Leverage and capital structure chapter 13 solutions Essay

Leverage and capital structure chapter 13 solutions - Essay Example Total leverage reflects the combined impact of operating and financial leverage on the firm. High operating leverage and high financial leverage will lead to high total leverage. The following equation explains the relationship between the degree of total leverage and the degrees of both operating and financial leverage. Poor capital structure decisions can result in high cost of capital, thereby lowering the NPVs of projects. On the other hand, effective capital structure decisions can lower the cost of capital leading to higher NPVs thereby increasing the value of the firm. All the items on the right hand side of the balance sheet, excluding current liabilities are sources of capital. The firm’s capital structure directly affects its financial risk, which is the risk to the firm of being unable to cover required financial obligations. The more debt and preferred stock a firm has in its capital structure, the greater its financial leverage and risk. The penalty for not meeting financial obligations is bankruptcy. Managers of firms typically act as agents of owners. The owners give the managers the authority to manage the firm for the owners’ benefit. The agency problem created by this relationship extends to the relationship between owners and lenders. Lenders can control the firm’s risk and protect themselves against adverse effects of the agency problem by including appropriate provisions in loan agreements. On the other hand, firms benefit by obtaining funds at lower costs by agreeing to the financial and operating constraints placed by loan provisions. A signal is a financial action by management that is believed to reflect its view of the firm’s stock value. Generally, debt financing is viewed as a positive signal that management believes the stock is under-valued while a stock issue is viewed as a

Hedge Funds-who is the winner(literature review) Essay

Hedge Funds-who is the winner(literature review) - Essay Example In the later part, we give an analysis, consult other authors and available literature in the field, and critically assess Brown’s article on hedge funds. The phrase â€Å"hedge funds† alone has not been well defined. Dr. Grenville, Deputy Governor of the Reserve Bank of Australia could not mention the proper definition. The Bank of Australia, in a paper submitted to the Australian House of Representatives, indicated that it was very concerned about the activities of highly leveraged financial intermediaries known as â€Å"hedge funds†. The paper stated that they were concerned that the funds made money â€Å"by attacking an exchange rate that has already overshot, so that it overshoots even further.† Through published actions and short selling, a bandwagon forms, then the funds would pull out. The Bank paper further stated that this was what happened to the ERM crisis that hit the British Pound in 1992, the Asian currency crisis in 1997 and speculative attacks on the Hong Kong dollar peg in 1998. With their action, the funds were holding the small countries hostage. (p 301) Brown (2001) pointed out that the International Monetary Fund reported that in the 1990s, there were financial intermediaries that had been investing steadily into South East Asia. There was a net inflow of about US$20 billion into the region over and above portfolio and direct investment; this was up to 1995 and 1996 when it increased to US$45 billion per annum. Then, there was a collapse of the Baht and the Ringgit in 1997 (the start of the Asian financial crisis), and a sudden outflow of US$58 billion. It was then perceived by the central bankers in the region that the collapse in the currency had everything to do with an attack on the currencies of the region by well-financed international speculators. Hedge funds could be the cause of the Asian financial crisis. One of those who believed on this was Dr. Mahathir bin Mohamad when he said,