Deck 15: Financial Engineering and Security Design

Question 1

Albert,Inc.stock is $42.00 per share.The company's quarterly dividend is forecasted as $0.50 per share,increasing 10.0% at the start of every year.What is the price of a zero-coupon equity-linked bond,promising to pay one share in 3 years,given annual interest rates of 8.0%?

A) $32.60
B) $36.20
C) $42.60
D) $62.40

Answer 1

B

Question 2

A commodity linked bond is issued with an embedded call option.The current commodity price is $52,as is the exercise price on the call option.The call option is priced at $5.56.If the promised payment on the bond is the same as the issue price of $40,what is the yield on the bond if effective interest rates are 4.0% and the bond has a 1-year maturity?

A) 2.24%
B) 2.80%
C) 3.50%
D) 4.0%

Answer 2

A

Question 3

A commodity linked bond is issued with an embedded call option.The current commodity price is $110,as is the exercise price on the call option.The call option is priced at $3.41.If the promised payment on the bond is the same as the issue price of $100,what is the implied coupon if effective interest rates are 3.0% and the bond has a 1-year maturity?

A) $0.66
B) $0.77
C) $0.88
D) $0.99

Answer 3

D

Question 4

What possible tax advantage exists in equity-linked notes?

Question 5

Which of the following financially engineered products is NOT used to defer the payment of capital gains taxes on securities that have appreciated?

A) Commodity Linked Options
B) DECS
C) Equity Linked Notes
D) PEPS

Question 6

Assume oil prices rise dramatically and the spot price of oil is $230 per barrel and the 3-year forward price is $245.Annualized 1-year,2-year,and 3 year interest rates are 4.2%,4.4%,and 4.6%,respectively.For a commodity-linked note to sell at par,what is the annual coupon?

A) $6.00
B) $16.00
C) $26.00
D) $36.00

Question 7

Mel,Inc.stock is $135.00 per share.The company's semi-annual dividend is forecasted as $2.10 per share,indefinitely.What is the price of a zero-coupon equity-linked bond,promising to pay one share in 3 years,given annual interest rates of 5.0%?

A) $101.35
B) $110.26
C) $123.45
D) $155.22

Question 8

We wish to cap participation in a 3-year equity-linked option at 50.0% return.Our profit alpha is 3.0%.The S&P 500 price = 950,div = 0.015,σ = 0.22,and interest rates are 4.8%.What is the implied participation rate?

A) 0.66
B) 0.76
C) 0.96
D) 1.16

Question 9

Will,Inc.stock is $63.35 per share.The company's quarterly dividend is forecasted as $0.10 per share,increasing 5.0% every quarter.A coupon equity-linked bond,promising to pay one share of Will,Inc.in 2 years pays a semi-annual coupon of $0.20.If annualized interest rates are 8.0%,what is the price of the bond?

A) $59.55
B) $61.14
C) $63.12
D) $65.22

Question 10

What is the price of a 2-year equity-linked CD under the following terms? No coupon is paid.At maturity the CD pays 80.0% of the S&P 500 index appreciation.The S&P 500 price = 900,div = 0.02,σ = 0.20,and interest rates are 5.0%.

A) $890.22
B) $990.23
C) $1064.20
D) $1110.55

Question 11

Assume the price of Mary,Inc.stock is $56.00,interest rates are 4.8%,div yield = 0,and ?σ = 0.35.What is the price of a $1,000 par value 2-year price-participation note paying a 5.0% annual coupon and receiving 50.0% of all price appreciation above $65.00?

A) $896.44
B) $996.44
C) $1006.44
D) $1106.44

Question 12

Instead of issuing a pure commodity-linked debt,why would the commodity producing firm consider a combining interest plus participation in the commodity price appreciation?

Question 13

What is the primary difference between an equity-linked bond and a currency-linked bond?

Question 14

For whom would the issue of an oil-linked debt instrument not be considered a risky issue?

Question 15

Assume the spot price of gold is $745 per ounce and the 2-year forward price is $773.Annualized 1-year and 2-year forward interest rates are 5.0% and 5.2%,respectively.For a commodity-linked note to sell at par,what is the annual coupon?

A) $23.09
B) $24.09
C) $25.09
D) $26.09

Question 16

Assume the spot price of gold is $750 per ounce,the 1-year forward price is $770,and the annual interest rate is 4.5%.What is the price of a zero-coupon note paying 1 ounce of gold in one year?

A) $770
B) $750
C) $725
D) $736

Question 17

Wayne,Inc.stock is $40.00 per share.The company's quarterly dividend is forecasted as $0.45 per share,indefinitely.A coupon equity-linked bond,promising to pay one share of Wayne,Inc.in 3 years pays a quarterly coupon of $0.50.If annual interest rates are 4.0%,what is the price of the bond?

A) $40.56
B) $42.60
C) $44.56
D) $46.60

Question 18

Dawn,Inc.stock is $37.00 per share.The company's semi-annual dividend is forecasted as $0.25 per share,increasing every 6 months by 20.0%.What is the price of a zero-coupon equity-linked bond,promising to pay one share in 4 years,given annual interest rates of 6.0%?

A) $32.29
B) $33.49
C) $34.39
D) $35.69

Question 19

How does a coupon bond differ from an equity-linked bond?

Question 20

The chapter discusses the merging of debt and options.Ask the class why firms would consider such instruments.Highlight the use of a PERC by a company that has difficulty issuing debt,yet can offer the carrot of price appreciation.