MBA 503C Finance Management
Week 2 Discussion
What is an opportunity cost and how can it be measured?
An opportunity cost is the rate of return you could earn on an alternative investment or similar risk. It can be measured by the benefits of the investment you decide to make.
Would you rather have a saving account that pays 3% interest compounded semiannually or one that pays 3% interest compounded daily?
Compounded means earning interest on your interest. So, the more frequently interest is compounded the more you can earn. The difference is especially notable when dealing with a larger amount of money and/or an extended period of time.
What is the effective annual rate of interest?
The effective annual ...view middle of the document...
Explain whether the following statement is true or false: “Only weak companies issue debentures.” Why is there a yield spread between a corporate bond and a Treasury bond?
False. Extremely strong companies can use debentures because they do not need to put up property as security for their debt. Corporate yields include default risk premiums and somewhat higher liquidity premiums. With the Treasury bond it is almost considered risk free.
Why are bond ratings important to firms, investors, and markets?
Bond ratings are important because they are an indicator of default risk and the rating has a direct, measurable influence on the bonds interest rate and the firm’s cost of debt. Also, bonds purchased by institutional investors are restricted to investment-grade securities. So, if a firm’s bonds fall below BBB, it will have a difficult time selling new bonds because many will not be allowed to buy them.
Why do the prices of fixed-rate bonds fall if expectations for inflation rise?
If investors expect the inflation rate to rise, then they expect the real return on their bond to fall, as future payments .The higher inflation expectations decrease bond demand.
If you bought a share of common stock, you would probably expect to receive dividends plus an eventual capital gain. Would the distribution between the dividend yield and the capital gains yield be influenced by the firm’s decision to pay more dividends rather than to retain and reinvest more of its earnings?
An owner of common stock is entitled to receive dividends, but only out of a company that has earnings out of which they can be paid and management decides to pay dividends. If a stock is sold for higher than what was paid for it, then that is a gain. Investors expect to receive a gain on stocks sold.