Unit 16 derivatives extra

All of the following are characteristics of a rights offering EXCEPT A) the subscription price is below the current market value B) it is issued to current stockholders C) the rights are marketable D) the subscription period is up to 2 years

D. Rights offerings are usually very short-lived (30 to 45 days). U16LO3

Bail Bonds, Inc., might issue warrants in connection with a bond issue for which of the following reasons? As an inducement to make the bonds more marketable To lower their interest cost on the issue To increase the marketability of their common stock To increase the number of common shares outstanding A) I, II, III, and IV B) I only C) I and II D) I and IV

C. Warrants permit the purchase of common stock of the issuer at a fixed price. A bond with warrants attached has more value than a straight bond and is more attractive (marketable) to investors. Attaching warrants to a bond issue usually permits the bonds to be issued with a lower interest rate. U16LO3

A farmer who produces soybeans believes that this year's crop will be the biggest ever. The farmer would most likely hedge this risk by A) going short soybean futures B) going long soybean futures C) going short soybean forwards D) going long soybean forwards

C. A big crop means more supply and lower prices when the crop is harvested. Hedging involves taking an opposite position (benefiting if prices fall). If the farmer is correct, selling short at today's price will enable delivery in the future at that higher price. Because this is a producer who will have product to deliver, forwards are likely to be more appropriate than futures. U16LO4

Which of the following statements about preemptive rights are TRUE? Preemptive rights give shareholders the right to purchase shares in new stock issues in direct proportion to the number of shares they already own. Preemptive rights allow shareholders to buy as many new shares as they want at any time. Preemptive rights allow shareholders to maintain their proportionate share of ownership in the corporation.

D. Preemptive rights give shareholders the right to purchase, in direct proportion to the number of shares they already own, shares in new issues of stock before they are offered to the general public. This allows current shareholders to maintain their proportionate share of ownership in the corporation. U16LO3

Covered call writing is a strategy where an investor A) buys a call on a security he has sold short B) sells a call on a security he owns to reduce the volatility of the stock's returns and to generate income with the premium C) buys two calls on the same security he owns to leverage the position D) sells a call on an index that contains some of the securities that he has in his portfolio

A covered call is simply defined as an investor owning 100 shares of the underlying stock for each option written (sold). The premium received is not only a source of income, but also serves to provide downside protection to the extent of the amount received. U16LO2

Mr. Brown has received preemptive rights from one of the stocks held in his portfolio. Which of the following is NOT an alternative regarding these stock rights? A) Redeeming them from the issuer for cash B) Selling at the market C) Exercising D) Giving the rights to his son

A. Rights are not redeemable by the issuer. They may be sold in the secondary market or be given to someone else to exercise. If exercised, rights are exchanged for an appropriate number of shares of the underlying common stock. U16LO3

Put Down

Afraid the price will go down

A speculator, believing that a drought in the Midwest will lead to a weak corn crop, would probably A) take a short position in corn futures B) take a long position in orange juice futures C) take a long position in corn forwards D) take a long position in corn futures

D. A weak corn crop means a shortage in the supply. That will lead to an increase in prices. When one is speculating that prices will go up, the best position is a long one. So, why not the long forwards? Those who purchase forwards contracts anticipate accepting delivery of the asset. This individual is merely speculating and has no interest in taking physical possession of the commodity and paying for transportation, silage, and insurance until the commodity is sold. If the person in the question had been a user of corn (a cereal maker, for example), then the forward contract would have been a better choice. U16LO4

For which of the following is there no active secondary market? A) Futures contracts B) Options C) ETFs D) Forward contracts

D. One of the disadvantages when investing in forward contracts is that there is no active secondary market. Because each contract is between one buyer and one seller and there is no standardization, no exchange trading is possible. U16LO4

Bullish and Bearish Options Positions

Long call- Right to buy bullish Long put- Right to sell bearish Short call- Obligation to sell bearish Short put- Obligation to buy bullish

An investor who is long a put option for 100 shares of ABC common stock A) has the right to sell 100 shares at the higher of the exercise or market price B) has the right to sell 100 shares at the stated exercise price C) has the right to buy 100 shares at the lower of the exercise or market price D) has the right to buy 100 shares at the stated exercise price

One who is long a put is an owner of the option. Owning a put option gives the holder the right to sell the underlying asset (in this case 100 shares of ABC stock) at the stated exercise (or strike) price. This would be advantageous if the strike price is above the current market price. U16LO2

Call up

Scared that price will go up