Investments Final

A call option with a strike price of $50 on a stock selling at $55 costs $6.50. What are the call option's intrinsic and time values? (Intrinsic value ; Time value)

$5.0 ; $1.5

A coupon bond that pays interest annually has a par value of $1,000, matures in 5 years, and has a yield to maturity of 12%. If the coupon rate is 9%, the intrinsic value of the bond today will be ________.

$891.86

All other things equal (YTM = 10%), which of the following has the longest duration (a) A 30 year bond with a 10% coupon (b) A 20 year bond with a 9% coupon (c) A 20 year bond with a 7% coupon (d) A 10 year zero coupon bond

(a) A 30 year bond with a 10% coupon

The bonds of Elbow Grease Dishwashing Company have received a rating of C by Moody's. The C rating indicates that the bonds are __________. (a) High grade (b) Intermediate grade (c) Investment grade (d) Junk bond

(d) Junk bond

You purchase one MBI July call option for a premium of $5. The exercise price is $120. You hold the option until the expiration date, when MBI stock sells for $123 per share. You will realize a __________ on the investment. ("+" for profit, "-" for loss)

-$2

You purchase one MBI July put option for a premium of $3. The exercise price is $120. You hold the option until the expiration date, when MBI stock sells for $123 per share. You will realize a __________ on the investment. ("+" for profit, "-" for loss)

-$3

(Q1~Q2) The current stock price for Admiral Motors Company is 49. Its expected ROE is 14% and its expected EPS is $7. The firm's plowback ratio is 50%. What will be its PEG ratio?

1

The yield to maturity on a bond is: above the coupon rate when the bond sells at a discount and below the coupon rate when the bond sells at a premium. the discount rate that will set the present value of the payments equal to the bond price. equal to the holding period of returns when you sell the position. What is the set of the correct statement?

1 and 2 only

A two-year bond with par value $1,000 making annual coupon payments of $100 is priced at $1,000. What is the yield to maturity of the bond?

10%

Q6~8 are based on the following information On January 1, 2017, you buy a three-year, annual-pay coupon bond with 6% coupon rate, $1000 face value, and yield to maturity 6%. On January 1, 2018, you receive the first coupon of the bond, and on January 1, 2019, you receive the second coupon. Immediately after receiving the second coupon, you sell the bond. Assume that yields on bonds of all maturities are equal to 4.5% on January 1, 2019. What is the selling price of the bond on January 1, 2019?

1014.35

A firm pays a current dividend of $2, which is expected to grow at a rate of 8% indefinitely. If the current value of the firm's shares is $72, what is the required return(=discount rate = expected return) applicable to the investment based on the constant-growth dividend discount model (DDM)?

11%

You establish a straddle on Fincorp using September call and put options with a strike price of $80. The call premium is $7.00 and the put premium is $8.50. What is the most you can lose on this position?

15.50

A common stock pays an annual dividend per share of $2.20. The risk-free rate is 7% and the risk premium for this stock is 3%. If the annual dividend is expected to remain at $2.20, what is the value of the stock?

22

An investor buys a call at a premium of $4.50 with an exercise price of $40. At what stock price will the investor break even on the purchase of the call? (Hint: Break even price: The price of underlying asset which makes the option profit = 0)

44.50

(Q1~Q2) The current stock price for Admiral Motors Company is 49. Its expected ROE is 14% and its expected EPS is $7. The firm's plowback ratio is 50%. Calculate the growth rate.

7%

The following price quotations are for exchange-listed options on Primo Corporation common stock. Company Strike Expiration Call Premium Put Premium Primo 61.12 55 February 7.25 0.48 With transaction costs ignored, how much would a buyer have to pay for one call option contract. Assume each contract is for 100 shares.

725

You are asked to compare two options with parameters as given. The risk-free interest rate for all cases should be assumed to be 6%. Assume the stocks on which these options are written pay no dividends. Which put option is written on the stock with the lower premium? Put T X σ Current Price of Underlying asset A 0.5 $50 0.20 $50 B 0.5 50 0.25 50 (Hint: If the option value is low, then it has low premium)

A

__________ option can only be exercised on the

A European

Consider a bond paying a coupon rate of 10% per year semiannually when the yield to maturity is 8% per year. The bond has three years until maturity. Find the bond's price when it is just issued.

Answer: $1052.42 Bond pricing formula: (When par value is not given, it is $1000 as default) 𝐵𝑜𝑛𝑑 𝑉𝑎𝑙𝑢𝑒=𝐶𝑜𝑢𝑝𝑜𝑛∗1𝑟[1−1(1+𝑟)𝑇]+𝑃𝑎𝑟 𝑉𝑎𝑙𝑢𝑒(1+𝑟)𝑇 Here, r=𝑌𝑇𝑀𝑛 Note that it is semiannual, so r = 8%/2 = 4% T = 3*2 = 6 Coupon = 10%*1000/2 = 50 Putting all information, 𝐵𝑜𝑛𝑑 𝑉𝑎𝑙𝑢𝑒=50∗10.04[1−1(1.04)6]+1000(1.04)6=1052.42

Price $25.26 52 Week Low $25.20 Dividend $2.35 PE 10.50 Beta 1.00 ROE 9.00% FCFE 3.10 Fraction of Earnings Paid in Dividends 60.00% 𝐸[𝑅𝑚𝑘𝑡] 9.50% 𝑅𝑓 2.50% 𝐸[𝑃𝑅𝐶,𝑡+1] $30.50 For this question, let's assume that the growth rate is 2.1% regardless of the answer for Q23. Using the constant growth dividend model, what should be the trading price of RC?

Answer: $32.42 We have to calculate r by using CAPM. 𝑟𝑖=𝑟𝑓+𝛽𝑖(𝑟𝑚−𝑟𝑓)=2.5+1∗(9.5−2.5)=9.5% Constant growth DDM: P𝑡=𝐷𝑡+1𝑟−𝑔=𝐷𝑡∗(1+𝑔)𝑟−𝑔=2.35∗(1.021)0.095−0.021=32.42

You write one MBI July call contract at the strike price of $120 for a premium of $4. You hold the option until the expiration date, when MBI stock sells for $121 per share. You will realize a __________ on the investment.

As an option writer, you receive a premium. But, you have to sell the stock at $120 even though the market price is $121. Answer: +$3 Therefore, Payoff = 120 - 121 = - 1 Profit = -1 + 4 = +3

A person with a long position in a commodity futures contract wants the price of the commodity to __________.

B. increase substantially

A bond has a coupon rate of 9% and a yield to maturity of 10%. Is the bond selling above or below par value?

Below par value

When are bonds sold?

Bonds are sold at a premium when coupon rate > yield-to-maturity Bonds are sold at a par when coupon rate = yield-to-maturity Bonds are sold at a discount when coupon rate < yield-to-maturity Technically, it should be yield-to-maturity instead of the prevailing interest rate. They are almost the same, but there is risk adjustment for yield-to-maturity.

Which of the following credit ratings belong to the high-yield bond tranches on the S&P scale? Choose two options.

CCC and B

Consider two companies: Shoe Co. and Footwear. The two companies are similar across all dimensions except for the following: Shoe Co. has a PE ratio of 22, an ROE of 35%, and retains 65% of its earnings. Footwear has a PE ratio of 17, an ROE of 30% and retains 50% of its earnings. Accounting for growth, which company is more likely undervalued?

Calculate growth then PEG Shoe Co. is undervalued

•__________ bonds represent a novel way of obtaining insurance from capital markets against specified disasters.

Catastrophe

_______ is a measure of the curvature, or the degree of the curve, in the relationship between bond prices and bond yields.

Convexity

Why is an American option more valuable than a European option?

If you buy an American option, you can exercise it anytime before the expiration. If it is an European option, you can only exercise it on the expiration day. Therefore, American option is more valuable and more expensive.

Which type of risk is most significant for nearly all bonds?

Interest rate risk

How do investors interpret duration?

Investors interpret the duration in two ways: (1) weighted average of maturity, and (2) price sensitivity to interest rate changes. They are mathematically almost the same.

Which of the following is NOT the correct description of the Chapter 11 Bankruptcy?

It is a liquidation bankruptcy

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 forecast? Your forecast: Good chance of a major market decline between now and end of year.

Long put options

You purchase one Microsoft December $140 put contract for a premium of $5.30. What is your maximum possible profit? Assume each contract is for 100 shares

Maximum possible profit = (Purchase price - Premium) * No. Of shares Maximum possible profit = (140 - 5.30) *100 shares Maximum possible profit = 134.7 * 100 shares Maximum possible profit = 13470

Which of the following yield curves generally implies an upcoming crisis in the economy?

Negative slope

buying vs selling put options

The writer (seller) of a put option has an obligation to buy shares when the buyer exercises the option. The buyer of a put option has a right to sell shares if she wants to do so.

Consider the liquidity preference theory of the term structure of interest rates. On average, one would expect investors to require ________.

a higher yield on long-term bonds than on short-term bonds

[Current event] When a CEO receives a stock option (or stock warrant) from her company as a part of the compensation package, it is the same as ____________ in the options market. a. Buying call options b. Buying put options c. Writing call options d. Writing put options

a. Buying call options

All else the same, an American-style option will be more valuable than a European-style option. a. True b. False

a. True

True or False: A stock has an intrinsic value of $15 and an actual stock price of $13.50. You know that this stock is undervalued in the stock market. a. True b. False

a. True

You can be sure that a bond will sell at a premium to par when _________. a. its coupon rate is greater than the prevailing interest rate b. its coupon rate is less than the prevailing interest rate c. its coupon rate is equal to the prevailing interest rate d. its coupon rate is less than its conversion value e. it is a really good bond

a. its coupon rate is greater than the prevailing interest rate

A coupon bond that pays interest of $65 annually has a face value of $1,000, matures in 5 years, and is selling today at a $76.50 discount from par value. The current yield on this bond is __________. a. 6.5% b. 7.0% c. 7.5% d. 8%

b. 7.0% Current bond price = 1000 - 76.5 = 923.5 Current yield = (Annual coupon payment)/(current bond price) = 65/923.5=7.0%

Which of the following determinants have a negatve relationship with the premium of a call option? a. Price of underlying stocks b. Exercise price c. Volatility of underlying stock price d. Time to Expiration

b. Exercise price Call options have a negative relationship with the volatility of the price of the underlying asset. It is because the call option can benefit from upside potential, but their negative payoff is protected since they don't have to exercise the option.

True or False: All other things equal, a bond's duration is higher when the coupon rate is higher a. True b. False

b. False

The S&P 500 Index futures contract is an example of a(n) __________ delivery contract. The pork bellies contract is an example of a(n) __________ delivery contract.

cash; actual

The duration of a 5-year zero-coupon bond is __________ years. a. 0 b. 3 c. 4 d. 5

d. 5

Which one-year option strategy will give the highest expected net profit if you are very confident that the stock price will move VERY LITTLE over the next year? a. Bear put spread b. Covered Call c. Long a straddle d. Short a straddle

d. Short a straddle

If you take a short position in a future contract, you

gain when the price of underlying asset decreases.

If you take a long position in a future contract, you

gain when the price of underlying asset increases.

You can be sure that a bond will sell at a premium when ________.

its coupon rate is greater than its yield to maturity

Everything else equal, the ________ the maturity of a bond and the ________ the coupon, the greater the sensitivity of the bond's price to interest rate changes.

longer; lower

Deployment Specialists pays a current (annual) dividend of $1 and is expected to grow at 20% for two years and then at 5% thereafter. If the required return (=discount rate = expected return) for Deployment Specialists is 8.0%, what is the intrinsic value of its stock?

$45.56

You predict that interest rates are about to fall. Which bond will give you the highest capital gain? (a) Zero coupon, long maturity (b) High coupon, short maturity (c) High coupon, long maturity (d) Low coupon, long maturity

(d) Low coupon, long maturity

You would typically find all but which one of the following in a bond contract? (a) Covenants (b) Maturity information (c) Coupon rate information (d) Price earnings ratio

(d) Price earnings ratio

You establish a straddle on Fincorp using September call and put options with a strike price of $80. The call premium is $7.00 and the put premium is $8.50. What will be your profit or loss if Fincorp is selling for $88 in September? ("+" means profit, and "-"means loss)

+7.50

A zero-coupon bond with face value $1,000 and maturity of two years sells for $826.45. What is its yield to maturity?

10.00%

Q6~8 are based on the following information On January 1, 2017, you buy a three-year, annual-pay coupon bond with 6% coupon rate, $1000 face value, and yield to maturity 6%. On January 1, 2018, you receive the first coupon of the bond, and on January 1, 2019, you receive the second coupon. Immediately after receiving the second coupon, you sell the bond. Assume that yields on bonds of all maturities are equal to 4.5% on January 1, 2019. What is the price that you pay for the bond on January 1, 2017?

1000

Q6~8 are based on the following information On January 1, 2017, you buy a three-year, annual-pay coupon bond with 6% coupon rate, $1000 face value, and yield to maturity 6%. On January 1, 2018, you receive the first coupon of the bond, and on January 1, 2019, you receive the second coupon. Immediately after receiving the second coupon, you sell the bond. Assume that yields on bonds of all maturities are equal to 4.5% on January 1, 2019. What is your HPR on your 2-year bond investment?

13.44%

If the coupon rate on a bond is 4.5% and the bond is selling at a premium, which of the following is the most likely yield to maturity on the bond?

4.30%

A bond with an annual coupon rate of 4.8% sells for $970. The face value is $1000. What is the bond's current yield?

4.95%

A call option with a strike price of $62 on a stock selling at $73 costs $12.0. What are the call option's intrinsic and time values? (Round your answers to 2 decimal places.)

Answer: Intrinsic value $11.00 Time value $1.00 Option premium = Intrinsic value + time value Intrinsic value is the money you can receive by exercising options or by forfeiting options. In this case, Intrinsic value = 73 - 62 = 11 Therefore, the time value = 12 - 11 = 1

Price $25.26 52 Week Low $25.20 Dividend $2.35 PE 10.50 Beta 1.00 ROE 9.00% FCFE 3.10 Fraction of Earnings Paid in Dividends 60.00% 𝐸[𝑅𝑚𝑘𝑡] 9.50% 𝑅𝑓 2.50% 𝐸[𝑃𝑅𝐶,𝑡+1] $30.50 23. What is an appropriate estimate for the RC's growth rate?

Answer: 3.60% 𝑔𝑟𝑜𝑤𝑡ℎ=𝑔=𝑅𝑂𝐸∗𝑝𝑙𝑜𝑤𝑏𝑎𝑐𝑘 𝑟𝑎𝑡𝑖𝑜 Plowback ratio = 1 - Fraction of earnings paid in dividends = 1 - payout ratio Therefore, g = 9*0.4 = 3.60%

In the futures market the short position's loss is __________ the long position's gain.

C. equal to

Today's futures markets are dominated by trading in _______ contracts.

C. financial

what is the duration of a bond?

Duration is weighted average of maturity, weighted by cash flows. If you receive more coupon, more cash flow occur before the principal payment. Therefore, coupon rate is inversely related to duration.

Todd Mountain Development Corporation is expected to pay a dividend of $3 in the upcoming year. Dividends are expected to grow at the rate of 6% per year. The risk-free rate of return is 3%, and the expected return on the market portfolio is 16%. The stock of Todd Mountain Development Corporation has a beta of .60. Using the constant-growth DDM, the intrinsic value of the stock is _________. A. 7.25% B. 10.25% C. 14.75% D. 21%

First, use CAPM to calculate the required return. (ri = rf+Bi(rm-rf). Then input into the Constant growth DDM. Answer is 62.50

Duration of a zero-coupon bond

For zero-coupon bonds, duration is the same as the time to maturity.

Which of the following entity has the lowest holding in the corporate bond market? (Who is the smallest investor in the corporate bond market?)

Household direct investment

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 forecast? Your forecast: Good chance of major market movements, either up or down, between now and end of year.

Long straddle.

Procter & Gamble (PG ) has paid consistent dividends for years. However, its dividend growth slowed in the 2015 fiscal year, making a one stage dividend discount model unsuitable for accurate valuation. This example will use P&G's 7% dividend growth rate for 2021 2024 in the first part of the formula and the 2025 growth rate of 3% as the projected future rate for the second stage. Assume the cost of equity is 10%, and dividend in 2020 was $2.10 per share. What is the stock value at the end of 2020?

Use DDM? 34.53

what is undervalued vs overvalued?

When we say "undervalued", it means that the current stock price is under the intrinsic value of a stock. On the contrary, "overvalued" means that the current stock price is above the intrinsic value.

Ace Frisbee Corporation produces a good that is very mature in the firm's product life cycle. Ace Frisbee Corporation is expected to pay a dividend in year 1 of $3, a dividend in year 2 of $2, and a dividend in year 3 of $1. After year 3, dividends are expected to decline at the rate of 2% per year. An appropriate required return for the stock is 8%. Using the multistage DDM, the stock should be worth __________ today. a. $13.07 b. $13.22 c. $15.68 d. $18.51 e. $18.78

a. $13.07 multistage DDM: 𝑃𝑡=(𝐷𝑡+1)1+𝑟+(𝐷𝑡+2)(1+𝑟)2+(𝐷𝑡+3)(1+𝑟)3+1(1+𝑟)3(𝐷𝑡+3)∗(1+𝑔)𝑟−𝑔 Note that g=−0.02 𝑃𝑡=31.08+2(1.08)2+1(1.08)3+1(1.08)31∗(0.98)0.10=2.78+1.71+0.79+7.78=13.07

An investor buys 100 shares of AMZN stock at $2,000/share and also purchases 100 put options with a strike price of $1,900 and a premium of $10/option. What is the total profit to the investor if the stock price plummets to $1,400 by the time the options expire? a. -$11,000 b. -$10,000 c. -$9,000 d. $10,000

a. -$11,000 It is a typical protective put strategy. Profit from 100 shares: 100 * (1400 - 2000) = - 60,000 Profit from 100 put option: 100 * (1900 - 1400 - 10) = 49,000 Therefore, the total profit = -60,000 + 49,000 = - 11,000 Note that the investor managed to limit the amount of loss by using the protective put.

True or False: Duration is a concept that is useful in assessing a bond's price volatility when interest rates change. a. True b. False

a. True

True or False: The writer of a put option agrees to buy shares at a set price if the option holder desires a. True b. False

a. True

The required return is 10% on each of two stocks, A and B. Each of the stocks is expected to pay a dividend of $4 in the upcoming year. The expected growth rate of dividends is 6% for stock A and 5% for stock B. Using the constant-growth dividend model, the price of stock A _________.

a. should be higher than the price of stock B If everything else is the same, stocks with a higher growth rate will have a higher stock price (common sense). In a mathematical equation, the stock price: P=𝐷1𝑟−𝑔 Therefore, the higher the g is so the higher the P is.

The writer of a put option __________.

agrees to buy shares at a set price if the option holder desires

[Current event] What is SPAC? a. It is new tech that seeks to improve and automate the delivery and use of financial services b. It is a company that has no commercial operations and is formed strictly to raise capital through an initial public offering (IPO) for the purpose of acquiring or merging with an existing company. c. It is a decision by a company to buy back its own shares from the marketplace. A company might do it to boost the value of the stock and to improve the financial statements. d. It is is a strategy used to manage interest rate risks.

b. It is a company that has no commercial operations and is formed strictly to raise capital through an initial public offering (IPO) for the purpose of acquiring or merging with an existing company.

[Current event] A _____________ is a decision by a company to buy back its own shares from the marketplace. A company might buy back its shares to boost the value of the stock and to improve the financial statements. Companies tend to do it when they have cash on hand and the stock market is on an upswing. What is a appropriate term for _________? a. SPAC b. Share repurchase c. Dividend d. Seasoned equity offering e. Repurchase agreement

b. Share repurchase

Consider two bonds, A and B. Both bonds presently are selling at their par value of $1,000. Each pays interest of $120 annually. Bond A will mature in 5 years, while bond B will mature in 6 years. If the yields to maturity on the two bonds change from 12% to 14%, ________.

both bonds will decrease in value but bond B will decrease more than bond A

All other things equal, which of the following has the longest duration? a. A 20-year bond with a 10% coupon & 10% yield-to-maturity b. A 20-year bond with a 10% coupon & 11% yield-to-maturity c. A 20-year zero-coupon bond with 10% yield-to-maturity d. A 19-year bond with a 10% coupon yielding 10%

c. A 20-year zero-coupon bond with 10% yield-to-maturity Duration has a positive relationship with time to maturity. Duration has a negative relationship with coupon rates.

[Current event] Which of the following statements is NOT a reason for rising corporate debts? a. Low-interest rates are prevalent. b. Investors require a higher amount of payouts. c. Firms invest a record of amount money into capitals. d. Managers expect that firms' stock prices will increase.

c. Firms invest a record of amount money into capitals.

An investor who goes long in a futures contract will __________ any increase in value of the underlying asset and will __________ any decrease in value in the underlying asset. a. pay; pay b. pay; receive c. receive; pay d. receive; receive

c. receive; pay

Consider two bonds, A and B. Both bonds presently are selling at their par value of $1,000. Each pays a coupon of $120 annually. Bond A will mature in 5 years, while bond B will mature in 6 years. If the yields to maturity on the two bonds change from 12% to 14%, _________.

d. both bonds will decrease in value but bond B will decrease more than bond A Duration is higher when coupon rates are low and time to maturity is longer. Therefore, bond B has longer duration. It means that bond B's price is more sensitive to changes in YTM (or interest rate)

[Current event] Pension crisis comes from the fact that _________________. a. the convexity of assets is higher than the convexity of liabilities. b. the convexity of liabilities is higher than the convexity of assets. c. the duration of assets is higher than the duration of liabilities. d. the duration of liabilities is higher than the duration of assets.

d. the duration of liabilities is higher than the duration of assets.

Assuming semiannual compounding, a 20 year zero coupon bond with a par value of $1,000 and a required return of 13.8% would be priced at __________.

insert

A wheat farmer should __________ in order to reduce his exposure to risk associated with fluctuations in wheat prices.

sell wheat futures