Question 1.1.

Fairweather Corporation purchases merchandise on terms of 2/15, net 40, and its gross purchases (i.e., purchases before taking off the discount) are $800,000 per year.  What is the maximum dollar amount of costly trade credit the firm could get, assuming it abides by the supplier’s credit terms?  (Assume a 365-day year.)

(Points : 15)

Question 2.2.

A U.S. based importer, Zarb Inc., makes a purchase of crystal glassware from a firm in Switzerland for 39,960 Swiss francs, or $24,000, at the spot rate of 1.665 francs per dollar.  The terms of the purchase are net 90 days, and the U.S. firm wants to cover this trade payable with a forward market hedge to eliminate its exchange rate risk.  Suppose the firm completes a forward hedge at the 90-day forward rate of 1.682 francs.  If the spot rate in 90 days is actually 1.638 francs, how much will the U.S. firm have saved or lost in U.S. dollars by hedging its exchange rate exposure?

(Points : 15)

Question 3.3.

Suppose 90-day investments in Britain have a 6% annualized return and a 1.5% quarterly (90-day) return.  In the U.S., 90-day investments of similar risk have a 4% annualized return and a 1% quarterly (90-day) return.  In the 90-day forward market, 1 British pound equals $1.65.  If interest rate parity holds, what is the spot exchange rate?

(Points : 15)

Question 4.4.

Preissle Company’s stock sells for $42 per share.  The company wants to sell some 20-year, annual interest, $1,000 par value bonds.  Each bond would have 75 warrants attached to it, each exercisable into one share of stock at an exercise price of $47.  The firm’s straight bonds yield 10%.  Each warrant is expected to have a market value of $2.00 given that the stock sells for $42.  What coupon interest rate must the company set on the bonds in order to sell the bonds-with-warrants at par?

(Points : 15)

Question 5.5.

Mikkleson Mining is considering issuing a 10-year convertible bond that would be priced at its $1,000 par value.  The bonds would have an 8.00% annual coupon, and each bond could be converted into 20 shares of common stock.  The required rate of return on an otherwise similar nonconvertible bond is 10.00%.  The stock currently sells for $40.00 a share, has an expected dividend in the coming year of $2.00, and has an expected constant growth rate of 5.00%.  What is the estimated floor price of the convertible at the end of Year 3?

(Points : 15)

Question 6.6.

Potter & Lopez Inc. just sold a bond with 50 warrants attached. The bonds have a 20-year maturity and an annual coupon of 12%, and they were issued at their $1,000 par value. The current yield on similar straight bonds is 15%. What is the implied value of each warrant?

(Points : 15)

Question 7.7. Arthouse Inc., a national artist supply chain, is considering purchasing a smaller chain, Craftworks Inc.  Arthouse’s analysts project that the merger will result in incremental free flows and interest tax savings with a combined present value of $72.52 million, and they have determined that the appropriate discount rate for valuing Craftworks is 16%.  Craftworks has 4 million shares outstanding and no debt.  Craftwork’s current price is $16.25.  What is the maximum price per share that Arthouse should offer? (Points : 15)

Question 8.8. Kelly Tubes is considering a merger with Reilly Tires.  Reilly’s market-determined beta is 0.9, and the firm currently is financed with 20% debt, at an interest rate of 8%, and its tax rate is 25%.  If Kelly acquires Reilly, it will increase the debt to 60%, at an interest rate of 9%, and the tax rate will increase to 35%.  The risk-free rate is 6% and the market risk premium is 4%.  What will Reilly’s required rate of return on equity be after it is acquired? (Points : 15)

Question 9.9.

Company A can issue floating-rate debt at LIBOR + 1%, and it can issue fixed rate debt at 9%.  Company B can issue floating-rate debt at LIBOR + 1.5%, and it can issue fixed-rate debt at 9.4%.  Suppose A issues floating-rate debt and B issues fixed-rate debt, after which they engage in the following swap:  A will make a fixed 7.95% payment to B, and B will make a floating-rate payment equal to LIBOR to A.  What are the resulting net payments of A and B?

(Points : 15)

Question 10.10. Suppose the December CBOT Treasury bond futures contract has a quoted price of 80-07.  If annual interest rates go up by 1.00 percentage point, what is the gain or loss on the futures contract?  (Assume a $1,000 par value, and round to the nearest whole dollar.) (Points : 15)