BUSF_A01.qxd

Suggested answers to selected problem questions

8.1

The reasons for the relative popularity of convertible loan notes include the following

factors:

l They might be easier to issue than equity, in terms of acceptability to potential investors,

because they are loan notes as long as the notes holder wishes them to be, yet they can

be converted to equity if it is beneficial to the loan notes holder to do so. Thus their value

is underpinned by their value as pure loan notes, yet they have ‘upside’ potential

because, in effect, they bestow the right to buy equity at a predetermined price.

l The business may prefer to issue loan notes to gain advantage from the tax relief on

interest, but may find it hard to do so if investors seek investments with more potential

for capital gains.

8.2

In essence financial claims fall into two types: equityand debt. As will be explored in some

detail in Chapter 11, each one has its attractions from the point of view of the business (as

represented by its existing shareholders). One of the reasons for having some claims that

are, in essence, equity and some that are basically debt is that it enables the business to

strike the appropriate balance. This does not really explain the wide diversity of equity and

debt ‘instruments’ found in practice.

The major reason for businesses going beyond simple equity and debt is generally to try

to meet the precise investment requirements of a variety of potential investors. This is much

the same as a shoe shop stocking a range of different styles and sizes of footwear. By doing

this it can appeal to the needs and tastes of a wide variety of customers. Businesses that

limit their financial instruments to two will find it much more difficult to raise finance than

those that can offer investors something that caters more precisely to their needs and tastes.

8.4 Memphis plc

Pre-contract announcement value of the business 20m ×£1.20 = £24m

NPV of the contract 4m

Pre-rights value of the business 28m

Rights issue (number of shares =£10m/£0.80) 12.5m shares 10m

Post-rights value of the business 32.5m shares 38m

Ex-rights price per share £38m/32.5m = £1.1692

The right to buy one of the new shares would theoretically cost £0.3692 each, because a

buyer could pay this amount for the right to pay the business a further £0.80 and obtain a

share worth £1.1692.

9.1 XYZ plc

The statement implies that the person making it has superior knowledge compared with

those who, by their actions (buying and selling) in the stock market, influence share prices.

Evidence on the efficiency of the capital market, cited in Chapter 9, suggests that this is

likely to be true only if the person making the statement has inside information. Otherwise

the evidence shows that the market knows best, on average.

9.2

CME does not imply that all investors know all that there is to know about all securities

traded in the market. It does not even imply that any individual investor knows all

that there is to know about any particular security. CME simply implies that the current

Chapter 8

Chapter 9

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