You Are the Manager of a Company That Has an Equal

question 7

Multiple Choice

You are the manager of a company that has an equal chance of earning either $20,000 or $40,000 before taxes.Your firm is subject to a 20% tax rate on the first $30,000 and 35% on all income earned beyond that point.If you are offered a costless hedge to achieve guaranteed before tax earnings of $30,000,what is the expected benefit to hedging?

• A) $24,000
• B) $23,250
• C) $750
• D) none of the above

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Definitions:

Principal

The primary amount of a loan or investment, excluding interest or profits.

Callable Bonds

Bonds that can be redeemed by the issuer before their maturity date at a specified price.

Maturity

The point in time when a financial instrument or obligation, such as a bond or loan, becomes due and payment is required.

Premium

The amount paid for an insurance policy, or the extra cost above the nominal value of something such as a bond or stock.