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business
essentials of investments

Questions and Answers of Essentials of Investments

Use the Black-Scholes formula to find the value of a call option on the following stock:Time to expiration 6 months Standard deviation 50% per year Exercise price $50 Stock price $50 Annual interest
a. Calculate the value of a call option on the stock in Problem 9 with an exercise price of 110.b. Verify that the put-call parity theorem is satisfied by your answers to Problem 9 and part (a).(Do
We will derive a two-state put option value in this problem. Data: S0 = 100; X = 110; 1 + r =1.10. The two possibilities for ST are 130 and 80.a. Show that the range of S is 50, whereas that of P is
Show that Black-Scholes call option hedge ratios also increase as the stock price increases.Consider a 1-year option with exercise price $50, on a stock with annual standard deviation 20%.The T-bill
Reconsider the determination of the hedge ratio in the two-state model (see Section 21.2), where we showed that one-third share of stock would hedge one option. What would be the hedge ratio for the
In each of the following questions, you are asked to compare two options with parameters as given. The risk-free interest rate for all cases should be assumed to be 4%. Assume the stocks on which
Consider the following data for the firms Acme and Apex:Equity ($ million)Debt ($ million)ROC (%)Cost of Capital (%)Acme 100 50 17 9 Apex 450 150 15 10a. Which firm has the higher economic value
A firm has an ROE of 3%, a debt-to-equity ratio of .5, and a tax rate of 35% and pays an interest rate of 6% on its debt. What is its operating ROA?
The SEC due diligence team is searching for the reason behind Hatfield’s inventory build-up relative to its sales growth. One way to identify a deliberate manipulation of financial results by
Hatfield has begun recording all new equipment leases on its books as operating leases, a change from its consistent past use of capital leases, in which the present value of lease payments is
Labor officials believe that the management of Hatfield is attempting to understate its net income to avoid making any concessions in the labor negotiations. Which of the following actions by
What is the major difference between the approach of international financial reporting standards versus U.S. GAAP accounting? What are the advantages and disadvantages of each?
Use the financial statements of Heifer Sports Inc. in Table 19A to find the following information for Heifer’s:a. Inventory turnover ratio in 2017.b. Debt/equity ratio in 2017.c. Cash flow from
Chiptech, Inc., is an established computer chip firm with several profitable existing products as well as some promising new products in development. The company earned $1 a share last year, and just
The Generic Genetic (GG) Corporation pays no cash dividends currently and is not expected to for the next four years. Its latest EPS was $5, all of which was reinvested in the company.The firm’s
The Duo Growth Company just paid a dividend of $1 per share. The dividend is expected to grow at a rate of 25% per year for the next three years and then to level off to 5% per year forever. You
Recalculate the intrinsic value of GE shares using the free cash flow model of Spreadsheet 18.2(available in Connect; link to Chapter 18 material) under each of the following assumptions.Treat each
Recalculate the intrinsic value of GE in each of the following scenarios by using the three-stage growth model of Spreadsheet 18.1 (available in Connect; link to Chapter 18 material). Treat each
The Digital Electronic Quotation System (DEQS) Corporation pays no cash dividends currently and is not expected to for the next five years. Its latest EPS was $10, all of which was reinvested in the
The risk-free rate of return is 8%, the expected rate of return on the market portfolio is 15%, and the stock of Xyrong Corporation has a beta coefficient of 1.2. Xyrong pays out 40% of its earnings
The stock of Nogro Corporation is currently selling for $10 per share. Earnings per share in the coming year are expected to be $2. The company has a policy of paying out 50% of its earnings each
The market consensus is that Analog Electronic Corporation has an ROE = 9%, a beta of 1.25, and plans to maintain indefinitely its traditional plowback ratio of 2/3. This year’s earnings were$3 per
a. MF Corp. has an ROE of 16% and a plowback ratio of 50%. If the coming year’s earnings are expected to be $2 per share, at what price will the stock sell? The market capitalization rate is 12%.b.
a. Computer stocks currently provide an expected rate of return of 16%. MBI, a large computer company, will pay a year-end dividend of $2 per share. If the stock is selling at $50 per share, what
Deployment Specialists pays a current (annual) dividend of $1.00 and is expected to grow at 20% for 2 years and then at 4% thereafter. If the required return for Deployment Specialists is 8.5%, what
OceanGate sells external hard drives for $200 each. Its total fixed costs are $30 million, and its variable costs per unit are $140. The corporate tax rate is 30%. If the economy is strong, the firm
Atech has fixed costs of $7 million and profits of $4 million. Its competitor, ZTech, is roughly the same size and this year earned the same profits, $4 million. However, ZTech operates with fixed
Smith knows that a firm’s generic strategy should be the centerpiece of a firm’s strategic plan.On the basis of a compilation of research and documents, Smith makes three observations about the
Smith notes in her report that the West Winery might differentiate its wine product on attributes that buyers perceive to be important. Which of the following attributes would be the most likely area
Which of Smith’s points effectively support the conclusion that consumers have strong bargaining power over the industry?
If the French home currency were to greatly appreciate in value compared to the English currency, what is the likely impact on the competitive position of the East Winery?a. Make the firm less
IAAI uses primarily historical data in its calculations and forecasts. Which of the following regarding the actions of IAAI is most accurate?a. Credit risk premiums may be useful to IAAI because they
Which of the domestic series that the IAAI research department listed for use as leading indicators is least appropriate?a. Industrial production.b. Average weekly hours in manufacturing.c. The S&P
Stock prices are useful as a leading indicator. To explain this phenomenon, which of the following is most accurate? Stock prices:a. Predict future interest rates as well as trends in other
The researchers at IAAI have forecast positive trends for both job creation and consumer confidence.Which, if either, of these trends should have a positive effect on stock prices?
Your business plan for your proposed start-up firm envisions first-year revenues of $120,000, fixed costs of $30,000, and variable costs equal to one-third of revenue.a. What are expected profits
Why do you think the index of consumer expectations for business conditions is a useful leading indicator of the macroeconomy? (See Table 17.2.)
Here are four industries and four forecasts for the macroeconomy. Match the industry to the scenario in which it is likely to be the best performer.Industry Economic Forecasta. Housing constructionb.
Consider two firms producing smartphones. One uses a highly automated robotics process, whereas the other uses workers on an assembly line and pays overtime when there is heavy production demand.a.
Choose an industry and identify the factors that will determine its performance in the next three years. What is your forecast for performance in that time period?
If you believe the U.S. dollar will depreciate more dramatically than other investors anticipate, what will be your stance on investments in U.S. auto producers?
The spot rates of interest for five U.S. Treasury securities are shown in the following exhibit.Assume all securities pay interest annually.Spot Rates of Interest Term to Maturity Spot Rate of
U.S. Treasuries represent a significant holding in many pension portfolios. You decide to analyze the yield curve for U.S. Treasury notes.a. Using the data in the table below, calculate the 5-year
The shape of the U.S. Treasury yield curve appears to reflect two expected Federal Reserve reductions in the federal funds rate. The current short-term interest rate is 5%. The first reduction of
A portfolio manager at Superior Trust Company is structuring a fixed-income portfolio to meet the objectives of a client. The portfolio manager compares coupon U.S. Treasuries with zero-coupon
Sandra Kapple is a fixed-income portfolio manager who works with large institutional clients.Kapple is meeting with Maria VanHusen, consultant to the Star Hospital Pension Plan, to discuss management
The tables below show, respectively, the characteristics of two annual-pay bonds from the same issuer with the same priority in the event of default, and spot interest rates. Neither bond’s price
The 6-month Treasury bill spot rate is 4%, and the 1-year Treasury bill spot rate is 5%. What is the implied 6-month forward rate for six months from now?
Use the data from Problem 18.Suppose that you want to construct a 2-year maturity forward loan commencing in 3 years.a. Suppose that you buy today one 3-year maturity zero-coupon bond. How many
Suppose that the prices of zero-coupon bonds with various maturities are given in the following table. The face value of each bond is $1,000.Maturity (years) Price 1 $925.93 2 853.39 3 782.92 4
The current yield curve for default-free zero-coupon bonds is as follows:Maturity (years) YTM (%)1 10%2 11 3 12a. What are the implied 1-year forward rates?b. Assume that the pure expectations
Suppose that a 1-year zero-coupon bond with face value $100 currently sells at $94.34, while a 2-year zero sells at $84.99. You are considering the purchase of a 2-year-maturity bond making annual
The yield to maturity (YTM) on 1-year zero-coupon bonds is 5%, and the YTM on 2-year zeros is 6%. The YTM on 2-year-maturity coupon bonds with coupon rates of 12% (paid annually)is 5.8%.a. What
You observe the following term structure:Effective Annual YTM 1-year zero-coupon bond 6.1%2-year zero-coupon bond 6.2 3-year zero-coupon bond 6.3 4-year zero-coupon bond 6.4a. If you believe that the
Prices of zero-coupon bonds reveal the following pattern of forward rates:Year Forward Rate 1 5%2 7 3 8 In addition to the zero-coupon bond, investors also may purchase a 3-year bond making annual
Below is a list of prices for zero-coupon bonds of various maturities.Maturity (years)Price of $1,000 Par Bond(zero-coupon)1 $943.40 2 873.52 3 816.37a. An 8.5% coupon $1,000 par bond pays an annual
The yield to maturity on 1-year zero-coupon bonds is currently 7%; the YTM on 2-year zeros is 8%. The Treasury plans to issue a 2-year maturity coupon bond, paying coupons once per year with a coupon
The term structure for zero-coupon bonds is currently:Maturity (years) YTM (%)1 4%2 5 3 6 Next year at this time, you expect it to be:Maturity (years) YTM (%)1 5%2 6 3 7a. What do you expect the rate
Consider the following $1,000 par value zero-coupon bonds:Bond Years to Maturity YTM(%)A 1 5%B 2 6 C 3 6.5 D 4 7 According to the expectations hypothesis, what is the market’s expectation of the
a. Assuming that the expectations hypothesis is valid, compute the expected price of the 4-year bond in Problem 7 at the end of (i) the first year; (ii) the second year; (iii) the third year;(iv) the
The following is a list of prices for zero-coupon bonds of various maturities.a. Calculate the yield to maturity for a bond with a maturity of (i) one year; (ii) two years;(iii) three years; (iv)
What is the relationship between forward rates and the market’s expectation of future short rates?Explain in the context of both the expectations hypothesis and the liquidity preference theory of
17. The DuPont formula defines the net return on shareholders’ equity as a function of the following components:• Operating margin.• Asset turnover.• Interest burden.• Financial
16. 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.
15. In an inflationary period, the use of FIFO will make which one of the following more realistic than the use of LIFO?a. Balance sheet.b. Income statement.c. Cash flow statement.d. None of the
A newly issued bond pays its coupons once annually. Its coupon rate is 5%, its maturity is 20 years, and its yield to maturity is 8%.a. Find the holding-period return for a 1-year investment period
Masters Corp. issued two bonds with 20-year maturities. Both bonds are callable at $1,050. The first bond was issued at a deep discount with a coupon rate of 4% and a price of $580 to yield 8.4%. The
14. During a period of rising prices, the financial statements of a firm using FIFO reporting instead of LIFO reporting would show:a. Higher total assets and higher net income.b. Higher total assets
Describe the likely effect on the yield to maturity of a bond resulting from:a. An increase in the issuing firm’s times-interest-earned ratio.b. An increase in the issuing firm’s debt-to-equity
13. A company’s current ratio is 2.0. If the company uses cash to retire notes payable due within 1 year, would this transaction increase or decrease the current ratio and asset turnover
Which of the following most accurately describes the behavior of credit default swaps?a. When credit risk increases, swap premiums increase.b. When credit and interest rate risk increase, swap
12. 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
11. In reviewing the financial statements of the Graceland Rock Company, you note that net income increased while cash flow from operations decreased from 2007 to 2008.a. Explain how net income could
An investor believes that a bond may temporarily increase in credit risk. Which of the following would be the most liquid method of exploiting this?a. The purchase of a credit default swap.b. The
Assume that two firms issue bonds with the following characteristics. Both bonds are issued at par.ABC Bonds XYZ Bonds Issue size $1.2 billion $150 million Maturity 10 years* 20 years Coupon 6%
10. Mulroney (see CFA Problems 7–9) 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
9. In addition to the discounted dividend model approach, Mulroney (see previous problem)decided to look at the price–earnings ratio and price–book ratio, relative to the S&P 500, for both
A 10-year bond of a firm in severe financial distress has a coupon rate of 14% and sells for$900. The firm is currently renegotiating the debt, and it appears that the lenders will allow the firm to
A 30-year maturity, 8% coupon bond paying coupons semiannually is callable in five years at a call price of $1,100. The bond currently sells at a yield to maturity of 7% (3.5% per half-year).a. What
8.a. Mulroney (see the previous problem) 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
7. Eastover Company (EO) is a large, diversified forest products company. Approximately 75% of its sales are from paper and forest products, with the remainder from financial services and real
5. This problem should be solved using the following data:Cash payments for interest $(12)Retirement of common stock (32)Cash payments to merchandise suppliers (85)Purchase of land (8)Sale of
A newly issued 20-year maturity, zero-coupon bond is issued with a yield to maturity of 8% and face value $1,000. Find the imputed interest income in: (a) the first year; (b) the second year;and (c)
Return to Table 14.1, showing the cash flows for TIPS bonds.a. What is the nominal rate of return on the bond in year 2?b. What is the real rate of return in year 2?c. What is the nominal rate of
4. The cash flow data of Palomba Pizza Stores for last year are as follows:Cash payment of dividends $ 35,000 Purchase of land 14,000 Cash payments for interest 10,000 Cash payments for salaries
3. Scott Kelly is reviewing MasterToy’s financial statements in order to estimate its sustainable growth rate. Consider the information presented in the following exhibit.MasterToy, Inc.: Actual
2. The information in the following exhibit comes from the notes to the financial statements of QuickBrush Company and SmileWhite Corporation:QuickBrush SmileWhite Goodwill The company amortizes
Consider a bond paying a coupon rate of 10% per year semiannually when the market interest rate is only 4% per half-year. The bond has three years until maturity.a. Find the bond’s price today and
Fill in the table below for the following zero-coupon bonds, all of which have par values of $1,000.Price Maturity (years)Bond-Equivalent Yield to Maturitya. $400 20 ___b. $500 20 ___c. $500 10 ___d.
1. An analyst applies the DuPont system of financial analysis to the following data for a company:• Leverage ratio (assets/equity) 2.2• Total asset turnover 2.0• Net profit margin 5.5%•
Repeat Problem 11 using the same data, but now assume that the bond makes its coupon payments annually. Why are the yields you compute lower in this case?
5. The ABC Corporation has a profit margin on sales below the industry average, yet its ROA is above the industry average. What does this imply about its asset turnover?6. Firm A and firm B have the
Assume you have a 1-year investment horizon and are trying to choose among three bonds. All have the same degree of default risk and mature in 10 years. The first is a zero-coupon bond that pays
4. The Crusty Pie Co., which specializes in apple turnovers, has a return on sales higher than the industry average, yet its ROA is the same as the industry average. How can you explain this?
Consider an 8% coupon bond selling for $953.10 with three years until maturity making annual coupon payments. The interest rates in the next three years will be, with certainty, r1 = 8%, r2 =10%, and
Consider a bond with a 10% coupon and yield to maturity = 8%. If the bond’s yield to maturity remains constant, then in one year, will the bond price be higher, lower, or unchanged? Why?
3. What financial ratios would a credit rating agency such as Moody’s or Standard and Poor’s be most interested in? Which ratios would be of most interest to a stock market analyst deciding
Treasury bonds paying an 8% coupon rate with semiannual payments currently sell at par value.What coupon rate would they have to pay in order to sell at par if they paid their coupons annually?(Hint:
2. If markets are truly efficient, does it matter whether firms engage in earnings management? On the other hand, if firms manage earnings, what does that say about management’s view on efficient
1. What is the major difference in approach of international financial reporting standards and U.S.GAAP accounting? What are the advantages and disadvantages of each?

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