You are on page 1of 17


MICHELLE CHIA KAR YAN 930609-14-5906 200170



Page 1 of 17


1.0 CONTENT ................................................................................. 2 2.0 TASK 1 ...................................................................................... 3 3.0 TASK 2 ...................................................................................... 4 4.0 TASK 3 ...................................................................................... 6 5.0 TASK 4 ...................................................................................... 7 6.0 TASK 5 ...................................................................................... 9 7.0 REFERENCES ........................................................................ 13 8.0 COURSEWORK ..................................................................... 14

Page 2 of 17

2.0 TASK 1
In 2012 Pfizer had 12,000 million shares stock authorized. 8,863 million in issue, and 6,746 million outstanding (figures rounded to the nearest million). Its equity account was as follows. $ Common stock Additional paid-in capital Retained earnings Treasury shares 443 70,283 44,148 (57,391)

1.1 What is the par value of each share?

=0.05 1.2 What was the average price at which shares were sold?

= 7.98 1.3 How many shares had been repurchased 8,863 million 6,746 million = 2,117 million 1.4 What was the average price at which the shares were repurchased?

Page 3 of 17

= $ 27.11 per share

Type equation here.

1.5 What was the net book value of Pfizers common equity? 443 million + 70,283 million + 44,148 million 57,391 million = 57,483 million

3.0 TASK 2
Inbox software was founded in 2010. Its founder put up $2 million for 500,000 shares of common stock. Each share had a par value of $10. 2.1 Construct an equity account (like the one in Table 14.2) for inbox on the day after its founding. Ignore any legal or administrative costs of setting up the company The day after the founding of Inbox: shares ($0.10 per value) Additional paid-in capital Retained earning Treasury shares at cost common equity 50,000 1,950,000 0 0 2,000,000 Net $ Common

Page 4 of 17

2.2 after two years of operation, Inbox generated earning of $120,000 and paid no dividends. What was the equity account at this point? After two years of operation: Common shares ($0.10 per value) Additional paid-in capital Retained earning Treasury shares at cost common equity $ 50,000 1,950,000 120,000 0 2,120,000 Net

2.3 After three years the company sold 1 million additional shares for $5 per share. It earned $250,000 during the year and paid no dividends. What was the equity account? After three years of operation: Common shares ($0.10 per value) Additional paid-in capital Retained earning Treasury shares at cost common equity 50,000 6,850,000 370,000 0 7,270,000 Net $

Page 5 of 17

4.0 TASK 3
In shareholders of the Pickwick Paper Company need to elect five directors. There are 200,000 shares outstanding. How many shares do you need to own to ensure that you can elect at least one director if 3.1 The company has majority voting?

=100,001 3.2 if has cumulative voting? 200,0005=1,000,000


Page 6 of 17

= 33.333 (share holder) = 33.334

5.0 TASK 4
4.1 Large businesses spend millions of dollars annually on insurance. Why? Should they insure against all risks or does insurance make more sense for some risks than others?

Insurance companies have the experience to assess routine risks and to advise companies on how to decrease the frequency of losses. Insurance company experience and the very competitive nature of the insurance industry result in correct pricing of routine risks. However, BP, for example, has concluded that insurance industry pricing of coverage for large potential losses is not efficient because of the industrys lack of experience with such losses. Consequently, BP has chosen to self insure against these large potential losses. Effectively, this means that BP uses the stock market, rather than insurance companies, as its vehicle for insuring against large losses. Other than that, large losses result in reductions in the value of BPs stock. The stock market can be an efficient risk absorber for these large but diversifiable risks.

Page 7 of 17

Insurance company expertise can be beneficial to large businesses because the insurance companys experience enable the insurance company to correctly price insurance coverage for routine risks and to provide advice on how to minimize the risk of loss. Furthermore, the insurance company is able to pool risks and thereby minimize the cost of insurance. Rarely does it pay for a company to insure against all risks, however. Typically, large organization self-insure against small potential losses.

4.2 On some catastrophe bonds, payments are reduced if the claims against the issuer exceed a specified sum. In other cases payments are reduced only if claims against the entire industry exceed some sum. What are the advantages and disadvantages of the two structures?

If payments are decreased when claims against one issuer exceed a specified amount, the issuer is co-insured above some level, and some degree of on-going viability is ensured in the event of a catastrophe. The disadvantage and cons is that, knowing this, the insurance firm may over-commit in this area in order to gain additional premiums. If the payments are reduced based on claims against the entire industry, an on-going and viable insurance market may be assured but some firms may under-commit and yet still enjoy the benefits of lower payments. Basis risk will be highest in the first case due to the larger firm specific risk.

Page 8 of 17

4.3 List some of the commodity futures contracts that are traded on exchanges. Who do you think could usefully reduce risk by buying each of these contracts? Who do you think might wish to sell each contract? The list of commodity futures contracts is long, and includes: Gold Buyers include jewelers. Sellers include gold-mining companies. Sugar Buyers include bakers. Sellers include sugar-cane farmers. Aluminum Buyers include aircraft manufacturers. Sellers include bauxite miners.

6.0 TASK 5
Consider the commodities and financial assets listed in Table. The risk-free interest rate is 6 percent a year, and the term structure is flat.

5.1 Calculate the six-month futures price for each case. To calculate the six-month futures price, we use the following basic relationships for commodities and for financial futures, respectively: Ft = S0 (1 + rf + storage costs convenience yield)t Ft = S0 (1 + rf y)t

Page 9 of 17

Thus, the six-month futures prices are: Magnoosium: 2,800 (1.03 0.04) = $2,772 per ton Oat Bran: 0.44 (1.03 0.03) = $0.44 per bushel Biotech: 140.2 1.03 = $144.41 Allen Wrench: 58.00 [1.03 (1.20/58.00)] = $58.54 5-Year T-Note: 108.93 [1.03 (4.00/108.93)] = $108.20 Ruple: * 3.017 ruples/$ 237 *Note that, for the currency futures (i.e., the Westonian ruple), the spot currency quote is an indirect quote (i.e., ruples per dollar) rather than a direct quote (i.e., dollars per ruple). If I buy ruples today in the spot market, I pay ($1/3.1) per ruple in the spot market and earn interest of [(1.120.5) 1] = 0.0583 = 5.83% for six months. If I buy ruples in the futures market, I pay ($1/X) per ruple (where X is the indirect futures quote) and I earn 6% interest on my dollars. Thus, the futures price of one ruple should be: 1.0583/(3.1 1.03) = 0.33144 = 1/3.017 Therefore, a futures buyer should demand 3.017 ruples for $1.

5.2 Explain how a magnoosium producer would use a futures market to lock in the selling price of a planned shipment of 1,000 tons of magnoosium six months from now. The magnoosium producer would sell 1,000 tons of six-month magnoosium

Page 10 of 17


5.3 Suppose the producer takes the actions recommended in your answer to (5.2), but after one month magnoosium prices have fallen to $2,200. What happens? Will the producer have to undertake additional futures market trades to restore its hedged position? Because magnoosium prices have fallen, the magnoosium producer will receive payment from the exchange. It is not necessary for the producer to undertake additional futures market trades to restore its hedge position.

5.4 Does the biotech index futures price provide useful information about the expected future performance of biotech stocks? No, the futures price depends on the spot price, the risk-free rate of interest, and the convenience yield.

5.5 Suppose Allen Wrench stock falls suddenly by $10 per share. Investors are confident that the cash dividend will not be reduced. What happens to the futures price? The futures price will fall to $48.24 (same calculation as above, with a spot price of $48): 48.00 [1.03 (1.20/48.00)] = $48.24
Page 11 of 17

5.6 Suppose interest rates suddenly fall to 4 percent. The term structure remains flat. What happens to the six-month futures price on the five-year Treasury note? What happens to a trader who shorted 100 notes at the futures price calculated in part (a)? First, we recalculate the current spot price of the 5-year Treasury note. The spot price given ($108.93) is based on semi-annual interest payments of $40 each (annual coupon rate is 8%) and a flat term structure of 6% per year. Assuming that 6% is the compounded rate, the six-month rate is: (1 + 0.06)1/2 1 = 0.02956 = 2.956% Incorporating similar assumptions with the new term structure specified in the problem, the new spot price of the 5-year Treasury note will be $118.16. Thus, the futures price of the 5-year T-note will be: 118.16 [1.02 (4.00/118.16)] = $116.52 The dealer who shorted 100 notes at the (previous) futures price has lost money.

5.7 An importer must make a payment of one million ruples three months from now. Explain two strategies the importer could use to hedge against unfavorable shifts in the rupledollar exchange rate. The importer could buy a three-month option to exchange dollars for ruples, or the importer could buy a futures contract, agreeing to exchange dollars for ruples in three months time.
Page 12 of 17

1. ml 2. _nrs=true&pf=p&output=search&sclient=psyab&oq=bredley&gs_l=&pbx=1&bav=on.2,or.r_qf.&bvm=bv.46340616,d.bmk&fp=7cd4 b16ab95c27b7&biw=1688&bih=748 3. 4. 5. Test Book (Corporate Financial Management Edition)

Page 13 of 17

1. Financial intermediaries contribute in many ways to our individual well-being and the smooth functioning of the economy. List out THREE example and briefly explain them. The payment Mechanism Think how inconvenient life would be if all payments had to be made in cash. Fortunately, checking accounts, credits cards, and electronic transfers allow individuals and firms to send and receive payments quickly and safely over along distances. Banks are the obvious providers of payments services, but they are not alone. For example, if you buy shares in a money-market mutual fund, your money is pooled with that of other investors and is used to buy safe, short-term securities. You can then write checks on this mutual fend investment, just as if you had a bank deposit.

Borrowing and Lending

Almost all financial institutions are involved in channeling

savings toward those who can best use them. Thus, if Ms Jones has more money now than she needs and wishes to save for a rainy day, she can put the money in a bank savings deposit. If Mr. Smith wants to buys a car now and pay a for it later, he can borrow money from the bank. Both the lender and borrower are happier than if they were forced to spend cash as it arrived. Of course, individuals are not alone in needing to raise cash. Companies with profitable investment opportunities may wish to borrow from the bank, or they may raise the finance by selling new shares or bonds. Governments also often run at a deficit, which they fund by issuing large quantities of debt. In principle, individuals or firms with cash surpluses could take out newspaper advertisements or surf he Net looking for those with cash shortages. But it can be cheaper
Page 14 of 17

and more convenient to use a financial intermediary, such as a bank, to link up the borrower and lender. For example, banks are equipped to check out the would-be borrowers creditworthiness and to monitor the use of lent out. Would you lend money to a stranger contacted over the internet? You would be safer lending the money to the bank and letting the bank decide what to do with it. Notice that banks promise their checking account customers instant access to their money and at the same time make long-term loans to companies and individuals. This mismatch between the liquidity of the banks liabilities (the deposits) and most of its assets (loans) is possible only because the number of depositors is sufficiently large that the bank can be fairly sure that they will not all want to withdraw their money simultaneously.

Pooling Risk. Financial markets and institutions allow firms and individuals to pool their risks. For instance, insurance companies make it possible to share the risk of an automobile accident or a household fire. Here is another example. Suppose that you have only a small sum of invest. You could buy the stock of a single company, but then you would be wiped out if that company went belly-up. It is generally better to buy shares in a mutual fund that invests in a diversified portfolio of common stocks or other securities. In this case you are exposed only to the risk that security prices as a whole will fall. The basic functions of financial markets are the same the world over. So it is not surprising that similar institutions have emerged to perform these functions. In almost every country you will find banks accepting deposits, making loans, and looking after the
Page 15 of 17

payments system. You will also encounter insurance companies offering life insurance and protection against accident. If the country is relatively prosperous, other institutions, such as pension funds and mutual funds, will also have been established to help manage peoples savings. Of course there are differences in institutional structure. Take banks, for example. In many countries where securities markets are relatively undeveloped, banks play a much more dominant role in financing industry. Often the banks undertake a wider range of activities than they do in the United States. For example, they may take large equity stakes in industrial companies; this would not generally be allowed in the United States.

2. In most companies stockholders elect directors by using a system of majority voting. Please explain the voting procedures. In most companies stockholders elect directors by a system of majority voting. In this case, each director is voted upon separately and stockholders can cast one vote for each share that they own. If companys articles permits cumulative voting, the directors are voted upon jointly and stockholders can, if they wish, allot all their votes to just one candidate. 8 Cumulative voting makes it easier for a minority group among the stockholders to elect directors who will represent the groups interests. That is why some shareholder groups campaign for cumulative voting. One many issues a simple majority of votes cast is sufficient to carry the day, but the company charter may specify some decisions that require a supermajority of, say, 75% of those eligible to vote. For example, a supermajority vote is sometimes needed to approve a merger.
Page 16 of 17

The issues on which stockholders are asked to vote are rarely contested, particularly in the case of large, publicly traded firms. Occasionally, there are proxy contests in which the firms existing management and directors complete with outsiders, for effective control of the corporation. But the odds are stacked against the outsides, for the insiders can get the firm to pay all the costs of presenting their case and obtaining votes.

Page 17 of 17