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Unformatted text preview: Bodie, Kane, Marcus, Perrakis and Ryan, Chapter 2 Answers to Selected Problems 1. The following multiple-choice problems are based on questions that have appeared in past CFA examinations. a A firms preferred stock often sells at yields below its bonds because i. A referred stock generally carries a higher agency rating. Note: This cannot be the right answer. Since interest payments to bond- holders have to be paid and dividends dont, preferred stocks cannot have a better rating than bonds. ii. Owners of preferred stocks have a prior claim on the firms earnings. Note: This cannot be the right answer. The statement refers to common stocks, not bonds. iii. Owners of preferred stocks have a prior claim on a firms assets in the event of liquidation. Note: This cannot be the right answer. Bondholders get paid before pre- ferred stock holders in the event of liquidation. iv. Corporations owning stocks may exclude from income taxes most of the div- idend income they receive. This is the right answer. Tax rates on dividends are less than tax rates on interest income for anybody, not only corporations. However corporation ben- efits from huge tax credit on dividend payments, which can go up to 100% if 1 the dividend comes from domestic corporation. This makes preferred stocks very attractive for corporations, and this explains why they can be sold with a much lower yield than comparable bonds. b Which is the most risky transaction to undertake in the stock index option markets if the stock market is expected to increase substantially after the transaction is completed? (i) Write a call option. (ii) Write a put option. (iii) Buy a call option. (iv) Buy a put option. Answer: Risk is what we cant control. When buying options, call or put, there is some risk that the option ends up worthless but the fact that it will be exercised or not entirely depends on the option holder and thus does not constitute risk....
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- Spring '12