Management Engineering - Finance Lab + Corporate FInance

Full exam

Exercise 1 Eros wants to invest into corporate bonds. On the market there are some alternatives: a) TVB345; risk free, zero coupon bond, maturity 5 months, price 99.751 b) KIS742; maturity 17 months, annual coupon 2%, rating BBB, clean price 99.998 c) MLF489; maturity 17 months, annual coupon 3% but paid every 6 months, rating BB, clean price 100.855 The spread requested by the market on BBB and BB bonds, compared to risk free securities, is equal to 1% and 1.4% respectively. Find: 1. The dirty price and the accrued interest for KIS742 and MLF489 bonds 2. Some points of the interest rate term structure of risk-free securities 3. The duration and YTM of the three bonds 4. The % change in the price of MLF489 if suddenly interest rates will increase by 1% on all maturities 5. The qualitative shape of a graph in which on the horizontal axis we have time and on the vertical axis the dirty price and clean price of bond MLF489, assuming that interest rates on the market will not change so much in the next months On the market there is a fourth bond (MLF490) which has all the same characteristics as MLF489 but it’s callable. Should the price of MLF490 on the market be larger or lower compared to MLF489? Exercise 2 Juliet wants to open a new laboratory to engineer innovative satellites. The initial investment required is equal to € 0.7 million. Expected operating cash flows, gross of income taxes, are as follows: time 1 = € 0.1 million, time 2 = € 0.25 million, time 3 = € 1 million, time 4 = € 0.8 million. The value of the project after time 4 is negligible, since other investments are expected to be required thereafter. The annual unlevered cost of capital for equity investors is equal to 20%. The tax rate on operating cash flows is equal to 20%. Compute the net present value (NPV) of the project under these alternative assumptions: 1. The initial investment is financed by equity capital only, available at time 0 from the entrepreneurial team 2. The initial investment will be financed partly by the entrepreneurial team and partly by an equity capital round with external investors, this requiring costs for legal staff and advisory equal to € 0.03 million (to be paid at time 1 and deductible from the taxable base) 3. The initial investment is financed by equity capital available and by new debt (amount € 0.3 million, annual interest rate 6%, paid back at time 4) 4. The initial investment is financed by equity capital available and by new debt (amount € 0.3 million, annual interest rate 6%, paid back from time 1 to time 4; the bank requires 4 constant annual payments R, which are comprehensive of interests and principal redemption) 5. The initial investment is financed by equity capital available and by new debt (annual interest rate always 6%); the bank wants that the ratio L between debt and value of the project is constant and equal to 40%. W hat is the cost of equity capital in this case? If you have time, after completing all three exercises, help Juliet in estimating the cash flows for shareholders and their expected return in cases #3 and #4. Exercise 3 Romeo manages a chain of coffee houses in Verona and is worried about the recent jump in the price of coffee on the market. Today the wholesale price is US$ 2.55 per pound, while just 6 months ago it was US$ 1.82 per pound. Analysts think that the price at time 6/12 can further increase to US$ 2.95 per pound, or go down to US$ 2.45 per pound. Assuming that the annual risk free rate in the Euro area is 0.2% and in the USA is 0.4%, compute: 1. The forward price of coffee, at 6/12 2. The value of a forward contract to buy coffee at 6/12, delivery price US$ 2.5 per pound 3. How do the previous answers change if we consider that there is a cost of carry on coffee equal to US$ 0.01 per pound per quarter 4. The value of a European call option on coffee, strike price US$ 2.7 per pound, time to delivery 6/12 (do not consider the costs of carry) 5. The value of the corresponding European put option Discuss the pros and cons (and costs) of possible hedging strategies that Romeo can take, in order to avoid increases in the costs for raw materials. Then, discuss if the European call option above can be traded on the market at the price of US$ 2.60 or maybe US$ 1.82. Academic year 20 21-20 22 The test must be completed in 120 minutes . Write immediately surname and name on papers provided by the staff. During the test you cannot read personal notes or books. If – to your opinion – the text is not clear, or is ambiguous, you can introduce proper assumptions. Corporate Finance (Prof. G. Giudici) Written test – February 14th 20 22 ♥