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# Currency conversions, exchange rates, bond coupon, hedging,

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If one Swiss franc can purchase \$0.85 U.S. dollars, how many Swiss francs can one U.S. dollar buy?

1.2588

1.1765

1.3647

1.2471

1.0824

Suppose 90-day investments in Britain have a 6% annualized return and a 1.5% quarterly (90-day) return. In the U.S., 90-day investments of similar risk have a 4% annualized return and a 1% quarterly (90-day) return. In the 90-day forward market, 1 British pound equals \$1.50. If interest rate parity holds, what is the spot exchange rate (\$/£)?

\$1.5074

\$1.4019

\$1.4924

\$1.5376

\$1.7185

Its investment bankers have told Donner Corporation that it can issue a 25-year, 8.1% annual payment bond at par. They also stated that the company can sell an issue of annual payment preferred stock to corporate investors who are in the 40% tax bracket. The corporate investors require an after-tax return on the preferred that exceeds their after-tax return on the bonds by 2.25%, which would represent an after-tax risk premium. What coupon rate must be set on the preferred in order to issue it at par?

10.10%

6.06%

8.08%

8.56%

9.61%

Suppose DeGraw Corporation, a U.S. exporter, sold a solar heating station to a Japanese customer at a price of 139.0 million yen, when the exchange rate was 140 yen per dollar. In order to close the sale, DeGraw agreed to make the bill payable in yen, thus agreeing to take some exchange rate risk for the transaction. The terms were net 6 months. If the yen fell against the dollar such that one dollar would buy 154.4 yen when the invoice was paid, what dollar amount would DeGraw actually receive after it exchanged yen for U.S. dollars?

\$900,259.07

\$711,204.66

\$1,008,290.16

\$954,274.61

\$702,202.07

Stover Corporation, a U.S. based importer, makes a purchase of crystal glassware from a firm in Switzerland for 39,960 Swiss francs, or \$24,000, at the spot rate of 1.665 francs per dollar. The terms of the purchase are net 90 days, and the U.S. firm wants to cover this trade payable with a forward market hedge to eliminate its exchange rate risk. Suppose the firm completes a forward hedge at the 90-day forward rate of 1.682 francs. If the spot rate in 90 days is actually 1.665 francs, how much will the U.S. firm have saved or lost in U.S. dollars by hedging its exchange rate exposure?

\$242.57

\$259.55

\$208.61

\$213.46

\$269.25

Atlas Anglers Inc. is considering issuing a 15-year convertible bond that will be priced at its \$1,000 par value. The bonds have a 6.5% annual coupon rate, and each bond can be converted into 20 shares of common stock. The stock currently sells at \$30 a share, has an expected dividend in the coming year of \$3, and has an expected constant growth rate of 5.5%. What is the estimated floor price of the convertible at the end of Year 3 if the required rate of return on a similar straight-debt issue is 9.5%?

\$758.87

\$664.01

\$695.63

\$790.48

\$806.29

Suppose the exchange rate between U.S. dollars and Swiss francs is SF 1.41 = \$1.00, and the exchange rate between the U.S. dollar and the euro is \$1.00 = 0.50 euros. What is the cross rate of Swiss francs to euros?

2.9046

3.0738

2.8200

2.3970

3.1584

A 6-month put option on Smith Corp.'s stock has a strike price of \$47.50 and sells in the market for \$8.90. Smith's current stock price is \$41. What is the option premium?

\$2.20

\$2.40

\$2.55

\$2.35

\$2.70

Herring Inc. is considering issuing 15-year, 7.5% semiannual coupon, \$1,000 face value convertible bonds at a price of \$1,000 each. Each bond would be convertible into 25 shares of common stock. If the bonds were not convertible, investors would require an annual nominal yield of 10%. What is the straight-debt value of the bond at the time of issue?

\$904.79

\$613.96

\$694.75

\$912.86

\$807.84

Which of the following statements is most CORRECT?

The high value of the U.S. dollar relative to Japanese and European currencies in the 1980s, made U.S. companies comparatively inexpensive to foreign buyers, spurring many mergers.

During the 1980s, the Reagan and Bush administrations tried to foster greater competition and they were adamant about preventing the loss of competition; thus, most large mergers were disallowed.

The expansion of the junk bond market made debt more freely available for large acquisitions and LBOs in the 1980s, and thus, it resulted in an increased level of merger activity.

Increased nationalization of business and a desire to scale down and focus on producing in one's home country virtually halted cross-border mergers in the 1980s.

Because strategic alliances and joint ventures are easy to form and enable firms to compete better in the global economy than would mergers, merger activity has virtually come to a halt in the 21st century.
From the lessee viewpoint, the riskiness of the cash flows, with the possible exception of the residual value, is about the same as the riskiness of the lessee's

equity cash flows.

capital budgeting project cash flows.

debt cash flows.

pension fund cash flows.

sales.

Curry Corporation is setting the terms on a new issue of bonds with warrants. The bonds will have a 30-year maturity and annual interest payments. Each bond will come with 20 warrants that give the holder the right to purchase one share of stock per warrant. The investment bankers estimate that each warrant will have a value of \$10.50. A similar straight-debt issue would require a 10% coupon. What coupon rate should be set on the bonds-with-warrants so that the package would sell for \$1,000?

7.77%

7.62%

6.84%

6.53%

6.14%

A currency trader observes the following quotes in the spot market:
1 U.S. dollar = 1.21 Japanese yen
1 British pound = 2.25 Swiss francs
1 British pound = 1.65 U.S. dollars

Given this information, how many yen can be purchased for 1 Swiss franc?

1.0471

1.0382

0.8873

0.9494

0.683

#### Solution Summary

The solution answers multiple choice question related to Currency conversions, exchange rates, bond coupon, hedging, option.

\$2.19

## Finance

1. Which, if any, of the following statements are false?

A. Market interest rates and bond prices vary inversely.
B. For a given absolute change in interest rates from the same base level, the proportionate increase in bond prices when rates fall is smaller than the proportionate decrease in bond prices when rates rise.
C. For identical coupon rates and a given absolute change in interest rates from the same base level, long-term bonds change proportionately more in price than short-term bonds.
D. For identical maturities and a given absolute change in interest rates from the same base level, low-coupon bonds change proportionately less in price than high-coupon bonds.

2 What is the duration of a six-year, 4.5 percent coupon rate, annual coupon payment, \$1000 par value government bond priced today to yield 4 percent to maturity (use the text formula or Excel's MDuration function)? What is the convexity of this instrument? [Recall that Bonds and Bond Prpoerties.xls illustrates the duration and convexity calculations.] Using one of the following approximation formulas with yield data in decimal form,

[if text formula] % Change in Price * 100 * (-1.0 * Duration * (YieldNew-YieldOld)/(1+YieldOld)),
[if Excel function] % Change in Price * 100 * (-1.0 * MDuration * (YieldNew-YieldOld)),

what is the approximate percentage change in this bond's price if yields on comparable securities rise to 5 percent? What is the actual percentage change in this bond's price if yields on comparable securities rise to 5 percent (use a financial calculator or Excel's PV function)?

3. Consider the dividend discount model, the capital asset pricing model, the arbitrage pricing model and the firm valuation model. If these accurately portray the intrinsic values of stock prices and stock returns, then what is the corresponding fundamental relationship between stock prices and interest rates? Explain your answers.

PART II

1. Suppose the Federal Reserve sells government securities from its existing holdings to the financial sector and the non-bank public. Trace through the expected consequences of this secondary market action on the banking system - reserves, loanable and investable funds, and deposits; financial markets - bond and stock prices, and interest rates; inflationary pressures; credit-sensitive spending; and the general state of the economy as measured by real GDP (or real income) and unemployment.

2. Deficit spending at the Federal level involves increased government purchases or reduced net taxation with new bonds issued by the US Treasury. The Federal Reserve must sell these new bonds to the public. It can do so without adjusting its own policies or, by combining this sale with open market purchases, it can, in effect, monetize the debt. What are the consequences for interest rates, spending financed by private borrowing, the money supply, the bond supply and inflation from each of these two options for dealing with new Treasury issues? In the second case for simplicity, assume the open market purchase matches in value the auction and sale of new Treasury securities.

PART III
1. The portfolio managers of a bank determined that over the next year interest-sensitive assets are in the amount of \$1.1 billion while interest-sensitive liabilities are in the amount of \$1.5 billion. Moreover, when considering all of the bank's financial assets and liabilities, they determined that the average duration of assets is 3.6 years while the average duration of liabilities (adjusted for net worth) is 2.5 years. Considering your text's discussion in Chapter 19 of a firm's GAP and Duration GAP (DGAP), what is the interest rate risk facing this institution for net income and market value? Consider and discuss each by thinking about what happens to net interest income and relative asset prices (market values) as interest rates rise or fall. What strategies could management employ to hedge against this risk by buying or selling futures, call options or put options (that is, for each derivative, should they buy or sell?)?

2. Suppose you believe that D's stock price is going to decline from its current level sometime during the next 6 months. Suppose you buy a 6-month put option on D's stock for \$200. This put option gives you the right to sell 100 shares of D's stock at an exercise price of \$45 per share. What is the most you could lose in this purchase, at what price for D's stock would you break even by exercising this option and how much would you make if D's stock fell to \$42 per share?

3. A U.S. importer makes a purchase from a German firm in the amount of 27,200 Euros. At the current spot rate of 0.85 Euros per dollar, how much is this purchase in U.S. dollars? Next, consider that this U.S firm will not have to pay the German firm for 90 days and that the U.S. firm is concerned that the dollar might weaken over this 90-day period. Suppose the U.S. firm completes a forward hedge at the 90-day forward rate of 0.85 Euros per dollar (that is, the 90-day forward rate currently is the same as the spot rate). If in 90 days the dollar weakens so that the spot rate is 0.80 Euros per dollar, how much of a loss (in dollars) will the U.S. firm have avoided by hedging its exchange rate exposure?

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