FINANCE1AFirst Question 1. What problem arises as a result of the separation of ownership and management of a firm?Advocacy problemAgency problemSelf-interest problemSubordination problem2. What is the nominal rate of return of a 10-year Treasury bond if the prevailing risk premiums are as follows: real-risk free rate is 2.0%; inflation premiumis 5.0%; maturity risk premium is 0.3%; and default risk premium is 0.2%.O 2.00%7.00%O 7.30%7.50%3. Which of the following are acceptable criteria for determining the weights in the weighted average cost of capital?Market value of the capital structure and historical costs of financingMarket value of the capital structure and the target mix of debt and equityUsing the after-tax cost of debt and the market value of the capital structureUsing the book value of the capital structure and the prior level of debt and equity

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1. What problem arises as a result of the separation of ownership and management of a firm? Advocacy problem Agency problem Self-interest problem Subordination problem

EBK CFIN

6th Edition

ISBN:9781337671743

Author:BESLEY

Publisher:BESLEY

Chapter5: The Cost Of Money (interest Rates)

Section: Chapter Questions

Problem 19PROB

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Next, we need to calculate MMMs cost of debt. We can use different approaches to estimate it One approach is to take the companys interest expense and divide it by total debt (which is the sum of short-term debt and long-term debt). This approach only works if the historical cost of debt equals the yield to maturity in todays market (i.e., if MMMs outstanding bonds are trading at dose to par). This approach may produce misleading estimates in years in which MMM issues a significant amount of new debt. For example, if a company issues a great deal of debt at the end of the year, the full amount of debt will appear on the year-end balance sheet, yet we still may not see a sharp increase in annual interest expense because the debt was outstanding for only a small portion of the entire year. When this situation occurs, the estimated cost of debt will likely understate the true cost of debt. Another approach is to try to find this number in the notes to the companys annual report by accessing the company's home page and its Investor Relations section. Alternatively, you can go to other external sources, such as bondsonline.com, for corporate bond spreads, which can be used to find estimates of the cost of debt. Finally, you can also go to Morningstar.com, which will provide yield to maturity information on the firms various bond issues. A longer-term issues YTM could provide an estimate of the firms current cost of debt to be used in the WACC calculation. Remember that you need the after-tax cost of debt to calculate a firm's WACC, so you will need MMMs tax rate (which has averaged around 30% in recent years). What is your estimate of MMMs after-tax cost of debt?
Suppose there is a large probability that L will default on its debt. For the purpose of this example, assume that the value of Ls operations is 4 million (the value of its debt plus equity). Assume also that its debt consists of 1-year, zero coupon bonds with a face value of 2 million. Finally, assume that Ls volatility, , is 0.60 and that the risk-free rate rRF is 6%.
An Overview of Financial Management and the Financial Environment Differentiate between the following types of markets: physical asset vs. financial markets, spot vs. futures markets, money vs. capital markets, primary vs. secondary markets, and public vs. private markets the real risk free rate of interest is 3%. Inflation is expected to be 2% this year and 4% during the next 2 years. Assume that the maturity risk premium (MRP) is zero. What is the yield on a 2 year Treasury security? What is the yield on 3 year Treasury securities? If Apple Computer decided to issue additional common stock, and someone purchased 100 shares of this stock from Merrill Lynch, the underwriter, would this transaction be a primary market transaction or a secondary market transaction? Would it make a difference if the investor purchased previously outstanding Apple stock in the dealer market?
The yield on a firms bond is 8.75% and your economist believes that the cost of common can be estimated using a risk premium of 3.85% over firms own cost of debt. What is the firms cost of common from reinvested earnings?
Which of the following statements is right? Group of answer choices a)Ignoring the liquidity risk, the 10-treasry bond should have the same interest rate as the 10-year corporate bond. b)Ignoring the default risk, the 10-treasry bond should have the same interest rate as the 10-year corporate bond. c)The return of the 10-year treasury bond must be less than that of the 10-year corporate bond d)The return of the 10-year treasury bond must be greater than that of the 10-year corporate bond
The yield to maturity (YTM) on 1-year zero-coupon bonds is 5%, and the YTM on 2-year zeros is 6%. The YTM on 2-year-maturity coupon bonds with coupon rates of 12% (paid annually) is 5.8%.a. What arbitrage opportunity is available for an investment banking firm?b. What is the profit on the activity?
If the pure expectations theory of the term structure is correct, which of the following statements would be CORRECT? a. If a 1-year Treasury bill has a yield to maturity of 7% and a 2-year Treasury bill has a yield to maturity of 8%, this would imply the market believes that 1-year rates will be 7.5% one year from now. b. The yield on a 5-year corporate bond should always exceed the yield on a 3-year Treasury bond. c. Interest rate (price) risk is higher on long-term bonds, but reinvestment rate risk is higher on short-term bonds. d. An upward-sloping yield curve would imply that interest rates are expected to be lower in the future. e. Interest rate (price) risk is higher on short-term bonds, but reinvestment rate risk is higher on long-term bonds
Which of the following statements is true? A. Yield spread is reflected in the size of the bid-ask spreads. B. Issuer credit ratings, or corporate family ratings, reflect a debt issuer’s overall creditworthiness and typically apply to a firm’s senior secured debt. C. An investor with an investment horizon of 6 years buys a bond with a modified duration of 6.0. if the yield-to-maturity (YTM) is 0.0214, this investment will have no duration gap. D. Compared to long-term duration bonds, short-term duration bonds have narrow bid-ask spreads.
Which of these five statement is the most correct and why ? a. Other things held constant, a callable bond would have a lower required rate of return than a noncallable bond. b. Other things held constant, a corporation would rather issue noncallable bonds than callable bonds. c. Reinvestment rate risk is worse from a typical investor's standpoint than interest rate risk. d. If a 10-year, R1 000 par, zero coupon bond were issued at a price which gave investors a 10 percent rate of return, and if interest rates then dropped to the point where rd = YTM = 5%, we could be sure that the bond would sell at a premium over its R1 000 par value. e. If a 10-year, R1 000 par, zero coupon bond were issued at a price which gave investors a 10 percent rate of return, and if interest rates then dropped to the point where rd = YTM = 5%, we could be sure that the bond would sell at a discount below its R1 000 par value.
A firm issues a one-year bond with face value 1000 at time T and the firm’s assets value is 1,500 and the volatility of the firm’s assets is 0.3. What is the distance to default of this firm in KMV model? What is the probability of default?
The risk-free rate on long-term Treasury bonds is 6.04%. Assume thatthe market risk premium is 5%. What is the required return on the market? Now use the SML equation to calculate the two companies’ requiredreturns.
Question Consider the following balance sheet positions for a financial institution:• Rate-sensitive assets = $120 million; Rate-sensitive liabilities = $180 million.• Rate-sensitive assets = $230 million; Rate-sensitive liabilities = $200 million.a) Calculate the repricing gap and the impact on net interest income of a 2 percent increase in interest rates for each position. b) Calculate the repricing gap and the impact on net interest income of a 2 percent decrease in interest rates for each position.c) Explain the type of risk this FI is exposed to in each position.