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Letter of TransmittalDr. Dilip Kumar Sen

Professor School of Business

Independent University Bangladesh (IUB)

Subject: Submission of Financial Management report.

Dear Sir,

With due respect, I would like to inform you that I have completed the Financial Management

report on “Rapidly Rising Corporate Debt: Are Firms Now Vulnerable to an Economic

Slowdown”.It is immense pleasure for me because I have successfully completed this report by

receiving your continues guideline as a supervisor.

I have endeavoured to prepare this report from my level of best to accumulate relevant &

insightful information. If I am included any wrong information in unconsciously so please

forgive me as your student. It is a great experience for me to make this report. I have tried to

make the report comprehensively within the schedule time & limited recourse.

I make to ensure you that if you have any query about any matter collecting information

regarding this report so please ask me and I will best try to answer you.

You’re Sincerely

Mohammad Abdul Ahad Bin Seraj

ID: 1330036

MBA Department.

Independent University Bangladesh (IUB)

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Executive Summary

Financial management is an exciting, challenging, planning directing, monitoring, organizing,

controlling and ever-changing discipline. Changing technology and increased globalization are

dramatically transforming financial practices and markets. Financial management is concerned

with the acquisition, financing and management of assets with some overall goal in mind. Basic

financial management includes activities such as managing the day-to-day operations of a

business, such as paying suppliers, cost of capital, and budgeting. It also includes making long-

term investments in plant and equipment and obtaining the money or financing for your

operations. New business leaders and managers have to develop at least basic skills in financial

management. Expecting others in the organization to manage finances is clearly asking for

trouble. Basic skills in financial management start in the critical areas of cash management and

bookkeeping, which should be done according to certain financial controls to ensure integrity in

the bookkeeping process. New leaders and managers should soon go on to learn how to generate

financial statements and analyze those statements to really understand the financial condition of

the business. Financial analysis shows the "reality" of the situation of a business seen as such;

financial management is one of the most important practices in management. This topic will help

you understand basic practices in financial management, and build the basic systems and

practices needed in a healthy business.

Introduction:

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The title of the case is Rapidly Rising Corporate Debt: Are Firms Now Vulnerable to an

Economic Slowdown. Name of the author is Carol Osler & Gijoon Hong. It was published in

June 2000.Venue is Current Issues in Economics & Finance, Federal Reserve Bank of New York

Venue type is conference.

In recent years, U.S. corporate debt has grown rapidly. Between 1995 and 1999, the

outstanding debt of nonfinancial corporations rose a hefty 46 percent—a trend typified by last

year’s increase of 12 percent. Viewed as a share of GDP, such debt has now reached

unprecedented heights. This high level of debt made some observers think about the problem,

they think if it has made the nonfinancial corporate sector financially weak and vulnerable to

economic downturns. Such thoughts have gained importance from the recent worsening of other

gauges of corporate health, notably default rates and recovery rates on defaulted debt.

Investigation of whether concerns over the build-up of U.S. corporate debt are in fact justified.

Examination of the health of the nonfinancial corporate sector on a firm-by-firm basis, focusing

chiefly on three key measures of health: leverage, liquidity, and overall solvency. The analysis

suggests that the sector is in good shapes a whole, and that its financial health has actually

improved during the late 1990s. After all, the financial condition of small firms is not as healthy

as that of large ones, and small firms are continuing to experience a decline in terms of financial

condition . Also consideration should be paid on how the corporate sector might fare in the face

of an economic challenge such as a major stock market correction or a large rise in interest rates.

Investigation on this, despite the sector’s current high level of borrowing, leverage would remain

manageable in the wake of a large market correction. A significant rise in interest rates, however,

could push the sector’s liquidity risk to the relatively high levels seen in the 1980

The rapid growth in corporate debt during the late 1990s raises questions about the

financial health of the sector and, indirectly, about the sensitivity of other sectors to economic

troubles.The increase of debt in the late 1990s has raised concerns about the U.S. nonfinancial

business sector’s health and its weakness to economic downturns. An investigation of the

segment suggests that while little firms are experiencing some weakness, corporations as a

collection are in superior financial shape. U.S. corporate debt has developed rapidly in current

years. Between 1995 and 1999, the exceptional debt of nonfinancial corporations rise a hefty 46

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percent—a trend typified by last year’s boost of 12 percent. Viewed as a share of GDP, such debt

has now reached extraordinary heights. This apparently high level of debt has concerned some

observers, who speculate whether it has made the nonfinancial corporate sector financially weak

and vulnerable to economic downturns. Such concerns have gained integrity from the recent

deterioration of other.

Main Issue:

The main issue of this study is we investigate whether concerns over the build-up of U.S.

corporate debt are in fact reasonable. The health of the nonfinancial corporate sector on a firm-

by-firm basis, focusing chiefly on three key measures of health: leverage, liquidity, and overall

solvency. This study analysis suggests that the sector as a whole is in good shape, and that its

financial health has actually improved during the late 1990s. Consider how the corporate sector

might fare in the face of an economic challenge such as a major stock market correction or a

large rise in interest rates. Nonetheless, the health of small firms is not as robust as that of large

ones, and small firms are continuing to experience a decline in health.

Theme of the study:

From this case, we can understand clearly that if the debt in the financial economics

increases than the proportion of debt also increases in non-financial companies. Due to these

many firms faces loss, but in this loss, mostly small firms are bigger sufferers compared to big

firms. To overcome this loses; they carry out some research, which are leverage, equity and

overall solvency. In small, on-financial firms the above following proportions of the researches

are not accurate, but in small firms the proportions of this research are usually less, but also as

the debt ratio is more in non-financial small firms, so for that the debt default happens more. As

the health size in non-financial firms are smaller so for that they are suffering financially.

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Analysis and interpretation:

Alternative Measures of Borrowing

U.S. corporate debt has grown rapidly in recent years. Between 1995 and 1999, the

outstanding debt of nonfinancial corporations rose a hefty 46 percent—a trend typified by last

year’s increase of 12 percent. Viewed as a share of GDP, such debt has now reached

unprecedented heights.

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Average Leverage of U.S. Nonfinancial Firms Weighted by Stock Market Value

Average leverage for nonfinancial firms declined fairly steadily—from 0.35 in late 1995

to 0.22 in September 1999—despite the concurrent rise in overall debt. In essence, nonfinancial

corporations in September 1999 on average had debt liabilities with a face value only slightly

more than one-fifth the value of their outstanding equity. Moreover, average corporate leverage

for the nonfinancial sector was rather low relative to the post-1974 average of 0.47.

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Turn to a measure of average corporate leverage that uses asset values to determine

earnings capacity (Chart 3, top line). By this measure, the average leverage ratio declined

modestly during the late 1990s and—at 0.23 in September 1999—was still slightly below its

historical average of 0.25. Although this measure has fallen less dramatically than our central

measure and remains closer to its own historical average, it nonetheless suggests that the

leverage of the nonfinancial corporate sector is not high.

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Despite differences in the liquidity ratios, all three confirm that the liquidity risk of the

nonfinancial corporate sector has not risen sharply during the late 1990s.In addition; the ratios

suggest that the sector’s liquidity risk presently is not very high.

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To measure solvency, economists typically compute a summary measure of corporate

health called a Z-score. This score is a combination of five accounting ratios that assess leverage,

liquidity, sales, working capital, and retained earnings. The first and most familiar Z-score was

published by Altman (1968). More recently, alternatives have been offered by Begley, Ming, and

Watts (1996) and Shumway (1999). To calculate Z-scores, one multiplies each ratio by a number

—for example (in the case of Altman’s Z-score), 1.00 for the sales ratio, 3.30 for the retained

earnings ratio—and sums the resulting products. Since Z-scores measure solvency, a higher

score indicates a lower risk of bankruptcy. Three Z-scores for the U.S. nonfinancial corporate

sector, computed using the methods of the researchers cited above, show that the likelihood of

bankruptcy in this sector declined on average in the late 1990s.

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As we see from this Chart, the financial health of small firms did indeed worsen during

the late 1990s. Leverage ratios for the smallest 20 percent of firms (ranked by market value) rose

sharply after 1995 and are now fairly high by historical standards. Liquidity measures confirm

that the decline in health is concentrated in the smallest firms, as do solvency measures such as

Altman’s Z-score. This sizable deterioration can explain why measures such as default rates rose

in the late 1990s, even as overall leverage declined.

Table-1

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Years Rapidly Rising Corporate Debt

1995 to 1999 58% outstanding debt of nonfinancial corporations.

1995 to1999 0.35 to 0.22 average leverage for nonfinancial firms declined fairly.

1974 to 1998 Average 0.47 leverage for nonfinancial firms declined fairly.

1990 to 1995 2.6 % growth rate that easily exceeds.

1975 to1995 1.9% growth rate that easily exceeds.

1974 to 1995 0.5% leverage of the nonfinancial corporate sector remains below.

1990 to 1995 0.80 to 1.04 corporate health's, an employment weighted incense.

1974 to 1998 0.83 to 1.34 leverage according to this measure is still well below

1996 to1999 1.00 to 3.30 Z-scores sales ratio is the retained earnings ratio—and sums

the resulting products.

1995 to 1999 3.2 to 5.2 % while the average value recovered from defaulted debt.

1995 to 1999 9.7 to 3.3 Z-score, solvency still more than double the historical average

1990 to 1999 57 % average stock price decline implied by this scenario

Generation of Questions:

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Why are US firm using more short term debts?

How to determining of short term debt financing?

What is the condition of financial sector?

Is the condition of financial sectoring better them non-financial sector?

How to handle short term debt?

What type of necessary of resource or examine help to reduce debt default level?

Is there any another way to solve this situation?

How to improve the situation?

How big is the debt overhang problem?

Is the raise of leverage level solving this problem?

Summary:

By analysing US corporations had seen as the outstanding debt has increased so the

economic factors are also being suffered. The main reason for this is the repayment of debt is not

being done so for that the big firms are able to operate their work properly but as the capital of

the small firms are also small. So as they are giving loans, they are not getting back the amount

of loan from their receivers so for that their debt increases. As the debt increases, the interest rate

is increasing; equity risk is also increasing so also the leverage amount is decreasing as debt

increases.

Conclusion:

The nonfinancial corporate sector is in good financial health. Some weakness, however,

exists among the sector’s smallest firms. The sector as a whole would likely withstand a major

stock market correction without a huge disruption, but a large rise in interest rates could bring

the sector’s liquidity risk back to the relatively high levels common in the 1980s. December 1995

to December 1998 is the most recent period for which we have reasonably comprehensive

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employment data. Financial firms, by their nature, borrow heavily, so their leverage is generally

extremely high. By excluding financial firms from our analysis, we avoid distortion

comparisons. The impact of an interest rate rise makes no allowance for likely negative effects

on business activity, so the actual increase in liquidity risk would likely be even higher than

these figures suggest.

Corporate finance theory currently cannot prescribe a “correct” level of borrowing for

individual firms, and thus it cannot define an absolute level of leverage that would be safe or

appropriate for the economy as a whole. Even more noteworthy is the possibility that the ratio

would Approach the 1980s average of 0.190; corporate liquidity during this decade was a source

of widespread concern.

Policy Prescriptions:

Financial firms, by their nature, borrow heavily, so their leverage is generally extremely

high. By excluding financial firms from our analysis, we avoid distortion comparisons. In

addition, except where noted, 1999 data were available only through the third quarter. Further

examination of the firm-by-firm data suggests that there are no noticeable patterns of change

across industries aside from those related to size. Interest expense is reported in the aggregate for

each firm. Cash flow is operating income before depreciation. By excluding capital expenditures

from our measure of cash flow, we do not change our overall conclusions. So the actual increase

in liquidity risk would likely be even higher than these figures suggest.

Directions for Future Research:

Here are some future researches given below:

Current liabilities are primarily notes payable, debt due in one year, accounts payable,

income taxes payable and accrued expenses. Current assets are mainly cash and short-term

deposits, accounts receivable, inventories, and prepaid expenses. Interest expense is reported

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in the aggregate for each firm. Cash flow is operating income before depreciation. By

excluding capital expenditures from our measure of cash flow, we do not change our overall

conclusions.

Set up a payment plan. Your creditor sometimes will do this for you, but in some cases--

such as when you make a large purchase at no interest for the first year. Decide whether you

want to distribute the payments evenly or whether you want to pay more at the beginning or

end.

Consider whether you should consolidate your debts into one payment. If you have

several short- and long-term loans that you are trying to repay, it might make sense to

consolidate your loans. This allows you to make one easy payment and might spread out the

loan over a longer term.

Reduce your expenses. With a short-term loan, you want to apply as much money as you

can toward paying it off. To do this, you should try to reduce your expenses for the duration

of the loan.

Consider whether you should refinance your home to include the short-term debt. If

you're worried that you won't be able to pay off the short-term loan on time, you might be

able to refinance your home to get the money that you need. If you use your home equity to

pay off the short-term debt, the money will become part of your mortgage payments.

Apply all extra money to paying off the debt. When you cut back on your costs, be sure

that you use the extra money to pay off the debt. This will decrease the time that it takes to

repay your loan.

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References:

Altman, E. I. 1968. “Financial Ratios, Discriminant Analysis, and the Prediction of Corporate

Bankruptcy.” Journal of Finance 23,

http://citeseerx.ist.psu.edu/viewdoc/

similar;jsessionid=981069180485ECB050D689C228289293?doi=10.1.1.203.4781&type=ab

Begley, J., J. Ming, and S. Watts. 1996. “Bankruptcy Classification Errors in the 1980s: An

Empirical Analysis of Altman’s and

Ohlson’s Models.” Review of Accounting Studies

How to Handle Short-Term Debt | eHow http://www.ehow.com/how_5730141_handle-

short_term-debt.html#ixzz2UnvAlUAI

Shumway, Tyler. 1999. “Forecasting Bankruptcy More Accurately: A Simple Hazard Model.”

Unpublished paper, University of

Michigan–Ann Arbor Business School.