Securitization is the packaging and selling of loans (good and bad debt) as well as other asset backed securities. Remember the financial crises, what can be done better today. The pooling of assets and selling them to investors. The creation of tranches involve different payment structures and cash flows. In a two-tranche system, tranche A will have priority over tranche B.

Take a look and discuss some of the risks we covered in the course. We started this course talking about the financial crises and some of the risks and here we are back to one of the most important financial risks in the past 10 years. What do we know more importantly what do need to do in this area we do going forward

Please give me 200 words dicsussion. Thanks a lot.

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These assumptions are necessary for the M&M theory on capital structure.

For the Proposition M&M II beginning on page 498, still in a perfect capital market which includes no taxes, M&M state that the cost of capital of EQUITY increases with the firm's market value debt-equity ratio. But, when you examine this Proposition more closely, for a new investment the cost of capital will equal the weighted average of the firm's equity and debt costs. What does this mean in practical terms? It means that M&M "loosens" a part of the Proposition I, and admit that the cost of equity does increase as the debt-equity ratio increases. But, if you examine this closely, it means that the OVERALL cost of capital, captured in the WACC stays constant. And, the pre-tax WACC is the same as the after-tax WACC, since there is no tax! If the WACC stays constant while the equity cost increases, this means that the debt costs are going down,relatively; on the contrary, if the equity costs are going down, then the debt costs are going up. This is shown on page 500 in Figure 14.1. And, of course, the weights count.

But, in the real-world, the M&M Propositions do not hold....corporations and individuals do have taxes, and do have transactions costs for debt and equity...buying bonds and stocks, for example.

So, as we have learned, the Beta coefficient for equity does increase as the amount of debt level increases (due to increasing risks of default of interest payments or repayment of the bonds at maturity)...and the costs of debt increase, but as we weight those, the WACC actually varies, based on the real-world that includes taxes....we normally see the WACC being a U-shaped curved that varies as a function of the debt to equity ratio.

That is the background for this Written Assignment. Dr. Steadman

) Discuss the MM Proposition I and MM Proposition II (definition, assumptions, results and implications)? Remember, at the MBA level, more is better. But, to the point, and no "hot air."

Franco Modigliani and Merton Miller (M & M) are two very famous financial economists that both won the Nobel Prize in Economics for their work in the finance area, particularly in capital structure theories (see the Description of this in the box on page 504 of your text). In their famous 1958 article (see footnote on page 490), they argued that with perfect capital markets, the total value of a firm should not depend on its capital structure. In other words, the total value of a firm would be the same with all equity, or financing with 100% debt. This is the basic MM Proposition I stated on p.493. But, as you should see, the "perfect capital markets" assumes 3 key assumptions, including no taxes or transactions costs dealing with equity or debt. Additionally, a key assumption is that individuals and firms can trade the same set of securities at competitive market prices equal to the present value of their future cash flows. These assumptions are necessary for the M&M theory on capital structure. For the Proposition M&M II beginning on page 498, still in a perfect capital market which includes no taxes, M&M state that the cost of capital of EQUITY increases with the firm's market value debt-equity ratio. But, when you examine this Proposition more closely, for a new investment the cost of capital will equal the weighted average of the firm's equity and debt costs. What does this mean in practical terms? It means that M&M "loosens" a part of the Proposition I, and admit that the cost of equity does increase as the debt-equity ratio increases. But, if you examine this closely, it means that the OVERALL cost of capital, captured in the WACC stays constant. And, the pre-tax WACC is the same as the after-tax WACC, since there is no tax! If the WACC stays constant while the equity cost increases, the figure also shows that the debt costs are also going up; similarly, if the equity costs are going down, then the debt costs are going down also as the debt-to-value decreases. This is shown on page 500 in Figure 14.1. And, of course, the weights of debt and equity (0/100, 25/75, 50/50, 75/25, 100/0) count. But, in the real-world, the M&M Propositions do not hold....corporations and individuals do have taxes, and do have transactions costs for debt and equity...buying bonds and stocks, for example. So, as we have learned, the Beta coefficient for equity does increase as the amount of debt level increases (due to increasing risks of default of interest payments or repayment of the bonds at maturity)...and the costs of debt increase, but as we weight those, the WACC actually varies, based on the real-world that includes taxes....we normally see the WACC being a U-shaped curved that varies as a function of the debt to equity ratio.

Questions:

1. Discuss the MM Proposition I and MM Proposition II (definition, assumptions, results and implications)? Remember, at the MBA level, more is better. But, to the point, and no "hot air."

2. Assume you are doing a financial analysis for Kroger Inc. Here is one of the income statements that you analyze (all figures in $ Millions):

Which year does Kroger Incorporation have the highest tax shield and why? Be very specific.

Year	2006	2005	2004
Total Sales	60,553	56,434	53,791
Cost of goods sold	45,565	42,140	39,637
Selling, general & admin expenses	11,688	12,191	11,575
Depreciation	1265	1256	1209
Operating Income	2035	847	1370
Other Income	0	0	0
EBIT	2035	847	1370
Interest expense	510	557	604
Earnings before tax	1525	290	766
Taxes (35%)	534	102	268
Net Income	991	189	498

Read the Background Information about FirstRate Company, below. Then, explain what the companyâs treasurer should do about the draft versions of the projected financial statements and short-term cash flow forecast (prepared by him) in response to comments made by the companyâs chief financial officer (CFO) in their meeting. Do not recommend specific treasury management steps, such as selling investment securities, factoring accounts receivable, reducing operating costs, or seeking alternative financing arrangements. (The background information is not sufficient to formulate such steps, nor is there enough time to implement such steps before the CFO meets with FirstRateâs banks to discuss the financial projections and cash flow forecast). It is most important that you clearly provide the reasons for your recommendations. Background Information about FirstRate Company For nearly two decades, FirstRate has been the second largest firm in its industry, maintaining market share approaching 25 percent and generating stable, if modest, sales and net income growth. Beginning in 20X1, FirstRate began to experience intensified competition from several recent entrants into its industry, including a well-capitalized firm that expanded into FirstRateâs industry by exploiting a distribution channel it developed over many years in its original line of business. FirstRate responded to this increased crowding by "competing on price." In contrast, under its historical strategy, the company positioned itself based on brand recognition, product leadership, and personalized customer service. Along with its revised pricing strategy, FirstRate liberalized its customer credit and product return policies. In response to the effects of its revised pricing strategy on the companyâs operating performance, management immediately scaled back the companyâs product development plans, but was initially slow to critically re-examine its cost structure. FirstRate eventually reduced staff and closed some facilities as it outsourced certain production and fulfillment activities. However, the transitional costs of implementing these changes were significant. In addition, to support its revised pricing strategy, the company expanded its advertising and promotion. While FirstRateâs new strategy yielded greater-than-historical sales growth for the company, its reported net income suffered, along with its stock price. In response to the effects of these changes on FirstRateâs financial performance and condition, its lending banks increased the collateral requirements and interest rates on their loans to the company. The CFO of FirstRate Company is preparing for a meeting at one of the banks where the company been a long-time borrower. The companyâs $40 million working capital line of credit (LOC) will expire shortly. The company currently has $33.5 million in borrowings outstanding under the LOC and this balance will become due and payable in 30 days, unless the bank renews the LOC. The companyâs treasurer has just completed projected financial statements and a short-term cash flow forecast for the company. In anticipation of her bank meeting, the CFO met with the treasurer to discuss the financial projection and forecast. The CFO expressed her concern that "these will fail to make a favorable impression" on the bank. She continued, "Our recent results have already brought pressure from all of our banks. Itâs important that we have the banks in our corner while we implement our revised strategy." The treasurer responded, "Iâve prepared these [projections and forecasts] using our "best case" assumptions and estimates." The CFO replied cryptically, "Well, âsharpen your pencilâ because these are probably not going to get the job done." As the treasurer left her office, the CFO reminded him that, "We have more than a thousand employees, even more stockholders, not to mention dozens of suppliers, and our customers to take care of."

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