Eksamensoppgaver

Question 1

l) Given your knowledge of the international oil and gas market, would you as a
shareholder prefer the company to use more debt? Why / why not?

Answer 1

Substituting debt for equity has at least two benefits for owners, viz.
- saving taxes (equity is taxed twice, while debt is taxed only once), and
- disciplining management (avoiding negative NPV investments for a firm with “fat”
cash flows).
Using too much debt, on the other hand, may create bankruptcy costs, both direct costs
(PDLGD) but in particular indirect costs (stakeholder costs and underinvestment costs
connected with possible debt overhang).
The amount of debt must therefore be set in light of the expected level and stability of
future cash flows, and future investment opportunities.
- The oil & gas industry is mature, normally having a “fat” and relatively stable cash flow.
- Have few profitable growth opportunities. The companies’ exploration activities are
mainly directed towards replenishing existing reserves, rather than hoping to find and
develop additional net reserves.
- The industry’s “end-game” is characterized by consolidation (the bigger players buying
smaller players) and restructuring (buying/selling geographically dispersed assets, and
downstream activities, viz. refinery capacity and retail outlets).
These characteristics apply a fortiori for the largest and most profitable player, Exxon Mobil.
Although management are generally viewed as stock holder friendly, the company may be
tempted to make (too) expensive acquisitions of other oil firms, or invest in other industries
(as they did earlier, when buying US Steel).
Thus, an owner would probably like to see a gearing up of the company.

Question 2

What is credit migration?

Answer 2

Definition(s) for CREDIT MIGRATION:

1. ) refers to upgrading or worsening in a credit’s ranking and credit grade over time. Credit Migration Risk is the risk that a portfolio’s credit quality will materially deteriorate over time without allowing a repricing of the constituent loans to compensate the creditor for the now higher default risk being undertaken. Example of credit migration risk in Student Loan Portfolios: When prepayment penalties are not imposed, a long-dated student loan portfolio is exposed to the risk of retaining a greater proportion of poor credits as time unfolds than was anticipated at origination. And because spreads are inflexible after origination, the creditor may no longer be fairly compensated for default risk.

redit Rating Transition is the migration of a debt instrument from one rating to another rating over a period of time. This migration is either an upgrade or a downgrade from an existing rating. This movement indicates the change in the credit quality of the instrument assessed by the rating agency. The International Rating Agencies such as S&Ps, Moody’s, and Fitch assess the credit quality of all the debt instrument in their portfolio and assign a rating to the credit quality. This rating changes as and when new information is available about the obligor’s financial health.

Question 3

You have (hopefully) found that the multiplier is low.
c) How do you think the Norwegian banks nevertheless are able to routinely offer their
customers similar products with the multiplier 100%?

Answer 3

Increase excess amount relative to the call premium:

• increase horizon T (excess amount incr. prop. to T, while C incr. prop to T)
• foreign index w/lower national interest level (lower F & cheaper call)
• price index w.o. dividends (lower F & cheaper call)
• basket index (diversification  lower  & cheaper call)
• asian tail calculation (lower  & cheaper call)

Question 4

e) In light of this information and the results of your analysis above, how do you assess
the company’s dividend policy and capital structure? (preferably draw on your reviews
of question 1.b above)

Answer 4

25 % nto gjeld I forhold til syss.kap (11 % rel. Enterprise Value)
- Noe høyere enn snitt for Oslo Børs (15 %)
20 % kontantutdeling i forhold til forjeneste + omtrent det samme i tilbakekjøp
- Lavt kontantutbytte men sum kontant og tilbakekjøp er som normalt for OB
- Svært lønnsomt
- Relativt sterk vekst, men dyr vekst (kjøp)
- Høy konjunkturell risiko men dominerende markedsposisjon
- Disiplinert ledelse (aksjer og opsjoner)

Question 5

Why a negative market reaction to SEO’s (or SPO’s)?

What determines the size of the price drop?

What can the firm do to reduce the cost of this negative market reaction?

Answer 5

Why a negative market reaction to SEO’s (or SPO’s)?
- Investors are worried that firms may issue equity when management thinks the shares are
overvalued (while issuing debt when they are undervalued)
- Investors will thus bid down the price of the issuer’s stock as soon as they learn of the firm’s
intention to issue stock.
- The negative price reaction is not a result of “dilution” (more shares outstanding),
but simply a result of perceived negative information implied by the firm’s announcement.

What determines the size of the price drop?

• Probability that the security is seriously overvalued (price volatility)
• Degree of information asymmetry
• Firm’s perceived incentive to take advantage of superior information
• Cost of foregoing investment for undervalued firm

What can the firm do to reduce the cost of this negative market reaction?
- Use a reputable investment banker to add credibility.
- Improve communication: convince investors that the stock, in fact, is not overpriced.
9 / 9
- Issue equity following earnings releases.
- Use a private placement.
- Use a rights issue (if current shareholders are believed to subscribe to the issue).