Managerial Finance_Problem Set 1 Need answers for the attached document with no plagiarism and also attaching PowerPoint for your reference. Problem -

Managerial Finance_Problem Set 1
Need answers for the attached document with no plagiarism and also attaching PowerPoint for your reference.

Problem Set #1

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Managerial Finance_Problem Set 1 Need answers for the attached document with no plagiarism and also attaching PowerPoint for your reference. Problem

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Assume that you recently got a job as an investment analyst and your boss has developed the following set of questions you must answer to explain the U.S. financial system to one of your firms clients.
1. Why is corporate finance important to all managers?
2. Describe the organizational forms a company might have as it evolves from a start-up to a major corporation. List the advantages and disadvantages of each form.
3. How do corporations go public and continue to grow? What are agency problems? What is corporate governance?
4. What should be the primary objective of managers?
5. Do firms have any responsibilities to society at large?
6. Is stock price maximization good or bad for society?
7. Should firms behave ethically?
8. What three aspects of cash flows affect the value of any investment?
9. What are free cash flows?
10. Who are the providers (savers) and users (borrowers) of capital? How is capital transferred between savers and borrowers?
11. What do we call the cost that a borrower must pay to use debt capital? What two components make up the cost of using equity capital? What are the four most fundamental factors that affect the cost of money, or the general level of interest rates, in the economy?
12. What are some economic conditions that affect the cost of money?
13. What are financial securities? Describe some financial instruments.
14. List some financial institutions.
15. What are some different types of markets?
16. Along what two dimensions can we classify trading procedures?
17. What are the differences between market orders and limit orders?
18. Explain the differences among broker-dealer networks, alternative trading systems, and registered stock exchanges.
19. Briefly explain mortgage securitization and how it contributed to the global economic crisis.

Submit your answers in a Word document. Overview of Financial Management and the Financial Environment
CHAPTER 1
2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Topics in Chapter
Forms of business organization
Objective of the firm: Maximize wealth
Determinants of fundamental value
Financial securities, markets and institutions

2020 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a password-protected website for classroom use.

Why is corporate finance important to all managers?
Corporate finance provides the skills managers need to:
Identify and select the corporate strategies and individual projects that add value to their firm.
Forecast the funding requirements of their company, and devise strategies for acquiring those funds.

Business Organization from Start-up to a Major Corporation
Sole proprietorship
Partnership
Corporation

Starting as a Proprietorship
Advantages:
Ease of formation
Subject to few regulations
No corporate income taxes
Disadvantages:
Limited life
Unlimited liability
Difficult to raise capital to support growth

Starting as or Growing into a Partnership
A partnership has roughly the same advantages and disadvantages as a sole proprietorship.

Becoming a Corporation
A corporation is a legal entity separate from its owners and managers.
File papers of incorporation with state.
Charter
Bylaws

Advantages and Disadvantages of a Corporation
Advantages:
Unlimited life
Easy transfer of ownership
Limited liability
Ease of raising capital
Disadvantages:
Double taxation
Cost of set-up and report filing

Becoming a Public Corporation and Growing Afterwards
Initial Public Offering (IPO) of Stock
Raises cash
Allows founders and pre-IPO investors to harvest some of their wealth
Subsequent issues of debt and equity

Agency Problems and Corporate Governance
Agency problem: managers may act in their own interests and not on behalf of owners (stockholders)
Corporate governance is the set of rules that control a companys behavior towards its directors, managers, employees, shareholders, creditors, customers, competitors, and community.
Corporate governance can help control agency problems.

What should be managements primary objective?
The primary objective should be shareholder wealth maximization, which translates to maximizing the fundamental stock price.
Should firms behave ethically? YES!
Do firms have any responsibilities to society at large? YES! Shareholders are also members of society.

Is maximizing stock price good for society, employees, and customers? (1 of 2)
Employment growth is higher in firms that try to maximize stock price. On average, employment goes up in:
firms that make managers into owners (such as LBO firms)
firms that were owned by the government but that have been sold to private investors

Is maximizing stock price good for society, employees, and customers? (2 of 2)
Consumer welfare is higher in capitalist free market economies than in communist or socialist economies.
Fortune lists the most admired firms. In addition to high stock returns, these firms have:
high quality from customers view
employees who like working there

What three aspects of cash flows affect an investments value?
Amount of expected cash flows (bigger is better)
Timing of the cash flow stream (sooner is better)
Risk of the cash flows (less risk is better)

Free Cash Flows (FCF)
Free cash flows are the cash flows that are available (or free) for distribution to all investors (stockholders and creditors).
FCF = sales revenues – operating costs – operating taxes – required investments in operating capital.

What is the weighted average cost of capital (WACC)?
WACC is the average rate of return required by all of the companys investors.
WACC is affected by:
Capital structure (the firms relative use of debt and equity as sources of financing)
Interest rates
Risk of the firm
Investors overall attitude toward risk

What determines a firms fundamental, or intrinsic, value?
Intrinsic value is the sum of all the future expected free cash flows when converted into todays dollars:

See big picture diagram on next slide.

Determinants of Intrinsic Value: The Big Picture

Who are the providers (savers) and users (borrowers) of capital?
Households: Net savers
Non-financial corporations: Net users (borrowers)
Governments: U.S. governments are net borrowers, some foreign governments are net savers
Financial corporations: Slightly net borrowers, but almost breakeven

The Capital Allocation Process

Transfer of Capital from Savers to Borrowers
Direct transfer
Example: A corporation issues commercial paper to an insurance company.
Through an investment banking house
Example: In an IPO, seasoned equity offering, or debt placement, company sells security to investment banking house, which then sells security to investor.
Through a financial intermediary
Example: An individual deposits money in bank and gets certificate of deposit, bank makes commercial loan to a company (bank gets note from company).

Cost of Money
What do we call the price, or cost, of debt capital?
The interest rate
What do we call the price, or cost, of equity capital?
Cost of equity = Required return = dividend yield + capital gain

What four factors affect the cost of money?
Production opportunities
Time preferences for consumption
Risk
Expected inflation

What economic conditions affect the cost of money?
Federal Reserve policies
Budget deficits/surpluses
Level of business activity (recession or boom)
International trade deficits/surpluses

Financial Securities

Debt Equity Derivatives

Money
Market T-Bills
CDs
Eurodollars
Fed Funds Options
Futures
Forward contract

Capital
Market T-Bonds
Agency bonds
Municipals
Corporate bonds Common stock
Preferred stock LEAPS
Swaps

What are some financial institutions?
Commercial banks
Investment banks
Savings & Loans, mutual savings banks, and credit unions
Life insurance companies
Mutual funds
Exchanged Traded Funds (ETFs)
Pension funds
Hedge funds and private equity funds

What are some types of markets?
A market is a method of exchanging one asset (usually cash) for another asset.
Physical assets vs. financial assets
Spot versus future markets
Money versus capital markets
Primary versus secondary markets

Primary vs. Secondary Security Sales
Primary
New issue (IPO or seasoned)
Key factor: issuer receives the proceeds from the sale.
Secondary
Existing owner sells to another party.
Issuing firm doesnt receive proceeds and is not directly involved.

Along what two dimensions can we classify trading procedures??
By location
Physical location exchanges where trading is face-to-face
Computer/telephone networks
By the way that orders from buyers and sellers are matched
Open outcry auction with face-to-face trading
Dealers (i.e., market makers) buy from and sell to clients from an inventory of stocks. Orders are not always automatically matched by computers.
Automated trading platforms match orders and execute trades automatically.

Types of Orders
Instructions on how a transaction is to be completed
Market Order Transact as quickly as possible at current price
Limit Order Transact only if specific situation occurs. For example, buy if price drops to $50 or below during the next two hours.

Broker-Dealer Networks
Registered with the SEC, but less regulated than alternative trading systems (ATS) and registered stock exchanges.
Broker-dealer purchases stock being offered for sale by a client and then immediately sells it to another client who wished to buy the stock.
Broker-dealer is the counterparty to each of the clients. Called internalization.
Broker-dealer must report the transactions, but not any information prior to the trade.
Trades in broker-dealer networks are called off exchange or over-the-counter (OTC).
Trades can be with individuals (called retail trades) or with institutions. Large trades (10,000 shares or more) are called block trades and are sometimes called upstairs trades.

Alternative Trading System (ATS)
A broker-dealer than registers with the SEC as an ATS.
ATS usually has an automated trading platform to match orders from clients.
Owner of the ATS is not always the counterparty, in contrast to a broker-dealer network.
The ATS must report trades, but not any pre-trade information.
Therefore, an ATS is often called a dark pool

Registered Stock Exchange
Stocks can only be listed at a registered stock exchange
May be traded elsewhere
Must comply with more regulations than an ATS.
Must report:
Trades
Pre-trade information regarding bids and quotes

NYSE versus NASDAQ
The NYSE is the oldest U.S. registered stock exchange.
The NASDAQ Stock Market has the most listings because it is willing to list smaller corporations than the NYSE.
NYSEs listings have a much bigger market value than NASDAQs listed stocks.

Stock Exchange Listings (1 of 2)

Exchange Number of Listings Market Value of Listings (Trillions)

NYSE 3,131 $27.9

NASDAQ 3,274 11.3

NYSE MKT 362 0.2

6,767 $39.4

Source: www.nasdaq.com/screening/company-list.aspx, November, 2017.

Stock Exchange Listings (2 of 2)

Owner of Trading Venue % of Dollar Volume

Cboe Global Markets 18%

NASDAQ OMX 22%

Intercontinental Exchange: (includes NYSE) 22%

Others 3%

Total trading on all exchanges: 65%

Dark pools (ATS): 34 13%

Broker-dealer networks: Over 250

Retail trades 8%

Institutional trades 14%

Total broker-dealer trades: 22%

Total trading off-exchange: 35%

Home Mortgages Before S&Ls
The problems if an individual investor tried to lend money to an aspiring homeowner:
Individual investor might not have enough money to fund an entire home
Individual investor might not be in a good position to evaluate the risk of the potential homeowner
Individual investor might have difficulty collecting mortgage payments

S&Ls Before Securitization
Savings and loan associations (S&Ls) solved the problems faced by individual investors
S&Ls pooled deposits from many investors
S&Ls developed expertise in evaluating the risk of borrowers
S&Ls had legal resources to collect payments from borrowers

Problems faced by S&Ls Before Securitization
S&Ls were limited in the amount of mortgages they could fund by the amount of deposits they could raise
S&Ls were raising money through short-term floating-rate deposits, but making loans in the form of long-term fixed-rate mortgages
When interest rates increased, S&Ls faced crisis because they had to pay more to depositors than they collected from mortgagees

Taxpayers to the Rescue
Many S&Ls went bankrupt when interest rates rose in the 1980s.
Because deposits are insured, taxpayers ended up paying hundreds of billions of dollars.

Securitization in the Home Mortgage Industry
After crisis in 1980s, S&Ls now put their mortgages into pools and sell the pools to other organizations, such as Fannie Mae.
After selling a pool, the S&Ls have funds to make new home loans
Risk is shifted to Fannie Mae

Fannie Mae Shifts Risk to Its Investors
Risk hasnt disappeared, it has been shifted to Fannie Mae.
But Fannie Mae doesnt keep the mortgages:
Puts mortgages in pools, sells shares of these pools to investors
Risk is shifted to investors.
But investors get a rate of return close to the mortgage rate, which is higher than the rate S&Ls pay their depositor.
Investors have more risk, but more return
This is called securitization, since new securities have been created based on original securities (mortgages in this example)

Collateralized Debt Obligations (CDOs)
Fannie Mae and others, such as investment banks, can also split mortgage pools into special securities
Some securities might pay investors only the mortgage interest, others might pay only the mortgage principal.
Some securities might mature quickly, others might mature later.
Some securities are senior and get paid before other securities from the pool get paid.
Rating agencies give different
Risk of basic mortgage is parceled out to those investors who want that type of risk (and the potential return that goes with it).

Other Assets Can be Securitized
Car loans
Student loans
Credit card balances

The Dark Side of Securitization (1 of 2)
Homeowners wanted better homes than they could afford.
Mortgage brokers encouraged homeowners to take mortgages even thought they would reset to payments that the borrowers might not be able to pay because the brokers got a commission for closing the deal.
Appraisers thought the real estate boom would continue and over-appraised house values, getting paid at the time of the appraisal.
Originating institutions (like Countrywide) quickly sold the mortgages to investment banks and other institutions.

The Dark Side of Securitization (2 of 2)
Investment banks created CDOs and got rating agencies to help design and then rate the new CDOs, with rating agencies making big profits despite conflicts of interest.
Financial engineers used unrealistic inputs to generate high values for the CDOs.
Investment banks sold the CDOs to investors and made big profits.
Investors bought the CDOs but either didnt understand or care about the risk.
Some investors bought insurance via credit default swaps.

The Collapse
When mortgages reset and borrowers defaulted, the values of CDOs plummeted.
Many of the credit default swaps failed to provide insurance because the counterparty failed.
Many originators and securitizers still owned sub-prime securities, which led to many bankruptcies, government takeovers, and fire sales, including:
New Century, Countrywide, IndyMac, Northern Rock, Fannie Mae, Freddie Mac, Bear Stearns, Lehman Brothers, and Merrill Lynch.

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