Business finance : theory and practice

Derivatives
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only partially) the claims of the creditors. This type of liquidation is sometimes
referred to colloquially as bankruptcy.
Order of paying claimants
Irrespective of which type of liquidation is involved, the liquidator, having realised all
of the non-cash assets, must take great care as to the order in which the claimants are
paid. Broadly speaking, the order is:
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1 Secured creditors. These would tend to be loan creditors (those that have lent money
to the company). Where the security is on a specified asset or group of assets, the
proceeds of disposal of the asset are to be applied to meeting the specific claim. If
the proceeds are insufficient, the secured creditors must stand with the unsecured
creditors for the shortfall. If the proceeds exceed the amount of the claim, the excess
goes into the fund available to unsecured creditors.
2 Unsecured creditors. This group would usually include most trade payables (those
that have supplied goods and services to the business on credit). It would also
include any unsecured loan creditors.
In fact, ranking even before the secured creditors come claimants who have preferential
rights. These include HM Revenue and Customs (the UK tax authority) for the
company’s tax liabilities (if any), and the employees for their wages or salary arrears.
Only after the creditors have been paid in full will the balance of the funds be paid
out to the shareholders, each ordinary share commanding an equal slice of the funds
remaining after the creditors and preference shareholders have had their entitlement.
The order of payment of creditors will be of little consequence except where there
are insufficient funds to meet all claims. Where this is the case, each class of claim must
be met in full before the next class may participate.
Although this summary of company regulation is set in a UK context, as was mentioned
earlier, virtually all of the world’s free enterprise economies have similar laws
surrounding the way in which most businesses are organised.
1.8 Derivatives
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A striking development of business finance, and of other areas of commercial management,
since around 1980 is the use of derivatives. Derivatives are assets or obligations
whose value is dependent on some asset from which they are derived. In
principle, any asset could be the subject of a derivative. In practice, assets such as commodities
(for example, coffee, grain, copper) and financial instruments (for example,
shares in companies, loans, foreign currency) are the ones that we tend to encounter
as the basis of a derivative.
A straightforward example of a derivative is an option to buy or sell a specified
asset, on a specified date or within a specified range of dates (the exercise date), for a
specified price (the exercise price). For example, a UK exporter who has made a sale
in euros, and expects the cash to be received in two months’ time, may buy the option
to sell the euros for sterling at a price set now, but where delivery of the euros would
not take place until receipt from the customer in two months’ time. Note that this is a
right to sell but not an obligation. Thus if the sterling value of a euro in two months’
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