Exam 23: Swap Contracts, Convertible Securities, and Other Embedded Derivatives

Exhibit 23.6 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) BioTech Industries has debentures outstanding (par value $1,000) convertible into the company's common stock at $30. The coupon rate is 11 percent payable semiannually and they mature in 10 years. -Refer to Exhibit 23.6. Calculate the conversion value of the bond if the stock price is $27.00 per share.

The issuance of convertibles will ultimately lead to greater dilution than an initial issue of stock.

A(n) ____ contract is an arrangement whereby the coupon rate on a note moves in the opposite direction of some variable rate index.

The writer of a ____ agreement makes settlement payments when LIBOR is greater than the striking rate of the agreement.

Warrants differ from options in a number of ways. Which of the following statements about warrants and options is false?

Exhibit 23.10 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) TexMex Corporation has decided to borrow $50,000,000 for six months in two three-month issues. The corporation is concerned that interest rates will rise over the next three months. Thus, the corporation purchases a 3 * 6 FRA whereby the corporation pays the dealer's quoted fixed rate of 3.5% in exchange for receiving 3-month LIBOR at the settlement date. In order to hedge her exposure, the dealer buys LIBOR from Newport Inc. at its bid rate of 3%. The notional principal is $50,000,000 and that there are 60 days between month 3 and month 6. -Refer to Exhibit 23.10. Suppose that 3-month LIBOR is 4.0% on the rate determination day, and the contract specified settlement in arrears at month 6, describe the transaction that occurs between the dealer and TexMex.

The conversion premium for a convertible bond is calculated as:

Exhibit 23.1 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) A company buys an interest rate cap that pays the difference between LIBOR and 8% if LIBOR exceeds 8%. Current LIBOR is 7%. The amount of the option is $2,500,000, and the settlement is every 6 months. Assume a 360 day year. -Refer to Exhibit 23.1. Find the payoff if LIBOR closes at 8.2%.

Suppose the premium on a three year, four percent floor is equal to the premium on a three year, eight percent cap. This combination is referred to as

By attaching a convertible feature to a bond issue a firm can often get a lower rate of interest on its debt.

Options embedded in real assets owned by firms are known as

Exhibit 23.4 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Black Gold Industries (BGI) is an independent oil producer with production capacity of 500,000 barrels per month. Due to the cost structure of the business, BGI needs to receive $56.50 per barrel in order to remain solvent. On the other side of this situation is Petrochemicals Unlimited (PU) which uses an average of 500,000 barrels of West Texas crude oil in its normal production operations. The nature of PU's business is such that they will financially suffer if they have to pay more than an average of $57.80 per barrel for oil over the next six years. To hedge against their exposure to volatile oil prices, BI and PU contact a swap dealer to arrange the six-year oil swap described below: -Refer to Exhibit 23.4. Describe the transaction that occurs between PU and the swap dealer if the monthly average oil futures settlement price is $58.45.

All of the following are normal characteristics of a convertible bond, except

Exhibit 23.10 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) TexMex Corporation has decided to borrow $50,000,000 for six months in two three-month issues. The corporation is concerned that interest rates will rise over the next three months. Thus, the corporation purchases a 3 * 6 FRA whereby the corporation pays the dealer's quoted fixed rate of 3.5% in exchange for receiving 3-month LIBOR at the settlement date. In order to hedge her exposure, the dealer buys LIBOR from Newport Inc. at its bid rate of 3%. The notional principal is $50,000,000 and that there are 60 days between month 3 and month 6. -Refer to Exhibit 23.10. Suppose that 3-month LIBOR is 4.0% on the rate determination day, and the contract specified settlement in advance, describe the transaction that occurs between the dealer and TexMex.

Exhibit 23.1 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) A company buys an interest rate cap that pays the difference between LIBOR and 8% if LIBOR exceeds 8%. Current LIBOR is 7%. The amount of the option is $2,500,000, and the settlement is every 6 months. Assume a 360 day year. -Refer to Exhibit 23.1. Find the payoff if LIBOR closes at 7.8%.

The investment value of a convertible bond is the price which it would be expected to sell as a straight debt instrument.

Exhibit 23.6 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) BioTech Industries has debentures outstanding (par value $1,000) convertible into the company's common stock at $30. The coupon rate is 11 percent payable semiannually and they mature in 10 years. -The common stock of BioTech Industries pays a dividend of $1 per share and has a current market price of $27 per share. The convertible bond is selling for $1100. The payback or breakeven time for the bond is

A major difference between a call option and a warrant is that call options are issued by the company so that any proceeds from the sale of stock go to the issuing firm.

Exhibit 23.4 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) Black Gold Industries (BGI) is an independent oil producer with production capacity of 500,000 barrels per month. Due to the cost structure of the business, BGI needs to receive $56.50 per barrel in order to remain solvent. On the other side of this situation is Petrochemicals Unlimited (PU) which uses an average of 500,000 barrels of West Texas crude oil in its normal production operations. The nature of PU's business is such that they will financially suffer if they have to pay more than an average of $57.80 per barrel for oil over the next six years. To hedge against their exposure to volatile oil prices, BI and PU contact a swap dealer to arrange the six-year oil swap described below: -Refer to Exhibit 23.4. Describe the transaction that occurs between BGI and the swap dealer if the monthly average oil futures settlement price is $58.45.

Exhibit 23.10 USE THE INFORMATION BELOW FOR THE FOLLOWING PROBLEM(S) TexMex Corporation has decided to borrow $50,000,000 for six months in two three-month issues. The corporation is concerned that interest rates will rise over the next three months. Thus, the corporation purchases a 3 * 6 FRA whereby the corporation pays the dealer's quoted fixed rate of 3.5% in exchange for receiving 3-month LIBOR at the settlement date. In order to hedge her exposure, the dealer buys LIBOR from Newport Inc. at its bid rate of 3%. The notional principal is $50,000,000 and that there are 60 days between month 3 and month 6. -Refer to Exhibit 23.10. Suppose that 3-month LIBOR is 4.0% on the rate determination day, and the contract specified settlement in arrears at month 6, describe the transaction that occurs between the dealer and Newport.