I True or False -1- A high Book Value to Price ratio means a stock is overvalued

Finance Oct 09, 2020

I True or False

-1- A high Book Value to Price ratio means a stock is overvalued. _______

-2- The ratio of Book Value to Market Value can be greater than 1 for a firm. _______

-3- For any horizon value, the “Horizon” should be the expected time of a steady state. _______

II 15% Define

-1- Counter-party risk

-2- An option

-3- Free Cash Flow

III 50% Calculation – please hand in a spreadsheet with your work. Label your answers 1 – 7:

A firm projects these free cash flows (FCF) over the next five years: { -$3.0, -$1.0, $1.0, $3.0, $5.0} (in millions of dollars). It has five million shares outstanding, and faces a cost of equity of five percent. Using a discounted cash flows (DCF) method solve for:

-1- The horizon value of the firm.

-2- The value of a share.

-3- The firm is thinking of issuing another five million shares how will this impact -2-

-4- Should a shareholder be in favor of the new issuance (-3-), if the firm invests in a project that it expects will grow FCF by an additional $2 million per year through year 10.

-5- What will the value of the stock be if the firm is right?

-6- You think there is a 50% chance that the firm is right, but an equal chance profit will stop growing in year 7. Would you buy the firm at the price you found in -2-?

-7- What is the highest price you’d pay for the stock? Why?

IV 20% For thought

-1- One can buy or sell a call or a put, whether call or put, what distinguishes the seller of the product?

-2- In 1999 Southwest Airlines bought profitable options for jet fuel, several years into the future.

-a- In your own words what was the purpose of this program?

-b- What types of risks did Southwest face in these agreements?

-3- In 2008 the New York MTA lost a lot of money on swaps when interest rates moved unexpectedly in the wake of the Financial Crisis.

-a- In your own words, what was the purpose of the MTA swaps program?

-b- What types of risks did MTA face in these agreements?

-4- Given the experiences of MTA and Southwest, how would you advise a firm to consider hedging in options markets?

-5- Clearing houses act to connect buyers and sellers and they backstop agreements. Considering the 2019 experience of Nasdaq Clearing – what do you think the lessons are for a firm like Southwest or MTA when dealing in options through a clearing house?