The SEC attempt to protect investors who are purchasing newly issued securities by requiring issuers to

provide relevant financial information to prospective investors.

Question 4.-

No, the real value of a security is determined by the equilibrium forces of an efficient market.
Assuming that the information provided on newly issued securities is accurate, the market will
establish the value of a security regardless of the opinions rendered by the SEC, or, for that
matter, opinions offered by any advisory service or analyst.

Question -8

Bonds provide a stream of fixed nominal payments over its life. Investment in
bonds nevertheless involves risks, including inflation risks, maturity risks,
liquidity risks, and default risks. Therefore, investors require extra returns for
bearing each of these risks, called the risk premium.

Answer and Explanation:

The interest rate on a T-year bond = risk free rate + average inflation + maturity
risk premium. To find the interest rate on bonds with different maturities, we
need to compute average inflation and maturity risk premium in each case.

For 1-year bond, inflation next year = 7%, maturity risk premium is 0.2%, so
interest rare = 2% + 7% + 0.2% = 9.2%.

For 2-year bond, average inflation rate = (7% + 5%) / 2 = 6%, maturity risk
premium = 0.2% + 0.2% = 0.4%. So interest rate = 2% + 6% + 0.4% = 8.4%.

For 3-year bond, average inflation rate = (7% + 5% + 3%) / 3 = 5%, maturity risk
premium = 0.2% + 0.2%*2 = 0.6%. So interest rate = 2% + 5% + 0.6% = 7.6%.

For 4-year bond, average inflation rate = (7% + 5% + 3% + 3%) / 4 = 4.5%, maturity
risk premium = 0.2% + 0.2%*3 = 0.8%. So interest rate = 2% + 4.5% + 0.8% =
7.3%.

For 5-year bond, average inflation rate = (7% + 5% + 3% + 3% + 3%) / 5 = 4.2%,

maturity risk premium = 0.2% + 0.2%*4 = 1%. So interest rate = 2% + 4.2% + 1% =
7.2%.

For 10-year bond, average inflation rate = (7% + 5% + 3% + 3% + 3% + 3%*5) / 10

= 3.6%, maturity risk premium is capped at 1%. So interest rate = 2% + 3.6% +
1% = 6.6%.

For 20-year bond, average inflation rate = (7% + 5% + 3% + 3% + 3% + 3%*15) / 20

= 3.3%, maturity risk premium is capped at 1%. So interest rate = 2% + 3.3% +
1% = 6.3%.
Case study 1

Corporate philanthropy is always a sticky issue, but it can be justified in terms of

helping to create a more attractive community that will make it easier to hire a
productive work force. Corporate philanthropy, however, might be negatively perceived
by

b. Provided that the rate of return on assets exceeds the interest rate on debt, greater
use of debt will raise the expected rate of return on stockholders' equity. Also, the
interest on debt is tax deductible, which provides a further advantage. However, (1)
greater use of debt will have a negative impact on the stockholders if the Company's
return on assets falls below the cost of debt, and (2) increased use of debt increases
the chances of going bankrupt. The effects of the use of debt, called "financial
leverage," are spelled out in detail in Chapter 17.stockholders who do not live in the
company's headquarters city (San Francisco in this case), because they do not see any
direct benefits. Stockholders are interested in actions that maximize share price, and if
competing firms are not making

c. The company will be retaining more earnings, so its growth rate should go up, which
should increase its stock price. The decline in dividends, however, will pull the stock
price down. It is unclear whether the net effect on its stock will be an increase or a
decrease in its price; the change will depend on whether stockholders prefer dividends
or increased growth.similar contributions, the "cost" of this philanthropy has to be borne
by someone—the stockholders. Thus, stock price could decrease.