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introduction to corporate finance

Questions and Answers of Introduction To Corporate Finance

Expiration date: The maturity date of the option; after this date, the option is dead. LO.1
American and European options: An American option may be exercised anytime up to the expiration date. A European option differs from an American option in that it can be exercised only on the
The most familiar options are puts and calls. These options give the holder the right to sell or buy shares of common stock at a given exercise price. American options can be exercised any time up to
We showed that a strategy of buying a stock and buying a put is equivalent to a strategy of buying a call and buying a zero coupon bond. From this, the put–call parity relationship was
The value of an option depends on fi ve factors:a. The price of the underlying asset.b. The exercise price.c. The expiration date.d. The variability of the underlying asset.e. The interest rate on
Much of corporate fi nancial theory can be presented in terms of options. In this chapter, we pointed out that:a. Common stock can be represented as a call option on the fi rm.b. Stockholders enhance
Options What is a call option? A put option? Under what circumstances might you want to buy each? Which one has greater potential profi t? Why? LO.1
American and European Options What is the difference between an American option and a European option? LO.1
Intrinsic Value What is the intrinsic value of a call option? Of a put option? How do we interpret this value? LO.1
Options and Stock Risk If the risk of a stock increases, what is likely to happen to the price of call options on the stock? To the price of put options? Why? LO.1
Options and Expiration Dates What is the impact of lengthening the time to expiration on an option’s value? Explain. LO.1
Options and Stock Price Volatility What is the impact of an increase in the volatility of the underlying stock’s return on an option’s value? Explain. LO.1
Insurance as an Option An insurance policy is considered analogous to an option. From the policyholder’s point of view, what type of option is an insurance policy? Why? LO.1
Equity as a Call Option It is said that the equityholders of a levered fi rm can be thought of as holding a call option on the fi rm’s assets. Explain what is meant by this statement. LO.1
Put–Call Parity A put and a call have the same maturity and strike price. If they have the same price, which one is in the money? Prove your answer and provide an intuitive explanation. LO.1
Two-State Option Pricing Model T-bills currently yield 5.5 percent. Stock in Nina Manufacturing is currently selling for $55 per share. There is no possibility that the stock will be worth less than
Understanding Option Quotes Use the option quote information shown here to answer the questions that follow. The stock is currently selling for $83.Option and Strike Calls Puts NY Close Expiration
Calculating Payoffs Use the option quote information shown here to answer the questions that follow. The stock is currently selling for $114.NY Close Expiration Price Vol. Last Vol. Last Macrosoft
Two-State Option Pricing Model The price of Ervin Corp. stock will be either $75 or $95 at the end of the year. Call options are available with one year to expiration. T-bills currently yield 6
Two-State Option Pricing Model The price of Tara, Inc., stock will be either $60 or $80 at the end of the year. Call options are available with one year to expiration. T-bills currently yield 5
Put–Call Parity A stock is currently selling for $61 per share. A call option with an exercise price of $65 sells for $4.12 and expires in three months. If the risk-free rate of interest is 2.6
Put–Call Parity A put option that expires in six months with an exercise price of $50 sells for $4.89. The stock is currently priced at $53, and the risk-free rate is 3.6 percent per year,
Put–Call Parity A put option and a call option with an exercise price of $70 and three months to expiration sell for $2.87 and $4.68, respectively. If the risk-free rate is 4.8 percent per year,
Put–Call Parity A put option and a call option with an exercise price of $65 expire in two months and sell for $2.86 and $4.08, respectively. If the stock is currently priced at $65.80, what is the
Black–Scholes What are the prices of a call option and a put option with the following characteristics?Stock price $38 Exercise price $35 Risk-free rate 6% per year, compounded continuously
Black–Scholes What are the prices of a call option and a put option with the following characteristics?Stock price $86 Exercise price $90 Risk-free rate 4% per year, compounded continuously
Delta What are the deltas of a call option and a put option with the following characteristics?What does the delta of the option tell you?Stock price $87 Exercise price $85 Risk-free rate 5%
Black–Scholes and Asset Value You own a lot in Key West, Florida, that is currently unused.Similar lots have recently sold for $1.6 million. Over the past fi ve years, the price of land in the area
Risk-Neutral Valuation A stock is currently priced at $75. The stock will either increase or decrease by 15 percent over the next year. There is a call option on the stock with a strike price of $70
Risk-Neutral Valuation In the previous problem, assume the risk-free rate is only 8 percent.What is the risk-neutral value of the option now? What happens to the risk-neutral probabilities of a stock
Black–Scholes A call option matures in six months. The underlying stock price is $85, and the stock’s return has a standard deviation of 20 percent per year. The risk-free rate is 4 percent per
Black–Scholes A stock is currently priced at $35. A call option with an expiration of one year has an exercise price of $50. The risk-free rate is 12 percent per year, compounded continuously, and
Equity as an Option Sunburn Sunscreen has a zero coupon bond issue outstanding with a $10,000 face value that matures in one year. The current market value of the fi rm’s assets is $10,500. The
Equity as an Option and NPV Suppose the fi rm in the previous problem is considering two mutually exclusive investments. Project A has a NPV of $700, and project B has a NPV of $1,000. As the result
Equity as an Option Frostbite Thermalwear has a zero coupon bond issue outstanding with a face value of $20,000 that matures in one year. The current market value of the fi rm’s assets is $22,000.
Two-State Option Pricing Model Ken is interested in buying a European call option written on Southeastern Airlines, Inc., a nondividend-paying common stock, with a strike price of$110 and one year
Two-State Option Pricing Model Maverick Manufacturing, Inc., must purchase gold in three months for use in its operations. Maverick’s management has estimated that if the price of gold were to rise
Black–Scholes and Collar Cost An investor is said to take a position in a “collar” if she buys the asset, buys an out-of-the-money put option on the asset, and sells an out-of-the-money call
Two-State Option Pricing and Corporate Valuation Strudler Real Estate, Inc., a construction fi rm fi nanced by both debt and equity, is undertaking a new project. If the project is successful, the
Put Delta In the chapter, we noted that the delta for a put option is N(d1) LO.1
Is this the same thing as N(d1)? (Hint: Yes, but why?) LO.1
Delta You purchase one call and sell one put with the same strike price and expiration date.What is the delta of your portfolio? Why? LO.1
How many different volatilities would you expect to see for the stock? LO.1
Unfortunately, solving for the implied standard deviation is not as easy as Mal suggests.In fact, there is no direct solution for the standard deviation of the stock even if we have all other
Are all of the implied volatilities for the options the same? (Hint: No.) What are the possible reasons that can cause different volatilities for these options? LO.1
After you discuss the importance of volatility on option prices, your boss mentions that he has heard of the VIX. What is the VIX and what does it represent? You might need to visit the Chicago Board
When you are on the CBOE Web site, look for the option quotes for the VIX. What does the implied volatility of a VIX option represent? LO.1
What are the goals of successful companies?
What are the three key attributes common to all successful companies?
How does expertise in corporate finance help a company become successful?
What are the key differences between sole proprietorships, partnerships, and corporations
Explain why the value of any business other than a very small one will probably be maximized if it is organized as a corporation.
Identify the hybrid forms of organization discussed in the text, and explain the differences among them.
What is management’s primary objective?
How does stock price maximization benefit society?
What three basic factors determine the price of a stock?
What three factors determine cash flows?
Distinguish between: (1) physical asset markets and financial asset markets; (2)spot and futures markets; (3) money and capital markets; (4) primary and secondary markets; and (5) private and public
What are derivatives, and how is their value related to that of an “underlying asset”?
What is relationship investing?
Identify three ways capital is transferred between savers and borrowers.
Distinguish between investment banking houses and financial intermediaries.
List the major types of intermediaries and briefly describe the primary function of each.
What are the differences among open outcry auctions, dealer markets, and ECNs?
What are some major differences between the NYSE and the Nasdaq stock market?
What is the price paid to borrow money called?
What are the two items whose sum is the “price” of equity capital?
How are interest rates used to allocate capital among firms?
What happens to market-clearing, or equilibrium, interest rates in a capital market when the demand for funds declines? What happens when inflation increases or decreases?
Why does the price of capital change during booms and recessions?
Write out an equation for the nominal interest rate on any debt security.Distinguish between the real risk-free rate of interest, r*, and the nominal, or quoted, risk-free rate of interest, rRF.
How is inflation dealt with when interest rates are determined by investors in the financial markets?
Does the interest rate on a T-bond include a default risk premium? Explain.Distinguish between liquid and illiquid assets, and identify some assets that are liquid and some that are illiquid.
Explain the shapes of a “normal” yield curve, an “abnormal” curve, and a“humped” curve.
If the rate of inflation is expected to increase, would this increase or decrease the slope of the yield curve?
If the rate of inflation is expected to remain constant in the future, would the yield curve slope up, down, or be horizontal?
Explain why corporate bonds’ default and liquidity premiums are likely to increase with maturity.
Explain why corporate bonds always trade at higher yields than Treasury bonds and why BBB-rated bonds always trade at higher yields than otherwise similar AA-rated bonds.
Assuming that the pure expectations theory is correct, how are long-term interest rates calculated?
Other than inflationary expectations, name some additional factors that influence interest rates, and explain the effects of each.
How does the Fed stimulate the economy? How does the Fed affect interest rates? Does the Fed have complete control over U.S. interest rates; that is, can it set rates at any level it chooses?
The company is considering offering terms of 2/10, net 30. It anticipates that 70 percent of its customers will take advantage of the discount. The new policy will reduce the collection period to 28
Credit Policy The Tropeland Company has annual sales of $50 million, all of which are on credit. The current collection period is 45 days, and the credit terms are net LO.1
Credit Markup In Problem 21, what is the break-even price per unit under the new credit policy? Assume all other values remain the same. LO.1
Credit Markup In Problem 20, what is the break-even price per unit that should be charged under the new credit policy? Assume that the sales fi gure under the new policy is 3,300 units and all other
Break-Even Quantity In Problem 20, what is the break-even quantity for the new credit policy? LO.1
Credit Policy Evaluation Happiness Systems currently has an all-cash credit policy. It is considering making a change in the credit policy by going to terms of net 30 days. Based on the following
Credit Policy Evaluation The Jungle Corporation is considering a change in its cash-only policy. The new terms would be net one period. Based on the following information, determine if Jungle should
Credit Policy The Silver Spokes Bicycle Shop has decided to offer credit to its customers during the spring selling season. Sales are expected to be 400 bicycles. The average cost to the shop of a
Credit Policy Berkshire Sports, Inc., operates a mail-order running shoe business. Management is considering dropping its policy of no credit. The credit policy under consideration is this:Current
Factoring Receivables Your fi rm has an average collection period of 34 days. Current practice is to factor all receivables immediately at a 2 percent discount. What is the effective cost of
Factoring The factoring department of Inter American Bank (IAB) is processing 100,000 invoices per year with an average invoice value of $1,500. IAB buys the accounts receivable at 3.5 percent off
Credit Policy Evaluation The Johnson Company sells 3,000 pairs of running shoes per month at a cash price of $90 per pair. The fi rm is considering a new policy that involves 30 days’ credit and an
Evaluating Credit Policy Bismark Co. is in the process of considering a change in its terms of sale. The current policy is cash only; the new policy will involve one period’s credit. Sales are
Credit Policy Evaluation Champions, Inc., is considering a change in its cash-only sales policy. The new terms of sale would be net one month. Based on the following information, determine if
Its accounts are, on average, nine days past due. If annual credit sales are $8 million, what is the company’s balance sheet amount in accounts receivable? LO.1
Size of Accounts Receivable The Orbison Corporation sells on credit terms of net LO.1
The discount is taken by 60 percent of the customers. What is the amount of the company’s accounts receivable? In reaction to sales by its main competitor, Sewage Spray, Essence of Skunk is
Size of Accounts Receivable Essence of Skunk Fragrances, Ltd., sells 4,000 units of its perfume collection each year at a price per unit of $400. All sales are on credit with terms of 2/15, net LO.1
ACP and Receivables Turnover Music City, Inc., has an average collection period of 52 days. Its average daily investment in receivables is $46,000. What are annual credit sales?What is the

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