You own a parcel of vacant land. You can develop it now, or wait. a. What is the advantage of waiting? b. Why might you decide to develop the property immediately?
> Dorlcote Milling has outstanding a $1 million 3% mortgage bond maturing in 10 years. The coupon on any new debt issued by the company is 10%. The finance director, Mr. Tulliver, cannot decide whether there is a tax benefit to repurchasing the existing bo
> Zenco, Inc. is financed by 3 million shares of common stock and by $5 million face value of 8% convertible debt maturing in 2026. Each bond has a face value of $1,000 and a conversion ratio of 200. What is the value of each convertible bond at maturity i
> In 1996, Marriott International made an issue of unusual bonds called liquid yield option notes, or LYONS. The bond matured in 2011, had a zero coupon, and was issued at $532.15. It could have been converted into 8.76 shares. Beginning in 1999 the bonds
> Iota Microsystems’ 10% convertible is about to mature. The conversion ratio is 27. a. What is the conversion price? b. The stock price is $47. What is the conversion value? c. Should you convert?
> Alpha Corp. is prohibited from issuing more senior debt unless net tangible assets exceed 200% of senior debt. Currently the company has outstanding $100 million of senior debt and has net tangible assets of $250 million. How much more senior debt can Al
> A puttable bond is a bond that may be repaid before maturity at the investor’s option. Sketch a diagram similar to Figure 24.3 showing the relationship between the value of a straight bond and that of a puttable bond.
> “A call option is always riskier than the stock it is written on.” True or false? How does the risk of an option change when the stock price changes?
> True or false? a. Convertible bonds are usually senior claims on the firm. b. The higher the conversion ratio, the more valuable the convertible. c. The higher the conversion price, the more valuable the convertible. d. Convertible bonds do not share ful
> Explain the three principal ways in which the terms of private placement bonds commonly differ from those of public issues.
> Look at Table 24.1: a. Suppose the debenture was issued on September 1, 1992, at 99.489%. How much would you have to pay to buy one bond delivered on September 15? Don’t forget to include accrued interest. b. When is the first interest payment on the
> Use Table 24.1 (but not the text) to answer the following questions: a. Who are the principal underwriters for the J.C. Penney bond issue? b. Who is the trustee for the issue? c. How many dollars does the company receive for each debenture after deductio
> For each of the following sinking funds, state whether the fund increases or decreases the value of the bond at the time of issue (or whether it is impossible to say): a. An optional sinking fund operating by drawings at par. b. A mandatory sinking fund
> Select the most appropriate term from within the parentheses: a. (High-grade utility bonds/Low-grade industrial bonds) generally have only light sinking fund requirements. b. Collateral trust bonds are often issued by (utilities/industrial holding compan
> It was one of Morse’s most puzzling cases. That morning Rupert Thorndike, the autocratic CEO of Thorndike Oil, was found dead in a pool of blood on his bedroom floor. He had been shot through the head, but the door and windows were bol
> Look back at the first Backwoods Chemical example at the start of Section 23-1. Suppose that the firm’s book balance sheet is The debt has a one-year maturity and a promised interest payment of 9%. Thus, the promised payment to Backwoods’s creditors is
> Digital Organics has 10 million outstanding shares trading at $25 per share. It also has a large amount of debt outstanding, all coming due in one year. The debt pays interest at 8%. It has a par (face) value of $350 million, but is trading at a market v
> How much would it cost you to insure the bonds of Backwoods Chemical against default? (See Section 23-1.) Section 23-1: (In 2009, Caesars Entertainment issued $3.7 billion of second lien notes maturing in 2018.1 By late 2014 these notes were trading at o
> Use the Black–Scholes formula to value the following options: a. A call option written on a stock selling for $60 per share with a $60 exercise price. The stock’s standard deviation is 6% per month. The option matures in three months. The risk free inte
> What problems are you likely to encounter when using a market-based approach for estimating the probability that a company will default?
> Discuss the problems with developing a numerical credit scoring system for evaluating personal loans. You can only test your system using data for applicants who have in the past been granted credit. Is this a potential problem?
> Company X has borrowed $150 maturing this year and $50 maturing in 10 years. Company Y has borrowed $200 maturing in five years. In both cases asset value is $140. Sketch a scenario in which X does not default but Y does.
> Company A has issued a single zero-coupon bond maturing in 10 years. Company B has issued a coupon bond maturing in 10 years. Explain why it is more complicated to value B’s debt than A’s.
> The following table shows some financial data for two companies: Use the formula shown in Section 23-4 to calculate which has the higher probability of default.
> You own a 5% bond maturing in two years and priced at 87%. Suppose that there is a 10% chance that at maturity the bond will default and you will receive only 40% of the promised payment. What is the bond’s promised yield to maturity? What is its expecte
> Use the Black–Scholes model and redraw Figures 23.5 and 23.6 assuming that the standard deviation of the return on the firm’s assets is 40% a year. Do the calculations for 60% leverage only. (Hint: It is simplest to assume that the risk-free interest rat
> What variables are required to use a market-based approach to calculate the probability that a company will default on its debt?
> The difference between the value of a government bond and a simple corporate bond is equal to the value of an option. What is this option and what is its exercise price?
> Other things equal, would you expect the difference between the price of a Treasury bond and a corporate bond to increase or decrease with a. The company’s business risk? b. The degree of leverage?
> Over the coming year Ragwort’s stock price will halve to $50 from its current level of $100 or it will rise to $200. The one-year interest rate is 10%. a. What is the delta of a one-year call option on Ragwort stock with an exercise price of $100? b. U
> Why is it more difficult to estimate the value at risk for a portfolio of loans rather than for a single loan? Why did this pose a problem for rating agencies that needed to assess the risk of packages of mortgage loans before the financial crisis?
> You have an A-rated bond. Is a rise in rating more likely than a fall? Would your answer be the same if the bond were B-rated?
> Suppose you expect to need a new plant that will be ready to produce turbo-encabulators in 36 months. If design A is chosen, construction must begin immediately. Design B is more expensive, but you can wait 12 months before breaking ground. Figure 22.9 s
> In binomial trees, risk-neutral probabilities are set to generate an expected rate of return equal to the risk-free interest rate in each branch of the tree. What do you think of the following statement: “The value of an option to acquire an asset increa
> Respond to the following comments. a. “You don’t need option pricing theories to value flexibility. Just use a decision tree. Discount the cash flows in the tree at the company cost of capital.” b. “These option pricing methods are just plain nutty. The
> In Section 10-4 we considered two production technologies for a new Wankel-engined outboard motor. Technology A was the most efficient but had no salvage value if the new outboards failed to sell. Technology B was less efficient but offered a salvage val
> You have an option to purchase all of the assets of the Overland Railroad for $2.5 billion. The option expires in nine months. You estimate Overland’s current (month 0) present value (PV) as $2.7 billion. Overland generates after-tax fr
> A variation on Problem 12: Suppose the land is occupied by a warehouse generating rents of $150,000 after real estate taxes and all other out-of-pocket costs. The present value of the land plus warehouse is again $1.7 million. Other facts are as in Probl
> You own a one-year call option to buy one acre of Los Angeles real estate. The exercise price is $2 million, and the current, appraised market value of the land is $1.7 million. The land is currently used as a parking lot, generating just enough money to
> Look back at the Malted Herring option in Section 22-2. How did the company’s analysts estimate the present value of the project? It turns out that they assumed that the probability of low demand was about 45%. They then estimated the e
> Imagine that Google’s stock price will either rise by 33.3% or fall by 25% over the next six months (see Section 21-1). Recalculate the value of the call option (exercise price = $530) using (a) the replicating portfolio method and (b) the risk-neutral
> Look again at Table 22.2. How does the value in 1982 of the option to invest in the Mark II change if a. The investment required for the Mark II is $800 million (vs. $900 million)? b. The present value of the Mark II in 1982 is $500 million (vs. $467 mi
> Describe each of the following situations in the language of options: a. Drilling rights to undeveloped heavy crude oil in Northern Alberta. Development and production of the oil is a negative-NPV endeavor. (Assume a break-even oil price is C$90 per bar
> True or false? a. Real-options analysis sometimes tells firms to make negative-NPV investments to secure future growth opportunities. b. Using the Black–Scholes formula to value options to invest is dangerous when the investment project would generate
> In Chapter 4, we expressed the value of a share of stock as P0 = EPS1 /r + PVGO where EPS1 is earnings per share from existing assets, r is the expected rate of return required by investors, and PVGO is the present value of growth opportunities. PVGO
> Redo the example in Figure 22.8, assuming that the real option is a put option allowing the company to abandon the R&D program if commercial prospects are sufficiently poor at year 2. Use put–call parity. The NPV of the drug at date
> Josh Kidding, who has only read part of Chapter 10, decides to value a real option by (1) setting out a decision tree, with cash flows and probabilities forecasted for each future outcome; (2) deciding what to do at each decision point in the tree; and
> Alert financial managers can create real options. Give three or four possible examples.
> Why is quantitative valuation of real options often difficult in practice? List the reasons briefly.
> Gas turbines are among the least efficient ways to produce electricity, much less thermally efficient than coal or nuclear plants. Why do gas-turbine generating stations exist? What’s the option?
> Take another look at our two-step binomial trees for Google, for example, in Figure 21.2. Use the replicating-portfolio or risk-neutral method to value six-month call and put options with an exercise price of $450. Assume the Google stock pri
> Some corporations have issued perpetual warrants. Warrants are call options issued by a firm, allowing the warrant holder to buy the firm’s stock. a. What does the Black–Scholes formula predict for the value of an infinite-lived call option on a non-div
> In Section 21-1 we used a simple one-step model to value two Google options each with an exercise price of $530. We showed that the call option could be replicated by borrowing $233.22 and investing $294.44 in .556 shares of Google stock. The put option
> Flip back to Tables 6.2 and 6.6, where we assumed an economic life of seven years for IM&€™s guano plant. What’s wrong with that assumption? How would you undertake a more complete analysis? Tables 6.2: Table 6.6: Per
> Your company has just awarded you a generous stock option scheme. You suspect that the board will either decide to increase the dividend or announce a stock repurchase program. Which do you secretly hope they will decide? Explain.
> Show how the option delta changes as the stock price rises relative to the exercise price. Explain intuitively why this is the case. (What happens to the option delta if the exercise price of an option is zero? What happens if the exercise price becomes
> Use the put-call parity formula (see Section 20-2) and the one-period binomial model to show that the option delta for a put option is equal to the option delta for a call option minus 1. Section 20-2: Look now at Figure 20.4 (a), which shows
> A start-up company is moving into its first offices and needs desks, chairs, filing cabinets, and other furniture. It can buy the furniture for $25,000 or rent it for $1,500 per month. The founders are of course confident in their new venture, but nevert
> Use the Black–Scholes program from the Beyond the Page feature to value the Owens Corning warrants described in Section 21-4. The standard deviation of Owens Corning stock was 41% a year and the interest rate when the warrants were issued was 5%. Owens C
> Is it better to exercise a call option on the with-dividend date or on the ex-dividend date? How about a put option? Explain.
> Other things equal, which of these American options are you most likely to want to exercise early? a. A put option on a stock with a large dividend or a call on the same stock. b. A put option on a stock that is selling below exercise price or a call o
> a. Can the delta of a call option be greater than 1.0? Explain. b. Can it be less than zero? c. How does the delta of a call change if the stock price rises? d. How does it change if the risk of the stock increases?
> a. In Section 21-3 we calculated the risk (beta) of a six-month call option on Google stock with an exercise price of $530. Now repeat the exercise for a similar option with an exercise price of $450. Does the risk rise or fall as the exercise price is r
> Suppose you construct an option hedge by buying a levered position in delta shares of stock and selling one call option. As the share price changes, the option delta changes, and you will need to adjust your hedge. You can minimize the cost of adjustment
> The current price of United Carbon (UC) stock is $200. The standard deviation is 22.3% a year, and the interest rate is 21% a year. A one-year call option on UC has an exercise price of $180. a. Use the Black–Scholes model to value the
> The current price of the stock of Mont Tremblant Air is C$100. During each six-month period it will either rise by 11.1% or fall by 10% (equivalent to an annual standard deviation of 14.9%). The interest rate is 5% per six-month period. a. Calculate the
> Suppose that you have an option that allows you to sell Buffelhead stock (see Problem 12) in month 6 for $165 or to buy it in month 12 for $165. What is the value of this unusual option? Problem 12: Buffelhead’s stock price is $220 and could halve or dou
> Recalculate the value of the Buffelhead call option (see Problem 12), assuming that the option is American and that at the end of the first six months the company pays a dividend of $25. (Thus the price at the end of the year is either double or half the
> Suppose that you own an American put option on Bufflehead stock (see Problem 12) with an exercise price of $220. a. Would you ever want to exercise the put early? b. Calculate the value of the put. c. Now compare the value with that of an equivalent Eu
> Buffelhead’s stock price is $220 and could halve or double in each six month period (equivalent to a standard deviation of 98%). A one-year call option on Buffelhead has an exercise price of $165. The interest rate is 21% a year. a. What is the value of
> Look again at the bus lease described in Table 25.2. a. What is the value of the lease if Greymare’s marginal tax rate is Tc = .20? b. What would the lease value be if, for tax purposes, the initial investment had to be written off in equal amounts ov
> Suppose that National Waferonics has before it a proposal for a four-year financial lease. The firm constructs a table like Table 25.2. The bottom line of its table shows the lease cash flows: These flows reflect the cost of the machine, depreciation
> Look at Table 25.1. How would the initial break-even operating lease rate change if rapid technological change in limo manufacturing reduces the costs of new limos by 5% per year?
> The price of Moria Mining stock is $100. During each of the next two six-month periods the price may either rise by 25% or fall by 20% (equivalent to a standard deviation of 31.5% a year). At month 6 the company will pay a dividend of $20. The interest r
> In Problem 8 we assumed identical lease rates for old and new desks. a. How does the initial break-even lease rate change if the expected inflation rate is 5% per year? Assume that the real cost of capital does not change. (Hint: Look at the discussion o
> Refer again to Problem 8. Suppose a blue-chip company requests a six year financial lease for a $3,000 desk. The company has just issued five-year notes at an interest rate of 6% per year. What is the break-even rate in this case? Assume administrative c
> Acme has branched out to rentals of office furniture to start-up companies. Consider a $3,000 desk. Desks last for six years and can be depreciated on a five-year MACRS schedule (see Table 6.4). What is the break-even operating lease rate for a new desk?
> How does a leveraged lease differ from an ordinary, long-term financial lease? List the key differences.
> What happens if a bankrupt lessee affirms the lease? What happens if the lease is rejected?
> Explain why the following statements are true: a. In a competitive leasing market, the annual operating lease payment equals the lessor’s equivalent annual cost. b. Operating leases are attractive to equipment users if the lease payment is less than the
> The following terms are often used to describe leases: a. Direct b. Full-service c. Operating d. Financial e. Rental f. Net g. Leveraged h. Sale and lease-back i. Full-payout Match one or more of these terms with each of the following statements: A. The
> Suppose that the Greymare lease gives the company the option to purchase the bus at the end of the lease period for $1. How would this affect the tax treatment of the lease? Recalculate its value to Greymare and the manufacturer. Could the lease payments
> Reconstruct Table 25.2 as a leveraged lease, assuming that the lessor borrows $80,000, 80% of the cost of the bus, nonrecourse at an interest rate of 11%. All lease payments are devoted to debt service (interest and principal) until the loan is paid off
> Magna Charter has been asked to operate a Beaver bush plane for a mining company exploring north and west of Fort Liard. Magna will have a firm one-year contract with the mining company and expects that the contract will be renewed for the five-year dura
> Suppose a stock price can go up by 15% or down by 13% over the next year. You own a one-year put on the stock. The interest rate is 10%, and the current stock price is $60. a. What exercise price leaves you indifferent between holding the put or exercis
> Look again at the valuation in Table 22.2 of the option to invest in the Mark II project. Consider a change in each of the following inputs. Would the change increase or decrease the value of the expansion option? a. Increased uncertainty (higher standa
> Some years ago the Australian firm Bond Corporation sold a share in some land that it owned near Rome for $110 million and as a result boosted its annual earnings by $74 million. A television program subsequently revealed that the buyer was given a put o
> Figure 20.14 shows some complicated position diagrams. Work out the combination of stocks, bonds, and options that produces each of these positions.
> Table 20.4 lists some prices of options on common stocks (prices are quoted to the nearest dollar). The interest rate is 10% a year. Can you spot any mispricing? What would you do to take advantage of it?
> In December 2014, a 13-month call on the stock of Amazon.com, with an exercise price of $305, sold for $42.50. The stock price was $305. The risk-free interest rate was 1%. How much would you be willing to pay for a put on Amazon stock with the same matu
> Is it more valuable to own an option to buy a portfolio of stocks or to own a portfolio of options to buy each of the individual stocks? Say briefly why.
> The common stock of Triangular File Company is selling at $90. A 26-week call option written on Triangular File’s stock is selling for $8. The call’s exercise price is $100. The risk-free interest rate is 10% per year. a. Suppose that puts on Triangular
> a. If you can’t sell a share short, you can achieve exactly the same final payoff by a combination of options and borrowing or lending. What is this combination? b. Now work out the mixture of stock and options that gives the same final payoff as investm
> Suppose that Mr. Colleoni borrows the present value of $100, buys a six month put option on stock Y with an exercise price of $150, and sells a six-month put option on Y with an exercise price of $50. a. Draw a position diagram showing the payoffs when t
> A European call and put option have the same maturity and both are at the money. The stock does not pay a dividend. Which option should sell for the higher price? Explain.
> FX Bank has succeeded in hiring ace foreign exchange trader Lucinda Cable. Her remuneration package reportedly includes an annual bonus of 20% of the profits that she generates in excess of $100 million. Does Ms. Cable have an option? Does it provide her
> “The buyer of the call and the seller of the put both hope that the stock price will rise. Therefore the two positions are identical.” Is the speaker correct? Illustrate with a position diagram.
> Discuss briefly the risks and payoffs of the following positions: a. Buy stock and a put option on the stock. b. Buy stock. c. Buy call. d. Buy stock and sell call option on the stock. e. Buy bond. f. Buy stock, buy put, and sell call. g. Sell put.
> Look again at Figure 20.13. It appears that the investor in panel (b) can’t lose and the investor in panel (a) can’t win. Is that correct? Explain.
> Suppose you buy a one-year European call option on Wombat stock with an exercise price of $100 and sell a one-year European put option with the same exercise price. The current stock price is $100, and the interest rate is 10%. a. Draw a position diagram
> There is another strategy involving calls and borrowing or lending that gives the same payoffs as the strategy described in Problem 3. What is the alternative strategy? Problem#3: Suppose that you hold a share of stock and a put option on that share. Wh
