Banking Terms - Set 15 (Exchage rate risk, Inflation risk & Put provision on bond, Unsystematic risk, Call premium)

Call premium

Premium in price above the par value of a bond or share of preferred stock that must be paid to holders to redeem the bond or share of preferred stock before its scheduled maturity date.

Put Provision on Bond

A put provision grants the bondholder the right to sell the issue back to the issuer at par value on designated dates. Here the advantage to the investor is that if interest rates rise after the issue date, thereby reducing a bond’s price, the investor can force the issuer to redeem the bond at par value.

Unsystematic risk

It is also called as the diversifiable risk or residual risk. The risk that is unique to a company such as a strike, the outcome of unfavorable litigation, or a natural catastrophe that can be eliminated through diversification.

Inflation risk on bonds

If investors purchase a bond on which they can realize a coupon rate of 5% but the rate of inflation is 6%, the purchasing power of the cash flow actually has declined. Inflation risk arises because of the variation in the value of cash flows from a security due to inflation, as measured in terms of purchasing Power.

Exchange-rate risk on bonds

A non-domestic-currency nominated bond has unknown domestic currency cash flows. The domestic currency cash flows are dependent on the exchange rate at the time the payments are received.

For example, suppose that a German investor purchases a bond whose payments are in British pounds (GBP). If pounds depreciate relative to euros (EUR), fewer euros will be received and vice versa. This risk is also referred to currency risk.

Banking Terms - Set 14 (Rights issue, Acceptance period, Bearer shares, Compensation, Book value)

Book Value

The value of a company's assets as shown in the Annual Report and Accounts. It stands to the net assets of the company [total assets - total liabilities].

For E.g. Company A has $24 billion in assets and $19.3 billion in liabilities, then the company’s book value would be the difference between above two i.e. $4.7 billion.
This value divided by the total number of outstanding shares will give the book value per share of a company. If this value is greater than company's market value, then it is considered as undervalued.

Compensation

Compensation is the amount of money (or) additional securities a purchaser receives from the seller, if he had bought the shares before the ex-date of a corporate action and the shares gets settled in his account only after the ex-date.

For E.g. Person A buys 100 shares from Person B before the ex-date of a cash dividend. Shares and the price he pays for them however settle after the ex-date. This means that, the seller will receive the cash proceeds as a result of cash dividend, while the buyer is entitled to them. The buyer has to CLAIM the cash proceeds from the seller.

Bearer Shares

Securities can either have "bearer" or "registered" form. For E.g. In the past, when securities were in paper form, a shareholder would go to his bank and take the paper with him to collect for example a dividend. As proof that the dividend was paid out, the bank employee would tear off one of the many coupons from the share. The name of the shareholder was not registered anywhere by the issuer of the security. The bank could go to the issuer and exchange the coupon for the dividend payment.

Acceptance Period

The acceptance period is the period in which shareholder can accept the offer. They would usually do so by sending an instruction to their broker or custodian.

E.g. Company A has announced a tender offer, it has announced a period of 7 days to accept the tenders/bids which has been allocated to them, such a period is called a Acceptance Period.

Entitlement Calculation for Rights Issue

If a Rights Issue or an Open Offer is announced, the ratio and Call Cost will be used to calculate the entitlement of a particular person.

Company X announces a Rights Issue offering 2 new shares for every 5 held, at 1USD and person A has 1000 Ordinary shares on the EX-Date, then A's entitlement would be as follows,
2 new shares for every 5 held on the Ex-date means, that person A will be able to buy 400 new shares & Call cost of 1USD per new share purchased = 400x1USD = 400USD.