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principles corporate finance

Questions and Answers of Principles Corporate Finance

30. Several years ago The Wall Street Journal reported that the winner of the Massachusetts State Lottery prize had the misfortune to be both bankrupt and in prison for fraud. The prize was
29. A leasing contract calls for an immediate payment of $100,000 and nine subsequent$100,000 semiannual payments at six-month intervals. What is the PV of these payments if the annual discount rate
28. Which would you prefer?a. An investment paying interest of 12% compounded annually.b. An investment paying interest of 11.7% compounded semiannually.c. An investment paying 11.5% compounded
27. You have just read an advertisement stating, “Pay us $100 a year for 10 years and we will pay you $100 a year thereafter in perpetuity.” If this is a fair deal, what is the rate of interest?
26. How much will you have at the end of 20 years if you invest $100 today at 15% annually compounded? How much will you have if you invest at 15% continuously compounded?
25. Refer back to Sections 2.2–2.4. If the rate of interest is 8% rather than 10%, how much would you need to set aside to provide each of the following?a. $1 billion at the end of each year in
24. If the interest rate is 7%, what is the value of the following three investments?a. An investment that offers you $100 a year in perpetuity with the payment at the end of each year.b. A similar
23. Recalculate the NPV of the office building venture in Section 2.1 at interest rates of 5, 10, and 15%. Plot the points on a graph with NPV on the vertical axis and the discount rates on the
22. Kangaroo Autos is offering free credit on a new $10,000 car. You pay $1,000 down and then $300 a month for the next 30 months. Turtle Motors next door does not offer free credit but will give you
21. David and Helen Zhang are saving to buy a boat at the end of five years. If the boat costs$20,000 and they can earn 10% a year on their savings, how much do they need to put aside at the end of
20. Siegfried Basset is 65 years of age and has a life expectancy of 12 more years. He wishes to invest $20,000 in an annuity that will make a level payment at the end of each year until his death.
19. As winner of a breakfast cereal competition, you can choose one of the following prizes:a. $100,000 now.b. $180,000 at the end of five years.c. $11,400 a year forever.d. $19,000 for each of 10
18. Halcyon Lines is considering the purchase of a new bulk carrier for $8 million. The forecasted revenues are $5 million a year and operating costs are $4 million. A major refit costing $2 million
17. A factory costs $400,000. It will produce an inflow after operating costs of $100,000 in year 1, $200,000 in year 2, and $300,000 in year 3. The opportunity cost of capital is 12%.Calculate the
16. Mike Polanski is 30 years of age and his salary next year will be $40,000. Mike forecasts that his salary will increase at a steady rate of 5% per annum until his retirement at age 60.a. If the
15. A machine costs $380,000 and is expected to produce the following cash flows:Year 1 2 3 4 5 6 7 8 9 10 Cash flow ($000s) 50 57 75 80 85 92 92 80 68 50
14. A factory costs $800,000. You reckon that it will produce an inflow after operating costs of $170,000 a year for 10 years. If the opportunity cost of capital is 14%, what is the net present value
13.a. If the one-year discount factor is .905, what is the one-year interest rate?b. If the two-year interest rate is 10.5%, what is the two-year discount factor?c. Given these one- and two-year
12. What is the PV of $100 received in:a. Year 10 (at a discount rate of 1%)?b. Year 10 (at a discount rate of 13%)?c. Year 15 (at a discount rate of 25%)?d. Each of years 1 through 3 (at a discount
11. You are quoted an interest rate of 6% on an investment of $10 million. What is the value of your investment after four years if interest is compounded:a. Annually?b. Monthly? orc. Continuously?
10. The continuously compounded interest rate is 12%.a. You invest $1,000 at this rate. What is the investment worth after five years?b. What is the PV of $5 million to be received in eight years?c.
9.a. The cost of a new automobile is $10,000. If the interest rate is 5%, how much would you have to set aside now to provide this sum in five years?b. You have to pay $12,000 a year in school fees
8. The interest rate is 10%.a. What is the PV of an asset that pays $1 a year in perpetuity?b. The value of an asset that appreciates at 10% per annum approximately doubles in seven years. What is
7. A common stock will pay a cash dividend of $4 next year. After that, the dividends are expected to increase indefinitely at 4% per year. If the discount rate is 14%, what is the PV of the stream
6. An investment costs $1,548 and pays $138 in perpetuity. If the interest rate is 9%, what is the NPV?
5. If you invest $100 at an interest rate of 15%, how much will you have at the end of eight years?
4. A project produces a cash flow of $432 in year 1, $137 in year 2, and $797 in year 3. If the cost of capital is 15%, what is the project’s PV?
3. If the cost of capital is 9%, what is the PV of $374 paid in year 9?
2. If the PV of $139 is $125, what is the discount factor?
1. At an interest rate of 12%, the six-year discount factor is .507. How many dollars is $.507 worth in six years if invested at 12%?
2. Answer this question by drawing graphs like Figure 1A.1 . Casper Milktoast has $200,000 available to support consumption in periods 0 (now) and 1 (next year). He wants to consume exactly the same
1. Look back to the numerical example graphed in Figure 1A.1 . Suppose the interest rate is 20%. What would the ant (A) and grasshopper (G) do if they both start with $100,000?Would they invest in
12. Many firms have devised defenses that make it more difficult or costly for other firms to take them over. How might such defenses affect the firm’s agency problems? Are managers of firms with
11. Why might one expect managers to act in shareholders’ interests? Give some reasons.
10. If a financial institution is caught up in a financial scandal, would you expect its value to fall by more or less than the amount of any fines and settlement payments? Explain.
9. Ms. Espinoza is retired and depends on her investments for her income. Mr. Liu is a young executive who wants to save for the future. Both are stockholders in Scaled Composites, LLC, which is
8. We can imagine the financial manager doing several things on behalf of the firm’s stockholders. For example, the manager might:a. Make shareholders as wealthy as possible by investing in real
7. F&H Corp. continues to invest heavily in a declining industry. Here is an excerpt from a recent speech by F&H’s CFO:We at F&H have of course noted the complaints of a few spineless investors and
6. In most large corporations, ownership and management are separated. What are the main implications of this separation?
5. Which of the following statements more accurately describe the treasurer than the controller?a. Responsible for investing the firm’s spare cash.b. Responsible for arranging any issue of common
4. Which of the following statements always apply to corporations?a. Unlimited liability.b. Limited life.c. Ownership can be transferred without affecting operations.d. Managers can be fired with no
3. Vocabulary test. Explain the differences between:a. Real and financial assets.b. Capital budgeting and financing decisions.c. Closely held and public corporations.d. Limited and unlimited
2. Which of the following are real assets, and which are financial?a. A share of stock.b. A personal IOU.c. A trademark.d. A factory.e. Undeveloped land.f. The balance in the firm’s checking
1. Read the following passage: “Companies usually buy ( a ) assets. These include both tangible assets such as ( b ) and intangible assets such as ( c ). To pay for these assets, they sell ( d )
13.1. Explain the difference between a call option on yen and a call option on yen futures.
13.2. Why are options on bond futures more actively traded than options on bonds?
13.3. "A futures price is like a stock paying a dividend yield." What is the dividend yield?
13.7. Calculate the value of a five-month European put futures option when the futures price is $19, the strike price is $20, the risk-free interest rate is 12% per annum, and the volatility of the
13.8. Suppose you buy a put option contract on October gold futures with a strike price of $400 per ounce. Each contract is for the delivery of 100 ounces. What happens if you exercise when the
13.9. Suppose you sell a call option contract on April live cattle futures with a strike price of 70 cents per pound. Each contract is for the delivery of 40,000 pounds. What happens if the contract
13.10. Consider a two-month call futures option with a strike price of 40 when the risk-free interest rate is 10% per annum. The current futures price is 47. What is a lower bound for the value of
13.11. Consider a four-month put futures option with a strike price of 50 when the risk-free interest rate is 10% per annum. The current futures price is 47. What is a lower bound for the value of
13.12. A futures price is currently 60. It is known that over each of the next two three-month periods it will either rise by 10% or fall by 10%. The risk-free interest rate is 8% per annum. What is
13.13. In Problem 13.12 what is the value of a six-month European put option on futures with a strike price of 60? If the put were American, would it ever be worth exercising it early? Verify that
13.17. "The price of an at-the-money European call futures option always equals the price of a similar at-the-money European put futures option." Explain why this statement is true.
13.19. Show that if C is the price of an American call option on a futures contract when the strike price is X and the maturity is T, and P is the price of an American put on the same futures
13.21. Calculate the implied volatility of soybean futures prices from the following information concerning a European put on soybean futures: Current futures price 525 Exercise price 525 Risk-free
13.22. Use the DerivaGem software to calculate implied volatilities for the May options on corn futures in Table 13.3. Assume the futures prices in Table 2.2 apply and that the risk-free rate is 5%
14.1. What pattern of implied volatilities is likely to be observed whena. Both tails of the stock price distribution are thinner than those of the lognormal distribution?b. The right tail is fatter,
14.2. What pattern of implied volatilities is likely to be observed for six-month options when the volatility is uncertain and positively correlated to the stock price?
14.3. What pattern of implied volatilities are likely to be caused by jumps in the underlying asset price? Is the pattern likely to be more pronounced for a six-month option than for a three-month
14.4. A call and put option have the same strike price and time to maturity. Show that the difference between their prices should be the same for any option pricing model.
14.5. Explain carefully why Figure 14.4 is consistent with Figure 14.3.
14.6. The market price of a European call is $3.00 and its Black-Scholes price is $3.50. The Black Scholes price of a European put option with the same strike price and time to maturity is $1.00.
14.8. What are the major problems in testing a stock option pricing model empirically?
14.10. Option traders sometimes refer to deep-out-of-the-money options as being options on volatility. Why do you think they do this?
14.11. A European call option on a certain stock has a strike price of $30, a time to maturity of one year, and an implied volatility of 30%. A European put option on the same stock has a strike
14.12. Suppose that the result of a major lawsuit affecting Microsoft is due to be announced tomorrow. Microsoft's stock price is currently $60. If the ruling is favorable to Microsoft, the stock
14.14. A stock price is $40. A six-month European call option on the stock with a strike price of $30 has an implied volatility of 35%. A six-month European call option on the stock with a strike
14.15. "The Black-Scholes model is used by traders as an interpolation tool." Discuss this view.
14.16. A company's stock is selling for $4. The company has no outstanding debt. Analysts consider the liquidation value of the company to be at least $300,000 and there are 100,000 shares
14.19. Data for a number of foreign currencies are provided on the author's Web site: http://www.rotman.utoronto.ca/"hull Choose a currency and use the data to produce a table similar to Table 14.1.
14.20. Data for a number of stock indices are provided on the author's Web site: http://www.rotman.utoronto.ca/"hull Choose an index and test whether a three standard deviation down movement happens
16.25. An Excel spreadsheet containing daily data on a number of different exchange rates and stock indices can be downloaded from the author's Web site: http://www.rotman.utoronto.ca/"hull Choose
19.4. Suppose that c and p are the prices of a European average price call and a European average price put with strike price X and maturity T, c2 and p2 are the prices of a European average strike
Define Risk Limits
20.15. Suppose thata. The yield on a five-year Treasury bond is 7%b. The yield on a five-year corporate bond issued by company X is 9.5%c. A five-year credit default swap providing insurance against
20.14. An insurance company's losses of a particular type are to a reasonable approximation normally distributed with a mean of $150 million and a standard deviation of $50 million. (Assume no
20.13. In a basket credit default swap, does the cost of the insurance increase or decrease as the correlations between the defaults of the reference entities in the basket increase?
20.11. Explain how a 5 x 8 option contract for May 2001 on electricity with daily exercise works. Explain how a 5 x 8 option contract for May 2001 on electricity with monthly exercise works. Which is
20.10. Would you expect mean reversion to cause the volatility of the three-month forward price of an energy source to be greater than or less than the volatility of the spot price? Explain.
20.9. Suppose that you have 50 years of temperature data at your disposal. Explain the analysis you would you carry out to calculate the forward cumulative CDD for next July.
20.8. "The position of a buyer of a credit default swap is similar to the position of someone who is long a Treasury bond and short a corporate bond." Explain this statement.
20.7. Explain how CAT bonds work.
20.6. How can a gas producer user derivative markets to hedge risks?
20.3. A contract provides a payoff in dollars equal to the HDD observed on a day. Characterize this as an option.
20.2. A credit default swap requires a premium of 60 basis points per year paid semiannually. The principal is $300 million and the credit default swap is settled in cash. A default occurs after four
20.1. Explain the difference between a credit default swap and a total return swap.
19.17. Estimate the interest rate paid by P&G on the 5/30 swap in Section 19.3 if (a) the CP rate is 6.5% and the Treasury yield curve is flat at 6% and (b) the CP rate is 7.5% and the Treasury yield
19.15. Explain why a regular European call option is the sum of a down-and-out European call and a down-and-in European call.
19.13. Does a lookback call become more valuable or less valuable as we increase the frequency with which we observe the asset price in calculating the minimum?
19.11. Suppose that the strike price of an American call option on a non-dividend-paying stock grows at rate g. Show that if g is less than the risk-free rate, r, it is never optimal to exercise the
19.10. Prove that an at-the-money forward start option on a non-dividend-paying stock that will start in three years and mature in five years is worth the same as a two-year at-the- money option
19.9. Explain why a down-and-out put is worth zero when the barrier is greater than the strike price.
19.8. The text derives a decomposition of a particular type of chooser option into a call maturing at time t2 and a put maturing at time t. By using put-call parity to obtain an expression for c
19.6. Explain the relationship between a cancelable swap and a swap option.
19.5. Explain why IOs and POs have opposite sensitivities to the rate of prepayments.
19.2. Describe the payoff from a portfolio consisting of a lookback call and a lookback put with the same maturity.
19.1. Explain the difference between a forward start option and a chooser option.
18.17. Suppose that zero rates are as in Problem 18.14. Use DerivaGem to determine the value of an option to pay a fixed rate of 6% and receive LIBOR on a five-year swap starting in one year. Assume

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