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Problem Set 1 (Ruonan Wu 674096980)

Question 1.

Moral Hazard is the risk that a party to a transaction has not entered into the contract in good faith, has provided misleading information about its assets, liabilities or credit capacity, or has an incentive to take unusual risks in a desperate attempt to earn a profit before the contract settles.

In the 2008 financial crisis, financial institutions who held loans were some of the largest and most important banks. They expected that the government would not allow them to fail due to the huge risk (too big to fail) and they would receive special protection from the government. Big banks or institutions in this case could not bear the full costs of the risks.

Another example is that given the liquidity provided by the collateralized debt market, lenders were able to relax their standards. Normally, banks lend money after careful analysis. However, lenders assumed that they could avoid holding the debt through its entire maturity and others would bear the risk of default.

Question 2.

Fannie Mae and Freddie Mac are publicly-owned government sponsored enterprises (GSEs). They guarantee/buy mortgages about one half of the mortgage market and bundle them into “securitized” pools, removing the need for banks to “fund” mortgages and the risk of making these loans. Securitization makes loan market more liquid and can increase total funding for these loans. Therefore, Fannie Mae and Freddie Mac allow banks to make more mortgages at a lower interest rate and to relax the standards of lending.

Question 3.

a. M/B=Market Capitalization/Book value of equity=36/22.2=1.62

b. Interest coverage=Operating Income/Interest Payment=10.4/7.7=1.35  

c. EV/EBITDA=(36+5.5+113.2-23.2)/(10.4+1.2)=11.336

d. Market Debt/Equity (D/E)=95.5/36=4.108

    Market debt =notes payable/short term debt +long term debt-cash=5.5+113.2-23.2=95.5

e. Current ratio=Current Assets/Current Liabilities= 57/34.7=1.643

Question 4.

a. Cash and long-term debt both would decrease by 20 million. Book value of equity remained the same.

b. Inventory would decrease by 5 million, and the book value of equity would decrease by the same amount.

c. Cash would decrease by 5 million and Property, plant and equipment PPE would increase by 10 million. And long-term debt would increase by 5 million.

Book value of equity would be unchanged.

d. Both the accounts receivable and the book value of equity would  decrease by 3 million.

e. No effect. 

f. No effect.

Question 5.

a.

And 994.4 million was held in foreign subsidiaries.

And the money is invested to available-for sale securities and trading securities, which is as follows.