Question 1

Accredited Investor

Accepted Answer

Under Federal Legislation regulated by the U.S. Securities and Exchange Commission (SEC), an accredited investor is classified as an individual or business entity that can legally trade in securities.

Regulators have strict guidelines on who can be considered an accredited investor. Under new legislation passed in late 2020 by the SEC, individuals can now qualify as an accredited investor “based on measures of professional knowledge, experience or certifications in addition to the existing tests for income or net worth.”

Who is considered an accredited investor?

To be considered an accredited investor, individuals will need to provide substantial proof that personal net worth exceeds the $1 million threshold. Additionally, accredited investors can also be people who are legally married and have a joint net worth that meets SEC standards. Total net worth should include all current assets that exceed the greater of $1 million. And these assets exclude the primary residence and the value thereof.

What are the benefits of becoming an accredited investor?

Private companies can offer securities for investment that are not available to the general public.

These securities products can include:

Venture Capital Funds (VC)
Angel Investing
Hedge Funds
Private Equity Opportunities
Equity Crowdfunding

There are also additional private investment securities that can be accessed by accredited investors.

How do you become an accredited investor?

Meet all regulations and standards outlined by the SEC.
Ensure a combined or individual net worth exceeds $1 million.
Primary residence value may not be included in overall net worth.
Exceed the minimum income requirement of $200,000 per year during the last two calendar years.
For spouses, the combined minimum income is $300,000 per year.

Get more details about becoming an accredited investor.

Question 2

UCC-1 / Perfected Interest

Accepted Answer

A UCC-1 financing statement is a legal form that a creditor files to give notice that it has or may have an interest in the

The UCC-11 financing statement is regarded as a legal form that a creditor can file, allowing them to give notice that it may have an interest in the personal property of a debtor. Depending on the priority of debt involved, a creditor gives public notice that they have the right to possess and sell certain assets to debts owed by the debtor or borrower.

Filing a UCC-1 statement indicates the possession of certain securities by the creditor. This enables them to sell these assets to make the repayments of the debt owed to them.

What is Perfected Interest?

The perfected interest statement is used to outline the perfection of security interest and the rights to personal property. The creditor will in good faith use the perfected interest statement as a way to inform third parties about the perfection of interest on assets allocated as collateral.

Using perfected securities can assure the creditor that no other party will be able to claim the same type of collateral once the debtor has defaulted. The statement clearly outlines the collateral allocated to the creditor, and that those securities will be used to fulfill missed principal and interest payments of the loan.

Attachment under Article 9

Once a security interest has been imposed by a debtor, only then can the security interest attach once the following has occurred:

The value is given by the Secured Party.
Rights are appointed to the debtor considering the collateral.
Security interest within the collateral must have been appointed to the Secured Party.

Final considerations

A perfected interest statement is erected to offer a creditor a safety net on perfect collateral in the event a lender or debtor goes bankrupt. With this in mind, a specific creditor can file a perfected interest or securities statement on the rights to assets owed to a specific lender.

Question 3

Settlement

Accepted Answer

Settlements are common in a court of law and refer to the resolution between two or more disputing parties. A settlement can involve various parties and has a wide range of contributing aspects. In most instances, a settlement has been reached either before or after the court actions have commenced.

Legal Definition of a Settlement

The term settlement can vary from the situation, but in most common uses it can refer to the dismantling of litigation, payment, and closing of an account, to complete execution of an estate and the distribution of the property of interest to beneficiaries.

To resolve any disputes between involved parties, and before a settlement can be agreed upon – fair and transparent negotiations will be conducted.

Settlement Versus Lawsuit

Settlement: In a court of law, a settlement can be considered in favor of both the plaintiff and the defendant. A lot of court cases will negotiate for a settlement agreement, as it requires fewer resources and time to resolve. This is dependent on each case, and settlements can vary across the board.
Lawsuit: If an individual has sustained injury and no settlement can be agreed upon, or the defendant refuses to accept the desired settlement – plaintiffs can pursue a lawsuit. This form of legal action will require more physical time of parties involved, and extend the negotiation period.

Once a plaintiff has entered a lawsuit with additional parties, the case may then be considered to go to trial where an additional jury will oversee the negotiations by the attorney. Only once a lawsuit has ended, both the plaintiff and defendant will be informed of the resolution thereof.

The Outcomes of a Settlement

The outcomes of a settlement will solely depend on the factors involved in each case. Certain evidence, facts, documents, and testimonials can be used to strengthen a settlement case.

Read more: How pre- and post-settlement financing works.

Question 4

Pro-rata

Accepted Answer

Pro-Rata stems from Latin which means “in a proportion of.” It is a term, which carries both financial and legal attributes and is used to describe a proportionate allocation. Many businesses and companies use the phrase ‘pro-rata’ as a method of assigning an amount according to its share of the whole.

How is pro-rata used in business?

Some businesses will offer employees pro-rata wages, this is more associated with employees who work on a contractual or freelance basis. The assumption is that an employee who works on a freelance basis will receive a fraction of the salary or wages paid out to those employees who work full-time.

Consider the following as an example of pro-rata wage calculation:

A company hires two employees, one working 25 hours per week on a pro-rata basis, another on a 40 hour per week full-time contract. The full-time position offers $25,000 per annum, while the other receives a pro-rata rate.

To calculate:

$25,000 (salary per annum) / 40 (hours per week) = 625

625 x 25 (pro rata hours per week) = $15,625

This shows that the employee working on pro-rata rates will receive a basic salary of $15,625 per annum – a proportionate allocation of the full-time amount.

Where can “Pro Rata” allocations apply?

The use of pro-rata allocations is not only used to determine wages or annual income of employees. Additional applications thereof are found to calculate scheduled off days, pension contribution, employee subsidies, bonuses, and increases.

Employees who are offered a pro-rata position will receive somewhat fewer perks and benefits than those who are working full time. A consideration that needs to be reviewed carefully by those parties involved.

A pro-rata position can offer more leniency to those employees who aren’t looking for a full-time employment commitment.

Question 5

Pre-settlement Funding

Accepted Answer

Just as with post-settlement funding, a pre-settlement loan or funding provides plaintiffs with non-recourse funding for essential living needs. This is issued to them while plaintiffs are still awaiting the outcomes of their case or the trial. The pre-settlement funding assists the lawyers of plaintiffs to spend more time negotiating a settlement with defendants.

Approvement of pre-settlement funding is solely based on the strength of the plaintiff’s case. Insurers and financial providers who offer pre-settlement funding will review the plaintiff’s case to ensure that the loan or investment will generate profit once the case has been settled.

Who reviews pre-settlement funding applications?

Once a plaintiff or their lawyer has submitted a pre-settlement funding application to the insurer – a team of underwriters will review the case and the possible outcomes thereof.

What determines the success of a pre-settlement loan?

Once the pre-settlement loan of funding has been submitted, a team of underwriters will review the case. In doing so, they will seek out:

The case: Whether the lawsuit involves personal injury to the plaintiff, a loan lawsuit, or where the plaintiff will receive cash compensation – underwriters will review the quality of the case and what the settlement will be for the plaintiff.
Lawyer/Attorney Experience: Underwriters will consider the experience of the lawyer/attorney who is handling the settlement negotiations on behalf of the plaintiff. Most insurers would consider more experienced lawyers as a positive take to the outcomes of the case.
The success of settlement: What will the success rate of the case be? This is to consider whether the plaintiff stands a good chance to receive the agreed settlement.

Pre-settlement funding will not impact the credit score of the plaintiff and is used to ensure a plaintiff can sustain themselves while awaiting the outcomes of their lawsuit.

Question 6

Disbursement

Accepted Answer

Disbursements are payments made by any private or public fund to investors. The definition of disbursement can also be understood in terms of giving payment to complete the final payment on certain expenses.

What can disbursement mean for a business?

Disbursement in the business environment regards the cash flow of the business. Once a new item has been purchased by the business the period of the expense and that of the disbursement occurs on two separate occasions.

Disbursements for Investors

This usually refers to a payment made to any investors directly associated with the business or company. These payments can exist in the form of dividends, cash, or a cash equivalent thereof. Usually, shareholders will receive an electronic fund transfer (EFT) of their disbursements.

Disbursement Checks

The form in which disbursements are paid is called a ‘disbursement check.’ This is used to pay for various expenses a business may encounter. These may include:

Payroll
Payment of Suppliers
Wages and Employee Salaries
Reimbursements
Shareholder Dividends
Emergency Expenses
Profit Distribution among executives

Disbursements Versus Expenses

In the business environment, these concepts can easily be confused with each other.

Disbursements: This concerns an agent or company paying a specific individual on behalf of another. Furthermore, disbursements are different from reimbursements. Whereas a reimbursement can be considered the exact amount repaid to a business or individual.

Expenses: Generally speaking expenses can be considered any type of purchases made or funds distributed to improve business operations, i.e. purchasing new equipment. These can also include employee salaries, thus making it difficult to differentiate between disbursements and expenses.

The differences between these two concepts can be confusing, thus business owners need to have a firm grip on the expenses running through their business, but also the disbursements they make throughout the financial calendar.

Question 7

Default

Accepted Answer

When a borrower is unable to make repayments on their loan according to previously agreed-upon terms and conditions. A person can be considered “in default” when they have not repaid their loan on time.

The most common example of being in default occurs with the high rate of student debt currently present in the United States. Students who have not repaid their student loans within 270 days (9 months) will receive a letter from their service provider to inform them they have defaulted.

What are the consequences of going in default?

Before any loan can be taken out, an individual will have to sign a debt-related agreement. In the event that you can not oblige to these agreements, the consequences of going in default can be the following:

Students can be dismissed from Tax Refunds
Your credit score can be tarnished
Any form of future wages can be garnished without a court order

The severity of being in default is relatively serious, as this can affect any future endeavors to undertake a new loan for personal or professional reasons.

What steps are taken before going in default?

Before any person can go in default with their lender, the service provider will need to exercise a form of “due diligence.” This entails the service provider, or lender conducting repeated efforts to collect any outstanding repayments.

How to get out of default?

Once an individual has been classified in default, full repayment of the full loan amount has to be made to be considered out of default. There are two ways to get out of default:

Loan rehabilitation
Loan consolidation

These can be considered by the individual and their lender to reach an agreement on how the lender can come out of default.

Read more: Default process – what should you know?

Question 8

Asset Class

Accepted Answer

Some assets will exhibit similar traits in comparison to others and will be categorized as an asset class. At Yieldstreet, most of our offerings will be categorized within the specialty finance asset class. This sets them aside from traditional stock or bonds asset classes.

An asset class is primarily used to group various securities into categories, to help investors better diversify their portfolios. Creating these asset classes, as with Yieldstreet, gives investors more leverage and flexibility to find offerings that will fit their individual preferences.

What are the different asset classes?

Although various asset classes have come to life since the rapid modernization of global markets – many investors and asset managers will regard the four main classes as:

Fixed Income Assets

This class allows investors to allocate funds towards corporate and government bonds. These securities often pay investors interest correlated on market performance.

Equity Assets

Stocks or part ownership that are allocated by companies to the general public.

Real-Estate Assets

In the U.S., as in many other developed nations, purchasing a property of any kind has the potential be a lucrative investment. Real estate can include apartments, houses, commercial properties, farms, smallholding, etc. Real estate investment has historically remained attractive based on the physical existence of the property, rather than those securities only available in a virtual environment.

Cash or Equivalent Assets

This asset class is for both short-term and long-term investment, as it offers high liquidity. Examples of cash equivalent assets include commercial papers, treasury bills, and more. This asset class is often more liquid of an investment, meaning it is more easily accessible should an investor need it.

Question 9

Seniority

Accepted Answer

Companies structure the order in which they will be required to repay their debts. This applies to both companies that are fully operational or who have filed for bankruptcy. Senior debt will receive prevalence before junior debt and will be paid off first.

For public companies who have publicly traded stock, shareholders and bondholders will receive the privilege of being paid first in the event of a company going out of business.

Senior Debt

Senior debt can be secured using company assets as a form of collateral. Using company assets allows lenders to have priority in case the company has to file for bankruptcy. The use of company assets as collateral can include physical equipment, real estate, property, or buildings.

Senior debt, like other types of debt, has a layer of interest. Companies that fail to make principal or interest payments will prioritize senior debt. Because this form of debt has priority it has been considered to carry the lowest risk factor associated with debts and loans.

Uses of Senior Debt

Some companies have found that using senior debt as a form of capital injection into their business or company can assist with a wide variety of operational and expansion liquidity.

Here are some of the most common uses of senior debt in modern-day business.

To assist with the financial capital for everyday funding: Funding everyday operations such as internal cash flow.
Recapitalization: Raising new capital as a way to recapitalize for certain investments, return of capital to investors and shareholders, or to fund dividends for personal liquidity.
Debt Restructuring: Using senior debt to repay existing debt.
Expansion of Growth: Gaining additional capital as a way to expand product offering or increase operational procedures.
Acquisitions: Using senior debt to acquire additional services, products and reach a larger market.

What’s included in a subscription agreement?

The Subscription Agreement Governance allows the use of these agreements for new and small businesses who require funding and investment from various parties. The Governance of this agreement relies heavily on SEC Rule 506(b) and 506(c) of Regulation D.

Under these conditions, important parts of the subscription should include, share ownership, director resolution, outstanding shares, non-compete and confidentiality clauses, and indemnity clauses. These are among some of the most important parts new business owners should always include in their newly drafted subscription agreements.

What are the advantages of a subscription agreement?

Overall, subscription agreements have become a popular way for new and small businesses to find public investors. This allows them to potentially receive better financial backing while limiting the potential financial liability of their investors.

Question 11

Inventory

Accepted Answer

Any tangible goods which are part of a business that is intended to be sold is considered as inventory. This can include various products and items that the business puts up for physical sale to the general public.

If a business is low on inventory, it will usually mean that a stock item is either out of stock, demand has increased and supply has decreased, or the need thereof has gradually reduced.

Businesses in retail and hospitality are great examples of where you will find inventory. These items will include clothing, shoes, furniture, food items, consumables, etc. Any item that is available to be purchased can be considered as tangible goods or inventory.

Today businesses are making use of inventory management software to assist with stocktaking of all current items currently available in their store.

Four types of inventory

Raw Materials: Any item that is of a natural existence that will be later on used to help manufacture a new product. Wood can be considered a raw material, as it can be turned into desks, chairs, beds, and other items.
Work In Progress Items: These are all items that are accounted for by the business that have yet been completed. Although these items are not yet fully completed, businesses still consider them as part of their inventory to keep track of supply and demand.
Available Goods: Once items have been manufactured from raw materials, they are considered finished goods or available goods. These items will either be stored away for later use, or directly be put up for sale depending on the intended need.
Excess Goods: Finally, if there is an overhaul of goods in the store, businesses will usually withhold them until older items have been sold.

Question 12

SPV or Special Purpose Vehicle

Accepted Answer

An SPV is a newly-formed company that has been designed to keep all company-related investments secure and private. Regardless of the originator or Yieldstreet credit risk – SPVs are most commonly used as asset securitization.

Special Purpose Vehicles act as a separate legal entity that has been created by a company or organization. The use of an SPV has become more and more common in modern business. The use thereof is apparent for when a company goes bankrupt, the SPV can continue as normal.

Why create an SPV?

Lowers Financial Risk: New projects and assets acquired by the company can be diversified with the use of an SPV. This helps lower financial risk for those involved, and can equally distribute associated risk among investors.
Asset Protection and Transfer: Some business owners and company executives may establish an SPV for the sole purpose to transfer and protect company assets. Because certain assets can be difficult to transfer, or come under scrutiny an SPV can create a separation of assets.
Tax Purposes: Some companies set up their SPV in a designated tax-haven location. These tax havens offer attractive tax incentives for larger companies.
Loan Securitization: Companies looking to acquire additional loans or funding will create an SPV under which they can take out a new loan.

Risks for creating an SPV

Although some may see an SPV as beneficial, associated risks can include:

Lax regulation: Assets not directly associated with the parent company can influence the overall financial health of the parent company, especially when reviewing their balance sheet.
Underperformance: If an SPV underperforms, this can directly influence the parent company’s overall access to better capital markets.
Credit Risk: If an SPV does not perform as desired, the credit quality of the partnering company may be diminished.

Find out more: What you need to know about SPVs.

Question 13

Collateral

Accepted Answer

Many companies will offer asset-based capital loans. Meaning, companies or individuals that are taking out a loan, will offer assets or securities as collateral for the loan.

Here’s an example of how it works:

Fred, a young, and hardworking individual is looking to take out a personal loan. The financial institution approves his loan application, but because some personal loans are usually not secured, he will need to provide some form of collateral that holds monetary value.

In this case, Fred puts an insurance policy up as collateral until he can fully repay both interest and primary payments of the personal loan. Once he has repaid his personal loan, he is again in default owner of his insurance policy.

What can be used as collateral?

This may depend on the type of loan and the financial institution. Normally collateral can include:

Cars
Vehicles
Houses or Property
Jewelry
Insurance Policies
Future Salaries
Savings
Stocks or Bonds

Can a business offer collateral for a loan?

Small and midsize businesses can apply for business loans and offer collateral as secondary security. In this case, business owners can offer intangible assets such as investment funding, payment rights, accounts receivable, or perhaps copyrights as collateral.

Business loans work a lot differently than personal loans, and business owners will need to be aware that financial institutions will review financial statements, equity investments, credit rating, and the overall financial health of the business.

Do you need collateral with a positive credit score?

In many instances, individuals with a positive or good credit score won’t need to offer any form of collateral as secondary security. The same goes for business owners looking to apply for a business credit card.

Learn more about Collateral, its types, meaning, and examples.

Question 14

Allocation

Accepted Answer

An umbrella definition of allocation will include the split or division of assets and investments between various transactional stakes in a financial portfolio.

What’s the difference between asset and investor allocation?

Asset Allocation

Individuals, companies, and governments will allocate a percentage of their overall portfolio to a wide range of different asset classes. These can include bonds, stocks, shares, real estate. Individuals allocate their assets across various classes to ensure a more diversified portfolio, to lower risk and, ideally, increase returns.

Investor Allocation

Investment allocation is based on the individual percentage of ownership of certain assets. Individuals or investors will receive an equal split on a pro-rata basis. What this means for investors, is that the agreed percentage thereof will be allocated to what they choose.

Think of it as putting all your eggs either in one basket or in different baskets.

What is an allocation strategy?

Before creating an investment strategy, investors will need to consider the three main asset classes:

Fixed Income
Cash
Equities

Under each of these, investors will find various sub-classes, offering variable risks, capital gains, monetary returns, and market behavior.

Thus, creating an allocation strategy puts the investor in control of where they would like to invest money. There are a wide variety of allocations available and can include, stocks, bonds, real estate, art, minerals, cryptocurrency, savings account, and foreign exchange among others.

Overall, investors look to balance and diversify their portfolios or investment opportunities to have various streams of financial income.

What is a potentially good allocation strategy?

Each allocation strategy will be different. Here is an example of asset allocation for individuals planning to retire in 10 years:

61% – stocks
28% – bonds
3% – cash
8% – other

Question 15

Senior-secured

Accepted Answer

Senior-secured refers to a portion of the debt that is paid off first. Senior-secured debt is usually offered by a corporation, LLC, or trust fund and receives priority in securing the loan with specified collateral.

What this entails is that a senior-secured loan is issued by a company itself, rather than the lender or financial institution. It’s becoming more prevalent in modern business as it offers companies the ability to restructure and recapitalize their debt and equity portfolios.

Senior-Secured Debt

In the event that a company files for bankruptcy, or perhaps goes out of business – senior-secured debt is a portion of the money borrowed which needs to be paid off first. Once these debts have been paid off first, additional payouts to shareholders, investors, and bondholders will be paid out.

Senior-Secured Loans

These loans are secured using company assets and are issued by non-investment-backed businesses or institutions. Companies and individuals make use of senior-secured loans or SSL as a way to diversify their income strategy.

When a company undergoes an SSL, they’re usually looking to withhold current capital, and use the additional loan to hedge rising interest rates. There are multiple reasons why a company will undergo a senior-secured loan, most notable to assist with operational costs.

Sources of Senior-Secured Debt

Selected Financial Institutions: Smaller businesses and firms have the ability to undergo secured debts from selected financial institutions.
Public Bond Market: Larger companies and corporations who have publicly traded stock can issue senior debt through the bond market.
Non-Investment Private Firms: Companies can decide to sell off portions of the company to private investors to help secure a loan. This option makes it easier, as the company can select private investors who they would like to sell to, and create a personalized payment period.

Question 16

Operating Agreement

Accepted Answer

Through an operating agreement, the investors—or members—set the bylaws for a LLC (Limited Liability Corporation) or SPV (Specialty Purpose Vehicle). This lays out how the members will operate their LLC and lay out how the LLC will be managed.

What is an operating agreement?

According to the United States Small Business Administration, an operating agreement is considered the primary document that is used by a Limited Liability Company (LLC). This agreement is a clear outline of the business’s financial and operating rules for those involved.

An operating agreement will house the internal layout of operations for the business owners, ensuring specific regulations and provisions are covered. The operating agreement will act as the official and binding contract to the members of the LLC.

Why is an operating agreement good to have?

When starting a business with multiple owners, or investors, an operating agreement gives a clear and concise layout of the duties, responsibilities, and regulations of the involved parties.

Other reasons to have an operating agreement can include:

Establish the role of each member: The operating agreement will lay out the role of each member and to which capacity they need to fulfill it.
Tax purposes: When forming an LLC, owners will set up an operating agreement to separate themselves from the business. The operating agreement will help owners show their separateness from the business.
Mitigate State Default Rules: If an LLC has no operating agreement, the state will consider it to operate under “default rules.” This allows the state to regulate how business assets should be disposed of. Giving the state more capacity to regulate business assets.

What should an operating agreement include?

All legal names of the involved parties
Names and Doing Business As names of the business
Company Address
Address of the registered agent, if any

Question 17

Compound Interest

Accepted Answer

Arguably speaking compound interest can be considered “interest on interest.”

The term “compound interest” refers to the total amount of interest calculated, not only on initial investment or loan but also on the accumulated interest obtained from previous years.

Compound interest can be calculated annually, quarterly, or monthly depending on the type of investment or loan provided by the financial institution. There are also two types of compound interest, namely periodic and continuous compound interest.

How do you calculate compound interest?

Compound interest is calculated using the following formula:

A = P (1 + r / m) mt

A: total value of the final investment

P: initial capital provided for the investment

r: the percentage investors will receive on their investment

m: the amount of time the investment is compounded (i.e. annually, quarterly, monthly)

t: the total amount of years, or months the investment will take to complete.

Here is a look at some real-world examples of compound interest at work.

Why is compound interest better?

Banks and fund managers will usually opt for investors to invest larger portions of money for longer periods as it offers better compound interest. Investors will usually see their initial investment growing faster as time progresses, allowing them to increase their wealth a lot quicker.

What are the types of compound interest?

Periodic Compound Interest: Investors will negotiate with financial institutions or fund managers on a decided interval at which the initial investment will receive interest. This can be monthly, quarterly, or annually.
Continuous Compound Interest: This is applied to initial investments with the smallest intervals possible, using the basic compound interest formula as previously discussed. This is the latter of the two, and most financial institutions won’t normally make use of continuous compound interest as a rule.

Question 18

Covenants

Accepted Answer

A formal debt agreement amendment in an indenture that is entered by a borrowing party or individual to proclaim which activities may or may not be carried out.

Covenants, usually referred to as financial covenants, will include the promises and agreements a borrowing party needs to agree upon concerning that of a loan agreement.

Here are some examples of how covenants work.

Because financial covenants are considered legal agreements, the borrowing company or individual will need to maintain a specific financial ratio.

These financial ratios will be determined by the creditor or lender, but in most instances, the borrowing company will need to peak above or below a certain financial benchmark. These benchmarks can include the total assets to debt ratio, debt to equity ratio, or interest coverage ratio.

What is the importance of a financial covenant?

The financial covenant was introduced to ensure lenders are protected from the associated risks when lending money to an unknown borrowing company. The purpose of the financial covenant, as mentioned, creates a legally binding agreement that puts the security and safety of the lender at hand.

To include a financial covenant in a debt agreement, the lender puts forth certain benchmarks the borrowing company will have to meet to ensure principal payments and interest payments can be made.

What happens when a financial covenant is breached?

Both parties involved in the debt agreement will have previously agreed on collateral that will be stated in the financial covenant. If a borrowing company can not make repayments or breaches the financial covenant, the lender can legally recall the full loan amount to be repaid or collect collateral from the borrowing company.

Breaching a financial covenant can tarnish the reputation of the borrowing company, but also put them at risk to be denied any future financial loans.

Question 19

Irrevocable Letter Of Direction (LOD)

Accepted Answer

An irrevocable letter of direction, also known as, a letter of direction gives the recipient-specific rights regarding the sender or writer’s personal finances.

What is the purpose of a letter of direction?

Nearly any individual can write a letter of direction, albeit the correct procedures have been adhered to. An individual can write a letter of direction to their bank, instructing them to close a personal account on their behalf. This gives the bank authority to close the chosen account and transfer the leftover funds to the appointed bank account.

A letter of direction can also be used between two or more business partners. If one business partner decides to revoke certain rights, he or she can write a letter of direction, diverting their responsibilities and rights to another partner within that business.

How to write a letter of direction?

One thing that a writer of a LOD should consider is that it’s not legally enforceable on the recipient. To ensure a smooth transition within a business or that of financial assets, the writer should include the following in their LOD:

Clearly state the intention of the LOD
State who the letter is from, and who it is directed to
Keep any unnecessary details out of the LOD to prevent confusion
Clearly outline the reasons for the letter, and what are the repercussions thereof
Be concise and to the point
Always sign off on a letter

There are dozens of great examples that you can read through in order to craft the perfect letter of direction.
Why is a LOD written?

The reasons for a LOD will differ for each situation, but in some instances, it’s simply written to resolve any disputes, assist with personal finances, or ensure the transition of authority and rights from one person to another.

Question 20

Carried Interest

Accepted Answer

The term carried interest refers to the amount of carried interest a fund manager or hedge fund manager receives on the overall performance of an investment.

Regardless of whether or not they have contributed to the initial investment – carried interest acts as compensation for a fund manager to help motivate them to ensure constant enhancement of selected funds.

Key takeaways:

Carried interest can be regarded as basic compensation for fund managers as motivation to ensure investment performance.
Some investors also see carried interest as capital gains on investments carried over to be reinvested.
Currently, fund managers are taxed 20% on all capital gains received through carried interest.
How is carried interest calculated?
Depending on the original agreement set up between investors and managers, carried interest is typically between 20-25% of a fund’s annual profit. Some fund managers will agree upon a set percentage, while others will require both a fee and shared profit of the fund’s overall performance.

Is carried interest taxed?

All fund managers are subject to a 20% tax rate on the returns they generate from initial profits from investors. Although the investor is subject to different taxation i.e. capital-gains tax, or perhaps income tax, which is set at 37% in the United States, fund managers still pay a lot less than ordinary income taxpayers.

When is carried interest paid?

Every investor or fund manager will set certain targets for their initial investments. A real-world example will constitute that investments will first need to reach a minimum of 7-8% return on investment before carried interest can be paid out to the fund manager.

This is dependent on each scenario, as various fund managers will set up an agreement that meets both their needs and that of the investor.

Question 21

Confession of Judgement

Accepted Answer

Signing a Confession of Judgement or Consent Judgement agreement is a legal written agreement between a lender and creditor (borrower). The Confession of Judgement is signed by the lender, agreeing to pay any money owed to the creditor, enabling both parties to avoid going to court to resolve any disputes if they had to arise.

The severity of a Confession of Judgement

A Confession of Judgement is a serious legal matter that should not be taken lightly. This agreement was created in order to protect lenders if a borrower defaults.

Furthermore, in a court of law, the Confession of Judgement is seen as a legal written contract or agreement signed by a defendant who is agreeing to pay a set amount of damages to a plaintiff and accept liability for damages caused to the plaintiff.

A confession of judgment is also sometimes called a cognovit note. These are used by creditors to protect themselves from protracted legal battles with borrowers who default.

How long is a confession of judgment valid?

The agreement has a three-year validity. The final agreement has no effect unless a creditor files it to court in the event of a lender not being able to make any repayments.

Once all repayments have been made, and the final amount has been settled, the lender can request a copy of the Confession of Agreement – clearly indicating that all payments have been made to the creditor (borrower) and both parties have signed off on the agreement.

Why use a Confession of Judgement?

In some extreme cases, a Confession of Judgement agreement is drawn up and signed by both parties to delay any inherent trials, as this can become lengthy and extremely expensive for both parties involved. This allows lenders an extended period to make any outstanding payments to creditors.

Question 22

Post-settlement funding

Accepted Answer

In legal practice, post-settlement funding is provided to a former plaintiff in exchange for payments at a later date. Once a settlement has been agreed upon, a plaintiff may require financial aid as many settlements are structured over a long period.

The post-settlement funding provides them some form of compensation during the time to which they will be unable to access the money they are entitled to. Although a settlement may have been finalized, plaintiffs will not necessarily have immediate access to these funds.

This can become a burden for both the plaintiff and their lawyer/attorney. Many plaintiffs will use the settlement as financial aid to pay off any legal debt they have obtained during a lawsuit.

How beneficial is post-settlement funding?

Post-settlement funding is largely based on the involved parties and the outcomes of the case. The use of post-settlement funding has become a crucial aspect for plaintiffs who managed to win a lawsuit, who require supplementary funding to settle any legal debt.

Benefits of post-settlement funding:

Relieve financial stress caused by lawsuits
Assist with financial aid while waiting for the settlement
Helps plaintiffs to regain financial footing after a case has been settled
Provides legal transparency for plaintiffs
Encourages plaintiffs to carry out lawsuits that have been unfairly ruled out

How is post-settlement funding acquired?

If a plaintiff has successfully secured the settlement through the court of law, the plaintiff can then apply for post-settlement funding. The funding is acquired through a release between the insurer and the plaintiff. To obtain the funding, a plaintiff should provide the settlement agreement and the outcomes thereof.

Applications for the funding can be done by the plaintiff, or with the assistance of their lawyer. The advance will then be sent to the insurer and paid out once accepted.

Question 23

Plaintiff

Accepted Answer

In a court of law, a plaintiff can be considered as an individual or group that brings a case against another involved party. The plaintiff can also be referred to as a claimant.

What is the difference between a plaintiff and a defendant?

A plaintiff will be an individual that opens a lawsuit against another individual or party, who is considered to be the defendant.

Proceedings for a plaintiff to open a lawsuit

Each case will be treated under the rule of law established by the judicial system. In the United States, each state has established certain guidelines on the proceedings for plaintiffs to open a lawsuit.

If a plaintiff wants to begin a lawsuit, he or she must first file a complaint and a summons to the appropriate court. In the first step, a plaintiff must clearly state and outline the reason for the lawsuit. This will entail a description against the defendant.

Secondly, the plaintiff must establish a summons, this can be in written format or appear in the appropriate court. The summons will establish the requirements for how each party must respond with the amendment of the complaints associated with the lawsuit.

There are of course different legal proceedings for each plaintiff and will be based upon whether the plaintiff is a public or private individual.

The Importance of a Burden of Proof

When a plaintiff begins a lawsuit, the burden of proof will require them to provide the necessary evidence, documents, and testimonials to support their claims. The burden of proof is usually presented to the person who filed the claim i.e. the plaintiff.

The burden of proof is a legally binding arrangement between the civil court and the parties involved. The burden of proof will establish who is accountable for providing supplementary evidence.

Read more: Plaintiffs First: The Ethics of Litigation Funding

Question 24

Payment Frequency

Accepted Answer

Payment frequency represents how often investors receive principal or interest payments.

Payment Frequency Schedules

Once a loan has been approved by the lender, payment frequency will be based on initial factors including the financial stability of the borrower, and the type of loan.

Here are a few payment frequency schedules:

Once off or On-Demand Payment

The full amount owed is repaid immediately, with consideration to the approved interest rate.

Monthly

Monthly payment is made throughout a full financial year. The loan amount is divided over 12 months, giving an estimate of the monthly repayment.

Quarterly

Each quarter an estimated amount will be paid to cover the amount owed. Lenders will set up a designated estimate, based on the size of the loan and the associated interest.

Bi-annually, monthly or weekly.

Bi-annual, bi-monthly, or bi-weekly payments can offer less burden on the borrower and lower the risk for the lender.

For example, if a loan is repaid over a bi-weekly basis, the loan amount will be multiplied by 12 (months) and divided by 26 (weeks). This formula will deliver an estimate to be paid every second week.

Annually

Some lenders will allow borrowers to make an annual repayment on their loan, but this may take longer to repay the amount owed. With annual repayments or instalments, borrowers will need to consider the accumulated interest rate above the repayment amount.

Final thoughts

Payment frequency can help determine the full amount owed on a loan. Lenders will include all the necessary information regarding the payment frequency, including the interest rate and associated risks. Some lenders will state how the interest rate is divided when selecting a longer repayment schedule.

Question 25

Participation Agreement

Accepted Answer

The participation agreement can serve as a legally binding agreement between the originator and investors. With Yieldstreet offerings, the participation agreement will be signed by the originator, and also the manager of the SPV.

The manager will sign the agreement as a proxy, allowing investors to purchase the participation in the loan.

How does a participation agreement work?

Once a lead or primary lender has offered to sell off parts of a loan, a participation agreement will be set up to outline primary lender duties and those involved. The agreement will indicate the interest rate and other related terms of the participation.

Important participation agreement outlines:

Loan participants duties and responsibilities
Investment and purchase made by each participant
Enforcement of the loan
Modification made to the loan with the primary lender and participants
Overview of the borrower’s financial stability
State the primary lender’s duties and responsibilities

Why is a participation agreement important?

Providing a binding agreement contract between the primary lender and participants establishes the rights, responsibilities, and duties of those involved parties. The agreement creates a legally binding arrangement between each participant to provide the necessary funding.

These agreements can act as a safety net for the primary lender, as those participating can not withdraw from the loan without prior notice. The core of the participation agreement should clearly state the role each participant has in the loan, and how duties should be divided and fulfilled.

Participation agreement limits liability for the primary lender. Through the means of participation loans, primary lenders can create a broader and more diversified loan portfolio.

When should a participation agreement be created?

When a primary lender has notified involved participants about possible loan participation, an agreement should be drawn up as soon as all participants have reviewed the loan outline. The agreement will then be drafted, taking into consideration the various conditions concerned for each participant.

Question 26

Participation

Accepted Answer

Various financial institutions can allow lenders to participate in the funding of a loan. At Yieldstreet originators can sell as much as 100% to nearly 5% of the loan. The percentage involved will vary from the situation, as this is dependent on the deal at hand.

Essentially participation will involve multiple lenders simultaneously if one lender cannot cover all portions of the loan.

Why is Loan Participation beneficial?

One can think that loan participation can offer a wide range of benefits to both lenders and borrowers. Here is a look at some of the benefits associated with loan participation:

Financial Liquidity: Some financial institutions or lenders will sell off parts of a loan to improve their financial liquidity. Participant sharing means that these lenders can lower the financial and management risks that can be associated with their portion of the loan.
Shared Responsibilities: If the primary lender has sold off parts of the loan, participants can share loan responsibilities based on the amount purchased – lowering the risk management of each lender.
Larger Loans: With more than one lender involved, financial institutions can fund large loans for borrowers. This enables them to have sufficient funding for participating loans and provide funding to other borrowers.
Sharing Profits: Lenders that buy-in loan participation will be able to share in the profits generated by the primary financial institution. Collaborating with lenders that have large market influence can help these institutions generate more business and overall financial stability.

Bank Loan Participation

Some banks and credit unions will purchase parts of a loan to broaden their lending portfolios. When banks participate in loan purchasing, it helps to diversify financial involvement and market influence. Additionally, these institutions will participate in loans to increase demand for lending services when demand thereof has decreased.

Question 27

Originator

Accepted Answer

Originators are the individuals or firms who post offerings soliciting opportunities on Yieldstreet or other crowdfunding platforms. Originators can determine the terms of the loan with the borrower. Once the originator and borrower have approved the terms, the originator will return it to Yieldstreet which will fund all or part of the loan.

What role does the originator have?

When a borrower requires a loan from any type of financial institution, an originator will act as the liaison between the lender and the borrower. The originator takes the borrower through all of the procedures to complete the loan application. This involves collecting all the necessary documents, and verifying whether the provided information is correct. The originator will assist with answering questions on the loan application for the borrower.

Mortgage Loan Originators (MLO)

A mortgage loan originator, also known as the mortgage officer, assists borrowers to get the right mortgage for real estate transactions. The mortgage officer will determine the amount of the loan and the interest rate thereof. The mortgage officer will conclude proceedings on the loan application by verifying the information and documents provided by the borrower. The MLO can work alongside an associated financial institution, or with several lenders. When an MLO works with several lenders, borrowers may have access to a wider set of lending opportunities and can decide on a loan that best suits their financial situation.

What are the types of mortgage originators?

Mortgage Bankers

Individuals associated with a financial institution can carry out mortgages making use of their personal funds.

Mortgage Loan Originator

As previously discussed, the MLO acts as a middleman, assisting with the collection and verifying of the borrower’s information. The MLO connects the borrower with the lender and provides additional ‘education’ about the loan. Throughout the process of the loan application, the originator will guide and assist the borrower.

Question 28

Non-recourse

Accepted Answer

Some lenders will allow a borrower to secure a loan through a non-recourse debt pledge. This entails the lender pledging a form of collateral, i.e. real estate or property, for which the borrower is not personally liable.

Non-recourse debt (loan) can be considered a high-risk loan for lenders. If a borrower defaults, the lender can then seize the collateral.

The legal proceedings of both recourse and the non-recourse loan will be different in each state.

The difference between recourse and non-recourse loans

The Internal Revenue Service differentiates between two categories of loans, recourse and non-recourse loans:

Recourse Loan: If a loan has not yet been fully repaid, a lender can collect items for the owed debt even after they have collected the collateral. This form of debt will also allow lenders the right to garnish wages and levy accounts.
Non-Recourse Loan: When a borrower defaults, lenders can only collect the agreed-upon collateral. An everyday example of non-recourse debt or loans involves the repayment of home loans. In case a borrower defaults, the bank is allowed to foreclose the home but further legal steps can be taken to collect money owed on the loan.

Why use a non-recourse loan/debt?

Borrowers will undergo a non-recourse loan or debt to help secure their finances. This form of debt offers no personal liability to any of their assets, or to which they have offered as collateral.

This enables borrowers to have better security over their wages, and personal liability. As no legal action can be taken by the lender if a borrower defaults. Lenders do have the right to obtain the agreed collateral such as property or real estate to repay the loan.

Question 29

Mass Tort

Accepted Answer

Mass torts involve the civil action of numerous plaintiffs against selected or multiple corporate defendants. These civil grievances are resolved in state or federal courts.

When are mass tort lawsuits used?

Depending on the severity of the lawsuit, a mass tort lawsuit will be used in the event of:

Extreme exposure to a toxic working environment involving harmful chemicals.
Sustained injury due to inappropriate medical equipment and defective devices.
Exposure and injury sustained due to harmful and illicit drugs.

What are Mass Tort claims?

Mass tort claims or lawsuits are used in a court of law to ensure the plaintiffs aren’t treated or ruled out as a single entity but considered as mass tort plaintiffs.

In these cases, the court will decide on the necessary compensation each plaintiff will receive. The compensation will be based on the severity of their case and the damages they have succumbed to.

What is the difference between a Mass Tort and Class Action Lawsuit?

Although these two types of lawsuits may share some similarities, the proceedings are treated differently in court.

Read more:

Question 30

Loan-To-Value (LTV)

Accepted Answer

An LTV ratio is used to evaluate the ratio amount between the loan amount, and the value of the underlying asset. A lender or creditor uses loan-to-value as a way to determine the cushion a borrower has between the underlying asset and the loan amount.

Take a look at the following example:

A company is looking to renovate a building and is seeking a loan worth $100,000. The creditor or financial institution performs diligence on the underlying asset (the building). Through the process of diligence, the creditor determines the LTV.

The building has been appraised at a value of $200,000, nearly 50% less than what the loan will be. Concluding, that the loan, if approved will have a 50% LTV.

With this example, you can see that the loan the company is seeking only represents 50% of the underlying asset.

What is a good LTV ratio?

The LTV ratio may differ across the spectrum, but many creditors will seek out an LTC ratio that is less than 80%. A smaller LTV ratio makes it easier for the borrower to repay, and meet financial agreements made with the creditor. Something to remember is that the lower a loan-to-value ratio is, the more secure the loan will be for both parties involved.

Loan-To-Value for Mortgages

New home buyers will in most cases require a home loan to help with the purchase. In this regard, creditors or lenders will appraise the home to determine the LTV ratio. If the LTV ratio is considerably low, lenders will approve the loan.

If a home is appraised for less than what the buyers will purchase it for – lenders will consider the lower appraisal value, instead of the purchase price.

Question 31

Liquidity

Accepted Answer

In economics, investment bankers and financial brokers use the term “liquidity” to describe how rapidly an asset can be sold off for cash. Liquidity can come in various forms, most notable assets include Treasury Bills and Publicly Traded Stock.

One can refer to liquidity as assets sold or traded within 24 hours for cash. When assets such as undeveloped real estate or commercial property cannot be sold off within 24 hours, it’s considered “illiquid.”

Illiquid assets are still considered financially viable assets, as long as they are sold without significant loss of value.

Why is liquidity considered important?

A lot of individuals and successful investors will use their liquid assets as their emergency savings. Because liquidity can be sold off relatively easily, and without hassle, it provides investors and individuals with a quick financial backing and emergency savings solution.

Assets versus Liquidity in Business

Businesses of any kind have access to financial savings and their assets. These assets can range in financial value. If a business or company needs to access their liquid assets to make payments or inject large cash flow into the business. Liquid assets can then easily and quickly be sold off.

Liquid Business Assets: These include accounts receivable, equivalents, and inventory of the business.
Non-liquid Assets: Assets that will take longer to sell off for cash include buildings, real estate or property, large equipment, and trademarks.

Why is liquidity important?

In business, liquidity can be used to track and measure the financial stability of the business. Liquidity is also considered important to help secure loans and create attainable goals for the business.

Overall, liquidity is a key indicator of the financial well-being of a business. It gives financial institutions a clearer picture if the business is able to make their loan repayments, and adhere to tax regulations.

Question 32

Lien

Accepted Answer

A lien is considered a legal right to claim or seize any property from a borrower who has failed to make full repayments to a creditor. In a legal standing agreement between a borrower and creditor, the creditor has the right to withhold the property until the loan has been repaid, or can sell off the property to cover outstanding amounts owed on the loan.

An agreement is only considered a lien once it has been filed with the necessary authorities, and the creditor has legal authority over the borrower’s property.

What types of Liens exist?

Consensual Lien: Borrowers will in some cases voluntarily consent to a legal contractual obligation to secure a financial loan. The loans are considered for the purchase of the real estate, and the borrower uses the property as security to make principal payments to the creditor.
Non-consensual Lien: This lien is considered a statutory lien, and is assessed by the local government. The reason for this is to ensure property owners have successfully paid all real estate taxes owed on their property.

If a property owner has failed to make the necessary tax payments, the property may be seized and sold to ensure the owed tax is repaid. These liens are usually issued either by local government authorities or the court.

Other forms of liens

Auto Loans: made to assist with the purchasing of a vehicle
Home Loans: to purchase property or real estate
Judgment Lien: when a creditor legally wins a lawsuit against a borrower and seized their property.
Tax Lien: used by local government entities such as the Internal Revenue Services (IRS) to seize property to fulfill repayment of real estate taxes.
Mechanic and Construction Lien: filed to local government authorities when an individual can’t make payments to contractors on completed work on their home or property.

Read more: Understanding first lien, senior secured and subordinated debt.

Question 33

Internal Rate of Return

Accepted Answer

A discount rate where the net present value (NPV) of both positive and negative cash flows is equal to zero. This is used to estimate the profit potential for prospective investments. When the IRR is higher than an investor’s required rate of return, that means the project is desirable. Yet if the IRR is below the required rate of return, then the project should be rejected.

What is IRR used for in business?

Businesses of any size can use the internal rate of return as a way to better evaluate certain projects or investments. Essentially you can look at IRR as the breakeven discount rate which will give a better indication of whether a project or investment will be profitable in the long run.

Usually, businesses will look to have a larger IRR, that exceeds expectations as this will offer a more lucrative return on their initial investment. The bigger the return, the better.

A simpler approach

Because the IRR of capital investments and physical goods can become extremely complex over a longer period a simple approach would be the following:

An individual receives 15% interest on their $2,000 investment.
Thus, $2,000 at the current period earns $2,000 x 15% = $200 per annum.
$2,000 invested now, will give you $2,300 in one year.
Finally, the IRR here indicates that in one year from now, $2,300 will be worth $2,000.

What we’re seeing here is that the physical value of money or goods decreases over time. Meaning that the same amount of money invested now will deliver better returns in the long run.

Note: This example is based on an individual investment.

Read more:

Question 34

Inventory Financing

Accepted Answer

When a business or company would like to secure a loan, for whatever intended purpose, inventory can be used as collateral for the loan. It’s a high-risk maneuver – considering the fact that if the loan cannot be fully repaid, inventory can be seized and sold by the lender.

Two Main Types of Inventory Financing

To ensure better security and risk assessment for both the lender and the borrower, there are currently two main types of inventory financing.

Inventory Loan

Usually, when a new small business is set to open, entrepreneurs may acquire an inventory loan. This works quite similar to that of a small business loan, but instead, it’s calculated against the amount of inventory required by the business.

The owners are responsible to make monthly installments or set up a repayment term for the inventory loan. As inventory is sold off, owners will make the necessary repayments of the loan.

Inventory Line of Credit

An inventory line of credit allows business owners to establish a sort of partnership with their financial institutions or lenders. With this, business owners will be able to receive additional funding on an as-needed basis.

Using an inventory line of credit, business owners have more leniency considering their initial loan and allow them to be covered in the event of unforeseeable circumstances.

When will a small business use inventory financing?

Small business owners may require additional financial support to assist with the growth of their business. A small business owner may use inventory financing for:

To assist with immediate cash shortages
Increase and grow product offering
Introduce a new line of products
Increase supply to help meet growing demands

Inventory financing is mainly used by small business owners to assist with short-term-based financial backing, but over time can help increase overall inventory expansion.

Question 35

Investment Memorandum

Accepted Answer

Before an investor can finalize the perspective of their desired investment, a team of investment managers will set up an investment memorandum. The investment memorandum acts as a profile to consider all investments and products to determine whether the offerings will meet the client’s desired needs.

Yieldstreet will use its team of highly skilled investment experts to set up an investment memorandum. This memorandum or document will deliver extensive information regarding the initial offering to investors.

Creating an investment memorandum can be an extensive process. The members involved in setting up the memorandum will need to do a thorough investigation into the company or individual before a final summary can be delivered.

What’s included in an investment memorandum?

There are a plethora of objectives included in the final version of an investment or offering memorandum before it is delivered to the client.

Included objectives:

A full company profile of those selected
Financial management statements
Operational statements
All risks associated with the desired companies
Legal terms and conditions

Why should investors request an investment memorandum?

Although private investment can be considered high risk, this memorandum acts as a dossier to help protect both investors and sellers against any liability associated with selling unregistered securities.

Furthermore, it acts as an informative guide to help investors assess the investment and whether or not they would benefit from it.

Who prepares the investment memorandum?

Various financial institutions can assist to prepare an investment memorandum. At Yieldstreet, a team of investment experts will review the investor profile and associated risks and will create a memorandum based on investment needs.

Investment bankers are some of the most skilled professionals to help prepare such a memorandum.

Question 36

HNWI or High Net Worth Individuals

Accepted Answer

HNWI, also known as a High Net Worth Individual is a person whose personal assets exceed $1 million. These personal assets can include shares, stock, bonds, and other personal investments, but exclude the primary residence of the individual involved.

When is a person considered a ‘High Net Worth Individual’?

The term HNWI has become more prominent in recent media coverage. The United States Securities and Exchange Commission officially defines these individuals as persons who have at least $750,000 in manageable assets. These can be divided into a variety of categories including:

Private/public stocks or bonds.
Liquid assets include savings, short-term U.S. Treasury bills, any money market accounts.
Mutual Funds
Insurance Policies
Annuities

These are some of the primary examples that can help contribute to an individual’s wealth.

In the United States, among other developed nations, there are currently more than 11.6 million households harboring a net worth between $1 million to $ 5 million as reported by the investment banking group Spectrum Group.

Three categories of high net worth individuals

Currently, there are three categories of high net worth individuals:

HNWI: An individual with an estimated net worth of $1 million to $5 million.
Mid-Tier: Any individual with a net worth that exceeds $5 million up to $30 million.
Ultra-High-Net-Worth: These individuals are considered the ‘ultra rich’ with a net worth that exceeds the $30 million thresholds.

How does one become an HNWI?

There are various ways in which someone can become an HNWI. The key takeaways here are to consider your current liquid assets. Individuals who can grow their current liquid assets to the value of $1 million (excluding primary residence) will be considered as an HNWI.

HNWI has somewhat of a tax advantage, thus if individuals manage their liquid assets more attentively, including retirement plans such as 401(k) – it will gradually help grow personal your wealth and net worth.

Read more:

Question 37

Cost of Capital

Accepted Answer

Cost of capital refers to the minimum rate of return a business or company has to generate before a new purchase, or investment starts to make money. The cost of capital is also seen as the cost of a company’s funds, including debt and equity.

For any business or major corporation to achieve profitability, the business will need to generate sufficient capital that covers all its operational costs. Any leftover capital available is considered as the profits of the business or company.

Calculating the cost of capital

For businesses to calculate the cost of capital, three separate calculations will need to be completed first. These calculations are:

Weightage of Debt x cost of Debt
Weightage of preference Shares x cost of preference shares
Weightage of Equity x the Cost of Equity

Once each of these has been individually calculated business owners or financial administrators can then add each set value to find the total cost of capital.

Individual calculations for each of these are relatively complex, thus businesses make use of accountants to assist in the final calculation of the cost of capital.

Cost of Capital and Capital Structure

Determining the final capital structure of a business or company can be difficult to calculate. For this to be determined, both debt financing and equity financing will need to be calculated. These are two different entities and host their advantages and disadvantages.

Capital structure is important to calculate, as this will contribute to the cost of capital currently owned by the business or company.

Costs associated with the expansion of the business, i.e. acquisition of land, commercial property, or construction to enhance operations can be associated with the capital costs of the business. Items, equipment, and other assets that are acquired to benefit the business and employees are also considered capital costs.

Question 38

Correlation

Accepted Answer

Correlation is the simple understanding that refers to two items, or things that share a mutual relationship or similarity. Correlation can be used in a wide variety of fields and industries but can be prominent in the financial and banking industry.

Highly Correlated Versus Uncorrelated Investments

High Correlated Investments: These investments respond to the same forces driven by the market.
Uncorrelated Investments: These investments do not respond to changes or fluctuations of the market and have no direct similarity to other parts of the market.

Fund managers will usually use a correlation coefficient as a way to measure and calculate the value of investment portfolios and are used to help manage these portfolios. Using economic and financial correlation, fund managers can also help investors diversify their portfolios.

What is an example of correlation in investment?

One of the easiest examples to understand the correlation between stocks or assets is to look at that provided by Getbaraka.com:

In 2020, Uber Technologies and Lyft Inc shared the same type of positive correlation between 1 January 2020 and September 2020. What’s significant about this correlation is that both these companies had similar stock performance throughout 2020.

Even more, these companies share the same type of industry and offer the same type of products and services and one another.

Types of correlation

Positive Correlation

In terms of economics, a positive correlation is recognized when an investment relates and responds to the market forces. Simply put, when the market goes up, investments go up, and when the market decreases, so do the corresponding investments. This occurs as these two forces are correlated to one another.

Negative Correlation

A negative correlation is the opposite of what a positive correlation is. If the market performs poorly, then certain investments will decrease compared to market profitability.

Zero Correlation

The correlation coefficient is zero, meaning there is no real relationship between the two sets.

Question 39

Contingency Fee Representation

Accepted Answer

When a plaintiff is unable to pay lawyer or attorney fees, the plaintiff does not have to pay any legal fees unless or until a case has been settled. This enables the lawyer to receive a percentage of the plaintiff’s recovery.

A contingency fee representation is used in severe cases where a plaintiff is seeking monetary compensation for any injury or damages caused to themselves of any property.

Contingency Fees Versus Non-Contingency Fees

Contingency Fees: In many cases, lawyers will receive an hourly rate which they are paid to assist with a plaintiff’s case. In the event of a contingency fee system, a lawyer can secure a percentage of the plaintiff’s recovery from the case as compensation.

Non-contingency Fees: Under this system, rates for lawyers are based on various aspects such as the complexity of the case, the experience of the lawyer, resources involved in the case, and finally the amount of time the lawyer will be spending on the case.

In this regard, lawyers are paid an hourly rate, covering any costs they have endured throughout the time they have worked on the case. Additionally, costs can include delivery costs, filing fees, and court costs among others.

What is a typical contingency fee?

Lawyers and plaintiffs can agree upon a final percentage that will be compensated to the lawyer once the case has been settled. This percentage can range from 25-33% of the amount settled in favor of the plaintiff.

Factors that can influence the contingency fee:

What is the complexity level of the case?
Who is responsible for the litigation costs involved?
What happens if the plaintiff loses the case?

In the event that a plaintiff and lawyer lose the case, lawyers will receive no compensation for their efforts. This is one of the biggest drawbacks of contingency fee representation, as this can be a less promising route for lawyers looking for a payment to take.

Question 40

Asset-based Investments

Accepted Answer

Asset-based investment, sometimes referred to as asset-based financing, is a form of investment that collateralizes company securities (i.e. commercial property, land, or physical assets) to obtain a financial loan.

How does asset-based financing work?

Here’s a quick example: SimplyGo is an electric car manufacturing company looking to expand operations in Texas. Although the company is profitable and sees a steady stream of revenue, it requires a financial backing to open a new manufacturing plant.

After much consideration, the company decides to apply for a business loan from the bank. The bank approves the loan but acquires SimplyGo to put its current manufacturing plant in California as collateral in case the company doesn’t meet interest and principal payment deadlines.

More than 10 years after the financing has been approved and SimplyGo has become a national success, the bank releases the asset-backed financial security of the company.

The scenario is a relatively straightforward example of how companies can use their personal assets as collateral to obtain additional financing.

When are asset-based investments used?

In general speaking terms, companies and individuals use asset-backed investments when they have exhausted their credit limits. Although this gives the company or individual more flexibility, it still comes with a high capital risk.

In some instances companies or individuals aren’t able to make interest and principal payments, allowing banks to seize any capital securities or items put up for financing.

Why is asset valuation important?

Valuing company assets allow the company and executives to determine the true value of the company through its many different assets. The same goes for high-profile investors. Valuing assets are divided into two main categories, tangible and intangible assets, which are treated differently but contribute to the overall value of the company.

Glossary terms