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Question - Baker Hughes is in the oil and gas equipment and services industry. Suppose that Baker Hughes managers are considering a new oilfield servicing operation that would cost $250 million. Its book debt-to-equity ratio would increase only slightly, so its credit ratings would not change. The managers consider raising funds for the project by selling $250 million in new bonds with a maturity of 5 years. The managers judge that the proposed project would have about the same risk as Baker Hughes's existing operations. The firm has an outstanding bond that matures in about 5 years and has a yield to maturity of 7.482%. Treasury bonds with the same years to maturity have yields of 2.611%.
Estimate the required annual rate of return on Baker Hughes's new bond that the company plans to issue to fund the new project.
Hubbard argues that the Fed can control the Fed funds rate, but the interest rate that is important for the economy is a longer-term real rate of interest. How much control does the Fed have over this longer real rate?
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