Problem $1$

Consider IKEA's return policy:

$"$If you've changed your mind and are not entirely satisfied with your purchase, simply return the unused item within $45$ days for an exchange or refund."

IKEA's return policy represents:

a$)$ a European put option written by IKEA.

b$)$ a European call option written by IKEA.

c$)$ an American put option written by IKEA.

d$)$ an American call option written by IKEA.

e$)$ a European put option written by IKEA customers.

f$)$ an American put option written by IKEA customers.

Problem $2$

If you write a put option you...:

a$)$ may exercise the option if the stock price rises.

b$)$ may be forced to buy the underlying stock for the exercise price.

c$)$ hope the stock price falls.

d$)$ have the right to sell the underlying stock for the exercise price.

e$)$ have the right to remain silent.

f$)$ have the right to buy the underlying stock for the exercise price.

Problem $3$

An investor purchases a stock for $$24$ and writes a call option on the same stock with an exercise price of $$28$ for a premium of $$2$ per share. The call option expires in one year. Assume that the stock pays no dividends, there are no transaction costs, and the investor will sell the stock in one year, exactly when the option expires.

a$)$ What is the maximum profit the investor can earn on the combined "covered call" position?

b$)$ What is the lowest possible profit from the combined investment?

c$)$ It is now exactly one year later and the investor tells you that her profit on the combined "covered call" position is $$0.$ What is the stock price based on this information?

Problem $4$

Mr$.$ Schenk runs a franchise of laundry stores called Deep Clean Inc. $($DCI$).$ Currently DCI uses only equity capital. Mr$.$ Schenk was approached by representatives from Lenders Inc. who have pointed out to him that his cost of unlevered equity capital is $15\%$ and the cost of debt capital is only $6\%.$ The reps said his company $($which produces before$-$tax operating cash flows of $$5$ million per year$)$ would benefit from using some debt. They recommend that he issues $$12$ million worth of bonds and use the entire proceeds to repurchase $$12$ million worth of its own stocks. Assume that both the firm's cash flows and the debt are perpetual, and DCI's marginal corporate tax rate is $30\%.$

a$)$ What is the current value of the firm without debt?

b$)$ If Mr$.$ Schenk follows Lenders Inc.$\text{'}$s plan:

i$.$ What would be the value of the firm?

ii$.$ What would be the cost of equity of the firm?

c$)$ Now assume interest expenses were not tax deductible. If Mr$.$ Schenk still followed Lenders' advice to issue debt and repurchase an equal amount of equity, even though interest expenses were not tax deductible:

i$.$ What would be the value of the firm?

ii$.$ What would be the cost of equity of the firm?

Problem $5$

CL Corp. has a WACC of $12\mathrm{.}17\%.$ The company's equity beta is $1\mathrm{.}3,$ and its semi$-$annual coupon bonds have a yieldto$-$maturity of $8\mathrm{.}8\%($APR$,$ semi$-$annually compounded$).$ The risk$-$free rate is $4\%,$ the expected return on the market portfolio is $11\mathrm{.}5\%,$ and the tax rate is $35\%.$ What is CL$\text{'}$s debt$-$to$-$equity $($D$/$E$)$ ratio?