Exam 2 Study Guide
Exam 2 Study Guide 3154
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This 49 page Study Guide was uploaded by Adele Wheeler on Friday March 25, 2016. The Study Guide belongs to 3154 at Virginia Polytechnic Institute and State University taught by Professor Lel in Spring 2016. Since its upload, it has received 63 views. For similar materials see Corporate Finance in Finance at Virginia Polytechnic Institute and State University.
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Date Created: 03/25/16
Notes on Corporate Finance Readings Voice in the wilderness -Jack Bogle, founder of mutually owned Vanguard group -focus on keeping costs down -fraction of a percentage point a year for investors to own a diversified portfolio -active management, chasing hot asset classes, incurs high transaction fees and actually causes investors to buy high and sell – the opposite of what they were supposed to do -cost of individual transactions has fallen, but the volume has increased tremendously -costs compound just as returns do over time, which reduces returns -double agency problem for small investors -money goes to mutual fund managers who give it to corporate executives and the managers almost always vote in favor of the executives’ actions -incentive to increases amount of managed funds -as assets of mutual funds have risen ($5 billion to $6 billion), expense ratio has also risen (0.5% - 0.99%) -individual investor is harmed -more frequent turnover and higher volatility of current portfolios, which hurts investors -star managers lead to lower returns than those of simply a mutual fund Mentioned in class: important! -gap between market return and investment return has been narrowing -market return = return to SH -investment return = initial dividend + earnings growth -difference is a reflection of changes in valuation, speculative return, optimism 1970s: investment return > market return -oil shock and stagflation -plummeting demand for equity 1980s and 1990s: investment return < market return -share prices rose faster than dividends (investment return) Today: investment return is roughly equal to market return – very small gap -pension funds severely hurt -can’t actually achieve assumed returns -switch in the private sector to defined-contribution schemes -retirement income is dependent on investment performance -employees don’t save enough, allocate portfolios inefficiently, and incur too many costs -huge warning for retirement security Bernanke Saves Companies $700 billion as Verizon Leads Sales -savings comes from interest payments through Fed’s stimulus (low interest rates to encourage lending) -default risk lowered because low interest rates allowed companies to pay off debt easier -extended maturity dates (1 year and 5 year bonds were replaced by 30 year bonds) -in addition to low interest rates (almost 0 and now negative in Europe), the Fed purchased about $3 trillion in bonds -buying bonds pumps money into banks and the economy, making it more available to lend, and therefore has a lower interest rate (quantitative easing) -with the saved money, companies hired workers and expanded -CAPEX (fixed assets) increased by $699 billion, up 8.7% -even previously higher risk companies are able to get cash -junk bond corporations with the highest default risk are now able to sell bonds to borrow money -despite potential of the Fed raising the rate as the US gets out of recession, corporations are still taking advantage of the low rates -Verizon sold record of $49 billion in bonds -biggest corporate offering on record Quantitative Easing – pumping cash directly into the financial system through bond purchases -increased confidence in market, opened credit markets -during financial crisis, bond sales drastically fell -uncertainty of future means that corporations don’t want to expand -focus instead is on paying off current debt instead of taking on more during crisis Fed Taper as economy heals -companies are now selling bonds with record low coupon payments -bond prices have fallen and yields have risen -price is the present value of stream of coupon payments and return of principal at maturity – as such, price and yield (interest rate) have an inverse relationship -focus on 10-year Treasuries -yield is increasing, indicating that the economy is recovering and the Fed can start to raise the interest rate -during the loosening of the credit market following the crash, bond yields sharply fell and prices rose -excessive risk-taking by investing too much into US bonds funds following the financial crisis Warning -debt has been increasing incredibly quickly as companies take advantage of low interest rates -faster than cash flows -Rite-Aid which used to take advantage of low interest rates and could get loans is ranked at the Bottom Rung of junk bonds according to Moody’s -QE won’t last forever, and eventually the market will push rates back up -firms relying on low interest rates from QE will have to find new ways to succeed Companies Feast on Cheap Money -companies shifting from short-term bonds to long-term bonds to take advantage of low interest rates in the present -reduces refinancing need in the future during higher interest rate periods -better return for investors with long-term bonds and low default risk -increased supply of bonds now reduces supply of bond in the future -perfect time to issue new bonds because of low interest rates and ahead of even more economic uncertainty -during periods of uncertainty, demand for bonds sharply increases -corporations couldn’t initially keep up with demand -billions of dollars saved on interest payments for corporations -spread between return of risk-free Treasuries and corporate bonds has fallen -investors seek less risk in corporate bonds -with such low interest rates, bond prices are HIGH (remember inverse relationships from present value) -prices will fall as interest rates rise in the future, lose money upon maturity, capital loss -solid companies are able to issue bonds because of the high demand and provides stability Uber Raises $1.6 Billion in Debt Offering -convertible debt (bondholders can convert their bonds to stocks after a certain amount of time) -very attractive -wealthy investors like Goldman Sachs can buy convertible debt ahead of IPO -huge amount of trust in the success of Uber -increasing debt offerings and about to have an IPO (initial public offering) to expand globally
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