BUSI 408 final CTC Questions & Answers
The 100-year bonds we discussed in A 100-year bond looks like a share of preferred stock. In particular, it is a
the chapter have something in loan with a life that almost certainly exceeds the life of the lender,
common with junk bonds. Critics assuming that the lender is an individual. With a junk bond, the credit risk
charge that, in both cases, the issuers can be so high that the borrower is almost certain to default, meaning that
are really selling equity in disguise. the creditors are very likely to end up as part owners of the business. In
What are the issues here? why would both cases, the "equity in disguise" has a significant tax advantage.
a company want to sell "equity in
disguise"?
One measure of liquidity is the bid-ask spread. Liquid instruments have
All treasury bonds are relatively
relatively small spreads. Looking at Figure 6.4, the bellwether bond has a
liquid, but some are more liquid than
spread of .02 percent; it is one of the most liquid of all investments.
others. Which issues appear to be
Generally, liquidity declines after a bond is issued. Some older bonds will
most liquid? the least liquid?
often have spreads that are much wider.
Yes. Some investors have obligations that are denominated in dollars; i.e.,
Are there any circumstances under they are nominal. Their primary concern is that an investment provides the
which an investor might be more needed nominal dollar amounts. Pension funds, for example, often must
concerned about the nominal return plan for pension payments many years in the future. If those payments are
on an investment than the real return? fixed in dollar terms, then it is the nominal return on an investment that is
important.
, BUSI 408 final CTC Questions & Answers
As indicated by a # of examples in Earnings contain information about recent sales and costs. This information
this chapter, earnings announcments is useful for projecting future growth rates and cash flows. Thus,
by companies are closely followed by unexpectedly low earnings often lead market participants to reduce
and frequently result in, share price estimates of future growth rates and cash flows, which results in even
revisions. 2 issues come to mind. lower prices. The reverse is often true for unexpectedly high earnings.
1)Earning annoucements concern past
periods If the market values stocks
based on expectations of the future,
why are numbers summarizing past
performance relevant? 2) These
annoucements concern accounting
earnings. Such earnings have little to
do with cash flow, so again, why are
they relevant?
Based on his own analysis, Tom is Equity is inherently riskier than debt (except, perhaps, in the unusual case
recommending that the company where a firm's assets have a negative beta). For this reason, the cost of
increase its use of equity financing, equity exceeds the cost of debt. If taxes are considered in this case, at
because "Debt costs 12.5 percent, but reasonable tax rates, the cost of equity does exceed the cost of debt.
equity only costs 10%; this equity is
cheaper." Ignoring all the other issues,
what do you think about the
conclusion that the cost of equity is
less than the cost of debt?
, BUSI 408 final CTC Questions & Answers
based on the dividend growth, what The two components are the dividend yield and the capital gains yield. For
are the 2 components of the total most companies, the capital gains yield is larger. This is easy to see for
return on a share of stock? which do companies that pay no dividends. For companies that do pay dividends,
you think is typically larger? the dividend yields are rarely over five percent and are often much less.
Based on the most recent financial This is the current yield only, not the promised yield to maturity. In
statements, Bedlam Product's total addition, it is based on the book value of the liability, and it ignores taxes.
liabilities are $8 million. Total interest
expense for the coming year will be
about $1 million. Tom therefore
reasons, "We owe $8 million, and we
will pay $1 million interest. Therefore,
our cost of debt is obviously $1
million/$8 million = .125 or 12.5%."
What's wrong with this conclusion?
The 100-year bonds we discussed in A 100-year bond looks like a share of preferred stock. In particular, it is a
the chapter have something in loan with a life that almost certainly exceeds the life of the lender,
common with junk bonds. Critics assuming that the lender is an individual. With a junk bond, the credit risk
charge that, in both cases, the issuers can be so high that the borrower is almost certain to default, meaning that
are really selling equity in disguise. the creditors are very likely to end up as part owners of the business. In
What are the issues here? why would both cases, the "equity in disguise" has a significant tax advantage.
a company want to sell "equity in
disguise"?
One measure of liquidity is the bid-ask spread. Liquid instruments have
All treasury bonds are relatively
relatively small spreads. Looking at Figure 6.4, the bellwether bond has a
liquid, but some are more liquid than
spread of .02 percent; it is one of the most liquid of all investments.
others. Which issues appear to be
Generally, liquidity declines after a bond is issued. Some older bonds will
most liquid? the least liquid?
often have spreads that are much wider.
Yes. Some investors have obligations that are denominated in dollars; i.e.,
Are there any circumstances under they are nominal. Their primary concern is that an investment provides the
which an investor might be more needed nominal dollar amounts. Pension funds, for example, often must
concerned about the nominal return plan for pension payments many years in the future. If those payments are
on an investment than the real return? fixed in dollar terms, then it is the nominal return on an investment that is
important.
, BUSI 408 final CTC Questions & Answers
As indicated by a # of examples in Earnings contain information about recent sales and costs. This information
this chapter, earnings announcments is useful for projecting future growth rates and cash flows. Thus,
by companies are closely followed by unexpectedly low earnings often lead market participants to reduce
and frequently result in, share price estimates of future growth rates and cash flows, which results in even
revisions. 2 issues come to mind. lower prices. The reverse is often true for unexpectedly high earnings.
1)Earning annoucements concern past
periods If the market values stocks
based on expectations of the future,
why are numbers summarizing past
performance relevant? 2) These
annoucements concern accounting
earnings. Such earnings have little to
do with cash flow, so again, why are
they relevant?
Based on his own analysis, Tom is Equity is inherently riskier than debt (except, perhaps, in the unusual case
recommending that the company where a firm's assets have a negative beta). For this reason, the cost of
increase its use of equity financing, equity exceeds the cost of debt. If taxes are considered in this case, at
because "Debt costs 12.5 percent, but reasonable tax rates, the cost of equity does exceed the cost of debt.
equity only costs 10%; this equity is
cheaper." Ignoring all the other issues,
what do you think about the
conclusion that the cost of equity is
less than the cost of debt?
, BUSI 408 final CTC Questions & Answers
based on the dividend growth, what The two components are the dividend yield and the capital gains yield. For
are the 2 components of the total most companies, the capital gains yield is larger. This is easy to see for
return on a share of stock? which do companies that pay no dividends. For companies that do pay dividends,
you think is typically larger? the dividend yields are rarely over five percent and are often much less.
Based on the most recent financial This is the current yield only, not the promised yield to maturity. In
statements, Bedlam Product's total addition, it is based on the book value of the liability, and it ignores taxes.
liabilities are $8 million. Total interest
expense for the coming year will be
about $1 million. Tom therefore
reasons, "We owe $8 million, and we
will pay $1 million interest. Therefore,
our cost of debt is obviously $1
million/$8 million = .125 or 12.5%."
What's wrong with this conclusion?
