The UK and US governments’ responses to the 2008 financial crisis

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Question 1 (25 marks)
Derivative contracts can magnify the impact of underlying movements in asset values, creating large gains or extreme losses. Two types of derivatives have been implicated as being part of the reason for the 2008 financial crisis.
• a.Name the two derivatives in question and describe how, and why, their contracts originate. (6 marks)
• b.Conduct an internet search into the UK and US governments’ responses to the 2008 financial crisis and their attempts to prevent a similar crisis happening again.
o i.Name the UK and US acts that were brought into law in response to the crisis. (2 marks)
o ii.Outline the new regulatory authorities, and their responsibilities, that were brought into existence by the UK. (5 marks)
o iii.Describe what is meant by ‘ring-fencing’ retail banks and how this protects bank customers. (3 marks)
• c.Both put and call options can be traded on wheat futures. The current strike price of 3-month wheat is $204 for both options. The put option costs $5.10 per ton and the call option is $5.95 per ton.
o i.At the 3-month date, wheat is trading at $212.05. Which option would be exercised? Calculate the payoff and gain for the put option. What is the gain for the call option compared to the market price? (4 marks)
o ii.Calculate the payoff and gain for the put option and the gain/(loss) for the call option if the price of wheat at the 3-month date is $197.80. (2 marks)
o iii.At what prices would the two options be price neutral?

 

 

Question 2 (25 marks)
Read through the accompanying material regarding Johnson & Johnson’s Credo. This document was written in 1943 and is still believed to be operationally relevant for the business by the current board of directors.
Johnson & Johnson: Our Credo
The values that guide our decision-making are spelled out in Our Credo. Put simply, Our Credo challenges us to put the needs and well-being of the people we serve first.
Robert Wood Johnson, former chairman from 1932 to 1963 and a member of the Company’s founding family, crafted Our Credo himself in 1943, just before Johnson & Johnson became a publicly traded company. This was long before anyone ever heard the term “corporate social responsibility.” Our Credo is more than just a moral compass. We believe it’s a recipe for business success. The fact that Johnson & Johnson is one of only a handful of companies that have flourished through more than a century of change is proof of that.
Our Credo
We believe our first responsibility is to the patients, doctors and nurses, to mothers and fathers and all others who use our products and services. In meeting their needs everything we do must be of high quality. We must constantly strive to provide value, reduce our costs and maintain reasonable prices. Customers’ orders must be serviced promptly and accurately. Our business partners must have an opportunity to make a fair profit.
We are responsible to our employees who work with us throughout the world. We must provide an inclusive work environment where each person must be considered as an individual. We must respect their diversity and dignity and recognize their merit. They must have a sense of security, fulfilment and purpose in their jobs. Compensation must be fair and adequate and working conditions clean, orderly and safe. We must support the health and well-being of our employees and help them fulfil their family and other personal responsibilities. Employees must feel free to make suggestions and complaints. There must be equal opportunity for employment, development and advancement for those qualified. We must provide highly capable leaders and their actions must be just and ethical.
We are responsible to the communities in which we live and work and to the world community as well. We must help people be healthier by supporting better access and care in more places around the world. We must be good citizens — support good works and charities, better health and education, and bear our fair share of taxes. We must maintain in good order the property we are privileged to use, protecting the environment and natural resources.
Our final responsibility is to our stockholders. Business must make a sound profit. We must experiment with new ideas. Research must be carried on, innovative programs developed, investments made for the future and mistakes paid for. New equipment must be purchased, new facilities provided, and new products launched. Reserves must be created to provide for adverse times. When we operate according to these principles, the stockholders should realize a fair return.
Source: Johnson & Johnson (2020) Our Credo. Available at: www.jnj.com/credo/ (Accessed: 27 October 2020).
• a.
o i.Identify three responsibilities or activities discussed in the Credo where Johnson & Johnson address their corporate social responsibility, and detail how they affect the financial management goal of profit maximisation. Also, detail which stakeholder group(s) is(are) impacted and how. (6 marks)
o ii.Identify three responsibilities or activities discussed in the Credo where Johnson & Johnson address their corporate social responsibility and detail how they impact on the financial management goal of shareholder wealth maximisation. List which stakeholder group(s) is(are) affected and how, by the responsibility or activity identified, alongside the discussion of the impact. (6 marks)
o iii.Based on your answers to points (i) and (ii) above, discuss how the financial goals of profit maximisation and shareholder wealth maximisation are aligned regarding the responsibilities and activities outlined in the Credo. Does the time horizon of the financial goals have an impact? Are there instances you believe there is alignment – both positive and negative – and any instances when the impact is contrary? (6 marks)
• b.When considering groups that a company has corporate social responsibility towards, a common list of stakeholders for a commercial organisation includes (listed alphabetically):
o customers
o employees
o government
o investors
o local community
o regulators
o suppliers.
Imagine you are the finance director of a large UK Company. When considering the stakeholders listed, identify three groups that can attempt to influence your board of director’s corporate social responsibility activities to align them with their own interests, and explain how they could achieve this. (6 marks)

Citing and referencing (1 mark).
Your answer to this question should be no more than 600 words.

 

 

 

 

 

Question 3 (25 marks)
The information below is available about a 15-year fixed coupon bond issued by Pure Air Plc and the market.
Face value £100
Current market price £120
Annual coupon rate 4%
Prevailing interest rate 3%
• a.
o i.Compute the semi-annual coupons for this bond. (2 marks)
o ii.Given the information above, is the price of the bond likely to increase or decrease in the future? Justify your answer and also calculate the new price. (5 marks)
o iii.Emma is one of the major bondholders of Pure Air Plc, owning 45% of the total bonds issued by the company. She is disappointed at the corporate bonds’ performance over the last few years and is planning to make her voice heard during the next round of voting. Do you think she will be able to do this? How? Justify your answer. (3 marks)
• b.Explain the concept of time value of money. (6 marks)
• c.Imagine you have currently invested £100,000 in a savings account. If the interest rate is expected to be 1% next year, 2% in the year afterwards and 3% in the third year, what will your investment be worth at the end of three years? (4 marks)
• d.You have been offered: (i) £70,000 in six years’ time from now; or (ii) £60,000 today. The current interest rate is 3%. Which option will you choose? Briefly justify your answer and show all your workings. (4 marks)
Citing and referencing (1 mark).
Your answer to this question should be no more than 350 words.

 

 

 

Question 5 (25 marks)
• a.When using the Gordon growth formula, assuming that RE > g, describe, in general terms, what happens as g gets closer to RE. Examine, and give examples of, what happens to P0 as g becomes very close to RE. (4 marks)
• b.If RE = g or RE < g, what are the results of using the Gordon growth formula? Discuss in detail an approach that could be adopted, if you still want to use a dividend discount model. (8 marks)
• c.What other situation can cause problems with using the Gordon growth formula? What does this mean for the valuation of companies that are in this situation? Outline any approaches that might assist you in the valuation of these companies. (5 marks)
• d.You own shares in Mistral Turbines Plc who have paid dividends since 2013. The annual dividends have been rising annually from £1.05 in 2013 to £1.80 in 2020. The company’s beta was 1.2.
The UK 10 Year Bond rate in 2020 was 0.25% and the market risk premium was assumed to be 4%.
The company has announced that, in order to enable a faster business growth, they will be retaining more profit in future years and, therefore, will be reducing the dividend rate by 1% per annum over the next five years starting in 2021. At the end of year 5 they expect to maintain that dividend rate in perpetuity.
o i.What is the historical growth rate of Mistral Turbines Plc to 2 decimal points? (2 marks)
o ii.Derive the current cost of equity for the company to 2 decimal points. (1 mark)
o iii.Calculate the fundamental value of Mistral Turbines Plc. (4 marks)
Citing and referencing (1 mark).
Your answer to this question should be no more than 400 word

 

 

 

 

 

Sample Solution

Would it be advisable for us to be permitted to take our very own lives? In numerous societies antiquated and not all that old suicide has been viewed as the best alternative in specific conditions. Cato the Younger submitted suicide instead of live under Caesar. For the Stoics there was nothing essentially corrupt in suicide, which could be normal and the best choice (Long 1986, 206). On the other hand, in the Christian convention, suicide has to a great extent been viewed as unethical, resisting the desire of God, being socially unsafe and restricted to nature (Edwards 2000). This view, to pursue Hume, overlooks the way that by dint suicide being conceivable it isn’t against nature or God (Hume 1986). By the by, being permitted to take our very own lives encroaches on the morals of open strategy in an assortment of ways. Here we will quickly look at the instance of doctor helped suicide (PAS) where a person’s desire to pass on might be supported by the activity of another. Hume viewed suicide as ‘free from each attribution of blame or reprimand’ (Hume 1986, 20) and in reality suicide has not been a wrongdoing in the UK since 1961 (Martin 1997, 451). Helping, abetting, guiding or securing a suicide is anyway a unique statutory wrongdoing, albeit couple of indictments are brought. As of late the issue of PAS has realized the discussion ‘whether and under what conditions people ought to have the capacity to decide the time and way of their demises, and whether they ought to have the capacity to enroll the assistance of doctors’ (Steinbock 2005, 235). The British Medical Association restricts willful extermination (leniency slaughtering) yet acknowledges both legitimately and morally that patients can reject life-drawing out treatment – this that they can submit suicide (BMA 1998). Neglecting to forestall suicide does not establish abetting (Martin 1997, 451) despite the fact that PAS ‘is the same in law to some other individual helping another to submit suicide’ (BMA 1998). In Oregon, be that as it may, PAS, limited to capable people who ask for it, has been authorized (Steinbock 2005, 235, 238). A qualification ought to be kept up among suicide and (leniency) slaughtering, acts in which the specialists vary, however obviously precisely where the line ought to be drawn is a piece of the issue. The moral contentions in help of PAS include enduring and independence (Steinbock 2005, 235-6). The principal affirmation is that is merciless to draw out the life of a patient who is in torment that can’t be medicinally controlled; the second, in the expressions of Dr Linda Ganzini dependent on her investigation in Oregon, includes the possibility that ‘being in charge and not subject to other individuals is the most essential thing for them in their diminishing days’ (cited in Steinbock 2005, 235). The coherent result of these contentions is that, if PAS can be supported on the grounds of torment or self-governance, for what reason would it be a good idea for it to be limited to skillful people or the critically ill? Surely the judge in Compassion in passing on v State of Washington (1995) expressed that ‘if at the core of the freedom secured by the Fourteenth Amendment is this uncurtailable capacity to accept and follow up on one’s most profound convictions about existence, the privilege to suicide and the privilege to help with suicide are the right of no less than each rational grown-up. The endeavor to limit such rights to the critically ill is deceptive’ (Steinbock 2005, 236). As noted above, religious dissatisfaction with suicide has turned out to be less pertinent an as referee of morals and approach. In fair social orders that may best be depicted as mainstream with a Christian legacy, the perspectives of religious gatherings ought not confine the freedom of people in the public arena (Steinbock 2005, 236). Others contend that the job of the doctor is to mend and help and not to hurt, however supporters of PAS would state that passing isn’t constantly destructive and helped suicide is an assistance. Undoubtedly, in a nation where PAS isn’t lawful individuals who wish to bite the dust without condemning the individuals who aid their suicide might be driven abroad, as on account of Reginald Crew who was kicking the bucket of engine neurone sickness and made a trip to Switzerland for AS, biting the dust in January 2002 (English et al. 2003, 119). This may cause more damage through the worries of disengagement and stress than enabling the PAS to happen. The two most genuine concerns are that PAS would be mishandled and would prompt negative changes in the public arena. This could occur from numerous points of view through defenseless gatherings, for example, poor people, the elderly and so on, being constrained into picking PAS (Steinbock 2005, 237). The BMA underscores a worry for the message that would be given to society about the estimation of specific gatherings of individuals (BMA 1998). This is a piece of a more extensive concern additionally communicated in a Canadian Senate enquiry of 1995 (BMA 1998) which focuses to a strategy of suicide anticipation among some defenseless gatherings that would be rendered odd by looking to ease suicide among the debilitated. Notwithstanding, the introduction is somewhat deceitful, since there is a distinction in the explanation behind potential suicide that must be examined. For instance, looking to counteract suicide among the adolescent may include projects of social consideration or expanding life prospects, and this style of arrangement isn’t appropriate on account of the individuals who may look for PAS. In Oregon in any event, it appears that feelings of dread about PAS have not emerged, and one specialist presumes that the generally low utilization of PAS is characteristic of it being excessively prohibitive (Steinbock 2005, 238). Clients of PAS, as opposed to being poor people and socially defenseless as anticipated, would in general be working class and taught, with more youthful patients bound to pick it than the elderly, and most were selected in hospice care. Issues about PAS and killing should be cleared up and contended independently. With regards to this issue at any rate, the topic of whether suicide ought to be permitted is the wrong one to inquire. A beginning stage is to ask how skilled people can be permitted to satisfy their desires as to life and demise issues without imperiling other individuals, regardless of whether specialists or friends and family and whether widely inclusive enactment is possible.

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