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Questions and Answers of Financial Markets Institutions

Suppose we observe the three-year Treasury security rate ( 1R3 ) to be 12 percent, the expected one-year rate next year— E ( 2r1 )—to be 8 percent, and the expected one-year rate the following
Suppose we observe the following rates: 1R1 8%, 1R2 10%. If the unbiased expectations theory of the term structure of interest rates holds, what is the one-year interest rate expected one year
One-year Treasury bills currently earn 3.45 percent. You expect that one year from now, one-year Treasury bill rates will increase to 3.65 percent. If the unbiased expectations theory is correct,
Suppose that the current one-year rate (one-year spot rate) and expected one-year T-bill rates over the following three years (i.e., years 2, 3, and 4, respectively) are as follows: 1 1 R Er Er Er
The current one-year Treasury-bill rate is 5.2 percent and the expected one-year rate 12 months from now is 5.8 percent. According to the unbiased expectations theory, what should be the current rate
You are considering an investment in 30-year bonds issued by Moore Corporation. The bonds have no special covenants. The Wall Street Journal reports that one-year T-bills are currently earning 3.25
A particular security’s equilibrium rate of return is 8 percent. For all securities, the inflation risk premium is 1.75 percent and the real interest rate is 3.5 percent. The security’s
What is the difference between simple interest and compound interest? ( LG 2-9 )
How does the liquidity premium theory of the term structure of interest rates differ from the unbiased expectations theory? In a normal economic environment, that is, an upward-sloping yield curve,
If we observe a one-year Treasury security rate higher than the two-year Treasury security rate, what can we infer about the one-year rate expected one year from now? ( LG 2-7 )
What factors cause the demand for funds curve to shift? ( LG 2-4 )
What factors cause the supply of funds curve to shift? ( LG 2-4 )
Who are the demanders of loanable funds? ( LG 2-2 )
Who are the suppliers of loanable funds? ( LG 2-1 )
Identify the sources of positive net present value.AppendixLO1
Implement the real options approach to value projects, the options inherent in mines and vacant land, and the options to wait or to expand a project. Know the effect of these options on a firm’s
Use the ratio comparison approach to value real assets, and in the case of price/earnings ratios, how to adjust the ratio to make appropriate comparisons between firms with different leverage
Compare the virtues and pitfalls of the competitive analysis approach to evaluate real investments and know how to apply it.AppendixLO1
Maytag merges with Whirlpool. Assume that Maytag’s price/earnings ratio is 20 and Whirlpool’s is 15. If Maytag accounts for 60 percent of the earnings of the merged firm, and if there are no
The XYZ firm can invest in a new DRAM chip factory for $425 million. The factory, which must be invested in today, has cash flows two years from now that depend on the state of the economy.The cash
Vacant land has been zoned for either one 10,000-square-foot five-unit condominium or two single-family homes, each with 3,000 square feet.The cost of constructing the single-family homes is $100 per
A silver mine has reserves of 25,000 troy ounces of silver. For simplicity, assume the following schedule for extraction, ore purification, and sale of the silver ore:Also assume the following:•
Widget production and sales take place over a oneyear cycle. For simplicity, assume that all costs (revenues) are paid (received) at the end of the one-year cycle.A factory with a life of three years
Assume that the futures closing prices on the New York Mercantile Exchange at the end of August 2002 specify that futures prices per barrel for light sweet crude oil delivered monthly from
Compute the risk-neutral probabilities attached to the two states—high demand and low demand—in Example 12.2. Show that applying these probabilities to value the mine provides the same answer for
Although there is no empirical evidence to strongly support this hypothesis, some financial journalists have claimed that American managers are shortsighted and overly risk averse, preferring to take
Example 12.9 illustrates how an increase in leverage can affect Micro Technologies’price/earnings ratio. If the interest rate on the new debt was 2 percent rather than 6 percent, would the firm’s
Porter and Spence (1982) pointed out that firms may want to overinvest in production capacity to show a commitment to maintain their market share to competitors. In their model, excess plant capacity
Solve the unlevered price/earnings ratio, A/X, by rearranging equation (12.1).AppendixLO1
In Example 12.11, assuming that the stock per share and the firm’s operations do not change as a consequence of the leveraged recapitalizationa. Identify the dividend yield both before and after
Describe the ways in which firms can raise funds for new investment.AppendixLO1
Understand the process of issuing new securities.AppendixLO1
Comprehend the role played by investment banks in raising capital.AppendixLO1
Discuss how capital is raised in countries outside the United States.AppendixLO1
Analyze trends in raising capital.AppendixLO1
In many European countries such as the United Kingdom and Switzerland, rights issues are much more common than the public, underwritten offers that firms in the United States chiefly use. Can you
In a rights offering with a fixed price for exercising the right, does it matter what the exercise price is?Do shareholders care? Explain.AppendixLO1
Competitive underwritings appear to be cheaper than negotiated ones, but almost no firms use the former.Can you give some reasons for this?AppendixLO1
The Securities Exchange Act of 1934 made insider trading illegal. What are the costs and benefits of prohibiting insider trading?AppendixLO1
Smaller firms tend to raise most of their outside capital from private sources, mainly banks. As firms become larger, they obtain greater proportions of their outside capital needs from the public
Why do you think the largest banks in the world are in Japan and Germany, not the United States? Do you expect this to change in the future?AppendixLO1
Contrast operating and financial leases.
Construct a repayment schedule.
Enumerate the components of credit policy.
Calculate the economic order quantity.
Differentiate earnings from cash.
Interpret a cash budget’s bottom line.
Construct a cash budget.
Contrast the cash budget with the income statement.
Add the impact of changes in any assets that do not spontaneously change with sales.
Use regression analysis to forecast assets and liabilities that change with sales.
Compute the cost of capital.
Enumerate the sources of return from an investment company.
Compute rates of return.
Enumerate the features of convertible securities.
Contrast preferred stock and bonds.
Isolate the tax feature associated with municipal bonds.
Contrast the means for retiring bonds.
Adjust the required return for risk.
Compute and interpret the financial ratios covered in the chapter
Enumerate the sources of several limitations to accounting data
Beta coefficients may differ if you obtain them from different sources. These discrepancies occur because various sources use different timeperiods or a different measure of the market when
Construct a loan amortization schedule.
Use an interest table or a financial calculator.
Interpret the results of your solutions.
Solve time value of money problems.
Trace the mechanics of a stock purchase or sale.
Understand that in the absence of taxes, transaction costs, and other market frictions, capital structure can affect firm values only when the debt-equity choice affects cash flows (the
Explain how corporate taxes provide incentives for firms to use debt financing as well as how they affect the decision to buy or lease capital assets.AppendixLO1
Understand why personal taxes provide an incentive for firms to use equity financing.AppendixLO1
Explain how nondebt tax shields, such as depreciation deductions and R&D expenses, affect the capital structure choice.AppendixLO1
Use the yields on municipal bonds to quantify the total tax gain associated with a leverage change.AppendixLO1
Understand how inflation affects the capital structure choice.AppendixLO1
Suppose rD 12%, 10%, Tc 33%, TD 20%.a. What is the marginal tax rate on stock income TE which would make an investor indifferent in terms of after-tax returns between holding stock or bonds?
Suppose the firm in exercise 14.2 unexpectedly announces that it will issue additional debt, with the same seniority as existing debt and a face value of $50. The firm will use the entire proceeds to
Assume that the real riskless interest rate is zero and the corporate tax rate is 33 percent. IGWT Industries can borrow at the riskless interest rate.It will have an inflation-adjusted EBIT next
As owner of 10 percent of ABC Industries, you have control of its capital structure decision. The current corporate tax rate is 34 percent and your personal tax rate is 31 percent. Assume that the
Explain how inflation affects the capital structure decision. Does inflation affect the capital structure choice differently for different firms?AppendixLO1
Assume the corporate tax rate is 50 percent, AAA corporate bonds are trading at a yield of 9 percent, and municipal bonds are trading at a yield of 6 percent. How can the shareholders of an AAArated
During the early 1990s, most new airplanes were leased by the airlines. This was not true during the early and mid-1980s. Explain why.AppendixLO1
Restaurant chains like McDonald’s sometimes franchise their restaurants and sometimes own them outright. The franchised restaurants are usually owned by individuals who hold them in subchapter S
Real estate investment trusts (REITs) are companies set up to manage investment properties like office buildings and apartment houses. REITs are not subject to corporate taxes and are required to
X-Tex Industries has large depreciation tax deductions and can thus eliminate all of its taxable income with a relatively small amount of debt. In contrast, Unique Scientific Equipment Corporation is
Jeff started an Internet company, Finstrat.com, which, unlike others in the industry, generated taxable earnings almost immediately. Jeff owns 10 percent of the shares, and the rest of the shares are
ABC, Inc., financed with both equity and $10 million in perpetual debt, has pretax cash flow estimates for the current year as follows:Probability Pretax Cash Flow 0.3 $1.5 million 0.5 $2 million 0.2
The Jack and Tyler Pizza Co. is financed entirely with equity and has grown very quickly over the past 8 years. The firm has hired the consulting firm of Stephanie & Chiara, LLC, to analyze the
Understand the effect of leverage on the cost of equity and the beta of the firm when there is a corporate tax deduction for interest payments.AppendixLO1
Apply the adjusted present value method (APV) to value real assets.AppendixLO1
Understand the weighted average cost of capital (WACC) and the effect of leverage on the WACC when there is a corporate tax deduction for interest payments.AppendixLO1
Understand how debt affects the payoffs of projects to equity holders.AppendixLO1
Analyze the Hughes acquisition by first computing the betas of the comparison firms, Lockheed and Northrop, as if they were all equity financed. Hint:Use equation (13.7) to obtain UA from E.In
Compute UA, the beta of the unlevered assets of the Hughes acquisition, by taking the average of the betas of the unlevered assets of Lockheed and Northrop.In 1985, General Motors (GM) was evaluating
Compute the E for the Hughes acquisition at the target debt level.In 1985, General Motors (GM) was evaluating the acquisition of Hughes Aircraft Corporation. Recognizing that the appropriate WACC
Compute the WACC for the Hughes acquisition.In 1985, General Motors (GM) was evaluating the acquisition of Hughes Aircraft Corporation. Recognizing that the appropriate WACC for discounting the
Compute the value of Hughes with the WACC from exercise 13.4.In 1985, General Motors (GM) was evaluating the acquisition of Hughes Aircraft Corporation. Recognizing that the appropriate WACC for
Compute the value of Hughes if the WACC of GM at its existing leverage ratio is used instead of the WACC computed from the comparison firms (see exercise 13.4).In 1985, General Motors (GM) was
Apply the APV method. First, compute the value of the unlevered assets of the Hughes acquisition.Next, compute the present value of the tax shield.Finally, add the two numbers.In 1985, General Motors
Compute the WACC of Marriott’s restaurant division in Example 13.15 by doing the following:a. Compute the E of Marriott’s restaurant division using equation (13.6).b. Apply the CAPM’s risk
GT Associates have plans to start a widget company financed with 60 percent debt and 40 percent equity. Other widget companies are financed with 25 percent debt and 75 percent equity and have equity
The HTT Company is considering a new product.The new product has a five-year life. Sales and net income after taxes for the new product are estimated in the following table:Net Income Net Sales after

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