Deck 16: Corporate Applications

Question 1

What three components exist in the value of an "outperform stock option"?

Answer 1

The standard option price,the outperformance feature,and the multiplier.

Question 2

James,Inc.has zero-coupon outstanding debt maturing in 8 years.In rank of seniority,each pays at maturity $20 million,$15 million,and $40 million.Assume asset value = $60 million,?r = 0.05,σ = 0.28,and no dividend is paid.What is the yield on the $15 million subordinate debt?

A) 5.72%
B) 6.72%
C) 7.72%
D) 8.72%

Answer 2

B

Question 3

Why does a company sell a put when issuing compensation options?

Answer 3

The short put acts like a hedge against the repurchasing of shares.

Question 4

We will assume that Nathans,Inc.has 3-year zero-coupon debt outstanding,which will pay $200 at maturity.The assets are valued at $175,σ = 0.20,r = 0.04,and the company does not pay a dividend.Using a Black-Scholes model,what is the value of the equity?

A) $23.05
B) $43.05
C) $63.05
D) $83.05

Question 5

A company issues an option grant with an outperformance feature,against the S&P 500.Assume S&P 500 = 1100,S = 46,k = 45,σ = 0.30,r = 0.04,and 10 years until expiration.The S&P 500 has a dividend yield of 2.5%,standard deviation of 20.0% and a 0.45 correlation coefficient with the stock.What is the value of the outperformance option?

A) $11.92
B) $15.99
C) $19.75
D) $21.05

Question 6

What feature of reload options prevents the use of a Black-Scholes valuation?

Question 7

Compute the yield on debt given a 10-year zero-coupon bond paying $500 at maturity.Assume the asset value is $450,σ = 0.35,r = 0.06,and no dividend is paid.

A) 6.62%
B) 7.26%
C) 8.26%
D) 9.62%

Question 8

Daniels,Inc.has assets valued at $2 million and 50,000 outstanding shares.A 5-year zero-coupon bond exists,which pays $400,000 at maturity.The bond is convertible into 10,000 shares.Assume σ = 0.30,r = 0.055,and no dividend is paid.What is the value of the bond?

A) $402,672
B) $452,172
C) $415,022
D) $385,172

Question 9

The use of collars in acquisitions serves the purpose of addressing what two issues in an offer?

Question 10

In the case of an acquisition,with which of the following offer structures does the acquired firm bear the most risk between the time the offer is accepted and the time it is consummated?

A) Fixed stock offer
B) Floating stock offer
C) Fixed collar offer
D) Floating collar offer

Question 11

How does a reload option provide additional compensation compared to regular compensation options?

Question 12

What is the expected return on equity using the Black-Scholes formula,given a zero-coupon bond that pays $250 at maturity in 4 years? Assume assets are worth $200,r = 0.05,σ = 0.30,and no dividend is paid.The return on assets is 11.5%.

A) 10.27%
B) 14.27%
C) 18.27%
D) 22.27%

Question 13

A company issues an option grant with an outperformance feature,against the S&P 500.Assume S&P 500 = 1100,S = 46,k = 45,σ = 0.30,r = 0.04,and 10 years until expiration.The S&P 500 has a dividend yield of 2.5%,standard deviation of 20.0% and a 0.45 correlation coefficient with the stock.What is the value of the outperformance feature?

A) $2.25
B) $3.29
C) $4.11
D) $4.78

Question 14

Willco,Inc.issues compensation options with the following terms.Strike = $45,?price = $42.00,σ = 0.48,r = 0.05,div = 0.02.What is the value of the option if it will be ?repriced at $30? Assume 10 years to expiration.

A) $22.78
B) $24.65
C) $26.22
D) $30.46

Question 15

A company issues an option grant with an outperformance feature,against the S&P 500.Assume S&P 500 = 1100,S = 46,k = 45,σ = 0.30,r = 0.04,and 10 years until expiration.The S&P 500 has a dividend yield of 2.5%,standard deviation of 20.0% and a 0.45 correlation coefficient with the stock.What is the value of the outperformance option?

A) $11.92
B) $15.99
C) $19.75
D) $21.05

Question 16

Lechno,Inc.issues compensation options with the following terms.Strike = $65,?price = $63.50,σ = 0.22,r = 0.045,div = 0.015.What is the value of the option if it will be repriced at $40? Assume 10 years to expiration.

A) $18.64
B) $22.22
C) $24.32
D) $26.84

Question 17

A company issues an option grant with an outperformance feature,against the S&P 500.Assume S&P 500 = 950,S = 22,k = 25,σ = 0.25,r = 0.06,and 5 years until expiration.The S&P 500 has a dividend yield of 2%,standard deviation of 18.0% and a 0.30 correlation coefficient with the stock.What is the value of the outperformance feature?

A) $0.99
B) $1.31
C) $1.59
D) $1.72

Question 18

Jessie,Inc.has 4-year zero-coupon bonds outstanding,which will pay $1,000 at maturity.The assets are valued at $900,σ = 0.25,r = 0.045,and the company does not pay a dividend.Using a Black-Scholes model,what is the yield on debt?

A) 4.68%
B) 6.48%
C) 8.46%
D) 8.64%

Question 19

Why should or should not a company expense compensation options? Divide the class into two groups and assign each a different opinion.Have each prepare arguments to support their case.After brief group meetings,have each group present their conclusions.

Question 20

What is the difference in the expected returns on equity when using a Black-Scholes formula versus a traditional weighted average formula? Assume rA = 0.12,rf = 0.06,asset value = $170,equity value = $45,debt to value ratio = 0.55,and delta = 0.6500.

A) 1.00%
B) 1.20%
C) 1.40%
D) 1.60%