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Midterm

FIN 401 Study Guide - Midterm Guide: Interest Rate Cap And Floor, Forward Contract, Forward Price


Department
Finance
Course Code
FIN 401
Professor
Scott Anderson
Study Guide
Midterm

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CHAPTER 15- RAISING CAPITAL CHAPTER 24- RISK MANAGEMENT AND DERIVATIVE SECURITIES
Rights valuation: Ro=(Po-S)/(N+1)
Over priced= CP-OP/OP
Rights share price=ME=M0-R0
3 ways VC make money:
1-identify attractive investments
2- increase value of these investments 3-
contractsderivatives
ownership=# shares held/total shares
Seasonal offering: everyone knows the price per
share, they are already investors EX) Co wants
to raise $2M equity 1-sell shares a-discount
price (below mrkt price) b- flotation costs
(transaction Fe=5% (100/1-0.05)=210.5M) 2-
Issue rights to S.H. rights give owners the
right, but not the obligation to buy 1 share of Co
on a future date, for same price in exchange for
some number of rights
Derivative: security or asset whose value
is derived from some underlying security
or asset
Approaches: math (TVM), diagram
(geometry), Intuition
Users: investors, hedgers, arbitrageurs
Hedging: reducing firms exposure to price
Exchange rate volatility
Commodity price volatile
Options puts-right to sell benefit: price
Calls- right to buy strike/ exercise price
Types: forward contract buy future asset for
price, Future exchange forward contracts,
Swaps series of forward contracts,
European options: only exercised at expiry
American options: may be exercised on day up to
and including expiry
Profit= payoff-cost payoff=expire- future
Ex-rights share price: Pe=Po-Ro OR
Shares OS/(rights amount/S) when
you buy stocks you don‘t get the rights,
price drops, rights trade on own [After
ex right price do not include +1]
Date: 4 days prior to holder of record
IPO 1- prospectus (historical ‗audited‘ financial
statements, financial, business, people, market
info, risk factors)2-under written current
owners- hire investment bank i- market IPO
sell my shares ii-determine IPO price ―offer
price‖
IPO expected profit= undervalue$ - overvalue$
Rules: 1-zero sum game every winner
theres a loser 2- only 2 time periods matter
a-now b- expiry (maturity) 3- expiry buyer
will a- makes money b- lose money 4- all
derivatives are options in disguise
Large debt concerned interest rate
Import-export concerned exchange rate
Managing financial risk
Risk profile: measure exposure to risk
Reduce risk exposure: Δ in $ can (-) affect
CF
Hedging SR $ exposure: unforeseen events
Hedging LT exposure: economic exposure
Hedging forward contracts
Rights valuation steps
1: # new shares issued= total funds
raised/ subscription price
2: # of rights to buy new share= #old
shares/ # new shares
3: Value of a right= R0=(M0-S)/(N+1)
Dilution:
Proportionate ownership: SH not purchase any
new shares & proportional ownership decreases
Value: book VS. MV: new shares sold below
book value, firms ROE falls
MV: decreases in MVPS following issues of
new shares of common stock, occurs if funds
are used to invest (-)NPV projects
Buyer of Call
CALL
Seller of Call
+ ∞
MAX Π
Premium
Premium
MAX loss
-
x +premium
BEP
x +premium
Buyer of Put
PUT
Seller of Put
x - premium
MAX Π
Premium
Premium
MAX loss
-(x premium)
x - premium
BEP
x -premium
Payoff profile: & on FC—unexpected $ Δ
Types of interest rate hedges
Interest rate cap: call optionsold
conjunction with floating-rate loan
Floor: put optionsells= rate never fall
below specified in contract
Simultaneous: purchase of cap and sale of
floor= collar
Shares to raise new funds
1: revised amount raised
= project cost/(1-fc)
2: new shares
= revised cost/ S
Futures contracts
Settled regularly in cash market to
market
Publically traded
Legal (no chance of default)
Buyer and sellermust be
underlying commodity
Buys contractgoes long
Seller contractshorts contract
No upfront cost
Forward contract
Private
Legal
No market to market
Buying commodity itself
No upfront costs
Price in contract (forward price)
P0
CHAPTER 23- MERGERS & ACQUISITIONS
NPVacq=Vaft-Vbf
Vaft=Va+VB+synergy-cash paid
Syngery=NPVT+PremiumT
Premium paid= price-org value
PPSaft=PPSBF+(NPV/#shares bidding firm)
Max PPS would make NPV=0
Max price paid = VT+synergies
Syngery=ΔV=VAB-(VA+VB)
Exchange= (VB+Syngery)/PPSA
P/E ratio= values/earnings= (current value-
NPV)/total earning
EPS=EX+EY/shares OSX- exchanged shares
Bidding firm (acquire)- SHs in bidding firm
NPV in an acquisition
Takeover defenses 1- dual classes of stock a-
voting b- nonvoting complete defense o
hostile take over 2- staggered elections for BOD
3- shareholders‘ rights plan (give existing SH
right to buy shares) 4- regulator (competition
tribunal) 5- ―lawyers‖ (desperate times) some
PMT if Co. goes under)
Target firm- SHs in the target firm
―NPV‖premium the target SH record
buy the premium b/c of synergies
premium<synergiesNPV>0
Corporate goverence- Market of corporate
control
Forward contract legally binding
agreement between 2 parties calling
for the sale of an asset or product in
the future at a price agreed upon today
Forward price= S(1+r)t+CT
Derivatives
1- Options 2- Forwards 3- Futures
Reasons merged firm more efficient,
Vertical merger (same
suppliers/customers), Pension surplus
(defined benefit plan)
Merger premium= acq-VY
Acq= share exΔ ratio(shares osY)(PPS)
Forms of legal acquisitions
Mergersabsorption of 1 firm by another
Stockbuy firms voting stock (tender offer)
Assespurchasing its assets
Classifications
Horizontal- same product market
Vertical- re-organization firm at different
stages of the production process
Conglomerate- combination of firms in
unrelated lines of business
Accounting for acquisition
Purchase: difference between $ and FMV
is ‗goodwill‘ on acquirer B/S
Pooling interest: B/S combined- no good
will, used when 90% of voting common
stock is exΔ for voting stock in combined
Financial effects of acquisitions
EPS growth
Diversification: reduces only
unsystematic risk
Gains from acquisition
Revenue enhancement
Cost reduction
Lower taxes
Lower capital requirement
Defensive tactics
Repurchase/ standstill agreement
Exclusionary self tenders
Poison pill & share rights plan
Going private or leverage buyout
CHAPTER 25- OPTIONS Never negative
Value of a call option at expiration: S0= Stock
price today S1= Stock price at expiration (in
one period) C0= Value of the call option today
C1= Value of the call option on the expiration
date E= exercise price on the option= Strike
price
C1=0 if (S1-E)≤ 0 C1=(S1-E) if (S1-E)>0
Call options: issued by individuals
Conversion 1 option contract =100 option
Current value 1 warrant
PVbond+x(warrant)= face value
Intrinsic Value of a call option: (> of)
CALL OPTION: S0-E OR ZERO
PUT OPTION: E-S0 OR ZERO
Option Valuation: C0-[E/(1+Rf)t]
[if (S0-E)>0]
Goodwill= acquisition-FMV
FMV= net fixed assets+NWC
Profit= initial payoff at maturity
Conversion premium
= con$-P0/P0(100)
Convertible Bonds: exΔ for common shares
Conversation value= conversion ratio (current stock $)
price)
Straight bond value= PV calc
Conversion premium: bond $ exceeds stock $
Option value= conv option value+ speculative option
Speculative option= floor value- SBV
Conversion option value= priceconv-floor value
Conversion price= face value/ conversation ratio
Floor convertible: min value of bond is the greater of
SBV and conversion value
Warrants: by stock directly from the
company at a fixed price during a
specified period, issued by firm
Combination with privately placed
debt
Shares o/s don‘t change
No cash goes to firm
Cash raised shares o/s
EPS will fall upon warrant
exercise
Factors that affect Call Prices
Exercise $ decrease
Time to expiry increase
More risky (Volatility) increase
Stock Increase
Rf increase
Factors that affect put prices
Exercise $ increase
Time to expiry unsure (?)
More risky (Volatility)
Stock decrease
Rf decrease
S1 < E
S1 < E
Call
Out of money
In the money
Put
In the money
Out of money
Bid: ―short‖, sell option
Ask: ―going long‖, buy option
TMV of call= C0-intrinsic value
Profitbuyer=(payoff-cost)(#options)
Profitseller=cost-payoff(#options)
Cost= option premium
BE set profit to 0
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