Mark Washington, CFA, is an analyst with BIC. One year ago, BIC analysts predicted that the U.S. equity market would experience a slight downturn and suggested delta-hedging the BIC portfolio. U.S. equity markets did indeed fall, but BIC’s portfolio performance was disappointing, lagging its peer group by nearly 10%. Washington is reviewing the options strategy to determine why the hedged portfolio did not perform as expected. Which of the following best explains a delta-neutral portfolio? The return on a delta-neutral portfolio is hedged against: a. Small price changes in the underlying asset. b. Small price decreases in the underlying asset. c. Any small price change in the underlying asset.
> Mark Washington, CFA, is an analyst with BIC. One year ago, BIC analysts predicted that the U.S. equity market would experience a slight downturn and suggested delta-hedging the BIC portfolio. U.S. equity markets did indeed fall, but BIC’s portfolio perf
> A call option with X = $50 on a stock priced at S = $55 sells for $10. Using a volatility estimate of σ = .30, you find that N(d1) = .6 and N(d2) = .5. The risk-free interest rate is zero. Is the implied volatility based on the option price more or less
> Recalculate the value of the call option in Problem 11, successively substituting one of the changes below while keeping the other parameters as in Problem 11: a. Time to expiration = 3 months. b. Standard deviation = 25% per year. c. Exercise price = $5
> Find the Black-Scholes value of a put option on the stock in Problem 11 with the same exercise price and expiration as the call option. Data from problem 11: Time to expiration……………………………………6 months Standard deviation……………………………..50% per year Exercise p
> 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 r
> The common stock of the P.U.T.T. Corporation has been trading in a narrow price range for the past month, and you are convinced it is going to break far out of that range in the next three months. You do not know whether it will go up or down, however. T
> A 2-year investment of $2,000 results in a cash flow of $150 at the end of the first year and another cash flow of $150 at the end of the second year, in addition to the return of the original investment. What is the dollar-weighted (internal) rate of re
> Suppose you think AppX stock is going to appreciate substantially in value in the next year. Say the stock’s current price, S0, is $100, and a call option expiring in one year has an exercise price, X, of $100 and is selling at a price,
> Turn back to Figure 20.1, which lists prices of various Microsoft options. Use the data in the figure to calculate the payoff and the profits for investments in each of the following January 18 expiration options, assuming that the stock price on the exp
> Demonstrate that an at-the-money call option on a given stock must cost more than an at themoney put option on that stock with the same expiration. The stock will pay no dividends until after the expiration date. (Hint: Use put-call parity.)
> Netflux is selling for $100 a share. A Netflux call option with one month until expiration and an exercise price of $105 sells for $2 while a put with the same strike and expiration sells for $6.94. What must be the market price of a zero-coupon bond wit
> Joe Finance has just purchased a stock index fund, currently selling at $2,400 per share. To protect against losses, Joe also purchased an at-the-money European put option on the fund for $120, with exercise price $2,400, and 3-month time to expiration.
> You buy a share of stock, write a 1-year call option with X = $10, and buy a 1-year put option with X = $10. Your net outlay to establish the entire portfolio is $9.50. (a) What is the payoff of your portfolio? (b) What must be the risk-free interest rat
> Assume a stock has a value of $100. The stock is expected to pay a dividend of $2 per share at year-end. An at-the-money European-style put option with one-year expiration sells for $7. If the annual interest rate is 5%, what must be the price of a 1-yea
> A FinCorp put option with strike price 60 trading on the Acme options exchange sells for $2. To your amazement, a FinCorp put with the same expiration selling on the Apex options exchange but with strike price 62 also sells for $2. If you plan to hold th
> Consider the following portfolio. You write a put option with exercise price 90 and buy a put option on the same stock with the same expiration date with exercise price 95. a. Plot the value of the portfolio at the expiration date of the options. b. On t
> An executive compensation scheme might provide a manager a bonus of $1,000 for every dollar by which the company’s stock price exceeds some cutoff level. In what way is this arrangement equivalent to issuing the manager call options on the firm’s stock?
> A portfolio of stocks generates a −9% return in 2018, a 23% return in 2019, and a 17% return in 2020. What was the annualized return (geometric mean) for the entire period?
> Use the spreadsheet from the Excel Application box on spreads and straddles (available in Connect or through your course instructor; link to Chapter 20 material) to answer these questions. a. Plot the payoff and profit diagrams to a straddle position wit
> A bearish spread is the purchase of a call with exercise price X2 and the sale of a call with exercise price X1, with X2 greater than X1. Graph the payoff to this strategy and compare it to Figure 20.10.
> a. A butterfly spread is the purchase of one call at exercise price X1, the sale of two calls at exercise price X2, and the purchase of one call at exercise price X3. X1 is less than X2, and X2 is less than X3 by equal amounts, and all calls have the sam
> Imagine that you are holding 5,000 shares of stock, currently selling at $40 per share. You are ready to sell the shares but would prefer to put off the sale until next year for tax reasons. If you continue to hold the shares until January, however, you
> An investor purchases a stock for $38 and a put for $.50 with a strike price of $35. The investor sells a call for $.50 with a strike price of $40. What is the maximum profit and loss for this position? Draw the profit and loss diagram for this strategy
> Recently, Galaxy Corporation lowered its allowance for doubtful accounts by reducing bad debt expense from 2% of sales to 1% of sales. Ignoring taxes, what are the immediate effects on (a) operating income and (b) operating cash flow?
> Use the DuPont system and the following data to find return on equity. Leverage ratio (assets/equity) ……………………………. 2.2 Total asset turnover…………………………………………….2.0 Net profit margin…………………………………………………5.5% Dividend payout ratio…………………………………………..31.8%
> Firm A and Firm B have the same ROA, yet Firm A’s ROE is higher. How can you explain this?
> 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?
> 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?
> a. If the exchange rate for the British pound goes from U.S.$1.55 to U.S.$1.35, then the pound has: i. Appreciated and the British will find U.S. goods cheaper. ii. Appreciated and the British will find U.S. goods more expensive. iii. Depreciated and the
> Use the following cash flow data for Rocket Transport to find Rocket’s a. Net cash provided by or used in investing activities. b. Net cash provided by or used in financing activities. c. Net increase or decrease in cash for the year. Cash dividend………………
> A firm has a tax burden ratio of .75, a leverage ratio of 1.25, an interest burden of .6, and a return on sales of 10%. The firm generates $2.40 in sales per dollar of assets. What is the firm’s ROE?
> Michelle Industries issued a Swiss franc–denominated 5-year discount note for SFr200 million. The proceeds were converted to U.S. dollars to purchase capital equipment in the United States. The company wants to hedge this currency exposure and is conside
> Joan Tam, CFA, believes she has identified an arbitrage opportunity for a commodity as indicated by the following information: Spot price for commodity……………………………………………..$120 Futures price for commodity expiring in 1 year……………….$125 Interest rate for 1 y
> Sandra Kapple asks Maria VanHusen about using futures contracts to protect the value of the Star Hospital Pension Plan’s bond portfolio if interest rates rise. VanHusen states: a. “Selling a bond futures contract will generate positive cash flow in a ris
> A firm has an ROE of 3%, a debt-to-equity ratio of .5, and a tax rate of 21% and pays an interest rate of 6% on its debt. What is its operating ROA?
> Maria VanHusen, CFA, suggests that using forward contracts on fixed-income securities can be used to protect the value of the Star Hospital Pension Plan’s bond portfolio against the possibility of rising interest rates. VanHusen prepares the following ex
> How can a perpetuity, which has an infinite maturity, have a duration as short as 10 or 20 years?
> In what circumstances would you choose to use a dividend discount model rather than a free cash flow model to value a firm?
> Consider an increase in the volatility of the stock in the previous problem. Suppose that if the stock increases in price, it will increase to $130, and that if it falls, it will fall to $70. Show that the value of the call option is now higher than the
> You are attempting to value a call option with an exercise price of $100 and one year to expiration. The underlying stock pays no dividends, its current price is $100, and you believe it has a 50% chance of increasing to $120 and a 50% chance of decreasi
> Suppose that the risk-free interest rate is zero. Would an American put option ever be exercised early? Explain
> Return to Example 21.1. Use the binomial model to value a 1-year European put option with exercise price $110 on the stock in that example. Confirm that your solution for the put price satisfies put-call parity.
> You would like to be holding a protective put position on the stock of XYZ Co. to lock in a guaranteed minimum value of $100 at year-end. XYZ currently sells for $100. Over the next year, the stock price will increase by 10% or decrease by 10%. The T-bil
> You are very bullish (optimistic) on stock EFG, much more so than the rest of the market. In each question, choose the portfolio strategy that will give you the biggest dollar profit if your bullish forecast turns out to be correct. Explain your answer.
> A collar is established by buying a share of stock for $50, buying a 6-month put option with exercise price $45, and writing a 6-month call option with exercise price $55. On the basis of the volatility of the stock, you calculate that for a strike price
> Hatfield Industries is a large manufacturing conglomerate based in the United States with annual sales in excess of $300 million. Hatfield is currently under investigation by the Securities and Exchange Commission (SEC) for accounting irregularities and
> Consider a 6-month expiration European call option with exercise price $105. The underlying stock sells for $100 a share and pays no dividends. The risk-free rate is 5%. What is the implied volatility of the option if the option currently sells for $8? U
> Should the rate of return of a call option on a long-term Treasury bond be more or less sensitive to changes in interest rates than is the rate of return of the underlying bond?
> Would you expect a $1 increase in a call option’s exercise price to lead to a decrease in the option’s value of more or less than $1?
> What would be the Excel formula in Spreadsheet 21.1 for the Black-Scholes value of a straddle position?
> 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 not use continuous compounding to calculate the presen
> We showed in the text that the value of a call option increases with the volatility of the stock. Is this also true of put option values? Use the put-call parity theorem as well as a numerical example to prove your answer.
> You are a portfolio manager who uses options positions to customize the risk profile of your clients. In each case, what strategy is best given your client’s objective? a. ∙ Performance to date: Up 16%. ∙ Client objective: Earn at least 15%. ∙ Your for
> The common stock of the C.A.L.L. Corporation has been trading in a narrow range around $50 per share for months, and you believe it is going to stay in that range for the next three months. The price of a 3-month put option with an exercise price of $50
> Why do you think the most actively traded options tend to be the ones that are near the money?
> Hatfield Industries is a large manufacturing conglomerate based in the United States with annual sales in excess of $300 million. Hatfield is currently under investigation by the Securities and Exchange Commission (SEC) for accounting irregularities and
> What are the trade-offs facing an investor who is considering writing a call option on an existing portfolio?
> You think there is great upward potential in the stock market and would like to participate in the upward move if it materializes. However, you are not able to afford substantial stock market losses and so cannot run the risk of a stock market collapse,
> Devise a portfolio using only call options and shares of stock with the following value (payoff) at the option expiration date. If the stock price is currently $55, what kind of bet is the investor making?
> You write a call option with X = 50 and buy a call with X = 60. The options are on the same stock and have the same expiration date. One of the calls sells for $3; the other sells for $9. a. Draw the payoff graph for this strategy at the option expiratio
> You write a put option with X = 100 and buy a put with X = 110. The puts are on the same stock and have the same expiration date. a. Draw the payoff graph for this strategy. b. Draw the profit graph for this strategy. c. If the underlying stock has posit
> Consider the following options portfolio. You write a February 8 expiration call option on Microsoft with exercise price $100. You write a February 8 put option with exercise price $95. a. Graph the payoff of this portfolio at option expiration as a func
> What are the trade-offs facing an investor who is considering buying a put option on an existing portfolio?
> In what ways is owning a corporate bond similar to writing a put option? A call option?
> Some agricultural price support systems have guaranteed farmers a minimum price for their output. Describe the program provisions as an option. What is the asset? The exercise price?
> Jane Joseph, a manager at Computer Science, Inc. (CSI), received 10,000 shares of company stock as part of her compensation package. The stock currently sells at $40 a share. She would like to defer selling the stock until the next tax year. In January,
> Hatfield Industries is a large manufacturing conglomerate based in the United States with annual sales in excess of $300 million. Hatfield is currently under investigation by the Securities and Exchange Commission (SEC) for accounting irregularities and
> In this problem, we derive the put-call parity relationship for European options on stocks that pay dividends before option expiration. For simplicity, assume that the stock makes one dividend payment of $D per share at the expiration date of the option.
> We said that options can be used either to scale up or reduce overall portfolio risk. What are some examples of risk-increasing and risk-reducing options strategies? Explain each.
> What financial ratios would a credit rating agency such as Moody’s or Standard & Poor’s be most interested in? Which ratios would be of most interest to a stock market analyst deciding whether to buy a stock for a diversified portfolio?
> 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 markets?
> 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?
> Consider the following data for the firms Acme and Apex: a. Which firm has the higher economic value added? b. Which firm has the higher economic value added per dollar of invested capital?
> Use the financial statements of Heifer Sports Inc. in Table 19A to find the following information for Heifer’s: a. Inventory turnover ratio in 2020. b. Debt/equity ratio in 2020. c. Cash flow from operating activities in 2020. d. Avera
> 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 paid out a dividend of $.50 per share. Investors belie
> The MoMi Corporation’s cash flow from operations before interest and taxes was $2 million in the year just ended, and it expects that this will grow by 5% per year forever. To make this happen, the firm will have to invest an amount equal to 20% of preta
> 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 think the appropriate market capitalization rate is 20% 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. What price do you expect MF shares to sell for in three
> In what circumstances is it most important to use multistage dividend discount models rather than constant-growth models?
> Recalculate the intrinsic value of Rio Tinto 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 scenario independently. a. The terminal growth rate
> 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 company. The firm’s expected ROE for the next five year
> 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 year in dividends. The rest is retained and invested in pr
> The FI Corporation’s dividends per share are expected to grow indefinitely by 5% per year. a. If this year’s year-end dividend is $8 and the market capitalization rate is 10% per year, what must the current stock price be according to the DDM? b. If the
> 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 share. The annual dividend was just paid. The consensus
> Mary Smith, a CFA candidate, was recently hired for an analyst position at a large bank in London. Her first assignment is to examine the competitive strategies employed by various French wineries. Smith’s report identifies four winerie
> Mary Smith, a CFA candidate, was recently hired for an analyst position at a large bank in London. Her first assignment is to examine the competitive strategies employed by various French wineries. Smith’s report identifies four winerie
> Institutional Advisors for All Inc., or IAAI, is a consulting firm that advises foundations, endowments, pension plans, and insurance companies. The members of the research department foresee an upward trend in job creation and consumer confidence and pr
> 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 21%. If the economy is strong, the firm will sell 2 million drives, but if there is a recession
> 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 must be the market’s expectation of the dividend growth ra
> General Weedkillers dominates the chemical weed control market with its patented product Weed-ex. The patent is about to expire, however. What are your forecasts for changes in the industry? Specifically, what will happen to industry prices, sales, the p
> a. Use a spreadsheet to answer this question and assume the yield curve is flat at a level of 4%. Calculate the convexity of a “bullet” fixed-income portfolio, that is, a portfolio with a single cash flow. Suppose a single $1,000 cash flow is paid in yea
> A newly issued bond has a maturity of 10 years and pays a 7% coupon rate (with coupon payments coming once annually). The bond sells at par value. a. What are the convexity and the duration of the bond? Use the formula for convexity in footnote 7. b. Fin
> A 12.75-year-maturity zero-coupon bond selling at a yield to maturity of 8% (effective annual yield) has convexity of 150.3 and modified duration of 11.81 years. A 30-year-maturity 6% coupon bond making annual coupon payments also selling at a yield to m
> Mary Smith, a CFA candidate, was recently hired for an analyst position at a large bank in London. Her first assignment is to examine the competitive strategies employed by various French wineries. Smith’s report identifies four winerie
> a.Use a spreadsheet to calculate the durations of the two bonds in Spreadsheet 16.1 if the market interest rate increases to 12%. Why does the duration of the coupon bond fall while that of the zero remains unchanged? (Hint: Examine what happens to th
> A 30-year maturity bond has a 7% coupon rate, paid annually. It sells today for $867.42. A 20-year maturity bond has a 6.5% coupon rate, also paid annually. It sells today for $879.50. A bond market analyst forecasts that in five years, 25-year maturity
> Institutional Advisors for All Inc., or IAAI, is a consulting firm that advises foundations, endowments, pension plans, and insurance companies. The members of the research department foresee an upward trend in job creation and consumer confidence and pr
> Why do you think the change in the index of labor cost per unit of output is a useful lagging indicator of the macroeconomy? (See Table 17.2.)
> 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 based on these expectations? b. What is the degree of ope
> Tri-coat Paints has a current market value of $41 per share with earnings of $3.64. What is the present value of its growth opportunities (PVGO) if the required return is 9%?
