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Finance Questions

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1. Explain what a yield curve is, and the three different types of curves.

Explain Expectations Theory, and give an example.

2. Explain Liquidity Preference Theory, and give an example.

3.Explain Market Segmentation Theory, and give an example.

4. What is the I-Bond and why was it offered by the USD of Treasury?

5. Why do financial managers prefer to calculate values of projects or investments in present values?

6. What is meant by "the present value of a future amount"?

7. How would you calculate that?

8. What is the difference between simple and compound interest?

9. What is the difference between simple and compound interest?

10. What is the difference between an annuity and an annuity due, and which always has the greater future value, and why?

11. What is the impact of international assets on a portfolio?

Is there more or less risk?

12. Explain the term Beta in determining risks in a portfolio or security.

13. What is an IPO? Give an example.

14. What does a firm have to do, legally before "going public"?

15. What are the differences between debt and equity capital?

16. What are the differences between common and preferred stock? Which would you prefer and why?

17. What risks do common stockholders take that other suppliers of long-term capital do not?

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The response addresses the queries posted in 2011 Words,APA References

Finance

1.

The curve relating to the maturity of debt and interest rates is called the yield curve. The yield curve may assume any shape, but it is generally upward sloping. It means that more the maturity greater the interest risk. In the other debt market, yield curve is used as the benchmark to find out the term structure of the interest rates. Mainly it is used to forecast the changes in economic output and growth.

The three different types of curves are as follows:

1. Normal yield curve: This yield curve depicts that yield is mainly depends on the maturity period. It means that longer maturity bonds have higher yield, due to high risk involved in it as compared to the short term bonds or securities.

2. Flat yield curve: Flat yield curve explains that both the yields i.e. short duration and long duration are quite similar. It is also termed as the economic conversion predictor.

3. Inverted yield curve: An inverted yield curve is results when the short term rates are higher than the long term rates (Van Horne, Wachowicz & Bhaduri, 2008).

2.

The expectation theory supports the yield curve which is upward sloping, since investors always expect the short term rates to increase in the future. This implies that the long term rates will be higher than the short term rates. This theory also depicts that on the successive maturities, expected yield of the same security is determined by investor anticipations of interest rates in the future period of time. Expectation theory does assume that there is more efficiency in the capital markets and there are no transaction costs and investor's sole purpose is to maximize their returns. For example: Investor accepts 9% on bond in the first year and predicting the future rate will be 11%, but the expected current rate will be 10%. The average of the interest rates i.e. first year and following year is (9% + 11%)/2= 10% . thus we conclude that investors will earn the same average expected returns on all maturity combinations.

3.

Liquidity preference theory depicts that higher cost of long term financing induce the investors to hold the bonds for the long duration of time. This theory explains that lenders are risk averse and risk generally increases with the length of lending time because it is more difficult to forecast the more distant future. For example: Investors, who are risk averse, always prefer to make short term investments because to predict the future changes is difficult for the investors.

4.

The market segmentation theory assumes that the debt market is divided into several segments based on the maturity of debt. In each segment, the yield of debt depends on the demand and supply. Investor's preferences of each segment arise because they want to match the maturities of securities to reduce the susceptibility to interest rate changes. This theory also assumes that investors do not shift from one maturity to another in their borrowing-lending activities and therefore, the shifts in yields are caused by changes in the demand and supply of bonds of different maturities. Overall, it implies that investors strongly prefer to invest in assets with maturities matching their liabilities and ...

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Finance questions on different concepts

1. Which of the following statements concerning common stock and the investment banking process is not correct?

A. The preemptive right gives each existing common stockholder the right to purchase his or her proportionate share of a new stock issue.
B. If a firm sells 1,000,000 new shares of Class B stock, the transaction occurs in the primary market.
C. Listing a large firm's stock is often considered to be beneficial to stockholders because the increases in liquidity and reputation probably outweigh the additional costs to the firm.
D. Stockholders have the right to elect the firm's directors, who in turn select the officers who manage the business. If stockholders are dissatisfied with management's performance, an outside group may ask the stockholders to vote for it in an effort to take control of the business. This action is called a tender offer.
E. The announcement of a large issue of new stock could cause the stock price to fall. This loss is called "market pressure," and it is treated as a flotation cost because it is a cost to stockholders that is associated with the new issue.

2. Which of the following statements about listing on a stock exchange is most correct?

A. Listing is a decision of more significance to a firm than going public.
B. Any firm can be listed on the NYSE as long as it pays the listing fee.
C. Listing provides a company with some "free" advertising, and it may enhance the firm's prestige and help it do more business.
D. Listing reduces the reporting requirements for firms, because listed firms file reports with the exchange rather than with the SEC.
E. The OTC is the second largest market for listed stock, and it is exceeded only by the NYSE.

3. Heavy use of off-balance sheet lease financing will tend to

A. make a company appear more risky than it actually is because its stated debt ratio will be increased.
B. make a company appear less risky than it actually is because its stated debt ratio will appear lower.
C. affect a company's cash flows but not its degree of risk.
D. have no effect on either cash flows or risk because the cash flows are already reflected in the income statement.
E. affect the lessee's cash flows but only due to tax effects.

4. Sutton Corporation, which has a zero tax rate due to tax loss carry-forwards, is considering a 5-year, $6,000,000 bank loan to finance service equipment. THe loan has an interest rate of 10% and would be amortized over 5 years, with 5 end-of-year payments. Sutton can also lease the equipment for 5 end-of-year payments of $1,790,000 each. How much larger or smaller is the bank loan payment than the lease payment?

A. $177,169
B. $196,854
C. $207,215
D. $217,576
E. $228,455

5. Europa Corporation is financing an ongoing construction project. The firm will need $5,000,000 of new capital during each of the next 3 years. The firm has a choice of issuing new debt or equity each year as the funds are needed, or issue only debt now and equity later. Its target capital structure is 40% debt and 60% equity, and it wants to be at that structure in 3 years, when the project has been completed. Debt flotation costs for a single debt issue would be 1.6% of the gross debt proceeds. Yearly flotation costs for 3 separate issues of debt would be 3.0% of the gross amount. Ignoring time value effects, how much would the firm save by raising all of the debt now, in a single issue, rather than in 3 separate issues?

A. $79,425
B. $83,606
C. $88,006
D. $92,406

6. The State of Idaho issued $2,000,000 of 7% coupon, 20-year semiannual payment, tax-exempt bonds 5 years ago. The bonds had 5 years of call protection but now the state can call the bonds if it chooses to do so. The call premium would be 5% of the face amount. Today 15-year, 5%, semiannual payment bonds can be sold at par, but flotation costs on this issue would be 2%. What is the net present value of the refunding?

A. $278,606
B. $292,536
C. $307,163
D. $322,521
E. $338,647

7. The basic doctrine of fairness under bankruptcy provisions states that claims must be recognized in order of their legal and contractual priority.

A. True
B. False

8. Which of the following is generally not true and an advantage of going public.

A. Facilitates stockholder diversification.
B. Increases the liquidity of the firm's stock.
C. Makes it easier to obtain new equity capital.
D. Establishes a market value of the firm.
E. Makes it easier for owner-managers to engage in profitable self-dealings.

9. Which of the following statements is not correct?

A. When a corporation's shares are owned by a few individuals who own most of the stock or are part of the firm's management, we say that the firm is "closely, or privately held."
B. "Going public" establishes a firm's true intrinsic value and ensures that a liquid market will always exist for the firm's shares.
C. Publicly owned companies have sold shares to investors who are not associated with management, and they must register with and report to a regulatory agency such as the SEC.
D. When stock in a closely held corporation is offered to the public for the first time, the transaction is called "going public," and the market for such stock is called the new issue market.
E. It is possible for a firm to go public and yet not raise any additional new capital.

10. What would be the priority of the claims as to the distribution of assets in a liquidation under Chapter 7 of the Bankruptcy Act? From highest to lowest.

(1) Trustee's costs to administer and operate the firm.
(2) Common Stockholders.
(3) General, or unsecured, creditors.
(4) Secured creditors, who have a claim to the proceeds from the sale of specific property pledged to secure a loan.
(5) Taxes due to federal and state governments.

A. 1, 4, 3, 5, 2
B. 5, 4, 1, 3, 2
C. 4, 1, 5, 3, 2
D. 5, 1, 4, 2, 3
E. 1, 5, 4, 3, 2

11. Which of the following statements is most correct?

A. In a private placement, securities are sold to private (individual) investors rather than to institutions.
B. Private placements occur most frequently with stocks, but bonds can be sold in private placement.
C. Private placements are convenient for issuers, but the convenience is offset by higher flotation costs.
D. The SEC requires that all private placements be handled by a registered investment banker.
E. Private placements can generally bring in funds faster than is the case with public offerings.

12. Dakota Trucking Company (DTC) is evaluating a potential leas for a truck with a 4 year life that costs $40,000 and falls into the MACRS 3-year class. If the firm borrows and buys the truck, the loan rate would be 10%, and the loan would be amortized over the truck's 4-year life, so the interest expense for taxes would decline over time. The loan payments would be made at the end of each year. The truck will be used for 4 years, at the end of which time it will be sold at an estimated residual value of $10,000. If DTC buys the truck,m it would purchase a maintenance contract that costs $1,000 per year, payable at the end of each year. The lease terms, which include maintenance, call for a $10,000 lease payment (4 payments total) at the beginning of each year. DTC's tax rate is 40%. What is the NAL? (Note: MACRS rates for Years 1 to 4 are 0.33, 0.45, 0.15, and 0.07.)

A. $849
B. $896
C. $945
D. $997
E. $1,047

13. Rainier Bros. has 12% semiannual coupon bonds outstanding that mature in 10 years. Each bond is now eligible to be called at a call price of $1,060. If the bonds are called, the company must replace them with new 10-year bonds. The flotation cost of issuing new bonds is estimated to be $45 per bond. How low would the yield to maturity on the new bonds have to be in order for it profitable to call the bonds today?

A. 9.29%
B. 9.78%
C. 10.29%
D. 10.81%
E. 11.35%

14. Bankruptcy plays no role in settling labour disputes and product liability suits. Such issues are outside the bounds of bankruptcy law and are covered by other statutes.

A. True.
B. False.

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