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Problems 1-30

Input boxes in tan Output boxes in yellow Given data in blue Calculations in red Answers in green

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sis ToolPak"

Chapter 25

Question 1 Input Area:

Initial investment # of years Rate of return

$

1,000 9 11%

Output Area:

FV

$

2,691.23

Chapter 25

Question 2 Input Area:

Amount needed # of years Rate of return

$

15,000 8 9%

Output Area:

PV

$

7,301.28

Chapter 25

Question 3 Input Area:

Current stock price $ Exercise price $ Call option $ Expiration (months) Risk-free rate

62 60 4.10 3 2.6%

Output Area:

Put price

$

1.71

Chapter 25

Question 4 Input Area:

Expiration (months) Exercise price $ Put option $ Current stock price $ Risk-free rate

6 50 5.08 47 4.8%

Output Area:

Call price

$

3.27

Chapter 25

Question 5 Input Area:

Exercise price Expiration (months) Put option Call option Risk-free rate

$ $ $

70 3 3.10 4.35 4.8%

Output Area:

Stock price

$

70.42

Chapter 25

Question 6 Input Area:

Exercise price Expiration (months) Put option Call option Current stock price

$ $ $ $

65 4 1.05 6.27 69.38

Output Area:

Rate

3.90%

Chapter 25

Question 7 Input Area:

Expiration (months) Put option Call option Exercise price Current stock price

$ $ $ $

5 8.10 6.12 70 66.81

Output Area:

Interest rate

4.18%

Chapter 25

Question 8 Input Area:

Current stock price Exercise price Risk-free rate Expiration (months) Standard deviation

$ $

69 70 6% 3 41%

Output Area:

d1 d2 N(d1) N(d2) Call Put $ $

0.1055 (0.0995) 0.5420 0.4604 5.65 5.61

Chapter 25

Question 9 Input Area:

Current stock price Exercise price Risk-free rate Expiration (months) Standard deviation

$ $

86 90 5.50% 4 62%

Output Area:

d1 d2 N(d1) N(d2) Call Put $ $

0.1032 (0.2548) 0.5411 0.3995 11.24 13.60

Chapter 25

Question 10 Input Area:

Current stock price $ Exercise price $ Risk-free rate Expiration (months) Standard deviation

89 85 5% 9 39%

Output Area:

d1

0.4161

N(d1) 0.6613 For a call option the delta is 0.6613 For a put option, the delta is (0.3387) The delta tells us the price of an option for a $1 change in the price of the underlying asset.

Chapter 25

Question 11 Input Area:

Current selling price Price % increase Standard deviation Option to buy Expiration (months) Risk-free rate

$1,900,000 10% 20% $2,050,000 12 5%

Output Area:

The 'stock' price is and the exercise price is $2,050,000 d1 d2 N(d1) N(d2) Call $

$1,900,000

(0.0299) (0.2299) 0.4881 0.4091 129,615.91

Chapter 25

Question 12 Input Area:

Current selling price Price % increase Standard deviation Option to sell Expiration (months) Risk-free rate Call

$

$

$

1,900,000 10% 20% 2,050,000 12 5% 129,615.91

Output Area:

Put $ 179,636.23 You would have to pay $253,110.14 $ 179,636.23 in in order to guarantee the right to sell the land for $ 2,050,000

Chapter 25

Question 13 Input Area:

Stock price Exercise price Risk-free rate Expiration (months) Standard deviation

$ $

84 80 6% 6 53%

Output Area:

a. d1 d2 N(d1) N(d2) Call Put Call intrinsic value Put intrinsic value b. Call option time value Put option time value $ $ $ $ $ $

0.3976 0.0229 0.6545 0.5091 15.46 9.09 4 11.46 9.09

c. The time premium (theta) is more important for a call option than a put option, therefore, the time premium is, in general, larger for a call option.

Chapter 25

Question 14 Input Area:

Exercise price Expiration (months) Call option Stock price Risk-free rate

$ $ $

30 4 3.81 27.05 5%

Output Area:

Put price

$

6.26

Chapter 25

Question 15 Input Area:

Expiration (months) Stock price Standard deviation Risk-free rate Exercise price

$

$

6 85 20% 4% -

Output Area:

d1 d2 N(d1) N(d2) B-S call price Call intrinsic value Call price $ $

#DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0! 85.00 85.00

An option can never sell for less than its intrinsic value.

Chapter 25

Question 16 Input Area:

Exercise price Expiration (months) Stock price Risk-free rate Standard deviation

$ $

70 6 74 5% 0%

Output Area:

Standard deviation 0% So d1 and d2 go to positive infinity, so N(d1) and N(d2) go to 1. This is the no risk call option formula discussed in an earlier chapter. C = S - Ee-Rt Call price $ 5.73

Chapter 25

Question 17 Input Area:

Stock price Expiration (months) Exercise price Risk-free rate Standard deviation

$ $

42 12 50 12% ∞

Output Area:

For standard deviation = infinity, d1 goes to positive infinity so N(d1) goes to 1, and d2 goes to negative infinity so N(d2) goes to 0; C = S = $ 42

Chapter 25

Question 18 Input Area:

Face value of debt Maturity (months) Market value Standard deviation Risk-free rate

$ $

15,000 12 16,100 32% 6%

Output Area:

d1 d2 N(d1) N(d2) Equity value Debt value $ $

0.5687 0.2487 0.7152 0.5982 3,064.54 13,035.46

Chapter 25

Question 19 Input Area:

Face value Market value Maturity (months) Standard deviation Risk-free rate Project A: NPV Standard deviation Project B: NPV Standard deviation

$ $

15,000 16,100 12 32% 6%

$

1,500 46%

$

2,100 24%

Output Area:

a. Project A: d1 d2 N(d1) N(d2) Equity value Debt value Project B: d1 d2 N(d1) N(d2) Equity value Debt value $ $ $ $

0.7079 0.2479 0.7605 0.5979 4,938.60 12,661.40

1.1757 0.9357 0.8801 0.8253 4,360.22 13,839.78

b. Although the NPV of project B is higher,

the equity value with project A is higher. While NPV represents the increase in the value of the assets of the firm, in this case, the increase in the value of the firm's assets resulting from the project B is mostly allocated to the debtholders, resulting in smaller increase in the value of the equity. Stockholders would, therefore, prefer project A even though it has a lower NPV. c. Yes. If the same group of investors have equal stakes in the firm as bondholders and stockholders, then total firm value matters and project B should be chosen, since it increases the value of the firm to $ 18,200 instead of $ 17,600 d. Stockholders may have an incentive to take on more risky, less profitable projects if the firm is leveraged; the higher the firm's debt load, all else the same, the greater is this incentive.

Chapter 25

Question 20 Input Area:

Face value of debt Maturity (months) Market value Standard deviation Risk-free rate

$ $

25,000 12 27,300 43% 6%

Output Area:

d1 d2 N(d1) N(d2) Equity value Debt value Cost of debt $ $

0.5592 0.1292 0.7120 0.5514 6,455.02 20,844.98 18.18%

Chapter 25

Question 21 Input Area:

Face value Market value Maturity (years) Standard deviation Risk-free rate Equity(#18) Equity(#20) Debt(#18) Debt(#20)

$ $

$ $ $ $

40,000 43,400 12 19% 6% 3,064.54 6,455.02 13,035.46 20,844.98

Output Area:

a. Equity Debt b. d1 d2 N(d1) N(d2) Equity value Debt value c. Equity Debt

$ $

9,519.56 33,880.44 0.8402 0.6502 0.7996 0.7422 6,742.92 36,657.08 (2,776.65) 2,776.65

$ $ $ $

d. In a purely financial merger, when the standard deviation of the assets declines, the value of the equity declines as well. The shareholders will lose exactly the amount the bondholders gain. The bondholders gain as a result of the coinsurance effect. That is, it is less likely that the new company will default on the debt.

Chapter 25

Question 22 Input Area:

Maturity (years) Face value Market value Standard deviation Risk-free rate NPV

$ $

$

10 25,000,000 16,000,000 41% 6% 750,000

Output Area:

a. d1 d2 N(d1) N(d2) Equity value b. Debt value c. Rd d. d1 d2 N(d1) N(d2) Equity value $ $ $

0.7668 (0.5297) 0.7784 0.2982 8,363,715.92 7,636,284.08 11.86% 0.8022 (0.4944) 0.7888 0.3105 8,951,454.33

e. Debt value $ 7,798,545.67 Rd 11.65% When the firm accepts the new project, part of the NPV accrues to bondholders. This increases the present value of the bond, thus reducing the return on the bond. Additionally, the new project makes the firm safer in the sense it increases the

value of assets, thus increasing the probability the call will end in the money and the bondholders will receive their payment.

Chapter 25

Question 23 Input Area:

Maturity (years) Face value Market value Standard deviation Risk-free rate d. # years until payment

$ $

2 40,000 17,000 60% 7% 5

Output Area:

a. PV b. d1 d2 N(d1) N(d2) Equity value Put price c. Value of bond Rd d. PV d1 d2 N(d1)

$

34,774.33 (0.4192) (1.2677) 0.3376 0.1025 2,175.55 19,949.88 14,824.45 49.63% 28,187.52 0.2939 (1.0477) 0.6156

$ $ $

$

N(d2) 0.1474 Equity value $ 6,310.66 Put price $ 17,498.18 Value of bond $ 10,689.34 Rd 26.39% The value of the debt declines because of the time value of money, i.e., it will be longer until shareholders receive their payment. However, the required return on the debt declines. Under the current situation, it is not likely the company will have the assests to pay off bondholders. Under the new plan where the company operates for five more years, the probability of increasing the value of assets to meet or exceed the face value of debt is higher than if the company only operates for two more years.

Chapter 25

Question 24 Input Area:

Maturity (years) Face value Market value Standard deviation Risk-free rate d, New standard deviation

$ $

5 50,000 46,000 44% 7% 55%

Output Area:

a. PV b. d1 d2 N(d1) N(d2) Equity value Put price c. Value of bond Rd d. PV d1 d2 N(d1) N(d2) Equity value Put price Value of bond Rd $ $ $ $ $ $

$35,234.40 0.7629 (0.2209) 0.7772 0.4126 21,216.74 10,451.14 24,783.26 14.04% 35,234.40 0.8317 (0.3981) 0.7972 0.3453 24,506.51 13,740.92 21,493.49 16.89%

$

The value of the debt declines. Since the standard deviation of the company's assets increases, the value of the put option on the face value of the bond increases, which decreases the bond's current value. e. Bondholders gain/(lose) $ (3,289.77) Stockholders gain/(lose) $ 3,289.77 This is an agency problem for bondholders. Management, acting to increase shareholder wealth in this manner, will reduce bondholder wealth by the exact amount that shareholder wealth is increased.

Chapter 25

Question 25 Input Area:

Current stock price Standard deviation Risk-free rate Strike price Expiration (months) Dividend yield

$

$

114 50% 5% 105 6 3%

Output Area:

Going back to chapter on dividends, the price of the stock will decline by the amount of the dividend (less any tax effects). Therefore, we would expect the price of the stock to drop when a dividend is paid, reducing the upside potential of the call by the amount of the dividend. The price of a call option will decrease when the dividend yield increases. d1 d2 N(d1) N(d2) Call price $ 0.4377 0.0841 0.6692 0.5335 20.52

Chapter 25

Question 26 Input Area:

Current stock price Strike price Expiration (months) Dividend yield Standard deviation Risk-free rate

$ $

114 105 6 3% 50% 5%

Output Area:

Going back to the chapter on dividends, the price of the stock will decline by the amount of the dividend (less any tax effects). Therefore, we would expect the price of the stock to drop when a dividend is paid, reducing the decreasing the stock price. The price of a put option will increase when the dividend yield increases. Price $ 10.62

Chapter 25

Question 27 Output Area:

N(d1) is the probability that "z" is less than or equal to N(d1), so 1 - N(d1) is the probability that "z" is greater than N(d1). Because of the symmetry of the normal distribution, this is the same thing as the probability that "z" is less than N(-d1). So, N(d1) - 1 = N(-d1).

Chapter 25

Question 28 Output Area:

From put-call parity, P = E*e-RT + C - S. Substituting the Black-Scholes call option formula for C and using the result in the previous question produces the put option formula: P = E *e-Rt + C - S = E*e-Rt + S*N(d1) - E*e-Rt*N(d2) - S = S*(N(d1) - 1) + E*e-Rt*(1 - N(d2)) = E*e-Rt*N(-d2) - S*N(-d1)

Chapter 25

Question 29 Input Area:

Current stock price Risk-free rate Standard deviation Strike price Expiration date

$

$

50 12% 60% 100 -

Output Area:

Based on Black-Scholes, the call option is worth $50. The reason is that present value of the exercise price is zero, so the second term disappears. Also, d1 is infinite, so N(d1) is equal to one. The problem is that the call option is European with an infinite expiration, so why would you pay anything for it since you can never exercise it? The paradox can be resolved by examining the price of the stock. Remember that the call option formula only applies to a non-dividend paying stock. If the stock will never pay a dividend, it (and a call option to buy it at any price) must be worthless.

Chapter 25

Question 30 Output Area:

The delta of the call option is N(d1) and the delta of the put option is N(d1) - 1. Since you are selling a put option, the delta of the portfolio is N(d1) - [N(d1) - 1]. This leaves the overall delta of your position as 1. This position will change dollar for dollar in value with the underlying asset. This position replicates the dollar "action" on the underlying asset.

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