Debt Level

we combine components we have explored during the last several weeks: Stocks, Bonds and Risk.  The focus of this week is how a firm structures its financing (debt, equity, retained earnings). A firm has to trade-off return, risk, and the timing of inflows and outflows.  Let’s see how much you have learned….   Individual Discussion Instructions  Check out the list of statements below. Each individual can choose one statement to discuss- each may be chosen by only two students within each group Please provide an explanation of the reasoning of the statement- 1-2 sentences Now, using what you know about return, risk, and timing, unpack the statement.  Provide a discussion – why are they incorrect or incomplete?   (hints are provided below each statement) – 1-2 sentence. Example:  Statement: “Derivatives are financial weapons of mass destruction” a view of Warren Buffet This is an opinion that is motivated by large financial losses that derivatives can cause for investors and firms. For example, Amaranth Advisors used natural gas derivative contracts to speculate on nat-gas leading to large losses for their investors and disruption of the nat-gas market. However, derivative contracts can also be used for cash flow smoothing and price stability (example: Cotton futures). This allows hedgers to increase cash flow stability.  Both speculators and hedgers participate in both sides of the contracts to provide a liquid well-functioning market. Berkshire Hathaway utilizes Derivative Contracts in its investment strategies. In conclusion, they can be dangerous when used incorrectly or with malicious intent, and can also be helpful for the agricultural, energy, and financial economic participants List of Statements- paste into group wiki page and each student chooses one to discuss It is better to use a shorter mortgage term than a longer mortgage term to save on interest Hint: What are the benefits of a longer mortgage? It is best to pay for a house in cash because borrowing is expensive Hint: What else can a firm do with cash Firms should not hold so much debt Hint: why might a firm use debt rather than other types of financing The firm went bankrupt due to a decrease in revenue Hint:  what other factors have to be true for this to be the case?  Think about variables on the Income Statement The covid-19 pandemic caused the firm to go bankrupt Hint: the pandemic is just the situation, what other factors have to be true for this to be the case The firm was carrying too much debt, which led to bankruptcy Hint: Does a bankruptcy occur because of the debt level?  Connect the dots here The firm has a large number of assets and is large, making it a very profitable successful firm Hint: how are assets and income related?

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