Question: OceanGate sells external hard drives for $200

> 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?

> 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

> 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

> 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%?

> A 30-year maturity bond making annual coupon payments with a coupon rate of 12% has duration of 11.54 years and convexity of 192.4. The bond currently sells at a yield to maturity of 8%. a. Use a financial calculator or spreadsheet to find the price of t

> My pension plan will pay me $10,000 once a year for a 10-year period. The first payment will come in exactly five years. The pension fund wants to immunize its position. a. What is the duration of its obligation to me? The current interest rate is 10% pe

> You are managing a portfolio of $1 million. Your target duration is 10 years, and you can invest in two bonds, a zero-coupon bond with maturity of five years and a perpetuity, each currently yielding 5%. a. How much of (i) the zero-coupon bond and (ii) t

> Pension funds pay lifetime annuities to recipients. If a firm will remain in business indefinitely, the pension obligation will resemble a perpetuity. Suppose, therefore, that you are managing a pension fund with obligations to make perpetual payments of

> You will be paying $10,000 a year in tuition expenses at the end of the next two years. Bonds currently yield 8%. a. What are the present value and duration of your obligation? b. What maturity zero-coupon bond would immunize your obligation? c. Suppose

> Consider two firms producing smartphones. One uses a highly automated robotics process, whereas the other uses workers on an assembly line and pays overtime when there is heavy production demand. a. Which firm will have higher profits in a recession? b.

> Long-term Treasury bonds currently are selling at yields to maturity of nearly 6%. You expect interest rates to fall. The rest of the market thinks that they will remain unchanged over the coming year. In each question, choose the bond that will provide

> Unlike other investors, you believe the Fed is going to loosen monetary policy. What would be your recommendations about investments in the following industries? a. Gold mining b. Construction

> Rank the durations or effective durations of the following pairs of bonds: a. Bond A is a 6% coupon bond, with a 20-year time to maturity selling at par value. Bond B is a 6% coupon bond, with a 20-year time to maturity selling below par value. b. Bond A

> What characteristics will give firms greater sensitivity to business cycles?

> A firm pays a current dividend of $1.00, which is expected to grow at a rate of 5% indefinitely. If current value of the firm’s shares is $35.00, what is the required return based on the constant growth dividend discount model (DDM)?

> The administrator of a large pension fund wants to evaluate the performance of four portfolio managers. Each portfolio manager invests only in U.S. common stocks. Assume that during the most recent 5-year period, the average annual total rate of return i

> a. The historical yield spread between AAA bonds and Treasury bonds widened dramatically during the financial crisis in 2008. If you believed that the spread would soon return to more typical historical levels, what should you have done? b. This would be

> Repeat Problem 4, but now assume the coupons are paid semiannually. Problem 4: a. Find the duration of a 6% coupon bond making annual coupon payments if it has three years until maturity and has a yield to maturity of 6%. b. What is the duration if the

> What are the differences between bottom-up and top-down approaches to security valuation? What are the advantages of a top-down approach?

> If a security is underpriced (i.e., intrinsic value > price), then what is the relationship between its market capitalization rate and its expected rate of return?

> The difference between a Roth IRA and a traditional IRA is that in a Roth IRA taxes are paid on the income that is contributed, but the withdrawals at retirement are tax-free. In a traditional IRA, however, the contributions reduce your taxable income, b

> George More is a participant in a defined contribution pension plan that offers a fixed-income fund and a common stock fund as investment choices. He is 40 years old and has an accumulation of $100,000 in each of the funds. He currently contributes $1,50

> What is the least-risky asset for each of the following investors? a. A person investing for her 3-year-old child’s college tuition. b. A defined benefit pension fund with benefit obligations that have an average duration of 10 years. The benefits are no

> Your neighbor has heard that you successfully completed a course in investments and has come to seek your advice. She and her husband are both 50 years old. They just finished making their last payments for their condominium and their children’s college

> Suppose that sending an analyst to an executive education program will raise the precision of the analyst’s forecasts as measured by R-square by .01. How might you put a dollar value on this improvement? Provide a numerical example.

> Figure 27.3 includes a box for the econometrics unit. Item (3) is to “help other units.” What sorts of specific tasks might this entail?

> Jand, Inc., currently pays a dividend of $1.22, which is expected to grow indefinitely at 5%. If the current value of Jand’s shares based on the constant-growth dividend discount model is $32.03, what is the required rate of return?

> How would the application of the BL model to a stock and bond portfolio (per the example in the text) affect security analysis? What does this suggest about the hierarchy of use of the BL and TB models?

> Is statistical arbitrage true arbitrage? Explain.

> With respect to hedge fund investing, the net return to an investor in a fund of funds would be lower than that earned from an individual hedge fund because of: a. Both the extra layer of fees and the higher liquidity offered. b. No reason; funds of fund

> Which of the following would be the most appropriate benchmark to use for hedge fund evaluation? a. A multifactor model. b. The S&P 500. c. The risk-free rate.

> Which of the following is most accurate in describing the problems of survivorship bias and backfill bias in the performance evaluation of hedge funds? a. Survivorship bias and backfill bias both result in upwardly biased hedge fund index returns. b. Sur

> Why is it harder to assess the performance of a hedge fund portfolio manager than that of a typical mutual fund manager?

> How might the incentive fee of a hedge fund affect the manager’s proclivity to take on high-risk assets in the portfolio?

> Here are data on three hedge funds. Each fund charges its investors an incentive fee of 20% of total returns. Suppose initially that a fund of funds (FF) manager buys equal amounts of each of these funds, and also charges its investors a 20% incentive fe

> Return again to Problem 14. Now suppose that the manager misestimates the beta of Waterworks stock, believing it to be .50 instead of .75. The standard deviation of the monthly market rate of return is 5%. a. What is the standard deviation of the (now im

> Return to Problem 14. a. Suppose you hold an equally weighted portfolio of 100 stocks with the same alpha, beta, and residual standard deviation as Waterworks. Assume the residual returns (the e terms in Equations 26.1 and 26.2) on each of these stocks a

> Deployment Specialists pays a current (annual) dividend of $1.00 and is expected to grow at 20% for 2 years and then at 4% thereafter. If the required return for Deployment Specialists is 8.5%, what is the intrinsic value of its stock?

> The following is part of the computer output from a regression of monthly returns on Waterworks stock against the S&P 500 index. A hedge fund manager believes that Waterworks is underpriced, with an alpha of 2% over the coming month. a. If he holds a

> Suppose a hedge fund follows the following strategy. Each month it holds $100 million of an S&P 500 index fund and writes out-of-the-money put options on $100 million of the index with exercise price 5% lower than the current value of the index. Suppose

> Log in to Connect and link to Chapter 26 to find a spreadsheet containing monthly values of the S&P 500 index. Suppose that in each month you had written an out-of-the-money put option on one unit of the index with an exercise price 5% lower than the cur

> Reconsider the hedge fund in Problem 10. Suppose it is January 1, the standard deviation of the fund’s annual returns is 50%, and the risk-free rate is 4%. The fund has an incentive fee of 20%, but its current high water mark is $66, and net asset value

> A hedge fund with net asset value of $62 per share currently has a high water mark of $66. Is the value of its incentive fee more or less than it would be if the high water mark were $67?