2023 FIN 53 4 Quiz 5 Week 6 30 Multiple choices Question 1 Which of the | Assignments Online

If the underlying stock does not pay a dividend, it does not make good economic sense to exercise a call option prior to its expiration date, even if this would yield an immediate profit.

Call options generally sell at a price greater than their exercise value, and the greater the exercise value, the higher the premium on the option is likely to be.

Call options generally sell at a price below their exercise value, and the greater the exercise value, the lower the premium on the option is likely to be.

Call options generally sell at a price below their exercise value, and the lower the exercise value, the lower the premium on the option is likely to be.

Because of the put-call parity relationship, under equilibrium conditions a put option on a stock must sell at exactly the same price as a call option on the stock.

The price of these call options is likely to rise if XYZ’s stock price rises.

The higher the strike price on XYZ’s options, the higher the option’s price will be.

Assuming the same strike price, an XYZ call option that expires in one month will sell at a higher price than one that expires in three months.

If XYZ’s stock price stabilizes (becomes less volatile), then the price of its options will increase.

If XYZ pays a dividend, then its option holders will not receive a cash payment, but the strike price of the option will be reduced by the amount of the dividend.
              

If the underlying stock does not pay a dividend, it does not make good economic sense to exercise a call option prior to its expiration date, even if this would yield an immediate profit.

Call options generally sell at a price greater than their exercise value, and the greater the exercise value, the higher the premium on the option is likely to be.

Call options generally sell at a price below their exercise value, and the greater the exercise value, the lower the premium on the option is likely to be.

Call options generally sell at a price below their exercise value, and the lower the exercise value, the lower the premium on the option is likely to be.

Because of the put-call parity relationship, under equilibrium conditions a put option on a stock must sell at exactly the same price as a call option on the stock.

An option’s value is determined by its exercise value, which is the market price of the stock less its striking price. Thus, an option can’t sell for more than its exercise value.

As the stock’s price rises, the time value portion of an option on a stock increases because the difference between the price of the stock and the fixed strike price increases.

Issuing options provides companies with a low cost method of raising capital.

The market value of an option depends in part on the option’s time to maturity and also on the variability of the underlying stock’s price.

The potential loss on an option decreases as the option sells at higher and higher prices because the profit margin gets bigger.

a call option.

a put option.

an out-of-the-money option.

a naked option.

a covered option.
 
              

Strike price.

Variability of the stock price.

Option’s time to maturity.

All of the above.

None of the above.
 
              

-$510.25

$1,989.75

$2,089.24

$2,193.70

$2,303.38
 

Put options give investors the right to buy a stock at a certain strike price before a specified date.

Call options give investors the right to sell a stock at a certain strike price before a specified date.

Options typically sell for less than their exercise value.

LEAPS are very short-term options that were created relatively recently and now trade in the market.

An option holder is not entitled to receive dividends unless he or she exercises their option before the stock goes ex dividend.

The options with the $25 strike price will sell for $5.

The options with the $25 strike price will sell for less than the options with the $35 strike price.

The options with the $25 strike price have an exercise value greater than $5.

The options with the $35 strike price have an exercise value greater than $0.

If Deeble’s stock price rose by $5, the exercise value of the options with the $25 strike price would also increase by $5.
 
              

The price of the call option will increase by $2.

The price of the call option will increase by more than $2.

The price of the call option will increase by less than $2, and the percentage increase in price will be less than 10%.

The price of the call option will increase by less than $2, but the percentage increase in price will be more than 10%.

The price of the call option will increase by more than $2, but the percentage increase in price will be less than 10%.

If the underlying stock does not pay a dividend, it makes good economic sense to exercise a call option as soon as the stock’s price exceeds the strike price by about 10%, because this permits the option holder to lock in an immediate profit.

Call options generally sell at a price less than their exercise value.

If a stock becomes riskier (more volatile), call options on the stock are likely to decline in value.

Call options generally sell at prices above their exercise value, but for an in-the-money option, the greater the exercise value in relation to the strike price, the lower the premium on the option is likely to be.

Because of the put-call parity relationship, under equilibrium conditions a put option on a stock must sell at exactly the same price as a call option on the stock.

$2.43

$2.70

$2.99

$3.29

$3.62
 
              

-$310.25

$1,689.75

$1,774.24

$1,862.95

$1,956.10
 
              

GCC’s stock price suddenly increases.

The exercise price of the option is increased.

The life of the option is increased, i.e., the time until it expires is lengthened.

The Federal Reserve takes actions that increase the risk-free rate.

GCC’s stock price becomes more risky (higher variance).
 
              

In-the-money

Put

Naked

Covered

Out-of-the-money
 
              

The bond-yield-plus-risk-premium approach to estimating the cost of common equity involves adding a risk premium to the interest rate on the company’s own long-term bonds.  The size of the risk premium for bonds with different ratings is published daily in The Wall Street Journal.

The WACC is calculated using a before-tax cost for debt that is equal to the interest rate that must be paid on new debt, along with the after-tax costs for common stock and for preferred stock if it is used.

An increase in the risk-free rate is likely
to reduce the marginal costs of both debt and equity.

The relevant WACC can change depending on the amount of funds a firm raises during a given year.  Moreover, the WACC at each level of funds raised is a weighted average of the marginal costs of each capital component, with the weights based on the firm’s target capital structure.

Beta measures market risk, which is generally
the most relevant risk measure for a publicly-owned firm that seeks to maximize its intrinsic value.  However, this is not true unless all of the firm’s stockholders are well diversified.

The WACC is calculated using before-tax
costs for all components.

The after-tax cost of debt usually exceeds
the after-tax cost of equity.

For a given firm, the after-tax cost of debt is always more expensive than the after-tax cost of non-convertible preferred stock.

Retained earnings that were generated in the past and are reported on the firm’s balance sheet are available to finance the firm’s capital budget during the coming year.

The WACC that should be used in capital budgeting is the firm’s marginal, after-tax cost of capital.

rs> re > rd > WACC.

re> rs > WACC > rd.

WACC > re > rs> rd.

rd> re > rs > WACC.

WACC > rd > rs > re.

The WACC as used in capital budgeting is an estimate of a company’s before-tax cost of capital.

The percentage flotation cost associated with issuing new common equity is typically smaller than the flotation cost for new debt.

The WACC as used in capital budgeting is an estimate of the cost of all the capital a company has raised to acquire its assets.

There is an “opportunity cost” associated with using retained earnings, hence they are not “free.”

The WACC as used in capital budgeting would
be simply the after-tax cost of debt if the firm plans to use only debt to finance its capital budget during the coming year.

The company will take on too many high-risk projects and reject too many low-risk projects.

The company will take on too many low-risk projects and reject too many high-risk projects.

Things will generally even out over time, and, therefore, the firm’s risk should remain constant over time.

The company’s overall WACC should decrease
over time because its stock price should be increasing.

The CEO’s recommendation would maximize the
firm’s intrinsic value.

Since the costs of internal and external
equity are related, an increase in the flotation cost required to sell a new issue of stock will increase the cost of retained earnings.

Since its stockholders are not directly
responsible for paying a corporation’s income taxes, corporations should focus on before-tax cash flows when calculating the WACC.

An increase in a firm’s tax rate will increase the component cost of debt, provided the YTM on the firm’s bonds is not affected by the change in the tax rate.

When the WACC is calculated, it should reflect the costs of new common stock, retained earnings, preferred stock, long-term debt, short-term bank loans if the firm normally finances with bank debt, and accounts payable if the firm normally has accounts payable on its balance sheet.

If a firm has been suffering accounting losses that are expected to continue into the foreseeable future, and therefore its tax rate is zero, then it is possible for the after-tax cost of preferred stock to be less than the after-tax cost of debt.

If a firm has a beta that is less than 1.0, say 0.9, this would suggest that the expected returns on its assets are negatively
correlated with the returns on most other firms’ assets.

If a firm’s managers want to maximize the value of their firm’s stock, they should, in theory, concentrate on project risk as measured by the standard deviation of the project’s expected future cash flows.

If a firm evaluates all projects using the same cost
of capital, and the CAPM is used to help determine that cost, then its risk as measured by beta will probably decline over time.

Projects with above-average risk typically have higher
than average expected returns.  Therefore, to maximize a firm’s intrinsic value, its managers should favor high-beta projects over those with lower betas.

Project A has a standard deviation of expected returns
of 20%, while Project B’s standard deviation is only 10%.  A’s returns are negatively correlated with both the firm’s other assets and the returns on most stocks in the economy, while B’s returns are positively correlated.  Therefore, Project A is less risky to a firm and should be evaluated with a lower cost of capital.

A change in a company’s target capital
structure cannot affect its WACC.

WACC calculations should be based on the before-tax costs of all the individual capital components.

Flotation costs associated with issuing new common stock normally reduce the WACC.

If a company’s tax rate increases, then, all else equal, its weighted average cost of capital will decline.

An increase in the risk-free rate will normally lower the marginal costs of both debt and equity financing.

In the WACC calculation, we must adjust the cost of preferred stock (the market yield) to reflect the fact that 70% of the dividends received by corporate investors are excluded from their taxable income.

We should use historical measures of the component costs from prior financings that are still outstanding when estimating a company’s WACC for capital budgeting purposes.

The cost of new equity (re) could possibly be lower than the cost of retained earnings (rs) if the market risk premium, risk-free rate, and the company’s beta all decline by a sufficiently large amount.

A firm’s cost of retained earnings is the rate of return stockholders require on a firm’s common stock.

The component cost of preferred stock is expressed as rp(1 – T), because preferred stock dividends are treated as
fixed charges, similar to the treatment of interest on debt.

M should have the lower WACC because it is like most other companies, and investors like that fact.

M and W should have identical WACCs because their risks as measured by the standard deviation of returns are identical.

If M and W merge, then the merged firm MW should have a WACC that is a simple average of M’s and W’s WACCs.

Without additional information, it is impossible to predict what the merged firm’s WACC would be if M and W merged.

Since M and W move counter cyclically to one another, if they merged, the merged firm’s WACC would be less than the simple average of the two firms’ WACCs.

A Division B project with a 13% return.

A Division B project with a 12% return.

A Division A project with an 11% return.

A Division A project with a 9% return.

A Division B project with an 11% return.

The market risk premium declines.

The flotation costs associated with issuing new common stock increase.

The company’s beta increases.

Expected inflation increases.

The flotation costs associated with issuing preferred stock increase.

The project should definitely be accepted because its expected return (before any risk adjustments) is greater than its required return.

The project should definitely be rejected because its expected return (before risk adjustment) is less than its required return.

Riskier-than-average projects should have their expected returns increased to reflect their higher risk.  Clearly, this would make the project acceptable regardless of the amount of the adjustment.

The accept/reject decision depends on the firm’s risk-adjustment policy.  If Norris’ policy is to increase the required return on a riskier-than-average project to 3% over rS, then it should reject the project.

Capital budgeting projects should be evaluated solely on the basis of their total risk.  Thus, insufficient information has been provided to make the accept/reject decision.

The interest rate used to calculate the WACC is the average after-tax cost of all the company’s outstanding debt as shown on its balance sheet.

The WACC is calculated on a before-tax basis.

The WACC exceeds the cost of equity.

The cost of equity is always equal to or greater than the cost of debt.

The cost of retained earnings typically exceeds the cost of new common stock.

The discounted cash flow method of estimating the cost
of equity cannot be used unless the growth rate, g, is expected to be constant forever.

If the calculated beta underestimates the firm’s true investment risk–i.e., if the forward-looking beta that investors think exists exceeds the historical beta–then the CAPM method based on the historical beta will produce an estimate of rs and thus WACC that is too high.

Beta measures market risk, which is, theoretically, the most relevant risk measure for a publicly-owned firm that seeks to maximize its intrinsic value.  This is true even if not all of the firm’s stockholders are well diversified.

An advantage shared by both the DCF and CAPM methods when they are used to estimate the cost of equity is that they
are both “objective” as opposed to “subjective,” hence little or no judgment is required.

The specific risk premium used in the CAPM is the same as the risk premium used in the bond-yield-plus-risk-premium approach.