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Chapter 5: 12DQ (page 524)

Bonds of different risk classes will have a spread between their interest rates. Is this spread always the same? Why? (LO16-2)

Short Answer

Expert verified

The spread between interest rate and bonds of different risk classes is not always the same because the variations in the yield spread depend upon the changes in the economy.

Step by step solution

01

Spread

In finance, the term spread is used to denote the difference between two rates or yieldsassociated with stocks or bonds. The determination of spread facilitates the investors to assess the nature of the bond, whether the bond is expensive or cheap.

02

Impact on the spread

The spread between bonds of different risk classes and their interest rate is not always the same. The yield spread changes according to the variations in the economy.In addition, high rated bonds contain less risk, and low rated contain high-risk such changes in the rating also differentiate the spreads.

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Most popular questions from this chapter

Midland Corporation has a net income of \(19 million and 4 million shares outstanding. Its common stock is currently selling for \)48 per share. Midland plans to sell common stock to set up a major new production facility with a net cost of \(21,120,000. The production facility will not produce a profit for one year, and then it is expected to earn a 13 percent return on the investment. Stanley Morgan and Co., an investment banking firm, plans to sell the issue to the public for \)44 per share with a spread of 4 percent.

c. What are the earnings per share (EPS) and the price-earnings ratio before the issue (based on a stock price of $48)? What will be the price per share immediately after the sale of stock if the P/E stays constant?

Jordan Broadcasting Company is going public at \(50 net per share to the company. There also are founding stockholders that are selling part of their shares at the same price. Prior to the offering, the firm had \)26 million in earnings divided over 11 million shares. The public offering will be for 5 million shares; 3 million will be new corporate shares and 2 million will be shares currently owned by the founding stockholders.

a. What is the immediate dilution based on the new corporate shares that are being offered?

b. If the stock has a P/E of 30 immediately after the offering, what will the stock price be?

c.hould the founding stockholders be pleased with the $50 they received for their shares?


What act of Congress created the Securities and Exchange Commission?

The Ellis Corporation has heavy lease commitments. Prior to SFAS No. 13, it merely footnoted lease obligations in the balance sheet, which appeared as follows:

In \( millions

In \) millions

Current assets

\(70

Current liabilities

\)30

Fixed assets

\(70

Long-term liabilities

\)30

Total liabilities

\(60

Stockholder’s equity

\)80

Total assets

\(140

Total stockholder’s equity and liabilities

\)140

The footnotes stated that the company had $14 million in annual capital lease obligations for the next 20 years.

e. In an efficient capital market environment, should the consequences of SFAS No. 13, as viewed in the answers to parts c and d, change stock prices and credit ratings?

What method of “bond repayment” reduces debt and increases the amount of common stock outstanding? (LO16-3)
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