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financial markets institutions

Questions and Answers of Financial Markets Institutions

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
Compute the net present value of the mold in Example 13.4, assuming that the debt capacity of the project is zero.AppendixLO1
Use the risk-neutral valuation method to directly show that the risk-neutral discounted value of the existing debt of Unitron is $636,000 higher if the project in Example 13.17 is adopted.AppendixLO1
Applied Micro Devices (AMD) currently spends$213,333 a year leasing office space in Austin.Because lease payments are tax deductible at a 25 percent corporate tax rate, the firm spends about$160,000
SL, Inc., is currently an all equity-firm with a beta of equity of 1. The risk-free rate is 5 percent and the market risk premium is 8 percent. Assume the CAPM is true and that there are no taxes.
The Akron Company consists of $50 million in perpetual riskless debt and $50 million in equity.The current market value of its assets is $100 million and the beta of its equity return is 1.2.Assume
Akron, from the last example, is considering an exchange offer where half of Akron’s outstanding debt ($25 million) is retired. The purchase of this debt would be financed by issuing $25 million in
Distinguish between managerial incentives and shareholder incentives.AppendixLO1
Understand how the differences between manager and shareholder incentives affect the ownership structure, capital structure, and investment policies of firms.AppendixLO1
Describe ways to design compensation contracts that minimize manager-shareholder incentive problems.AppendixLO1
Discuss why managers might tend to want their organizations to grow.AppendixLO1
Discuss the factors that determine whether firms are likely to have large ownership concentrations.AppendixLO1
John Jacobs, the CEO of High Tech Industries, owns 51 percent of the shares of his $50 million company. The firm is starting a new project that requires $25 million in new equity capital. Jacobs is
Consider three similar firms that differ only in the extent to which they are controlled by their boards of directors. In firm 1, the board has complete control of the investment decisions, operating
As a Washington policy analyst, you are asked to comment on a proposed law that would make it more difficult for large outside shareholders to extract private benefits from the partial control they
You are a member of the compensation committee of the board of directors for both Chrysler and Chevron. How should the compensation contracts for the CEOs of these two companies differ?AppendixLO1
The tendency of firms to use stock-based compensation is higher for firms with higher market-to-book ratios. Provide two explanations for this empirical observation.AppendixLO1
Cybertex’s management currently owns 1 percent of the firm’s outstanding shares. The firm is currently financed with 50 percent debt and 50 percent equity but is planning to increase its leverage
Suppose that you are designing the compensation contract for the Chicago Bulls’ new coach. Two main alternatives are possible. In (a) you will design his bonus based on the total number of wins
Describe the concept of DV01, the dollar value of a one-basis-point decrease (in original and term structure variations) and the concept of duration (in MacAuley, modified, and present value
Understand the relation between duration and DV01, and the formulas needed to use either concept for hedging.AppendixLO1
Implement immunization and contingent immunization strategies, using both duration and DV01.AppendixLO1
Explain the link between immunization and hedging, and how to use this link to manage the asset base and capital structure of financial institutions.AppendixLO1
Understand and compute convexity, and know how to use it properly.AppendixLO1
A 3-year coupon bond has payments as follows:This 8 percent coupon bond is currently trading at par ($100).a. What is the annually compounded yield of the bond?b. Compute the MacAuley duration and
Prove that if the present value of a cash flow is represented by PV (cash flow) exp(rtt)and for all t’s, rt shifts up by a constant , the derivative of the percentage change in the bond’s
Bond A has a DV01 of $.10 per $100 face value.Bond B has a DV01 of $.05 per $100 face value.a. If Daniela buys $1 million (face amount) of bond A, what should her position (face amount)in bond B be
The DV01 of a Treasury bond maturing on November 15, 2021, with an 8 percent coupon(4 percent paid semiannually) and a $100 face value is $.10. The DV01 of a Treasury note maturing on May 15, 2012,
A 2-year default-free straight-coupon bond has annual coupons of $8 per $100 of face value.Assume that a default-free zero-coupon bond with one year to maturity sells for $90 per $100 of face value
Compute the duration, DV01, and convexity of a semiannual straight-coupon bond with three years to maturity. The bond trades at par with a 6 percent coupon. Assume the term structure of interest
Compute the duration, DV01, and convexity of a 6 percent 2-year par bond that pays semiannual coupons. Assume the term structure of interest rates is flat.AppendixLO1
Discuss how you might use the 6 percent 2-year bond in exercise 23.7 to hedge a position in the 3-year bond from exercise 23.6.AppendixLO1
How would your answer to exercise 23.8 change if the bond in exercise 23.7 were a 10 percent 2-year premium bond with a yield curve still at a flat 6 percent?AppendixLO1
Discuss qualitatively how your answer to exercise 23.8 would change if the bond in exercise 23.7 was a 10 percent 2-year par bond. (This means that the term structure of interest rates is not
Understand the importance of the mean-standard deviation diagram and know how to locate within the diagram the efficient frontier of risky assets, the capital market line, the minimum variance
Compute and use both the tangency portfolio and the efficient frontier of risky assets.AppendixLO1
Understand the linkage between mean-variance efficiency and risk-expected return equations.AppendixLO1
Describe how to compute the beta of a portfolio given the betas of individual assets in the portfolio and their respective portfolio weights.AppendixLO1
Comprehend what the market portfolio is, what assumptions are needed for the market portfolio to be the tangency portfolio—that is, for the Capital Asset Pricing Model (CAPM) to hold—and the
Here are some general questions and instructions to test your understanding of the mean standard deviation diagram.a. Draw a mean-standard deviation diagram to illustrate combinations of a risky
Compute the tangency portfolio weights assuming a risk-free asset yields 5 percent.AppendixLO1
How does your answer to exercise 5.2 change if the risk-free rate is 3 percent? 7 percent?AppendixLO1
Draw a mean-standard deviation diagram and plot AOL, Microsoft, and Intel on this diagram as well as the three tangency portfolios found in exercises 5.2 and 5.3.AppendixLO1
Show that an equally weighted portfolio of AOL, Microsoft, and Intel can be improved upon with marginal variance-marginal mean analysis.AppendixLO1
Repeat exercises 5.2 and 5.3, but use a spreadsheet to solve for the tangency portfolio weights of AOL, Microsoft, and Intel in the three cases. The solution of the system of equations requires you
a. Compute the betas of AOL, Microsoft, and Intel with respect to the tangency portfolio found in exercise 5.2.b. Then compute the beta of an equally weighted portfolio of the three stocks.AppendixLO1
Using the fact that the hyperbolic boundary of the feasible set of the three stocks is generated by any two portfolios:a. Find the boundary portfolio that is uncorrelated with the tangency portfolio
What is the covariance of the return of the tangency portfolio from exercise 5.2 with the return of all portfolios that have the same expected return as AOL?AppendixLO1
Using a spreadsheet, compute the minimum variance and tangency portfolios for the universe of three stocks described below. Assume the risk-free return is 5 percent. Hypothetical data necessary for
The Alumina Corporation has the following simplified balance sheet (based on market values)a. The debt of Alumina, being risk-free, earns the risk-free return of 6 percent per year. The equity of
The following are the returns for Exxon (which later merged with Mobil) and the corresponding returns of the S&P 500 market index for each month in 1994.Exxon S&P 500 Month Return (%) Return
What value must ACYOU Corporation’s expected return be in Example 5.4 to prevent us from forming a combination of Henry’s portfolio, ACME, ACYOU, and the risk-free asset that is mean-variance
Assume that the tangency portfolio for stocks allocates 80 percent to the S&P 500 index and 20 percent to the Nasdaq composite index. This tangency portfolio has an expected return of 13 percent per
Exercise 5.14 assumed that the tangency portfolio allocated 80 percent to the S&P 500 index and 20 percent to the Nasdaq composite index. The beta for the S&P 500 index with this tangency portfolio
Using data only from 1991–1995, redo Example 5.9. Which differs more from the answer given in Example 5.9: the expected return estimated by averaging the quarterly returns or the expected return
Estimate the Bloomberg-adjusted betas for the following companies.Unadjusted Beta Delta Air Lines 0.84 Procter & Gamble 1.40 Coca-Cola 0.88 Gillette 0.90 Citigroup 1.32 Caterpillar 1.00 ExxonMobil
Compute the tangency and minimum variance portfolios assuming that there are only two stocks:Nike and McDonald’s. The expected returns of Nike and McDonald’s are .15 and .14, respectively.The
There exists a portfolio P, whose expected return is 11%. Stock I has a covariance with P of .004, and Stock II has a covariance with P of .005. If the expected returns on Stocks I and II are 9% and
The expected return of the S&P 500, which you can assume is the tangency portfolio, is 16% and has a standard deviation of 25% per year. The expected return of Microsoft is unknown, but it has a
Decompose the variance of a security into market-related and nonmarket-related components, as well as common factor and firm-specific components, and comprehend why this variance decomposition is
Identify the expected return, factor betas, factors, and firm-specific components of a security from its factor equation.AppendixLO1
Explain how the principle of diversification relates to firm-specific risk.AppendixLO1
Compute the factor betas for a portfolio given the factor betas of its component securities.AppendixLO1
Design a portfolio with a specific configuration of factor betas in order to design pure factor portfolios, as well as portfolios that perfectly hedge an investment’s endowment of factor
State what the arbitrage pricing theory (APT) equation means and what the empirical evidence says about the APT. You also should be able to use your understanding of the APT equation to form
Prove that the portfolio-weighted average of a stock’s sensitivity to a particular factor is the same as the covariance between the return of the portfolio and the factor divided by the variance of
What is the minimum number of factors needed to explain the expected returns of a group of 10 securities if the securities returns have no firmspecific risk? Why?AppendixLO1
Consider the following two-factor model for the returns of three stocks. Assume that the factors and epsilons have means of zero. Also, assume the factors have variances of .01 and are uncorrelated
What are the expected returns of the three stocks in exercise 6.3?AppendixLO1
Write out the factor betas, factor equations, and expected returns of the following portfolios:(1) A portfolio of the three stocks in exercise 6.3 with $20,000 invested in stock A, $20,000 invested
How much should be invested in each of the stocks in exercise 6.3 to design two portfolios? The first portfolio has the following attributes:factor 1 beta 1 factor 2 beta 0 The second portfolio has
Two stocks, Uni and Due, have returns that follow the one factor model:How much should be invested in each of the two securities to design a portfolio that has a factor beta of 3? What is the

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