• (10%) An investor bought one call at strike price $60 for $8, and one put at strike price $30 for $4. The current stock price is $45. Draw the profit diagram for this portfolio.

• (12%) TSMC stock has a volatility of 25% with expected return 8% per year. The current stock price is $100 per share. The risk-free interest rate is 2%. What is the Black-Scholes value of an at-the-money European put with 1 year maturity?

• (10%) Consider European stock options with an exercise price of $40 that expire in 3 months. Assume the underlying stock pays no dividends, is trading at $40, and has a volatility of 20% per annum, and that the risk-free rate is 3% per annum. Currently the call price is $1.74 and the put price is $1.30. Construct an arbitrage portfolio and show how much profit can be made.

• (12%) Your factory can either stamp 150,000 CDs at a cost of $5 per CD, or 500,000 CDs at a cost of $8 per CD. If your CD has a hit song, you can sell it to retailers for $10 per CD. Otherwise, you can only charge $6 per CD. There is a 1-in-10 chance that your CD will be a hit. You will not find out whether you have a hit until next year, but fortunately this will be before you have to stamp CDs. Your cost of capital is 10% per year. You only have the lease of the factory for next year. There is no production this year.
  • -What is the expected selling price per CD? ?
  • -How many CDs should you produce at the expected selling price?that is, if you had to gear the factory for a particular production quantity today? ?
  • -What is the value of your factory if you can decide next year? ?
  • -What is the value of flexibility in this example? ?

• (16%) Consider purchasing a $50,000 SUV that you expect to last for 10 years. The IRS uses a 6-years straight-line schedule on cars. You company can finance this car. Your company can produce sales of $100,000 per year with it. Maintenance costs will be $5,000 per year. The income tax rate is 30% per annum. The company dividend is $6 this year and expected to grow at 3% per year. Currently the stock price is $50. Calculate NPV of this car.

2016 IMBA Financial Management Final Exam Multiple-Choice Questions (3% each) 1. The correlation coefficient between stock B and the market portfolio is 0.8. The standard deviation of stock B is 35% and that of the market is 20%. Calculate the beta of the stock. A. 1. 0 B. 1. 4 C. 0. 8 D. 0. 7 2. The presence of a risk-free asset enables the investor to: I) invest in the market portfolio; II) find an interior portfolio using quadratic programming; III) borrow or lend at the risk-free rate; IV) form portfolios having greater Sharpe ratios A. I and II only B. I and III only C. III and IV only D. IV only 3. The correlation coefficient between the efficient portfolio and the risk-free asset is: A. +1. 0 B. 1.0 C. 0. 0 D. need further information 4. A stock return's beta measures: A. the stock's covariance with the risk-free asset. B. the change in the stock's return for a given change in the market return. C. the return on the stock. D. the standard deviation on the stock's return. 5. Assume the following data for a stock: Beta = 1.5; Risk-free rate = 4%; Market rate of return = 12%; and Expected rate of return on the stock = 15%. Then the stock is: A. overprice d. B. underprice d. C. correctly priced. D. cannot be determined. 6. If capital markets are efficient, then the sale or purchase of any security at the prevailing market price is generally: A. a positive-NPV transaction. B. a zero-NPV transaction. C. a negative-NPV transaction. D. no general trend exists for such transactions. 7. Which of the following is a statement of weak-form efficiency? I) If markets are efficient in the weak form, then it is impossible to make consistently superior profits by using trading rules based on past returns. II) If markets are efficient in the weak form, then prices will adjust immediately to public information. III) If markets are efficient in the weak form, then prices reflect all information. A. I only B. II only C. II and III only D. III only 8. If markets are efficient, which of the following investors should achieve superior returns over time? A. Investors who choose stocks by throwing darts at a list of stocks in the financial pages of a newspaper B. Analysts who spend considerable time evaluating the best stocks to buy C. Mutual fund managers who manage other people's money for a living D. None of the options 9. MM Proposition I with corporate taxes states that: I) capital structure can affect firm value by an amount that is equal to the present value of the interest tax shield; II) by raising the debt-to-equity ratio, the firm can lower its taxes and thereby increase its total value; III) firm value is maximized by using an all-equity capital structure A. I only B. II only C. III only D. I and II 10. Although the use of debt provides tax benefits to the firm, debt also puts pressure on the firm to: I) Meet interest and principal payments, which if not met can put the company into financial distress; II) make dividend payments, which if not met can put the company into financial distress; III) meet both interest and dividend payments, which when met increase the firm cash flow; IV) meet increased tax payments, thereby increasing firm value A. I only B. II only C. II and III only D. III and IV only 11. MM Proposition II states that: I) the expected return on equity is positively related to leverage; II) the required return on equity is a linear function of the firm's debt to equity ratio; III) the risk to equity increases with leverage A. I only B. II only C. III only D. I, II, and III 12. Learn and Earn Company is financed entirely by common stock that is priced to offer a 20% expected rate of return. The stock price is $60 and the earnings per share are $12. The company wishes to repurchase 50% of the stock and substitutes an equal value of debt yielding 8%. Suppose that before refinancing, an investor owned 100 shares of Learn and Earn common stock. What should he do if he wishes to ensure that risk and expected return on his investment are unaffected by this refinancing? A. Borrow $3,000 and buy 50 more shares. B. Continue to hold 100 shares. C. Sell 50 shares and purchase $3,000 of 8% debt (bonds). D. Sell 8% of his stock and invest in bonds. 13. Suppose ABCD's stock price is currently $50. In the next six months, it will either fall to $40 or rise to $60. What is the current value of a six-month call option with an exercise price of $50? The six-month risk-free interest rate is 2% (periodic rate). A. $5.3 9 B. $15.0 0 C. $8.2 5 D. $8.0 9 14. All else equal, if the volatility (variance) of the underlying stock increases, then the: A. value of a put option increases and that of a call option decrease. B. value of a put option decreases and that of a call option increase. C. value of both a put option and a call option increase. D. value of both a put option and a call option decrease. Short-Answer Questions (60%) 1. (10%) An investor bought one call at strike price $60 for $8, and one put at strike price $30 for $4. The current stock price is $45. Draw the profit diagram for this portfolio. 2. (12%) TSMC stock has a volatility of 25% with expected return 8% per year. The current stock price is $100 per share. The risk-free interest rate is 2%. What is the Black-Scholes value of an at-the-money European put with 1 year maturity? 3. (10%) Consider European stock options with an exercise price of $40 that expire in 3 months. Assume the underlying stock pays no dividends, is trading at $40, and has a volatility of 20% per annum, and that the risk-free rate is 3% per annum. Currently the call price is $1.74 and the put price is $1.30. Construct an arbitrage portfolio and show how much profit can be made. 4. (12%) Your factory can either stamp 150,000 CDs at a cost of $5 per CD, or 500,000 CDs at a cost of $8 per CD. If your CD has a hit song, you can sell it to retailers for $10 per CD. Otherwise, you can only charge $6 per CD. There is a 1-in-10 chance that your CD will be a hit. You will not find out whether you have a hit until next year, but fortunately this will be before you have to stamp CDs. Your cost of capital is 10% per year. You only have the lease of the factory for next year. There is no production this year. a. What is the expected selling price per CD? b. How many CDs should you produce at the expected selling pricethat is, if you had to gear the factory for a particular production quantity today? c. What is the value of your factory if you can decide next year? d. What is the value of flexibility in this example? 5. (16%) Consider purchasing a $50,000 SUV that you expect to last for 10 years. The IRS uses a 6-years straight-line schedule on cars. You company can finance this car. Your company can produce sales of $100,000 per year with it. Maintenance costs will be $5,000 per year. The income tax rate is 30% per annum. The company dividend is $6 this year and expected to grow at 3% per year. Currently the stock price is $50. Calculate NPV of this car