Twyman Exam 1, 1
Exam 1 Ashley V Twyman
Presented in partial fulfillment for Financial Analysis & Management 565 8/17/2009 – 9/27/2009 Dr. Joel Light
Twyman Exam 1, 2
1. Suppose you own $100,000 worth of 30-year US Treasury bonds. Is this a risk less asset? In addition, you own $100,000 worth of 90-day US Treasury bills. You “roll over” this investment every 90 days by reinvesting the proceeds in another issue of 90-day US Treasury bills. Is this investment risk less? What are some of the primary factors associated with risk? Create a hierarchy of five investments from less risky to more risky based on these factors. No, the US Treasury bonds or bills are NOT a risk less asset. The interest rate on US Treasury bonds is subject to change. For example, three months ago I Bonds were paying over 5% interest and now they are paying 0%. The rate for EE Bonds can fluctuate as well, so the amount of interest you are earning on your money is always a guess. You may never loose your originally invested money, but you can loose time in interest because the bonds have a minimum amount of time deposit (which depends on the type of bond). For example, my daughter has a slew of I Bonds, which were earning 5.64% interest and are now earning nothing, but I am unable to access the money and change the vehicle of investment because we have not had them long enough to meet the minimum time require for the bonds. You must also consider the rate of inflation when looking at bonds as a form of investment. When you fist purchase a bond, say for $50, when that bond becomes available for use with cash withdrawal, $50 may be equal to $5 today (some bonds can be invested for 30 years or more. When I was a kid, it took about 18 years for EE Bonds to earn face value (i.e. you buy an EE Bond for $25 but the face of the bond reads $50 because that is what it will equal when it reaches full maturity). Now it is estimated that an EE Bond takes 30 years to reach maturity. That’s quite a difference! 1. Explain some of the issues a person must take into consideration when investing in a foreign investment. Describe some of the reasons a person might require a different yield from a foreign investment than that of a similar domestic investment. One issue that might be a factor is the currency exchange rate. Everyone in America understands the value of the American dollar, but not everyone understands that in other countries the value of the American dollar is different. For example, the last time I was in Europe the American dollar was worth .70 Euro, and was, therefore, less valuable than the Euro. On the other hand, the American dollar is equal to 13.25 Mexican pesos. The American dollar obviously goes farther in Mexico than in Europe. This is why an investor would require a different yield on their investment. They would need to make sure that when they consider the conversion rate that they are still getting their required rate of return after the conversion of the money. It may appear as though they are going to get
Twyman Exam 1, 3 their required return and their realized return may be far less if the exchange rate is not considered. Another issue may be the banking or investment regulations of the specific foreign country in which the investment is going to take place. Just because in American we have federal banking regulations, it doesn’t mean that other countries do or that they are the same as they are in the United States. Many people take that for granted and may not think about asking to educate themselves on the rules and laws of the country in which their funds are resting. 2. A firm calculates its cost of debt and finds it to be 9.75%. It then calculates its cost of equity capital and finds it to be 16.25%. The firm’s CEO tells the firm’s CFO that the firm should issue debt because it is cheaper than equity. How should the CFO respond to the CEO and why? The CFO should tell the CEO that even though their debt to asset ratio seems to be in the favor of assets, this is not necessarily grounds for issuing more debt. In order to issue debt you must have asset to counter act it in order for a company to stay afloat. If the ratio sways to favor debt too much, then bankruptcy may ensue. I understand that it seems more costly to keep assets verses debt, but it may be the only way to keep a company’s head above water.