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Corporate Finance With Connect Access Card 10th Edition Stephen Ross ,Randolph Westerfield ,Jeffrey Jaffe - Solutions
Black–Scholes A stock is currently priced at $35. A call option with an expiration of one year has an exercise price of $50. The risk-free rate is 7 percent per year, compounded continuously, and the standard deviation of the stock’s return is infinitely large. What is the price of the call
Equity as an Option Sunburn Sunscreen has a zero coupon bond issue outstanding with a $25,000 face value that matures in one year. The current market value of the firm’s assets is $26,300. The standard deviation of the return on the firm’s assets is 38 percent per year, and the annual risk-free
Equity as an Option and NPV Suppose the firm in the previous problem is considering two mutually exclusive investments. Project A has an NPV of $1,200, and Project B has an NPV of $1,600. As a result of taking Project A, the standard deviation of the return on the firm’s assets will increase to
Equity as an Option Frostbite Thermalwear has a zero coupon bond issue outstanding with a face value of $30,000 that matures in one year. The current market value of the firm’s assets is $36,400. The standard deviation of the return on the firm’s assets is 53 percent per year, and the annual
Mergers and Equity as an Option Suppose Sunburn Sunscreen and Frostbite Thermalwear in the previous problems have decided to merge. Because the two companies have seasonal sales, the combined firm’s return on assets will have a standard deviation of 29 percent per year.a. What is the combined
Equity as an Option and NPV A company has a single zero coupon bond outstanding that matures in 10 years with a face value of $15 million. The current value of the company’s assets is $13.4 million, and the standard deviation of the return on the firm’s assets is 39 percent per year. The
Two-State Option Pricing Model Ken is interested in buying a European call option written on Southeastern Airlines, Inc., a non-dividend–paying common stock, with a strike price of $75 and one year until expiration. Currently, Southeastern’s stock sells for $78 per share. In one year Ken knows
Two-State Option Pricing Model Rob wishes to buy a European put option on BioLabs, Inc., a non-dividend–paying common stock, with a strike price of $40 and six months until expiration. BioLabs’ common stock is currently selling for $30 per share, and Rob expects that the stock price will either
Two-State Option Pricing Model Maverick Manufacturing, Inc., must purchase gold in three months for use in its operations. Maverick’s management has estimated that if the price of gold were to rise above $1,530 per ounce, the firm would go bankrupt. The current price of gold is $1,450 per ounce.
Black–Scholes and Collar Cost An investor is said to take a position in a “collar”if she buys the asset, buys an out-of-the-money put option on the asset, and sells an out-of-the-money call option on the asset. The two options should have the same time to expiration. Suppose Marie wishes to
Debt Valuation and Time to Maturity McLemore Industries has a zero coupon bond issue that matures in two years with a face value of $50,000. The current value of the company’s assets is $29,000, and the standard deviation of the return on assets is 60 percent per year.a. Assume the risk-free rate
Debt Valuation and Asset Variance Brozik Corp. has a zero coupon bond that matures in five years with a face value of $60,000. The current value of the company’s assets is $57,000, and the standard deviation of its return on assets is 50 percent per year. The risk-free rate is 6 percent per year,
Two-State Option Pricing and Corporate Valuation Strudler Real Estate, Inc., a construction firm financed by both debt and equity, is undertaking a new project. If the project is successful, the value of the firm in one year will be $280 million, but if the project is a failure, the firm will be
Black–Scholes and Dividends In addition to the five factors discussed in the chapter, dividends also affect the price of an option. The Black–Scholes option pricing model with dividends is:C = S × e–dt × N(d1) – E × e–Rt × N(d2)d1 = [ln(S/E) + (R – d + σ2/2) × t]/(σ × √_ t )d2
Put–Call Parity and Dividends The put–call parity condition is altered when dividends are paid. The dividend-adjusted put–call parity formula is:S × e−dt − P = E × e−Rt + C where d is again the continuously compounded dividend yield.a. What effect do you think the dividend yield will
Put Delta In the chapter we noted that the delta for a put option is N( d 1 ) − 1.Is this the same thing as −N(− d 1 )? ( Hint: Yes, but why?)
Black–Scholes Put Pricing Model Use the Black–Scholes model for pricing a call, put–call parity, and the previous question to show that the Black–Scholes model for directly pricing a put can be written as follows:P = E × e−Rt × N(−d2 ) − S × N(−d1 )
Black–Scholes A stock is currently priced at $50. The stock will never pay a dividend. The risk-free rate is 12 percent per year, compounded continuously, and the standard deviation of the stock’s return is 60 percent. A European call option on the stock has a strike price of $100 and no
Delta You purchase one call and sell one put with the same strike price and expiration date. What is the delta of your portfolio? Why?
How many different volatilities would you expect to see for the stock?You are currently working for Clissold Industries. The company, which went public five years ago, engages in the design, production, and distribution of lighting equipment and specialty products worldwide. Because of recent
Unfortunately, solving for the implied standard deviation is not as easy as Mal suggests.In fact, there is no direct solution for the standard deviation of the stock even if we have all the other variables for the Black–Scholes model. Mal would still like you to estimate the implied standard
Are all of the implied volatilities for the options the same? ( Hint: No.) What are the possible reasons that can cause different volatilities for these options?You are currently working for Clissold Industries. The company, which went public five years ago, engages in the design, production, and
After you discuss the importance of volatility on option prices, your boss mentions that he has heard of the VIX. What is the VIX and what does it represent? You might need to visit the Chicago Board Options Exchange (CBOE) at www.cboe.com to help with your answer.You are currently working for
When you are on the CBOE website, look for the option quotes for the VIX. What does the implied volatility of a VIX option represent?You are currently working for Clissold Industries. The company, which went public five years ago, engages in the design, production, and distribution of lighting
A controversial practice with employee stock options is repricing. What happens is that a company experiences a stock price decrease, which leaves employee stock options far out of the money or “underwater.’’ In such cases, many companies have “repriced’’ or“restruck’’ the
As we have seen, much of the volatility in a company’s stock price is due to systematic or marketwide risks. Such risks are beyond the control of a company and its employees. What are the implications for employee stock options? In light of your answer, can you recommend an improvement over
Real Options What are the two options that many businesses have?
Project Analysis Why does a strict NPV calculation typically understate the value of a company or project?
Real Options Utility companies often face a decision to build new plants that burn coal, oil, or both. If the prices of both coal and gas are highly volatile, how valuable is the decision to build a plant that can burn either coal or oil? What happens to the value of this option as the correlation
Real Options Star Mining buys a gold mine, but the cost of extraction is currently too high to make the mine profitable. In option terminology, what type of option(s)does the company have on this mine?
Real Options You are discussing real options with a colleague. During the discussion, the colleague states, “Real option analysis makes no sense because it says that a real option on a risky venture is worth more than a real option on a safe venture.’’ How should you respond to this statement?
Real Options and Capital Budgeting Your company currently uses traditional capital budgeting techniques, including net present value. After hearing about the use of real option analysis, your boss decides that your company should use real option analysis in place of net present value. How would you
Insurance as an Option Insurance, whether purchased by a corporation or an individual, is in essence an option. What type of option is an insurance policy?
Real Options How would the analysis of real options change if a company has competitors?
Employee Stock Options Gary Levin is the chief executive officer of Mountainbrook Trading Company. The board of directors has just granted Mr. Levin 30,000 at-themoney European call options on the company’s stock, which is currently trading at $50 per share. The stock pays no dividends. The
Employee Stock Options Jared Lazarus has just been named the new chief executive officer of BluBell Fitness Centers, Inc. In addition to an annual salary of $410,000, his three-year contract states that his compensation will include 15,000 at-the-money European call options on the company’s stock
Binomial Model Gasworks, Inc., has been approached to sell up to 5 million gallons of gasoline in three months at a price of $3.65 per gallon. Gasoline is currently selling on the wholesale market at $3.30 per gallon and has a standard deviation of 58 percent. If the risk-free rate is 6 percent per
Real Options Jet Black is an international conglomerate with a petroleum division and is currently competing in an auction to win the right to drill for crude oil on a large piece of land in one year. The current market price of crude oil is $93 per barrel, and the land is believed to contain
Binomial Model There is a European put option on a stock that expires in two months. The stock price is $73, and the standard deviation of the stock returns is 70 percent. The option has a strike price of $80, and the risk-free interest rate is a 5 percent annual percentage rate. What is the price
Binomial Model In the previous problem, assume that the exercise style on the option is American rather than European. What is the price of the option now?( Hint: How will you find the value of the option if it can be exercised early? When would you exercise the option early?)
Real Options You are in discussions to purchase an option on an office building with a strike price of $63 million. The building is currently valued at $60 million. The option will allow you to purchase the building either six months from today or one year from today. Six months from today, accrued
Dilution What is dilution, and why does it occur when warrants are exercised?
Warrants and Convertibles What is wrong with the simple view that it is cheaper to issue a bond with a warrant or a convertible feature because the required coupon is lower?
Convertible Bonds Why will convertible bonds not be voluntarily converted to stock before expiration?
Convertible Bonds When should a firm force conversion of convertibles? Why?
Warrant Valuation A warrant with six months until expiration entitles its owner to buy 10 shares of the issuing firm ’ s common stock for an exercise price of $31 per share. If the current market price of the stock is $15 per share, will the warrant be worthless?
Conversion Price A convertible bond has a conversion ratio of 24.6. What is the conversion price?
Warrant Value A warrant gives its owner the right to purchase three shares of common stock at an exercise price of $53 per share. The current market price of the stock is $58. What is the minimum value of the warrant?
Convertible Bond Value An analyst has recently informed you that at the issuance of a company’ s convertible bonds, one of the two following sets of relationships existed:Scenario A Scenario B Face value of bond $1,000 $1,000 Straight value of convertible bond 900 950 Market value of convertible
Convertible Bond Value Sportime Fitness Center, Inc., issued convertible bonds with a conversion price of $51. The bonds are available for immediate conversion.The current price of the company ’ s common stock is $44 per share. The current market price of the convertible bonds is $990. The
Convertible Bonds You own a callable, convertible bond with a conversion ratio of 24.25.The stock is currently selling for $48 per share. The issuer of the bond has announced a call at a call price of 110.What are your options here? What should you do?
Warrant Value General Modems has five-year warrants that currently trade in the open market. Each warrant gives its owner the right to purchase one share of common stock for an exercise price of $55.a. Suppose the stock is currently trading for $51 per share. What is the lower limit on the price of
Convertible Bonds Bernanke Corp. has just issued a 30-year callable, convertible bond with a coupon rate of 6 percent annual coupon payments. The bond has a conversion price of $93. The company ’ s stock is selling for $28 per share. The owner of the bond will be forced to convert if the bond ’
Convertible Bonds Rob Stevens is the chief executive officer of Isner Construction, Inc., and owns 950,000 shares of stock. The company currently has 6 million shares of stock and convertible bonds with a face value of $40 million outstanding. The convertible bonds have a conversion price of $38,
Convertible Calculations You have been hired to value a new 20-year callable, convertible bond. The bond has a 5.8 percent coupon rate, payable annually. The conversion price is $150, and the stock currently sells for $32.20. The stock price is expected to grow at 12 percent per year. The bond is
Warrant Value Superior Clamps, Inc., has a capital structure consisting of 7 million shares of common stock and 900,000 warrants. Each warrant gives its owner the right to purchase one share of newly issued common stock for an exercise price of $25. The warrants are European and will expire one
Why do you think Chris is suggesting a conversion price of $45? Given that the company is not publicly traded, does it even make sense to talk about a conversion price?Chris Guthrie was recently hired by S & S Air, Inc., to assist the company with its shortterm financial planning and to evaluate
What is the floor value of the S & S Air convertible bond?Chris Guthrie was recently hired by S & S Air, Inc., to assist the company with its shortterm financial planning and to evaluate the company ’ s performance. Chris graduated from college five years ago with a finance degree. He has been
What is the conversion ratio of the bond?Chris Guthrie was recently hired by S & S Air, Inc., to assist the company with its shortterm financial planning and to evaluate the company ’ s performance. Chris graduated from college five years ago with a finance degree. He has been employed in the
What is the conversion premium of the bond?Chris Guthrie was recently hired by S & S Air, Inc., to assist the company with its shortterm financial planning and to evaluate the company ’ s performance. Chris graduated from college five years ago with a finance degree. He has been employed in the
What is the value of the option?Chris Guthrie was recently hired by S & S Air, Inc., to assist the company with its shortterm financial planning and to evaluate the company ’ s performance. Chris graduated from college five years ago with a finance degree. He has been employed in the finance
Is there anything wrong with Todd ’ s argument that it is cheaper to issue a bond with a convertible feature because the required coupon is lower?Chris Guthrie was recently hired by S & S Air, Inc., to assist the company with its shortterm financial planning and to evaluate the company ’ s
Is there anything wrong with Mark ’ s argument that a convertible bond is a bad idea because it allows new shareholders to participate in gains made by the company?Chris Guthrie was recently hired by S & S Air, Inc., to assist the company with its shortterm financial planning and to evaluate the
How can you reconcile the arguments made by Todd and Mark?Chris Guthrie was recently hired by S & S Air, Inc., to assist the company with its shortterm financial planning and to evaluate the company ’ s performance. Chris graduated from college five years ago with a finance degree. He has been
During the debate, a question comes up concerning whether the bonds should have an ordinary (not make-whole) call feature. Chris confuses everybody by stating, “ The call feature lets S & S Air force conversion, thereby minimizing the problem Mark has identified.’ ’ What is he talking about?
Hedging Strategies If a firm is buying call options on pork belly futures as a hedging strategy, what must be true about the firm’s exposure to pork belly prices?
Forwards and Futures What is the difference between a forward contract and a futures contract? Why do you think that futures contracts are much more common? Are there any circumstances under which you might prefer to use forwards instead of futures? Explain.
Hedging Interest Rates A company has a large bond issue maturing in one year.When it matures, the company will float a new issue. Current interest rates are attractive, and the company is concerned that rates next year will be higher. What are some hedging strategies that the company might use in
Swaps Explain why a swap is effectively a series of forward contracts. Suppose a firm enters a swap agreement with a swap dealer. Describe the nature of the default risk faced by both parties.
Swaps Suppose a firm enters a fixed for floating interest rate swap with a swap dealer. Describe the cash flows that will occur as a result of the swap.
Hedging Strategies For the following scenarios, describe a hedging strategy using futures contracts that might be considered.a. A public utility is concerned about rising costs.b. A candy manufacturer is concerned about rising costs.c. A corn farmer fears that this year’s harvest will be at
Hedging Strategies William Santiago is interested in entering the import/export business. During a recent visit with his financial advisers, he said, “If we play the game right, this is the safest business in the world. By hedging all of our transactions in the foreign exchange futures market, we
Hedging Strategies Kevin Nomura is a Japanese student who is planning a oneyear stay in the United States. He expects to arrive in the United States in eight months. He is worried about depreciation of the yen relative to the dollar over the next eight months and wishes to take a position in
Futures Quotes Refer to Table 25.2 in the text to answer this question. Suppose you sell five March 2012 silver futures contracts on November 22, 2011, at the last price of the day. What will your profit or loss be if silver prices turn out to be $31.39 per ounce at expiration? What if silver
Marking to Market You are long 10 gold futures contracts, established at an initial settle price of $1,580 per ounce, where each contract represents 100 ounces. Over the subsequent four trading days, gold settles at $1,587, $1,582, $1,573, and $1,584, respectively. Compute the cash flows at the end
Marking to Market You are short 25 gasoline futures contracts, established at an initial settle price of $2.46 per gallon, where each contract represents 42,000 gallons.Over the subsequent four trading days, gasoline settles at $2.42, $2.47, $2.50, and$2.56, respectively. Compute the cash flows at
Duration What is the duration of a bond with three years to maturity and a coupon of 7 percent paid annually if the bond sells at par?
Duration What is the duration of a bond with four years to maturity and a coupon of 8 percent paid annually if the bond sells at par?
Duration Blue Steel Community Bank has the following market value balance sheet:Asset or Liability Market Value(in $ millions)Duration(in years)Federal funds deposits $ 31 0 Accounts receivable 590 .20 Short-term loans 340 .65 Long-term loans 98 5.25 Mortgages 485 12.85 Checking and savings
Hedging with Futures Refer to Table 25.2 in the text to answer this question.Suppose today is November 22, 2011, and your firm produces breakfast cereal and needs 140,000 bushels of corn in March 2012 for an upcoming promotion. You would like to lock in your costs today because you are concerned
Interest Rate Swaps ABC Company and XYZ Company need to raise funds to pay for capital improvements at their manufacturing plants. ABC Company is a well-established firm with an excellent credit rating in the debt market; it can borrow funds either at 11 percent fixed rate or at LIBOR + 1 percent
Duration Ted and Alice Hansel have a son who will begin college 10 years from today. School expenses of $30,000 will need to be paid at the beginning of each of the four years that their son plans to attend college. What is the duration of this liability to the couple if they can borrow and lend at
Duration What is the duration of a bond with two years to maturity if the bond has a coupon rate of 7 percent paid semiannually, and the market interest rate is 5 percent?
Forward Pricing The forward price ( F ) of a contract on an asset with neither carrying costs nor convenience yield is the current spot price of the asset ( S 0 )multiplied by 1, plus the appropriate interest rate between the initiation of the contract and the delivery date of the asset. Derive
Forward Pricing You enter into a forward contract to buy a 10-year, zero coupon bond that will be issued in one year. The face value of the bond is $1,000, and the 1-year and 11-year spot interest rates are 5 percent and 7 percent, respectively.a. What is the forward price of your contract?b.
Forward Pricing This morning you agreed to buy a one-year Treasury bond in six months. The bond has a face value of $1,000. Use the spot interest rates listed here to answer the following questions:Time EAR 6 months 3.61%12 months 4.05 18 months 4.73 24 months 5.42a. What is the forward price of
Financial Engineering Suppose there were call options and forward contracts available on coal, but no put options. Show how a financial engineer could synthesize a put option using the available contracts. What does your answer tell you about the general relationship between puts, calls, and
What is the monthly mortgage payment on Jerry’s mortgage?Jennifer Williamson recently received her MBA and has decided to enter the mortgage brokerage business. Rather than work for someone else, she has decided to open her own shop. Her cousin Jerry has approached her about a mortgage for a
What is the most significant risk Jennifer faces in this deal?Jennifer Williamson recently received her MBA and has decided to enter the mortgage brokerage business. Rather than work for someone else, she has decided to open her own shop. Her cousin Jerry has approached her about a mortgage for a
How can Jennifer hedge this risk?Jennifer Williamson recently received her MBA and has decided to enter the mortgage brokerage business. Rather than work for someone else, she has decided to open her own shop. Her cousin Jerry has approached her about a mortgage for a house he is building.The house
Suppose that in the next three months the market rate of interest rises to 6.2 percent.a. How much will Max be willing to pay for the mortgage?b. What will happen to the value of Treasury bond futures contracts? Will the long or short position increase in value?Jennifer Williamson recently received
Suppose that in the next three months the market rate of interest falls to 4.6 percent.a. How much will Max be willing to pay for the mortgage?b. What will happen to the value of Treasury bond futures contracts? Will the long or short position increase in value?Jennifer Williamson recently received
Are there any possible risks Jennifer faces in using Treasury bond futures contracts to hedge her interest rate risk?Jennifer Williamson recently received her MBA and has decided to enter the mortgage brokerage business. Rather than work for someone else, she has decided to open her own shop. Her
Reasons for Net Working Capital In an ideal economy, net working capital is always zero. Why might net working capital be positive in a real economy?
Calculating Cash Collection s The Litzenberger Company has projected the following quarterly sales amounts for the coming year:Q1 Q2 Q3 Q4 Sales $740 $810 $780 $940a. Accounts receivable at the beginning of the year are $310. Litzenberger has a 45-day collection period. Calculate cash collections
Calculating Cycle s Consider the following financial statement information for the Bulldog Icers Corporation:Item Beginning Ending Inventory $17,385 $19,108 Accounts receivable 13,182 13,973 Accounts payable 15,385 16,676 Net sales $178,312 Cost of goods sold 140,382 Calculate the operating and
Calculating Payment s Lewellen Products has projected the following sales for the coming year:Q1 Q2 Q3 Q4 Sales $620 $555 $705 $780 Sales in the year following this one are projected to be 15 percent greater in each quarter.a. Calculate payments to suppliers assuming that Lewellen places orders
Calculating Payments The Thakor Corporation’s purchases from suppliers in a quarter are equal to 75 percent of the next quarter’s forecast sales. The payables period is 60 days. Wages, taxes, and other expenses are 20 percent of sales, and interest and dividends are $73 per quarter. No capital
Calculating Cash Collection s The following is the sales budget for Shleifer, Inc., for the first quarter of 2013:January February March Sales budget $234,800 $249,300 $271,000 Credit sales are collected as follows:65 percent in the month of the sale.20 percent in the month after the sale.15
Calculating the Cash Budge t Here are some important figures from the budget of Cornell, Inc., for the second quarter of 2013:April May June Credit sales $547,200 $570,240 $630,720 Credit purchases 211,680 252,720 288,450 Cash disbursements Wages, taxes, and expenses 57,240 69,422 72,432 Interest
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