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Financial Management homework

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Financial Management
by THREESU
1. Consider a convertible bond that is trading at a conversion premium of 20 percent. If the value of the
underlying stock rises by 25 percent, the value of the bond will: A. rise by less than 25%. B. rise by 25%.
C. rise by more than 25%. D. remain unchanged. Correct answer: A The convertible bond implicitly gives
bondholders a call option on the underlying stock. The delta of this option will vary between 0 (when the
option is extremely out of the money) and 1 (when the option is extremely in the money). In this case, the
bond is trading at a conversion premium of 20% so the delta must be somewhere between zero and one,
and hence the price of the convertible bond will rise by less than the price of the underlying stock. 2. If a
cash flow of $10,000 in two years' time has a PV of $8,455, the annual percentage rate, assuming
continuous compounding is CLOSEST to: A. 8.13%. B. 8.39%. C. 8.75%. D. 8.95%. Correct answer: B
Continuously compounded rate = ln(FV/PV)/N = ln(10000 / 8455) / 2 = 8.39%. 3. The current values of a
firm's assets and liabilities are 200 million and 160 million respectively. If the asset values are expected
to grow by 40 million and liability values by 30 million within a year and if the annual standard deviation
of these values is 50 million, the distance from default in the KMV model would be closest to: A. 0.8
standard deviations. B. 1.0 standard deviations. C. 1.2 standard deviations. D. Cannot not be
determined. Correct answer: B Distance from default = (Expected value of assets - Expected value of
liabilities) / Standard deviation = (240 - 190)/50 = 1.0. 4. What is the semiannual-pay bond equivalent
yield on an annual-pay bond with a yield to maturity of 12.51 percent? A. 12.00%. B. 11.49%. C. 12.51%.
D. 12.14%.

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Correct answer: D: The semiannual-pay bond equivalent yield of an annual-pay bond = 2 * [(1 + yield to
maturity on the annual-pay bond)0.5 -1] = 12.14%.
5. You want to test at the 0.05 level of significance that the mean price of luxury cars is greater than
$80,000. A random sample of 50 cars has a mean price of $88,000. The population standard deviation is
$15,000. What is the alternative hypothesis? A. The population mean is greater than or equal to $80,000.
B. The population mean is less than $80,000. C. The population mean is not equal to $80,000. D. The
population mean is greater than is $80,000. Correct answer: D The alternate hypothesis is the statement
which will be accepted if the null hypothesis is proven wrong. Therefore, we make whatever we are
trying to test as the alternate hypothesis - in this case that the mean price of luxury cars is greater than
$80,000, and the null hypothesis as the opposite (the mean price of luxury cars is less than or equal to
$80,000). This problem is a common example of how statisticians establish hypotheses by proving that
the opposite (i.e. the null hypothesis) is false. 6. Suppose that Gene owns a perpetuity, issued by an
insurance company that pays $1,250 at the end of each year. The insurance company now wishes to
replace it with a decreasing perpetuity of $1,500 decreasing at 1% p.a. without any change in the
payment dates. At what rate of interest (assuming a flat yield curve) would Gene be indifferent between
the choices? A. 4%. B. 5%. C. 6%. D. 9%. Correct answer: B 1,250 / r = 1,500 / (r + 1%) or, 1,250 x (r +
1%) = 1,500 x r or, r = 12.5 / (1,500 - 1,250) = 5%. 7. Which of the following is considered to be the
responsibility of the legal risk manager? I. Inadequate documentation o f OTC derivatives transactions.
II. The enforceability of netting agreements in bankruptcy. III. Default on interest and principal payments.
A. I only B. II only C. I and II only D. I, II, and III

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Financial Management by THREESU 1. Consider a convertible bond that is trading at a conversion premium of 20 percent. If the value of the underlying stock rises by 25 percent, the value of the bond will: A. rise by less than 25%. B. rise by 25%. C. rise by more than 25%. D. remain unchanged. Correct answer: A The convertible bond implicitly gives bondholders a call option on the underlying stock. The delta of this option will vary between 0 (when the option is extremely out of the money) and 1 (when the option is extremely in the money). In this case, the bond is trading at a conversion premium of 20% so the delta must be somewhere between zero and one, and hence the price of the convertible bond will rise by less than the price of the underlying stock. 2. If a cash flow of $10,000 in two years' time has a PV of $8,455, the annual percentage rate, assuming continuous compounding is CLOSEST to: A. 8.13%. B. 8.39%. C. 8.75%. D. 8.95%. Correct answer: B Continuously compounded rate = ln(FV/PV)/N = ln(10000 / 8455) / 2 = 8.39%. 3. The current values of a firm's assets and liabilities are 200 million and 160 million respectively. If the asset values are expected to grow by 40 million and liability values by 30 million within a year and if the annual standard deviation of these values is 50 million, the distance from default in the KMV model would be closest to: A. 0.8 standard deviations. B. 1.0 standard deviations. C. 1.2 standard deviations. D. Cannot not be determined. Correct ...
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