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Questions and Answers
What is the primary advantage of equity financing for a company?
What is the primary advantage of equity financing for a company?
Which of the following best describes a debenture?
Which of the following best describes a debenture?
What happens to the priority of secured debts in the event of company insolvency?
What happens to the priority of secured debts in the event of company insolvency?
Which of the following is NOT a characteristic of bonds compared to shares?
Which of the following is NOT a characteristic of bonds compared to shares?
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What is a fixed charge in the context of secured borrowing?
What is a fixed charge in the context of secured borrowing?
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What characterizes the essential nature of a floating charge?
What characterizes the essential nature of a floating charge?
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Which of the following events can lead to the crystallization of a floating charge?
Which of the following events can lead to the crystallization of a floating charge?
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In what context do floating charges operate differently in Scotland compared to England?
In what context do floating charges operate differently in Scotland compared to England?
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Which of the following assets would be classified as a floating charge?
Which of the following assets would be classified as a floating charge?
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What detail differentiates the ranking of fixed charges from floating charges?
What detail differentiates the ranking of fixed charges from floating charges?
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How can a floating charge be characterized prior to its crystallization?
How can a floating charge be characterized prior to its crystallization?
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What is the primary effect of a floating charge before it crystallizes?
What is the primary effect of a floating charge before it crystallizes?
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Which of the following accurately describes floating and fixed charges?
Which of the following accurately describes floating and fixed charges?
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What does the concept of the 'prescribed part' refer to in relation to floating charges?
What does the concept of the 'prescribed part' refer to in relation to floating charges?
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A debenture is a document that solely proves equity financing.
A debenture is a document that solely proves equity financing.
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In a fixed charge, legal title of the asset is transferred to the lender.
In a fixed charge, legal title of the asset is transferred to the lender.
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Floating charges provide the highest priority in the case of company insolvency.
Floating charges provide the highest priority in the case of company insolvency.
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A company maintains its control structure when financing through debt.
A company maintains its control structure when financing through debt.
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Bonds and shares can be traded in the same manner within public listed companies.
Bonds and shares can be traded in the same manner within public listed companies.
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A floating charge can be created by incorporated and unincorporated bodies.
A floating charge can be created by incorporated and unincorporated bodies.
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The essential characteristic of a floating charge is that the asset subject to it is finally appropriated as security until a future event occurs.
The essential characteristic of a floating charge is that the asset subject to it is finally appropriated as security until a future event occurs.
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Crystallisation of a floating charge occurs automatically upon a company's decision to cease business.
Crystallisation of a floating charge occurs automatically upon a company's decision to cease business.
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In Scotland, floating charges can convert into fixed charges contractually by notice.
In Scotland, floating charges can convert into fixed charges contractually by notice.
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Floating charges provide the charger complete freedom to deal with charged assets prior to crystallisation.
Floating charges provide the charger complete freedom to deal with charged assets prior to crystallisation.
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Vehicles and machinery are typically secured with floating charges due to their changeable nature in businesses.
Vehicles and machinery are typically secured with floating charges due to their changeable nature in businesses.
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The 'prescribed part' refers to a fixed amount that is ring-fenced for unsecured creditors in the event that floating charge assets are insufficient.
The 'prescribed part' refers to a fixed amount that is ring-fenced for unsecured creditors in the event that floating charge assets are insufficient.
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Accounts receivable are often considered a fixed charge due to their static nature in business operations.
Accounts receivable are often considered a fixed charge due to their static nature in business operations.
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In England, floating charges can crystallise by notice, allowing flexibility in terms of timing.
In England, floating charges can crystallise by notice, allowing flexibility in terms of timing.
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Once a floating charge crystallises, it can no longer be set aside by a liquidator or administrator.
Once a floating charge crystallises, it can no longer be set aside by a liquidator or administrator.
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Study Notes
Corporate Financing: Debt Financing
- Security: A charge over an asset (e.g., mortgage). A mortgage is the strongest form of security (fixed charge). From a company perspective, securities are instruments to raise capital.
Equity Financing
- Method: Issuing shares.
- Ownership: Shareholders become owners.
- Pros: Generally cheaper; potential high capital growth.
- Cons: New shares can dilute existing shareholder control (unless pre-emption rights are used).
Debt Financing
- Method: Borrowing money. The company is the debtor, and lenders are creditors.
- Pros: Maintains existing shareholder control; no dilution of shareholder rights.
- Cons: Interest payments are required, and repayment schedules are crucial. Lenders usually demand security (charges) over company or director assets.
Debentures/Bonds
- Definition: A written acknowledgement of a loan, a type of document proving the equity financing. In public companies, they are often traded alongside shares.
- Features: Companies repay the loan with interest (coupon) according to a schedule.
- Investment: Bonds are often attractive when interest rates are low.
Secured Borrowing
- Charges: Most common form of security for borrowing. No transfer of legal title or possession.
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Types of Charges:
- Fixed Charge: Specific, defined assets (e.g., property, buildings, vehicles)
- Floating Charge: Applies to a class of assets that change over time during normal business (e.g., inventory, accounts receivable).
- Floating Charge Characteristics: Assets' use is not restricted until an event (crystallization) triggers the charge.
- Examples: Cash (floating), and property (fixed); accounts receivables (floating), vehicles (fixed); intellectual property (fixed); machinery (fixed); inventory (floating).
Debenture/Bonds (at a deeper level)
- Complexity: If a company borrows from multiple parties, a trustee might be involved to safeguard debenture holders' interests.
- Statutory Basis (Corporate Trustees and Debentures): Debenture includes stock, bonds within Company Act.
Debenture Holders
- Benefits: A trustee facilitates registration, transfer, and protection of debenture holder interests where there are multiple lenders.
Events of Crystallisation
- Trigger: Events that convert a floating charge into a fixed charge.
- Examples: Winding up order, appointment of an administrator, ceasing business operations, and certain contractually specific clauses.
Floating Charges (England/Scotland Comparison)
- Difference: Scotland has a statutory basis for floating charges, crystallizing only upon statutory triggers; England allows for some contractual triggers.
Fixed vs. Floating Charges (Summary)
- Fixed Charges: Limited ability to deal with charged assets before crystallisation, ranking ahead of floating charges.
- Floating Charges: Broader ability to deal with assets until crystallisation. Certain creditors (e.g., liquidators) have priorities regarding floating charge assets.
Registration of Charges
- Requirement: Charges must be registered within 21 days to be valid against administrators, liquidators, and other secured creditors.
- Consequences of Non-Registration: The security is rendered void; the underlying borrowing remains.
Priority Issue (Company Insolvency)
- Order of Priority: Fixed charges rank highest; followed by liquidation expenses, preferential debts, floating charges (with ring-fenced unsecured creditor percentages), and finally unsecured creditors. Note: certain floating charges created within 12 months of insolvency have their validity challenged.
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Description
This quiz covers the fundamental concepts of corporate financing, focusing on debt financing and equity financing. It explores methods, pros and cons of each type of financing, and the implications for shareholders and company control. Test your knowledge on the differences between securing loans and raising capital through issuing shares.
