Financial Management and Derivatives: A Problem-Solving Assignment

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Financial Management and Derivatives: A Problem-Solving AssignmentA 6-month put option on Makler Corp.'s stock has a strike price of $47.50 and sells in themarket for $8.90. Makler's current stock price is $41.00. What is the exercise value ofthe option?Answer$6.10$7.30$6.50$6.05$6.45Lissa Co.'s stock price is currently $26.75. A 6-month call option on Lissa's stock has astrike price of $25 and has an expected volatility of 40% (i.e., expected standarddeviation = 40%). The risk-free rate is 6%. According to the Black-Scholes optionpricing model, what is the value of the option?Answer$5.05$4.45$5.27$4.28$3.25If one U.S. dollar buys 1.46 Canadian dollars, how many U.S. dollars can you purchasefor one Canadian dollar?Answer0.71230.55480.68490.56850.6781Warren Corporation's stock sells for $42 per share. The company wants to sell some 20-year, annual interest, $1,000 par value bonds. Each bond would have 75 warrantsattached to it, each exercisable into one share of stock at an exercise price of $47. Thefirm's straight bonds yield 10%. Each warrant is expected to have a market value of $4.00given that the stock sells for $42. What coupon interest rate must the company set on thebonds in order to sell the bonds-with-warrants at par?Answer5.89%6.74%6.48%5.63%8.03%Operating leases often have terms that include:maintenance of the equipment by the lessor.full amortization over the life of the lease.very high penalties if the lease is cancelled.

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restrictions on how much the leased property can be used.much longer lease periods than for most financial leases.Which of the following statements is most CORRECT?AnswerA.Preferred stock generally has a higher component cost of capital to the firm than doescommon stock.B.By law in most states, all preferred stock must be cumulative, meaning that thecompounded total of all unpaid preferred dividends must be paid before any dividendscan be paid on the firm's common stock.C. From the issuer's point of view, preferred stock is less risky than bonds.D. Whereas common stock has an indefinite life, preferred stocks always have a specificmaturity date, generally 25 years or less.E. Unlike bonds, preferred stock cannot have a convertible feature.Which of the following statements concerning risk management is NOTCORRECT?AnswerA. Risk management can reduce the volatility of cash flows, and this decreases theprobability of bankruptcy.B.Risk management makes sense for firms directly engaged in activities that involvecommodities whose values can be hedged, and it doesn't make much sense for most otherfirms.C.Companies with volatile earnings pay more taxes than more stable companies due tothe treatment of tax credits and the rules governing corporate loss carry-forwards andcarry-backs. Therefore, our tax system encourages risk management to stabilizeearnings.D. Risk management can reduce the likelihood of low cash flows, and therefore reducethe probability of financial distress.E. Risk management involves identifying events that could have adverse financialconsequences and then taking actions to prevent and/or to minimize the damage causedby these events.The text gives a number of valid, acceptable reasons for companies to merge. Which ofthe following is not acceptable?AnswerA.Synergistic benefits arising from mergers.B. Reduction in competition resulting from mergers.C. Attempts to stabilize earnings by diversifying.D. Attempts to minimize taxes by acquiring a firm with large accumulated losses thatcan be used immediately.E. Using surplus cash to acquire another firm and prevent unfavorable tax consequencesfor shareholders.Which of the following statements is CORRECT?AnswerA. An option's value is determined by its exercise value, which is the market price of thestock less its strike price. Thus, an option can't sell for more than its exercise value.B. As stock price rises, the premium portion of an option on a stock increases becausethe difference between the price of the stock and the fixed strike price increases.

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C. If the company is consistently profitable, its call options will always be in the money.D.The market value of an option depends in part on the option's time to maturity and onthe variability of the underlying stock's price.E. The potential loss on an option decreases as the option sells at higher and higherprices because the profit margin gets bigger.Thomson Engineering is issuing new 30-year bonds that have warrants attached. If notfor the attached warrants, the bonds would carry an 11% annual interest rate. However,with the warrants attached the bonds will pay an 8% annual coupon. There are 30warrants attached to each bond, which have a par value of $1,000. What is the value ofthe straight-debt portion of the bonds?AnswerA.$739.19B.$790.93C.$872.24D.$835.28E.$768.75Suppose in the spot market 1 U.S. dollar equals 1.5 Canadian dollars. 6-month Canadiansecurities have an annualized return of 6% (and thus a 6-month periodic return of 3%).6-month U.S. securities have an annualized return of 6.5% and a periodic return of3.25%. If interest rate parity holds, what is the U.S. dollar-Canadian dollar exchange ratein the 180-day forward market? In other words, how many Canadian dollars are requiredto purchase one U.S. dollar in the 180-day forward market?AnswerA. 1.8705B.1.6610C. 1.5114D. 1.4964E. 1.4366If one British pound can purchase $1.90 U.S. dollars, how many British pounds can oneU.S. dollar buy?AnswerA. 0.4947B.0.6105C. 0.4053D. 0.5263E. 0.4579A commercial bank recognizes that its net income suffers whenever interest rates increase.Which ofthe following strategies would protect the bank against rising interest rates?AnswerBuying inverse floaters.Entering into an interest rate swap where the bank receives a fixed payment stream,and in return agrees to make payments that float with market interest rates.Purchase principal only (PO) strips that decline in value whenever interest rates rise.

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Enter into a short hedge where the bank agrees to sell interest rate futures.Sell some of the bank's floating-rate loans and use the proceeds to make fixed-rateloans.Suppose hockey skates sell in Canada for 165 Canadian dollars, and 1 Canadian dollar equals 0.71U.S. dollars.If purchasing power parity (PPP) holds, what is the price of hockey skates in the UnitedStates?Answer$94.89$99.58$113.64$131.21$117.15Quaid Co.'s common stock sells for $34, pays a dividend of $2.10, and has an expected long-termgrowth rate of 6%.The firm's straight-debt bonds pay 10.8%.Quaid is planning a convertible bondissue.The bonds will have a 20-year maturity, pay a 10% annual coupon, have a par value of $1,000,and a conversion ratio of 25 shares per bond.The bonds will sell for $1,000 and will be callable after10 years.Assuming that the bonds will be converted at Year 10, when they become callable, what willbe the expected return on the convertible when it is issued?Answer12.86%13.63%11.32%12.35%11.96%Herbert Engineering is issuing new 15-year bonds that have warrants attached. If not for the attachedwarrants, the bonds would carry a 9% annual interest rate. However, with the warrants attached thebonds will pay a 6.1% annual coupon. There are 30 warrants attached to each bond, which has a parvalue of $1,000. What is the value of the straight-debt portion of the bonds?Answer$796.09$720.27$835.89$766.24$877.69

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