Concept Test 6 Groups 4, 8, 9 and 10

Greek Bonds Tumble on Concern Germany May Hold Back on Bailout

April 26 (Bloomberg) -- Greek bonds tumbled, pushing yields to the highest since at least 1998, on concern Germany isnt moving fast enough to agree to the terms of a 45 billion-euro ($60 billion) aid package. Investors demanded an extra 6.35 percentage points in yield to buy the nations 10-year bonds rather than benchmark German bunds as Chancellor Angela Merkel said she wont release rescue funds until Greece shows its got a sustainable, credible plan to cut its deficit. Citigroup Inc. said a reorganization of the debt or extra support for the nation looks unavoidable. Portugals bonds fell on concern the debt crisis is spreading. The market is increasingly nervous the funding will not be in place before the next payments are due, said Nick Stamenkovic, a fixed-income strategist in Edinburgh at RIA Capital Markets Ltd., a broker for banks and investors. Germany is playing hardball and until we see the money on the table investors will demand a higher premium to hold the debt. The 10-year Greek bond yield jumped 80 basis points to 9.6 percent as of 5 p.m. in London. The 6.25 percent security due in June 2020 slid 4.56, or 45.60 euros per 1,000-euro face amount, to 78.74. The two-year yield jumped 300 basis points to 13.94 percent, after soaring earlier to 14.66 percent. Greeces fiscal crisis dominated weekend meetings in Washington of finance ministers and central bankers from around the world after the nation said on April 23 it wanted as much as 45 billion euros of financial support that was made available by its European neighbors and the International Monetary Fund. The nations bonds have lost 12.6 percent this year, according to Bloomberg/EFFAS indexes, while the debt crisis has helped push the euro down almost 7 percent against the dollar since Dec. 31.

Required 1. How would the increased yield in Greek bonds affect the Greek economy and a company undertaking capital projects (6 Marks)

2. What effect will this have on an average Greek citizen (4 Marks)

Concept Test 6 Groups 4, 8, 9 and 10 Solution Part 1 With an increase in the required return on Greek bonds, we will expect the required return on other instruments in Greece to increase (1) This will cause the cost of debt and the cost of equity to increase (1) WACC used to evaluate projects in Greece will increase (1) The result will be that NPV of projects will decrease due to the higher return now demanded. (1) There will be less capital investment in the Greek economy (1) There would also be a decrease in the employment rate (1)

Part 2 Greece is effectively replacing one loan with another one which will need to repaid at some point (1) The way that Greece can obtain funds to repay these loans is by raising taxes both corporate and individual (1) The result is that the average Greek citizen will be required to bare his/her burden of the debt (1) There will also be an increase in interest rates further placing a burden on indebted individuals (1)