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Questions and Answers of Corporate Finance

Max and Veronica Shuman, along with their teenage sons, Terry and Thomas, live in Portland, Oregon. Max is a sales rep for a major medical firm, and Veronica is a personnel officer at a local bank.
It€™s probably safe to say that there€™s nothing more important in determining a bond€™s rating than the underlying financial condition and operating results of the
Is there a single market rate of interest applicable to all segments of the bond market, or are there a series of market yields? Explain and note the investment implications of such a market
What does the term duration mean to bond investors and how does the duration of a bond differ from its maturity? What is modified duration, and how is it used? What is effective duration, and how
Describe the process of bond portfolio immunization, and explain why an investor would want to immunize a portfolio. Would you consider portfolio immunization a passive investment strategy comparable
Briefly describe a bond ladder and note how and why an investor would use this investment strategy. What is a tax swap and why would it be used?
What strategy would you expect an aggressive bond investor (someone who’s looking for capital gains) to employ?
Why is interest sensitivity important to bond speculators? Does the need for interest sensitivity explain why active bond traders tend to use high-grade issues? Explain.
Explain why interest rates are important to both conservative and aggressive bond investors. What causes interest rates to move, and how can you monitor such movements?
What is the term structure of interest rates and how is it related to the yield curve? What information is required to plot a yield curve? Describe an upward-sloping yield curve and explain what it
How might you, as a bond investor, use information about the term structure of interest rates and yield curves when making investment decisions?
Explain how market yield affects the price of a bond. Could you price a bond without knowing its market yield? Explain.
Why are bonds generally priced using semiannual compounding? Does it make much difference if you use annual compounding?
What’s the difference between current yield and yield to maturity? Between promised yield and realized yield? How does YTC differ from YTM?
Briefly describe the term bond-equivalent yield. Is there any difference between promised yield and bond-equivalent yield? Explain.
Why is the reinvestment of interest income so important to bond investors?
Briefly describe each of the following theories of the term structure of interest rates. a. Expectations hypothesis b. Liquidity preference theory c. Market segmentation theory According to these
Briefly explain what will happen to a bond’s duration measure if each of the following events occur. a. The yield to maturity on the bond falls from 8.5% to 8%. b. The bond gets 1 year closer to
Assume that an investor comes to you looking for advice. She has $200,000 to invest and wants to put it all into bonds. a. If she considers herself a fairly aggressive investor who is willing to take
An investor is considering the purchase of a $1,000 par value bond with an 8% coupon rate (with interest paid semiannually) that matures in 5 years. If the bond is priced to yield 6%, what is the
What is the current yield for a $1,000 par value bond that pays interest semiannually, has 9 years to maturity, and is currently selling for $937 with a bond equivalent yield of 12%?
An investor is considering the purchase of an 8%, 18-year corporate bond that’s being priced to yield 10%. She thinks that in a year, this bond will be priced in the market to yield 9%. Using
A bond is currently selling in the market for $1,170.68. It has a coupon of 12% and a 20-year maturity. Using annual compounding, calculate the promised yield on this bond.
A bond is currently selling in the market for $1,098.62. It has a coupon of 9% and a 20-year maturity. Using annual compounding, calculate the yield to maturity on this bond.
Compute the current yield of a 10%, 25-year bond that is currently priced in the market at $1,200. Use annual compounding to find the promised yield on this bond. Repeat the promised yield
You are evaluating an outstanding issue of $1,000 par value bonds with a 12% coupon rate that mature in 30 years and make quarterly interest payments. If the current market price for the bonds is
A 10%, 25-year bond has a par value of $1,000 and a call price of $1,075. (The bond’s first call date is in 5 years.) Coupon payments are made semiannually. a. Find the current yield, YTM, and YTC
Assume that an investor is looking at 2 bonds: Bond A is a 20-year, 9% (semiannual pay) bond that is priced to yield 10.5%. Bond B is a 20-year, 8% (annual pay) bond that is priced to yield 7.5%.
A zero-coupon bond that matures in 15 years is currently selling for $209 per $1,000 par value. What is the promised yield on this bond?
A zero-coupon ($1,000 par value) bond that matures in 10 years has a promised yield of 9%. What is the bond’s price?
Two bonds have par values of $1,000. One is a 5%, 15-year bond priced to yield 8%. The other is a 7.5%, 20-year bond priced to yield 6%. Which of these has the lower price?
A 25-year, zero-coupon bond was recently being quoted at 11.625% of par. Find the current yield and the promised yield of this issue, given that the bond has a par value of $1,000. Using semiannual
Assume that an investor pays $800 for a long-term bond that carries an 8% coupon. In 3 years, he hopes to sell the issue for $950. If his expectations come true, what yield will this investor
Using annual compounding, find the yield to maturity for each of the following bonds. a. A 9.5%, 20-year bond priced at $957.43 b. A 16%, 15-year bond priced at $1,684.76 c. A 5.5%, 18-year bond
A bond has a Macaulay duration of 8.62 and is priced to yield 8%. If interest rates go up so that the yield goes to 8.5%, what will be the percentage change in the price of the bond? Now, if the
An investor wants to find the duration of a 25-year, 6% semiannual-pay, noncallable bond that’s currently priced in the market at $882.72, to yield 7%. Using a 50 basis point change in yield, find
Find the Macaulay duration and the modified duration of a 20-year, 10% corporate bond priced to yield 8%. According to the modified duration of this bond, how much of a price change would this bond
Which one of the following bonds would you select if you thought market interest rates were going to fall by 50 basis points over the next 6 months? a. A bond with a Macaulay duration of 8.46 years
Stacy Picone is an aggressive bond trader who likes to speculate on interest rate swings. Market interest rates are currently at 9%, but she expects them to fall to 7% within a year. As a result,
Elliot Karlin is a 35-year-old bank executive who has just inherited a large sum of money. Having spent several years in the bank’s investments department, he’s well aware of the concept of
Using semiannual compounding, find the prices of the following bonds. a. A 10.5%, 15-year bond priced to yield 8% b. A 7%, 10-year bond priced to yield 8% c. A 12%, 20-year bond priced at 10% Repeat
A 15-year bond has an annual-pay coupon of 7.5% and is priced to yield 9%. Calculate the price per $1,000 par value.
A $1,000 par value bond has a current price of $800 and a maturity value of $1,000 and matures in 5 years. If interest is paid semiannually and the bond is priced to yield 8%, what is the bond’s
A 20-year bond has a coupon of 10% and is priced to yield 8%. Calculate the price per $1,000 par value using semiannual compounding. If an investor purchases this bond 2 months before a scheduled
A $1,000 par value bond with an 8% coupon rate (semiannual interest) matures in 5 years and currently sells for $1,200. What is the bond’s yield to maturity?
Dave and Marlene Carter live in the Boston area, where Dave has a successful orthodontics practice. Dave and Marlene have built up a sizable investment portfolio and have always had a major portion
Grace Hesketh is the owner of an extremely successful dress boutique in downtown Chicago. Although high fashion is Grace’s first love, she’s also interested in investments, particularly bonds and
Describe put and call options. Are they issued like other corporate securities?
Describe at least 3 ways in which investors can use stock options.
What’s the most that can be made from writing calls? Why would an investor want to write covered calls? Explain how you can reduce the risk on an underlying common stock by writing covered calls.
Briefly describe the differences and similarities between stock-index options and stock options. Do the same for foreign currency options and stock options.
Identify and briefly discuss 2 ways to use stock-index options. Do the same for foreign currency options.
Why would an investor want to use index options to hedge a portfolio of common stock? Could the same objective be obtained using options on ETFs? If the investor thinks the market is in for a fall,
What are LEAPS? Why would an investor want to use a LEAPS option rather than a regular listed option?
What are listed options, and how do they differ from conventional options?
What are the main investment attractions of put and call options? What are the risks?
What is a stock option? What is the difference between a stock option and a derivative security? Describe a derivative security and give several examples.
What is a strike price? How does it differ from the market price of the stock?
Why do put and call options have expiration dates? Is there a market for options that have passed their expiration dates?
Briefly explain how you would make money on (a) a call option and (b) a put option. Do you have to exercise the option to capture the profit?
How do you find the intrinsic (fundamental) value of a call? Of a put? Does an out-of-the- money option have intrinsic value?
Name at least 4 variables that affect the price behavior of listed options, and briefly explain how each affects prices. How important are fundamental (intrinsic) value and time value to in-the-money
Using the stock option quotations in Figure 14.4 (on page 556), find the option premium, the time value, and the stock index breakeven point for the following puts and calls. a. The December put
Prepare a schedule similar to the one in Table 14.1 (on page 544) for the call and put options listed in Figure 14.4 (on page 556). Briefly explain your findings.
Alcan stock recently closed at $52.51. Assume that you write a covered call on Alcan by writing one September call with a strike price of $55, and buying 100 shares of stock at the market price. The
Assume you hold a well-balanced portfolio of common stocks. Under what conditions might you want to use a stock-index (or ETF) option to hedge the portfolio? a. Briefly explain how such options could
P. F. Chang holds a well-diversified portfolio of high-quality, large-cap stocks. The current value of Chang’s portfolio is $735,000, but he is concerned that the market is heading for a big fall
Angelo Martino just purchased 500 shares of AT&E at $61.50, and he has decided to write covered calls against these stocks. Accordingly, he sells five AT&E calls at their current market price of
Rick owns stock in a retailer that he believes is highly undervalued. Rick expects that the stock will increase in value nicely over the long term. He is concerned, however, that the entire retail
Suppose the DJIA stands at 11,200. You want to set up a long straddle by purchasing100 calls and an equal number of puts on the index, both of which expire in 3 months and havea strike of 112. The
A stock trades for $45 per share. A call option on that stock has a strike price of $50 and an expiration date 1 year in the future. The volatility of the stock’s returns is 30%, and the risk-free
Gillette is trading at $31.11. Call options with a strike price of $35 are priced at $0.30. What is the intrinsic value of the option, and what is the time value?
Verizon is trading at $36. Put options with a strike price of $45 are priced at $10.50. What is the intrinsic value of the option, and what is the time value?
A 6-month call option contract on 100 shares of Home Depot common stock with a strike price of $60 can be purchased for $600. Assuming that the market price of Home Depot stock rises to $75 per
You believe that oil prices will be rising more than expected and that rising prices will result in lower earnings for industrial companies that use a lot of petroleum-related products in their
Refer to the table for XLB in Problem 14.6. What happens if you are wrong and the price of XLB increases to $25 on the expiration date?
Dorothy Santosuosso does a lot of investing in the stock market and is a frequent user of stock-index options. She is convinced that the market is about to undergo a broad retreat and has decided to
Myles Houck holds 600 shares of Lubbock Gas and Light. He bought the stock several years ago at $48.50, and the shares are now trading at $75. Myles is concerned that the market is beginning to
Hector Francisco is a successful businessman in Atlanta. The box-manufacturing firm he and his wife, Judy, founded several years ago has prospered. Because he is self employed, Hector is building his
A little more than 10 months ago, Luke Weaver, a mortgage banker in Phoenix, bought 300 shares of stock at $40 per share. Since then, the price of the stock has risen to $75 per share. It is now near
What are BANs and TANs? Why are they accounted for differently?
Exploring Vero Beach€™s Financial Report Refer to the financial statements of the City of Vero Beach in Chapter 3 and to Table 8€“1.1. What amount did Vero Beach report in its government-wide
The accounting for BANs depends on events subsequent to year-end.In anticipation of issuing of long-term bonds, a state issues $200 million of 60-day BANs to finance highway construction. It expects
Demand bonds may provide the issuer with the disadvantages but not the advantages of long-term debt.On January 1, 2013 a city issues $2 million in 7% demand bonds. Although the bonds have a term of
BANs, TANs, and RANs may sound alike, but they are not necessarily accounted for in a like manner.In August 2012 voters of Balcones, a medium-sized city approved a $15 million general obligation bond
Think of another company or product besides Apples iPod and note the connections between other functional areas and finance.
Why are ethics important in corporate finance? What is the likely consequence of unethical behavior by a corporation and its managers?
List and briefly describe five main career paths open to finance graduates.
What is a financial intermediary? Why do you think these institutions have steadily been losing market share to capital markets as the principal source of external financing for corporations? List
List the five basic corporate finance functions. What is the general relationship among them?
Which of the five basic corporate finance functions might be considered nontraditional? Why do you think these functions have become so important in recent years?
What are the costs and benefits of each of the three major organizational forms in the United States? Why do you think the various hybrid forms of business organization have proven so successful?
Comment on the following statement: Sooner or later, all successful private companies that are organized as proprietorships or partnerships must be-come corporations.
What are agency costs? Why do these tend to increase in severity as a corporation grows larger?
What are the relative advantages and disadvantages of using sophisticated management compensation packages to align the interests of managers and shareholders?
Why must a financial manager have an integrated understanding of the five basic finance functions? Why the corporate governance function is considered a finance function? Has the risk-management
What are the advantages and disadvantages of the different legal forms of business organization? Could the limited liability advantage of a corporation also lead to an agency problem? Why? What legal
Describe the differences between businesses in the United States and those in foreign countries with respect to taxation, financial disclosure, and ownership structure. Is privatization reducing or
Can there be a difference between profit maximization and shareholder wealth maximization? If so, what could cause this difference? Which of the two should be the goal of the firm and its management?
What role do the FASB and SEC play with regard to GAAP?

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