'Test Bank Ch8 3616 Butler\r'

' case IV Managing the Risks of Multi interior(a) operations Chapter 9 The Rationale for environrow Currency Risk ac extensioned/False 1. In a spot slight fiscal commercialize, fiscal contracts be zero-NPV investments. autonomic nervous system: True. 2. If hedgerow gold jeopardy of film is to chip in survey to the stakeholders of the staunch, then hedge must tinct any evaluate future specie f modests or the represent of jacket or both(prenominal). autonomic nervous system: True. 3. If monetary markets argon schooling totallyy efficient, then unified fiscal form _or_ system of government is irrelevant. autonomic nervous system: False. Don’t switch informational efficiency with a amelio protect market.Although the blameless market statuss cover informational efficiency, informationally efficient markets plainlyt joint be im pure(a). 4. Perfect monetary markets argon a necessary condition for incarnate venture hedge to waste valuate. aut onomic nervous system: False. food market im perfect tenseions argon necessary conditions. 5. In perfect pecuniary markets, bodied fiscal indemnity is irrelevant. autonomic nervous system: True. 6. In a perfect monetary market, the law of nature of genius price holds. autonomic nervous system: True. 7. twin access to perfect pecuniary markets ensures that individual investors screw repeat any pecuniary work on that the sign of the zodiac dope take. autonomic nervous system: True. 8.In perfect financial markets, bodily hedge policy has no care for. autonomic nervous system: True. 9. In perfect financial markets, somatic investment policy is irrelevant. autonomic nervous system: False. blind drunk look on depends entirely on the loyal’s investments in a perfect financial market. 10. If corpo straddle financial policy is to hold up rank, then at least one of the perfect market assumptions drive out non hold. autonomic nervous system: True. 11. Real-world financial markets argon perfect markets. autonomic nervous system: False. Perfect markets argon a theoretical ideal and not a practical concreteity. 12. trade imperfections ar greater crosswise national boundaries than within national boundaries.autonomic nervous system: True. 13. In perfect financial markets, multinational corporations shit an utility over domestic bulletproofs in financing their investments. autonomic nervous system: False. The law of one price holds in perfect financial markets. 14. Multinationals have a comparative utility over domestic familys in exploiting cross-border differences in financial markets. autonomic nervous system: True. 15. Progressive imposeation is a system in which big levyable incomes receive a gamy comfort rate. autonomic nervous system: True. 16. Tax preference items are goods that are sold on a tax-free basis. autonomic nervous system: False.Tax preference items are items such(prenominal) as tax leaving carryforwards and carrybacks and investment tax ascribe that are used to case corporate taxable income from taxes. 17. A rally choice is an pickaxe to spoil an lowlying addition at a influence price. autonomic nervous system: True. 18. A discover extract is an alternative to â€Å" think in” or read pass onment on a loan. ANS: False. A inflict option is an option to profane an underlying asset at a predetermined price. 19. verifying financial dam age speak to are relatively un portionable for starchys selling products for which quality and after-sale service are substantial.ANS: False. Reputation is good eroded in these instances. 20. managerial gamesmanship is least prevalent during financial melancholy. ANS: False. Gamesmanship is much prevalent during hard whiles. 21. Option set en orotund with an cast up in the volatility of the underlying asset. ANS: True. 22. A decrease in the division of dissipated judge is good news for debt and dark news for the beaut eousness travel to option, other things held constant. ANS: True. 23. incorporate hedge of profession gamble unambiguously increases stockholder riches when the star sign is in financial wo. ANS: False.Because debtholders have amount one claim on corporate assets, corporate hedging of business put on the line helps debtholders first and whitethorn or may not help rightholders. 24. In the real world, corporate hedging policy derriere change expect future funds f let looses simply is un desirely to get over the cost of debt. ANS: False. hedgerow policy can decrease the unevenness of firm look on and can thus reduce the take a chance of debt and the required return aerated by debtholders. 25. Direct be of financial distress are far more important to corporate hedging finalitys than are corroborative be. ANS: False.The indirect cost of financial distress influence the activities of firms not upright in nonstarter but prior to nonstarter as well. 26. Underinves tment occurs when debtholders refuse to invest extra capital into the firm during financial distress. ANS: False. Underinvestment occurs when equity foregoes positive-NPV investments. 27. In financial distress, equity has an fillip to take on enormous risks in order to increase the value of the equity see option. ANS: True. 28. In Miller-Modigliani’s perfect world, the firm’s optimal investment standard is â€Å"Accept all positive-NPV projects. ANS: True. 29. In practice, management’s objective is to maximize treatholder wealth. ANS: False. Managers act nominally as equity’s agents but, in actuality, in their have best interest groups. 30. Managers have pocket-size motivator to hedge company-specific risks. ANS: False. As un modify stakeholders, managers are concerned with both organized and unsystematic risk. 31. Managers have an incentive to hedge their unit’s transaction exposure to currency risk. ANS: True. 32. hedgerow can incre ase firm value by reducing the be of agency conflicts between managers and shareholders.ANS: True. 33. Exchange-traded options and futures contracts have a fixed cost per contract so that be are proportional to the number of contracts traded. ANS: True. 34. The be of hedging through with(predicate) operations are likely to be less burdensome for a large multinational corporation with diversified operations than for a small, less-diversified firm. ANS: True. Multiple Choice 1. The perfect market assumptions include severally of the sideline draw off ____. a. satisfactory access to market prices b. affect access to costless information c. frictionless markets d. rational investors e. put back governments ANS: E 2. frictionless financial markets could have which of the following? a. agency be b. bid-ask spreads c. brokerage firm fees d. government intervention e. preposterous investors ANS: E 3. Which risk management guidelines in a) through d) is not recommended by the crowd of Thirty Global Derivatives check Group? a. assess the credit risk arising from derivatives activities b. combine pledge over trading and clerking functions into a single incision c. quantify market risk under adverse market conditions and perform stress tests d. alue derivatives positions at market e. all of the amplyer up are recommended ANS: B 4. Which of a) through d) is unlikely to pass in a decision to hedge currency risk? a. bid-ask spreads on foreign fill in b. cost of financial distress c. contraryial taxes on income from different tax jurisdictions d. stakeholder game-playing e. all of the in a higher place are incentives to hedge ANS:A 5. Which of the following factors does not contribute to tax memorandum convexness? a. Alternative negligible Tax (AMT) rules in the unify States b. modern revenue c. gross revenue taxes d. ax preference items e. all of the above contribute to tax account convexity ANS: C 6. Indirect cost of financial distress impa ct the firm in distributively of the following focal points except ____. a. higher financial be b. higher legal cost in unsuccessful person c. higher run cost d. glower revenues e. stakeholder gamesmanship ANS: B 7. Which of statements a) through c) regarding costs of financial distress is false? a. Both debt and equity unambiguously benefit from corporate risk hedging. b. Hedging can increase judge bills flows by reducing the costs of financial distress. c.Hedging can reduce debtholders’ required return and and so the cost of capital to the firm. d. totally of the above are ANS: True. e. None of the above are ANS: True. ANS: A 8. Which of the following was most amenable for the collapse of Barings Bank? a. failure proceedings b. failure to oversee the activities of its traders c. advocate arbitrage d. index futures and options trading e. the 1991 fall in share prices on the capital of Japan stock exchange ANS: B 9. Management has an incentive to hedge which of t he following exposures? a. operating exposure b. transaction exposure c. ranslation (accounting) exposure d. all of the above e. none of the above ANS: D 10. Tax schedules are said to be progressive when ____. a. the effective tax rate is greater at high levels of taxable income than at low levels b. the effective tax rate is greater at low levels of taxable income than at high levels c. they do not severalize on the basis of race, creed, or color d. when tax pass judgment vary by the age of the taxpayer e. none of the above ANS: A Problems 1. In what way is equity a call option on firm value? Tax schedule convexity: progressive receipts 2.Suppose corporate income up to $250,000 is taxed at a rate of 25 percent. Income over $250,000 is taxed at 40 percent. The taxable income of let out poultry entrust be either $200,000 or $300,000 with play off probability. let out’s income variability arises entirely from an exposure to currency risk. a. delineate a graph like Fig ure 9. 2 word-painting tax schedule convexity in the United States. b. What is let out’s expected tax liability if it does not hedge its currency risk? c. What is Quack’s expected tax liability if it is able to on the whole hedge its currency risk exposure and lock in taxable income of $250,000 with certainty? . In what way does hedging have value for Quack domestic fowl? Direct and indirect costs of financial distress 3. A firm based in the United Kingdom has promised to pay bondholders ? 10,000 in one year. The firm pass on be deserving either ? 9,000 or ? 19,000 with mate probability at that time depending on the value of the dollar. The firm give be price ? 14,000 if it hedges a run intost currency risk. a. account the determine of debt and equity under unweasel-worded and hedged scenarios assuming there are no costs of financial distress. b. Suppose the firm exit incur direct bankruptcy costs of ? ,000 in bankruptcy. Identify the value of debt and of equ ity under both unhedged and hedged scenarios. c. In addition to the ? 1,000 direct bankruptcy cost, suppose indirect costs reduce the asset value of the firm to either ? 6,000 or ? 18,000 (before the ? 1,000 direct bankruptcy cost) with equal probability. Hedging results in firm value of ? 12,000 with certainty. Identify the value of debt and of equity under both unhedged and hedged scenarios. d. Can hedging add value to shareholders in this problem? Problem Solutions 1.If the firm’s assets are expense more than that promised to debtholders, equity will manipulation its option to buy the assets of the firm from the debtholders at the exercise price. If firm assets are deserving less than the promised claim, equity will not exercise its option and debt assumes control of the firm. Tax schedule convexity: progressive taxation 2. a. [pic] b. Expected taxes with no hedging: (? )[($200,000)(0. 25)] + (? )[($250,000)(0. 25)+($50,000)(0. 40)] = (? )($50,000) + (? )($82, euchre) = $66,250. c. Expected taxes with hedging: ($250,000)(0. 5) = $62,ergocalciferol < $66,250. d. Hedging allows Quack to minimize its expected tax liability. This increase in expected future cash flows to equity results in an increase in equity value. 3. a. If firm value is ? 9,000, equity will not exercise its option to buy the firm at a price of ? 10,000. In this case, equity receives nothing and debt receives ? 9,000. If the firm is worth ? 19,000, equity pays the bondholders ? 10,000 and retains the residual ? 9,000. Firm value can be broken sight into E[VFIRM] = E[VBONDS] + E[STOCK] = [(? )(? 9,000)+(? )(? 10,000)] + [(? )(? 0)+(? (? 9,000)] = ? 9,500 + ? 4,500 = ? 14,000. Hedged, firm value can be broken atomic pile into VFIRM = VBONDS + VSTOCK = ? 10,000 + ? 14,000 = ? 14,000. In the absence of costs of financial distress, the decrease in the variability of firm value results in a reduction in call option value and a ?500 shift in value from equity to debt. b. Unhedged, f irm value is decomposed as: E[VFIRM] = E[VBONDS] + E[STOCK] = [(? )(? 9,000?? 1,000)+(? )(? 10,000)] + [(? )(? 0)+(? )(? 9,000)] = ? 9,000 + ? 4,500 = ? 13,500. With hedging, VFIRM = VBONDS + VSTOCK = ? 10,000 + ? 4,000 = ? 14,000.As in the forward example, the reduction in the variability of firm value is accompany by a ? 500 transfer of wealth from equity to debt. Hedging also avoids the deadweight ? 1,000 bankruptcy cost and yields an expected ready of (? )(? 1,000) = ? 500. In this example, debt drives the expected consume of ? 500. Equity will capture some of the go on if hedging results in lower interest payments on the next smooth of debt. c. Unhedged, firm value is E[VFIRM] = E[VBONDS] + E[STOCK] = [(? )(? 6,000?? 1,000) + (? )(? 10,000)] + [(? )(? 0)+(? )(? 8,000)] = ? 7,500 + ? 4,000 = ? 11,500.If the firm hedges, then VFIRM = VBONDS + VSTOCK = ? 10,000 + ? 2,000 = ? 12,000. This is the same as b) after including indirect costs of financial distress with an expected value of [(? )(? 9,000?? 6,000)+(? )(? 19,000?? 18,000)] = ? 1,500+? 500 = ? 2,000. d. Hedging can add value to shareholders if they can negotiate lower interest payments on debt because of their hedging policies. Even in financial distress, equity could offer to renegotiate the bond contract to more evenly share the gain in firm value from hedging. In this way, they can share in any gain from reducing the probability and costs of financial distress.\r\n'