Financial Intitution and Market

Introduction:
This Case study is about Carson Company who wants to increase their production
about 50 percent over next few years to satisfy demand for financing to expand
and accommodate increase in production. Recall that yield curve is upward
slopping and a possible slowdown in the economy because of potential fed action
to reduce inflation. This Company needs funding to cover payment of supplier and
also considering issuing stock and bonds to raise their fund in the next year.
Question and Answer
Question (a):
Assume that Carson Company has two choices to satisfy the increased demand
for its products. It could increase production by 10 percent with existing facilities
by obtaining short-term financing to cover the extra production expense and then
using a portion of the revenue received to finance this level of production in the
future. Alternatively, it could issue bond and use the proceeds to buy facility that
would allow for 50 percent more capacity. Which alternative should Carson
select?
Short-Term finance: Short term is a concept that refers to holding an asset for a
year or less.
Long-term Finance: Long term is a concept that refers to holding an asset for more
than a year.
Bond: Bond is a long term debt instrument representing the issuer contractual
obligation. It is a fixed income security where the interest payment and principle re
payment are fixed.
Answer:
Carson should go with 1st choice. Because it should not use the proceeds to buy
large facility until it is confident that full utilization of the space can be done. Thus
it should obtain short-term financing to cover extra production expense then use
a portion of the revenue received to finance this level of production in the future.
Question (b):
Carson currently has large amount of debt, and the asset has already been pledged
to back up its existing. It does not have additional collateral. At this time the credit
risk premium it would pay similar in the short term and long term debt markets.
Does this imply that the cost of financing is the same in both markets?
Pledge: A thing is given as security for the fulfillment of a contract or payment of

a debt and is liable to be forfeiture in the event of failure.
Answer:
This can avoid Long term debt for now. But if demand does not increase as it
anticipated the short term debt can be use when matured.
Question (c):
Should Carson consider using a call provision if it issue bond? Why? Why might
Carson decide not to include a call provision on bond?
Call provision: Call provision is the provision or option that makes the bond
callable or grant right to issuer the right to buy or sell prior to the maturity date.
Answer:
Yes, Carson Company should use a call provision if it issue bond Carson should
mature the bond before its maturity in order to reduce its debt or have lower
interest rate or in order to refinance the lowest rate. But Carson could have to
higher yield in order to compensate the bond holder if it include call provision on
the bond.
Question (d):
If Carson Issue bonds, it would be relatively small bond offering. Should Carson
consider a private placement of bonds? What type of investor might be interested
in participating in a private placement? Do you think Carson could offer the same
yield on a private placement as it could on a public placement? Explain
Answer:
Carson can consider a private placement of bond because it can reduce its
transactional cost. Investor like pension fund or an insurance company might be
interested in participating in a private placement.
No, Carson cannot offer the same yield on a private placement because as the
investor would need to take the lack of secondary market for the bond thus Carson
would have to pay a little higher yield on private placed bond in order to cover the
liquidity for their bond.
Question (e):
Financial Company such as insurance companies and pension funds commonly

purchase bonds. Explain the flow of funds that runs through these financial
institutions and ultimately reaches corporations that issue bond such as carson
company.
Insurance Company: Insurance Company provides individual and firm

insurance policies that reduce financial burden associated with death, illness and
damage to property. This Company charges premium in exchange for the insurance
that they provide.
Pension fund: Many Corporation and Government agencies offer pension plans
to their employee. The employer and employee periodically contribute funds to the
plan. Pension fund provide an efficient way for individual to save for their
retirement. The money that is contributed to individual retirement account is
commonly invested by the pension fund in stock or bonds issued by corporation or
in bond issued by Government.
Answer:
Financial Institution such as insurance company accommodates their fund from

their insurance policy holder who pays premium for the insurance policy. These
funds are utilized by the company until they are claimed by the policy holder and a
portion of these funds is used to purchase bonds.
In case of pension fund the company utilizes the pension funds to purchase bonds
until the money is claimed by the employee after retirement.

Financial Intitution and Market

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Financial Intitution and Market

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Introduction:

Question and Answer

Pledge: A thing is given as security for the fulfillment of a contract or payment of

Financial Company such as insurance companies and pension funds commonly

Insurance Company: Insurance Company provides individual and firm

Financial Institution such as insurance company accommodates their fund from

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