Questions and Answers
What is operating leverage?
Ability to use fixed operating costs to magnify the effects of changes in sales on earnings
What is financial leverage?
Degree to which a company uses fixed-income securities like debt and preferred equity
What is the main purpose of conducting break-even analysis?
To find the volume at which a business unit covers all fixed costs
What does a high degree of operating leverage indicate about a business?
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How is the sensitivity of earnings to changes in sales defined?
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In cost-volume-profit analysis, what volume must a unit operate at to recover all its fixed costs?
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Which type of financial leverage increases as a company uses more debt financing?
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What happens to earnings after the breakeven point for a leveraged firm?
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What is a key advantage for investors when investing in Eurodollar bonds compared to registered Yankee bonds?
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What type of bonds typically pay coupon interest annually and are considered the major international bond type?
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In the context of multicurrency bonds, what does FRN stand for?
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Which type of bond allows investors to exchange the bond for a predetermined number of equity shares of the issuer?
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What is the floor value of convertible bonds typically based on?
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Which type of bond usually sells at a premium above its straight debt value and conversion value?
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In the context of multicurrency bonds, what is the common reference rate used for indexing coupon payments on Floating Rate Notes?
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What term is used for designated maturity date at which the principal of a bond issue is promised to be repaid?
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Which type of bond structure has fixed coupon payments that are some percentage rates of the face value paid as interest to the bond holder?
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In multicurrency bonds, what feature makes investors willing to accept a lower coupon rate compared to straight fixed coupon bond rate?
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Study Notes
Break-Even Analysis
- Break-even analysis is used to determine how the volume of operations affects costs and profits.
- It helps determine the volume at which a business unit must operate to recover fixed costs and start making money.
- A break-even chart is used to visualize the relationship between costs, revenues, and profits.
Break-Even Point
- The break-even point is the point at which total revenue equals total costs.
- It is the point at which a business can recover its fixed costs and start making a profit.
Financial Leverage
- Financial leverage represents the relationship between earnings before interest and taxes (EBIT) and earnings available to equity shareholders.
- It is the degree to which a company uses fixed-income securities such as debt and preferred equity.
- A high degree of financial leverage means high interest payments, negatively affecting earnings per share.
Operating Leverage
- Operating leverage is a business entity's ability to use fixed operating costs to magnify the effects of changes in sales on earnings.
- It is the degree to which a company's earnings respond to changes in sales.
- A high operating leverage means high fixed costs and requires high business volumes.
Degree of Operating Leverage (DOL)
- DOL is the percentage change in operating income resulting from a percentage change in units sold.
- It measures the sensitivity of earnings to changes in sales.
Types of Bonds
- Straight Fixed Rate Bonds: fixed coupon payments, fixed maturity date, and face value repayment.
- Zero-Coupon Bonds: sold at a discount, no coupon payments, and face value repayment at maturity.
- Stripped Bonds: zero-coupon bonds resulting from stripping coupon and principal from coupon bonds.
- Dual Currency Bonds: fixed-rate bond issued in one currency and repaid in another currency.
International Bond Issuance
- Eurobonds are issued by borrowers to raise funds from the investing public.
- Lead managers and underwriting syndicates negotiate terms, ascertain market conditions, and manage bond issuance.
- Underwriters commit their own capital to buy the issue from the borrower at a discount.
Characteristics of Foreign Bonds
- Issued by a foreign entity (government, municipality, or corporation).
- Traded on a foreign market.
- Denominated in a foreign currency.
- Subject to currency risk.
Other Bond Types
- Floating Rate Notes (FRN): medium-term bonds with coupon payments indexed to a reference rate.
- Convertible Bonds: allow investors to exchange the bond for a predetermined number of equity shares.
- Eurodollar Bonds: straight fixed-rate bonds denominated in dollars, traded on foreign markets.
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