fall16q04

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School

University of Pennsylvania *

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238

Subject

Economics

Date

Nov 24, 2024

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pdf

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Uploaded by blochjacob

FOURTH QUIZ FNCE 238/738 October 31, 2016 WRITE ALL ANSWERS ON THE TEST. IF YOUR ANSWER CONTINUES ON THE BACK, MAKE A NOTE OF IT ON THE FRONT. 45 PTS / 25 MINUTES NAME:_____________________________________________ SECTION (12, 1:30 or 3):__________________________________

1. (10 pts) On September 9 th , 2015, to help pay for its acquisition of Shred-It, Stericycle Corp (which pays no dividends on its common shares, which were trading at $136.25 on 9/9/15) issued a preferred security at $1000/share. This security has a 5.25% dividend, and on September 15 th , 2018, converts into a number of shares of common equity, where this number depends on the average price S of its common stock over the month ending that day. If S < $136.25 then the number is 100 0/136.25, if 136.25 ≤ S ≤ $170.21 then the number is 1000/S, and if $170.21 < S then the number is 1000/170.21. How could you calculate the approximate value of this security? (Don’t actually calculate it, just detail the components of this calculation).

2. (10 pts) Here’s a clip from the website of the Federal Housing Finance Agency: Fannie Mae and Freddie Mac buy mortgages from lenders and either hold these mortgages in their portfolios or package the loans into mortgage-backed securities (MBS) that may be sold. Lenders use the cash raised by selling mortgages to the Enterprises to engage in further lending. The Enterprises’ purchases help ensure that individuals and families that buy homes and investors that purchase apartment buildings and other multifamily dwellings have a continuous, stable supply of mortgage money. Do you agree or disagree with the assertion that Fannie and Freddie are helpful to individuals and families buying homes? What evidence have we seen for or against that?

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3. An investor pays a 30% marginal rate on interest income and a 15% marginal rate on qualified dividends. a. (3 pts) Suppose that an investor views a standard preferred security as equivalent in every way, besides taxation, to a B-rated bond. If the investor is willing to buy a B-rated bond if its yield is at least 6%, what yield would the investor accept on a standard preferred security paying qualified dividends? b. (7 pts) Assuming the maximum marginal rate facing corporations is 35%, is it possible for a B-rated taxable industrial corporation to benefit from selling this investor a standard preferred, rather than a bond? Be precise.

4. (10 pts) Suppose Biocloud is a pharmaceutical company that might strike it big, but probably not. There is a 20% chance that it is worth 1200 in one period, and an 80% chance that it is worth just 150. Biocloud has issued just two kinds of securities: common shares and a convertible. The convertible matures in one period, has face value 100, and is convertible into 1/3 of the common shares (i.e. if bondholders convert, they will own 1/3 of the common shares). Biocloud can call the convertible for 100 now. Would that be a good idea? Explain numerically.

5. (5 pts) From a 2013 article (slightly edited): Return Rates for Utilities Get Harder Look March 21, 2013 6:29 p.m. ET Households getting electricity from Alabama Power Co. are using 6% less than five years ago. But their monthly power bills still have increased by an average of 8%, partly because of a lucrative rate agreement that the utility brokered with state regulators 30 years ago. The deal allows Alabama Power, the state's largest electric utility, to adjust its rates annually to maintain an after-tax return on equity, a measure of profit, of 13% to 14.5%. Now it is coming under fire from consumer advocates and one state utility commissioner, who argue that the utility's profit levels are too high. If the consumer advocates and state utility commissioner succeed in lowering the maximum allowable profit, by this measure, from 14.5%, would you expect this to affect Alabama Power’s capital structure decisions? Why or why not?

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