Chapter 1: Corporate Finance and the Financial Manager (стр. 7 )

6. Describe common loan stipulations and fees.

Common loan stipulations and fees include loan commitment fees, loan origination fees, and compensating balance requirements. A loan commitment fee is interest charged on the unused portion of a committed line of credit. A loan origination fee is a fee that a bank charges to cover credit checks and legal fees. A compensating balance requirement means that the firm must hold a certain percent of the principal of the loan in an account at the bank.

7. What is commercial paper?

Commercial paper is short-term, unsecured debt used by large corporations that is usually a cheaper source of funds than a short-term bank loan.

8. What is the maximum maturity of commercial paper?

Due to SEC registration requirements, the maximum maturity of commercial paper is 270 days.

9. What is factoring of accounts receivable?

Factoring of accounts receivables means the firm sells receivables to the lender (i. e., the factor) and the lender agrees to pay the firm the amount due from its customers at the end of the firm’s payment period.

10. What is the difference between a floating lien and a trust receipt?

In a floating lien arrangement, the entire inventory is used to secure the loan. This arrangement is risky to the lender because the value of the collateral securing the loan is reduced as inventory is sold. With a trust receipt loan, distinguishable inventory items are held in a trust as security for the loan. As these items are sold, the firm remits the proceeds from the sale to the lender in repayment of the loan.

Chapter 21: Option Applications and Corporate Finance

1. Does the holder of an option have to exercise it?

No, the holder has the right, but not the obligation to exercise the option. Therefore, a holder of an option will exercise the option only when it is beneficial to the holder.

2. What is the difference between an American option and a European option?

An American option allows the holder to exercise the option on any date up to and including the expiration date, while a European option allows the holder to exercise the option only on the expiration date.

3. How are the profits from buying an option different from the payoff to the option at expiration?

The payout on a long position in an option contract is never negative; the profit from purchasing an option and holding it to expiration could be negative.

4. How are the payoffs to buying a call option related to the payoffs from writing a call option?

Because the option is a contract between the writer of the option and the buyer of the option, the losses of one party are the gains of the other.

5. Can a European option with a later exercise date be worth less than an identical European option with an earlier exercise date?

Yes, a European option with a later exercise date can trade for less than an identical European option with an earlier exercise date. For example, suppose the stock price of XYZ goes to zero due to bankruptcy, the 1-month European put is worth more than the 1-year European put because you can exercise and get your money sooner.

6. Why are options more valuable when there is increased uncertainty about the value of the stock?

An increase in volatility increases the likelihood of a very high or very low return on the stock. The greater the stock price move when the option is in-the-money, the greater the option payoff. However, if the option is out-of-the money, the payoff is zero regardless of how large the stock
price change is.

7. What factors are used in the Black-Scholes formula to price a call option?

The five factors that are relevant to valuing an option: the stock price, the strike price, the risk-free rate, time to expiration of the option, and the volatility of the stock, are the factors in the Black-Scholes formula.

8. How can the Black-Scholes formula not include the expected return on the stock?

The expected return on the stock is not included as a factor in the Black-Scholes formula because the expected return of the stock is already incorporated into the current stock price, which is a factor in the formula.

9. Explain put-call parity.

Put-call parity relates the value of a call to the value of the stock, the bond, and the put with the same strike price and the same maturity date. It says that the price of a European call equals the price of the stock plus an otherwise identical put minus the price of a bond that matures on the exercise date of the option.

10. If a put option trades at a higher price from the value indicated by the put-call parity equation, what action should you take?

If a put trades at a higher price from the value indicated by the put-call parity, you can arbitrage by selling the overvalued put and stock and simultaneously buying the call option. You are guaranteed to make a profit while taking no risk.

11. Explain how equity can be viewed as a call option on the firm.

A share of stock can be thought of as a call option on the assets of the firm with the strike price equal to the debt outstanding.

12. Under what circumstances would equity holders have a possible incentive to take on negative-NPV investments?

The debt holders can be viewed as owning the firm and having sold a call option with a strike
price equal to the required debt payment. Remember that the value of an option increases as the volatility of the underlying security increases. Therefore, shareholders benefit from high-volatility investments. Because the price of the equity is increasing with the volatility of the firm’s assets, the shareholders can benefit from negative-NPV investments that increase the volatility of the value of the firm’s assets.

Chapter 22: Mergers and Acquisitions

1. What are merger waves?

Merger waves are periods when a large number of mergers occur (generally during an economic expansion), followed by a trough in merger activity (generally during slow economic times).

2. What is the difference between a horizontal and vertical merger?

A horizontal merger would be a merger between two companies in the same industry. A vertical merger occurs when an acquiring firm merges with another firm in an industry that is either a supplier to or a purchaser from the acquiring firm’s industry.

3. On average, what happens to the target share price on the announcement of a takeover?

The target share price increases an average of 15% on the announcement of a takeover.

4. On average, what happens to the acquirer share price on the announcement of a takeover?

On average, the share price of the acquirer increases 1% on the announcement of a takeover.

5. What are the reasons most often cited for a takeover?

The most common reasons given for acquiring a firm are the synergies that can be gained through an acquisition. These synergies include economies of scale and scope, the control provided by vertical integration, monopolistic power gains, expertise gains, improvements in operating efficiency, and benefits related to diversification such as increased borrowing capacity and tax savings.

6. Explain why risk diversification benefits and earnings growth are not good justifications for a takeover intended to increase shareholder wealth.

Risk diversification benefits are not a good justification for a takeover because investors can achieve the benefits of diversification themselves by purchasing shares in the two separate firms themselves; because most stockholders already hold a well-diversified portfolio, they get no further gains from diversifying through acquisition. Earnings growth is not a justification for a takeover because a high-growth company can combine with a low-growth company and increase the earnings per share, but lower the overall growth rate of the earnings.

7. What are the steps in the takeover process?

A tender offer, which is a public announcement of an intention to purchase a large block of shares for a specified price, is made. Both the target and the acquiring board of directors must approve the merger and put the question to a vote of the target shareholders (and, in some cases, the acquiring shareholders, also).

8. What do arbitrageurs do?

Risk arbitrageurs are traders who, once a takeover is announced, speculate on the outcome of the deal.

9. What defensive strategies are available to help target companies resist an unwanted takeover?

A poison pill, which gives target shareholders the right to buy shares in the target at a deeply discounted price, can be used as a defensive strategy because it makes the takeover very expensive. Having a staggered board can also be used as a defense because it prevents a bidder from acquiring control over the board in a short period of time. Other defenses include finding a friendly bidder (a white knight), making it expensive to replace management through the use of golden parachutes, and changing the capital structure of the firm.

10. How can a hostile acquirer get around a poison pill?

A hostile acquirer can try to get around a poison pill by using a proxy fight to gain control over the board at the next annual shareholders’ meeting.

11. What mechanisms allow corporate raiders to get around the free-rider problem in takeovers?

Corporate raiders overcome the free-rider problem by acquiring a toehold in the target, attempting a leveraged buyout, or by offering a freezeout merger.

12. Based on the empirical evidence, who gets the value added from a takeover? What is the most likely explanation of this fact?

The evidence suggests that most of the value added accrues to the target shareholders. This is most likely due to competition that exists in the takeover market. Once an acquirer starts bidding on a target company and it is clear that a significant gain exists, other potential acquirers begin bidding and competing the profits away.

Chapter 23: International Corporate Finance

1. What is an exchange rate?

An exchange rate is the price for a currency denominated in another currency.

2. Why would multinational companies need to exchange currencies?

U. panies that collect revenue in other countries with different currencies need to exchange their profits in the foreign currencies into dollars. Also, these firms might need to pay for parts and labor in other currencies.

3. How can firms hedge exchange rate risk?

Firms can hedge exchange rate risk in financial markets by using currency forward contracts to lock in an exchange rate in advance and by using currency option contracts to protect against an exchange rate moving beyond a certain level.

4. Why may a firm prefer to hedge exchange rate risk with options rather than forward contracts?

A firm prefers options to forward contracts when there is a chance that the transaction it is hedging will not take place. In this case, a forward contract requires the firm to make an exchange at an unfavorable rate for the currency it does not need, whereas an option allows the firm to walk away from the exchange.

5. What assumptions are needed to have internationally integrated capital markets?

We make the following assumptions: any investor can exchange either currency in any amount at the spot rate or forward rate and is free to purchase or sell any security in any amount in either country at their current market price.

6. What implication does internationally integrated capital markets have for the value of the same asset in different countries?

The implication of internationally integrated capital markets is that the value of a foreign investment does not depend on the currency (home or foreign) we use in the analysis.

7. Explain two methods we use to calculate the NPV of a foreign project.

One, we can calculate the NPV in the foreign country and convert it to local currency at the spot rate. Two, we can convert the cash flows of the foreign project into local currency and then calculate the NPV of these cash flows.

8. When do these two methods give the same NPV of the foreign project?

The two methods give the same NPV of a foreign project when markets are internationally integrated and uncertainty in spot exchange rates are uncorrelated with the foreign currency cash flows.

9. What tax rate should we use to value a foreign project?

Because a U. S. corporation pays the higher of the foreign or domestic tax rate on its foreign project, we should use the higher of these two rates to value a foreign project.

10. How can a U. S. firm lower its taxes on foreign projects?

A U. S. firm can lower its taxes by having foreign projects in other countries that can be pooled with the new project or by deferring the repatriation of earnings.

11. What are the reasons for segmentation of the capital markets?

Market segmentation can exist when a country’s risk-free securities are internationally integrated but markets for a specific firm’s securities are not. Also, some countries impose capital controls or foreign exchange controls that create barriers to international capital flows.

12. What is the main implication for international corporate finance of a segmented financial market?

The implication for international corporate finance of a segmented financial market is that one country or currency has a higher rate of return than another, when compared in the same currency.

13. What conditions cause the cash flows of a foreign project to be affected by exchange rate risk?

To value projects that have inputs and outputs in different currencies correctly, the foreign and domestic cash flows should be valued separately.

14. How do we make adjustments when a project has inputs and outputs in different countries?

When a project has inputs and outputs in different currencies, the foreign-denominated cash flows are likely to be correlated with changes in spot rates.