Exercise 1: This exercise is intended to make sure that we are all familiar with terms used debt financing. (10 points) (10)
Fill the blanks by choosing the appropriate term from the following list: lease, funded, floating-rate, Eurobond, convertible, subordinated, call, sinking fund, prime rate, private placement, global bond, public issue, senior, unfunded, Eurodollar rate, warrant, debentures, term loan.
a.Debt maturing in more than 1 year is often called FUNDED debt. b.An issue of bonds that is sold simultaneously in several countries is traditionally called a(n) GLOBAL BOND. c.If a lender ranks behind the firm’s general creditors in the event of default, the loan is said to be SUBORDINATED. d.In many cases, a firm is obliged to make regular contributions to a(n) SINKING FUND, which is then used to repurchase bonds. e.Most bonds give the firm the right to repurchase or CALL the bonds at specified prices. f.The benchmark interest rate that banks charge to their customers with good credit is generally termed the PRIME RATE. g.The interest rate on bank loans is often tied to short-term interest rates. These loans are usually called FLOATING RATE loans. h.Where there is a(n) PRIVATE PLACEMENT securities are sold directly to a small group of institutional investors. These securities cannot be resold to individual investors. In the case of a(n) PUBLIC ISSUE, debt can be freely bought and sold by individual investors. i.A long-term rental agreement is called a(n) LEASE.
j.A(n) CONVERTIBLE bond can be exchanged for shares of the issuing corporation. k.A(n) WARRANT gives its owner the right to buy shares in the issuing company at a predetermined.
Exercise 2:(18 points) (18)
Empirical evidence shows that stock market in the United States is efficient. a.Explain the three forms of market efficiency (see chapter 5, pages 178 – 183). b.How do you explain the fact that some people make very high returns on stock markets? c.How does competition among investors lead to efficient markets?
a. Market efficiency describes how prices respond to new information in a competitive marketplace. When new information reaches a competitive market, investors buy and sell in response to the news, causing the prices to adjust.
The degree of efficiency a particular market displays depends on the speed with which prices adjust to news and the type of information to which the market responds. Market efficiency literature generally refers to three classifications of efficiency:
1. Strong efficiency or strong-form: In this classification, all information in a market, whether public or private, is accounted for in a stock price. There is no such thing, in this form, as insider information that could give an investor an advantage.
2. Semi-strong efficiency or semi-strong form: in this form, all public information is reflected a stock's current price. The information is not necessarily just related to a company’s stock price; it may include information such as knowledge of a firm’s patents, the strength of its management or the weakness of competitors.
3. Weak efficiency or weak form: in this form all past prices of a stock are reflected in today's stock price meaning that one cannot analyze past prices to detect under (or over) valued stocks.
b. If you accept the market efficiency hypothesis (which, philosophically is not possible since, perfection, including perfect efficiency, is not possible) it is still possible to make very high returns on the stock market.
There are many examples of investors who have “beaten” the market, including Warren Buffet, who relies on a strategy of identifying undervalued stocks, or various portfolio or mutual fund managers who are able to outperform their competitors on a consistent basis.
The efficiency market hypothesis does not dismiss the possibility of anomalies in the...