FIN 571 Week 5 - DQs - 7644

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What is the major reason that subordinated debt is typically rated lower than senior debt?

There are several reasons why subordinated debt is rated lower than a senior debt but the major reason is that subordinated debt has a greater exposure to default risk.

Suppose that a firm wishes to maintain a capital structure that is consistent with an A senior debt rating. Under what circumstances would the firm maintain a lower degree of leverage than a cross section of single-A-rated firms?

There are several reasons why a firm migh choose a lower degree of leverage instead of a single A rated firm. Other factors that influence this kind of decision can be the proportion of intangible assets and the use of interest tax credits. When we think of leverage we need to understand that this is not the only thing that will contribute directly to the firm credit rating. There are other factors considering risk, etc. Some of these factors include the location of the firm, their income, how they manage, how much debt the firm currently has and what kind of industry is this firm in or classified as.

Explain why selecting a target senior debt rating is a reasonable approach to choosing a capital structure. Explain why a target senior debt rating of single-A is a prudent objective when there is only a very limited new issue market for non-investment-grade debt, and when investor willingness to purchase triple-B-rated debt is likely to be highly sensitive to the state of the economy

 

To select the last class of senior debt and a reasonable approach to the choice of capital structure, according to the classification consists of three of the five major considerations that influence decisions on capital structure. Scores on the credit rating show the companies ability to repay the debt markets to the degree of protection provided by the liquidity of their assets, and largely determines the ease of access to capital. The final rating of the senior debt only reasonable goal, because it is the lowest rating ever allowed the issuer to ensure continued access to capital markets.

 

 

 

 

 

The development of the new issue junk bond market had important implications for capital structure choice.The existence of a viable junk bond market means that firms can comfortably maintain higher degrees of leverage than they could prior to the development of this market. Do you agree or disagree? Justify your answer.

In a junk bond market is the market rate, which is dedicated to the sale of junk bonds or bonds with high incomes. Also known as market-grade bond  or speculative market grade bonds transactions without bond market investment grade bonds and high yield, is similar to the bond markets of the quality of investment markets and bank lending. As we know with the existence of a viable market for "junk bond" means that companies can more easily maintain a high degree of leverage than ever the opportunity to develop this market. Bonds issued by companies, credit ratings below investment grade, and usually gives the rating a ratio less than or equal to values, credit rating agencies is possible, however, guaranteed. Some of the things that are done to attract investors is for junk bonds to pay interest rate of investment grade are considered speculative investments and the ones that issue the bonds in the market either well known or poorly known companies that are in high debt. The obligation to pay a high yield is due to the credit risk over the issues of quality investments. Finally, junk bonds are most of the time issued by the institutions that finance the purchase deal-in which investors buy the company, and this produces new bonds, using business assets as collateral.

 

Explain the pricing spillover effect as well as define and discuss the spillover effect.

According to (Business Dictionary, 2010),  “Secondary effect which follows from a primary effect, and may be far removed from the event that caused the primary effect.”

Results from two laboratory studies show that spillover effects can occur in response to both positive and negative changes in either the price or quality of a product.  That is, the tendency for consumers to spend more on a shopping trip when something they were planning to buy is deeply discounted. Similarly, an unanticipated price increase, or a decrease in quality, on a planned purchase causes overall spending to go down.

 

Reference:

spillover effect. BusinessDictionary.com. Retrieved May 26, 2010, from BusinessDictionary.com website: http://www.businessdictionary.com/definition/spillover-effect.html

 

University of Chicago Press Journal (2006). Spillover effect: Why we end up spending more when we think we're saving. Retrieved May 26, 2010 from http://www.eurekalert.org/pub_releases/2006-11/uocp-sew110706.php

Solution Description

What is the major reason that subordinated debt is typically rated lower than senior debt?

There are several reasons why subordinated debt is rated lower than a senior debt but the major reason is that subordinated debt has a greater exposure to default risk.

Suppose that a firm wishes to maintain a capital structure that is consistent with an A senior debt rating. Under what circumstances would the firm maintain a lower degree of leverage than a cross section of single-A-rated firms?

There are several reasons why a firm migh choose a lower degree of leverage instead of a single A rated firm. Other factors that influence this kind of decision can be the proportion of intangible assets and the use of interest tax credits. When we think of leverage we need to understand that this is not the only thing that will contribute directly to the firm credit rating. There are other factors considering risk, etc. Some of these factors include the location of the firm, their income, how they manage,