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Home Assignment #4: M.Anas Shahid 16905 Answers

This document contains the answers to Home Assignment #4 for a student. It includes definitions for: 1) Investment bankers as financial intermediaries that help issue securities, deposits, and loans. 2) Financial intermediaries as specialized firms that facilitate transferring funds from savers to borrowers. 3) Key aspects of the term structure of interest rates and how it relates to the yield curve. 4) Explanations of normal and inverted yield curves based on short-term and long-term interest rates.

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36 views

Home Assignment #4: M.Anas Shahid 16905 Answers

This document contains the answers to Home Assignment #4 for a student. It includes definitions for: 1) Investment bankers as financial intermediaries that help issue securities, deposits, and loans. 2) Financial intermediaries as specialized firms that facilitate transferring funds from savers to borrowers. 3) Key aspects of the term structure of interest rates and how it relates to the yield curve. 4) Explanations of normal and inverted yield curves based on short-term and long-term interest rates.

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Anas4253
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HOME ASSIGNMENT #4

M.ANAS SHAHID

16905

ANSWERS:

·0 Investment banker
It deals with the issuance of securities, deposits and loans. The major IB houses
often are divisions of large financial service corporations that engage in wide
range of activities.
It is the process that involves under writing and distribution of new issues of
securities and helps businesses and other entities obtain needed financing.
·1 Financial intermediary
They are specialized financial firms that facilitate the transfer of funds from
savers to borrowers.
·2 Organized investment network
·3 Over-the-counter market
A collection of brokers and dealers connected electronically via phones and
computer that provide for trading in securities not listen on the physical stock
exchange.
·4 Electronic communications network (ECN).
Electronic systems that transfer information about securities transactions to
facilitate the execution of orders by automatically matching buying and selling
orders for a large number of investors.
·5 Term structure of interest rates
It is the relationship between long and short term rates. It is important to
borrowers who must decide whether to borrow by issuing long or short term
debt and to investors, who decide whether to buy long or short term bonds.
·6 Yield curve
Shows a snapshot of the relationship between short and long term rate on a
particular date.
·7 Normal” yield curve
It is an upward sloping yield curve. Because long term rates are generally higher
than short term rates so the curve is normally upward sloping.
·8 Inverted (“abnormal”) yield curve
This is a downward sloping yield curve. It is very rare and thus it is normally
referred to as inverted. It is when the short term rates are bigger than long term
rates on bonds.
·9 Liquidity preference theory
This theory states that, all else equal, investors (lenders) prefer to make short
trms loans rather than long term loans because short term securities are not
sensitive to change in interest rates and are more flexible. Whereas borrowers
generally prefer long term debt because they are willing to pay higher rate for
long term funds compared to short ones.
·10 Tax Shield
It is the reduction in income taxes that result from an allowable deduction from
taxable income e.g because interest on debt is tax deductible exp, taking on debt
creates a tax shield.
·11 Balance of Payment
The Balance of Payments or BoP is a statement or record of all monetary and
economic transactions made between a country and the rest of the world within
a defined period (every quarter or year).
·12 Debt Servicing
Cash required to make payments on the principal and interest on a debt for a
particular period.

B: No tax on dividends, hence we won’t take tax considerations on $150,000


since dividends are not tax deductible. They are paid out of the income which is
available after tax. They are already adjusted for stock.

Before tax cost (interest) × (1-tax rate)


Interest = 10/100 × 150000 = 15000
Tax rate 25%

=150000 × (1-0.25)
=15000 × (1-0.25)
=150000 × 0.75
= $11250

After tax cost of debt is lower than cost of preferred stock. Hence we will choose
debt. Dividend rate is 9% which is an outflow from net income and hence an
added deduction from net income

C:

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