Chapter 13 What is the difference in the expected returns on

subject Type Homework Help
subject Pages 5
subject Words 1167
subject Authors Robert L. McDonald

Unlock document.

This document is partially blurred.
Unlock all pages and 1 million more documents.
Get Access
page-pf1
Fundamentals of Derivatives Markets (McDonald)
Chapter 13 Corporate Applications
13.1 Multiple Choice Questions
1) We will assume that Nathans, Inc. has 3-year zero-coupon debt outstanding, which will pay
$200 at maturity. The assets are valued at $175, σ = 0.20, r = 0.04, and the company does not
pay a dividend. Using a Black-Scholes model, what is the value of the equity?
A) $23.05
B) $43.05
C) $63.05
D) $83.05
2) Jessie, Inc. has 4-year zero-coupon bonds outstanding, which will pay $1,000 at maturity.
The assets are valued at $900, σ = 0.25, r = 0.045, and the company does not pay a dividend.
Using a Black-Scholes model, what is the yield on debt?
A) 4.68%
B) 6.48%
C) 8.46%
D) 8.64%
3) Compute the yield on debt given a 10-year zero-coupon bond paying $500 at maturity.
Assume the asset value is $450, σ = 0.35, r = 0.06, and no dividend is paid.
A) 6.62%
B) 7.26%
C) 8.26%
D) 9.62%
4) What is the expected return on equity using the Black-Scholes formula, given a zero-coupon
bond that pays $250 at maturity in 4 years? Assume assets are worth $200, r = 0.05, σ = 0.30,
and no dividend is paid. The return on assets is 11.5%.
A) 10.27%
B) 14.27%
C) 18.27%
D) 22.27%
5) What is the difference in the expected returns on equity when using a Black-Scholes formula
versus a traditional weighted average formula? Assume rA = 0.12, rf = 0.06, asset value =
$170, equity value = $45, debt to value ratio = 0.55, and delta = 0.6500.
A) 1.00%
B) 1.20%
C) 1.40%
D) 1.60%
page-pf2
6) James, Inc. has zero-coupon outstanding debt maturing in 8 years. In rank of seniority, each
pays at maturity $20 million, $15 million, and $40 million. Assume asset value = $60 million,
r = 0.05, σ = 0.28, and no dividend is paid. What is the yield on the $15 million subordinate
debt?
A) 5.72%
B) 6.72%
C) 7.72%
D) 8.72%
7) Daniels, Inc. has assets valued at $2 million and 50,000 outstanding shares. A 5-year zero-
coupon bond exists, which pays $400,000 at maturity. The bond is convertible into 10,000
shares. Assume σ = 0.30, r = 0.055, and no dividend is paid. What is the value of the bond?
A) $402,672
B) $452,172
C) $415,022
D) $385,172
8) Willco, Inc. issues compensation options with the following terms. Strike = $45, price =
$42.00, σ = 0.48, r = 0.05, div = 0.02. What is the value of the option if it will be repriced at
$30? Assume 10 years to expiration.
A) $22.78
B) $24.65
C) $26.22
D) $30.46
9) Lechno, Inc. issues compensation options with the following terms. Strike = $65, price =
$63.50, σ = 0.22, r = 0.045, div = 0.015. What is the value of the option if it will be repriced at
$40? Assume 10 years to expiration.
A) $18.64
B) $22.22
C) $24.32
D) $26.84
10) A company issues an option grant with an outperformance feature, against the S&P 500.
Assume S&P 500 = 950, S = 22, k = 25, σ = 0.25, r = 0.06, and 5 years until expiration. The S&P
500 has a dividend yield of 2%, standard deviation of 18.0% and a 0.30 correlation coefficient
with the stock. What is the value of the outperformance feature?
A) $0.99
B) $1.31
C) $1.59
D) $1.72
page-pf3
11) A company issues an option grant with an outperformance feature, against the S&P 500.
Assume S&P 500 = 1100, S = 46, k = 45, σ = 0.30, r = 0.04, and 10 years until expiration. The
S&P 500 has a dividend yield of 2.5%, standard deviation of 20.0% and a 0.45 correlation
coefficient with the stock. What is the value of the outperformance option?
A) $11.92
B) $15.99
C) $19.75
D) $21.05
12) A company issues an option grant with an outperformance feature, against the S&P 500.
Assume S&P 500 = 1100, S = 46, k = 45, σ = 0.30, r = 0.04, and 10 years until expiration. The
S&P 500 has a dividend yield of 2.5%, standard deviation of 20.0% and a 0.45 correlation
coefficient with the stock. What is the value of the outperformance feature?
A) $2.25
B) $3.29
C) $4.11
D) $4.78
13) A company issues an option grant with an outperformance feature, against the S&P 500.
Assume S&P 500 = 1100, S = 46, k = 45, σ = 0.30, r = 0.04, and 10 years until expiration. The
S&P 500 has a dividend yield of 2.5%, standard deviation of 20.0% and a 0.45 correlation
coefficient with the stock. What is the value of the outperformance option?
A) $11.92
B) $15.99
C) $19.75
D) $21.05
14) In the case of an acquisition, with which of the following offer structures does the acquired
firm bear the most risk between the time the offer is accepted and the time it is
consummated?
A) Fixed stock offer
B) Floating stock offer
C) Fixed collar offer
D) Floating collar offer
15) A firm with assets value at $20 million issues a 10 year zero-coupon bond with a par value of
$22 million. Using a put option approach, what is the value of an insurance contract on the
bond given r = .05, volatility is given as .18 and there is no dividend paid by the company?
A) $0.82 million
B) $1.27 million
C) $2.23 million
D) $2.98 million
page-pf4
16) A firm with assets value at $10 million issues a 4 year zero-coupon bond with a par value of
$15 million. Using a put option approach, what is the value of the defaultable bond given r =
.06, volatility is given as .15 and there is no dividend paid by the company?
A) $7.83 million
B) $8.05 million
C) $8.89 million
D) $9.41 million
17) A firm with assets value at $200,000 issues a 3 year zero-coupon bond with a par value of
$250,000. Using a put option approach, what is the value of an insurance contract on the
bond given r = .08, volatility is given as .23 and there is no dividend paid by the company?
A) $29,672
B) $31,582
C) $33,331
D) $42,195
18) A firm with assets value at $500,000 issues a 6 year zero-coupon bond with a par value of
$550,000. Using a put option approach, what is the value of the defaultable bond given r =
.07, volatility is given as .33 and there is no dividend paid by the company?
A) $75,970
B) $245,601
C) $285,406
D) $361,376
19) A firm with assets value at $350,000 issues a 5 year zero-coupon bond with a par value of
$400,000. Interest rates are 5% and the volatility of the company's assets are determined to be
.29. If the company pays no dividend, what is the delta of the issued debt?
A) .307
B) .324
C) .365
D) .396
20) A firm with assets value at $100,000 issues a 3 year zero-coupon bond with a par value of
$110,000. Interest rates are 4% and the volatility of the company's assets are determined to be
.30. If the company pays no dividend, what is the change in the value of the firm's debt if the
value of the assets increases by $20,000?
A) $ 6,930 decrease
B) $ 7,580 increase
C) $ 8,309 decrease
D) $ 9,029 increase
13.2 Short Answer Essay Questions
1) How does a reload option provide additional compensation compared to regular
compensation options?
page-pf5
5
2) Why does a company sell a put when issuing compensation options?
3) What feature of reload options prevents the use of a Black-Scholes valuation?
4) What three components exist in the value of an "outperform stock option"?
5) The use of collars in acquisitions serves the purpose of addressing what two issues in an
offer?
13.3 Class Discussion Question
1) In advance of class, direct students to review material on portfolio diversification. In class,
assign one student the task of writing the portfolio standard deviation formula on the board.
Lead a discussion on the similarities between exchange options and portfolio diversification.
Ask the class how the Markowitz theory they learned previously is applied in exchange
options. See how many people can identify the risk reduction aspect of exchange options.

Trusted by Thousands of
Students

Here are what students say about us.

Copyright ©2022 All rights reserved. | CoursePaper is not sponsored or endorsed by any college or university.