Wider Economy Flashcards
If a client had a lot of excess cash and could not reinvest in the business, how would you advise them?
First, you must define what you think is significant excess cash. For companies that are in cyclical industries, paying out large amounts of cash might leave the company unprepared for a subsequent market downturn. Once you have established that your client does indeed have excess cash on the books, there are a few tried and tested uses for excess cash.
1) Invest in positive net present value (NPV) projects (acquisitions, CapEx, R&D)
2) Return money to shareholders in the form of share repurchases, dividends, and debt repayments
NOTE: Must take into account Kd, Ke, WACC, and tax considerations
What is your market outlook/macro trends from the past two years? What do you think will impact M&A activity this year?
Past two years = the highest interest rate increases in over 20 years meant no one knew what their cost of financing would be
10 year Treasury yield
2 year ago = 1.8%
1 year ago = 3.6%
6 months ago = 4.0%
Today 12/22 = 3.9%
How does the Federal Reserve change interest rates? What is the fed funds rate today?
The FED can adjust the Federal Funds Rate which is the interbank overnight rate at which the FED lends money. The lower the Federal Funds Rate, the lower real interest rates. The FED can also adjust the money supply through the purchase or sale of government bonds, whereby affecting inflationary expectations which will adjust nominal interest rates.
Benchmark federal funds rate
12/22 5.25-5.5
What is the federal funds rate?
The rate at which banks lend to one another that is set by the Federal Reserve.
What does the federal funds rate mean to investors and why do they care about it?
Investors care about the cost of capital and the cost of capital increases when the federal funds rate increases (risk free rate increases). This would diminish expected returns.
What does “RMT” stand for? What is it and how does it work? What’s an example?
Reverse Morris Trust. It is generally a tax free transaction, where one party ends up owning 49.9% of the business and the other party owns 50.1% of the business, with one of the parties paying a dividend to the other in order to make up for the difference in ownership. One famous example of this was DowDuPont. While the companies were together, there was a lot of asset transfers and it ended up breaking up into 3 separate companies (Dow, DuPont and Corteva, its agriculture arm).
What is an inverted yield curve? What does it mean?
An inverted yield curve shows that long-term interest rates are less than short-term interest rates. With an inverted yield curve, the yield decreases the farther away the maturity date is. Sometimes referred to as a negative yield curve, the inverted curve has proven in the past to be a reliable indicator of a recession.
SOFR vs LIBOR interest rate index? Why do we use them?
SOFR, transitioned from LIBOR
SOFR = Secured Overnight Financing Rate
LIBOR = London Interbank Offered Rate
indexed rate is an interest rate that is tied to a specific benchmark with rate changes based on the movement of the benchmark.
While LIBOR was unsecured and based upon quotations provided by a group of banks, SOFR uses U.S. Treasury bonds for collateral and is data-derived. It is based upon the overnight general collateral Treasury repo rate, reflecting the financing cost for Treasury securities
What are the Levered Beta ranges for Industrials companies?
From Aswath Damodaran’s website from January 2023
Auto 1.54 = 1.5
A&D 1.41 = 1.4
Steel 1.34 = 1.3
Building Materials 1.28 = 1.3
Construction 1.2 = 1.2
Transportation 1.06 = 1
