Hedging Jeopardy

Taxes

100

This is the function of the graph (concave/convex) that represents a firm's pre-tax vs. post-tax value

Concave

200

Through the Value-of-a-firm equation, we find that costless hedging _____ the value of a firm

Increases

300

Why do firms that face progressive tax brackets hedge their income volatility?

Hedging lowers the average tax rate paid

400

The investment tax credit does _____ (convex/concave) to the tax function, making it ____ (more/less) valuable to hedge

Convex, More

500

Can you explain to me the value of a firm's equation (in the absence of leverage):

V(0) = Σ (i=1:S) * P_i (V_i - T(V_i)V_i)

The value of a firm V, given the sum of all outcomes, where the value of a firm is the lesser of its taxed amount, multiplied by the price of one dollar today

Direct vs. Indirect Costs

100

Bankruptcy costs such as lawyer fees and court administration are considered ____

Direct costs

200

These costs may include loss of consumer confidence, or supplier demands

Indirect costs

300

These stakeholders demand "cash-in-advance" if your firm is in financial distress

Suppliers

400

According to the reading, these costs are more important to the firm when deciding to hedge

Indirect costs

500

Foreign customers are described as being this way regarding financial distress

More sensitive

Expected Value

100

Calculate the expected FIRM value for two equally likely outcomes of $500 and $1500

$1000

200

Calculate the expected EQUITY value of a firm with a $750 debt, and equally likely outcomes of $500 and $1500

$375

300

Calculate the expected value of DEBTHOLDERS for a firm with $1000 in debt, and equally likely outcomes of $400 and $2000.

$700

400

Calculate the value of DEBTHOLDERS for a firm with $1000 in debt, equally likely outcomes of $750 and $2000, with $300 in direct bankruptcy costs

$725

500

Calculate the expected FIRM and EQUITY value for a firm that has $1500 in debt, two equally likely outcomes of $1000 and $2500, direct bankruptcy costs of $500, and indirect bankruptcy costs of $75

Firm: $1462.50

Equity: $500

Debt vs Equity Scenarios

100

Equity's claim on the firm can be referred to as this type of financial asset

Call Option

200

During financial distress, equity holders have a motive to take on projects with ____ risk, even if they have a negative NPV

High

300

Hedging in the preparation of bankruptcy helps reduce ____ costs

Direct AND Indirect

400

This issue occurs when equity refuses to fund projects in distress due to debt being paid first

Underinvestment

500

Debt uses these provisions to prevent equity holders from paying out excessive dividends or taking high risk during financial distress

Protective covenants

Callbacks to Previous Chapters

100

What is the problem created by the IMF's role in offering loans to distressed countries in currency crises?

Moral Hazard

- How can you relate moral hazard to companies making decisions to hedge?

200

This type of hedge occurs when there is both a currency and maturity mismatch

Cross-Delta Hedge

300

What is rule #2?

Always keep the currency you are trading in the denominator.

400

Toyota hedging a $1 Million in receivables with a long $ put option, versus engaging in a 5 year currency swap. The option provides this that the swap doesn't

Asymmetric Protection/Disaster Insurance (downside protection and upside participation)

500

Please explain and compare the four main types of financial derivatives we have covered so far in this class

1. Forwards

2. Futures

3. Options

4. Swaps