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business
introduction to corporate finance
Questions and Answers of
Introduction To Corporate Finance
Prove equation (5.11). R-[1-(1-e)f]V (5.11) (1-e)f
Prove that inequality (5.12) provides a sufficient condition for the good entrepreneur to prefer the debt structure that leads to liquidation under the conditions of the lemma to which it refers.
This exercise illustrates the case of Lemma 5.2.1 in the model of Diamond (1991). Take \(L=R=1, \pi=\frac{1}{2}, X=1 \frac{3}{4}, C=0, f=\frac{1}{2}\), and \(f^{d}=\frac{1}{3}\).(a) What are the face
This exercise illustrates the case of Lemma 5.2.2 in the model of Diamond (1991). Keep everything from the previous exercise except that here \(X=1.4\) and \(C=0.35\). Show that in this case, if the
Consider a Robinson Crusoe economy in one period without an investment schedule. Show that \(x_{0}^{*}\) is given by the expression in the text.Data From Robinson Crusoe economy:- Suppose that there
Consider a Robinson Crusoe economy in one period without an investment schedule. Prove and interpret the fact that \(d^{2} y / d x^{2}\) is positive at the optimal point \(\left(x_{0}^{*},
Consider a Robinson Crusoe economy in one period with an investment schedule. Show that \(y_{p}(x)\) is decreasing in \(x\) with a negative second derivative.Data From Robinson Crusoe economy:-
Show that the optimal value of the investment in financial markets is given by the expression for \(\epsilon^{*}\) in the text.
Prove Corollary 1.1.1.Data From Corollary 1.1.1:- The optimal investment decision is the one that maximizes the current wealth of the agents.
Show how to get the expression for \(y_{,}(x)\).
Show the inequalities in relation (1.8). yf(x) yp(x) y.(x), (1.8)
Prove Proposition 1.1.2.Data From Proposition 1.1.2:- It is rational to invest in a project if its net present value is positive. This is simply another way of saying that the optimal level of
Consider an economy with two agents, \(\mathrm{A}\) and \(\mathrm{B}\), who live in a one period economy defined by two points in time. The preferences of agents A and B are represented respectively
Prove that if there is a strictly positive vector of state-prices \(\psi \in R^{K}\) such that \(V=\Gamma \psi\), then there are no arbitrage opportunities.
Derive the expression\[-\frac{\operatorname{cov}\left(R^{\theta}, \delta\right)}{E(\delta)}=\frac{\operatorname{cov}\left(R^{\theta},
When developing the beta-valuation model, it is stated that the existence of a portfolio satisfying \(\delta=\Gamma^{\top} \theta^{*}\) relies on the assumption that markets are complete. Explain why.
Consider two agents, \(\mathrm{A}\) and \(\mathrm{B}\), who live in a one-period economy defined by two points in time. They are given endowments at both points in time. Both agents have the
Consider a one-period economy with two possible states of nature at time \(t=1\). The risk-free rate in this economy is \(1 \%\). There is a project (call it project 1) in this economy with value
Consider a two-period model with two assets: a risk-free asset that pays \(R\) in each state of nature and a risky asset that pays \(D\) in the first state of nature and \(U\) in the second state.
Consider the following one-period model with two agents ( \(\mathrm{A}\) and \(\mathrm{B}\) ). At time \(t=0\) each agent chooses how to allocate his/her initial endowment (5) between the risk-free
In the binomial model, show that if \(V eq \frac{1}{V}\left[\frac{R-D}{U V-D} V_{1}(1)+\frac{U-R}{U-D} V_{0}(1)\right]\), there is an arbitrage opportunity.
Suppose that there is no risk-free asset in the preceding discrete-time setting. Would it be possible to choose a portfolio such that the value of this portfolio at date \(t=1\) would fit the payoff
Show that when the volatility changes, for fixed expected return \(\varepsilon, \pi\) can either increase or decrease.
Let a firm start at time \(t=0\) and have projects with payoffs \(\Gamma_{j}(T)=\) [10 86 6 for the three different states of nature at time \(t=T\). The firm is partially financed with debt with
Show how to explore arbitrage opportunities when \(V_{l} eq V_{u}\), if individuals can borrow capital with the same characteristics as firms.
Modigliani and Miller (1958) developed their theory under some different assumptions. They assumed that debt had an infinite life and that each period the firm had to pay interest on debt equal to
Suppose that any time an individual wants to sell/purchase assets (bonds and shares), he must pay a fixed amount \(T\) of transaction costs. In the context of Modigliani and Miller (1958), what is
Show that in the presence of personal income tax and corporate income tax, the gain from leverage to stockholders is given by the expression\[G_{l
In the presence of underutilization of a tax shield or leverage-related deadweight costs, the after-tax equilibrium model discussed in Kim (1989) says that the equilibrium is reached at a value of
In the context of Subsection 3.1.1, what is the effect of an increase in \(\alpha\) over the value of the firm \(V\) ? Suppose outsiders receive voting rights. Assuming managers want to keep control,
Prove that an outsider will not pay more than \((1-\alpha)\) times the value he expects the firm to have-that is, he will not pay the value \((1-\alpha) V^{*}\), but only \((1-\alpha) V^{0}\), for
Some authors argue that one way to control the conflicts of interests between managers and stockholders is to give stock options to managers. How can we explain this argument using the simple model
Explain condition (3.4) and show what happens to the optimal value \(f^{*}\left[w\left(a^{\circ}, \theta\right)\right]\) when \(\theta\) changes. - U'[0 f]=AG'[f]. (3.4)
Show that the risk-sharing rule implied by condition \(U^{\prime} / G^{\prime}=\lambda-\) \(\psi d\left(w_{a} / w_{b}\right) / d \theta\) is not Pareto-efficient when the agent is risk averse. Is it
Prove that when both utility functions \(V\) and \(G\) have constant absolute risk averse coefficients, the optimal fee schedule \(f(\cdot)\) is a linear function of the payoff.
How can the issuance of convertible debt and warrants contribute toward reducing the agency costs between stockholders and bondholders? What about call provisions in debt contracts?
Under what conditions can we say that the value of debtholders' position is the same as if they owned the company's assets and had given stockholders a call option with exercise price equal to the
Following the notations and assumptions of Myers (1977), show that management tends to underinvest and lead to an opportunity wealth loss when risky debt is considered.
How can the restrictions on dividends payment protect debtholders? What happens when the firm has plenty of cash?
The treasurer of E.I. DuPont de Nemours has a $500 million cash balance to invest over the next six months. She has been instructed to play it safe and to avoid unduly speculative risks. She has
Indian rupee forward contracts. The Indian rupee (INR) is currently trading at INR 50 = US$1. With 90-day Indian-rupee and U.S. dollar treasury bills currently yielding 10 percent and 2 percent per
Interest rate parity for asset managers and hedge fund arbitrageurs. You have been given the following information:Taking the perspective from a U.S.-based asset manager or hedge fund arbitrageur:a.
Covered interest rate arbitrage with withholding tax. On September 1, 2013, the treasurer of Volvo, the Swedish automotive manufacturer, is faced with the following investment dilemma: he could
Covered interest rate arbitrage. As a trader for the London-based money market Commonwealth Fund, you see the following quotes:a. From Barclays Bank, one-year sterling deposits/loans at 6. 0 percent
Selecting a construction loan. Italthai, the Bangkok-based construction company, has recently been awarded a baht (THB) 2,500 million contract for the renovation of Phuket International Airport. The
Speculating on the collapse of Argentina’s currency board. Dr. Lawrence Krohn is the New York–based lead currency strategist for Latin American currencies at Standard Bank. On the eve of its
Fuji Life Insurance Co. global money management (advanced). Hiko Yamamoto, the deputy treasurer of Fuji Life Insurance Co. (FLI), was reviewing one-year investment opportunities for the 100 billion
Yen carry trade at the Conan Doyle Galaxy Fund. Dr. Watson is the chief trader at the currency arbitrage desk of the U.S.-based Conan Doyle Galaxy Fund. He is considering arbitrage opportunities
Carry trade at a macro hedge fund. Ms. Ivanhoe is the chief strategist of Caran d’Ache—the Fribourg-based (Switzerland) macro hedge fund. Newly issued oneyear Greek government zero-coupon (Z)
Yen carry trade with investment in U.S. dollars/Icelandic króna. Louise is an associate with Charlemagne, a hedge fund domiciled in Luxembourg, who is considering the following arbitrages:Two
Covered interest rate arbitrage with transaction costs (advanced). Assume that U.S.-based potential arbitrageurs do not hold cash, but hold dollar-denominated securities. Covered investment in
Covered interest rate arbitrage with a two-tier exchange market (advanced).Monsieur Dassault, the treasurer of Renault-Finance S.A.—the Geneva-based international finance subsidiary of the French
Interest rate arbitrage with bid-ask spreads (advanced). Consider the configuration of bid-ask spot and 90-day forward US$/£ exchange rate on June 12, 2013, keeping in mind that the lower rate is
What are the key differences between currency forwards and futures contracts?
How is counterparty risk mitigated in a currency futures contract? Explain how the daily marking to market of currency futures reduces the risk of trading this derivative.
Compare counterparty risk for over-the-counter forward contracts with exchange-traded futures. Why is the secondary market for futures more liquid than it is for forwards?
What are the differences between currency put and call options?
What is the nature of credit or counterparty risk when trading options?
What is the difference between writing and buying a currency option?
Compare futures margins with options premiums.
Identify the key parameters that determine the value of a currency option.
Explain how the put-call parity ties the currency options market to the forwards market.
What is an option straddle strategy? How does it take advantage of exchange rate volatility?
What is meant by the intrinsic value and the time value of an option?
What are zero-premium options? Why are they more attractive to risk managers than plain-vanilla options?
Why does the net value of a cross-currency swap fluctuate continuously?
Why are cross-currency swaps compared to series of long-dated forward contracts?
Refer to Exhibit 7. 2 for futures prices.a. What is the March 2012 futures price for Australian dollars and Japanese yen?b. What is the cross-rate for March 2012 Japanese yen price of the Australian
Soledad McArthur is the chief currency trader at the Magna Carta macro hedge fund. She decides on January 15 to go long by buying Mexican peso (MXN) March and June futures currently trading at
A trader for Prometheus Partners—a macro hedge fund—is debating how to structure his bet that the euro-zone will break up in the next six to nine months, resulting in a massive capital flight
A hedge fund manager anticipates a weaker euro over the next 180 days. Both six-month put and call options on the euro are available with strike price at the money of US$1.33 = €1.a. Would you
Referring to problem 3, Prometheus Partners is considering currency options as alternative instruments to speculate on the possible demise of the euro. March 2013 European put and call options are
A trader at Credit Suisse First Boston is speculating on the movement of the Swedish krona (SEK). She is prepared to invest US$10 million in the transaction. The current spot rate between the krona
Assuming that Allied-Lyons was relying on a straddle strategy (refer to International Corporate Finance in Practice 7. 3 for background information), explain graphically and numerically under what
Writing a strangle (advanced). Assuming that Allied-Lyons would write a strangle as a speculative strategy, rather than a straddle as in problem 7, would you consider it to be more or less
Assuming (1) that you can buy a pound sterling call with strike price of $1.50 for 3 cents, (2) that you can sell a sterling put at the same strike price for 4 cents, (3) that the prevailing forward
On June 15 the premium on a September CAD put option is US$0.017 per CAD at a strike price of US$1.07. If the quarterly U.S. interest rate is 1. 25 percent, what is the price of a September CAD call
Show graphically that writing a covered call option on sterling amounts to writing a naked put option on sterling.
Currency swaps and the cost of debt. Michelin S.A., the French multinational tire manufacturer, needs to borrow $300 million to expand its U.S. plant in Georgia.It can issue a US$-denominated
With reference to the NSP/KLM currency swap, answer the following questions:a. What is the implied forward exchange rate used throughout the life of the swap for exchanging cash flows?b. At the end
Japan Airlines International (JAI) issues a fiveyear U.S. dollar−denominated 250 million bond yielding 5 percent. Preferring to keep its liabilities in its domestic currency, JAI immediately swaps
The Water & Sewer Department (WSD) of the City of Sacramento(California) has issued a floating rate note (FRN) maturing in seven years with an interest rate pegged to the U.S. dollar six-month LIBOR
What are the principal sources of financing available to firms that find themselves in a cash-deficit situation?
What are the principal functions performed by the financial sector?
What does it mean to describe financing as a global procurement decision?
What are financial intermediaries?
What is financial disintermediation? Is it desirable?
What are the conditions for successful disintermediation?
What is the role played by commercial paper in financial disintermediation?
What is securitization? Why does it lower the cost of consumer financing?
What are the unique risks inherent in an international securitization transaction?
What makes emerging capital markets emerge?
Toro, the Wisconsin-based AA-rated manufacturer of snowblowers and lawn mowers, anticipates that because of the seasonal nature of its business it will require an additional US$250 million for
Weyerhaeuser, the lumber multinational company, is comparing the cost of alternative methods for financing its exports trade. US$500 million is needed for 180 days and can be sourced from Chicago
Mellon Bank sold a credit default swap to MetLife for the protection of seven-year US$375 million mortgage-backed securities requiring a semiannual payment of 65 basis points. In case of default,
Ian Maxwell is the chief investment officer for Glasgow’s municipal workers’ pension funds (GMWF). He is intrigued by the high-yielding sovereign debt issued by PIIGS countries. Most notably,
Germany’s new issue of comparable five-year treasury bonds offers a much lower coupon of 3. 10 percent than Spain’s 6. 25 percent. Germany is AAA-rated.a. Can the Spanish and German bonds be
In 1999 Pemex—the Mexican state-owned oil company—is rated AA in Mexico for domestic bond issues but constrained in its international financing by Mexico’s B country rating.a. What is the
By issuing US$500 million of BBBrated future exports-backed securities through an offshore special purpose vehicle(SPV), Pemex was able to lower its cost of debt by 337.5 basis points as compared to
By accessing the IMF monthly Financial Statistics and other pertinent websites:a. Compute for 2012 the ratio of the market capitalization of the Caracas (Venezuela)stock exchange to the country
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