Essay Preview: Economics Case
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Q4-1- What is the relationship between the price of a financial asset and the return that investors require on that asset, holding other factors constant?
The relationship between the price of a financial asset and the return that the investor expects is all based on the level of risk. For example, if a business that is failing needs money to keep things running and a bank loans them money for cash flows they are going to have a very high interest rate. Since the risk is greater, the reward is greater.
a. Is the yield curve typically upward sloping, downward sloping, or flat?
It is typically upward sloping.
b. Notice the behavior of the yield curve and the S& P 500 between July 28, 1998, and October 19, 1998. In August 1998, Russia defaulted on billions of dollars of foreign debt. Then, in late September came the news that at the behest of the Federal Reserve, fifteen financial institutions would infuse $ 3.5 billion in new capital into hedge fund Long- Term Capital Management, which had lost nearly $2 billion in the previous month. Comment on these events as they relate to movements in the yield curve and the S& P 500 that you see in the animation.
I couldnt see the curve. All that showed for me was 04-11 but I would imagine the yield curve would be going down significantly. I think that interest rates would go higher because suddenly, we are out billions of dollars and other people are having to cover for it. I think stock prices would drop because people dont want to invest when countries are faulting on multi billion dollar loans.
How is preferred stock different from common?
Common stock tends to be more risky of the two but because of that risk, common stock owners own the firm and also get to vote on decisions. Preferred stock is considered senior but both types are considered equity. Common stock holders only get their dividends after the firm pays all its expenses as well as the promised dividends to preferred stockholders. Also, preferred stockholders dont have the right to vote on important decisions.
Describe the role of the underwriting syndicate in a firm-commitment offering.
They purchase shares and resell them but have a risk of not being able to sell them for what they bought them for. Buy a lot cheap and sell in pieces to different banks for a bigger profit.