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Questions and Answers of Corporate Finance

When the buyer of a put option on a futures contract exercises, explain the resulting position for the buyer and the writer.
An investor wants to protect against a rise in the market yield on a Treasury bond. Should the investor purchase a put option or a call option to obtain protection?
What is the intrinsic value and time value of a call option on bond W given the following information? strike price of call option = 97 current price of bond W = 102 call option price = 9
“There’s no real difference between options and futures. Both are hedging tools, and both are derivative products. It’s just that with options you have to pay an option premium, whereas futures
What arguments would be given by those who feel that the Black-Scholes model does not apply in pricing interest-rate options?
Below are some excerpts from an article titled “It’s Boom Time for Bond Options as Interest-Rate Hedges Bloom,” published in the November 8, 1990, issue of The Wall Street Journal.Answer each
What are the differences between an option on a bond and an option on a bond futures contract?
What is the motivation for the purchase of an over-the-counter option?
Suppose that a dealer quotes these terms on a five-year swap: fixed-rate payer to pay 4.4% for LIBOR and fixed-rate receiverto pay LIBOR for 4.2%.Answer the below questions.(a) What is the dealer’s
Consider the following interest-rate swap:• The swap starts today, January 1 of year 1 (swap settlement date)• The floating-rate payments are made quarterly based on actual / 360• The reference
Answer the below questions.(a) Assume that the swap rate for an interest-rate swap is 7% and that the fixed-rate swap payments are made quarterly on an actual / 360 basis. If the notional amount of a
Given the current 3-month LIBOR and the Eurodollar futures prices shown in the table below, compute the forward rate and the forward discount factor for each period.
Answer the below questions.(a) Suppose that at the inception of a five-year interest-rate swap in which the reference rate is 3-month LIBOR the present value of the floating-rate payments is
An interest-rate swap had an original maturity of five-years. Today, the swap has two years to maturity. The present value of the fixed-rate payments for the remainder of the term of the swap is
Suppose that a savings and loan association buys an interest-rate cap that has these terms: The reference rate is the 6-month Treasury bill rate; the cap will last for five years; payment is
What is the relationship between an interest-rate agreement and an option on an interest rate?
How can an interest-rate collar be created?
Value a three-year interest rate floor with a $10 million notional amount and a floor rate of 4.8% using the binomial interest-rate trees shown in Exhibit 31-11.
Give two interpretations of an interest-rate swap.
In determining the cash flow for the floating-rate side of a LIBOR swap, explain how the cash flow is determined.
How is the swap rate calculated?
Suppose that a life insurance company has issued a three-year GIC with a fixed-rate of 10%. Under what circumstances might it be feasible for the life insurance company to invest the funds in a
How can interest rate swap be used to reduce the duration of portfolio to match the duration of a benchmark?
A portfolio manager buys a swaption with a strike rate of 4.5% that entitles the portfolio manager to enter into an interest-rate swap to pay a fixed-rate and receives a floating rate. The term of
The following appeared on a quote sheet: “Receiver Swaption: An option to receive the fixed leg of a swap (i.e., long receiver is long duration). Payer Swaption: An option to pay the fixed leg of a
The manager of a savings and loan association is considering the use of a swap as part of its asset/liability strategy. The swap would be used to convert the payments of its portfolio of fixed-rate
How does the role of a credit derivative differ from that of an interest-rate swap in terms of controlling risk?
Answer the below questions.(a) For a single-name credit default swap, what is the difference between physical settlement and cash settlement?(b) In physical settlement, why is there a
For a CDS with the following terms, indicate the quarterly premium payment by filling in the below exhibit.
In the ISDA’s pay-as-you go template, why might there be payments by the credit protection buyer to the credit protection seller beyond that of the swap premium?
How do the cash flows for a CDS swap differ from that of a single-name CDS?
How does one approximate the CDS spread for a single-name CDS on a corporate entity?
Answer the below questions.(a) What is an asset swap?(b)In pricing a single-name CDS, what information does the par asset swap market contain?
The following is an excerpt from “MCDX Municipal CDS index on the rise,” Credit Default Swap Market Reporting, July 1, 2010 (blog.creditlime.com/2010/07/01/municipal-cds-index-rising/)The 5-year
In an April 21, 2011 article in Bloomberg.com by Abigail Moses entitled, “Greece, Portugal Sovereign Credit-Default Swaps Jump to
Answer the below questions. (a) Explain how a single-name CDS can be used by a portfolio manager who wants to short a reference entity.(b) Explain how a single-name CDS can be used by a portfolio
How are index CDS used by portfolio managers?
Why is a portfolio manager concerned with more than default risk when assessing a portfolio’s credit exposure?
How can a client determine if a portfolio manager is using a CDS for leveraging in such a way as to increase the portfolio’s risk relative to a bond index?
Answer the below questions.(a) What is meant by a reference entity?(b) What is meant by a reference obligation?
What authoritative source is used for defining a “credit event”?
Why is “restructuring” the most controversial credit event?
Why does a credit default swap have an option-type payoff?
Comment on the following statement:“Restructuring is included in credit default swaps and therefore the reduction in a reference obligation’s interest rate will result in the triggering of a
All other factors constant, for a given reference obligation and a given scheduled term, explain whether a credit default swap using full or old restructuring or modified restructuring would be more
The focus in an asset- backed securities CDS is on the cash-paying ability of the collateral and not on bankruptcy. Why?
What are some of the problems involved in implementing the goal of maximization of share-holder wealth?
Firms often involve themselves in projects that do not result directly in profits. For example, Apple, which we featured in the chapter introduction, donated $ 50 million to Stanford University
What is the relationship between financial decision making and risk and return? Would all financial managers view risk– return trade- offs similarly?
What is the agency problem and how might it impact the goal of maximization of shareholder wealth?
Define (a) Sole proprietorship, (b) Partnership, and (c) Corporation.
Identify the primary characteristics of each form of legal organization.(a) sole proprietor (b) partnership (c) Corporation
Using the following criteria, specify the legal form of business that is favored: (a) Organizational requirements and costs, (b) Liability of the owners, (c) The continuity of the business, (d)
The final stage in the interview process for an assistant financial analyst at Caledonia Products involves a test of your understanding of basic financial concepts. You are given the following
Distinguish between the money and capital markets.
Identify three distinct ways that savings are ultimately transferred to business firms in need of cash.
Explain the term opportunity cost with respect to the cost of funds to the firm.
Explain the impact of inflation on rates of return.
Define the term structure of interest rates.
Explain the popular theories for the rationale of the term structure of interest rates.
What major benefits do corporations and investors enjoy because of the existence of organized security exchanges?
What general criteria does an organized exchange examine to determine whether a firm’s securities can be listed on the exchange? (Specific numbers are not needed here but rather areas of
Why do you think most secondary- market trading in bonds takes place over the counter?
What is an investment banker, and what major functions does he or she perform?
What is the major difference between a negotiated purchase and a competitive bid purchase?
Why is an investment- banking syndicate formed?
Why might a large corporation want to raise long- term capital through a private placement rather than a public offering?
As a recent business school graduate, you work directly for the corporate treasurer. Your corporation is going to issue a new security and is concerned with the probable flotation costs. What
At present, 10- year Treasury bonds are yielding 4% while a 10- year corporate bond is yielding 6.8%. If the liquidity- risk premium on the corporate bond is 0.4%, what is the corporate bond’s
If the 10- year Treasury bond rate is 4.9%, the inflation premium is 2.1%, and the maturity- risk premium on 10- year Treasury bonds is 0.3%, assuming that there is no liquidity- risk premium on
You€™ve just taken a job at a investment banking firm and been given the job of calculating the appropriate nominal interest rate for a number of different Treasury bonds with different
You€™re looking at some corporate bonds issued by Ford, and you are trying to determine what the nominal interest rate should be on them. You have determined that the real risk- free
You want to invest your savings of $ 20,000 in government securities for the next 2 years. Currently, you can invest either in a security that pays interest of 8 percent per year for the next 2 years
If yields on Treasury securities were currently as follows:a. Plot the yield curve. b. Explain this yield curve using the unbiased expectations theory and the liquidity preference theory.
At present, the real risk- free rate of interest is 2%, while inflation is expected to be 2% for the next 2 years. If a 2- year Treasury note yields 4.5%, what is the maturity- risk premium for this
You’re considering an investment that you expect will produce an 8 percent return next year, and you expect that your real rate of return on this investment will be 6 percent. What do you expect
Assume the expected inflation rate to be 4 percent. If the current real rate of interest is 6 percent, what ought the nominal rate of interest to be?
You are considering investing money in Treasury bills and wondering what the real risk- free rate of interest is. Currently, Treasury bills are yielding 4.5% and the future inflation rate is expected
If the real risk- free rate of interest is 4.8% and the rate of inflation is expected to be constant at a level of 3.1%, what would you expect 1- year Treasury bills to return if you ignore the cross
At present, 20- year Treasury bonds are yielding 5.1% while some 20- year corporate bonds that you are interested in are yielding 9.1%. Assuming that the maturity- risk premium on both bonds is the
On the first day of your summer internship, you’ve been assigned to work with the chief financial officer (CFO) of SanBlas Jewels Inc. Not knowing how well trained you are, the CFO has decided to
A company’s financial statements consist of the balance sheet, income statement, and statement of cash flows. Describe what each statement tells us.
How do gross profits, operating profits, and net income differ?
How do dividends and interest expense differ?
Why is it that the preferred stockholders’ equity section of the balance sheet changes only when new shares are sold or repurchased, whereas the common stockholders’ equity section changes from
Why might one firm have positive cash flows and be headed for financial trouble, whereas another firm with negative cash flows could actually be in a good financial position?
What are the differences between GAAP and IFRS?
If ABC Company earned $ 280,000 in net income and paid cash dividends of $ 40,000, what are ABC’s earnings per share if it has 80,000 shares outstanding?
Given the following information, prepare a statement of cash flows. Beginning Cash.............. $ 20 Dividends................. 25 Increase in common stock......... 27 Increase in accounts
Interpret the following information regarding Maness Corporation€™s statement of cash flows.
Prepare a statement of cash flows for Abrahams Manufacturing Company for the year ended December 31, 2012. Interpret your results.Abrahams Manufacturing Company Income Statement for the Year Ended
Prepare a statement of cash flows from the following scrambled list of items. Increase in inventories........ $ 7,000 Operating income ........ 219,000 Dividends............. 29,000 Increase in
Given the information on page 90 for Pamplin Inc.:a. How much is the firm€™s net working capital and what is the debt ratio?b. Complete a common- sized income statement, a common- sized
Based on the information for T. P. Jarmon Company for the year ended December 31, 2012:a. How much is the firm€™s net working capital and what is the debt ratio?b. Complete a statement of
The William B. Waugh Corporation is a regional Toyota dealer. The firm sells new and used trucks and is actively involved in the parts business. During the most recent year, the company generated
Sandersen Inc. sells minicomputers. During the past year, the company’s sales were $ 3 million. The cost of its merchandise sold came to $ 2 million, and cash operating expenses were $ 400,000;
Prepare an income statement and a common- sized income statement from the following information.Sales............... $ 525,000Cost of goods sold......... 200,000General and administrative
Prepare a balance sheet from the following information. What is the net working capital and debt ratio? 2Cash................. $ 50,000 Accounts receivable.......... 42,700 Accounts
Prepare a balance sheet and a common- sized balance sheet from the following information.Cash.............. $ 30,000Accounts receivable........ 63,800Accounts payable......... 52,500Short- term
Prepare a balance sheet and income statement for Belmond, Inc. from the following information. Inventory ............... $ 6,500 Common stock............. 45,000 Cash...............

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