Questions and Answers of Contemporary Financial Management

Reasons a company may choose external growth by merger over internal growth can include the following: LO1a. The availability of lower-cost assetsb. Greater economies of scalec. The availability of
To manage long-term funding sources effectively, financial managers must understand the different types of securities the firm can issue. L01
An option is one type of derivative security giving the right to buy or sell an asset at a set price during a specified time period.L01a. A call option is an option to buy an asset at a set price.b.
The value of a call option is dependent upon four variables:a. The relationship between the option’s exercise price and the price of an underlying stockb. The time remaining until the option
Several formal option valution models are available to compute the value of options, including the Black-Scholes model, which is presented and illustrated in Appendix 20A.L01
A convertible security is a fixed-income security, such as a debenture or a share of preferred stock, that may be exchanged for the company’s common stock at the holder’s option.L01
A warrant is an option issued by a company to purchase shares of the company’s common stock for a particular price during a specified period of time.L01
In a rights offering, common stockholders receive an option to purchase additional shares of the company’s common stock, in proportion to the shares they currently own, at a price below the market
Swaps can be used to manage certain types of financial risk.L01
Companies that issue bonds often include a call option in the bond indenture, permitting the company to refund the bonds if interest rates decline. The bond refunding process is detailed in Appendix
The methods used to value short-term options and the models used in their valuation, such as the Black-Scholes model L01
The use and valuation of convertible securities, such as convertible bonds and preferred stocks L01
The uses and valuation of warrants L01
The uses and valuation of rights offerings L01
The uses of interest rate swaps and credit default swaps in the financing activities of the firm?L01
The procedure for determining whether to call a bond issue?L01
Short-term options on common stocks, stock market indexes (e.g., Standard & Poor’s 500 index), 30-year Treasury bonds (e.g., interest rate options), and foreign currency options (e. g., on the
Convertible fixed-income securities, such as debentures or preferred stocks, that may be exchanged for the company’s common stock at the holder’s option. By giving the fixed-income security
Warrants, which are options issued by a company to purchase shares of the company’s common stock at a particular price during a specified period of time.Warrants are frequently sold to investors as
A rights offering occurs when common stockholders are given an option to purchase additional shares of the company’s common stock, in proportion to the fraction they currently own, at a price below
Swaps are contracts between financial institutions or companies to exchange cash payments at specified points in time based on the value of an underlying asset.L01
Convertible debt or preferred stock securities are exchangeable for a company’s common stock at the option of the holder.ST1.
Convertible securities tend to reduce potential conflicts between fixed-income security holders and stockholders, resulting in reduced agency costs.ST1.
The price at which a convertible security is exchangeable for a common stock is the conversion price. L01
The number of common shares that can be obtained when a convertible security is exchanged is the conversion ratio, which is calculated by dividing the par value of the security by the conversion
At the time of issue, the conversion price normally exceeds the market price of the common stock by about 15 to 30 percent. L01
Convertible securities possess characteristics of both common stock and fixed-income securities. Their market value is a function of both their stock, or conversion, value and their value as a
A warrant is an option issued by a company to purchase shares of the company’s common stock at a particular price during a specific time period. Warrants are frequently issued as part of a
The exercise price of a warrant is the price at which the holder can purchase common stock of the issuing company. L01
The primary reason for issuing a warrant with a fixed-income security offering is that warrants tend to lower agency costs. L01
The formula value of a warrant depends on the number of common shares each warrant is entitled to receive when exercised and the difference between the common stock market price and the warrant
Define the following terms: L01a. Optionb. Callc. Putd. Contingent claim
What are the similarities and differences between options and warrants? L01
What variables are important in determining call option prices? L01
How does a stock’s expected price volatility affect the value of a call option on it? L01
In what ways are convertible securities and warrants similar? Dissimilar? L01
Why do companies issue convertible securities? L01
What is the relationship between conversion value, bond value, and market value for a convertible security? L01
How can a company effectively force conversion of a convertible security? L01
What is the preemptive right of common stockholders? In what type of company is the preemptive right important? Unimportant? L01
Why would a firm use an interest rate swap as part of its financing strategy? L01
The Bradford Company has debentures outstanding (par value ¼ $1,000) that are convertible into common stock at a price of $40 per share. The convertible bonds have a coupon interest rate of 8
The Somerset Company has warrants outstanding that expire in three years.Each warrant entitles the holder to purchase one share of common stock at an exercise price of $40 per share. Determine the
The Seven Springs Company plans to sell an additional 2 million shares of common stock through a rights offering. The company currently has 20 million shares outstanding. Each shareholder will
The LeMonde Corporation has debentures outstanding (par value ¼ $1,000) that are convertible into the company’s common stock at a price of $25 per share. The convertibles have a coupon interest
Automatic Data Processing issued $150 million of 6½ percent convertible debentures maturing in 2020. The debentures are convertible into common stock at $83.45 a share. The company’s common stock
Shaw Products Company, whose present balance sheet is summarized here, is considering issuing $100 million of 6 percent subordinated debentures (par value ¼$1,000), which are convertible into common
Oswego Manufacturing Company has decided to sell additional common stock through a rights offering. The company has 50 million shares outstanding and plans to sell an additional 5 million shares
The Findlay Company has debentures outstanding (par value ¼ $1,000) that are convertible into common stock at a price of $50 per share. The convertible bonds have a coupon interest rate of 9 percent
The Wolverine Corporation has a convertible preferred stock outstanding. The par value of this preferred stock is $100, and it pays a $10 dividend. The preferred stock is callable at 103 percent of
Five years ago, in conjunction with a financial restructuring, Laurenberg Electric sold a $100 million issue of bonds at a coupon interest rate of 12 percent. Each bond came with 30 detachable
The stock pays no dividends during the life of the option. Although this might seem like a serious limitation of the model, other models have been developed that take dividends into account. A common
The call option is a European option. European options can only be exercised at expiration, whereas American options can be exercised at any time up until the expiration date. This assumption is not
Stock prices are assumed to follow a random walk. Investors are assumed not to be able to predict the direction of the overall market or of any particular stock. L01
There are no transaction costs in the buying and selling of options. This assumption is violated in reality, but transaction costs are low enough that this assumption is not a serious limitation of
The probability distribution of stock returns is normally distributed. L01
Short-term, risk-free interest rates are assumed to be known and constant over the life of the option contract. The discount rate on 30-day U.S. government Treasury bills is often used as the
The variance of returns on the underlying stock is assumed to be constant and known to investors over the option’s life. L01
Disher Cotton Farms is a large cotton producer located near Lubbock, Texas. Each year Disher plants its fields in cotton and then waits until the fall before the cotton is picked and sold. Disher
The Japanese firm insists that payments be made in yen. The current exchange rate between the dollar and the yen is 108 yen per dollar. The 3-month forward exchange rate is 105 yen per dollar. What
Jenkins Electronics has purchased a large quantity of electronic components from a Japanese firm for use in its new DVD players. The Japanese supplier has agreed to give Jenkins payment terms of net
Independence Airline anticipates the need to buy 1 million gallons of jet fuel in 3 months. The current price of jet fuel is $0.60 per gallon. The 3-month futures price for jet fuel is $0.62 per
Shining Rock Mining is a gold-mining firm that is concerned about controlling the volatility of its revenues. The current price of gold is $325 per ounce, but over the past year it has traded for as
What are the primary differences between forward contracts and futures contracts? L01
How can patents, copyrights, and legal challenges be used to manage business risk? L01
Against what types of risks should a wealth-maximizing firm try to purchase insurance?What types of risks should be self-insured? L01
What role does diversification play in risk management strategies? L01
How can the acquisition of additional information be an effective tool of risk management? Give an original example of the use of this technique. L01
What types of risks should shareholder wealth-maximizing managers seek to offset in a firm they are managing? Why? L01
A long hedge involves the purchase of a forward or futures contract to cover required future purchases of a commodity or currency. Short hedges involve the sale of a forward or a futures contract to
A futures contract is a standardized contract, traded on an organized exchange, to buy or sell an asset at a specified future time at a specified price. Because it is standardized with respect to
A forward contract is an agreement to buy or sell an asset at some point in time in the future at a price agreed to at the time the forward contract is purchased or sold. Forward contracts can be
A hedge is a transaction that limits the risk associated with fluctuations in the price of a commodity, currency, or financial instrument. A hedge is accomplished by taking offsetting positions in
Nonhedging strategies that managers use to control risk include the acquisition of additional information; diversification; the purchase of insurance; the use of patents, copyrights, and other forms
The most important reason for firms to use risk management techniques is to reduce the chance of catastrophic financial distress. Other reasons include assuring that adequate cash flows will be
Risk management encompasses a range of strategies and techniques that can be used to reduce the variability of possible future returns from any business transaction. The goal is to reduce the
Hedging strategies for risk management? L01
Nonhedging strategies for managing risk? L01
The meaning and importance of risk management? L01
Long hedges involve the purchase of a forward or futures contract to cover required future purchases of a commodity or currency. Short hedges involve the sale of a forward or a futures contract to
Hedging strategies for reducing risk involve taking offsetting positions in the ownership of an asset or security through the use of derivative securities such as forward contracts, futures
Nonhedging strategies that can be used to manage business risk include the acquisition of additional information, diversification, insurance, the use of patents and copyrights, and the limited use of
There are several reasons why a firm may choose to employ risk management techniques, including reducing the chance of financial distress, assuring that the firm will have adequate cash flows to make
Risk is the possibility that the actual cash flows from an investment or any other business transaction will be different from the expected cash flows. L01
Take a look at the inventory control system maintained by RWS Information Systems.Prepare a 1-page memo summarizing their system.: L01
Books, etc., a nationwide chain of bookstores, anticipates that annual demand for the paperback version of a best-selling novel will be 150,000 copies. The books cost the firm $2 each. Books, etc.
General Cereal Company purchases various grains (e.g., wheat and corn) that it processes into ready-to-eat cereals. Its annual demand for wheat is 250,000 bushels.Assume that demand is uniform
Arizona Instruments uses integrated circuits (ICs) in its business calculators. Its annual demand for ICs is 120,000 units. The ICs cost Arizona Instruments $10 each. The company has determined that
Southeast Publishing Company employs a high-speed printing press in its operations. A typical production run of 5,000 to 50,000 copies of a textbook can be produced in less than one day. The manager
Quick-Copy Duplicating Company uses 110,000 reams of standard-size paper a year at its various duplicating centers. Its current paper supplier charges $2.00 per ream.Annual inventory carrying costs
Allstar Shoe Company produces a wide variety of athletic-type shoes for tennis, basketball, and running. Although sales are somewhat seasonal, production is uniform throughout the year. Allstar’s
The Blawnox Company is concerned about its bad-debt losses and the length of time required to collect receivables. Current sales are $43.8 million per year. Bad-debt losses are currently 3.5 percent
Saccomanno Industries, Inc., is considering whether to discontinue offering credit to customers who are more than 10 days overdue on repaying the credit extended to them. Current annual credit sales
Allied Apparel Company received a large order from Websters Department Stores, which operates a chain of approximately 300 popular-priced department stores located primarily in the New
The Bimbo Corporation has been experiencing a decline in sales relative to its major competitors. Because Bimbo is confident about the quality of its products, it suspects that this sales loss may
Jenkins Supply Corporation sells $120 million of its products to wholesalers on terms of “net 50.” Currently, the firm’s average collection period is 65 days. In order to speed up the
Creole Industries, Inc., estimates that if it spent an additional $20,000 to hire another collection agent in its credit department, it could lower its bad-debt loss ratio to 3.5 percent from a
Swenson Electric Company sells on terms of “net 30.” Given the following information on its receivables, construct an aging of accounts schedule as of September 1,: L01
Michigan Pharmaceuticals, Inc., a wholesale distributor of ethical drugs to local pharmacies, has been experiencing a relatively long average collection period because many of its customers face
The North Carolina Furniture Company (NCFC) manufactures upholstered furniture, which it sells to various small retailers in the Northeast and Midwest on credit terms of“2/10, net 60.” The

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