Finance 3 (Professor Lena Booth) Sample Questions for Final Exam

1. On November 18, 2011, three options on Richmond Associates stock, all expiring in December 2011, sold for the following prices: Option Call Call Put Exercise Price $50 $60 $70 Option Premium Per Share $7.50 $3.00 $14.50

You buy one call (100 shares) at $50 exercise price, sell (write) two calls (200 shares) at $60 exercise price, buy one put (100 shares) at $70 exercise price. a. b. 2. How much is required (or received) up front, on Nov 18? What is your net payoff from this strategy if Richmond Associates' stock price is at $54 at expiration?

Quotes for Pepperdine call options are flashing on your computer screen. You notice that the calls with two months until maturity are priced at $13 7/8 while the calls which expire in three-months are priced at 16 1/8. The stock has a variance of 0.20 and a current price is $110. The options have an exercise price of $100. The risk free rate is 5%. a. Should you buy either or both calls? You believe that the Black-Scholes formula correctly prices calls. b. Using call values derived from Black-Scholes, what does put-call parity imply the price of the corresponding puts?

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Your firm is confronted with a copper mining opportunity in Chile. A local mining company in Chile is willing to sell your firm the copper mining right to one of their sites, with the condition that your firm starts mining within a 5-year period starting from today. You are charged to do a feasibility study on this project. Based on the current copper prices, you estimate that the present value of the future cash inflows for this mine is $75 million while the cost of investment is $90 million. If the variance of the returns on copper mining in this region is estimated to be 0,025 and the risk free interest rate is at 6%, what is the maximum you will be willing to pay for this right? Given the following data: Fixed Rate Loan Floating Rate Loan Aaa Borrower Baa Borrower Agreement: 10% 11% LIBOR + 30 LIBOR + 60

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Baa borrower pays Aaa borrower 10.3% Aaa borrower pays Baa borrower LIBOR + 10

Finance 3 - Professor Lena Booth

Finance 3: Sample Questions for Final Exam

Assume that each borrower takes down the loan that he has comparative advantage in and then swaps with the other borrower. a) b) c) 5. What is the cost of borrowing floating rate loan for Aaa borrower after the swap? What is the cost of borrowing fixed rate loan for Baa borrower with the swap? What are the cost savings for Aaa and Baa borrowers after the swap?

Bright Star Couriers is analyzing the possible acquisition of Mama Restaurants. Neither firm has debt. The forecasts of Bright Star show that the purchase would increase its annual after-tax cash flow by $600,000 indefinitely. The current market value of Mama is $20 million. The current market value of Bright Star is $35 million. The appropriate discount rate for the incremental cash flows is 8%. a. b. What is the synergy from the merger? What is the value of Mama to Bright Star?

Bright Star is trying to decide whether it should offer 40% of its stock or $23 million in cash to Mama. c. d. e. 6. What is the premium to Bright Star of each alternative? What is the NPV to Bright Star of each alternative? Which alternative should Bright Star use?

A U.S. Corporation, Great Complexion, Inc., intends to import 2,000,000 Yen worth of cosmetics from Japan and will make payment in Japanese Yen (Yen) six months from now. The foreign exchange spot rate is Y85/US$. Annual interest rates for US dollar and Japanese Yen are 3% and 1% respectively. a. b. c. What is the six-month forward rate for Japanese Yen if interest rate parity holds? If Great Complexion were to hedge its position with a 6-month forward, how much US$ is needed to make the payment in 6 months? How can Great Complexion use currency trading to hedge against the foreign exchange risk associated with the purchase?

Finance 3 - Professor Lena Booth

Finance 3: Sample Questions for Final Exam

Guide to Conceptual Questions (Please make sure you understand the concepts behind each case): 1. 2. 3. 4. 5. 6. 7. 8. Costs and benefits of going public, IPO underpricing, IPO allocation mechanisms. What put call parity means and how to use it. How to use real options to form strategy, what strategy to use at what level: the tomato garden. Knowing the various currency exposures and how to manage them. Hedging using forward, futures, options and swaps, when to use which. Reasons to use interest rate swap or currency swap. Sensible and dubious reasons for mergers. Different pre- and post-offer defense tactics.

These are the answers for you to check your work. Step-by-step solutions will be provided after we discuss the questions in class. 1. a) -$16 per share or -$1,600 b) +$4.00 per share or +$400 total a)Two-month call=$14.21, Three-month call=$15.97 b) Two-month put=$3.38, Three-month put=$4.72 $14.64 million a) LIBOR-20 b) 11% c) 10.8% d) Savings: Aaa: 50 basis points Baa: 20 basis points a) $7.5 m b) $27.5 m c) Cost of cash: $3m, Cost of stock swap: $5m d) NPV of cash: $4.5m, NPV of stock swap: $2.5m e) Cash a) F=Y84.17/$ b) $23,761.23 c) forward, futures, options

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Finance 3 - Professor Lena Booth