Guide to Analysing Companies

C
CAP
61
01 Essential Finance 10/11/06 2:21 PM Page 61

---

 a life-of-loan cap, which places a ceiling on the amount
of interest that can be paid on the loan throughout its life;
 a payment cap, which limits the amount by which the
monthly payments can rise from year to year.
Capital
The money used to build a business. Capital is raised by issuing
shares and/or long-term debt instruments. The balance of a
company’s ordinary shares, preference shares and
long-term debt constitutes its capital structure. Together with its
retained profit, these make up the company’s capital em-
ployed. The key relationship between debt and equity is
known as gearing or leverage. For financial institutions,
capital is a safety net against sudden losses arising from bad
debt, bad management or skulduggery and fraud. (See also
working capital.)
Capital adequacy
A measure of a financial institution’s ability to withstand
credit and market risks. The Basel Committee on Banking Su-
pervision (a body composed mainly of the governors of the
central banks of the Group of Ten wealthiest countries) sets
down rules with which banks must comply. Banks must set
aside in their accounts part of their capital to cover the risk of
defaults caused by the failure of the companies they are
lending to or a collapse in the financial markets as a whole. In
the past, these standards have been mechanical rules that have
stipulated the size of the financial buffer that banks must main-
tain. In recent years, however, regulators have realised the need
for more sophisticated systems that can monitor the level of risk
to which banks may be exposed. For example, since the late
1980s banks have been allowed to use value at risk models
to determine the amount of capital they must hold to cover the
risks they are running. The Basel committee plans new rules (ex-
pected to be introduced in 2006) which will distinguish more