Answers to Warm-Up Exercises

E2-1. Suppliers and demanders oI Iunds

Answer: ndividuals as a whole spend less than they consume. The excess is invested, making it
available Ior businesses. I individuals consume more, Iewer dollars will be available Ior
investment. This would reduce the amount oI money available Ior new projects and drive up
the required return (i.e., required return oI investors buy bonds). Over time, employment,
salaries, and gross domestic product would decline.
E2-3 Money market vs. capital market
Answer: Money markets are short-term markets, so Iirms using these would be in need oI Iunds Ior less
than a year. Perhaps the business needs to increase inventory Ior a season, such as RV dealerships
building inventory prior to the spring/summer sales period. mmediately aIter a large sale, a
business may need to Iinance the presence oI accounts receivable on their balance sheet. Capital
markets, by contrast, are typically used Ior Iixed assets, which a company will use over several
years.
L24 MorLgagebacked securlLles
Answer CuesLlons you would ask lnclude
a 8eal esLaLe locaLlon (afLer all Lhe Lhree mosL lmporLanL deLermlnanLs of real esLaLe prlce are
locaLlon locaLlon locaLlon")
b ercenLage of properLles ln Lhe reglon LhaL are under waLer" (homeowners owe more Lhan
Lhey borrowed) or ln foreclosure
c 1ype of real esLaLe (commerclal properLles offer less llquldlLy lf Lhe markeL Lurns sour
because empLy homes can be renLed for revenue)
d recedence ln bankrupLcy (would oLher lenders have a senlor clalm Lo properLles ln
bankrupLcy?)
e CuallLy of real esLaLe (ls lL ln good condlLlon or would Lhere need Lo be repalrs prlor Lo
sale?)
f CredlLworLhlness of borrowers (how llkely ls lL LhaL borrowers wlll lose Lhelr [ob and be
unable Lo make paymenLs on a Llmely basls?)
g WhaL percenLage of borrowers are behlnd on Lhelr morLgage paymenLs
h Wlll borrowers soon be experlenclng an lnLeresL raLe lncrease because Lhey Look ouL a
morLgage wlLh a low lnlLlal raLe LhaL was ad[usLable afLer a perlod of Llme

23 Marglnal corporaLe Lax raLes
P1-8. LG 6: Marginal corporate tax rates
,sic
a.
T, C,cu,9ion
Pre9,
Income

,se T,

L
Amoun9
over ,se

T,
M,rgin,
R,9e
15,000 0 (0.15 L 15,000) 2,250 15.0
60,000 7,500 (0.25 L 10,000) 10,000 25.0
90,000 13,750 (0.34 L 15,000) 18,850 34.0
200,000 22,250 (0.39 L 100,000) 61,250 39.0
400,000 113,900 (0.34 L 65,000) 136,000 34.0
1,000,000 113,900 (0.34 L 665,000) 340,000 34.0
20,000,000 6,416,667 (0.35 L 1,666,666) 700,000 35.0
b.

As income increases to 335,000, the marginal tax rate approaches and peaks at 39. For
income in excess oI 335,000, the marginal tax rate declines to 34, and aIter 10
million
the marginal rate increases slightly to 35.

2-5
. LG 6: nterest versus dividend expense
In9ermedi,9e
a. EBT 40,000
Less: nterest expense 10,000
Earnings beIore taxes 30,000
Less: Taxes (40) 12,000
Earnings aIter taxes
*
18,000
*
This is also earnings available to common stockholders.
b. EBT 40,000
Less: Taxes (40) 16,000
Earnings aIter taxes 24,000
Less: PreIerred dividends 10,000
Earnings available Ior
common stockholders 14,000