Case Study Facts
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Case Study Facts
The spin-out that occurred in 2008 intensified its perilous capital situation.
The spin-out in 2008 and low-interest rates intensified its perilous capital situation.
Despite its 3 million futures, a national value exceeding $100 billion, and over 25% trading
volume from customers, the company faced a huge debt (Till & Heckinger, 2017).
Corzine’s investment strategy began demanding significant and risky investments in the firm’s
resources, leading to diminishing sources.
Corzine engaged in “repos to maturity” transactions in Europe and made short-term purchases of
European debt.
Jon Corzine joined MF Global during a challenging financial period where the company
experienced increased weakness in its financial status and internal control systems. Corzine
implemented increasingly risky strategies with an enormous investment of the company’s money.
The CEO intended to transform MF Global from a futures commission merchant to an
investment bank. Despite the company’s value exceeding $100 billion, three million options
positions and futures, and a large customer base that contributed to 25% of its trading volume,
the company faced stresses due to its massive debts. Also, MF Global Inc.’s spin-out from its
parent company in 2008 worsened its financial and capital situation. The company relied heavily
on proprietary funds.
Case Study Facts Cont.
MF Global Inc.’s reliance on proprietary funds increased the risk on customers’ funds
(Commodities Futures Trading Commission, 2013).
In 2011, Corzine failed to enhance the company’s deficient systems and increased reliance on
customers’ FCM accounts and cash, leading to unlawful use of customers’ monies.
MF Global Inc.’s sovereign debt portfolio increased by $2 billion by mid-2010.
The company’s board of directors and risk officer disagreed with Corzine’s strategy with an
alarm of bankruptcy.
Corzine underestimated the risk level caused by his strategy. Subsequently, the company
relied on proprietary funds. While the CEO thought the plan on “repo to maturity” would
increase the company’s global growth and lower its debts, the company’s risk officer and
directors perceived the approach as risky. The company recorded an increase in MF Global Inc.’s
sovereign debt by $2 billion, creating loopholes suggesting eventual bankruptcy.
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Related Questions
Gator Fabrics Inc. currently has zero debt (i.e., wd = 0). It is a zero growth company, and additional firm data are shown below. Now the company is considering using some debt, moving to the new capital structure indicated below. The money raised would be used to repurchase stock at the current price. It is estimated that the increase in risk resulting from the additional leverage would cause the required rate of return on equity to rise somewhat, as indicated below. If this plan were carried out, by how much would the WACC change, i.e., what is WACCOld − WACCNew?
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Following JPMorgan Chase's significant acquisition of
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to major corporate financial decisions, and what
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capital structure and dividend policy? Consider how
information asymmetry between management and
investors affects market efficiency, particularly during
periods of banking sector stress, and analyze how the
market's processing of complex financial information
influences both the timing and structure of major
corporate actions like acquisitions, stock buybacks, or
dividend changes. Examine the relationship between
market efficiency and the speed at which new
information is incorporated into stock prices, especially
in cases involving large financial institutions where
systemic risks may be a concern.
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Provide answer
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Company X has $10M of excess cash (i.e., cash that is not used in the company's operations) and operating assets that will generate risky (i.e., uncertain) future cash flows with a present value today of $25M. It has no other assets. The company has risky zero-coupon bonds outstanding with a face value of $20M, and no other debt.
Who is likely to gain and who is likely to lose from the following maneuvers?
a) Company X pays a cash dividend of $10M to its shareholders.
b) Company X halts operations and sells all of its operating assets for $15M. It invests the proceeds from this sale along with its $10M of existing cash in Treasury Bills (i.e., risk free bonds).
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6
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Although its own operations have shown no growth over the past decade, Hammerworks Inc. has built up a significant cash balance ($2.9 billion) in anticipation of a collapse in equity prices which it believes will create opportunities for valuable acquisitions. Following just such a correction, two potential targets are now being considered: Metallion has a current market capitalization of $1.1 billion, $550 million in 6% debt (YTM also 6%), and generates EBIT of $175 million annually with no growth (a 7.1% profit margin on annual sales of $1.4 billion). Goblikon has an enterprise value of $1.3 billion, a market valued D/E of 1.1, and has been growing its profits at 4% for the past several years (it currently has a P/E ratio of 10). In either case, Hammerworks would be expected to pay off the target’s bond holders in full as there is a change of control clause in their bond indentures. Since either acquisition would be paid for with cash, the firm expects that either acquisition…
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Although its own operations have shown no growth over the past decade, Hammerworks Inc. has built up a significant cash balance ($2.9 billion) in anticipation of a collapse in equity prices which it believes will create opportunities for valuable acquisitions. Following just such a correction, two potential targets are now being considered: Metallion has a current market capitalization of $1.1 billion, $550 million in 6% debt (YTM also 6%), and generates EBIT of $175 million annually with no growth (a 7.1% profit margin on annual sales of $1.4 billion). Goblikon has an enterprise value of $1.3 billion, a market valued D/E of 1.1, and has been growing its profits at 4% for the past several years (it currently has a P/E ratio of 10). In either case, Hammerworks would be expected to pay off the target’s bond holders in full as there is a change of control clause in their bond indentures. Since either acquisition would be paid for with cash, the firm expects that either acquisition…
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Kyma Inc. currently has zero debt. It is a zero growth company, and it has the data shown below. Now the company is
considering using some debt, moving to the new debt/assets ratio indicated below. The money raised would be used to
repurchase stock at the current price. It is estimated that the increase in risk resulting from the additional leverage would cause
the required rate of return on equity to rise somewhat, as indicated below. If this plan were carried out, by how much would the
WACC change, i.e., what is WACCold - WACCNew?
New Debt/Assets
35%
Orig. cost of equity, rs
10.0%
New Equity/Assets
65%
New cost of equity = rs
11.0%
Interest rate new = rd 7.0%
Tax rate
40.0%
O1.72%
O2.06%
1.38%
1.04%
arrow_forward
Long-Term Capital Management (LTCM) implemented a convergence trading strategy
involving corporate bonds and U.S. Treasuries. Expecting the spread between corporate
bond yields and Treasury yields to narrow over time, LTCM took large leveraged positions,
going long (buying) corporate bonds and short (selling) Treasuries. However, the 1998
Russian debt crisis triggered a flight to quality, causing corporate bond prices to fall and
Treasury prices to rise, leading to a divergence of the spreads and massive losses for
LTCM's trades.
On July 1, 1998, LTCM initiated a convergence trade by going long $100 million notional of
Baa-rated 10-year corporate bonds with a yield of 7.5% and coupon rate of 7%, and
shorting $100 million notional of 10-year U.S. Treasury bonds with a yield of 5.5% and
coupon rate of 5%.
a. Explain LTCM's rationale for going long corporate bonds and short Treasuries in their
convergence trade. What were the underlying assumptions behind this strategy?
b. Calculate…
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Why Softbank was willing to bail WeWork despite losses and mismanagement of funds (multiple answers possible):
a.
WeWork captured a ‘blue ocean’ type market opportunity
b.
WeWork had a charismatic CEO
c.
WeWork was labelled as a ‘unicorn’ start-up
d.
WeWork had an extremely high pre-IPO evaluation
e.
WeWork was experiencing faster growth than incumbent competitors
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6. Backroads Sporting Goods is trying to determine its optimal capital structure, which now consists of
only debt and common equity. The firm does not currently use preferred stock in its capital structure,
and it does not plan to do so in the future. To estimate how much its debt would cost at different debt
levels, the company's treasury staff has consulted with investment bankers and, on the basis of those
cussions, has created the following table:
4
Debt-to-Capital
Ratio
0.0
0.2
0.4
0.6
a 9.56%
h 10.48%
Equity-to-
Capital Ratio
11.13%
d. 11.45%
e. 12.25 %
(w.)
1.0
0.8
0.6
0.4
0.2
Debt-to-Equity
Ratio
(D/E)
0.00
0.25
0.67
1.50
4.00
Bond Rating
A
BBB
BB
Before-Tax
Cost of Debt
65%
7.5
9.5
D
Backroads uses the CAPM to estimate its cost of common equity. r.. The company estimates that the
risk-free rate is 6%, the market risk premium is 5%, and its tax rate is 40%. Backroads estimates that
if it had no debt, its "unlevered" beta, bu, would be 1.25. On the basis of this information,…
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During the Great Recession of 2008-2009, corporate cash conversion cycles typically increased in length by a significant amount. Why might this have occurred? Was it a good decision by corporate CFOs to allow this to happen? Explain.
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Related Questions
- Gator Fabrics Inc. currently has zero debt (i.e., wd = 0). It is a zero growth company, and additional firm data are shown below. Now the company is considering using some debt, moving to the new capital structure indicated below. The money raised would be used to repurchase stock at the current price. It is estimated that the increase in risk resulting from the additional leverage would cause the required rate of return on equity to rise somewhat, as indicated below. If this plan were carried out, by how much would the WACC change, i.e., what is WACCOld − WACCNew?arrow_forwardFollowing JPMorgan Chase's significant acquisition of First Republic Bank in 2023, how does the Efficient Market Hypothesis (EMH) explain the market's reaction to major corporate financial decisions, and what implications does this have for a company's approach to capital structure and dividend policy? Consider how information asymmetry between management and investors affects market efficiency, particularly during periods of banking sector stress, and analyze how the market's processing of complex financial information influences both the timing and structure of major corporate actions like acquisitions, stock buybacks, or dividend changes. Examine the relationship between market efficiency and the speed at which new information is incorporated into stock prices, especially in cases involving large financial institutions where systemic risks may be a concern.arrow_forwardProvide answerarrow_forward
- Company X has $10M of excess cash (i.e., cash that is not used in the company's operations) and operating assets that will generate risky (i.e., uncertain) future cash flows with a present value today of $25M. It has no other assets. The company has risky zero-coupon bonds outstanding with a face value of $20M, and no other debt. Who is likely to gain and who is likely to lose from the following maneuvers? a) Company X pays a cash dividend of $10M to its shareholders. b) Company X halts operations and sells all of its operating assets for $15M. It invests the proceeds from this sale along with its $10M of existing cash in Treasury Bills (i.e., risk free bonds).arrow_forward6arrow_forwardAlthough its own operations have shown no growth over the past decade, Hammerworks Inc. has built up a significant cash balance ($2.9 billion) in anticipation of a collapse in equity prices which it believes will create opportunities for valuable acquisitions. Following just such a correction, two potential targets are now being considered: Metallion has a current market capitalization of $1.1 billion, $550 million in 6% debt (YTM also 6%), and generates EBIT of $175 million annually with no growth (a 7.1% profit margin on annual sales of $1.4 billion). Goblikon has an enterprise value of $1.3 billion, a market valued D/E of 1.1, and has been growing its profits at 4% for the past several years (it currently has a P/E ratio of 10). In either case, Hammerworks would be expected to pay off the target’s bond holders in full as there is a change of control clause in their bond indentures. Since either acquisition would be paid for with cash, the firm expects that either acquisition…arrow_forward
- Although its own operations have shown no growth over the past decade, Hammerworks Inc. has built up a significant cash balance ($2.9 billion) in anticipation of a collapse in equity prices which it believes will create opportunities for valuable acquisitions. Following just such a correction, two potential targets are now being considered: Metallion has a current market capitalization of $1.1 billion, $550 million in 6% debt (YTM also 6%), and generates EBIT of $175 million annually with no growth (a 7.1% profit margin on annual sales of $1.4 billion). Goblikon has an enterprise value of $1.3 billion, a market valued D/E of 1.1, and has been growing its profits at 4% for the past several years (it currently has a P/E ratio of 10). In either case, Hammerworks would be expected to pay off the target’s bond holders in full as there is a change of control clause in their bond indentures. Since either acquisition would be paid for with cash, the firm expects that either acquisition…arrow_forwardKyma Inc. currently has zero debt. It is a zero growth company, and it has the data shown below. Now the company is considering using some debt, moving to the new debt/assets ratio indicated below. The money raised would be used to repurchase stock at the current price. It is estimated that the increase in risk resulting from the additional leverage would cause the required rate of return on equity to rise somewhat, as indicated below. If this plan were carried out, by how much would the WACC change, i.e., what is WACCold - WACCNew? New Debt/Assets 35% Orig. cost of equity, rs 10.0% New Equity/Assets 65% New cost of equity = rs 11.0% Interest rate new = rd 7.0% Tax rate 40.0% O1.72% O2.06% 1.38% 1.04%arrow_forwardLong-Term Capital Management (LTCM) implemented a convergence trading strategy involving corporate bonds and U.S. Treasuries. Expecting the spread between corporate bond yields and Treasury yields to narrow over time, LTCM took large leveraged positions, going long (buying) corporate bonds and short (selling) Treasuries. However, the 1998 Russian debt crisis triggered a flight to quality, causing corporate bond prices to fall and Treasury prices to rise, leading to a divergence of the spreads and massive losses for LTCM's trades. On July 1, 1998, LTCM initiated a convergence trade by going long $100 million notional of Baa-rated 10-year corporate bonds with a yield of 7.5% and coupon rate of 7%, and shorting $100 million notional of 10-year U.S. Treasury bonds with a yield of 5.5% and coupon rate of 5%. a. Explain LTCM's rationale for going long corporate bonds and short Treasuries in their convergence trade. What were the underlying assumptions behind this strategy? b. Calculate…arrow_forward
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