Moral hazard is not eliminated in debt financing because

A) borrowers have an incentive to assume greater risk than is in the interest of the lender.

B) firms with a great deal of debt often go bankrupt.

C) principal-agent problems are greater with debt financing than with equity financing.

D) the use of restrictive covenants tends to increase moral hazard.

Why are corporations more likely to raise funds externally by debt instead of equity?

A) moral hazard is less of a problem with debt contracts

B) transactions costs tend to be higher in the stock market than bond market

C) to avoid paying dividends

D) interest rates tend to be lower than dividend rates

Which of the following is NOT a bank liability?

A) checkable deposits

B) CDs

C) mortgage loans

D) borrowings from the Federal Reserve

Banks use repurchase agreements to

A) ensure that payments on consumer loans are made on time.

B) borrow funds from business firms or other banks.

C) guard against price fluctuations on long-term bonds.

D) ensure that they always have enough funds on hand to meet their federal tax liabilities.

If a bank has a leverage ratio of 0.1 and a return on capital of 2%, what is its return on equity?

A) 0.2%

B) 2.1%

C) 5%

D) 20%

Which of the following statements about checking deposits is true?

A) It is a liability for both households and banks.

B) It is an asset for both households and banks.

C) It is an asset for households but a liability for a bank.

D) It is a liability for households but an asset for a bank.

brownherring865

Let's change it up a little. You may have to dig a little for this one. Fannie Mae and Freddie Mac are two banking giants that have been in news because of their role in the 2008 financial crisis. Due to this many in the government believe that the two companies should be put out of business. On the other hand, there are many who believe the companies should remain as they are. See The Case For Keeping Fannie and Freddie Alive. The argument both ways is in a sales pitch for the two contrary opinions. how would you convince someone either way on the issue of Fannie and Freddie? A reference is required to support your post

On just one major piece of economic policy, President Obama and House Republicans share the same basic opinion: kill off government-backed mortgage giants Fannie Mae and Freddie Mac.

This rare bit of consensus might also prove to be a devastating mistake.

Fannie and Freddie which guarantee mortgages were placed under federal conservatorship in 2008 as the housing bust reached its apex. The firms are roughly within $42 billion of repaying the $187.5 billion they received from taxpayers, but Obama and much of Congress plan to wind them down in the belief that another federal bailout will never again be necessary.

We can't leave taxpayers on the hook for irresponsibility or bad decisions by some of these lenders or Fannie Mae or Freddie Mac, Obama said in a speech this month. We've got to encourage the pursuit of profit, but the era of expecting a bailout after you pursue your profit and you don't manage your risk well, that puts the whole country at risk. And we're ending those days. We're not going to do that anymore.

But the political debate has been lopsided thus far focused on putting Fannie and Freddie into the grave, while largely ignoring what their demise could mean for homebuyers and the economy a sharp jump in interest rates, and a drop in the availability of mortgages.

Senate Majority Leader Harry Reid (D-NV) has objected to plans to end both companies.

These are the government organizations that have made homeownership so easy, Reid recently told Nevada Public Radio. I don't agree with the president. He says he wants to get rid of them. I'm going to look closely at his recommendations because on their face, I don't like them.

Mostly, economists and investors are framing the issue in the same way as Reid.

It boils down to a tradeoff between shifting risk away from the government and taxpayers, versus keeping mortgages inexpensive and widely available, said Jed Kolko, the chief economist at the real estate firm Trulia. When push comes to shove, it's hard to do both.

Their executives received outlandish bonuses during the boom, only to foist the eventual losses caused by years of mismanagement onto the public. It rightfully enables sucker punches from Capitol Hill that voters approve of, even though the rescue kept the entire housing sector alive. Of the $1.75 trillion worth of mortgages originated last year, about 90 percent were made through the federal government.

This point matters because Fannie and Freddie ensure that the housing market does not seize up during a recession, said Ken Fears, an economist for the National Association of Realtors. Even if more private capital is needed in the mortgage industry, having the government participation creates liquidity that keeps the entire sector operating during tough economic times, Fears said.

Lawmakers tend to assume that the markets can transition over five or 10 years to a mortgage industry with a modest government backstop, or no taxpayer support at all. Before retiring at the end of May as a managing director for bond investor PIMCO, Scott Simon said that this amounted to a fantasy.

The private market can make mortgages, but they would trade at much higher yields and the down payments would be much higher because the private market cannot make competitive, fixed-rate mortgages with 20% or less of a down payment on the loans, Simon told National Mortgage News. Most of the people who think we should shut [the GSEs] down have a pure philosophical belief and they don't care what the outcome is. Or they simply don't understand anything about how housing finance works.

Fannie and Freddie help the economy with their guarantees, Simon reasoned but exposed taxpayers to their risks by having their own investment portfolios.

As of now, all profits from both companies go to the Treasury Department, per changes made last year to the terms of the conservatorship. In the original terms, Treasury received a 10 percent dividend from Fannie and Freddie. But Fannie and Freddie are now required to fork over all of their earnings forever to Treasury, a windfall that suddenly reduced the budget deficit.

A group of investors led by the hedge fund Perry Capital challenged this arrangement in a U.S. District Court lawsuit filed last month, claiming that they deserve a share of the proceeds after taxpayers have been repaid.

Because Fannie and Freddie are now generating cash, it would in theory be possible for the government to use these profits to create a capital cushion that prevents the need for a future taxpayer bailout.

By keeping the two companies under government control, taxpayers would benefit from the sale of about $200 billion worth of equity, investors in Fannie, Freddie, and other real estate assets explained in the background. The profits would be enough to create a capital cushion to insulate against a future downturn, without having to seek capital in the private market that could push mortgage interest rates higher.

But this requires Obama and GOP lawmakers to save Fannie and Freddie, precisely what they have vowed not to do. Obama wants a government insurance fund to replace them, while Republican congressmen favor an end to any Washington involvement with guarantees.

House Financial Services Committee Chairman Jeb Hensarling (R-TX) would eliminate almost all federal involvement in the mortgage market. His policy assumes that the rusty tin standard of 30-year, fixed-rate mortgages would soon fade away, as more homebuyers would settle for variable-rate mortgages. Interest rates on a 30-year, fixed mortgage currently average 4.4 percent, a figure that could instead swing violently over time depending on inflation and the Federal Reserve. When the Fed attempted to tamp down inflation between 1980 and 1982, rates soared above 16 percent with the government backstop in place.

Obama would like to preserve the 30-year, fixed-rate mortgage. He has endorsed adopting a more limited government backstop as outlined in a bipartisan Senate bill co-sponsored by Tennessee Republican Bob Corker and Virginia Democrat Mark Warner.

The Corker-Warner bill would also unwind Fannie and Freddie, bringing their dominance to an end. In their place would be private financial institutions that would pay into a government insurance fund. Mark Zandi, the chief economist for Moody's Analytics, estimated that the plan would cause mortgage rates to increase by as much as 1.25 percent in the near-term. This estimate assumes a 20 percent down payment and a credit score of 750, slightly above the current U.S. average.

But of course, lawmakers have not discussed the potential tradeoffs in the early stages of mortgage reform. Unless voters have a clearer picture of the consequences, some say it could produce the same kind of boondoggle caused by Obamacare in 2010.

I don't think there has been much of a sales job to the public on what a new mortgage finance system looks like, said Brian Gardner, senior vice president of Washington research at the investment bank Keefe, Bruyette & Woods. I don't think you shove this down the throat of the electorate, as we saw with the health care overhaul.

apricotgiraffe451

Final Project Scenario

You are an economist for the Vanda-Laye Corporation, which produces and distributes outdoor cooking supplies. The company has come under new ownership and management and will be undergoing changes in its product lines and operating structure. As an economist, your responsibilities include examining the market factors that affect success or failure of a product, including the supply and demand for the product, market conditions, and the behavior of competitors with similar products.

The new management has identified several possible investments for the coming year. It has asked you and your team to evaluate the possibilities and make a recommendation to the board of directors. Jorge has identified two mutually exclusive opportunities (Investment A) and two independent opportunities (Investment B) and assigned you the task of making a recommendation on the investments.

Investment A

Your company would like to increase its product lines. Two alternatives are available, a new line of outdoor smokers and a new line of outdoor grills. The two lines are mutually exclusive, meaning that only one of these investment alternatives can be selected. The projected cash flows and their respective probabilities for each alternative are given in the table. There are three possible levels of demand and their corresponding probabilities, which depend on the state of the economy.

Click here to download the table for Investment A. (Table Below)

Investment A

Demand	Probability	Year 1	Year 2	Year 3	Year 4	Year 5
Outdoor Smoker
High	0.2	$800,000	$900,000	$1,000,000	$1,100,000	$1,500,000
Moderate	0.6	$500,000	$700,000	$800,000	$960,000	$1,240,000
Low	0.2	$200,000	$350,000	$500,000	$600,000	$750,000
Outdoor Grill
High	0.2	$600,000	$750,000	$850,000	$975,000	$5,160,000
Moderate	0.6	$450,000	$500,000	$700,000	$825,000	$4,980,000
Low	0.2	$150,000	$220,000	$370,000	$500,000	$4,750,000

The two alternatives carry equal risk and should be evaluated at the company's cost of capital. The cost for the new smoker line will be $7,000,000. Also, the company has been guaranteed a buyer for the new line at the end of the fifth year. The buyer has agreed to purchase the new line for $7,900,000. The outdoor grill alternative will cost $3,987,000 and also has a guaranteed buyer, who has agreed to pay $4,000,000 at the end of the fifth year.

Investment B

Investment B involves two independent investment opportunities. The decisions on these two investment alternatives are also independent of Investment A. Investment B-1 involves a new packaging machine, which will eliminate the need for a local firm for packaging Vanda-Laye's products. The cost of this machine will be $24,000, and the expected revenues from this opportunity are given in the table and are considered to be of average risk. Investment B-2 is the purchase of a new computer system that will allow the company to sell its products on the Internet worldwide. The cost of this new system will be $29,000, with the expected cash flows after taxes given in the table.

Click here to download the table for Investment B. (Table Below)

Investment B

Year	Cash Flows

	Packaging Machine	Computer System
1	$8,400	$9,100
2	$4,800	$8,800
3	$7,800	$8,300
4	$6,200	$8,000
5	$5,500	$5,100
6	$4,600	$4,000
7	$3,000	$3,500

Jorge has asked you to provide detailed responses to the following:

Management of Vanda-Laye has determined that the capital structure of the company will involve 30% debt and 70% common equity. This structure will be used to finance all investments by the company. Currently, the company can sell new bonds at par, with a coupon rate of 7%. Any new common stock can be sold for $45, with a required return (or cost) of 15.57%. Using Microsoft Excel, calculate the company's cost of capital to be used in the evaluation of possible investment projects.

For Investment A:

Using Microsoft Excel, create a decision tree. Indicate the various levels of demand and their respective probabilities. Also, include the calculations for the expected cash flows.

Calculate the expected NPV for each alternative. Explain the decision rules for making a selection between the two alternatives on the basis of the expected NPV.

Assuming the two alternatives are mutually exclusive, specify which alternative you would recommend to the company. Explain why.

If the two alternatives were independent of each other, specify which project you would select. Would you accept both projects if funding were available for both? Explain your answer.

For Investment B:

Using Microsoft Excel, calculate the NPV for each alternative.

Using the decision-making criteria for the NPV, specify which alternative you would select if the two alternatives were mutually exclusive. Explain your answer.

Given that the two alternatives are independent of each other, specify which investment you would select, if not both. Explain your answer.

Using Microsoft Excel, calculate the IRR for each investment.

Using the decision-making criteria for the IRR, specify which alternative you would prefer. Explain your answer.

If funding were available, specify whether you would select both investments. Why or why not?

Calculate the profitability index (PI) for the two investments. Which project is preferred?

Determine whether there is a ranking conflict present in terms of the IRR and the NPV. Explain your answer. If a conflict does exist, explain how you would resolve the situation.

Submission Details:

Compile a report including all your responses from Weeks 1, 3, and 5. Make sure your report reads as one report rather than three reports pasted together. Complete all revisions suggested by your instructor in previous weeks. Make sure all responses are complete and accurate, supported by references and documented examples. The report should be 10â15 pages in length and include an executive summary.

You are an economist for the Vanda-Laye Corporation, which produces and distributes outdoor cooking supplies. The company has come under new ownership and management and will be undergoing changes in its product lines and operating structure. As an economist, your responsibilities include examining the market factors that affect success or failure of a product, including the supply and demand for the product, market conditions, and the behavior of competitors with similar products.

The new management has identified several possible investments for the coming year. It has asked you and your team to evaluate the possibilities and make a recommendation to the board of directors. Jorge has identified two mutually exclusive opportunities (Investment A) and two independent opportunities (Investment B) and assigned you the task of making a recommendation on the investments.

Investment A

Your company would like to increase its product lines. Two alternatives are available, a new line of outdoor smokers and a new line of outdoor grills. The two lines are mutually exclusive, meaning that only one of these investment alternatives can be selected. The projected cash flows and their respective probabilities for each alternative are given in the table. There are three possible levels of demand and their corresponding probabilities, which depend on the state of the economy.

Click here to download the table for Investment A.

The two alternatives carry equal risk and should be evaluated at the company's cost of capital. The cost for the new smoker line will be $7,000,000. Also, the company has been guaranteed a buyer for the new line at the end of the fifth year. The buyer has agreed to purchase the new line for $7,900,000. The outdoor grill alternative will cost $3,987,000 and also has a guaranteed buyer, who has agreed to pay $4,000,000 at the end of the fifth year.

Investment B

Investment B involves two independent investment opportunities. The decisions on these two investment alternatives are also independent of Investment A. Investment B-1 involves a new packaging machine, which will eliminate the need for a local firm for packaging Vanda-Laye's products. The cost of this machine will be $24,000, and the expected revenues from this opportunity are given in the table and are considered to be of average risk. Investment B-2 is the purchase of a new computer system that will allow the company to sell its products on the Internet worldwide. The cost of this new system will be $29,000, with the expected cash flows after taxes given in the table.

Click here to download the table for Investment B.