali, J and Arkwright, T (2000) An investigation of UK companies’ practices in the determination, interpretation and usage of cost of capital Journal of Interdisciplinary Economics (Vol 11) Alexander, S (1961) Price movements in speculative markets: trends or random walks Industrial Management Review (May) Alkaraan, F and Northcott, D (2006) Strategic capital investment decision-making: A role for emergent analysis tools? 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Finance and Accounting (April/May) Wilson Committee (1980) Committee to Review the Functioning of Financial Institutions (HMSO) 511 BUSF_Z06.qxd 11/19/08 10:35 Page 512 www.downloadslide.com Index Note: Page references in bold type relate to the Glossary abandonment of investment projects 133–4 abnormal returns 259, 264, 267 accountability of directors 10 accounting methods changes in 265, 338 deficiencies of 46–50, 64–5 accounting rate of return (ARR) 97– 9, 102, 440, 500 accounts receivable see trade receivables accruals 48 acid test ratio 58 ‘active’ trading 269 activity ratios 55–7, 67 Adnams plc 443 agency costs 27, 32, 207, 307– 8, 333, 336 –9, 390, 429, 437, 500 aggressive securities 199 Aharony, J 335 Akbar, S 335 Al-Ali, J 121, 204–5, 280, 285 Alcan Inc 395 Alexander, S 263 Alkaraan, F 100, 137, 143, 174, 205 Allen, F 336 Alternative Investment Market (AIM) 232, 442–3 American football 257–8 Amstrad plc 395 Andrade, G 311 ‘angels’ 442, 500 annual general meetings 222 annual reports of companies 9, 25 annuities and annuity tables 85–6, 132, 460, 500 arbitrage pricing model (APM) 205 – 6, 500 Arkwright, T 121, 204 –5, 280, 285 Arnold, G.C 99–100, 126, 134, 439 – 40 Arriva plc 338 Articles of Association asset-backed finance 241–2, 248 512 assets definition and valuation of 46–7 tendency towards overstatement of 52 Associated British Foods (ABF) plc 129, 354–5, 360, 368, 373, 425 Atrill, P.F 116 audit 9–10 see also post audits Automobile Association (AA) 17, 401 bad debts 369, 371 Baker, H 335 balance sheets 43–5, 64, 79, 500 values in 49 Balbirer, S.D 415–16, 427 Balfour Beatty plc 354 Bank of England 121, 412–13, 436, 442 bankruptcy and associated costs 15, 304, 310, 312, 315, 440, 500 Barclay, M 309, 314, 337 Barclays Bank plc 244 Barney, L 339 Bauger Group 402 bear positions 254 Beattie, V 315 Beaver, W.H 257 Benito, A 334 Benkato, O 309–10 Bernardo, A 336 beta (β) analysis 174, 199–204, 500 Blake, D 267 Boardman, C.M 101 boards of companies see also directors bonus shares 224–5, 265, 500 bonuses for directors 26 for managers 142 Boots the Chemist 17, 367 borrowing by businesses 14, 29–30, 294–6 Bradford and Bingley plc 339 brand names 141 Braund, S 121, 243 break-even analysis 158 Brealey, R 263 British Airports Authority (BAA) 395, 400 British Airways plc (BA) 158, 235, 239, 243, 245, 338, 400 British Energy plc 235 British Land Company 229 British Petroleum plc (BP) 129, 283, 338–9 British Sky Broadcasting Group plc 395 British Telecom Group plc (BT) 25, 337–8 Bruner, R 399 budgets, use of 356, 365 buffer stocks 364–5 bull positions 254 Bunn, P 314 business finance in relation to accounting and risk role of business risk 297, 302, 500 Busse, J 266 buy-and-hold policy 269 buy-ins 402, 500 buying back of shares 334–4, 338, 504 Cadbury Schweppes plc 64, 309, 403, 408–9 call options 422 capital allowances 117–19, 243, 500 capital asset pricing model (CAPM) 185, 198–205, 208–9, 264, 280, 500 assumptions of 202 and derivation of discount rates 204–5 practical use of 205 tests of 200–1 weaknesses of 185, 203–4 BUSF_Z06.qxd 11/19/08 10:35 Page 513 www.downloadslide.com Index capital gains tax 223, 331 capital gearing 59–60, 67, 306–7, 315 –17, 500 determinants of 315 capital market line (CML) 198–9, 206, 500 capital rationing 126–9, 145, 500, 502, 504 capitalisation of expenses 51 Carlton plc Carphone Warehouse Group plc 142 Carsberg, B 121 cash, holding of 372–9, 382–3 costs and risks of 373 models for management of 374 –5 practical aspects of 376–9 cash flow statements 45–6, 500 cash flows as distinct from accounting flows 112 –14, 144 forecasting of 117 and investment opportunities 337 planning of 377–9 in real terms 120–1 for small businesses 447 cash surpluses, short-term 376 Caterham Cars Ltd 402 Celec, S.E 101 chance, role of 268–9 ‘chartists’ 260 Chen, S 102, 137 Chicago Daily News 258 City Panel on Takeovers and Mergers 396–7 Clark, R.L 102 Clayton, R 310 clientele effect 306, 308, 332, 336, 339, 500 codes of practice 11–12, 396 Combined Code (on corporate governance) 11–12, 26, 500 Companies House competition, elimination or reduction of 389 Competition Commission 395–6 concealment of losses or liabilities 51 consensus views 257–9 control of companies 222–34, 239 conventions of accounting 47–9 convertible issues 240, 246, 248, 281, 500 Cooper, I 427–8 Coopers and Lybrand 398 corporate governance 9–12, 500 corporate objectives of companies 19–26, 32, 136, 437 corporation tax 139, 243, 331, 438–9 correlation coefficient 190–1, 500 Corven Ventures Ltd 402 cost of capital 117, 120, 126, 139, 274–7, 289, 500 minimisation of 281 see also opportunity cost of capital; weighted average cost of capital Costain Group plc 14, 229, 231 coupon rate 234, 501 covariance of expected returns 198, 501 covenants 238, 501 Craven, B.M 27 creative accounting 50–3, 67, 501 credit granting or denying of 368–70 taking of 379–80 credit ratings 235–6, 310 creditors of companies 14–15 see also trade payables creditworthiness of customers 369–71 Crossland, M 336 cum dividend 278–9, 336, 501 Cunningham, S.W 263 currency futures 422, 430 currency options 421–2, 431, 501 currency swaps 424, 501 current and non-current assets 44, 501 current ratio 57–8 Dann, L 265 Datta, S 400 days trade payables 57 days trade receivables 56–7 dealing charges 303–4 DeAngelo, H 309, 334 DeAngelo, L 334 Debenhams plc 17 debentures 234–5, 247–8, 275, 294, 501 debt financing, tax advantage of 306, 310 debtors see trade receivables decision-making, financial 17–21, 32 on investment and on financing 244 NPV as basis for 80 use of accounting information for 49–50 defensive securities 199 Dell Inc 51 Deloitte 314 Demirag, I 27 Dempsey, M 306, 336 depreciation 44–5, 49, 114–17 derivatives 15–18, 256, 501 Dewenter, K 336 Di Nino, V 421–4 Digital Look Ltd 204 Dimson, E 204, 206–7, 288 Director General of Fair Trading 395, 397 directors of companies 8–14 restrictions on 10, 13, 229, 308 role and responsibilities of 9–10, 14 types 11–12 disclosure 10 discount rates 204–5 discounted cash flow yield see internal rate of return discounting over time and discount rates 84–7, 115–17, 120–1, 174, 204–5, 244, 274–6, 283–8 for small businesses 439–41 techniques of 100–1 discounts on forward currency transactions 417 on new shares 227 for prompt payment 369, 371, 374 dislocation of production 361 diversification 501 international 427–9 of security investment 164–5, 176, 187–9, 195, 206, 208 for small businesses 440–1 through mergers 390–1, 400 within businesses 207, 390, 440–1 divestmemts 400–4, 501 dividend cover ratio 61 dividend yield (DY) 61, 221, 444–5 dividends 12–13, 222–3, 233, 278–81, 326–41 cancellation of 328 companies’ policies on 332–6, 339 effect on share prices 335 ‘home-made’ 327–9 paid by small businesses 448 reinvestment of 339 as a residual 328 scale of 334–5 timing of 329 traditional view of 329–30 Dr Pepper Snapple Group Inc 403 Domino’s Pizza plc 443 Dragons’ Den 442 513 BUSF_Z06.qxd 11/19/08 10:35 Page 514 www.downloadslide.com Index Draper, P 399 Drury, C 121, 243 Dryden, M.M 263 DuPont Corporation 129 earnings of companies see profits earnings per share 60, 137, 302–3, 338 easyJet plc 136, 400 economic risk from exchange rate movements 422–4, 431, 501 economic value for small businesses 447 economic value added (EVA) 137, 140 –2, 501 economies of scale 389–91 efficiency of capital markets 184–5, 197, 253, 256 –71, 303, 501 semi-strong form of 259, 264–6, 504 strong form of 259, 266–7, 332, 504 weak form of 259–64, 505 efficiency of foreign exchange markets 417–18 efficient frontier 194–6, 501 efficient market paradox 267 El-Masry, A 16 Elton, E.J 336 EMI Group plc 337 Enron Corporation 51–2 environmental factors 426 equity finance 12, 59, 219–23, 501 factors for businesses to consider 221–2 factors for potential investors to consider 222–3 raising of 223–32 Eriotis, N 310 Ernst and Young 142 ethical constraints 426 Ettridge, M 338 euro currency 411 Eurobonds 239, 501 European Union 218 ex dividend 278 –9, 336, 501 exchange rate costs 369, 373, 380 exchange rate risk 371–2, 379–81, 418, 430, 501 exchange rates determinants of 412–13 management of 418 theoretical explanations for 414 –17, 429 –30 executive and non-executive directors 11–12 expected returns from investments and loans 206 –7, 295, 299 514 expected value (EV) 162–6, 173, 175–6, 186–7, 189–90, 501 ‘expert’ investors 266–7 differences between industrial sectors 310 evidence on 308–11 Modigliani and Miller’s view of factoring 371 300–6, 309–13, 316–17 Fama, E 203, 263–5, 334–6 optimum level of 299, 310 Ferdinand, Rio 244 for small businesses 447 Ferreira, M and M 428 General Motors Corporation 235 Ferrovial company 395, 400 Givaudan company 401 filter rules 260, 263 Gleason, K 428 finance leases 242–3, 248, 277–8, 501 going concern convention 48–9 financial accounting, role of 112 Goodcare, A 315 financial risk 297, 501 goodwill 141, 361, 370, 373–4, 379 financial statements 39–46, 67 Gordon growth model 280 quality of 52 government securities 204 Financial Times 136, 235 Goyal, V 314 all-share index 203 Graham, J 101–2, 143, 205, 280–3, financing costs 117 310, 314, 316, 336 see also cost of capital Granada plc Finnerty, J 266 grants from public funds 245, 249 First Choice Holidays plc 25, 339, Green, T 266 424 Greene King plc 134 First Group plc 395 Gregory, A 205, 399 Firth, M 265–6 gross profit margin 54 Fisher, Irving 31, 197, 302 growth of companies 23 Fisher, L 265 Gruber, M.J 336 Fisher effect (on real interest rates) 415–16, 501 half-yearly financial statements international 416, 502 Hamada, R.S 309 flat yield 236 Hand, J 335–6 footballers and football clubs 244, Harris, P 399 401, 443 Harvey, C.R 101–2, 143, 205, 280–3, see also American football 310, 314, 316 Ford Motor Company 401–2 Hatzopoulos, P.D 99–100, 126, 134, foreign exchange 411–18, 429 439–40 dealing in 412 hedging problems with 418–25 against inflation 223 see also exchange rates in money markets 421, 431 foreign exchange markets herd insinct 267 efficiency of 417–18 Higgs Report 11 need for 411–12 hire purchase (HP) 244–5, 249, 502 Forum for Private Businesses 435 Hirshleifer, J 31 forward exchange contracts 412, historic cost 47–8, 141 417, 420–1, 430, 501 Hofler, R.A 310 Frank, M 314 Homaifar, G 309–10 Franks, J.R 399 Honda Motor Europe plc 367 French, K 203, 264, 334–6 Hope, A 121 Fuller, K 399 Hughes, C 136 hurdle rates 92, 94, 101, 203 Game Group plc 396 Game Station Ltd 396 Ibbotson, R.C 204–5 GB Airways Ltd 136, 400 Ikenberry, D.L 334–5 gearing 14, 51, 59, 282–3, 286, Imperial Chemicals Ltd 401 295–317, 401 income measurement 49 capital/financial and operating income statements 42–3, 64, 502 indifference curves 166–8 types 306–7 industrial buildings, tax relief on differences between countries 118–19 310 BUSF_Z06.qxd 11/19/08 10:35 Page 515 www.downloadslide.com Index inflation 47, 81, 120 –1, 144, 380, 502 forecasts of 121 hedging against 223 initial public offerings (IPOs) 225 –9, 502 inside information and insider dealing 10, 266–7 institutional investors 10–11, 222, 235, 303 – 4, 440 integer programming 129, 502 interest cover ratio 60 interest foregone 81 interest rate parity 416–17, 502 interest rate risk 238–9, 502 interest rate swaps 239, 502 interest rates on loan notes 237–9 risk-free 196, 203–4, 207, 503 internal rate of return (IRR) 87–94, 99 –101, 104, 203, 439 – 40, 502 International Accounting Standards Board 42 International Financial Reporting Standards 9, 42, 64 internationalisation of business 11, 408 –31 reasons for 409–11 risk associated with 427–9 inventories 359–68, 381–2, 448 models of 361–5 practical management of 365–6 inventories turnover period ratio 56 investment appraisal 153–76 alternative techniques of 80–99 and corporate objectives 99–100 data for 133 international 425–7, 431 methods used in practice 99–103, 105 multiple methods of 100 objectives of 113 and strategic planning 135–7 investment decisions implementation and monitoring of effects of 133 in practice 133–4 for small businesses 439–40 investment opportunities 79–80 and cash flows 337 comparison of 82 identification of 132–3 lasting for more than one year 83 –5 investment overseas 174 investment in securities 187–9, 195, 206, 208 investors’ ratios 60–1, 67, 221, 233, 236 ‘irrational’ behaviour 264, 268 Iskander-Datta, M 400 issue costs 221–2, 228–9, 233, 237, 240, 313, 315, 331 issuing houses 226 ITV Digital plc Jaffe, J 266 Jaguar Cars 401–2 Jarvis plc 227 JD Wetherspoon plc 25–6, 354–5 Jensen, M 24, 265, 308 JP Jenkins Ltd 443 Julio, B 334–5 junk bonds 235, 401, 502 just-in-time systems 366 Kaplan, S.N 311 Kaplanis, E 427–8 Kendall, M.G 261 Kester, W.C 310 Kim, J 338 Kingfisher plc 339 KPMG 399 Kumar, A 336 Ladbrokes plc 134 Laidlaw International Inc 395 Lamont, O 207 land and buildings, sale and leaseback of 244 Land Rover company 401–2 Landsman, W 335–6 law of one price 414–15, 502 Lease, R.C 336 leasing 242–5 see also sale and leaseback Lee, I 228 Leeds United FC 244, 401 lending by businesses 29–30 leverage 14 see also gearing leveraged buy-outs 401 Lewellen, W.G 336 liabilities, concealment of 51 Library House 442 ‘Limited’, use of term 8, 438 limited companies 6–9 limited liability 7, 223 Limmack, R.J 399 linear programming (LP) 128–9, 502 liquidation 502 of businesses 14–15, 220, 222, 304 of investments 223, 232, 234, 239, 253, 441 liquidity 58, 332–3 maintenance of 357 need for 356–7 liquidity ratios 57–9, 67 listed companies 6–7, 225–6, 443 Litzenberger, R 336 loan financing 59 see also secured loans; term loans loan notes 14, 46, 184, 217, 234–40, 247–8, 275–6, 287–9, 294, 297, 502 convertible 240, 281 perpetual 277 use in mergers 392 Lockhead, S 228 London Stock Exchange (LSE) 6, 9–12, 218, 225–6, 229, 232, 235, 253–6, 263, 267, 270, 396, 438, 440 dealing on 254–6 equity issues by listed businesses 226 members of 253–4 ownership of shares listed on 10–11 long-term financing of companies 12–14, 17, 253 influences on decisions about 218 selecting the most appropriate type of 245–6 sources of 217–49 long-term stability of companies 22–3 losses, concealment of 51 Lotus Cars Ltd 402 McClure, K.G 310 McKinsey and Co 134 McLaney, E 116, 205, 274, 280, 288 Mahate, A 399 Majestic Wine plc 443 management buy-outs (MBOs) 401–2, 435, 502 managers, interests of 26–7, 207, 270, 429 market makers 254 market portfolio 197, 199, 203, 502 expected return on 204–5 marketable investments 142, 376 Marks and Spencer plc 25, 338 Marsh, P 204, 206–7, 282, 288 Marston, C.L 27 Masulis, R 309 matching of expenses to revenue 48–9 Mathur, I 428 Mayers, D 265 mean value see expected value 515 BUSF_Z06.qxd 11/19/08 10:35 Page 516 www.downloadslide.com Index Mehrotra, V 314 Memoranda of Association mergers 388–400, 403, 502 appraisals of 394 financing of 391–4 hostile and friendly 394 –9 international 400 reasons for 388–91 reduction in number of 393, 400 regulation of 395–6 steps towards 396–7 success and failure of 398–400 mezzanine finance 402 Mikkelson, W 314 Miller, M.H 300–6, 309–13, 316 –17, 327– 40, 345 – mission 135 Modigliani, F 300–6, 309–13, 316 –17, 327– 40, 345 – Moeller, S 399 Moizer, P 336 ‘Monday effects’ 264 money changes in value of 47 see also inflation time value of 80–1 see also discounting money market hedges 421, 431, 502 money measurement convention 47 monopolies 391 Monopolies and Mergers Commission see Competition Commission Monsoon plc 337 Moody’s credit rating agency 235 Morris, R 265 Morrison, D 448 Mougoue, M 336 Myers, S 313 net asset turnover ratio 53–4 net operating profit after tax (NOPAT) 140–1 net present value (NPV) 80–101, 104, 111–13, 126 –7, 136 –7, 144, 203, 502 adjusted for tax effect of debt finance 316 advantages of 82 compared with ARR 97–9 compared with IRR 88–94 compared with PBR 96–7 and shareholder wealth 86 for small businesses 439–40 systematic understatement of 115 –16, 121 Netter, J 399 516 netting on foreign exchange transactions 420, 430 Next plc 102, 116, 338 Nissan Motors UK Ltd 368 Nissim, D 335–6 no credit period ratio 58–9 Nokia 435 Northcott, D 100, 137, 143, 174, 205 Northern Rock plc 223 offers by prospectus 226 Ooi, T.S 24–5, 100 O’Leary, Michael 337 operating cash cycle 352–3, 381, 502–3 operating leases 242 operating profit margin 138 operating profit margin ratio 55 opportunity cash flows 116 opportunity cost of capital 30, 276, 283, 285, 329, 503 options 15–16, 503 see also currency options; real options order quantities, optimal 365 ordinary shares 12–13, 246–7, 278, 289–90, 503 use in mergers 392 Organisation for Economic Cooperation and Development (OECD) 10 Osborne, P 121 Oswald, D 338 outsourcing 435, 503 over-the-counter (OTC) market 256 overdrafts 59, 375–9 overreaction 263–4 overseas investment and financing 409 overtrading 358–9, 503 Ozkan, A 282, 310 par values 220, 503 Parmalat SpA 52 Partch, M 314 Paudyal, K 399 payback period (PBR) 94–102, 104–5, 440, 503 compared with NPV 96–7 pecking-order theory 313–18, 333, 339, 503 pegging of currencies 411, 413 perfect markets 256 Pettit, R.R 335–6 pharmaceutical manufacturers 22 Picou, A 264 Pike, R.H 24–5, 99–101,133, 205 placing of shares 226–7 plant and machinery, tax relief on 118 ‘plc’ description PLUS market 443 Pointon, J 116, 205, 274, 280, 288 Polk, C 207 portfolio theory and portfolio effect 164, 185–209, 503 international 419, 425, 428–31 position analysis 136, 503 post audits 133–4, 503 Powell, G 335 pre-emption rights 229 preference shares 13–14, 232–4, 247, 278, 289, 503 preferences, trading-off of 166–7 Premier Oil plc 240 present value table 459 price/earnings (P/E) ratio 60–1, 221, 445–6 pricing models see arbitrage pricing model; capital asset pricing model primary capital market 218, 252, 503 primary ratio 54 private equity funds 16–18, 388, 400, 503 private limited companies 8, 438 probabilities, use of 159–62 profit and loss accounts see income statements profit-taking 269 profitability index 127, 503 profitability ratios 53–5, 67 profits definition of 25, 46, 48 economic 140 maximisation of 22 reinvestment of 13 retention of 45, 219, 222–5, 281, 315, 331, 439–42 taxable 117–19 prudence convention 48, 141 public companies public interest 391 public issues of shares 227–9 puchasing power parities (PPPs) 414–15, 426, 503 put options 422 Quest plc 401 quick assets ratio 58 Raab, R 265 Ramaswamy, K 336 Rank Group plc 238 BUSF_Z06.qxd 11/19/08 10:35 Page 517 www.downloadslide.com Index Rao, R 336 Rappaport, A 137 ratio analysis 53–67, 221 caution in interpretation of 63 limitations of 64–5 for management of working capital 358, 365 – 6, 372, 381 use for prediction of financial failure 66 real options 143, 146 realisation convention 47–8 rebalancing of portfolios 269 Reckitt Benckiser plc 25, 134 redemption of loan notes 237 of shares 14, 233 redemption dates 234–5 redemption yield 236 Registrar of Companies 8–9 Reinhart, W.J 101 remittances between countries 426 reorder costs 361 reorder levels 365 repeating patterns 260–1, 268 replacement decisions 130–2, 145 required rates of return 140–1, 270, 284 research and development costs 141 reserves 45 restructuring, corporate 141, 387– 404 Retail Prices Index (RPI) 120 return on capital employed (ROCE) 53 –5, 64, 137 maximisation of 22 return on ordinary share-holders’ funds 54 Ricci, C 421–4 rights issues 222–3, 228–32 pricing of 231 Rio Tinto plc 339, 395 risk 81, 503 as distinct from uncertainty 154 to future dividends 330 importance of taking account of 154 in investment appraisal 153–76 on investment in securities 187–9 reduction of 158–9, 390, 409–10 in relation to return 5, 185, 190–1, 218 –19, 246, 297, 299 for small businesses 440–1 specific and systematic 165 – 6, 188–9, 195, 198, 427, 440, 447, 504 see also business risk; economic risk; financial risk risk analysis for international investment 427 in practice 174, 176 risk aversion 95–6, 169–73, 186, 190, 311, 503 risk-free assets 196–7, 503 risk premia 199, 205–7 risk/return profiles 189–94 Ritter, J 228 Roberts, H 259 Roll, R 265 Rolls-Royce plc 100, 134, 199, 339, 355 Ross, S.A 205–6 Royal Bank of Scotland plc 225 Royal Dutch Shell plc 339 Rutterford, J 205 Ryan, H 142 Ryanair Holdings plc 337 Saga Ltd 401 sale and leaseback 244, 248–9, 503–4 sales revenue 138, 307, 315 ratio to to capital employed 53–4 satisficing 23–4, 504 scenario building 158, 504 Schlarbaum, G.G 336 Schooley, D 339 seasoned equity offerings (SEOs) 225, 227, 229, 504 secondary capital market 223, 252–71, 278, 504 secured loans 15, 219, 245, 504 securitisation 241–2, 248, 504 security market line (SML) 199–200, 504 sell-offs between established businesses 402, 504 sensitivity analysis 154–9, 174–5, 504 separation theorem 31, 504 derivation of 35–40 serial correlation tests 263 settlement periods 56–7, 372 Severn Trent plc 25 Shapiro, A.C 415–16, 427 share issues 46, 185, 221–9, 314–15, 331 in depressed markets 228 see also rights issues share options 26 share prices 13, 326–7, 332 effect of dividends on 335 shareholder value analysis (SVA) 137–40, 504 shareholders 8–10, 14–15, 219–20 capital gains for 331 contribution made to business by 45 prefererred habitats of 332 return on funds of 54 safeguarding the interests of 9–10, 20, 26–8, 307–8 wealth maximisation for 22–8, 173, 253, 269–70, 283, 298–300, 327, 387, 410, 437 wealth related to NPV 86, 137 see also institutional investors shares nominal value of 220, 233 ownership of 10–11 redemption of 14, 233 repurchase of 333–4, 338, 504 transferability of 7, 438 types 12–14 undervaluation of 313–15 see also share issues; share prices Sharpe, W 200 Shell see Royal Dutch Shell Shepherd Neame Ltd 443 Shlingemann, F 399 short-termism 27, 54–5, 504 Siddiqi, M 337 signalling 308, 331–2, 335–6, 504 Singh, M 428 Sinquefield, R 204–5 Skinner, D 334 small businesses 434–51 definition of 434–5 dividends paid by 448 failure of 436–7 importance of 435–6 investment decisions made by 439–40 organisation of 438 sources of finance for 441–4 taxation of 438–9, 447 valuation of 444–7 working capital for 448 Smith, C 309, 314, 337 special purpose entities (SPEs) 51 speed of reaction to market information 259, 265–6, 270 spin-offs 402–3 Standard and Poor’s 235 standard deviation 186–91, 206, 504 Stanley, K.L 336 Stark, A 335 Staunton, M 204, 206–7, 288 Stegemoller, M 399 Stern, Stewart and Company (SS) 140–2 Stiglitz, J.E 304 517 BUSF_Z06.qxd 11/19/08 10:35 Page 518 www.downloadslide.com Index 518 Stock Exchange Automated Quotations (SEAQ) system 254 –5 Stock Exchange Electronic Trading System (SETS) 255 stock in trade see inventories stock markets 184 –5, 252, 441–2 Storey, D 437 strategic planning 135–7, 504 Stulz, R 399 sub-prime loans 241 Sudarsanam, S 399 Sugar, Sir Alan 395 Summers, B 448 Sunder, S 265 supermarkets 58 Surowiecki, J 258–9 survival of businesses 22, 436–7 swaps see currency swaps; interest rate swaps Swary, I 335 SWOT analysis 136, 504 synergy 391 trade payables 379–83 management of 380 for small businesses 448–9 trade receivables 368–72, 382 for small businesses 448 management of 370–2 Trahan, E 142 transaction risk with foreign exchange 419–23, 505 translation risk with foreign exchange 424–5, 431, 505 Tucker, J 205, 274, 280, 288 turbulence in markets 265 turnover ratios 53–6 two-fund separation 197, 505 takeovers 27, 207, 388, 505 see also mergers Tata Group 401 Tate amd Lyle plc 388 tax shield of borrowings 305, 312–13, 505 taxation and tax relief 117–20, 139, 144, 222 – 4, 237, 239, 242 –3, 246, 305 – 6, 309 –15, 331, 426 for small businesses 438–9, 447 Tayles, M 121 technical analysis 260–3, 267, 504 tenders for issue of shares 227–8 term loans 241, 248, 277, 294, 504 Tesco plc 199, 239, 244, 280, 355 Thomas, M 205, 274, 280, 288 Thomson, S 315 time-adjusted measures of financial benefit 86–7 Timmermann, A 267 trade-off theory (between tax shield and costs of bankruptcy) 312 –17, 504 value-based management (VBM) 137–42, 145–6 value drivers 138–40, 505 variance 186, 505 see also standard deviation Vasilou, D 310 Veit, E 335 Ventoura-Neokosmidi, Z 310 venture capital 442, 505 Vodafone Group plc 256, 427 uncertainty, nature of 154 underdeveloped countries 253 underutilisation of assets 390 underwriting of share issues 227 Unilever plc 339 utility curves 195–7 utility theory 166–9, 176, 505 Walker, M 207, 399 warrants 240–1, 248, 282, 505 Warther, V 336 Watts, R 309, 337 wealth of companies 42, 45 tendency towards understatement of 49, 64 wealth of shareholders see shareholders weighted average cost of capital (WACC) 274, 282–90, 298–316, 505 tendency to be forward-looking 287 used as the discount rate 283–8 values used in practice 288–9 Welch, I 267, 336 West Cornwall Pasty Co Ltd 401 Weston, J.F 309 Whistles retail chain 402 Who Wants To Be A Millionaire? 258–9 Wilson, N 448 Wilson Committee report (1980) 441 ‘window dressing’ 269 withholding of unfavourable information 270 Wolfe, M 99 Wolseley plc 199 working capital 113, 139, 349–83, 505 decisions on 355–6 financing of 349–50, 357–8 general attitude to 356 link with long-term investment and financing 351–3 and liquidity 356–8 management of 350, 358 need for 349 scale of 354–5 for small businesses 448 working capital cycle 350–1 WorldCom 51 Xerox Corporation 51 Yield see discounted cash flow yield; dividend yield; flat yield; redemption yield Young, G 314, 334 Young, S 338 Young and Co’s Brewery plc 221 Z-scores 66, 505 Zaman, M 205 Zeitz, J 309–10 Zhao, Q 228 Ziv, A 335–6 ... morning and buying them back in the evening, than the normal expected returns from the shares over one day (see, for example, Mehdian and Perry 20 01, Sun and Tong 20 02, and Brusa, Liu and Schulman 20 03... the particular business, seems to be regarded as a standard means of determining discount rates Evidence (Petty and Scott 1981; Corr 1983; Al-Ali and Arkwright 20 00; Arnold and Hatzopoulos 20 00)... precipitated the action 26 5 BUSF_C09.qxd 11/19/08 10:14 Page 26 6 www.downloadslide.com Chapter • The secondary capital market and its efficiency More recently, Busse and Green (20 02) found that good