Question

You should make original posts discussing any three of the following statements. You are also required to post at least three responses to other student’s posts. Please note that this is a minimum requirement. Your grade will be a function of your effort. Please answer any three question. Thank you

1. If you were able to put together a portfolio that completely eliminated all risk, what return would you expect to earn and why?

2. If someone called you and told you that he/she could guarantee you high returns on your investments with little or no risk, what would you do and why.

3. When there is uncertainty in the marketplace, what happens to yield spreads and why?

4. Your grandfather has great faith in bonds and has heard about some “high yield bonds” that are available. He has asked you for your opinion. What advice will you give him?

5. Why do venture capital companies often choose preferred stock for their equity position?

6. Explain how supply and demand influences the price of common stock.

7. A company has a vacant building on its property that is completely depreciated and it proposes to use it for an expansion project. What cost if any, should it use for that building?

8. How does the use of accelerated depreciation encourage investment?

Answer 1

5. Why do venture capital companies often choose preferred stock for their equity position?

First understand preferred stock is a stock in which holder have preferential rights to receive fixed dividend and proceeds of liquidation over that of ordinary share/common stock.

Most Venture capital companies often choose preferred stock for their equity position as it gives VCs special preferences and protections.

1. The preferred stock is entitled to receive a specified amount of the proceeds from liquidation before the common stockholders receive anything. This liquidation proceeds often exceeds size of initial investment.
2. Preferred stockholders are entitled to receive fixed dividend payments before common stockholders receive any dividend payments.
3. VCs favor preferred because they tend to take an active role in the control and management of their portfolio companies, and American corporate law does not generally allow bondholders to take such a role.
4. Venture capital in US typically receives convertible preferred stock. It means preferred stock may be converted into common stock at some point.
5. If VCs were to invest in the company through common stock, the IRS would have a benchmark for valuation that is the amount paid by the VCs. On the other hand, preferred stock does not provide such a benchmark for valuing the common stock because it consists of a different bundle of rights.
6. Preferred stock allows startups to reduce the effective tax burden on employees, and thus the pretax cost of compensation for the firm.

6. Explain how supply and demand influences the price of common stock.

The law of supply and demand influences the price of common shares and, therefore, the stock market. The main factors influencing the demand for equities are the economic condition, the interest rates, the industry / sector situation and corporate results.

1) If the economy performing better than expected, it creates a greater demand for stocks that anticipate the better earnings.

2) Increase in interest rates tends to reduce demand for shares as the risk-free rate increases. Of course, rates tend to increase when the economy is improving, which increases demand for stocks, so these forces moderate each other.

 3) The profits, revenues, margins and prospects of the companies have a big impact on the demand for individual shares, which generates volatility in the price of the individual shares before and after the companies publish their results for the quarter or year

4) If a particular industry or sector such as telecommunication sector, automobile sector, FMCG etc. performing good it creates positive impact in investors mind which results in demand of stocks of that particular industry.

While the demand for shares is based on market dynamics, economic conditions, changes in central bank policy and corporate results, the supply of shares also impact share prices.

1) Companies can reduce the supply of shares through stock repurchases. This is when companies buy their shares at market prices and decrease the amount of existing shares in general. This leads to higher prices until demand decreases. 

2) Some actions performed by companies in which the stock price may decrease include initial public offers or issues of new shares. Whenever a new company gets listed on stock exchange, the number of companies shares increases.

3) Companies with financial or capital-related difficulties may issue more shares. This leads to a fall in share prices as the general supply of shares increases.

8. How does the use of accelerated depreciation encourage investment?

Companies in many countries pay tax on profits (revenue less expenses). There are different types of expenses, including salaries paid to workers, cost of goods sold, interest and amortization/depreciation.

In both financial accounting and tax accounting, companies cannot claim the total cost of fixed assets as an immediate expense. They must amortize the cost of the asset over a period, generally an approximation of the useful life of the asset.

Accelerated depreciation is a depreciation method by which a company, for the purposes of "financial accounting" or taxes, depreciates an asset so that the amount of depreciation taken each year is greater during the initial years of life. A higher amount of depreciation that is shown in the income statement in initial years leads to a reduction in profits and, therefore, to a reduction in taxes.

In general, governments offer the opportunity to use the accelerated depreciation method when there are specific policy reasons to encourage an industry, as lower tax collection encourages investment. Example, accelerated depreciation is used by government in some countries to encourage investment in renewable energy sector. Also, governments have increased accelerated depreciation methods in times of economic stress.