Question: Time Warner has bonds that are selling

> Mr. Wall is a little confused over the relationship between the embedded option and the callable bond. How does the value of the embedded call option change when interest rate volatility increases? a. It increases. b. It may increase or decrease. c. It d

> Mortgage pools also suffer from defaults. Explain how defaults are handled in a fully modified mortgage pool. In the case of a fully modified mortgage pool, explain why defaults appear as prepayments to the mortgage pool investor.

> Evaluate the following argument: “Prepayment is not a risk to mortgage investors because prepayment actually means that the investor is paid both in full and ahead of schedule.” Is the statement always true or false?

> What are some of the reasons that mortgages are paid off early? Under what circumstances are mortgage prepayments likely to rise sharply? Explain.

> Why is Macaulay duration an inadequate measure of interest rate risk for an MBS? Why is effective duration a better measure of interest rate risk for an MBS?

> Explain in general terms how a protected amortization class (or PAC) CMO works.

> Consider a single whole bond sequential CMO. It has two tranches, an A-tranche and a Z-tranche. Explain how the payments are allocated to the two tranches. Which tranche is riskier?

> Which has greater interest rate risk, an IO or a PO strip?

> What is a collateralized mortgage obligation? Why do they exist? What are three popular types?

> In general, if you buy a call option, what stock price is needed for you to break even on the transaction ignoring taxes and commissions? If you buy a put option?

> What is a collateralized mortgage obligation? Why do they exist? What are three popular types?

> If you believed inflation was going to increase over the coming years, would you rather invest in short-term or long-term debt?

> Briefly explain why a high level of national debt may be detrimental for economic growth.

> Two callable bonds are essentially identical, except that one has a refunding provision while the other has no refunding provision. Which bond is more likely to be called by the issuer? Why?

> All else the same, callable bonds have less interest rate sensitivity than non callable bonds. Why? Is this a good thing?

> Explain the difference between an original-issue junk bond and a fallen angel bond.

> What are some examples of embedded options in bonds? How do they affect the price of a bond?

> From the bondholder’s perspective, what are the potential advantages and disadvantages of floating coupons?

> For a callable Treasury bond selling above par, is it necessarily true that the yield to call will be less than the yield to maturity? Why or why not?

> Treasury and municipal yields are often compared to calculate critical tax rates. What concerns might you have about such a comparison? What do you think is true about the calculated tax rate?

> Complete the following sentence for each of these investors: a. A buyer of call options. b. A buyer of put options. c. A seller (writer) of call options. d. A seller (writer) of put options. The (buyer/seller) of a (put/call) option (pays/receives) money

> From an investor’s standpoint, what are the main differences between Treasury and municipal issues?

> From an investor’s standpoint, what are the key differences between Treasury and agency issues?

> What is a bond refunding? Is it the same thing as a call?

> What is the difference between gross margin and operating margin? What do they tell us? Generally speaking, are larger or smaller values better?

> Both ROA and ROE measure profitability. Which one is more useful for comparing two companies? Why?

> Why do you think most long-term financial planning begins with sales forecasts? Put differently, why are future sales the key input?

> A put and a call option have the same maturity and strike price. If both are at the money, which is worth more? Prove your answer and then provide an intuitive explanation.

> Recall the option strategies of a protective put and covered call discussed in the text. Suppose you have sold short some shares of stock. Discuss analogous option strategies and how you would implement them. (Hint: They’re called protective calls and co

> A put and a call option have the same maturity and strike price. If they also have the same price, which one is in the money?

> Are the put options in the money? What is the intrinsic value of a Milson Corp. put option? Calls Puts Option & Strike N.Y. Close Price Expiration Vol. Last Vol. Last Milson 59 55 Mar 98 3.50 66 1.06 59 55 Apr 54 6.25 40 1.94 59 55 Jul 25 8.63 17 3.

> Are the call options in the money? What is the intrinsic value of a Milson Corp. call option? Calls Puts Option & Strike N.Y. Close Price Expiration Vol. Last Vol. Last Milson 59 55 Mar 98 3.50 66 1.06 59 55 Apr 54 6.25 40 1.94 59 55 Jul 25 8.63 17

> How many option contracts on Milson stock were traded with an expiration date of July? How many underlying shares of stock do these option contracts represent? Calls Puts Option & Strike N.Y. Close Price Expiration Vol. Last Vol. Last Milson 59 55 M

> Regarding Ms. Smith’s and Mr. Van Eaton’s statements made about the competitive strategy of the South Winery: a. Both are incorrect. b. Both are correct. c. Only one is correct.

> Two of the options are clearly mispriced. Which ones? At a minimum, what should the mispriced options sell for? Explain how you could profit from the mispricing in each case. Calls Puts Option & Strike N.Y. Close Price Expiration Vol. Last Vol. Last

> Mr. Van Eaton tells Ms. Smith that he likes the fact that the conclusions in her report are backed up with facts, but he tells her that he is concerned about the section concerning the bargaining power of buyers. He says that while all of the points she

> Ms. Smith would likely categorize the French wine industry into which of the following life cycle phases? a. Decline phase b. Pioneer phase c. Mature phase

> If the French home currency were to greatly appreciate in value compared to the English currency, what is the likely impact on the East Winery? a. Make the firm less competitive in the English market. b. No impact since the major market for East Winery i

> Explain why the right to prepay a mortgage is similar to the call feature contained in most corporate bonds.

> What does it mean for a mortgage pool to be fully modified?

> From an investor’s point of view, what is the difference between mortgage pools backed by GNMA, FNMA, and FHLMC?

> All else the same, will the payments be higher on a 15-year mortgage or a 30-year mortgage? Why?

> How does mortgage securitization benefit mortgage originators?

> How does mortgage securitization benefit borrowers?

> Why is inflation associated with lower values of real GDP and wages?

> What is the impact of lengthening the time to expiration on an option’s value? Explain.

> What is a call option? A put option? Under what circumstances might you want to buy each? Which one has greater potential profit? Why?

> Zenith Co.’s bonds mature in 12 years and pay 7 percent interest annually. If you purchase the bonds for $1,150, what is your expected rate of return?

> Citigroup issued bonds that pay a 5.5 percent coupon interest rate. The bonds mature in 5 years. They are selling for $1,076. What would be your expected rate of return (yield to maturity) if you bought the bonds? What would the current yield be?

> You own a bond that has a par value of $1,000 and matures in 5 years. It pays a 5 percent annual coupon rate. The bond currently sells for $1,100. What is the bond’s expected rate of return?

> The market price is $900 for a 10-year bond ($1,000 par value) that pays 6 percent interest (6 percent semiannually). What is the bond’s expected rate of return?

> The Latham Corporation is planning on issuing bonds that pay no interest but can be converted into $1,000 at maturity, 7 years from their purchase. To price these bonds competitively with other bonds of equal risk, it is determined that they should yield

> ExxonMobil 20-year bonds pay 6 percent interest annually on a $1,000 par value. If the bonds sell at $945, what is the bonds’ expected rate of return?

> At the beginning of the year, you bought a $1,000 par value corporate bond with a 6 percent annual coupon rate and a 10-year maturity date. When you bought the bond, it had an expected yield to maturity of 8 percent. Today the bond sells for $1,060. a. W

> You purchased a bond for $1,100. The bond has a coupon rate of 8 percent, which is paid semiannually. It matures in 7 years and has a par value of $1,000. What is your expected rate of return?

> You own a 10-year bond that pays 6 percent interest annually. The par value of the bond is $1,000, and the market price of the bond is $900. What is the yield to maturity of the bond?

> Assume you own a bond with a market value of $820 that matures in 7 years. The par value of the bond is $1,000. Interest payments of $30 are paid semiannually. What is your expected rate of return on the bond?

> An 8-year bond for Rusk Corporation has a market price of $700 and a par value of $1,000. If the bond has an annual interest rate of 6 percent, but pays interest semiannually, what is the bond’s yield to maturity?

> Assume the market price of a 5-year bond for Margaret, Inc. is $900, and it has a par value of $1,000. The bond has an annual interest rate of 6 percent that is paid semiannually. What is the yield to maturity of the bond?

> Calculate the value of a bond that will mature in 14 years and has a $1,000 face value. The annual coupon interest rate is 5 percent, and the investor’s required rate of return is 7 percent.

> What are the markets and mechanics involved in generating simple arbitrage profits?

> What is meant by arbitrage profits?

> What different types of businesses operate in the international environment? Why are the techniques and strategies available to these firms different?

> How can we accommodate the effects of compounding in our calculation of the effective cost of short-term credit?

> How can the formula “interest = principle * rate * time” be used to estimate the cost of short-term credit?

> Define the following terms: a. Permanent asset investments b. Temporary asset investments c. Permanent sources of financing d. Temporary sources of financing e. Spontaneous sources of financing

> Define the hedging principle. How can this principle be used in the management of working capital?

> Explain what is meant by the statement “The use of current liabilities as opposed to long-term debt subjects the firm to a greater risk of illiquidity.”

> What advantages and disadvantages are generally associated with the use of short-term debt? Discuss.

> Discuss the risk–return relationship involved in the firm’s asset-investment decisions as that relationship pertains to its working capital management.

> Nealon Energy Corporation engages in the acquisition, exploration, development, and production of natural gas and oil in the continental United States. The company has grown rapidly over the last 5 years as it has expanded into horizontal drilling techni

> Define and contrast the terms working capital and net working capital.

> Define the following: a. Line of credit b. Commercial paper c. Compensating balance d. Prime rate

> What is meant by the following trade credit terms: 2/10, net 30? 4/20, net 60? 3/15, net 45?

> There are three major sources of unsecured short-term credit other than accrued wages and taxes. List and discuss the distinguishing characteristics of each.

> Dell Computer Corporation (DELL) has long been recognized for its innovative approach to managing its working capital. Describe how Dell pioneered the management of net working capital to free up resources in the firm.

> What would be the probable effect on a firm’s cash position of each of the following events? a. Rapidly rising sales b. A delay in the payment of payables c. A more liberal credit policy on sales (to the firm’s customers) d. Holding larger inventories

> Discuss the shortcomings of the percent of sales method of financial forecasting.

> United Parcel Service (UPS) provides package delivery services throughout the United States and the world. Discuss the impact of seasonal variations in the delivery business for forecasting the firm’s financing requirements.

> What is the primary weakness of using EBIT-EPS analysis as a financing decision tool?

> Define the following terms: a. Financial structure b. Capital structure c. Optimal capital structure d. Debt capacity

> You have finally saved $10,000 and are ready to make your first investment. You have the three following alternatives for investing the money: • A Microsoft bond with a par value of $1,000 that pays 4.2 percent on its par value in interest, sells for $1,

> Break-even analysis assumes linear revenue and cost functions. In reality, these functions may not always be linear over large output and sales levels. Why?

> A manager in your firm decides to employ break-even analysis. Of what shortcomings should this manager be aware?

> Distinguish between business risk and financial risk. What each type of risk?

> Explain how the financial manager might use industry norms in the design of the company’s financing mix.

> Many CFOs believe that the firm’s composite cost of capital is saucer-shaped or U-shaped. What does this mean?

> Why might firms whose sales levels change drastically over time choose to use debt only sparingly in their capital structures?

> In the chapter introduction we learned that AT&T (T) borrowed $3 billion by issuing bonds in the public bond market. Although this may sound like a lot of money, AT&T owed almost $65 billion in corporate debt at the end of 2011. The company had over $27

> Explain how simulation works. What is the value in using a simulation approach?

> Use the concept of real options to explain why large restaurant chains often introduce new concept restaurants that have negative NPVs.

> How do sunk costs affect the determination of cash flows associated with an investment proposal?

> Here are data on $1,000 par value bonds issued by Microsoft, GE Capital, and Morgan Stanley. Assume you are thinking about buying these bonds. Answer the following questions. a. Assuming interest is paid annually, calculate the values of the bonds if you

> If a project requires an additional investment in working capital, how should this be treated when calculating the project’s cash flows?

> If depreciation is not a cash-flow expense, does it affect the level of cash flows from a project in any way? Why?

> Why do we focus on cash flows rather than accounting profits in making our capital-budgeting decisions? Why are we interested only in incremental cash flows rather than total cash flows?

> When might two mutually exclusive projects having unequal lives be incomparable? How should managers deal with this problem?

> What causes the time-disparity ranking problem? What reinvestment rate assumptions are associated with the NPV and IRR capital-budgeting criteria?

> What are common reasons for capital rationing? Is capital rationing rational?

> What are mutually exclusive projects? Why might the existence of mutually exclusive projects cause problems in the implementation of the discounted cash flow capital-budgeting criteria?