Question: Table 26.4 contains spot and six-

> Table 27.5 shows the annual interest rate (annually compounded) and exchange rates against the dollar for different currencies. Are there any arbitrage opportunities? If so, how would you secure a positive cash flow today, while zeroing out a

> In November 2014, an American investor buys 1,000 shares in a Mexican company at a price of 500 pesos each. The share does not pay any dividend. A year later she sells the shares for 550 pesos each. The exchange rates when she buys the stock are shown in

> You have bid for a possible export order that would provide a cash inflow of €1 million in six months. The spot exchange rate is $1.3549 = €1 and the six-month forward rate is $1.3620 = €1. There are two sources of uncertainty: (1) the euro could apprec

> A Ford dealer in the United States may be exposed to a devaluation of the yen if this leads to a cut in the price of Japanese cars. Suppose that the dealer estimates that a 1% decline in the value of the yen would result in a permanent decline of 5% in t

> Companies may be affected by changes in the nominal exchange rate or in the real exchange rate. Explain how this can occur. Which changes are easiest to hedge against?

> Exacta, s.a. Exacta, s.a., is a major French producer, based in Lyons, of precision machine tools. About two thirds of its output is exported. The majority of these sales is within the European Union. However, the company also has a thriving business in

> Suppose you are the treasurer of Lufthansa, the German international airline. How is company value likely to be affected by exchange rate changes? What policies would you adopt to reduce exchange rate risk?

> Penny Farthing, the treasurer of International Bicycles, Inc., has noticed that the interest rate in Japan is below the rates in most other countries. She is, therefore, suggesting that the company should make an issue of Japanese yen bonds. Does this ma

> Look at Table 27.1. If the three-month interest rate on dollars is 0.2%, what do you think is the three-month interest rate on the Brazilian real? Explain what would happen if the rate were substantially above your figure. Table 2

> Table 27.1 shows the 90-day forward rate on the South African rand. a. Is the dollar at a forward discount or premium on the rand? b. What is the annual percentage discount or premium? c. If you have no other information about the two curr

> Why are pyramids common in many countries but not in the United States or United Kingdom?

> It is the year 2021 and Pork Barrels Inc. is considering construction of a new barrel plant in Spain. The forecasted cash flows in millions of euros are as follows: The spot exchange rate is $1.2 = €1. The interes

> Suppose that in 2023 one- and two-year interest rates are 5.2% in the United States and 1.0% in Japan. The spot exchange rate is ¥120.22/$. Suppose that one year later interest rates are 3% in both countries, while the value of the yen has appreciated to

> An importer in the United States is due to take delivery of clothing from Mexico in six months. The price is fixed in Mexican pesos. Which of the following transactions could eliminate the importer’s exchange risk? a. Sell six-month call options on peso

> Phillip’s Screwdriver Company has borrowed $20 million from a bank at a floating interest rate of 2 percentage points above three-month Treasury bills, which now yield 5%. Assume that interest payments are made quarterly and that the entire principal of

> Your investment bank has an investment of $100 million in the stock of the Swiss Roll Corporation and a short position in the stock of the Frankfurter Sausage Company. Here is the recent price history of the two stocks:
On the evidence of these six mo

> “Speculators want futures contracts to be incorrectly priced; hedgers want them to be correctly priced.” Why?

> Yesterday you sold six-month futures on the German DAX stock market index at a price of 9,120. Today the DAX closed at 9,100 and DAX futures closed at 9,140. You get a call from your broker, who reminds you that your futures position is marked to market

> Is a total return swap on a bond the same as a credit default swap? Why or why not?

> Consider the commodities and financial assets listed in Table 26.5. The risk-free interest rate is 6% a year, and the term structure is flat. a. Calculate the six-month futures price for each case. b. Explain how a magnoosium producer would use a futures

> Petrochemical Parfum (PP) is concerned about a possible increase in the price of heavy fuel oil, which is one of its major inputs. Show how PP can use either options or futures contracts to protect itself against a rise in the price of crude oil. Show ho

> What kind of industries do you think should thrive in a market-based financial system? In a bank-based system?

> Price changes of two gold-mining stocks have shown strong positive correlation. Their historical relationship is Average percentage change in A = .001 + .75 (percentage change in B) Changes in B explain 60% of the variation of the changes in A (R2 = .6).

> Legs Diamond owns shares in a Vanguard Index 500 mutual fund worth $1 million on July 15. (This is an index fund that tracks the Standard and Poor’s 500 Index.) He wants to cash in now, but his accountant advises him to wait six months so as to defer a l

> A gold-mining firm is concerned about short-term volatility in its revenues. Gold currently sells for $1,300 an ounce, but the price is extremely volatile and could fall as low as $1,220 or rise as high as $1,380 in the next month. The company will bring

> What is meant by “delta” (δ) in the context of hedging? Give examples of how delta can be estimated or calculated.

> Securities A, B, and C have the following cash flows:
a. Calculate their durations if the interest rate is 8%. b. Suppose that you have an investment of $10 million in A. What combination of B and C would hedge this investment against interest rate c

> In September 2020 swap dealers were quoting a rate for five-year euro interest rate swaps of 4.5% against Euribor (the short-term interest rate for euro loans). Euribor at the time was 4.1%. Suppose that A arranges with a dealer to swap a €10 million fiv

> The following table shows 2014 gold futures prices for varying contract lengths. Gold is predominantly an investment good, not an industrial commodity. Investors hold gold because it diversifies their portfolios and because they hope its price will rise.

> Why is transparency important in a market-based financial system? Why is it less important in a bank-based system?

> Banks are not the only financial intermediary from which corporations can obtain financing. What are the other intermediaries? How much financing do they supply, relative to banks, in the United Kingdom, Germany, and Japan?

> Agency problems are inevitable. That is, we can never expect managers to give 100% weight to shareholders’ interests and none to their own. a. Why not? b. List the mechanisms that are used around the world to keep agency problems under control.

> What is tunneling? Why does the threat of tunneling impede the development of financial markets?

> What is meant by the German system of codetermination?

> In December 2014, 6-month futures on the Australian S&P/ASX 200 Index traded at 5,376. Spot was 5,442. The interest rate was 2.5%, and the dividend yield was about 4.7%. Were the futures fairly priced?

> Which countries have a. The largest stock markets? b. The largest bond markets? c. The smallest direct holdings of shares by individual investors? d. The largest holdings of bank deposits by individual investors? e. The largest holdings of shares by

> What are some of the advantages and disadvantages of Japanese keiretsu’s?

> “Privatization appears to bring efficiency gains because public companies are better able to reduce agency costs.” Why do you think this may (or may not) be true?

> True or false? a. Hedging transactions in an active futures market have zero or slightly negative NPVs. b. When you buy a futures contract, you pay now for delivery at a future date. c. The holder of a financial futures contract misses out on any dividen

> We described carried interest as an option. What kind of option? How does this option change incentives in a private-equity partnership? Can you think of circumstances where these incentive changes would be perverse, that is, potentially value-destroying

> Explain the structure of a private-equity partnership. Pay particular attention to incentives and compensation. What types of investment were such partnerships designed to make?

> Read Barbarians at the Gate (Further Reading). What agency costs can you identify? Do you think the LBO was well-designed to reduce these costs?

> The Sealed Air leveraged restructuring is described in the Chapter 18 Beyond the Page feature. Outline the similarities and differences between the RJR Nabisco LBO and the Sealed Air restructuring. Were the economic motives the same? Were the results the

> True, false, or “It depends on. . .”? a. Carve-out or spin-off of a division improves incentives for the division’s managers. b. Private-equity partnerships have limited lives. The main purpose is to force the general partners to seek out quick payback

> True or false? a. When a company becomes bankrupt, it is usually in the interests of stockholders to seek a liquidation rather than a reorganization. b. In Chapter 11 a reorganization plan must be presented for approval by each class of creditor. c. In

> Private-equity partnerships have a limited term. What are the advantages of this arrangement?

> Phoenix Motors wants to lock in the cost of 10,000 ounces of platinum to be used in next quarter’s production of catalytic converters. It buys three-month futures contracts for 10,000 ounces at a price of $1,300 per ounce. a. Suppose the spot price of pl

> What advantages have been claimed for public conglomerates?

> True or false? a. One of the first tasks of an LBO’s financial manager is to pay down debt. b. Once an LBO or MBO goes private, it almost always stays private. c. Targets for LBOs in the 1980s tended to be profitable companies in mature industries. d

> Define the following terms: a. LBO b. MBO c. Spin-off d. Carve-out e. Asset sale f. Privatization g. Leveraged restructuring

> We described several problems with Chapter 11 bankruptcy. Which of these problems could be mitigated by negotiating a prepackaged bankruptcy?

> For what kinds of firm would an LBO or MBO transaction not be productive?

> Explain why equity can sometimes have a positive value even when companies file for bankruptcy.

> What is the difference between Chapter 7 and Chapter 11 bankruptcies?

> List the disadvantages of traditional U.S. conglomerates.

> What are the government’s motives in a privatization?

> Which of the following transactions are not likely to be classed as tax-free? a. A cash acquisition of assets. b. A merger in which payment is entirely in the form of voting stock.

> List some of the commodity futures contracts that are traded on exchanges. Who do you think could usefully reduce risk by buying each of these contracts? Who do you think might wish to sell each contract?

> Are the following hypothetical mergers horizontal, vertical, or conglomerate? a. IBM acquires Dell Computer. b. Dell Computer acquires Walmart. c. Walmart acquires Tyson Foods. d. Tyson Foods acquires IBM.

> Why may market-based financial systems be better in supporting innovation and in releasing capital from declining industries?

> What is meant by dual-class equity? Do you think it should be allowed or outlawed?

> Explain the distinction between a tax-free and a taxable merger. Are there circumstances in which you would expect buyer and seller to agree to a taxable merger?

> The Muck and Slurry merger has fallen through (see Section 31-2). But World Enterprises is determined to report earnings per share of $2.67. It therefore acquires the Wheelrim and Axle Company. You are given the following facts:
Once again there are n

> As treasurer of Leisure Products, Inc., you are investigating the possible acquisition of Plastitoys. You have the following basic data:
You estimate that investors currently expect a steady growth of about 6% in Plastitoys’ earnings and dividends. Un

> Suppose you obtain special information—information unavailable to investors—indicating that Backwoods Chemical’s stock price is 40% undervalued. Is that a reason to launch a takeover bid for Backwoods? Explain carefully.

> Sometimes the stock price of a possible target company rises in anticipation of a merger bid. Explain how this complicates the bidder’s evaluation of the target company.

> Respond to the following comments. a. “Our cost of debt is too darn high, but our banks won’t reduce interest rates as long as we’re stuck in this volatile widget-trading business. We’ve got to acquire other companies with safer income streams.” b. “Merg

> Briefly define the following terms: a. Purchase accounting b. Tender offer c. Poison pill d. Golden parachute e. Synergy

> True or false? a. Sellers almost always gain in mergers. b. Buyers usually gain more than sellers in acquisitions. c. Firms that do unusually well tend to be acquisition targets. d. Merger activity in the United States varies dramatically from year to ye

> Velcro Saddles is contemplating the acquisition of Pogo Ski Sticks, Inc. The values of the two companies as separate entities are $20 million and $10 million, respectively. Velcro Saddles estimates that by combining the two companies, it will reduce mark

> On some catastrophe bonds, payments are reduced if the claims against the issuer exceed a specified sum. In other cases payments are reduced only if claims against the entire industry exceed some sum. What are the advantages and disadvantages of the two

> Which of the following motives for mergers make economic sense? a. Merging to achieve economies of scale. b. Merging to reduce risk by diversification. c. Merging to redeploy cash generated by a firm with ample profits but limited growth opportunities. d

> Look again at Table 31.3. Suppose that B Corporation’s fixed assets are reexamined and found to be worth $12 million instead of $9 million. How would this affect the AB Corporation’s balance sheet under purchase accounting? How would the value of AB Corp

> Until recently, Augean Cleaning Products sold its products on terms of net 60, with an average collection period of 75 days. In an attempt to induce customers to pay more promptly, it has changed its terms to 2/10, EOM, net 60. The initial effect of the

> Look again at the last problem. Suppose (a) that it costs $95 to classify each new credit applicant and (b) that an almost equal proportion of new applicants falls into each of the four categories. In what circumstances should Mr. Khana not bother to u

> Jim Khana, the credit manager of Velcro Saddles, is reappraising the company’s credit policy. Velcro sells on terms of net 30. Cost of goods sold is 85% of sales, and fixed costs are a further 5% of sales. Velcro classifies customers on

> Phoenix Lambert currently sells its goods cash-on-delivery. However, the financial manager believes that by offering credit terms of 2/10 net 30 the company can increase sales by 4%, without significant additional costs. If the interest rate is 6% and th

> Listed below are some common terms of sale. Can you explain what each means? a. 2/30, net 60 b. 2/5, EOM, net 30 c. COD

> Consider three securities: a. A floating-rate bond b. A preferred share paying a fixed dividend c. A floating-rate preferred If you were responsible for short-term investment of your firm’s excess cash, which security would you probably prefer to hol

> Look back at Section 30-2. Cast Iron’s costs have increased from $1,000 to $1,050. Assuming there is no possibility of repeat orders, answer the following: a. When should Cast Iron grant or refuse credit? b. If it costs $12 to determine whether a custome

> Company X sells on a 1/30, net 60 basis. Customer Y buys goods invoiced at $1,000. a. How much can Y deduct from the bill if Y pays on day 30? b. What is the effective annual rate of interest if Y pays on the due date rather than on day 30? c. How wou

> Large businesses spend millions of dollars annually on insurance. Why? Should they insure against all risks or does insurance make more sense for some risks than others?

> What are the trade-offs involved in the decision of how much inventory the firm should carry?

> Galenic, Inc., is a wholesaler for a range of pharmaceutical products. Before deducting any losses from bad debts, Galenic operates on a profit margin of 5%. For a long time the firm has employed a numerical credit scoring system based on a small number

> Reliant Umbrellas has been approached by Plumpton Variety Stores of Nevada. Plumpton has expressed interest in an initial purchase of 5,000 umbrellas at $10 each on Reliant’s standard terms of 2/30, net 60. Plumpton estimates that if the umbrellas prove

> Suppose you are a wealthy individual paying 35% tax on income. What is the expected after-tax yield on each of the following investments? a. A municipal note yielding 7.0% pretax. b. A Treasury bill yielding 10% pretax. c. A floating-rate preferred st

> The IRS prohibits companies from borrowing money to buy tax-exempts and deducting the interest payments on the borrowing from taxable income. Should the IRS prohibit such activity? If it didn’t, would you advise the company to borrow to buy tax-exempts?

> In 2006 agency bonds sold at a yield of 5.32%, while high-grade tax-exempts of comparable maturity offered 3.7% annually. If an investor receives the same after-tax return from corporates and tax-exempts, what is that investor’s marginal rate of tax? Wha

> In Section 30-4 we described a three-month bill that was issued on an annually compounded yield of 5.16%. Suppose that one month has passed and the investment still offers the same annually compounded return. What is the percentage discount? What was you

> A three-month Treasury bill and a six-month bill both sell at a discount of 10%. Which offers the higher annual yield?

> Lockboxes The financial manager of JAC Cosmetics is considering opening a lockbox in Pittsburgh. Checks cleared through the lockbox will amount to $10,000 per day. The lockbox will make cash available to the company three days earlier than is currently t

> A parent company settles the collection account balances of its subsidiaries once a week. (That is, each week it transfers any balances in the accounts to a central account.) The cost of a wire transfer is $10. A check costs $.80. Cash transferred by wir

> a. Marshall Arts has just invested $1 million in long-term Treasury bonds. Marshall is concerned about increasing volatility in interest rates. He decides to hedge using bond futures contracts. Should he buy or sell such contracts? b. The treasurer of Ze

> Anne Teak, the financial manager of a furniture manufacturer, is considering operating a lockbox system. She forecasts that 300 payments a day will be made to lockboxes, with an average payment size of $1,500. The bank’s charge for operating the lockboxe

> Knob, Inc., is a nationwide distributor of furniture hardware. The company now uses a central billing system for credit sales of $180 million annually. First National, Knob’s principal bank, offers to establish a new concentration banking system for a fl

> Look again at the previous problem. Suppose another month has passed, so the bill has only one month left to run. It is now selling at a discount of 3%. What is the yield? What was your realized return over the two months? Previous problem: In Section 30

> Look at the previous problem. Assume that the change in credit terms results in a 2% increase in sales. Recalculate the effect of the changed credit terms. Previous problem: Until recently, Augean Cleaning Products sold its products on terms of net 60, w

> As treasurer of the Universal Bed Corporation, Aristotle Procrustes is worried about his bad debt ratio, which is currently running at 6%. He believes that imposing a more stringent credit policy might reduce sales by 5% and reduce the bad debt ratio to

> Some of the items in the previous problem involve a cash discount. For each of these, calculate the rate of interest paid by customers who pay on the due date instead of taking the cash discount.

> For each item below, choose the investment that best fits the accompanying description: a. Maturity often overnight (repurchase agreements/bankers’ acceptances) b. Maturity never more than 270 days (tax-exempts/commercial paper) c. Issued by the U.S.