So, in FSA, when adjusting the Balance Sheet for analysis, CFAI tells us that LT Debt should reflect market value. Lets say that rates have dropped (and the value of the debt has increased) we would adjust up the liabilities, and then drop ShEq. This is like saying “we have won on debt, as when we will refinance, we will do so at a lower rate” but “we will penalize our retained earnings, just to make the books balance”. If we actually care about reflecting market values, then we should increase assets to make the books balance. But in anycase, we will probably not sell this debt, so what has really changed for the underlying business? I can see the argument of adjusting this for comparison purposes, but for analysis purposes, it seems somewhat bogus… The BS should reflect real values, and the value of LT Debt is what we got when we issued it… Not some hypothetical value we could sell it at, when we wont part with it… Any thoughts?
You are supposed to increase LT liabilities & assets if fair value has increased.
my thought is I take the CFAI word as gospel no matter what I may disagree with, as there have been occasional issues. But for this exam, which is all I need to focus on, its CFAI way or the highway.
Topher: Schweser FSA Book P.261 last paragraph: “If interest rates rise, the firm’s debt is adjusted downwards to market value with an offsetting increase to equity.” tvPM: so why lose focus and reply to this thread…
I recall this from level 1, including the test. If interest rates drop, the market rate for your debt has increased to give the same yield on the debt. It’s sort of like saying, “we issued debt in a high interest environment, but should have done it at today’s lower interest rate environment” I guess there is more to it than that, but this would be the case if the bonds were issued without the ability to be refunded. It’s a loss simply because of the opportunity cost of lost interest that you have to pay that other companies issuing debt today wouldn’t have to pay
johnny – this is what the analyst should do. Given a company took debt some time ago - and they have it on the books - their D/E would look good - because D was low, E was high. Now D goes up because rates went down, E would go down (as an offsetting transaction to balance the A=L+E equation). and suddenly the D/E (Leverage) looks bad!!! that is what they are trying to tell you to do. Do not take things at its face value. There may be stuff under the cards which may cause a rethink. this is not what the company does (and definitely no sane company would do that – because it would cause too much fluctuation and more manipulations), but what the analyst who is valuing the company should do.
CP, I understand the mechanics, and appreciate youre reply… But my point is that analysts shoulden’t engage in this practice or revaluing debt, and that they definetely shouldent do it against equity. In anycase, I understand that there could be some use for this under a scenario where we would like to compare companies using ratios (another practice I find suspect), but even under this scenario, shoulden’t you revalue cost of common shares, since, you know, they also would represent a different value if we were to re-issue today…
And guys, I understand that everyone is focused on the exam, where CFAI is god… But I care about about proper financial analysis, and I like to challenge my thinking… So, in turn, I challenge ya’ll to convince me that CFAI is an infallible god and that I’m making an error of logic…
do that after June 6th please… not while this is going on. This becomes quite meaningless chatter and waste of time right now… sorry. you have all the time on your hands after June 6th…
someone’s got their pa***es in a bunch today…lol
johnnyblazini Wrote: ------------------------------------------------------- > CP, I understand the mechanics, and appreciate > youre reply… But my point is that analysts > shoulden’t engage in this practice or revaluing > debt, and that they definetely shouldent do it > against equity. > > In anycase, I understand that there could be some > use for this under a scenario where we would like > to compare companies using ratios (another > practice I find suspect), but even under this > scenario, shoulden’t you revalue cost of common > shares, since, you know, they also would represent > a different value if we were to re-issue today… johnny, after the exam, I will gladly investigate some of my securities books and we can look at it in more detail. Let’s try to remember this post or you can contact me through email at djaliman at shaw dot ca
I like the point about adjusting prior equity proceeds to refelct market values! Sure, if that’s what the intention of the adjustment is, then by all means, everything should be adjusted.