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1. Is the following statement true? "If the efficient-market hypothesis is true, then it makes no difference what securities a company issues: all are fairly priced." Discuss briefly.
2. It is sometimes suggested that--because retained earnings and depreciation allowances provide the bulk of business investment financing--the securities markets are largely redundant. Do you agree?
3. In 1996, Megacorp makes a rights issue, at $10 per share, of one new share for every four shares held. Before the issue there were 50 million shares outstanding, and the share price was $12. What is the value of a right? What is the prospective post-rights issue price of the stock?
4. The Carter Investment Company had a current market value of $72.51 a share as of last October 1. It pays a quarterly dividend of $1.00 a share. The dividend was announced on October 2; the stock went ex-dividend on October 14; the dividend was paid on October 16. On one of these dates its market value fell by $1. Which date?
5. What is the chief difference in the role of banks in corporate finance in the United States and in Japan?
6. Stock splits are supposed to be important events for a company's stock price to the extent that they convey information--the information that the management expects value to rise and thus that a greater number of shares outstanding will be necessary to keep the price of the stock in a range that investors will find maximally convenient. Can you think of other financial decisions by corporation managements that may carry information and affect the stock price? How, exactly?
7. [Problem 14 of chapter 13]: In May 1987, Citicorp announced that it was bolstering its loan loss reserves by $3 billion to reflect its exposure to insolvent Third World borrowers: second quarter earnings were thus tranformed from an $0.5 billion profit to a $2.5 billion loss. The next day, when the market had a chance to digest the news, the price rose to $53 a share from a previous day's close of $50. Other bank stocks fell...
Comment varied. Citicorp's chairman claimed that the accounting move "strengthens the institution." Analysts and bankers suggested that it was a step toward realism--that the action recognized "what the stock market [had] been saying for several months: that the value of the sovereign debt [owed by Third World governments to] to the big U.S. money center banks is between 25% and 50% less than is carried in their books. The London Financial Times warned that Citicorp had merely rearranged its balance sheet, and had not improved its capital base. A Financial Times columnist described the move as an "outsize piece of cosmetic self-indulgence," and a lead article stated that "even if all this means that Citicorp shareholders are $3 billion poorer today, the [Citicorp] group as a whole is better placed to absorb whatever shocks lie ahead."
There was discussion of the implications for other banks, concluding that: "there's no question that the market will put higher confidence in those institutions that can reserve [against potential losses] more fully."
It is not often that a company announces a $2.5 billion loss and its stock price rises by 6%. Do you think that the share price reaction was consistent with an efficient market? Why or why not?
8. Examine table 14-3 in chapter 14. Consider the five-year period 1990-1994. Over this five year period taken as a whole, how much money did nonfinancial corporations raise through net issues of stock? Through new issues of bonds? Through net "increases in accounts payable" (i.e., borrowing from your suppliers)? What proportion of total expenditures on capital were financed by these three sources of externally-generated capital?
Go to Brad DeLong's Home Page
Associate Professor of Economics Brad De
Long, 601 Evans
University of California at Berkeley; Berkeley, CA 94720-3880
(510) 643-4027 phone (510) 642-6615 fax