Fabozzi Frank, Peterson Pamela. Financial Management and Analysis Workbook

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30 QUESTIONS AND PROBLEMS

4. What are the differences between options and futures

contracts?

5. What is the interpretation of a swap?

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Introduction to Derivatives 31

PROBLEMS

Refer to Chapter 4, pages 83–104 in Financial Management

and Analysis.

1. Alex and Adrienne take positions in a futures contract.

Alex is the buyer of the futures contract and Adrienne is

the seller of the futures contract. If the futures price is

$100, what are the possible outcomes for the market par-

ticipants if Asset X increases to $135? If Asset X

decreases to $50?

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32 QUESTIONS AND PROBLEMS

2. Illustrate the characteristics of a call and a put option con-

tract given the following information: Lydia buys an

American call (put) option for $3 with the following

terms: The underlying is one unit of Asset X with an exer-

cise price of $75 and an expiration date of three months

from now.

3. Illustrate the purchase of a call option on Asset X that

expires in two months and has an exercise price of $40

and an option price of $2. What is the profit or loss for the

investor who purchases this call option and holds it until

its expiration date?

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Introduction to Derivatives 33

4. If the exercise price for a call option is $100 and the cur-

rent asset price is $110, what is the intrinsic value? What

is the intrinsic value for a put option with an exercise price

of $100 and a current asset price of $90?

5. Explain how futures are used to manage risk for a farmer

who grows corn and a canning company who buys the

corn for processing and selling in grocery stores.

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Ch4 Page 34 Monday, December 15, 2003 5:00 PM

CHAPTER

Taxation

FILL IN THE BLANKS

Refer to Chapter 5, pages 107–122 in Financial Manage-

ment and Analysis.

1. In the United States, ______________ passes the tax

______________ that comprises the ______________. The

______________, a part of the Treasury Department,

______________ these laws, ______________ the details,

and ______________ them. The ______________ does this

by ______________ and ______________ tax forms,

______________ tax payments, ______________ the law

in its regulations, and providing ______________ in some

situations.

2. The U.S. ______________ originated in ______________

with a(n) ______________ tax on corporate income but

has since become very ______________. The financial

______________ cannot simply assume that the tax rate

in existence ______________ will be the same in the

______________. The ______________-tax ______________

of a firm over time must take into consideration the

______________ tax rates.

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36 QUESTIONS AND PROBLEMS

3. The ______________ tax rate is the rate that ______________

the tax ______________ and is the rate at which the next

______________ of income would be taxed. The

______________ tax rate is the ______________ of the tax

______________ to the taxable income. A(n)

______________ tax is one that levies a higher

______________ tax rate on ______________ incomes. A

company’s ______________ or ______________ decision

is likely to affect ______________ income, and hence cash

flow, through the ______________ tax rate.

4. Corporate income distributed to ______________ as

______________ is taxed ______________, first as

______________ income and then as ______________

income, and then if the shareholder is another

______________, it could be taxed a(n) ______________

time. To minimize the chance of ______________ or more

taxation of the same income, the tax laws permit a(n)

______________ deduction. This is when a corporate

______________ of ______________ may deduct a portion

of its ______________ income from its ______________

income. The ______________ deduction ______________

the after-tax ______________ of a corporation

______________ in another corporation’s stock.

5. The two methods of depreciation available to business tax-

payers are a(n) ______________ method and a(n)

______________ method. A firm can select a method of

______________ that is based on the expected

______________ of ______________ depreciation of its assets

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Taxation 37

and the ______________ on reported ______________. The

current depreciation tax laws are the result of an ongoing

trend to create more ______________ in ______________

methods among business ______________ while at the

same time simplifying the ______________ and allowing

______________ depreciation and ______________ asset lives.

6. According to the tax law, a(n) ______________ is specifi-

cally a(n) ______________ gain that results when an asset

is ______________ for more than was ______________ for

it. Congress has traditionally granted special

______________ for capital gains through ______________

effective ______________ rates.

7. ______________ tax credit (______________) was intended

to ______________ investment spending by directly

______________ the ______________ income tax.

______________ can be ______________ at any time that

______________ feels investment ______________ needs to be

stimulated. Whereas ______________ and ______________

both ______________ taxes payable, a(n) ______________

reduces taxable income and thus ______________ reduces

the taxes paid.

8. A(n) ______________ is an excess of business ______________

over business gross ______________ in a tax year. The IRC

allows businesses to carry ______________ a net operating

loss to ______________ years and to carry ______________

the loss to ______________ years to ______________ the

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38 QUESTIONS AND PROBLEMS

taxes payable for those years. The current tax law permits

net operating losses of corporations to be carried

______________ three years from the year of the loss and

carried ______________ for 15 years.

9. Countries typically tax resident corporations on

______________ income, regardless of whether the

______________ is repatriated. ______________ corpora-

tions, that is, corporations whose corporate ______________

and place of ______________ are outside the country, are typ-

ically subject only to ______________ taxes derived from

within the country. The ______________ rates vary signifi-

cantly from country to country and some impose

______________ tax or ______________ tax rates. These

countries are referred to as tax ______________.

SHORT ANSWER QUESTIONS

Refer to Chapter 5, pages 107–122 in Financial Manage-

ment and Analysis.

1. In the United States there are several kinds of taxes

imposed. What are they and what is their purpose?

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Taxation 39

2. How does dividend income affect investors? How does

dividend income affect the corporation?

3. What are the features of the modified accelerated cost

recovery system (MACRS) and how is this different from

the straight-line method?

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