Questions and Answers of Accounting For Investments

The common stock of the C.A.L.L. Corporation has been trading in a narrow range around$50 per share for months, and you believe it is going to stay in that range for the next six months.The price of
The common stock of the P.U.T.T. Corporation has been trading in a narrow price range for the past month, but you are convinced it is going to break far out of that range in the next six months.You
Suppose you think AppX stock is going to appreciate substantially in value in the next year.Say the stock’s current price, S0, is $100, and a call option expiring in one year has an exercise price,
Turn back to Figure 20.1, which lists prices of various Microsoft options. Use the data in the figure to calculate the payoff and the profits for investments in each of the following December 17
Why do you think the most actively traded options tend to be the ones that are near the money? P-639
What are the trade-offs facing an investor who is considering writing a call option on an existing portfolio? P-639
What are the trade-offs facing an investor who is considering buying a put option on an existing portfolio? P-639
We said that options can be used either to scale up or reduce overall portfolio risk. What are some examples of risk-increasing and risk-reducing options strategies? Explain each. P-639
Trading in so-called exotic options now takes place in an active over-the-counter market. P-639
Many commonly traded securities embody option characteristics. Examples of these securities are callable bonds, convertible bonds, and warrants. Other arrangements such as collateralized loans and
The put-call parity theorem relates the prices of put and call options. If the relationship is violated, arbitrage opportunities will result. Specifically, the parity relationship states that P0 = C0
Options can be used either to lever up an investor’s exposure to an asset price or to provide insurance against volatility of asset prices. Popular option strategies include covered calls,
Options are traded on stocks, stock indexes, foreign currencies, fixed-income securities, and several futures contracts. P-639
American-style options allow exercise on or before the expiration date. European options allow exercise only on the expiration date. Most traded options are American style. P-639
A call option is the right to buy an asset at an agreed-upon exercise price. A put option is the right to sell an asset at a given exercise price. P-639
Should a convertible bond issued at par value have a higher or lower coupon rate than a nonconvertible bond issued at par? P-639
Graph the payoff diagram for the collar described in Example 20,5, P-639
Graph the profit and payoff diagrams for strips and straps. P-639
a. What will be the proceeds and net profits to an investor who purchases the December expiration Microsoft calls with exercise price $300 if the stock price at expiration is $315? What if the stock
If the delivery option is exercised, when and where does delivery take place? L025
What time period during the day is the contract traded? L025
What is the tick size (minimum price increment) for the contract? P-63
What is the size (number of euros) of each contract? P-63
You ran a regression of the yield of KC Company’s 10-year bond on the 10-year U.S. Treasury benchmark’s yield using month-end data for the past year. You found the following result: P-63
Use the following information to solve this problem.Issue Price Yield to Maturity Modified Duration*U.S. Treasury bond 11¾% maturing Nov. 15, 2035 100 11.75% 7.6 years U.S. Treasury long bond
Janice Delsing, a U.S.-based portfolio manager, manages an $800 million portfolio ($600 million in stocks and $200 million in bonds). In reaction to anticipated short-term market events, Delsing
a. Pamela Itsuji, a currency trader for a Japanese bank, is evaluating the price of a 6-month Japanese yen/U.S. dollar currency futures contract. She gathers the following currency and interest rate
Consider these data for the S&P 500 future’s contract maturing in, exactly one year. The S&P 500 index is at 4,290, and the contract price is F0 = 4,292.a. If the current interest rate is 2.5%, and
Suppose the 1-year futures price on a stock-index portfolio is 3,828, the stock index currently is 3,800, the 1-year risk-free interest rate is 3%, and the year-end dividend that will be paid on
Suppose that at the present time, one can enter 5-year swaps that exchange SOFR for 5%. An off-market swap would then be defined as a swap of SOFR for a fixed rate other than 5%. For example, a firm
Firm ABC enters a 5-year swap with firm XYZ to pay SOFR in return for a fixed 6% rate on notional principal of $10 million. Two years from now, the market rate on 3-year swaps is SOFR for 5%; at this
Desert Trading Company has issued $100 million worth of long-term bonds at a fixed rate of 7%. The firm then enters into an interest rate swap where it pays SOFR and receives a fixed 6% on notional
Suppose the U.S. yield curve is flat at 4% and the euro yield curve is flat at 3%. The current exchange rate is $1.10 per euro. What cash flows will be exchanged on a 4-year foreign exchange swap
A corporation plans to issue $10 million of 10-year bonds in three months. At current yields the bonds would have modified duration of eight years. The T-note futures contract is selling at F0 = 100
A manager is holding a $1 million bond portfolio with a modified duration of eight years. She would like to hedge the risk of the portfolio by short-selling Treasury bonds. The modified duration of
Yields on short-term bonds tend to be more volatile than yields on long-term bonds. Suppose that you have estimated that the yield on 20-year bonds changes by 10 basis points for every 15-basis-point
Return to Figure 23.7. Suppose the LIBOR rate when the first-listed Eurodollar contract matures in October is 1.0%. What will be the profit or loss to each side of the Eurodollar contract? P-63
Consider the following information:rUS = 2%; rUK = 3%E0 = 1.30 dollars per pound F0 = 1.29 (1-year delivery)where the interest rates are annual yields on U.S. or U.K. bills. Given this information:a.
Suppose that the spot price of the euro is currently $1.10. The 1-year futures price is $1.15. Is the interest rate higher in the United States or the euro zone? P-63
Suppose that the relationship between the rate of return on Digital Computer Corp. stock, the market index, and a computer industry index can be described by the following regression equation:
Suppose that the value of the S&P 500 stock index is 4,000.a. If each E-mini futures contract (with a contract multiplier of $50) costs $25 to trade with a discount broker, how much is the
Consider the futures contract written on the S&P 500 index and maturing in one year. The interest rate is 3%, and the future value of dividends expected to be paid over the next year is $70.The
When commodities are not stored for investment purposes, the equilibrium futures price can be derived from general risk–return principles. In this case, F0 = E(PT)(1 + r _____f 1 + k)T This futures
Commodity futures pricing is complicated by costs for storage of the underlying commodity.When the asset is willingly stored by investors, the storage costs net of convenience yield enter the futures
Swaps, which call for the exchange of a series of cash flows, may be viewed as portfolios of forward contracts. Each transaction may be viewed as a separate forward agreement. However, instead of
Interest rate futures contracts may be written on the prices of debt securities (as in the case of Treasury-bond futures contracts) or on interest rates directly (as in the case of Eurodollar or SOFR
Many investors such as hedge funds use hedging strategies to create market-neutral bets on perceived instances of relative mispricing between two or more securities. These are not arbitrage
The hedge ratio is the number of hedging vehicles such as futures contracts required to offset the risk of the unprotected position. The hedge ratio for systematic market risk is proportional to the
Hedging requires investors to purchase assets that will offset the sensitivity of their portfolios to particular sources of risk. A hedged position requires that the hedging vehicle provide profits
Futures contracts are traded on several stock market indexes. The contracts may be mixed with Treasury bills to construct artificial equity positions, which makes them potentially valuable tools for
Foreign exchange futures trade on several foreign currencies. The interest rate parity relationship for foreign exchange futures is F0 = E0 (_________ 1 + rUS 1 + rforeign)T with exchange rates
People are willing to buy and “store” shares of stock despite the fact that their purchase ties up capital. Most people, however, are not willing to buy and store soybeans. What is the difference
Suppose the initial spot exchange rate had been $1 = £1.4 and that the U.S. interest rate was 4%. Rework Table 23.4 to show what cash flows a dealer would offer to investors wishing to enter a
A pension fund holds a portfolio of money market securities that the manager believes are paying excellent yields compared to comparable short-term securities. However, the manager believes that
Show how a firm that has issued a floating-rate bond with a coupon equal to the SOFR rate can use swaps to convert that bond into synthetic fixed-rate debt. Assume the terms of the swap allow an
What would be the arbitrage strategy and associated profits in Example 23.1 if the initial futures price were F0 = $1.35/pound? P-63
What are the price limits (minimum price fluctuations) for the contract? P-636
For what months are the futures contracts available? P-636
What is the settlement method for the futures contract? P-636
What is the contract size for the futures contract? P-636
Identify the fundamental distinction between a futures contract and an options contract, and briefly explain the difference in the manner that futures and options modify portfolio risk. P-636
Joan Tam, CFA, believes she has identified an arbitrage opportunity for a commodity as indicated by the following information: P-636
Consider this arbitrage strategy to derive the parity relationship for spreads: (i) enter a long futures position with maturity date T1 and futures price F(T1); (ii) enter a short position with
The Excel Application box in the chapter (available in Connect; link to Chapter 22 material)shows how to use the spot-futures parity relationship to find a “term structure of futures prices,”that
The S&P portfolio pays a dividend yield of 1% annually. Its current value is 4,000. The T-bill rate is 4%. Suppose the S&P futures price for delivery in one year is 4,100. Construct an arbitrage
You are a corporate treasurer who will purchase $1 million of bonds for the sinking fund in three months. You believe rates will soon fall, and you would like to repurchase the company’s sinking
The multiplier for a futures contract on a stock market index is $50. The maturity of the contract is one year, the current level of the index is 4,500, and the risk-free interest rate is .5% per
FinTrade has just introduced a single-stock futures contract on Brandex stock, a company that currently pays no dividends. Each contract calls for delivery of 1,000 shares of stock in one year. The
It is now January. The current interest rate is 2%. The June futures price for gold is $1,500, whereas the December futures price is $1,510. Is there an arbitrage opportunity here? If so, how would
Suppose the value of the S&P 500 stock index is currently 4,000.a. If the 1-year T-bill rate is 3% and the expected dividend yield on the S&P 500 is 2%, what should the 1-year maturity futures price
a. A futures contract on a non-dividend-paying stock index with current value 150 has a maturity of one year. If the T-bill rate is 3%, what should the futures price be?b. What should the futures
a. Turn to the Mini-S&P 500 contract in Figure 22.1. If the margin requirement is 10% of the futures price times the contract multiplier of $50, how much must you deposit with your broker to trade
Evaluate the criticism that futures markets siphon off capital from more productive uses. P-636
What is the difference between the futures price and the value of the futures contract? P-636
What is the difference in cash flow between short-selling an asset and entering a short futures position? P-636
Why might individuals purchase futures contracts rather than the underlying asset? P-636
Why is there no futures market in cement? P-636
The equilibrium futures price will be less than the currently expected time T spot price if the spot price exhibits systematic risk. This provides an expected profit for the long position who bears
If the asset provides services or payments with yieldd, the parity relationship becomes F0 =P0(1 + rf− d)T. This model is also called the cost-of-carry model because it states that the futures
The spot-futures parity relationship states that the equilibrium futures price on an asset providing no service or payments (such as dividends) is F0 = P0(1 + rf)T. If the futures price deviates from
Futures contracts may be used for hedging or speculating. Speculators use the contracts to take a stand on the ultimate price of an asset. Short hedgers take short positions in contracts to offset
The long position’s gain or loss between time 0 and time t is Ft− F0. Because at the maturity date, T, FT = PT, the long’s profit if the contract is held until maturity is PT − F0, where PT
The clearinghouse steps in between each pair of traders, acting as the short position for each long and as the long position for each short. In this way traders need not be concerned about the
Futures contracts are traded on organized exchanges that standardize the size of the contract, the grade of the deliverable asset, the delivery date, and the delivery location. Traders negotiate only
A futures contract is similar to a forward contract, differing most importantly in the aspects of standardization and marking to market, which is the process by which gains and losses on futures
Forward contracts call for future delivery of an asset at a currently agreed-on price. The long trader purchases the good, and the short trader delivers it. If the price of the asset at the maturity
What must be true of the risk of the spot price of an asset if the futures price is an unbiased estimate of the ultimate spot price? P-636
Return to the arbitrage strategy laid out in Example 22.9. What would be the three steps of the strategy if F0 were too low, say, $3,950? Work out the cash flows of the strategy now and in one year
What are the sources of risk to an investor who uses stock index futures to hedge an actively managed stock portfolio? How might you estimate the magnitude of that risk? P-636
As in Example 22.5, suppose that oil will be selling in February for $71, $72, or $73 per barrel. Consider a firm that plans to buy 100,000 barrels of oil in February. Show that if the firm buys 100
What must be the net inflow or outlay from marking to market for the clearinghouse? P-636
a. Compare the profit diagram in Figure 22.2, Panel B, to the payoff diagram for a long position in a put option.Assume the exercise price of the option equals the initial futures price.b. Compare
The DuPont formula defines the net return on shareholders’ equity as a function of the following components: p-696• Operating margin.• Asset turnover.• Interest burden.• Financial
Jones Group has been generating stable after-tax return on equity (ROE) despite declining operating income. Explain how it might be able to maintain its stable after-tax ROE. p-696
A company’s current ratio is 2.0. Suppose the company uses cash to retire notes payable due within one year. What would be the effect on the current ratio and asset turnover ratio? p-696
A firm has net sales of $3,000, cash expenses (including taxes) of $1,400, and depreciation of $500.If accounts receivable increase over the period by $400, what would be cash flow from operations?
In reviewing the financial statements of the Graceland Rock Company, you note that net income increased while cash flow from operations decreased from 2023 to 2024.a. Explain how net income could
Mulroney previously calculated a valuation for Southampton for both the constant-growth and two-stage DDM as shown below:Constant-Growth Approach Two-Stage Approach$29 $35.50 Using only the
In addition to the discounted dividend model approach, Mulroney decided to look at the price–earnings ratio and price–book ratio, relative to the S&P 500, for both Eastover and
a. Mulroney recalled from her CFA studies that the constant-growth discounted dividend model was one way to arrive at a valuation for a company’s common stock. She collected current dividend and

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