Financial institutions in the U.S. economy

Suppose Raphael would like to use $10,000 of his savings to make a financial investment.

One way of making a financial investment is to purchase stock or bonds from a private company.

Suppose RoboTroid, a robotics firm, is selling stocks to raise money for a new lab—a practice known as (equity, debt) finance. Buying a share of RoboTroid stock would (an IOU, or promise to pay, from, or a claim to partial ownership in) the firm. In the event that RoboTroid runs into financial difficulty, (Raphael and the other stockholders will be paid first, or, the bondholders) will be paid first.

Suppose Raphael decides to buy 100 shares of RoboTroid stock.

Which of the following statements are correct? Check all that apply.

The Dow Jones Industrial Average is an example of a stock exchange where he can purchase RoboTroid stock.

Expectations of a recession that will reduce economywide corporate profits will likely cause the value of Raphael's shares to decline.

The price of his shares will rise if RoboTroid issues additional shares of stock.

Alternatively, Raphael could make a financial investment by purchasing bonds issued by the U.S. government.

Assuming that everything else is equal, a U.S. government bond that matures 10 years from now most likely pays a (higher, lower) interest rate than a U.S. government bond that matures 30 years from now.

Airbus sold an A400 aircraft to Delta Airlines, a U.S. company, and billed $30 million pay- able in six months. Airbus is concerned about the euro proceeds from international sales and would like to control exchange risk. The current spot exchange rate is $1.05/€ and the six-month forward exchange rate is $1.10/€. Airbus can buy a six-month put option on U.S. dollars with a strike price of €0.95/$ for a premium of €0.02 per U.S. dollar. Currently, six- month interest rate is 2.5 percent in the euro zone and 3.0 percent in the United States. a. Should a firm hedge? Why or why not? b. Compute the guaranteed euro proceeds from the American sale if Airbus decides to hedge using a forward contract. c. If Airbus decides to hedge using money market instruments, what action does Airbus need to take? What would be the guaranteed euro proceeds from the American sale in this case? d. If Airbus decides to hedge using put options on U.S. dollars, what would be the “expected” euro proceeds from the American sale? Assume that Airbus regards the current forward exchange rate as an unbiased predictor of the future spot exchange rate. e. At what future spot exchange do you think Airbus will be indifferent between the option and money market hedge?

Airbus sold an A400 aircraft to Delta Airlines, a U.S. company, and billed $30 million pay- able in six months. Airbus is concerned about the euro proceeds from international sales and would like to control exchange risk. The current spot exchange rate is $1.05/€ and the six-month forward exchange rate is $1.10/€. Airbus can buy a six-month put option on U.S. dollars with a strike price of €0.95/$ for a premium of €0.02 per U.S. dollar. Currently, six- month interest rate is 2.5 percent in the euro zone and 3.0 percent in the United States.

a. Should a firm hedge? Why or why not?

b. Compute the guaranteed euro proceeds from the American sale if Airbus decides to hedge using a forward contract.

c. If Airbus decides to hedge using money market instruments, what action does Airbus need to take? What would be the guaranteed euro proceeds from the American sale in this case?

d. If Airbus decides to hedge using put options on U.S. dollars, what would be the “expected” euro proceeds from the American sale? Assume that Airbus regards the current forward exchange rate as an unbiased predictor of the future spot exchange rate.

e. At what future spot exchange do you think Airbus will be indifferent between the option and money market hedge?

Ratchet Company uses budgets in controlling costs. The August 2020 budget report for the company’s Assembling Department is as follows. RATCHET COMPANY Budget Report Assembling Department For the Month Ended August 31, 2020 Difference Manufacturing Costs Budget Actual Favorable Unfavorable Neither Favorable nor Unfavorable Variable costs Direct materials $48,000 $47,000 $1,000 Favorable Direct labor 54,000 51,200 2,800 Favorable Indirect materials 24,000 24,200 200 Unfavorable Indirect labor 18,000 17,500 500 Favorable Utilities 15,000 14,900 100 Favorable Maintenance 12,000 12,400 400 Unfavorable Total variable 171,000 167,200 3,800 Favorable Fixed costs Rent 12,000 12,000 –0– Neither Favorable nor Unfavorable Supervision 17,000 17,000 –0– Neither Favorable nor Unfavorable Depreciation 6,000 6,000 –0– Neither Favorable nor Unfavorable Total fixed 35,000 35,000 –0– Neither Favorable nor Unfavorable Total costs $206,000 $202,200 $3,800 Favorable The monthly budget amounts in the report were based on an expected production of 60,000 units per month or 720,000 units per year. The Assembling Department manager is pleased with the report and expects a raise, or at least praise for a job well done. The company president, however, is unhappy with the results for August because only 58,000 units were produced. (a) State the total monthly budgeted cost formula. (Round cost per unit to 2 decimal places, e.g. 1.25.) The formula is $ + variable costs of $ per unit. (b) Prepare a budget report for August using flexible budget data. (List variable costs before fixed costs.) RATCHET COMPANY Assembling Department Flexible Budget Report For the Month Ended August 31, 2020 Difference Budget Actual Costs Favorable Unfavorable Neither Favorable nor Unfavorable $ $ $ $ $ $ In September, 64,000 units were produced. Prepare the budget report using flexible budget data, assuming (1) each variable cost was 10% higher than its actual cost in August, and (2) fixed costs were the same in September as in August. (List variable costs before fixed costs.) RATCHET COMPANY Assembling Department Flexible Budget Report For the Month Ended September 30, 2020 Difference Budget Actual Costs Favorable Unfavorable Neither Favorable nor Unfavorable $ $ $ $ $ $

Have you ever been a gig worker? A recent study found that 37 percent of U.S. workers participate in the gig economy, and government and other estimates say 40 percent will be working outside traditional full-time jobs by 2020. Clearly the gig economy is not a fad. The issue is often whether it benefits only the company or also the worker. Do people actually like being gig workers, or has the economy forced them into it, sometimes by taking second and third jobs?

A national survey by the Freelancers Union found that two in three of the 55 million U.S. workers who
freelanced in 2016 did so because they wanted to, not because they were forced to; the other one-third did it out of necessity.70 Although motivations for gig work may vary, it is clear that employers are benefitting. Of course, part-time contract workers are not new. What is new is the way gig work has spread to many white-collar professions. Here are two examples.

Joseph creates websites for a marketing company and a digital content studio. He also creates and edits motion graphics. “It’s been a fun ride, tiring but fun,” he says. “Finding time is always the struggle. I’m working on a freelance project every weekend.” Joseph thinks gig work has helped him improve his graphic skills faster than he might have done in a traditional job. “I get to move around to different companies, and if one thing falls out, I still have other things I can fall back on—and it keeps me sharp.”

Nicole, a mother of three, is a full-time clerk at a law firm, but she decided she needed extra money and signed up with a work-at-home call center. Her husband has joined too. Nicole says her gig job is one she could continue when she retires, and she likes that possibility.

“This is the future of work,” says Diane Mulcahy, a private equities investor whose clients often benefit
financially from the use of gig workers. “The full-time employee is getting to be the worker of last
resort.”

• Aside from the lack of benefits, what are the potentially negative effects for society of the gig
economy?
• What happens to the concept of loyalty between worker and employer if we move to a mostly gig
economy? Will that result be negative or positive? For whom, and why?

Q5: Application Question - Keeping Storm’s victims in mind

The dogs bark and the caravan moves on. The former Prime Minister Paul Keating’s aphorism about the transience of the public spotlight applies to the 3000 Australians who invested an estimated $3 billion through Storm Financial. These investors are now slipping from the public gaze as the caravan moves on.

There is little in the way of words that can explain the losses retirees who invested through Storm have faced since its collapse in late 2008. But a petition launched by Storm Financial investors addressed to the Prime Minister, Kevin Rudd, goes close to expressing the frustration of those who trusted in the Townsville financial planner.

After 17 months, a parliamentary inquiry and a settlement with the Commonwealth Bank, there are still plenty of reasons for Storm Financial’s investors to feel angry. They fell for a business model they trusted. Many say they relied on the fact Storm Financial held an Australian Financial Services Licence administered by the Australian Securities and Investments Commission.

The business model didn’t work, and the investors lost the lot. The Commonwealth Bank, to its great credit, has participated in a resolution scheme that nobody likes much but is better than nothing. Other banks — notably Bank of Queensland and Macquarie Group — have made no such public concessions about their treatment of Storm investors.

Sure, there are varying degrees in what went on. Those reasonably intelligent investors who thought they were on a rocket to the moon — well, really, what were they thinking? But those

elderly and unsophisticated investors who were mis-sold products (some were given official Storm documents that said their new debts were ‘Clayton’s debts’) have been given precious little assurance their post-collapse interests are being looked after.

Storm’s founder, Emmanuel Cassimatis, has himself likened his model of financial planning to that of a Big Mac or a Ford production line. The model didn’t care whether the client was rich, poor, mentally disabled or in the first stages of senile dementia — they all got the same rubbish.

Let there be no doubt, especially as Cassimatis uses this vacuum in any meaningful response by regulators to once again woo his former devotees, it really was rubbish: a house of cards waiting for the first serious downturn before it fell over.

Since the collapse, these investors have had nothing that could be classed as giving them comfort from ASIC. In March ASIC gamely said its investigation had moved from a ‘recovery options’ phase to a ‘commercial negotiations’ phase and ASIC set up — wait for it — a website.

On the plus side, there is a My Storm Investment back-end to the website, containing individual details for individual investors, that raises the hope ASIC is still on the case. Also on the plus side, ASIC grasped the nettle last year and took the unusual step of recommending to the parliamentary inquiry a policy position that all forms of commissions for financial planners should be banned.

However, the watchdog is perpetually constipated when it comes to explaining what it is actually doing in live investigations, fobbing off media and investor inquiries with various excuses and downplaying any emerging reportage.

(When its investigation into Storm raised media reports that ASIC chairman Tony D’Aloisio may be taking a personal interest in the matter, D’Aloisio promptly hosed the report down. You have got to wonder about how ASIC plays the public relations game when the boss uses the media to say he is not taking an unusual interest in a case that affected the livelihoods of 3000 Australians.)

ASIC is due to release a statement about its Storm investigation this month and it is to be hoped its work results in a better outcome than the comfortless position statements delivered so far.

Picture it for yourself. All your retirement savings gone, and no meaningful words from the corporate regulator about the course of the investigation more than 17 months after you lost the lot. The delay lengthens. A fickle media switches its gaze to more diverting topics.

No wonder Storm Financial investors are angry. No wonder they are signing the petition in droves. Source: Washington 2010.

3

Storm’s founder likened his model of financial planning to that of a Big Mac or a Ford production line. What do you think he meant by that? Why do you think the approach by Storm was not appropriate?

Why do you think that the collapse of Storm occurred in late 2008? Describe the economic circumstances of the time and their coincidence with Storm’s collapse.
(Background information: Storm advised clients to double gear in many cases. i.e. to borrow against their homes and invest in shares and then borrow again against the value of those shares. In many cases investors borrowed close to $1 million or more.)

What role does the writer ascribe to ASIC and why do you think he criticises ASIC’s actions?

Why do you think ASIC recommended to the parliamentary inquiry that all forms of commissions be banned? Do you think it would resolve the problem?

Salmone Company reported the following purchases and sales of its only product. Salmone uses a periodic inventory system. Determine the cost assigned to ending inventory using LIFO.

A manufacturer of fabricated metal products has acquired a new plasma table for $37,000. It is projected that the acquisition of this equipment will increase revenue by $10,000 per year. Operating costs for the machine will average $2,600 per year. The machine will be depreciated using the MACRS method, with a recovery period of 7 years. The company uses an after-tax MARR rate of 10% and has an effective tax rate of 30%.

What conclusion can be drawn by comparing the results of the before- and after-tax analyses?

Salmone Company reported the following purchases and sales of its only product. Salmone uses a periodic inventory system. Determine the cost assigned to the ending inventory using FIFO.