Question

1. Provide a real-life example of a long-term external source of finance (debt or equity issue) used by a blue-chip company in Hong Kong. A blue-chip company is defined as one of the listed corporations that constitute the leading stock index. In this case, the leading stock index in Hong Kong is the Hang Seng Index (HSI). Details of the HSI constituents can be found on www.hsi.com.hk.

   In your essay, describe the nature of the financial arrangement (e.g. purpose, duration, risk assessment, etc.). In your opinion, explain whether this financial arrangement was a right move and suggest alternatives to this arrangement with reference to what you learned in this course and provide justifications.

Answer 1

a) Provide a real-life example of a long-term external source of finance (debt or equity issue) used by a blue-chip company in Hong Kong.

A Company Listed in the Hong Kong Stock Market: The Hong Kong stock market has some of the biggest and robust companies in the world. Among the companies listed in this market include Asian Investment Finance Group Limited. This company is an investment holding entities which is involved in credit guarantee, investment and exporting businesses. It was listed in the Hong Kong on November 19, 2007 and since then, it has been performing well. Long Term Source of Finance The main source of finance for Asian Investment Finance Group Limited has been bank loans from several prominent banks from China. In fact, the company was started with finances obtained from a bank loan. The company was required to repay the first in seven years. Since then, the company has taken several other long term loans to finance its goals (Freris, 2018). This has proved to be a well calculated move because the company has been able to repay the different loans without struggling. It has also been able to extend its operations beyond China. With the steady growth, the company was able to successfully list its stock on the Hong Kong stock exchange. This further increased the funds available for different projects. Through the strategic financial moves, the company has been able to effectively become one of the biggest companies in china. It has also been able to withstand different economic tantrums.

b) What is External Sources of Finance?

External source of finance is the one where the source of finance comes from outside the organization and is generally bifurcated into different categories where first is long-term, being shares, debentures, grants, bank loans; second is short term, being leasing, hire purchase; and the other is short-term, including bank overdraft, debt factoring, etc.

When a company needs a lot of money and its internal sources of Finance are exhausted, the company tries out the external options. If we talk about external sources of finance, there are two types –

• Long term Financing
• Short term Financing

Long Term External Source of Finance

Under the long term External Source of Finance, companies fund their requirements by looking into options that are almost permanent and can offer them a huge amount in a go.

Below are the long term external sources of finance examples

#1 – Equity Financing

• One of the most common external sources of finance is equity financing. Equity financing can’t be used by every company since there is a lot of legislation to adhere to. Thus, equity financing can only be used by big companies.
• To finance the requirement through equity financing, the companies go for initial public offerings (IPOs) where they sell the rights to own shares in lieu of money. As a result, when the company makes profits, the shareholders of these equity shares receive dividends if the company decides to payout.
• These shareholders can also sell their shares in the market and earn a decent profit when the stock price of that particular company goes up. IPOs help companies amass huge money and then they can use that money to expand their businesses or to invest in a new project.

#2 – Debentures

• Debentures are another common means of finance used by companies who prefer debt over the equity.
• Debt is considered to be the cheaper mode of finance compared to equity. It does not share control with investors. It is because the interest paid to debenture holders is tax deductible. Rest of process of debentures issue is similar to equity issue.
• It is offered to the common public and therefore necessary legislations need to be complied with. Debentures also involve some cost of issuing and they are collateralized by some assets of the company.

#3 – Term loan

• The term is a loan offered by a bank or a financial institution.
• In the case of the term loan, the company doesn’t need to issue debentures. But bank/financial institution goes through a thorough analysis of the company and then they offer a loan.
• Term loans are also secured by the assets of the company. If the company fails to pay off the money within a stipulated time, the assets are acquired by the bank/financial institution.

#4 – Venture Capital

• Many companies when they are at their starting stage take the help of venture capitalists.
• Venture capitalists also do an intense analysis of the company and see the growth potential. And then if they feel satisfied, they invest in the company.
• Once the company does well and the venture capitalists see that the valuation of the company has drastically been increased, they choose the exit route.

#5 – Preferred Stock

• Preferred Stock is another long term external sources of finance. It has both the features of equity shares and the debt.
• Since these stocks are given preference over equity shareholders, they are called preference shareholders.
• They get the benefit of receiving the dividend even before the equity shareholders. If the company liquidates, preference shareholders are given preference over equity shareholders in dividends pay-out as well.

Short term financing

Sometimes, companies don’t need to borrow a lot of amounts. In that case, they can just take a little amount for a year or less and then repay back within the time. Let’s see the short term external sources of finance examples.

#1 – Bank Overdraft

• When the companies need money for day to day activities they can take the help of a bank overdraft.
• Bank overdraft is a sort of short term loan which can be paid off within a short period of time.

#2 – Short-Term Loan

• Companies may take a short-term loan for their immediate needs from the bank.
• Since the amount is small and the amount would be paid off within a short stint, the loan is unsecured in nature.

c) What is Hang Seng?

The Hang Seng Index (abbreviated: HSI, Chinese is a free float-adjusted market-capitalization-weighted stock-market index in Hong Kong. It is used to record and monitor daily changes of the largest companies of the Hong Kong stock market and is the main indicator of the overall market performance in Hong Kong. These 50 constituent companies represent about 58% of the capitalisation of the Hong Kong Stock Exchange.

HSI was started on November 24, 1969, and is currently compiled and maintained by Hang Seng Indexes Company Limited, which is a wholly owned subsidiary of Hang Seng Bank, one of the largest banks registered and listed in Hong Kong in terms of market capitalisation. It is responsible for compiling, publishing and managing the Hang Seng Index and a range of other stock indexes, such as Hang Seng China Enterprises Index, Hang Seng China AH Index Series, Hang Seng China H-Financials Index, Hang Seng Composite Index Series, Hang Seng China A Industry Top Index, Hang Seng Corporate Sustainability Index Series and Hang Seng Total Return Index Series. Hang Seng in turn, despite being a public company, is held in majority by another listed international financial institution HSBC.

Selection criteria for the HSI constituent stocks

HSI constituent stocks are selected with the use of extensive analysis, together with external consultation. To be qualified for selection, a company:

• must be among those that comprise top 90% of the total market value of all ordinary shares;
• must be among those that comprise top 90% of the total turnover on the Stock Exchange of Hong Kong Limited "SEHK"
• should have a listing history of 24 months or meet the requirements of the following Guidelines:

Guidelines for Handling Large-cap Stocks Listed for Less than 24 Months

For a newly listed large-cap stock, the minimum listing time required for inclusion in the stock universe for the HSI review is as follows:

Average MV Rank at Time of Review	Minimum Listing History
Top 5	3 Months
6–15	6 Months
16–20	12 Months
21–25	18 Months
Below 25	24 Months

Among the eligible candidates, final selections are based on their:

• market capitalisation and turnover rankings;
• representation of the respective sub-sectors within HSI; and
• financial performance.

d) What is a financial arrangement? Its purpose & duration,

A financial arrangement is defined in section 230-45, which provides that an entity has a financial arrangement if it has, under an arrangement, a cash settlable legal or equitable right to receive or obligation to provide a financial benefit, or a combination of one or more such rights and obligations.The term deposit is a financial arrangement subject to the financial arrangements rules. The application of the reduced rate of interest requires the repayment of interest already derived by the depositor or the set-off of interest owed against the principal sum ultimately repaid to the depositor.

A financial arrangement is an arrangement under which a person receives money in consideration for that person, or another person, providing money to any person.Examples of financial arrangements may include debt instruments (loans, bonds, notes, securities); derivative arrangements such as swaps, forwards and options; and certain hybrid arrangements.Therefore, the ability to elect to treat trade payables and receivables denominated in a foreign currency (being excepted financial arrangements) as financial arrangements meant that taxpayers could use the value reported in financial statements for tax purposes.

*Risk assessment

Risk Assessment Getting long term bank loans is always a risky decision. This is especially for a new company that has not been tested financially. But this company was almost guaranteed of repaying the loan. The terms of the first loan was that the company would be given a grace period until it is operations are steady (Aven, 2016). Consequently, the risks were minimal on the side of the company. The directors of the company were already experienced and as a result, they knew the right strategies that were needed to be applied for the company to grow. This experience further came with ready clients who were willing to work with the company.

The different structures, procedures, and histories of the agencies responsible for regulating toxic substances have produced diversity in their approaches to risk assessment, but common patterns can be discerned, and they permit some broad generalizations about agency organizational arrangements.

First, most agencies have exerted little effort to maintain a sharp organizational separation between employees engaged in assessing the risks associated with substances and those responsible for identifying and evaluating regulatory responses. This is not to suggest that the same persons perform both functions; generally, they do not, for agency organizations reflect considerable specialization, recognizing the distinctive training and capabilities of staff members. However, the two functions are often housed in one organizational unit that is responsible for preparing integrated analyses that incorporate assessments both of risk and of recommended regulatory responses. Sometimes, risk assessment staff are employed in an office that is separate from the office of those who formulate and analyze regulatory options, but, with some notable exceptions, this organizational structure does not lead to a rigid separation of the two staffs.

Second, with the exception of a few experiments in interagency risk assessment during the late 1970s and continuing informal exchanges of information, each agency has performed its own assessments of the risks posed by substances that are candidates for regulation. This operational autonomy does not reflect willful ignorance of the activities of sister agencies or indifference to the desirability of consistency in the evaluation of common candidate substances. Rather, it is a product of several factors, including the lack of obvious mechanisms for formalized interagency collaboration, the desire of agency policy-makers to reserve authority for policy discretion in reaching conclusions based on risk assessment, the perception that the diversity of types of exposure for which each agency is responsible makes collaborative risk assessment impractical, and differences in regulatory priorities and schedules.

Third, although the four agencies have viewed themselves as ultimately responsible for the risk assessments that support their actions, they often extend their own staff resources available for performing risk assessment by relying on consultants and contractors who are closely supervised by agency personnel. Some agencies—notably the Occupational Safety and Health Administration (OSHA) and the National Institute for Occupational Safety and Health (NIOSH)—whose staffs are small or lack needed expertise rely very heavily on nongovernment contractors and outside scientists in the academic community and government research institutions for performance of risk assessments or specific tasks related to risk assessment (such as literature reviews).