If corporate managers are risk-averse, does this mean they will not take risks?
-No, managers will still take risk, if it gives them a greater reward, or better return
. Briefly explain how the concept of risk can be incorporated into the capital budgeting process.
-The basic concept of capital budgeting is to maximize shareholder wealth in a risk return environment. Risk is a measure of variability and uncertainty. The greater the variability, the greater the risk.
-Investors should be able to differentiate between investments that produce "certain returns" and investments that produce an expected value of returns, but have a high coefficient of variation, or higher risk. To do this we can use risk-adjusted discount rates.
3. Briefly explain the effect of the risk-return trade-off on the market value of common stock.
-By increasing risk, discount rate decreases, so the present value decreases. Since the present value is lower, our stock price will be lower. The opposite it true as well...lower risk leads to lower discount rates, a higher net present value, and a higher stock price. We must be concerned with risk because higher profits don't always lead to higher stock prices, if the profits result from risky ventures.
Do corporations rely more on external or internal funds as sources of
Corporations rely more on external funds, b/c companies don't have enough funds internally to handle all investments. Internal funds depend on corporate profitability, retained earnings, dividends paid and depreciation tax shield fims available
2. Briefly explain the role of financial intermediaries in the flow of funds
through the three-sector economy.
-House hold savings are funneled to financial intermediearies that make investments into capital markets. Their job is to move the funds between gov, corporations, and housholds.
3. Briefly explain why is secondary market trading is important.
-it provides liquidity,
-it helps corporations understand pricing, and keep prices competitive
. In what way in an investment banker a risk taker?
When underwriting, the investment banker immediately buys the securities, and therefore assumes all risk. There is a time gap between when you buy and when you sell, so there is risk of changing rates.
. Briefly discuss how an underwriting syndicate decreases risk for each
underwriter and at the same time facilitates the distribution process.
By syndicating, the underwriter brings in other investment bankers. By distributing themoney, the risk is spread out. The investment banker calls on other invetment houses to sahre and distribute the investment. Underwriting syndicate if formed from many investment houses. Each of those act as wholesalers in distributing the shares to brokers and dealers. The brokers and dealers sell the shares to the public.
Briefly explain the advantages and disadvantages of being public.
1.greater access to public markets
2. liquidity for shareholders
4. assist in merger activities
5. estate planning
1. information on company must be made public
2. accululating information is expensive
3. pressure from investors and analysts
4. embarrassment from public failure
5. cost of selling new issue
1. Briefly discuss the relationship between bond prices and interest rates.
-they have an inverse relationship. The lower the interest rate compensates for higher the price of the bond.
. How does bond rating affect the interest rate paid by a corporation on
They higher the rating, the lower the risk, so there is a smaller interest rate paid by corporation
. Briefly discuss the advantages and disadvantages of debt.
Advantages of debt:
1.Interest payments are tax deductible. Which makes it the cheapest form of captial
2.It is a fixed obligation, and we know exactly what we need to do.
3.We are paying it back with cheaper doallars b/c of inflationary advantage
4.It can lower cost of capital
Disadvantages of debt:
1.It is a fixed obligation. You have to pay it
2.Some times the previsions can be putting to many retrictions on firm and cause problems.
If common stockholders are the owners of the company, why do they
have the last claim on assets and a residual claim on income?
Owners are paid last. Bonds have a contractual obligation which stockholders do not. stockholders pay depends on the success of the organizations. they have capital gains potential
Briefly explain the use of preferred stock from a corporate viewpoint.
- there are no contractual obligations
-if you sell preferred stock, you aren't giving up any voting rights, or dilute common stockholder shares
-contributes to the capital structure
-coporate investors receive 70% tax benefit