Question 1
1. Discuss the limitations of Black?Scholes option pricing formula. 2. Consider options on a non?dividend?paying stock when the stock price is $100, the strike price is $95, the risk?free interest rate is 2% per annum, the volatility is 25% per annum, and the time to maturity is 7 months. a. Price a European call option. Do not use Derivagem. b. If the option is an American call instead of a European call, will the call holder ever early exercise the option before expiration? (hint: Chapter 10, Section 5) Will the American call price be the same or different from part a. Explain. c. Price a European put option. Do not use Derivagem. d. If this is an American put, will the price be the same or different from part d? Explain. e. Use Derivagem to answer parts a and c. Copy paste the DG outputs to show that the prices are identical. f. Verify that put?call parity (Eq. 10.6) holds using your answers above. This is not a yes or no question. You must calculate both sides of the equation and show that the put?call parity holds. g. Suppose the European call is currently trading at $15. Calculate the implied volatility. Include the DG output. 3. What is VIX index? Suppose you expect the stock market volatility will greatly increase in the near future. With such expectation, how will you invest in VIX futures? 4. Use the Black?Scholes pricing to fill out the following table with ?+? or ???. + means the higher value of the variable increases the option price. ? means the variable has a negative effect on the option price. (You don?t have to include DG outputs for this question.) Variable European call price European put price current stock price strike price volatility risk?free rate dividends 5. A call option on a non-dividend-paying stock has a market price of $2.50. The stock price is $15, the exercise price is $13, the time to maturity is three months, and the risk-free interest rate is 5% per annum. What is the implied volatility? 6. Consider an American call option on a stock. The stock price is $70, the time to maturity is eight months, the risk-free rate of interest is 10% per annum, the exercise price is $65, and the volatility is 32%. A dividend of $1 is expected after three months and again after six months. Use the results in the appendix to show that it can never be optimal to exercise the option on either of the two dividend dates. Use DerivaGem to calculate the price of the option.
Question 2
1.How did the Bretton Woods system operate? What caused its collapse? Some think the current system of managed but floating rates is too unstable. What would generate the instability? 2.What is foreign aid and what is the goal of foreign aid? Does foreign aid promote economic development? Explain briefly. 3.How can two countries both be better off as a result of trade? How can tariffs protect U.S. jobs? Do tariffs lead to a net increase in jobs? Explain. Who are the winners and losers from trade restrictions? Given that trade restrictions impose losses on an economy, why are trade restrictions so common? 4.Describe developing countries and how they differ from industrial market economies. How can international trade aid development? In what ways does the international economy impose problems on developing countries? 5.Why can't all the balance of payments accounts be in surplus? What factors determine the demand for British pounds in foreign exchange markets? How are exchange rates determined under a flexible exchange rate system? All 5 response should be at least 75 words in length. You are required to use at least your textbook as source material for your response. All sources used, including the textbook, must be referenced; paraphrased and quoted material must have accompanying citations.
Question 3
To be solved by DKhetan 1. Suppose a stock had an initial price of $83 per share, paid a dividend of $1.40 per share during the year, and had an ending share price of $76. Compute the dividend yield, the capital gains yield and the percentage total return. A) 2.00%, ?8.00%, ?6.00% B) 1.69%, 8.43%, 10.12% C) 1.69%, ?8.43%, ?6.75% D) -1.69%, 8.43%, 6.75% 2. You've observed the following returns on Kelley Corporation's stock over the past five years: ?16 percent, 21 percent, 4 percent, 16 percent, and 19 percent. What was the arithmetic average return on the stock over this five-year period? What was the variance of returns over this period? The standard deviation? A) 8.80%, 0.023570, 15.35% B) 11.80%, 0.023570, 15.35% C) 8.80%, 0.034056, 18.45% D) None of the above 3. The geometric average return answers the question, "What was your average compound return per year over a particular period?" The arithmetic average return answers the question, "What was your return in an average year over a particular period?" A) True B) False 4. A stock has had returns of 29 percent, 14 percent, 23 percent, ?8 percent, 9 percent, and ?14 percent over the last six years. What are the arithmetic (AAR) and geometric (GAR) average returns for the stock? A) AAR = 8.83%, GAR = 7.69% B) AAR = 7.69%, GAR = 8.83% C) AAR = 8.83%, GAR = 8.83% D) AAR = 16.17%%, GAR = 15.52% 5. Eight months ago, you purchased 400 shares of Winston, Inc. stock at a price of $56.90 a share. To date the company has paid quarterly dividends of $.55 a share twice. Today, you sold all of your shares for $49.40 a share. What is your total percentage return on this investment? A) -11.2% B) -9.3% C) -8.4% D) 12.0% 6. Over the past 75 years, the total annual returns on large company common stocks averaged 11.8%, small company stocks averaged 16.6%, long-term government bonds averaged 5.8%, while Treasury Bills averaged 3.7%. What was the average risk premium earned by long-term government bonds and small company stocks, respectively? A) 1.8%; 11.9% B) 2.1%; 12.9% C) 4.4%; 13.9% D) None of the above. 7. For given variances of the individual securities, a negative covariance between the two securities increases the variance of the entire portfolio. A positive covariance between the two securities decreases the variance of the entire portfolio. A) True B) False 8. The efficient set of securities represents those securities and portfolios of securities that have the highest expected return per unit of total risk (standard deviation of return). A) True B) False 9. A systematic risk is one that influences a large number of assets, each to a greater or lesser extent. Because systematic risks have marketwide effects, they are sometimes called market risks. An unsystematic risk is one that affects a single asset or a small group of assets. Because these risks are unique to individual companies or assets, they are sometimes called unique or asset specific risks. A) True B) False 10. The capital asset pricing model (or CAPM for short), implies that the expected return on a security is linearly related to its beta. In practice, financial economists generally use a broad-based value weighted index such as the Standard & Poor's (S&P) 500 as a proxy for the market portfolio in order to estimate the beta for a security. Of course, all investors do not hold the same portfolio. However, we know that a large number of investors hold diversified portfolios, particularly when mutual funds or pension funds are included. A broad-based value weighted index such as the S&P 500, therefore, is a good proxy for the highly diversified portfolios of many investors. Since the average return on the S&P 500 proxy for the market portfolio has been higher than the average risk-free rate over long periods of time, [E(RM) ? RF] is presumably positive over long periods. Thus, the CAPM also implies that the expected return on a security is positively related to its beta. A) True B) False 11. Consider the following information on three stocks A, B and C: State of Probability of Rate of Return if State Occurs Economy State Occurring A B C Boom .2 .20 .35 .60 Normal .6 .15 .12 .05 Bust .2 .01 -.25 -.50 If your portfolio is invested 30 percent each in A and B and 40 percent in C, what is the portfolio expected return? The variance? The standard deviation? A) 9.16%, .08001, 28.29% B) 4.30%, .08001, 28.29% C) 9.16%, .03882, 19.70% D) 8.72%, .04612, 21.48% 12. The principle of diversification tells us that: A) concentrating an investment in three companies all within the same industry will greatly reduce your overall risk. B) concentrating an investment in two or three large stocks will eliminate all of your risk. C) spreading an investment across many diverse assets will eliminate some of the risk. D) spreading an investment across many diverse assets will eliminate all of the risk. 13. The slope of an asset?s security market line is the: A) reward-to-risk ratio. B) beta coefficient. C) risk-free interest rate. D) market risk premium. 14. Which one of the following statements is correct concerning the expected rate of return on an individual stock given various states of the economy? A) The expected return is a geometric average where the probabilities of the economic states are used as the exponential powers. B) The expected return is an arithmetic average of the individual returns for each state of the economy. C) The expected return is a weighted average where the probabilities of the economic states are used as the weights. D) The expected return is equal to the summation of the values computed by dividing the expected return for each economic state by the probability of the state. 15. If investors possess homogeneous expectations over all assets in the market portfolio, when riskless lending and borrowing is allowed, the market portfolio is defined to: A) be the same portfolio of risky assets chosen by all investors. B) have the securities weighted by their market value proportions. C) be a diversified portfolio. D) All of the above. 16. Using the CAPM, a stock has a beta of 1.3, the expected return on the market is 9 percent, and the risk-free rate is 4 percent. What must the expected return on this stock be? A) 11.70% B) 10.50% C) 14.00% D) 25.70% 17. While beta is theoretically the best measure of risk for a security in a portfolio, not all betas are created equal. Some are computed using weekly returns and some using daily returns. Some are computed using 60 months of stock returns; some consider more or less returns. Some betas are computed by comparing the stock to the S&P 500 Index, while others use alternative indices. Finally, some reporting firms (including Value Line) make adjustments to raw betas to reflect information other than just the fluctuation in stock prices. Further, portfolio managers are interested in knowing what the beta of the stock will be in the future, but betas have to be estimated using historical data. Anytime we use the past to predict the future, there is the danger of making a poor estimate. This is often called forecast risk (estimation risk) or forecast error. A) True B) False 18. A stock with an actual return that lies above the security market line: A) has less systematic risk than the overall market. B) has more risk than warranted based on the realized rate of return. C) has more systematic risk than the overall market. D) has yielded a higher return than expected for the level of risk assumed. 19. The Capital Market Line is the relationship between the expected returns and standard deviations of portfolios formed by combinations of: A) efficient portfolios. B) the risk-free asset and any risky asset. C) the risk-free asset and the optimal portfolio of risky assets. D) the risk-free asset and any portfolio of risky assets. 20. When a project is financed with both debt and equity, the cost of capital is determined by the cost of both debt and equity. If a firm uses both debt and equity, the cost of capital is a weighted average of each or the weighted average cost of capital (WACC). A) True B) False 21. Kelley Corporation has a target capital structure of 55 percent common stock and 45 percent debt. Its cost of equity is 16 percent, and the cost of debt is 9 percent. The relevant tax rate is 35 percent. What is Kelley's WACC? A) 11.43% B) 16.00% C) 5.85% D) 21.85% 22. Given the following information for Indiana Power Co., find the WACC. The company's tax rate is 35 percent; Debt: 4,000 7 percent coupon bonds outstanding, $1,000 par value, 20 years to maturity, selling for 103 percent of par; the bonds make semiannual payments; Common stock: 90,000 shares outstanding, selling for $57 per share; The firm?s beta is 1.10; Assume an 8 percent market risk premium (Remember the risk premium = [E(RM) ? Rf]; Rf = 6 percent risk-free rate. A) 14.80% B) 8.00% C) 6.72% D) 10.15% 23. The three forms of the efficient markets hypothesis (EMH) are: 1) Weak form. Market prices reflect all information, public or private. Investors are unable to earn abnormal returns using insider information or historical prices to predict future price movements. 2) Semi-strong form. In addition to historical data, market prices reflect all publicly-available information. Investors with insider, or private information, are able to earn abnormal returns. 3) Strong form. Market prices reflect information contained in historical prices. Investors are unable to earn abnormal returns using historical prices to predict future price movements. A) True B) False 24. During a trading day, American Air Inc. announces that it has lost a contract for a large transport plane project, which, prior to the news, it was widely believed to have secured. If the market is semistrong form efficient, how should the stock price react to this information if no additional information is released? A) At the time of the announcement, the price of the stock should immediately increase. B) At the time of the announcement, the price of the stock should not change. C) At the time of the announcement, the price of the stock should immediately decrease. D) At the time of the announcement, there is a 50 percent chance that the price of the stock could increase or decrease since stock price movement is random. 25. The EMH only says, within the bounds of increasingly strong assumptions about the information processing of investors, that assets are fairly priced. An implication of this is that, on average, the typical market participant cannot earn excessive profits from a particular trading strategy. However, that does not mean that a few particular investors cannot outperform the market over a particular investment horizon. A) True B) False 26. A basic premise of portfolio theory is that investors tend to be risk averse. In selecting their investments, investors seek out investments with the characteristic of providing the maximum expected rate of return for a given level of risk, or the minimum anticipated volatility (risk) for a given expected rate of return. A) True B) False 27. Assume an investor formed a portfolio comprised of 30% in the common stock of AT&T, Inc., (T) and 70% in the common stock of Apple, Inc. (AAPL). Use the data provided below to calculate the portfolio?s monthly expected return, standard deviation, and coefficient of variation. Spreadsheet estimates of average monthly return, standard deviation and covariance for each of these two stocks are as follows: (to convert to decimal format, move the decimal point two places to the left for both the average return and standard deviation; move the decimal point four places to the left for the covariance): T AAPL Average Monthly Return 2.28% 5.64% Standard Deviation of Return 5.56% 12.01% Covariance (T, AAPL) = -33 A) 4.63%, 55.85%, 12.06 B) 4.63%, 7.72%, 1.67 C) 3.39%, 4.49%, 1.33 D) None of the above 28. Consider a portfolio comprised of two stocks A and B: The estimates shown below are given in percentage format for the expected return, E(R), and standard deviation of returns (SD). Note: to convert to decimal format, move the decimal point two places to the left for both the E(R) and SD). Stock Weight E(R) SD A 0.40 16% 45% B 0.60 12% 30% The correlation between stocks A and B is .75. Calculate the portfolio expected return and standard deviation. A) 13.6%, 33.67% B) 13.6%, 12.73% C) 12.1%, 18.62% D) None of the above 29. An all-equity financed firm that has an 11 percent cost of capital is considering the following projects: Project Beta Expected Return W .75 11% X .95 13% Y 1.15 14% Z 1.50 15% The T-bill rate is 5 percent and the expected return on the market is 12 percent. Assuming the CAPM is the true return generating model, which projects should be accepted? Which projects would be incorrectly rejected if the firm?s cost of capital were used as a hurdle rate? A) Accept X, Y and Z; Reject W B) Accept W, Y and Z; Reject X C) Accept W, X and Z; Reject Y D) Accept W, X and Y; Reject Z 30. On-line Text Co. has four new text publishing products that it must decide on publishing to expand its services. The firm's WACC has been 17%. The projects are of equal risk, Beta of 1.6. The risk-free rate is 7% and the market rate is expected to be 12%. The projects expected IRRs are as follows: Project W = 14% Project X = 18% Project Y = 17% Project Z = 15% What project(s) should be clearly rejected? A) Reject X and Y B) Reject Y and Z C) Reject W D) Reject Z 31. In calculating the WACC, you must always use the book values for both debt and equity. A. True B. False 32. Financial markets continually fluctuate because they: A) are completely inefficient. B) are continually reacting to new information. C) take weeks to react to new information. D) only reflect historical information. 33. Suppose that firms with unexpectedly high earnings earn abnormally high returns for several months after the announcement. This would be evidence of: A) efficient markets in the weak form. B) inefficient markets in the weak form. C) inefficient markets in the semistrong form. D) inefficient markets in the all forms.
Question 4
1. Which of the following is the most valid reason to split a stock that has a market price of $110 per share? (Points : 1) Conserve cash. Reduce the market price to a more popular trading range. Obtain additional capital. Increase investor's net worth. 3. The Modigliani and Miller hypothesis does not work in the "real world" because (Points : 1) interest expense is tax deductible, providing an advantage to debt financing. higher levels of debt increase the likelihood of bankruptcy, and bankruptcy has real costs for any corporation. both A and B. dividend payments are fixed and tax deductible for the corporation. 4. Assume that the tax on dividends and the tax on capital gains is the same. All else equal, what would a prudent investor prefer? (Points : 1) The prudent investor would be indifferent between receiving dividends or capital gains. The prudent investor would prefer dividends?a dollar today is always worth more than a dollar to be received in the future. The prudent investor would prefer capital gains?the capital gain tax liability can be deferred until gains are realized. More information is needed. 5. Benkart's Tire Store has fixed costs of $220,000. Tires sell for $95 each and have a unit variable cost of $45. What is Benkart's break-even point in units? (Points : 1) 4,000 4,400 5,200 5,500 8. Moline Manufacturing Corporation reported the following items: Sales = $6,000,000; Variable Costs of Production = $1,500,000; Variable Selling and Administrative Expenses = $550,000; Fixed Costs = $1,350,000; EBIT = $2,600,000; and the Marginal Tax Rate =35%. Moline's break-even point in sales dollars is (Points : 1) $2,050,633. $2,197,500. $2,438,750. $2,785,000. 9. Sweet Tooth Bakery bakes and sells pies. Sweet Tooth has annual fixed costs of $880,000 and a variable cost per pie of $7.50. Each pie sells for $15.50 each. The firm expects to sell 500,000 pies annually. What is the break-even point in sales dollars? (Points : 1) $3,100,000 $2,875,000 $1,705,000 $1,625,000 10. If a firm has no operating leverage and no financial leverage, then a 10% increase in sales will have what effect on EPS? (Points : 1) EPS will remain the same EPS will increase by 10% EPS will decrease by 10% EPS will increase by less than 10%
Question 5
David?s Entertainment is a merchandising business. Their account balances as of November 30, 2012 (unless otherwise indicated), are as follows: 110 Cash $ 73,920 112 Accounts Receivable 34,250 113 Allowance for Doubtful Accounts 11,000 115 Merchandise Inventory 123,900 116 Prepaid Insurance 3,750 117 Store Supplies 2,850 123 Store Equipment 100,800 124 Accumulated Depreciation-Store Equipment 20,160 210 Accounts Payable 21,450 211 Salaries Payable 0 218 Interest Payable 0 220 Note Payable (Due 2017) 15,000 310 D. Williams, Capital (January 1, 2012) 73,260 311 D. Williams, Drawing 50,000 312 Income Summary 0 410 Sales 853,445 411 Sales Returns and Allowances 20,020 412 Sales Discounts 13,200 510 Cost of Merchandise Sold 414,575 520 Sales Salaries Expense 74,400 521 Advertising Expense 18,000 522 Depreciation Expense 0 523 Store Supplies Expense 0 529 Miscellaneous Selling Expense 2,800 530 Office Salaries Expense 40,500 531 Rent Expense 18,600 532 Insurance Expense 0 533 Bad Debt Expense 0 539 Miscellaneous Administrative Expense 1,650 550 Interest Expense 1,100 David?s Entertainment uses the perpetual inventory system and the First-in, First-out costing method. Transportation-in and purchase discounts should be added to the Inventory Control Sheet, but since this will complicate the computation of the First-in, First-out costing method, please ignore this step in the process. They also use the Allowance Method for bad debt. The Accounts Receivable and Accounts Payable Subsidiary Ledgers along with the Inventory Control Sheet should be updated as each transaction affects them (daily). David?s Entertainment sells four types of television entertainment units. The sale prices of each are: TV A: $3,500 TV B: $5,250 TV C: $6,125 PS D: $9,000 During December, the last month of the accounting year, the following transactions were completed: Dec. 1. Issued check number 2632 for the December rent, $2,600. 3. Purchased three TV C units on account from Prince Co., terms 2/10, n/30, FOB shipping point, $11,100. 4. Issued check number 2633 to pay the transportation changes on purchase of December 3, $400. (NOTE: Do not include shipping and purchase discounts to the Inventory Control sheet for this project.) 6. Sold four TV A and four TV B on account to Albert Co., invoice 891, terms 2/10, n/30, FOB shipping point. 10. Sold two projector systems for cash. 11. Purchased store supplies on account from Matt Co., terms n/30, $580. 13. Issued check to Prince Co. number 2634 for the full amount due, less discount allowed. 14. Issued credit memo for one TV A unit returned on sale of December 6. 15. Issued check number 2635 for advertising expense for last half of December, $1,500. 16. Received cash from Albert Co. for the full amount due (less return of December 14 and discount). 19. Issued check number 2636 to buy two TV C units, $7,600. 19. Issued check number 2637 for $6,100 to Joseph Co. on account. 20. Sold five TV C units on account to Cameron Co., invoice number 892, terms 1/10, n/30, FOB shipping point. 20. For the convenience of the customer, issued check number 2638 for shipping charges on sale of December 20, $700. 21. Received $12,250 cash from McKenzie Co. on account, no discount. 21. Purchased three projector systems on account from Elisha Co., terms 1/10, n/30, FOB destination, $15,600. 24. Received notification that Marie Co. has been granted bankruptcy with no amount of recovery. We are to write-off her amount due. (Note: See page 402 for entry required.) 25. Issued a debit memo for return of $5,200 because of a damaged projection system purchased on December 21, receiving credit from the seller. 26. Issued check number 2639 for refund of cash on sales made for cash, $600. (Customer was going to return goods until an allowance was arranged.) 27. Issued check number 2640 for sales salaries of $1,750 and office salaries of $950. 28. Purchased store equipment on account from Matt Co., terms n/30, FOB destination, $1,200. 29. Issued check number 2641 for store supplies, $470. 30. Sold four TV C units on account to Randall Co., invoice number 893, terms 2/10, n/30, FOB shipping point. 30. Received cash from sale of December 20, less discount, plus transportation paid on December 20. (Round calculations to the nearest dollar.) 30. Issued check number 2642 for purchase of December 21, less return of December 25 and discount. 30. Issued a debit memo for $300 of the purchase returned from December 28. Instructions: 1. Enter the balances of each of the accounts in the appropriate balance column of a four-column account (General Ledger). Write Balance in the item section, and place a check mark (x) in the Post Reference column. 2. Journalize the transactions in a sales journal, purchases journal, cash receipts journal, cash payments journal, or general journal as illustrated in chapter 7. Also post to the Accounts Receivable and Accounts Payable Subsidiary ledgers and Inventory Control Sheet as needed. 3. Total each column on the special journals and prove the journal. 4. Post the totals of the account named columns and individually post the ?other? columns as well to the General Ledger. 5. Prepare the Schedule of Accounts Receivable and the Schedule of Accounts Payable (their total amount must equal the amount in their controlling general ledger account). 6. Prepare the unadjusted trial balance on the worksheet. 7. Complete the worksheet for the year ended December 31, 2012, using the following adjustment data: a. Merchandise inventory on December 31 $90,800 b. Insurance expired during the year 1,250 c. Store supplies on hand on December 31 975 d. Depreciation for the current year needs to be calculated. The business uses the Straight-line method, the store equipment has a useful life of 10 years with no salvage value. (NOTE: the purchase and return will not be included as the dates of the transactions were after the 15th of the month). e. Accrued salaries on December 31: Sales salaries $1,400 Office salaries 760 2,160 f. The note payable terms are at 8%, payment is not being made until Jan. 3, 2013. Interest must be recognized for one month. g. Net realizable value of Accounts Receivable is determined to be $27,950. 8. Prepare a multiple-step income statement, a statement of owner?s equity, and a classified balance sheet in good form. (Recommend review of ?Current Liabilities? on pages 166 & 167 and ?Current Maturities of Long-term Debt? on page 480.) 9. Journalize and post the adjusting entries. 10. Journalize and post the closing entries. Indicate closed accounts by inserting a line in both balance columns opposite the closing entry. 11. Prepare a post-closing trial balance.
