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DISCUSSION QUESTIONS AND REPONSE FORMAT – NUMBER RESPONSES ACCORDINGLY (RESPONSE 160 WORDS EACH)
F3 -1. Why are junk bonds perceived as offering high returns with high risk? Which of the numerous risks associated with bonds is the most tolerable in your opinion? Explain why.
F3-2. If you have an opportunity to invest your retirement money on your own, would you invest a large amount of that money in the money market, stock market, or bond market? Explain.
F3-3. Financial Institution Simulation
When I was in graduate school, I took a class on financial institution management. While we did not have a simulation to mimic the Fed’s decisions, we did simulate the results of a bank’s management making decisions. We were put into teams that looked at many inputs before making decisions. Some of the inputs were macroeconomic inputs, such as the GDP, the Fed’s rates, etc. We also looked at previous decisions we had made, and the results of the combination of our decisions and the actual macroeconomic results during those time periods.
We then had to decide what we thought the upcoming conditions would be, and make decisions about what we as a bank would do. Some of the decisions we had to make included what rate to pay on savings accounts and CD’s (of various maturities), what rate to charge on a variety of loans, and what to do with any cash on hand in excess of our reserve requirements. We also had to make decisions about what we wanted our balance sheet to look like, including the duration gap between our assets and our liabilities.
For the first part of the class, our group was doing very well, and was making a lot of money. We were being fairly aggressive with our decision-making, and developed a little bit of a cocky attitude. Because we were being fairly aggressive, we were opening ourselves up to a certain amount of risk, as the positions we took on various items could backfire on us if the business conditions changed.
Well, you can guess what happened. The economic conditions changed suddenly, and all of the positions we took that were profitable when the economy was doing well were all of a sudden losing money as the economy tanked. Looking back, it is interesting that our behavior as students foreshadowed the behavior of the banks during the economic crisis.
Has anyone else ever played a simulation like this? How about a simulation on something else that is finance related?
F3-4. Bond Prices and Interest Rates
To help everyone understand how bond prices are impacted by interest rates, I am posting the following summary.
An investment in low-rate bonds would go down in value because the bonds would pay a certain amount of interest, which is a low rate. If a company were to invest in these bonds with a low interest rate, they would not have that money to invest later. Then, if interest rates go up, the company would miss out on buying these bonds that pay a higher interest. They would be holding bonds that pay a low rate, while everyone else investing in bonds at the new rate would earn more interest. All of a sudden, the investment that the company made in the old bonds would go down in value since it would make no sense for someone else to buy these bonds from the company unless they were given a discount. If I were investing in bonds, and I had to choose between a bond that paid 2% and one that paid 3%, I would invest in the 3% bond, unless I paid a lower price for the bond that only paid 2%. There is some price at which the return on the investment on the 2% bond is equal to the return on the investment in the 3% bond – the only difference being that some of that return is immediate since it would be the result of paying a lower price. This price can be determined by considering the time value of money.
In the same manner, if interest rates fall, the value of bond investments go up.
Briefly summarize what you have learned in Week 4. What did you learn that you had never even thought about before? Did you have an “Ah-ha” moment when a light bulb came on in your head? What did you previously know a little about that you gained a greater understanding of? Finally, what do you consider important that you learned this week, and why?
F4-1. If a company uses NPV for capital budgeting, how does an analyst adjust for projects of differing risk? If a company, with a normal payback requirement of two years or less, uses the following techniques, how might the company adjust for projects of differing risk in the approval process?
o Simple payback
What is capital structure? Why does it matter in terms of a company’s financial performance? How does a company’s capital structure affect overall risk?
F4-1a. Minimum Wage
Does raising minimum wage make sense or will it just cause an upward shift in prices (it woudl take time) and even out in the end.
Does it make us less competitive with Foreign markets?
F4-1b. Check this out first: http://money.cnn.com/2014/05/12/investing/craft-beer-constellation/index.html?iid=HP_River
This one caught my interest. I live in Wine country and Micro breweries are popping up all over. The 2 in this area that I spot at occassionally have very different strategies and both are doing VERY VERY well.
I am wondering what others think. Is this an market with great opportunity, or is it too late to jump on the band wagon?
Is it about size? I think the smaller breweries right now are doing very well, and getting too big might destroy the “Craft” Image.