Question

4. We can express a firm in terms of a call/put option. In this context, the equity in the firm is like the (a) with its strike price being the face value of debt. From another perspective, stockholders position is equivalent to holding a portfolio of a long

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position of the (b), a short position of the (c), and a long position of the (d). Which of the following has the correct answers for blanks (a)-(d) in that order?

A. futures on the firm; firm; put option on the firm; risk-free zero-coupon bond

B. put option on the firm; firm; call option on the firm; risk-free zero-coupon bond

C. call option on the firm; firm; put option on the firm; risk-free zero-coupon bond

D. put option on the firm; firm; risk-free zero-coupon bond; call option on the firm

E. call option on the firm; firm; risk-free zero-coupon bond; put option on the firm

8. Issuing debt instead of large new equity in a small, all-equity firm more likely:
   1. causes the owner-manager to work less hard and shirk their duties as they have less capital at risk.
   2. causes the owner-manager to consume more perquisites because the cost is passed to the debtholders.
   3. causes both more shirking and perquisite consumption since the government provides a tax shield on debt.
   4. causes agency costs to rise as owner-managers do not need to worry about other shareholders.
   5. causes the owner-manager to reduce shirking and perquisite consumption as the owner-manager does not face ownership dilution.

9. The introduction of personal taxes may reveal a disadvantage to the use of debt if the:
   1. dividend income tax rate is less than the interest income tax rate.
   2. dividend income tax rate is greater than the interest income tax rate.
   3. dividend income tax rate is equal to the interest income tax rate.
   4. interest income tax rate is zero.
   5. none of the above.

10. You can realize the same value/payoff as that derived from buying a put on a stock if you:
    1. have a short position in a stock, buy a call on a stock, and lend some fund at the risk-free rate (i.e., buy a risk-free zero-coupon bond).
    2. buy a call on a stock, write a put on a stock, and borrow some fund at the risk-

free rate (i.e., sell a risk-free zero-coupon bond).

C. sell a put on a stock, buy a call on a stock, and lend some fund at the risk-free rate.

D. lend some fund at the risk-free rate and sell a put on the stock.

E. borrow some fund at the risk-free rate and invest the proceeds in equivalent amounts of put and call options on a stock.

Answer 1

two of the answers will be given by put call parity

Put + stock price = call + PV(risk free bond)

Ans 1) Correct answer is option E call option on the firm; firm; risk-free zero-coupon bond; put option on the firm

Ans 2) Correct answer is option B causes the owner-manager to consume more perquisites because the cost is passed to the debtholders.

ans 3) Correct answer is option A dividend income tax rate is less than the interest income tax rate.

Ans 4) Correct answer is option A have a short position in a stock, buy a call on a stock, and lend some fund at the risk-free rate