Finance Report: Evaluating Corporate Governance and Portfolio Risk

This finance report provides a comprehensive analysis of several key financial concepts. It begins by differentiating between loans and bonds, outlining their characteristics and trading dynamics. The report then delves into portfolio risk, illustrating how diversification can reduce overall risk, and includes a detailed analysis of WACC (Weighted Average Cost of Capital) and capital structure. It explores the agency problem within corporate governance, detailing the relationship between shareholders and management, and suggests steps to improve corporate governance practices, including diversity in the board, effective risk management, and performance evaluations. Furthermore, the report examines the Enron scandal as a case study, highlighting the failures in corporate governance that led to its collapse, including issues with management conflicts of interest and lack of oversight.

Running head: QUESTION
Question
Name of the Student:
Name of the University:
Author Note:

QUESTION
Table of Contents
Question 1:.................................................................................................................................3
Part a:.....................................................................................................................................3
Part b:.....................................................................................................................................4
Part i ii iii iv v:...................................................................................................................4
Part vi:................................................................................................................................4
Question 2:.................................................................................................................................5
Part a b c d e:..........................................................................................................................5
Part f:......................................................................................................................................5
Question 3:.................................................................................................................................6
Part a:.....................................................................................................................................6
Part b:.....................................................................................................................................6
Part i:..................................................................................................................................6
Part ii:.................................................................................................................................7
Part iii:................................................................................................................................7
Part iv:................................................................................................................................7
Part v:.................................................................................................................................8
Question 4:.................................................................................................................................8
Part a:.....................................................................................................................................8
Part b:...................................................................................................................................10
References:...............................................................................................................................12

QUESTION

QUESTION
Question 1:
Part a:
Particulars Loan Bond
Issuance The loan is taken from the
bank.
The bonds are issued to the
general investors.
Interest rate Can be fixed or variable
interest rate.
Have a fixed rate of interest.
Source Is provided by the banks. Is sold in the bond market
by financial institution
Trading It is fixed by the bank Can be bought and sold in
the bond market.

QUESTION
Part b:
Part i ii iii iv v:
Figure 1:
Source:
Part vi:
As we move towards maturity the bond price falls towards the face value of the bond,
as it is seen when the yield is less than the coupon rate, the bond price is greater than the face
value of the bond. While when the yield is greater than the coupon rate, the bond price is less
than the face value of the bond. Thus, the yield of the bond is the return which can be
generated by the investor over the duration of the bond.

QUESTION
Question 2:
Part a b c d e:
Figure 2:
Source:
Part f:
The portfolio risk is the risk which the investor is exposed to by taking position in the
above two stocks. The individual stock return for each of the stock is very high at 22.02%
and 37.89% respectively, while the portfolio risk is 4.56%. Thus the risk which the investor is
exposed has reduced substantially. Thus this risk is classified as systematic risk, and the risk
has been reduced due to the benefits of diversification which has been received from the
portfolio. If the investor would had invested 100% in either of the stock, it would had
generated positive return for nestle, while a negative return for Tata steel. Hence the risk
would had been high for the investor, which has been removed by generating return with the
least amount of risk.

QUESTION
Question 3:
Part a:
The WACC of the company is the average cost of capital which the company faces
over all its funding. Thus, the cost of equity which is higher than the cost of debt due to the
equity shareholders taking a higher level of risk. The cost of debt is less than the cost of
equity since the debt-holders are secured and have a charge on the assets. Thus the different
level of cost for each type of funding is taken as a weighted average to highlight the WACC.
The optimal capital structure theory is a theory which highlights that the company has
different level of WACC at different level of capital structure. Thus as per the irrelevance
theory of MM it highlights the optimal capital structure is 100% debt as debt provides interest
rate tax shield which reduces the cost of debt. However, in real life the rise in debt leads to an
increase in the risk for shareholders which further increase the demand of return, thereby
increasing the cost of capital of the company. Thus the company managers maintain an
optimal capital structure, to reduce the WACC and hence lowering the cost of capital for the
company.
Part b:
Part i:

QUESTION
Part ii:
Part iii:
Part iv:

QUESTION
Part v:
The level of debt for the company has increased from the year 2018 to 2019, which
has led to the increase in the cost of debt for the company. The tax rate has stayed relatively
stable and the post-tax cost of debt is 7.56% in 2019 while 6.09% in 2018.
The cost of equity using CAPM provides a value of 11.74%, while the value as per
DDM is negative 5.45%. This is due to the negative growth rate of the dividend, over the
years for the company.
The capital structure of the company has changed in one year horizon, with the share
of equity falling while of debt rising by 4%. However, the WACC for the company is 10.58%
which is calculated using the following information calculated above.
Question 4:
Part a:
The shareholders are primary owners of the company, having stakes which is equal to
the number of shares which is held by the shareholders. Thus they act as the principal of the
company and thus management of the company would require expertise, management is
delegated to authorities who act as the agents for the shareholders. Thus each and every
decision which is taken by the agents and is in regards to the long term interest of the
shareholders needs to be approved by the shareholders which takes place in the Annual
General Meeting (ElKelish 2018).
Thus this creates an agency and principal relationship, which dictates that the agents
act in favour for the interest of the principal. Thus, when the agents act in favour of the
principal the agency problem is diminished. The agency problem is the problem, when the
principal act in their own self-interest ignoring the interest of the shareholders. Thus, this can

QUESTION
lead to an agency loss which can be measured by the results which were in favour for the
principal less the results obtained by the agents. Thus, a greater the agency loss the greater
the agency problem which is faced by the company. The agency loss is 0 when the agents act
entirely in the favour of the shareholders (Panda and Leepsa 2017).
The effective corporate governance steps is highlighted in the bullets below which
should be undertaken by the company,
 The diversity which is comprised in the board should increase, which means to
incorporate members from different culture and background. This has been proved in
the study which was undertaken by credit Suisse where it was highlighted that the
company with greater diversity at management performed exceptionally well with a
good financial track record (McDonnell 2019).
 The nominating committee should invest time in selecting the constituents of the
boards. The members of the board should have prior experience in the company’s
field of business with the necessary management skills. They should be qualified
enough to take sound decision for the principals of the company.
 The information should be dissipated on a timely basis, to make better decision by the
company management. The decision should also be timely communicated to the
necessary department. Thus, this would reduce wrong decision making and hence the
principal agent conflict resolved to some extent (Bhattacharya, Li and Rhee 2016).
 Risk management is an important aspect which needs to be maintained by the agent.
Thus the effective risk management would enable assessing the situation in a more
realistic way, this would lead to effective decision making by the agent which is in
line with the interest of the principal. Thus the agent principal conflict might be
reduced by this measure to some extent.

QUESTION
 Evaluation of Performance of the board is an important measure which should be
done on a periodic basis. This would enable and highlight the strength and weakness
of the board. Thus this measure would highlight the measures which should be taken
to improving board performance and if any reforms are required can be conducted to
achieve higher level of efficiency (Al-Sartawi 2018).
Part b:
The Enron scandal was one of the biggest example of the failure of the corporate
governance. The management or the agent were employing the assets which should had been
used for the interest of the principal for their own personal interest. Thus, this led to the
collapse of one of the largest company, highlighting the importance of corporate governance
(Chu, Yang and Yang 2016).
A post analysis after the fall of Enron highlights the various problem related to the
corporate governance within the company. The lack of corporate governance led to the
company management to hide billions of dollars in loan using accounting loop holes and
anomalies. Thus, the major problems agency problems are highlighted in the points below,
 The coalition of the management of the company and the board of directors resulted
in the increase in the agency problem. The CEO being the chairman of the board
created a problem of taking decision which were in favour of the management and not
the shareholders of the company. Thus the separation of the management from the
board is required to reduce the agency problem (Andrews, Linn and Yi 2017).
 The performance of the board and the management were not checked periodically as
what decisions were being taken and what benefits it would have provided to the
shareholders. Thus, the lack of proper measure to check led to the scam created by the
board which ultimately benefits the board and not the shareholders.

QUESTION
 The deals which were being signed needed to be properly analysed as what benefits
were being received by the board. Thus a deal which would lead to the benefit of the
board while creating no value for the stakeholders could have been avoided. However,
the lack of such measures led to the scandal and failure of corporate governance
(Carberry and Zajac 2017).