Download FBE 532 Midterm: Borrowing, Debt Capacity, and Acquisitions and more Exams Finance in PDF only on Docsity! FBE 532 – Take-Home Midterm Examination Due March 9, 2006 at 6pm Write your answers on sheets of 8.5x11” paper or type your answers but limit their length to approximately two- thirds to one page of double-spaced type (with normal margins and font size). Answer all three questions: they are equally weighted (33.3 points each) and cover the material discussed in class through March 2, 2006. While there is no way to enforce a time limit, the examination is intended to be a ninety-minute examination. I will not reward longer answers and value good organization and clear writing much more than many pages of words. Think about the question before answering and address each of the points raised using the analytical structure and concepts covered in class. The exam is due before class (6:00 pm Thursday, March 9, 2006) and can be sent to me via email (kdietrich@marshall.usc.edu) or fax (626-744-9599). Please append a cover sheet with your statement that you did not collaborate with anyone and provide the approximate amount of time you spent on the examination (in minutes). 1. From the Wall Street Journal February 2, 2006: “Not only is the 30-year bond coming back, but there are signs that if demand is strong at next week’s auction, the Treasury Department will do all it can to restore liquidity to the long-term sector of the government-debt market….Treasury also said it would consider 30-year bonds in May and Novembers after this year in order to meet trading needs for Treasury derivative products known as STRIPs “ [STRIP are equivalent to zero-coupon bonds payable up to thirty years from now.] a. What are advantages to the U.S. Treasury from borrowing in the long-term market currently (your answer may or may not be relevant to any debt issuer)? b. What is the duration of the 30-year bond (it has a 4.5% coupon and is trading close to par)? c. How much would a 30-year STRIP and the bond analyzed in (b) change in price if yields dropped from 4.5% to 4%? d. What is the relative advantage of STRIPS compared to coupon bonds for investors funding long-duration liabilities like annuity payments? e. What methods are available to help an investor funding annuities (as in (d) above) to hedge the risks from changes in interest rates and discuss how these hedges work? 2. On February 21, 2006, the following began a story in the Wall Street Journal Time Warner Inc.’s agreement with financier Carl Icahn to raise its stock-buyback programs to $20 billion will likely lift the company’s debt to $35 billion – the highest in absolute terms ever recorded by the company. Both the company and Wall Street analysts say the increased debt won’t endanger Time Warner’s investment-grade credit rating. Time Warner says that even at the higher level, its debt won’t go above its internal limit of three times its operating income before depreciation and amortization. A spokesman also noted the company’s debt has been higher as a ratio of operating earnings in the past. But the higher debt will reduce Time Warner’s flexibility to make acquisitions. It also marks a reversal for Chief Executive Richard Parsons, who, under pressure from investors, made debt reduction a top priority when he took the job in 2002. Helped by asset sales, he reduced net debt – debt minus cash and cash equivalents – to $16.1 billion at the end of 2005 from $25.8 billion at the end of 2002. a. Parsons has been trying to the lower debt of Time Warner. If asked, how would you present to him the benefits of increasing his firm’s leverage? b. In order to present a balanced argument, what concerns would you raise concerning issuing more debt to buy back stock in the company? c. What is the notion of “debt capacity” and what evidence do we have concerning the relation of the new Time Warner debt issuances to its debt capacity? d. What is the “ideal” leverage and what how does this concept relate to Time Warner? e. Icahn and his partners own around 6% of Time Warner. How could they benefit from this agreement? 1
