Chapter 24 fundamentals of corporate finance 9th edition test bank

24 Student: _ Which one of the following grants its owner the right to buy or to sell an asset at a prespecified price at any time during a stated period? A option B forward contract C futures contract D swap E intrinsic contract Elizabeth owns a call option on 100 shares of Microsoft stock She has decided to buy those shares This purchase is commonly referred to as: A striking the asset B expiring the option C exercising the option D putting the collar E the collar option Marti owns an option that allows him to purchase ABC stock at $50 a share The $50 price is referred to as the: A opening price B intrinsic value C strike price D market price E time value What is the final day on which an option can be exercised called? A payment date B ex-option date C opening date D expiration date E intrinsic date Felicia purchased an option which she can exercise anytime within the next six months Which type of option did she purchase? A market-ready B portable C daily D European E American Brad purchased an option that he can only exercise on the final day of the option period Which type of option did he purchase? A European B American C inflexible D dated E pointed Which of the following grants its owner the right to purchase an asset at a stated price? I American call II European call III American put IV European put A I only B I and II only C I and III only D II and IV only E III and IV only The owner of a put option has the _ an asset at a fixed price during a stated period of time A right to sell B right to buy C obligation to sell D obligation to buy E obligation to trade Which one of the following terms applies to the value of an option on its expiration date? A strike price B upper limit C deadline price D time value E intrinsic value 10 Suzie is the controller of The Price Rite Company She has been granted to the right to buy 1,000 shares of her employer's stock at $25 a share anytime within the next three years Which one of the following has Suzie been granted? A employee stock option B company bonus option C employee grant D employee exercise option E company benefits option 11 Which one of the following terms applies to an option that has an office building as its underlying asset? A financial option B liquid option C fixed option D real option E concrete option 12 The investment timing decision is the: A determination of when an option should be exercised B decision of when to purchase an option on an underlying asset C analysis of determining when an asset should be sold D determination of when a project should be abandoned E evaluation of the optimal time to begin a project 13 Lucas Enterprises recently opted to open a new retail outlet If the outlet outperforms the expectations, the manager can opt to increase the store's size If it underperforms, the manager can opt to close the store These choices that the manager has been given are called: A call options B put options C straddles D managerial options E executive options 14 Which one of the following considers all of the options implicit in a project? A expansion planning B contingency planning C asset management review D prospective evaluation E strategic evaluation 15 KT Enterprises has expanded its operations into a new field, which is the production of everyday dinnerware If this project goes well, the firm has the option to expand its production into fine china What type of option is this? A financial B strategic C put D intangible E call 16 Amy is a current shareholder of DJ Industries She has been given the right to purchase an additional 25 shares of DJ Industries stock at a price of $32 a share if she exercises that right within the next 12 months What is this security called that Amy has been given? A convertible bond B warrant C straddle D spread E put 17 Jeff owns a $1,000 face value bond He can exchange that bond for 25 shares of KNJ stock at any time within the next years What type of bond does Jeff own? A secured B warranted C convertible D junk E callable 18 The dollar amount of a bond's par value that is exchangeable for one share of stock is called the: A conversion premium B par value C conversion value D conversion price E conversion ratio 19 Alicia owns a $1,000 face value bond that can be converted into 20 shares of AB Limited stock Which one of the following terms refers to these 20 shares? A conversion premium B straight bond value C conversion value D conversion price E conversion ratio 20 The difference between the conversion price and the current stock price, divided by the current stock price, is called the: A conversion premium B straight bond value C conversion value D conversion price E conversion ratio 21 Latetia owns a convertible bond Which one of the following terms would describe the value of this bond if it were not convertible? A conversion premium B straight bond value C conversion value D inverted value E market value 22 Brad owns a convertible bond Which one of the following terms would apply to the value of this bond if he were to convert it into shares of stock today? A conversion premium B straight bond value C conversion value D inverted value E prescribed value 23 Which one of the following statements correctly describes your situation as the holder of a European call option? A You are obligated to buy if the option is exercised B You have a right to sell C You have a right to buy but only on the expiration date D You are obligated to sell if the option is exercised E You have a right to buy at any time before the option expires 24 Julie opted to exercise her August option on June 20th and as a result received $2,500 for the sale of her shares Which one of the following did Julie own? A warrant B American call C American put D European call E European put 25 Josh opted to exercise his January option at the end of December and paid $3,250 at that time to acquire 100 shares of stock Which one of the following did Josh own? A American call B American put C European call D European put E European convertible bond 26 Steve owns an option which grants him the right to purchase shares of Lokier Tool stock at a price of $45 a share Currently, the stock is selling for $52.40 a share Steve would like to realize his profits but is not permitted to exercise the option for another two weeks Which one of the following does Steve own? A straight bond B American call C American put D European call E European put 27 What is the primary difference between an American call option and a European call option? A The American call has a fixed strike price while the European strike price varies over time B An American call is a right to buy while a European call is an obligation to buy C An American call has an expiration date while the European call does not D An American call is written on 100 shares of the underlying security while the European call covers 1,000 shares E An American call an be exercised at any time up to the expiration date while the European call can only be exercised on the expiration date 28 You own a July $15 call on ABC stock Assume today is April 20 and the call has zero intrinsic value Which one of the following best describes this option? A worthless B unfunded C expired D in-the-money E out-of-the-money 29 A $20 put option on Wildwood stock expires today The current price of the stock is $18.50 Which one of the following best describes this option? A funded B unfunded C at-the-money D in-the-money E out-of-the-money 30 Which one of the following describes the maximum value of a call option? A strike price minus the initial cost of the option B exercise price plus the price of the underlying stock C strike price D market price of the underlying stock E purchase price 31 Which one of the following describes the lower bound of a call's value? A strike price or zero, whichever is greater B stock price minus the exercise price or zero, whichever is greater C strike price or the stock price, whichever is lower D strike price or zero, whichever is lower E stock price minus the exercise price or zero, whichever is lower 32 Which one of the following describes the intrinsic value of a call option? A the call's upper bound value B the call's lower bound value C market price of the underlying security D zero, if the call is in-the-money E negative amount, if the call is out-of-the-money 33 Which one of the following describes the intrinsic value of a put option? A lesser of the strike price or the stock price B lesser of the stock price minus the exercise price or zero C lesser of the stock price or zero D greater of the strike price minus the stock price or zero E greater of the stock price minus the exercise price or zero 34 Which one of the following statements is correct? A The value of a call decreases as the price of the underlying stock increases B The value of a call increases as the exercise price decreases C The value of a put increases as the price of the underlying stock increases D The value of a put decreases as the exercise price increases E The intrinsic value of a put must be zero on the expiration date 35 An increase in which of the following will increase the value of a call? I time to expiration II underlying stock price III risk-free rate of return IV price volatility of the underlying stock A I and III only B II, III, and IV only C I, III, and IV only D I, II, and III only E I, II, III, and IV 36 Which of the following will decrease the value of a call option? I a decrease in the exercise price II a decrease in the value of the underlying security III an increase in the risk-free rate IV an increase in the time to expiration A II only B I and II only C III and IV only D I, II, and IV only E I, II, and III only 37 Mark owns both a March $20 put and a March $20 call on Alpha stock Which one of the following statements correctly relates to Mark's position? Ignore taxes and transaction costs A A price decrease in Alpha stock will increase the value of Mark's call option B A March $30 call is worth more than Mark's $20 call C The time premium on an April $20 put is less than the time premium on Mark's put (Assume both puts expire in the same calendar year.) D A price increase in Alpha stock from $26 to $28 will increase the value of Mark's put E If the intrinsic value of Mark's put increases by $1 then the intrinsic value of his call must either decrease by $1 or equal zero 38 Travis owns both a September $30 call and a September $30 put If the call finishes at-the-money, then the put will: A also finish in-the-money B finish at-the-money C finish out-of-the-money D either finish at-the-money or in-the-money E either finish at-the-money or out-of-the-money 39 Which one of the following statements regarding employee stock options (ESOs) is correct? A ESOs grant an employee the right to buy a fixed number of shares of company stock at the market price B Employees must exercise their ESOs prior to those ESOs becoming vested C Employees may forfeit their ESOs if they terminate their employment with the issuing firm D If a firm issue ESOs it must make them available to all employees E Employees can sell their ESOs if they not want to personally exercise them 40 Employee stock options are primarily designed to which one of the following? A provide employees with put options on their shares of company stock B provide an immediately vested benefit to key employees C influence the actions and priorities of employees D distribute excess cash to key employees to avoid corporate taxation E provide an immediate capital gain to certain employees 41 Employee stock options: A usually have a positive intrinsic value when issued B must be backdated at least six months to comply with Sarbanes-Oxley C are generally "underwater" when issued D are frequently repriced if the options are in-the-money E are generally issued with a zero intrinsic value 42 The Sarbanes-Oxley Act of 2002 requires firms to report ESO grants within how many days of the grant? A calendar days B business days C calendar days D 30 business days E 45 calendar days 43 Delta Importers has a pure discount loan with a face value of $180,000 due in one year The assets of the firm are currently worth $265,000 The shareholders in this firm basically own a _ option on the assets of the firm with a strike price of _ A put; $180,000 B put; $265,000 C warrant; $265,000 D call; $180,000 E call; $265,000 44 Jack and Jill are house hunting They find House A situated on a hill They really like the house but want to continue searching the market for one more week before making their final decision to buy the house To avoid having someone else purchase House A while they continue their house hunting, they decide to place a $2,500 deposit on House A This deposit will apply to the purchase price if they buy House A If they not buy House A, they will forfeit the $2,500 Essentially, Jack and Jill have a _ on House A A financial put B financial call C warrant D real put E real call 45 The option to wait: I may be of minimal value if a project is dependent upon rapidly changing technology II is partially dependent upon the discount rate applied to the project being evaluated III is defined as temporarily shutting down a project for a period of time IV has a value equal to the NPV of a project if it is started at a later date minus the NPV if the project is started today A I and III only B II and IV only C I and II only D II, III, and IV only E I, II, and IV only 46 Ignoring which of the following will cause the NPV of a project to be underestimated? I option to abandon II option to expand III option to wait IV option to contract A I and III only B II, III, and IV only C I, II, and III only D I, III, and IV only E I, II, III, and IV 47 Which one of the following is an example of a strategic option for a restaurant? A.opening a new restaurant with a different look and an entirely different menu to see if that type of restaurant appeals to the public B deciding to close one hour earlier during the winter months due to slow sales C abandoning a menu item based on customer complaints D deciding to open only two new locations next year instead of the five that were originally scheduled E deciding to create separate lunch and dinner menus rather than have them combined on one menu 48 Last month, Hill Side Markets introduced a new board game Consumer demand has been overwhelming and appears that strong demand will exist over the long-term as young children absolutely love the game Given this, which one of the following options should Hill Side Markets consider in respect to this game? A suspension B expansion C abandonment D contraction E withdrawal 49 Three months ago, Toy Town introduced a new toy for pre-school children The store expected this toy to be an instant success and a fast moving item To their surprise, children have zero interest in this toy so sales have been abysmal Which one of the following options should Toy Town consider in respect to this toy? A suspension B expansion C abandonment D contraction E re-introduction 50 Which of the following are managerial options once a project is commenced? I modifying the production process II re-pricing the product III revising the marketing plan IV modifying the product's color and shape A I and II only B III and IV only C I, II, and III only D II, III, and IV only E I, II, III, and IV 51 Which one of the following statements related to warrants is correct? A Warrants are generally issued as an attachment to publicly-issued bonds B Warrants are excluded from trading on an organized exchange C Warrants are structured as long-term put options D Warrants are issued by individual investors E Warrants are generally added as an incentive to a private debt issue 52 Which of the following statements are correct concerning warrants? I Warrants are similar to put options II Warrants are similar to call options III When a warrant is exercised, the issuer is not involved in the transaction IV When a warrant is exercised, the issuer must issue new shares of stock A I only B II only C I and III only D II and IV only E I and IV only 53 When warrants are exercised, the: A earnings per share decrease B earnings per share remain constant C total equity in a firm remains constant D total equity in a firm decreases E number of bonds outstanding increases 54 Which of the following statements are correct concerning convertible bonds? I New shares of stock are issued when a convertible bond is converted II A convertible bond is similar to a bond with a call option III A convertible bond should always be worth less than a comparable straight bond IV A convertible bond can be described as having upside potential with downside protection A I and III only B I, II, and IV only C I, II, and III only D I, III, and IV only E II, III, and IV only 55 The conversion value of a convertible bond is equal to which one of the following? A Conversion ratio × Stock price B Conversion ratio × Conversion price C Face value of the bond/Conversion premium D Face value of the bond × (1 + Conversion premium) E Stock price × (1 + Conversion ratio) 56 The maximum value of a convertible bond is theoretically: A equal to the conversion value minus the straight bond value B equal to the face value of the bond multiplied by (1 + Conversion price) C limited to the maximum straight bond value D limited by the face value of the bond E unlimited 57 What is the cost of two November $25 put option contracts on Dove stock given the following price quotes? A $0.15 B $0.30 C $1.50 D $15.00 E $30.00 58 What is the value of five August $25 call contracts on Dove stock? A $34 B $68 C $340 D $680 E $3,400 59 What is the intrinsic value of the November $25 call on Dove stock? A -$0.98 B $0 C $0.15 D $6.12 E $7.10 60 You purchased six call option contracts on ABC stock with a strike price of $32.50 when the option was quoted at $1.80 The option expires today when the value of ABC stock is $34.60 Ignoring trading costs and taxes, what is the net profit or loss on this investment? A $0 B $180 C $210 D $840 E $1,260 61 You sold one call option contract with a strike price of $55 when the option was quoted at $0.80 The option expires today when the value of the underlying stock is $53.70 Ignoring trading costs and taxes, what is the net profit or loss on this investment? A -$250 B -$80 C $0 D $50 E $80 62 You sold three $35 call option contracts at a quoted price of $1.40 What is your net profit or loss on this investment if the price of the underlying asset is $36.70 on the option expiration date? A -$510 B -$90 C $90 D $510 E $930 63 You wrote eight call option contracts with a strike price of $42.50 at a call price of $1.35 per share What is your net gain or loss on this investment if the price of the underlying stock is $40.30 per share on the option expiration date? A -$2,840 B -$1,760 C -$1,080 D $1,080 E $1,760 64 The market price of Southern Press stock has been relatively volatile and you think this volatility will continue for a couple more months Thus, you decide to purchase a two-month European call option on this stock with a strike price of $45 and an option price of $2.20 You also purchase a two-month European put option on the stock with a strike price of $45 and an option price of $0.30 What will be your net profit or loss on these option positions if the stock price is $48 on the day the options expire? Ignore trading costs and taxes A -$30 B $50 C $80 D $270 E $330 65 Several rumors concerning Value Rite stock are causing the market price of the stock to be quite volatile Given this situation, you decide to buy both a one-month European $25 put and a one-month European $25 call on this stock The call price per share is $0.60 and the put price per share is $2.10 What will be your net profit or loss on these option positions if the stock price is $18 on the day the options expire? Ignore trading costs and taxes A -$210 B -$150 C -$60 D $430 E $490 66 Three months ago, Central Supply stock was selling for $51.40 a share At that time, you purchased five put options on the stock with a strike price of $50 per share and an option price of $0.60 per share The option expires today when the value of the stock is $42.70 per share What is your net profit or loss on this investment? Ignore trading costs and taxes A -$1,300 B -$1,000 C -$300 D $3,350 E $3,650 67 You wrote two put options on Xylo stock with an exercise price of $30 per share and an option price of $1.05 per share Today, the contracts expire and the stock is selling for $31.15 a share What is your net profit or loss on this investment? Ignore trading costs and taxes A -$115 B -$105 C $20 D $105 E $210 68 You sold ten put contracts on Cross Town Bank stock at an option price per share of $0.85 The options have an exercise price of $37.50 per share The options were exercised today when the stock price was $34 a share What is your net profit or loss on this investment assuming that you closed out your positions at a stock price of $34? Ignore transaction costs and taxes A -$3,500 B -$2,650 C $1,800 D $850 E $3,500 69 You own eight call option contracts on Swift Water Tours stock with a strike price of $15 When you purchased the shares the option price was $0.30 and the stock price was $15.25 What is the total intrinsic value of these options if the stock is currently selling for $16.08 a share? A -$83 B -$1.08 C $0 D $108 E $864 70 You recently purchased three put option contracts on Guillepsi stock with an exercise price of $42.50 What is the total intrinsic value of these contracts if the stock is currently selling for $43.70 a share? A -$360 B -$120 C $0 D $120 E $360 71 Last week, you purchased a call option on Edgewater stock with a strike price of $40 The stock price was $39.80 and the option price was $0.45 at that time What is the intrinsic value per share if the stock is currently priced at $39.10? A -$90 B -$70 C $0 D $70 E $90 72 Three weeks ago, you purchased a June $30 put option on Leeper Metals stock at an option price of $1.80 The market price of the stock three weeks ago was $30.60 Today, the stock is selling at $29.80 a share What is the intrinsic value of your put contract? A -$100 B -$20 C $0 D $20 E $60 73 This morning, you purchased a call option on Schoolhouse Supply Co stock that expires in one year The exercise price is $40 The current price of the stock is $43.40 and the risk-free rate of return is 3.6 percent Assume the option will finish in the money What is the current value of the call option? A $0 B $1.49 C $3.97 D $4.79 E $5.46 74 You currently own a one-year call option on Rail Company, Inc., stock The current stock price is $51.80 and the risk-free rate of return is 4.25 percent Your option has a strike price of $50 and you assume the option will finish in the money What is the current value of your call option? A $1.20 B $2.59 C $3.84 D $5.13 E $7.27 75 The common stock of Hazelton Refiners is selling for $72.30 a share U.S Treasury bills are currently yielding 4.8 percent What is the current value of a one-year call option on this stock if the exercise price is $70 and you assume the option will finish in the money? A $0 B $1.20 C $3.00 D $4.20 E $5.51 76 The common stock of Westover Foods is currently priced at $27.90 a share One year from now, the stock price is expected to be either $25 or $30 a share The risk-free rate of return is 4.2 percent What is the current value of one call option on this stock if the exercise price is $27.50? A $0 B $1.95 C $2.00 D $3.80 E $4.00 77 You own one call option with an exercise price of $40 on S'more Good stock The stock is currently selling for $41 a share but is expected to sell for either $37 or $43 a share in one year The risk-free rate of return is 4.25 percent and the inflation rate is 3.6 percent What is the current call option price if the option expires one year from now? A $0.55 B $0.69 C $1.37 D $2.43 E $2.75 78 The assets of Uptown Stores are currently worth $136,400 These assets are expected to be worth either $120,000 or $150,000 one year from now The company has a pure discount bond outstanding with a $130,000 face value and a maturity date of one year The risk-free rate is 4.3 percent What is the value of the equity in this firm? A $11,920 B $14,232 C $19,507 D $21,347 E $26,408 79 Electronic Importers has a pure discount bond with a face value of $25,000 that matures in one year The risk-free rate of return is 3.8 percent The assets of the business are expected to be worth either $23,000 or $35,000 in one year Currently, these assets are worth $27,500 What is the current value of the bond? A $17,746 B $19,207 C $20,222 D $22,549 E $23,048 80 The Glass House has total assets currently valued at $17,200 These assets are expected to increase in value to either $18,000 or $21,000 by next year The company has a pure discount bond outstanding with a face value of $20,000 This bond matures in one year Currently, U.S Treasury bills are yielding 5.4 percent What is the value of the equity in this firm? A -$3,000.00 B -$908.00 C $0 D $40.73 E $122.20 81 You are considering a project that has been assigned a discount rate of 14 percent If you start the project today, you will incur an initial cost of $8,500 and will receive cash inflows of $5,550 a year for two years If you wait one year to start the project, the initial cost will rise to $9,200 and the cash flows will increase to $5,800 a year for two years What is the value of the option to wait? A -$331.40 B -$194.46 C $228.51 D $230.49 E $334.68 82 Southern Shores is considering a project that has an initial cost today of $12,500 The project has a twoyear life with cash inflows of $7,500 a year Should the firm opt to wait one year to commence this project, the initial cost will increase by percent and the cash inflows will increase to $8,500 a year What is the value of the option to wait if the applicable discount rate is 14 percent? A $614.52 B $721.56 C $914.62 D $982.67 E $1,021.66 83 Western Industrial Products is considering a project with a four-year life and an initial cost of $212,000 The discount rate for the project is 16 percent The firm expects to sell 9,600 units on the last day of each year The cash flow per unit is $50 The firm will have the option to abandon this project at the end of year one (after year one's sales) at which time the project's assets could be sold for an estimated $125,000 The firm should abandon the project at the end of year one if the expected level of annual sales, starting with year 2, falls to _ units or less Ignore taxes A 1,113 units B 1,267 units C 1,922 units D 2,034 units E 2,108 units 84 Dressler Technologies is considering a project with a 3-year life and an initial cost of $85,000 The discount rate for the project is 14.5 percent The firm expects to sell 1,200 units on the last day of each year The cash flow per unit is $32 The firm will have the option to abandon this project at the end two years (after year sales) at which time the project's assets could be sold for an estimated $30,000 The firm's managers are interested in knowing how the project will perform if the sales forecast for year of the project is revised such that there is a 50/50 chance that the sales will be either 1,000 or 1,400 units a year What is the net present value of this project at time zero given the current sales forecasts? A -$3,474 B -$2,526 C $4,191 D $6,192 E $6,887 85 Patience is reviewing a project with projected sales of 4,200 units a year, a cash flow of $28 a unit, and a four-year project life Assume all operating cash flows occur on the last day of each year The initial cost of the project is $247,000 The relevant discount rate is 13 percent Patience has the option to abandon the project after two years at which time she feels she could sell the project's assets for $110,000 At what level of annual sales, starting in year 3, should she be willing to abandon this project? A 2,119 units B 2,355 units C 2,367 units D 2,516 units E 2,667 units 86 You own a convertible bond with a face value of $1,000 and a market value of $1,034 The bond can be converted into 14 shares of stock What is the conversion price? A $71.43 B $72.00 C $72.67 D $73.86 E $74.33 87 You own nine convertible bonds These bonds have a percent coupon, a $1,000 face value, and mature in years The bonds are convertible into shares of common stock at a conversion price of $25 How many shares of stock will you receive if you convert all of your bonds? A 285 B 300 C 350 D 360 E 400 88 A convertible bond has a face value of $5,000 and a conversion price of $80 The bond has a percent coupon, pays interest semi-annually, and matures in 12 years Similar bonds are yielding 7.5 percent The current price of the stock is $41.20 per share What is the conversion value of this bond? A $1,680 B $2,415 C $2,575 D $4,651 E $5,000 89 A convertible bond has a face value of $1,000 and a conversion price of $12.50 The bond has a percent coupon, pays interest semi-annually, and matures in 12 years Similar bonds are yielding percent The current price of the stock is $13.40 per share What is the straight bond value? A $782.57 B $781.82 C $827.74 D $832.09 E $843.47 90 Kurt owns a convertible bond that matures in three years The bond has a 7.5 percent coupon and pays interest semi-annually The face value of the bond is $1,000 and the conversion price is $25 Similar bonds have a market return of 9.25 percent The current price of the stock is $26.50 per share What is the straight bond value? A $948.20 B $955.05 C $972.80 D $987.78 E $991.15 91 Lucinda owns a convertible bond that matures in six years The bond has a percent coupon and pays interest annually The face value of the bond is $1,000 and the conversion price is $22 Similar bonds have a market return of 8.75 percent The current price of the stock is $21.60 per share What is the conversion value of this bond? A $835.60 B $848.40 C $942.11 D $981.82 E $1,000.00 92 Circle Stores stock is priced at $28 a share A $40 call on this stock has five months until expiration and a call price of $0.15 Why would an investor purchase a call that is so far out of the money? 93 What are the basic similarities and basic differences between warrants and call options? 94 What are the upper and lower bounds for an American call option? Explain what would happen in each case if the bound was violated 95 Explain the rationale behind the idea that equity is a call option on a firm's assets When would a shareholder allow this call to expire? 96 Call options are frequently attached to bonds, making them callable at the option of the issuer Consider a firm that just issued two sets of bonds: One is callable, has a percent coupon rate, 15 years to maturity, and cannot be called during the first three years; the second is noncallable, has a percent coupon rate, 15 years to maturity, and is identical to the first bond in every way except for the call option Suppose the noncallable bonds are sold for $1,000 each Will the callable bonds sell for more or less than $1,000? Who "purchases" the option in this case and who "sells" it? 97 Explain how the floor and the ceiling prices for a convertible bond are determined 98 T-bills currently yield 6.3 percent Stock in Pinta Manufacturing is currently selling for $46 per share There is no possibility that the stock will be worth less than $39 per share in one year What is the value of a call option on this stock if the exercise price is $22 per share? A $21.40 B $22.00 C $24.00 D $25.30 E $25.70 99 The price of Time Squared Corp stock will be either $80 or $95 at the end of the year Call options are available with one year to expiration T-bills currently yield percent and the current price of Time Squared Corp stock is $85 What is the value of a call option if the exercise price is $75 per share? A $14.25 B $15.06 C $18.78 D $24.25 E $25.06 100.The price of Dimension, Inc stock will be either $65 or $85 at the end of the year Call options are available with one year to expiration T-bills currently yield percent Suppose the current price of Dimension stock is $70 What is the value of the call option if the exercise price is $70 per share? A $6.07 B $8.48 C $11.58 D $15.39 E $17.62 101.Rackin Pinion Corporation's assets are currently worth $1,260 In one year, they will be worth either $1,200 of $1,610 The risk-free interest rate is percent Suppose Rackin Pinion has an outstanding debt issue with a face value of $1,200 What is the current value of the firm's debt? A $60.00 B $114.14 C $1,142.86 D $1,263.19 E $1,504.20 102.Buckeye Industries has a bond issue with a face value of $1,000 that is coming due in one year The value of Buckeye's assets is currently $1,200 Jim Tressell, the CEO, believes that the assets in the firm will be worth either $600 or $1,700 in a year The going rate on one-year T-bills is percent What is the current value of the firm's debt? A $601.18 B $796.57 C $844.24 D $878.78 E $911.03 103.A $1,000 convertible debenture has a conversion price for common stock of $85 per share The common stock is selling at $92 a share What is the conversion value of this bond? A $920.00 B $923.91 C $1,000.00 D $1,082.35 E $1,092.00 104.A bond with 10 detachable warrants has just been offered for sale at $1,000 The bond matures in 15 years and has an annual coupon of $80 Each warrant gives the owner the right to purchase two shares of stock in the company at $14 per share Ordinary bonds (with no warrants) of similar quality are priced to yield 11 percent What is the value of one warrant? A $7.00 B $13.58 C $14.00 D $16.67 E $21.57 105.Your company is deciding when to invest in a new machine The new machine will increase cash flow by $240,000 per year You believe the technology used in the machine has a 10-year life; in other words, no matter when you purchase the machine, it will be obsolete 10 years from today The machine is currently priced at $1,200,000 The cost of the machine will decline by $120,000 per year until it reaches $720,000, where it will remain Your required return is percent In which year should you purchase the machine? A Year B Year C Year D Year E Year 106.We are examining a new project We expect to sell 9,000 units per year at $45 net cash flow apiece for the next 20 years In other words, the annual operating cash flow is projected to be $45 × 9,000 = $405,000 The relevant discount rate is 14 percent, and the initial investment required is $1,730,000 After the first year, the project can be dismantled and sold for $1,350,000 If expected sales are revised based on the first year's performance, it would make sense to abandon the investment if the sales are less than which of the following number of units? A 4,580 units B 4,620 units C 4,750 units D 4,810 units E 5,020 units 107.We are examining a new project We expect to sell 8,000 units per year at $80 net cash flow apiece for the next 15 years In other words, the annual operating cash flow is projected to be $80 × 8,000 = $640,000 The relevant discount rate is 16 percent, and the initial investment required is $2,740,000 The project can be dismantled after the first year and sold for $2,130,000 Suppose you think it is likely that expected sales will be revised upward to 9,600 units if the first year is a success and revised downward to 3,000 units if the first year is not a success Suppose the scale of the project can be doubled in one year in the sense that twice as many units can be produced and sold Naturally, expansion would be desirable only if the project is a success This implies that if the project is a success, projected sales after expansion will be 19,200 Assume that success and failure are equally likely Note that abandonment is still an option if the project is a failure What is the value of the option to expand? A $1,774,328 B $1,809,941 C $1,828,406 D $1,848,920 E $1,872,312 24 Key A C C D E A B A E 10 A 11 D 12 E 13 D 14 B 15 B 16 B 17 C 18 D 19 E 20 A 21 B 22 C 23 C 24 C 25 A 26 D 27 E 28 E 29 D 30 D 31 B 32 B 33 D 34 B 35 E 36 A 37 E 38 B 39 C 40 C 41 E 42 B 43 D 44 E 45 E 46 E 47 A 48 B 49 C 50 E 51 E 52 D 53 A 54 B 55 A 56 E 57 E 58 E 59 D 60 B 61 E 62 B 63 D 64 B 65 D 66 D 67 E 68 B 69 E 70 C 71 C 72 D 73 D 74 C 75 E 76 B 77 E 78 B 79 E 80 D 81 A 82 C 83 A 84 C 85 B 86 A 87 D 88 C 89 A 90 B 91 D Feedback: Refer to section 24.3 92 Students should discuss the impact of time to maturity on option values They should point out that with five months left to maturity, there is a chance that the option could finish in the money, especially if the stock price is volatile A low option price per share such as $0.15, means that an investment in an option contract will be quite inexpensive However, investors apparently don't have a strong feeling the stock will reach $40 by share by the expiration date, or the option price would be much higher Feedback: Refer to section 24.7 93 Both warrants and call options grant their owners the right to purchase shares of stock at a prespecified price Warrants are issued by corporations while call options are issued by investors Warrants are usually attached to privately placed loans or bonds Warrants can be detached from the debt security and traded separately Call options are traded separately from the underlying stock Feedback: Refer to section 24.2 94 The upper bound on a call is the stock price If the call price exceeded the stock price, you would be paying more for the option to buy an asset than the asset itself costs The lower bounds are: C ≥ if S - E < and C ≥ (S - E) if (S - E) ≥ In the first case, if the exercise price exceeds the stock price, the call is out of the money and it will either be worthless or have some time value In the second case, if the call is in the money, the call must be worth at least the difference between the asset's value and the exercise price If the call was worth less than this value, rational investors would purchase calls, immediately exercise them, and then sell the stock at the current price, completing an arbitrage Feedback: Refer to section 24.5 95 The analogy only works for leveraged firms At maturity of the firm's debt, the stockholders have the option to either pay the creditors the face value of the debt or turn the firm's assets over to the firm's creditors If the firm's assets are worth less than the face value of the debt, the stockholders will not exercise the call, that is, they will let the creditors have the assets and the firm will be liquidated Feedback: Refer to section 24.7 96 The callable bond will sell for less than par The bond issuer buys the option and the bondholder writes it If the callable bonds sell for $950 each, the call option will be worth the difference between the two bond prices, or $50 per bond Feedback: Refer to section 24.7 97 The floor, or minimum, value of a bond is the bond's straight bond value The ceiling, or maximum, value is theoretically unlimited since there is no upper limit on a bond's conversion value 98 D 99 A 100 A 101 C 102 B 103 D 104 E 105 A 106 A 107 B 24 Summary Category AACSB: Analytic AACSB: N/A AACSB: Reflective thinking Difficulty: Basic Difficulty: Challenge Difficulty: Intermediate EOC #: 24-1 EOC #: 24-12 EOC #: 24-13 EOC #: 24-14 EOC #: 24-16 EOC #: 24-4 EOC #: 24-5 EOC #: 24-7 EOC #: 24-8 EOC #: 24-9 Learning Objective: 24-1 Learning Objective: 24-1 and 24-6 Learning Objective: 24-2 Learning Objective: 24-3 Learning Objective: 24-4 Learning Objective: 24-5 Learning Objective: 24-6 Ross - Chapter 24 Section: 24.1 Section: 24.2 Section: 24.3 Section: 24.4 Section: 24.5 Section: 24.6 Section: 24.7 Topic: Abandonment and expansion Topic: Abandonment value Topic: American option Topic: Call intrinsic value Topic: Call lower bound Topic: Call option Topic: Call payoff Topic: Call upper bound Topic: Call value Topic: Callable bonds Topic: Contingency planning Topic: Conversion premium Topic: Conversion price Topic: Conversion ratio Topic: Conversion value Topic: Convertible bonds Topic: Employee stock option Topic: Equity as a call option Topic: Equity as an option Topic: ESO backdating Topic: European option Topic: Exercising the option # of Questions 45 56 101 1 1 1 1 1 27 24 20 23 107 25 21 5 20 24 1 1 1 1 11 Topic: Expiration date Topic: Factors affecting option values Topic: Intrinsic value Topic: Investment timing decision Topic: Managerial options Topic: Option Topic: Option payoffs Topic: Option pricing bounds Topic: Option quotes Topic: Option to abandon Topic: Option to expand Topic: Option to wait Topic: Option value Topic: Put intrinsic value Topic: Put option Topic: Put payoff Topic: Put value Topic: Real options Topic: Straight bond value Topic: Strategic options Topic: Strike price Topic: Warrant values Topic: Warrants Topic: Warrants, calls, and convertibles 3 4 1 2 1