Chapter 5 – The Financial System, Corporate Governance, and Interest. The Financial System. The economy is divided into sectors Consumption Production (includes government) Services, products, and money flow between the sectors every day Producers pay wages Workers spend incomes
Chapter 5 – The Financial System, Corporate Governance, and Interest
(Consumer) Savings = (Business) Investment
Firms spend two kinds of money
Firms to raise money by:
Primary market transactions can occur
Privately Held Companies
Publicly Traded Companies
Harry Johnson, CEO
Plus: Stock option:
A situation that tempts people to act in immoral or unethical ways
In 2004 - 2006
Two actions were particularly important to the financial crisis
k = kPR + INFL + DR + LR + MR
k is the nominal or quoted interest rate
Using the Interest Rate Model, Sunshine Inc. is planning to borrow by issuing three year bonds (notes).
SOLUTION: To estimate the interest rate Sunshine will have to offer to sell the bonds (ks).
Calculate INFL, the average inflation rate over the life of the loan.
INFL = (3 + 4 + 4)/3 = 11/3 = 3.67 = 3.7
3 + 4 +4 are the inflation rates for the three years, or the life of this project. Add them together
The 3 is the number of years, or life of the project
Sunshine’s risk premium from assumptions
The debt market seems to be assigning Moonlight a default risk premium of 3.8%, which is (3.8/1.5 ) = 2.5 times as large as Sunshine’s. This implies more risk.
Inversion PeriodRecession Date
July 2000 - January 2001 March 2001
May 1989 - August 1989 July 1990
October 1980 - September 1981 July 1981
November 1978 - May 1980 January 1980
June 1973 - November 1974 November 1973
December 1968 - February 1970 December 1969