SECTION ONE

QUESTION ONE:

A. Hedging is offsetting or protecting against the risk of adverse price movements. While
diversification is an overall portfolio management strategy to smooth out risk among
all assets. Hedging is the preferred tool for corporate risk management because it
helps the company decrease to losses by offsetting one particular asset.

B. Add hedging allows the company to increase their debt capacity because it reduces
the risk of a company. Ex-dividend date occurs two days prior to the date of record.
The date is used as a trading date that informs new buyers of stock that any purchases
of stock On this date or after will not receive any dividend payments in the nearest
payment date.

C. European options can only be exercised at the expiration date while American options
can be exercised at any time before the expiry. American options are more valuable
because the European options have the lower risk. Furthermore, the American options
investors have their ability to exercise their contract at any time after entering the
contract and before the expiration date.

QUESTION TWO

A. Financial Leverage is considered a fair-weather friend because when company are

experiencing financial difficulties especially if the extreme difficulties banks and
other institutions may be hesitant to lend money. This is because are afraid the
company may not be able to repay them.
B. That is incorrect to say since revaluation only occurs when there is an increase in the
value a country’s currency by the central bank of the country. An appreciation of a
currency occurs due to demand and supply.
C. Round trip allows company’s managers to analyse the market when to finding out a
transaction’s volume and revenue.

SECTION TWO
QUESTION ONE

A. (i.) Wendy’s current return:

= EBIT/ NUMBER OF SHARES
=750,000/10,000
=$75 per share
Value per Share
= 10,000,000/10,000 = 1000
Return in %= (Return per share/ Value per share)*100
= 75/1000* 100
=7.5%
Thus, Wendy’s current return percentage is 7.5%

(ii.) Wendy’s current return is 700*$75 =$52,500

interest expense = debt *interest rate

=debt = .25%*$10,000,000

=$2,500,000

=2,500,000*0.05= $125,000

Ebit = 750,000- 125,000 = $625,000

Shares repurchased = $125,000/$75 = 1,667 shares

The company borrowed 25% of the capital

So I could lend 25% of my capital = 700*75= 52,500

I sell

B. Interest Rate Swap

Calculations:
X paying 13% and Y= LIBOR + 1%
If X was borrowing under floating and Y under fixed, then calculi=ate the differences:
Direct Borrowing: 13+LIBOR+1 = LIBOR +14%
Swap Borrowing: 10+ LIBOR + 2.5= LIBOR +12.5%
The saving made is 1.5% (14%-12.5%)
 If the savings are to be shared evenly then:
X borrows at LIBOR +2,5%
X pays Y =9.75% (12.5% - 2.5%)
X receives from Y= LIBOR
X’s net interest= 12.25%

Y borrows at 10%
Y pays X= LIBOR
Y receives from X= 9.75%
Y’s net interest= LIBOR+0.25%

9.75%
X Y
LIBOR

LIBOR
2.5% 10%

X’s Bank Y’s Bank

Fixed 13% Floating LIBOR +1%

Net Interest= 12.25% Net Income = LIBOR +0.25%

= 0.75% =0.75%

Saving of 1.25% has been distributed evenly.

C. Number of Common Stock =

400,000/$1 = 400,000 common stock

Stock Dividend = 400,000*10% =40,000

New common stock value = common stock value + stock dividend
=$400,000+40,000
= $440,000
New common stock value= $440,000
New retained earnings= retained earnings – stock dividend
 = $5,000,000-$40,000
New retained earnings= $4,960,000
capital surplus ($50*40,000) = $2,000,000

QUESTION TWO

A. Price of put option (P0)= [Pv of K(1-Nd20)]- [Sp*(1-Nd1)]

=134.85*(1-0.281)-125*(1-0.3336)

=- 0.43

=d1-sd*sqrt of time

=0.43-(0.3*0.5)

=-0.58

N(D1) = N(-0.43)= 0.3336

According to the table

d(-0.42) =0.3372

d(-0.44)=0.3300

so desired d1= 0.3336 – 0.0036

N(d2)= N(-0.58) = 0.2810

Pv of K = Exercise price/ e^interest rate*time period

=140/ exp^0.15*3/12

=134.85

B. F/S=(1+ra)/(1+rb)

F/S= 1+ Interest Rate Differential

99/100 = 1+interest rate differential

Interest rate differential = 0.99-1

= -1%