1. Fundamentals of Finance Bob Donchez
7/30/2018
CUBIC 2014 Section 2
Fundamentals of Finance
Bob Donchez
CUBIC Fundamentals of Finance

2. 2-0 Sources of capital funding by companies
Topics
2-0 Private sources of funding
2-1 Retained profits
2-2 Bonds and bank loans
2-3 Stock

3. Sources of Capital 2-0 Private Sources of Funding
Private start-ups initially get money from:
Self
Family and friends
Angel capital
Venture capital

4. Sources of Capital 2-1 Retained profits
Company profits can be used for:
Dividends
Retained earnings

5. The more a company pays in dividends (all other aspects remaining the same) A. The faster a company can grow B. The slower a company can grow C. Dividends have no effect on growth

6. Sources of Capital 2-2 Bonds
Section Topics:
Bond Terminology
Bond Ratings
Types of Bonds
Interest rates and their effect on bond values

7. Sources of Capital 2-2 Bonds
Bond Terminology
Par/Face Value: amount paid at maturity
Coupon: interest payment (usually fixed)
Maturity: date when bond face value paid
Yield to maturity (YTM): % return of bond (if held to maturity)
Bond covenants: loan agreement, terms

8. Sources of Capital 2-2 Bonds
7/30/2018
Sources of Capital Bonds
Rating agencies and sample rating chart
QUALITY
S&P
Moody's
Description
High Grade
AAA
Aaa
Bonds judged to be of the best quality. They carry the smallest degree of investment risk.  AA Aa
Bonds that are judged to be of high quality by all standards. They are rated lower than the best bonds because margins of protection may not be as large. 
Medium Grade A
Upper-medium grade obligations. Factors giving security to principal and interest are considered adequate.
Bottom of Inv. Grade
BBB
Baa
Bonds that are considered as medium-grade obligations -- they are neither highly protected or poorly secured.
Speculative Grade BB Ba
Bonds that have speculative elements. Protection of principal and interest may be moderate. B
Bonds that lack the characteristics of a desirable investment. There may be small assurance of principal and interest payments over any long period.
Default
CCC
Caa
Bonds of poor standing. These issues may be in default or there may be elements of danger present with respect to principal and interest. CC Ca
Obligations speculative to a high degree. These issues are often in default. C
Lowest rated class in Moody's list.
Rating given to income bonds on which interest is not being paid. D
Issues in arrears in interest and/or principal payments.
CUBIC Fundamentals of Finance

9. Sources of Capital 2-2 Bonds
Bond Ratings
Estimates bond quality, probability of default
Has major effect on yields and price
As ratings fall:
Quality of the bonds fall
The probability of bond default rises
The price of the bond falls
The resulting yields rise to compensate for risk

10. Sources of Capital 2-2 Bonds
Types of Bonds
Secured versus unsecured bonds
Callable bonds
Convertible bonds
Zero coupon bonds
Bond by issuer
Corporation
Government

11. Sources of Capital 2-2 Bonds
Yield curves (term structure of interest rates)
Provides the yields on the same type of bond over different maturity levels

12. Sources of Capital 2-2 Bonds
Interest rates
Changes in interest rate have a strong effect on bond prices:
As interest rates rise, bond prices fall
As interest rates fall, bond prices rise
Long term bonds are affected much more than short term bonds
On-line resources:

13. Sources of Capital 2-2 Bonds
Advantages of debt
Cheaper than equity
Usually a fixed cost
Usually a tax deductible interest expense
After expenses, interest, and taxes are paid, shareholders keep all profits remaining—no “dilution” of equity.
Debt can enhance profitability through financial leverage.

14. Sources of Capital 2-2 Bonds
Disadvantages of debt
Interest is a required expense and must be paid.
If not, possible bankruptcy
Debt usually entails many terms and conditions that can limit flexibility of the company.
The more debt used, the higher the probability of financial distress.

15. What will likely happen to the price of a bond issued by a company that may be approaching bankruptcy? A. Its price will rise B. Its price will fall C. The price will remain unchanged D. It really depends

16. Sources of Capital 2-3 Stocks and Stock Valuation
Topics
Features of equity
Stock valuation
Stock quotes

17. Typically, which security is riskier to an investor. A. Bonds B
Typically, which security is riskier to an investor? A. Bonds B. Common stock

18. Sources of Capital 2-3 Stocks and Stock Valuation
Features of equity
Common stock
Shareholders “own” the company
Proportional claim to company and dividends
Returns come from dividends and price appreciation
Shareholders elect Board of Directors who elect Officers
Proxy voting allows shareholders to appoint a representative to vote
Dividends paid at discretion of Board of Directors

19. Sources of Capital 2-3 Stocks and Stock Valuation
Stock Quotes
On-line resource:

20. Sources of Capital 2-3 Stocks and Stock Valuation
Price Trend
On-line resource:

21. Sources of Capital A comparison between stocks and bonds
Item
Bonds (debt)
Stock (equity)
Cost to Company
Cheaper
More Expensive
Risk to company
Higher
(can cause bankruptcy)
Lower
(can’t cause bankruptcy)
Return to Buyer
Risk to Buyer
(depends on rating)
(price fluctuates more)