- Levered Free Cash Flow is the cash available to both debt and equity investors after operations, working capital investments and capital expenditures. T/F
False.
Levered Free Cash Flow not to both debt and equity investor. it is only to equity investor.
Unlevered FCF is to both debt and equity investors
- If a company is holding assets on its balance sheet in which the Book Value is substantially greater than the Market Value, this is generally a positive indicator of the company’s credit strength. T/F
False.
BV>MV: negative indicator of the company’s credit strength
- If a company raises some additional capital through an equity issuance, this should have a positive impact on the company’s credit strength and debt rating. T/F
True.
More equity is good, more debt is bad from rating prespative
- All other factors equal, when risk free interest rates are falling, investments in floating rate bonds will increase in value faster than investments in fixed rate bonds.T/F
False.
In the case risk free interest rates are falling, a floating rate bonds coupon will fall as it re-sets its coupon. On the other hand, a fixed rate bonds coupon will not fall and therefore is preferred in this scenario.
rf goes down, debt value goes up, but with floating rate, the interest is going down when rf goes down.
When do you want to own floating bond? only when interest rate goes up.
When interest rate are falling, Debt value goes up, you want to own fixed rate with extremly long duration
- All other factors equal, a high market interest rate environment will decrease a bond’s interest rate risk.T/F
True. have to know the following relationship
Maturity up, Duration up
Coupon up, Duration down
- You are interested in buying $1,000,000 (par value) of IBM bonds. When you call your bond trader at Merrill Lynch, she quotes you her bid/offer price of 100/102. If you decide to buy at the quoted price, you will pay the trader $1,020,000. T/F
True.
Next you need to ask yourself is if it is dirty price or clean price.
Clean price: pay accrual interest separately, the buyer will pay to seller the accrual.
Dirty price: no payment of accrual interest
e.g. (from notes ) i pmt is $50 at the end of the year. I buy the bond in the middle of the year, should I give $25 accrual i to the seller?
if it is yes, then the price is clean.
if not, then the price is dirty
market convention is U.S. is clean
- All other factors equal (e.g. property condition, location, etc.); commercial properties with under-market rents should sell at lower Cap Rates than properties with over-market rents. T/F
True.
Property Value = NOI/Cap rate
you want to buy under market rent, because when who renew, you will have more CF, then NOI goes up.
Part II. Multiple Choice Questions
Information for questions 8 to 10 is as follows (Show your work):
You are the chief commercial real estate loan officer at First Hawaiian Bank. A client of the bank is interested in purchasing a B grade office building in downtown and would like a loan. After analyzing the building, you have determined that the Net Operating Income is about $10 million per year. In addition, First Hawaiian has the following criteria for underwriting office building real estate loans.
Min. Debt-Service-Coverage 1.30 Max. Loan-to-Value 70% Loan interest rate for loan sizing 6.00% Loan Maturity (Yrs) 5 Amortization (Yrs) 20 Cap Rates for B grade Office Buildings: 7.00%
- Based on the criteria and information above, what is your estimate of the office building’s value (round to the nearest $1,000)?
NOI / Cap rate = 10 million / 7% =142,857,000
Answer: E none of the above
***these real estate questions will guarantee on the test. very similar:
will ask for valuation, loan sizing, and some other drivers related question
9. Based on the criteria and information above, what is the loan size First Hawaiian Bank would be comfortable making on a non-recourse loan on this office building (round to the nearest $1,000)? A) $50,000,000 B) $66,667,000 C) $89,475,000 D) $100,000,000 E) $46,667,000
1) Max. loan pmt = monthly NOI / Min. DSC
=10 m / 12/ 1.3 = 833,000 / 1.3 = 641,000
**set i/y = 12
N= 240
i =6%
FV = 0
Pmt = 641,000
Cpt PV = 89,475,000 (Loan since from min DSC )
2) LTV 70% * estimate P Value = 142,857,000 70% = 10 m
(loan size base on Max. LTV)
Leaser of 1) and 2)
Answer: C
10. If you made the loan to purchase the office building at the loan size determined in question 9 above with an interest rate of 4.00% fixed, a maturity of 20 years fully amortizing, what would be the loan’s actual DSC ratio? A) 1.28 B) 1.30 C) 1.40 D) 1.54 E) 1.63
Actual DSC = NOI monthly / Monthly loan pmt (mortgage)
Monthly loan pmt: set i/y =12
N=240, i/y =4%, PV = loan size = 89,475,000, FV=0,
Cpt pmt = 542,201
833,000/542,201 = 1.536
Answer D
11. Companies with relatively high financial leverage will have: A) Higher ROE B) Lower ROE C) More volatile ROE D) Higher ROA E) Steady ROA
Answer: C
it is not A. Because what if you loose money?
you want more leverage when the economic goes up
Company can issue more debt if it has stable earning and CF, and in low volatile industry (in defensive industry)
look at the company, look at the industry
- In a rising interest rate environment, debt investors should:
A) Lengthen duration of their portfolio
B) Shorten the duration of their portfolio
Answer: B i up, debt down longer the duration, the riskier Credit: spread i rate risk: duration
- If the credit risk spread on a corporate bond with a 5 year maturity and a fixed interest rate tightens (i.e. gets smaller) significantly and risk free interest rates go up, the price on the bond:
A. would go up.
B. would go down.
C. could go up or down depending on the relative size of the credit spread tightening and interest rate move upward.
D. would stay about the same.
Answer: C
PV = FV / (1+i)^n
i= rf + spread
we don’t know how much they went up and how much they went down
- A bond has a duration of 5 years. Interest rates in the market are 5% today. If interest rates rise to 6% over the next couple of weeks, how will this bond’s price change in percentage terms?
A) This bond’s price will rise by 1 percent.
B) This bond’s price will fall by 1 percent.
C) This bond’s price will fall by 4.76 percent
D) This bond’s price will rise by 4.76 percent
E) This bond’s price will not change
duration formula
c
i up, B down
- Based on S&P’s “Total debt /(Total debt + Equity)” ratio and the S&P Credit Analysis chart provided with the Formula Sheet, what would be Surf Corporation’s unsecured, senior debt rating?
Income Statement Balance Sheet
Year Ended 12/31/11 12/31/11
Sales $1,400,000
Cost of GoodsSold 700,000 CurrentAssets $100,000
OperatingExpenses 535,000 Net FixedAssets 400,000
Depreciation 65,000 Total Assets 500,000
EBIT 100,000
Interest Expense 30,000 Debt 270,000
EBT 70,000 Common Stock 130,000
Taxes 23,000 RetainedEarnings 100,000
Net Income $ 47,000 Total Liab & Equity $500,000
A) BB
B) BBB
C) A
D) AA
270 / 500 = .54 =54%
A
long answer question: need to look over the rating sheet
16. AAA Communications bonds mature in 5 years with a par value of $1,000. They pay a coupon rate of 6% with annual payments. After analyzing AAA's financials, you determine the appropriate credit spread for the company’s debt is 0.75%. In addition, you check Bloomberg and the yields on U.S. treasury bonds are currently as follows: 2 years = 3% 5 years = 4% 10 years = 5% Using the information above, what is your estimated value for this bond? A. $835.83 B. $986.53 C. $1,054.49 D. $1,010.60
* Set i/y =1 n=5, i/y=rf + spread = 4 + .75 =4.75 pmt = 60 fv=1000 Cpt PV =1054.49
C
will have one on valuation of bond
and one look at yield of bond
make sure how to do both
17. Based on the financial information given below, what approximate S&P debt rating would you give Aloha Restaurants from a Return on Average Capital perspective (select closest rating category)? A) B B) BB C) A D) AAA
See the paper one
EBT + back interest = 160 K + 100 K = 260 K EBIT
Average Capital= (total capital this year +total capital last year)/2 = (1001 +851)/2 = 926
260/926 = 28%
look at Return on capital: AAA
Answer: D
- Given the following financial statements for Punchbowl Resorts Corporation, what is the cash flow resulting from changes in working capital for 2011?
Income Statement Balance Sheet
Year Ended 12/31/11 12/31/11 12/31/10
Sales $1,600,000 CurrentAssets $40,000 $35,000
Cost of Goods Sold 900,000 (Gross Fixed Assets 900,000 750,000)
Operating Expenses 420,000 Net Fixed Assets $320,000 $300,000
Depreciation 130,000 Total Assets $360,000 $335,000
EBIT 150,000 Current Liabilities $25,000 $30,000
Interest Expense 40,000 Long-term Debt 260,000 230,000
EBT 110,000 Common Stock 5,000 5,000
Taxes 40,000 Retained Earnings 70,000 70,000
Net Income $ 70,000 Total Liab & Equity $360,000 $335,000
A) $10,000
B) ($10,000)
C) $0
D) $15,000
Current Assets 5 up = -5
Current Liabilities 5 down = -5
Total = -10
B
- What was the cash flow resulting from capital expenditures (Capex) in 2011?
(a) ($150,000)
(b) ($20,000)
(c) ($320,000)
cross Fixed Assets up 150 K = -150 K
- If you lengthen you’re A/P terms, FCF will:
(a) Increase
(b) Decrease
(c) Stay the same
A/P increase , means you borrowing more from suppliers, FCF increase
A
Cash Convention Cycle (CCC) = + AR days + Inv days - AP days -Acc exp days
21. You are a bank operations officer responsible for calculating the interest due on a 3-month LIBOR floating rate loan. Interest on the loan is due tomorrow on the loan’s most recent 3 month payment period and the details are as follows: Principal Amount: $100,000 3-month LIBOR setting: 1.00% Credit Spread: 2.00% Interest Day Count Convention: 30/360 How much interest is due? (a) $750 (b) $3,000 (c) $250 (d) $100,000
100,000 * (1% + 2% ) * 90/360 = 750 (notes is not 30/360)
Cash Convention Cycle (CCC) = + AR days + Inv days - AP days -Acc exp days
CCC= days sales outsanding (AR) + Days of sales in inventory - days of payables outstanding
In short: we want inflow shorter time, and prolong outflow time.
always want to Cash Convention Cycle lower.
We want to squeeze this cycle Bus -> Cash
Improve Free Cash Flow, Increase Asset Turnover and Reduce funding requirements by Shortening your Cash Conversion Cycle!
Duration
formula and relationship of them
(changing in P/P)= - D* [Changing in i/(1+i)]
When i decrease, price of bond increase
When i increase, price of bond decrease
Sovereign Risk and Ratings
country that has 40,000 per capita GDP has almost alway hight rating
while $500 GDP has extremely low rating. Why?
because with $500 GDP, the ability to tax is low, while $40,000 per capita GDP can generate lots of tax revenue. and that why US should have AAA rating
