What is the effect of eliminating intercompany interest income and interest expense on consolidated net income when bonds have been sold directly to an affiliate? Why?
> Able Company issued $600,000 of 9 percent first mortgage bonds on January 1, 20X1, at 103. The bonds mature in 20 years and pay interest semiannually on January 1 and July 1. Prime Corporation purchased $400,000 of Able’s bonds from the original purchase
> Bradley Corporation sold bonds to Flood Company in 20X2 at 90. At the end of 20X4, Century Corporation purchased the bonds from Flood at 105. Bradley then retired the full bond issue on December 31, 20X7, at 101. Century holds 80 percent of Bradley’s vot
> Assume the same facts as in E8-1 and prepare entries using straight-line amortization of bond discount or premium. Data from E8-1: Lamar Corporation owns 60 percent of Humbolt Corporation’s voting shares. On January 1, 20X2, Lamar Corporation sold $150
> Lamar Corporation owns 60 percent of Humbolt Corporation’s voting shares. On January 1, 20X2, Lamar Corporation sold $150,000 par value, 6 percent first mortgage bonds to Humbolt for $156,000. The bonds mature in 10 years and pay interest semiannually on
> How does the use of interperiod tax allocation procedures affect the amount of income assigned to noncontrolling shareholders in the period in which the subsidiary records unrealized intercompany profits?
> Are there any book-tax differences that arise in an acquisition that do not require the inclusion of a deferred tax asset or liability in the net identifiable assets acquired?
> Snapper Corporation holds 70 percent ownership of Bit Company, and Bit holds 60 percent ownership of Slide Company. Should Slide be consolidated with Snapper Corporation? Why?
> How will parent company shares held by a subsidiary be reflected in the consolidated balance sheet when the treasury stock method is used?
> Major companies often have very complex organizational structures, sometimes consisting of different types of entities. Some organizational structures include combinations of corporations, partnerships, and perhaps other types of entities. Complex organi
> What effect will a subsidiary’s 15 percent stock dividend have on the consolidated financial statements?
> How is the amount of income assigned to the noncontrolling interest affected when the parent purchases the bonds of its subsidiary from an unaffiliated company for less than book value?
> How is the amount of income assigned to the noncontrolling interest affected by the direct placement of a subsidiary’s bonds with the parent company?
> When a subsidiary purchases the bonds of its parent from a nonaffiliate for less than book value, what will be the effect on consolidated net income and income to the controlling interest?
> What portion of the sales of an acquired company is included in the consolidated income statement following a midyear acquisition?
> Are sales included in the consolidated cash flows worksheet in computing cash flows from operating activities under (a) the indirect method or (b) the direct method?
> A parent company sells common shares of one of its subsidiaries to a nonaffiliate for more than their carrying value on the parent’s books. How should the parent company report the sale? How should the sale be reported in the consolidated financial state
> Why are changes in inventory balances not shown in the statement of cash flows when the direct method is used in presenting the cash flows from operating activities?
> What portion of subsidiary preferred stock outstanding is reported as part of the noncontrolling interest in the consolidated balance sheet?
> How do the consolidation entries at the end of the year change when an acquisition occurs at midyear rather than at the beginning of the year?
> Assume the same facts as in E8-6 except that the company uses straight-line amortization. Required: Select the correct answer for each of the following questions. What amount of interest expense should be included in the 20X4 consolidated income s
> How are dividends declared by an acquired company prior to the date of a midyear acquisition treated in the consolidated financial statements?
> How is an increase in inventory included in the amounts reported as cash flows from operating activities under (a) the indirect method and (b) the direct method?
> Why are payments to suppliers not shown in the statement of cash flows when the indirect method is used in presenting cash flows from operating activities?
> Why are dividend payments to noncontrolling shareholders treated as an outflow of cash in the consolidated cash flow statement but not included as dividends paid in the consolidated retained earnings statement?
> How do interperiod income tax allocation procedures affect consolidation entries in the period in which intercompany profits unrealized as of the beginning of the period are realized?
> How do interperiod income tax allocation procedures affect consolidation entries in the period in which unrealized intercompany profits arise?
> How do unrealized profits on intercompany transfers affect the amount reported as income tax expense in the consolidated financial statements?
> Why do companies that file consolidated tax returns often choose to allocate tax expense to the individual affiliates?
> What factors would cause an acquirer to include deferred tax assets and liabilities in the net identifiable assets acquired?
> Why not simply add a fourth part to the three-part consolidation worksheet to permit preparation of a consolidated cash flow statement?
> On January 1, 20X4, Passive Heating Corporation paid $104,000 for $100,000 par value, 9 percent bonds of Solar Energy Corporation. Solar had issued $300,000 of the 10-year bonds on January 1, 20X2, for $360,000. The bonds pay interest semiannually. Passi
> What is indirect ownership? How does one company gain control of another through indirect ownership?
> How are treasury shares held by a subsidiary reported in the consolidated financial statements?
> A parent company purchases additional common shares of one of its subsidiaries from the subsidiary at $10 per share above underlying book value. Explain how this purchase is reflected in the consolidated financial statements for the year.
> A subsidiary sells additional shares of its common stock to a nonaffiliate at a price that is higher than the previous book value per share. How does the sale benefit the existing shareholders?
> How does a call feature on subsidiary preferred stock affect the claim of the noncontrolling interest reported in the consolidated balance sheet?
> Why are subsidiary preferred dividends that are paid to nonaffiliates normally deducted from earnings in arriving at consolidated net income? When is it not appropriate to deduct subsidiary preferred dividends in computing consolidated net income?
> When multilevel affiliations exist, explain why it is generally best to prepare consolidated financial statements by completing the consolidation entries for companies furthest from parent company ownership first and completing the consolidation entries
> What effect will a subsidiary’s 15 percent stock dividend have on the consolidation entries used in preparing a consolidated balance sheet at the end of the year in which the dividend is distributed?
> Shortly after a parent company purchased its subsidiary’s bonds from a nonaffiliate, the subsidiary retired the entire issue. How is the gain or loss on bond retirement reported by the subsidiary treated for consolidation purposes?
> A parent purchases a subsidiary’s bonds directly from it. The parent later sells the bonds to a nonaffiliate. From a consolidated viewpoint, what occurs when the parent sells the bonds? Is a gain or loss reported in the consolidated income statement when
> Intercompany debt, both long term and short term, arises frequently. In some cases, intercorporate borrowings may arise because one affiliate can borrow at a cheaper rate than others, and lending to other affiliates may reduce the overall cost of borrowi
> A parent company purchased its subsidiary’s bonds from a nonaffiliate in the preceding year, and a loss on bond retirement was reported in the consolidated income statement. How will income assigned to the noncontrolling interest be affected in the year
> A subsidiary purchased bonds of its parent company from a nonaffiliate in the preceding period, and a gain on bond retirement was reported in the consolidated income statement as a result of the purchase. What effect will that event have on the amount of
> How would the relationship between interest income recorded by a subsidiary and interest expense recorded by the parent be expected to change when comparing a direct placement of the parent’s bonds with the subsidiary to a constructive retirement in whic
> How does the consolidation process deal with a subsidiary’s preferred stock?
> When the parent company purchases a subsidiary’s bonds from a nonaffiliate for more than book value, what income statement accounts will be affected in preparing consolidated financial statements? What will be the effect on income assigned to the control
> If an affiliate’s bonds are purchased from a nonaffiliate at the beginning of the current year, how can the amount of the gain or loss on constructive retirement be computed by looking at the two companies’ year-end trial balances?
> What is the effect of eliminating intercompany interest income and interest expense on consolidated net income when a loss on bond retirement has been reported in a prior year’s consolidated financial statements as a result of a constructive retirement o
> When a parent company sells land to a subsidiary at more than book value, the consolidation entries at the end of the period include a debit to the gain on the sale of land. When a parent purchases the bonds of a subsidiary from a nonaffiliate at less th
> For a multicorporate entity, how is the recognition of gains or losses on bond retirement changed when emphasis is placed on the economic entity rather than the legal entity?
> Kruse Corporation holds 60 percent of the voting common shares of Gary’s Ice Cream Parlors. On January 1, 20X6, Gary’s purchased $50,000 par value, 10 percent first mortgage bonds of Kruse from Cane for $58,000. Kruse originally issued the bonds to Cane
> Musical Corporation acquires 80 percent of Dustin Corporation’s common shares on January 1, 20X2. On January 2, 20X2, Dustin acquires 60 percent of Rustic Corporation’s common stock. Information on company book values
> Find the value of an American put option using the binomial option pricing model. The parameters are S 62, X 70, r 0.08, u 1.10, and d 0.95. There are no dividends. Use n 2 periods.
> Consider a currency swap for $10 million and SF 15 million. One party pays dollars at a fixed rate of 9 percent, and the other pays Swiss francs at a fixed rate of 8 percent. The payments are made semiannually based on the exact day count and 360 days in
> Show how to combine a currency swap paying Swiss francs at a floating rate and receiving Japanese yen at a floating rate with another currency swap to obtain a plain vanilla swap paying Swiss francs at a floating rate and receiving Swiss francs at a fixe
> The value Max[0, X(1 r)−T − S0] was shown to be the lowest possible value of a European put. Why is this value irrelevant for an American put?
> Compare and contrast the characteristics of contango, backwardation, normal contango, and normal backwardation markets.
> One way to create a bear spread positions is by purchasing a high strike put option and selling a low strike put option. Identify a strategy with call options that creates a similar bear spread-shaped profit profile. The following option prices were obs
> One way to create a bull spread positions is by purchasing a low strike call option and selling a high strike call option. Identify a strategy with put options that creates a similar bull spread shaped profit profile.
> Using the information in the previous problem, calculate the price of the put described in problem 17, using the Black model for pricing puts.
> Use the Black model to determine a fair price for an interest rate put that expires in 74 days. The forward rate is 9.79 percent, and the exercise rate is 10 percent. The appropriate risk-free rate is 8.38 percent. All rates are continuously compounded.
> Assume the 30-day LIBOR is 5 percent and the 120-day LIBOR is 6 percent. This implies a continuously compounded 90-day forward rate of 6.3448 percent. Verify this result and explain what happens to the continuously compounded forward rate as the number o
> Assume the 30-day LIBOR is 5 percent and the 120-day LIBOR is also 5 percent. This implies a continuously compounded 90-day forward rate of 5.0172 percent. Verify this result and explain what happens to the continuously compounded 90-day forward rate as
> A bank is offering an interest rate call with an expiration of 45 days. The call pays off based on 180-day LIBOR. The volatility of forward rates is 17 percent. The 45-day forward rate for 180-day LIBOR is 0.1322, and the exercise rate is 12 percent. The
> Identify and define three versions of put-call parity.
> In each case examined in this chapter and in the preceding problems, we did not account for the interest on funds invested. One useful way to observe the effect of interest is to look at a conversion or a reverse conversion. Evaluate the August 165 puts
> You are the manager of a bond portfolio of $10 million face value of bonds worth $9,448,456. The portfolio has a yield of 12.25 percent and a duration of 8.33. You plan to liquidate the portfolio in six months and are concerned about an increase in inter
> Assume a standard deviation of 8 percent and use the Black model to determine whether the call option in problem 17 is correctly priced. If not, suggest a riskless hedge strategy.
> Consider a $30 million notional amount interest rate swap with a fixed rate of 7 percent, paid quarterly on the basis of 90 days in the quarter and 360 days in the year. The first floating payment is set at 7.2 percent. Calculate the first net payment an
> On March 16, the June Treasury bond futures contract was priced at 100 17/32 and the September contract was at 99 17/32. Determine the implied repo rate on the spread. Assume that the cheapest bond to deliver on both contracts is the 11 1/4 maturing in 2
> Complete the following table with the correct formula related to various spread strategies. Collar Strategies Straddle with Calls with Calls Item and Puts and Puts Value at expiration Profit Maximum profit Maximum loss Breakeven and
> Complete the following table with the correct formula related to various spread strategies. Bull Вear Butterfly Spread Spread Spread Item with Calls with Puts with Calls Value at еxpiration Profit Maximum profit Maximum loss Breakeven and
> Suppose there is a commodity in which the expected future spot price is $60. To induce investors to buy futures contracts, a risk premium of $4 is required. To store the commodity for the life of the futures contract would cost $5.50. Find the futures pr
> Examine the following pairs of puts, which differ only by exercise price. Determine whether either of them violates the rules regarding relationships between American options that differ only by exercise price. a. August 155 and 160 b. October 160 and
> Examine the following pairs of calls, which differ only by exercise price. Determine whether either of them violates the rules regarding relationships between American options that differ only by exercise price. a. August 155 and 160 b. October 160 and
> Repeat the last problem using the approximation for an at-the-money call. Compare your answer with the one you obtained in problem 13. Is the approximation a good one? Why or why not?
> A swap dealer quotes that the rate on a plain vanilla swap, for it to pay fixed, is the five-year Treasury rate plus 10. To receive fixed, the dealer quotes the rate as the five-year Treasury rate plus 15. Assuming the five-year Treasury rate is 7.60 per
> Construct a table containing the up and down factors for a one-year option with a stock volatility of 55 percent and a risk-free rate of 7 percent for n 1, 5, 10, 50, and 100, where n is the number of binomial periods. Let u and d be defined as = e°V
> Consider a $100 million equity swap with semiannual payments. When the swap is established, the underlying stock is at 1,215.52. One party pays a fixed rate of 5.5 percent based on the assumption of 30 days per month and 360 days in a year. If the stock
> Solve for the price of a forward contract on a generic asset that expires on September 10 whose spot price as of June 10 is $45, assuming that the annually compounded risk-free rate is 6.01 percent.
> A corporation enters into a $35 million notional amount interest rate swap. The swap calls for the corporation to pay a fixed rate and receive a floating rate of LIBOR. The payments will be made every 90 days for one year and will be based on the adjustm
> The CEO of a large corporation holds a position of 25 million shares in her company’s stock, which is currently priced at $20 and pays no dividends. She is concerned that because of her large shareholdings and the fact that her compensation is tied to th
> The U.K. manager of an international bond portfolio would like to synthetically sell a large position in a French government bond, denominated in euros. The bond is selling at its par value of €46.15 million, which is equivalent to £30 million at the cur
> Suppose you are a municipal finance director for a large metropolitan city. Based on your asset-liability analysis, you determine that your rate-sensitive assets are equivalent to a one-year LIBOR deposit and your rate-sensitive liabilities are equivalen
> Suppose a trader has entered two $15 million notional amount equity swaps both with a fixed rate of 6 percent, paid quarterly on the basis of 90 days in the quarter and 360 days in the year. The first swap is a receive fixed and pay three-month total ret
> Suppose a trader has entered two $50 million notional amount interest rate swaps both with a fixed rate of 3 percent, paid quarterly on the basis of 90 days in the quarter and 360 days in the year. The first swap is a receive fixed and pay three-month LI
> An interest rate swap has two primary risks associated with it. Identify and explain each risk.
> On January 31, a firm learns that it will have additional funds available on May 31. It will use the funds to purchase $5,000,000 par value of the APCO 9 1/2 percent bonds maturing in about 21 years. Interest is paid semiannually on March 1 and September
> On January 2 of a particular year, an American firm decided to close out its account at a Canadian bank on February 28. The firm is expected to have 5 million Canadian dollars in the account at the time of the withdrawal. It would convert the funds to U.
> On June 17 of a particular year, an American watch dealer decided to import 100,000 Swiss watches. Each watch costs SF225. The dealer would like to hedge against a change in the dollar/Swiss franc exchange rate. The forward rate was $0.3881. Determine th
> Use the information in problem 16 to construct a euro covered call. Assume that the spot rate at the start is $0.9825.
> On March 16, the March Treasury bond futures settlement price was 101 21/32. Assume that the 12 1/2 percent bond maturing in about 22 years is the cheapest bond to deliver. The CF is 1.4639. Assume that the price at 3:00 P.M. was 150 15/32. Determine the
> For each of the following situations, determine whether a long or short hedge is appropriate. Justify your answers. a. A firm anticipates issuing stock in three months. b. An investor plans to buy a bond in 30 days. c. A firm plan to sell some foreign
> Explain how to determine whether to buy or sell futures when hedging.
> a. Define the minimum variance hedge ratio and the measure of hedging effectiveness. What do these two values tell you? b. What is the price sensitivity hedge ratio? How are the price sensitivity and minimum variance hedge ratios alike? How are they di
> Suppose you are a dealer in sugar. It is September 26, and you hold 112,000 pounds of sugar worth $0.0479 per pound. The price of a futures contract expiring in January is $0.0550 per pound. Each contract is for 112,000 pounds. a. Determine the original
> Recall from the chapters on options that we learned about bull and bear spreads. Intermarket futures spreads also are considered bull and bear spreads. Describe what you think might be a bull spread with T-bonds futures. Be sure to explain your reasoning
> You plan to buy 1,000 shares of Swiss International Airlines stock. The current price is SF950. The current exchange rate is $0.7254/SF. You are interested in speculating on the stock but do not want to assume any currency risk. You plan to hold the posi
> As we discussed in the chapter, futures can be used to eliminate systematic risk in a stock portfolio, leaving it essentially a risk-free portfolio. A portfolio manager can achieve the same result, however, by selling the stocks and replacing them with T
