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(Solution) Corporate Finance: Assignment

   

Added on  2021-04-21

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Running head: CORPORATE FINANCECorporate FinanceName of the Student:Name of the University:Authors Note:

CORPORATE FINANCE1Table of ContentsQ1A. Five factors that affect option premium:..........................................................................2Q1B. Explaining three types of derivatives:..............................................................................2Q1C. Explaining the difference between American and European options:.............................3Q2A. Depicting an optimal capital structure with graph:..........................................................4Q2B. Explaining CAPM with graph:.........................................................................................5Q3A. Explaining residual-dividend theory:...............................................................................5Q3B. Explaining expectations theory:.......................................................................................6Q4A. Depicting whether call and out option is in the money, at the money or out of themoney:........................................................................................................................................6Q4B. Calculating the exercise price of each of the call and put option:....................................7Q4C. Depicting what is time value of each put and call option:................................................7Q5. Calculating weighted average cost of capital of Google company using the information incase study:..................................................................................................................................8Q6. Calculating cost of equity capital for Dill using two different method:............................10Q7A. Calculating dividend yield of Ford shares:.....................................................................11Q7B. Calculating capital gain yield of Ford Shares:................................................................11Q8. Benefits of diversification to an investor and stating the key factor determining the extentof these benefits:......................................................................................................................12Reference and Bibliography:....................................................................................................13

CORPORATE FINANCE2Q1A. Five factors that affect option premium:There are relatively five factors, which affects the pricing and premium of option,which are strike price, type of option, time to expiration, interest rate and volatility. Theabove depicted factors mainly help in identifying the premiums of an option, which needs tobe paid by the investors for conducting the trade. The use of strike price is essential, as itmarks the overall change in prices, which can affect the actual profitability of the company.In addition, the type of option such as call and put mainly needs relevant calculation, whichderives the actual premium of the option. The expiration date and interest rates is alsocalculated to derive the current premiums of the options, as needed by the formulationmentioned in Black Scholes. Lastly, the volatility or beta is calculated to derive the overallrisk involved in the trade. The higher beta will increase the premiums will be for the tid andvice versa (Wilmott and Orrell 2017).Q1B. Explaining three types of derivatives:There are three types of derivatives, which is used by investor to hedge and conducttrades. The three types of derivatives are future & forward contract, Option contract andswaps, which privies adequate leverage to the investors for conducing relevant trades. Thefuture & forward contract is mainly used in fixings loses, which might incur in future due tothe change in prices. The oil and fuel sector mainly use forward and future contracts forreducing the negative impact of volatile crude prices. In addition, the option contract aremore complex and prudent, which allow the companies to increase their leverage withoutactually opting for the purchase of the contract (Hull and Basu 2016). The last derivativeoption is swap, which allows the investor to use complex methods in betting for and againstthe trend. The derivative contract such as swaps was the main reason behind the collapse offinancial market in 2008.

CORPORATE FINANCE3Q1C. Explaining the difference between American and European options:The difference between both the American and Europeans options mainly provideadequate levels, which help investor in making adequate trades that could hedge theirexposure in the market (Liu, Chen and Ralescu 2015). The Americana and European optionsdiffer in may stances, which are depicted in the table below.Types of differenceAmericana OptionsEuropean OptionsUnderlying AssetOptionable stocks andexchange traded funds mainlyAmerican style option fortradingMajor broad-based indicesmainly trade in European styleoptions such as S&P 500The right to exerciseAmerican style option allowsthe investor to exercise at anytimeEuropean style option onlyallows investor to exercise afterthe expirationTrading of index optionAmerican option stops tradingat the close of business on thethird Friday of the expirationmonthEuropean option stops tradingone day before the expirationdateSettlement priceSettle price of the underlyingasset for American option isthe closing price of the tradeThe detection of settle price forthe underlying asset cannot bedetected if the settlement priceis not published

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