Jan asks you for a loan. He wants $100 now and offers to pay you back $120 in 1 year. You can borrow and lend from the bank at an interest rate of 10% pa, given as an effective annual rate. Ignore credit risk. Remember: ### V_0 = \frac{V_t}{(1+r_\text{eff})^t} ###
Katya offers to pay you $10 at the end of every year for the next 5 years (t=1,2,3,4,5) if you pay her $50 now (t=0). You can borrow and lend from the bank at an interest rate of 10% pa, given as an effective annual rate. Ignore credit risk.
Question 3 DDM, income and capital returns The following equation is called the Dividend Discount Model (DDM), Gordon Growth Model or the perpetuity with growth formula: ### P_0 = \frac{ C_1 }{ r - g } ### What is ##g##? The value ##g## is the long term expected:
For a price of $13, Carla will sell you a share which will pay a dividend of $1 in one year and every year after that forever. The required return of the stock is 10% pa.
For a price of $6, Carlos will sell you a share which will pay a dividend of $1 in one year and every year after that forever. The required return of the stock is 10% pa.
For a price of $102, Andrea will sell you a share which just paid a dividend of $10 yesterday, and is expected to pay dividends every year forever, growing at a rate of 5% pa. So the next dividend will be ##10(1+0.05)^1=$10.50## in one year from now, and the year after it will be ##10(1+0.05)^2=11.025## and so on. The required return of the stock is 15% pa.
For a price of $1040, Camille will sell you a share which just paid a dividend of $100, and is expected to pay dividends every year forever, growing at a rate of 5% pa. So the next dividend will be ##100(1+0.05)^1=$105.00##, and the year after it will be ##100(1+0.05)^2=110.25## and so on. The required return of the stock is 15% pa.
For a price of $10.20 each, Renee will sell you 100 shares. Each share is expected to pay dividends in perpetuity, growing at a rate of 5% pa. The next dividend is one year away (t=1) and is expected to be $1 per share. The required return of the stock is 15% pa.
For a price of $129, Joanne will sell you a share which is expected to pay a $30 dividend in one year, and a $10 dividend every year after that forever. So the stock's dividends will be $30 at t=1, $10 at t=2, $10 at t=3, and $10 forever onwards. The required return of the stock is 10% pa.
For a price of $95, Sherylanne will sell you a share which is expected to pay its first dividend of $10 in 7 years (t=7), and will continue to pay the same $10 dividend every year after that forever. The required return of the stock is 10% pa.
For a price of $100, Vera will sell you a 2 year bond paying semi-annual coupons of 10% pa. The face value of the bond is $100. Other bonds with similar risk, maturity and coupon characteristics trade at a yield of 8% pa.
For a price of $100, Carol will sell you a 5 year bond paying semi-annual coupons of 16% pa. The face value of the bond is $100. Other bonds with similar risk, maturity and coupon characteristics trade at a yield of 12% pa.
For a price of $100, Rad will sell you a 5 year bond paying semi-annual coupons of 16% pa. The face value of the bond is $100. Other bonds with the same risk, maturity and coupon characteristics trade at a yield of 6% pa.
For a price of $100, Andrea will sell you a 2 year bond paying annual coupons of 10% pa. The face value of the bond is $100. Other bonds with the same risk, maturity and coupon characteristics trade at a yield of 6% pa.
For a price of $95, Nicole will sell you a 10 year bond paying semi-annual coupons of 8% pa. The face value of the bond is $100. Other bonds with the same risk, maturity and coupon characteristics trade at a yield of 8% pa.
Question 16 credit card, APR, effective rate A credit card offers an interest rate of 18% pa, compounding monthly. Find the effective monthly rate, effective annual rate and the effective daily rate. Assume that there are 365 days in a year. All answers are given in the same order: ### r_\text{eff monthly} , r_\text{eff yearly} , r_\text{eff daily} ###
A three year bond has a face value of $100, a yield of 10% and a fixed coupon rate of 5%, paid semi-annually. What is its price?
Question 18 DDM, income and capital returns The following equation is the Dividend Discount Model, also known as the 'Gordon Growth Model' or the 'Perpetuity with growth' equation. ### p_{0} = \frac{c_1}{r_{\text{eff}} - g_{\text{eff}}} ### What is the discount rate '## r_\text{eff} ##' in this equation?
Question 19 fully amortising loan, APR You want to buy an apartment priced at $300,000. You have saved a deposit of $30,000. The bank has agreed to lend you the $270,000 as a fully amortising loan with a term of 25 years. The interest rate is 12% pa and is not expected to change. What will be your monthly payments? Remember that mortgage loan payments are paid in arrears (at the end of the month).
Question 20 NPV, APR, Annuity Your friend wants to borrow $1,000 and offers to pay you back $100 in 6 months, with more $100 payments at the end of every month for another 11 months. So there will be twelve $100 payments in total. She says that 12 payments of $100 equals $1,200 so she's being generous. If interest rates are 12% pa, given as an APR compounding monthly, what is the Net Present Value (NPV) of your friend's deal?
Question 21 income and capital returns, bond pricing A fixed coupon bond was bought for $90 and paid its annual coupon of $3 one year later (at t=1 year). Just after the coupon was paid, the bond price was $92 (at t=1 year). What was the total return, capital return and income return? Calculate your answers as effective annual rates. The choices are given in the same order: ## r_\text{total},r_\text{capital},r_\text{income} ##.
What is the NPV of the following series of cash flows when the discount rate is 10% given as an effective annual rate? The first payment of $90 is in 3 years, followed by payments every 6 months in perpetuity after that which shrink by 3% every 6 months. That is, the growth rate every 6 months is actually negative 3%, given as an effective 6 month rate. So the payment at ## t=3.5 ## years will be ## 90(1-0.03)^1=87.3 ##, and so on.
Question 23 bond pricing, premium par and discount bonds Bonds X and Y are issued by the same US company. Both bonds yield 10% pa, and they have the same face value ($100), maturity, seniority, and payment frequency. The only difference is that bond X and Y's coupon rates are 8 and 12% pa respectively. Which of the following statements is true?
Question 24 implicit interest rate in wholesale credit, effective rate A bathroom and plumbing supplies shop offers credit to its customers. Customers are given 60 days to pay for their goods, but if they pay within 7 days they will get a 2% discount. What is the effective interest rate implicit in the discount being offered? Assume 365 days in a year and that all customers pay on either the 7th day or the 60th day. All rates given in this question are effective annual rates.
Question 26 APR, effective rate A European bond paying annual coupons of 6% offers a yield of 10% pa. Convert the yield into an effective monthly rate, an effective annual rate and an effective daily rate. Assume that there are 365 days in a year. All answers are given in the same order: ### r_\text{eff, monthly} , r_\text{eff, yearly} , r_\text{eff, daily} ###
Question 28 DDM, income and capital returns The following equation is the Dividend Discount Model, also known as the 'Gordon Growth Model' or the 'Perpetuity with growth' equation. ### P_{0} = \frac{C_1}{r_{\text{eff}} - g_{\text{eff}}} ### What would you call the expression ## C_1/P_0 ##?
Question 29 interest only loan You want to buy an apartment priced at $300,000. You have saved a deposit of $30,000. The bank has agreed to lend you the $270,000 as an interest only loan with a term of 25 years. The interest rate is 12% pa and is not expected to change. What will be your monthly payments? Remember that mortgage payments are paid in arrears (at the end of the month).
Question 30 income and capital returns A share was bought for $20 (at t=0) and paid its annual dividend of $3 one year later (at t=1). Just after the dividend was paid, the share price was $16 (at t=1). What was the total return, capital return and income return? Calculate your answers as effective annual rates. The choices are given in the same order: ## r_\text{total},r_\text{capital},r_\text{income} ##.
Question 31 DDM, perpetuity with growth, effective rate conversion What is the NPV of the following series of cash flows when the discount rate is 5% given as an effective annual rate? The first payment of $10 is in 4 years, followed by payments every 6 months forever after that which shrink by 2% every 6 months. That is, the growth rate every 6 months is actually negative 2%, given as an effective 6 month rate. So the payment at ## t=4.5 ## years will be ## 10(1-0.02)^1=9.80 ##, and so on.
Question 32 time calculation, APR You really want to go on a back packing trip to Europe when you finish university. Currently you have $1,500 in the bank. Bank interest rates are 8% pa, given as an APR compounding per month. If the holiday will cost $2,000, how long will it take for your bank account to reach that amount?
Question 33 bond pricing, premium par and discount bonds Bonds A and B are issued by the same company. They have the same face value, maturity, seniority and coupon payment frequency. The only difference is that bond A has a 5% coupon rate, while bond B has a 10% coupon rate. The yield curve is flat, which means that yields are expected to stay the same. Which bond would have the higher current price?
Question 34 implicit interest rate in wholesale credit A wholesale glass importer offers credit to its customers. Customers are given 30 days to pay for their goods, but if they pay within 5 days they will get a 1% discount. What is the effective interest rate implicit in the discount being offered? Assume 365 days in a year and that all customers pay on either the 5th day or the 30th day. All rates given below are effective annual rates.
Question 36 DDM, perpetuity with growth A stock pays annual dividends which are expected to continue forever. It just paid a dividend of $10. The growth rate in the dividend is 2% pa. You estimate that the stock's required return is 10% pa. Both the discount rate and growth rate are given as effective annual rates. Using the dividend discount model, what will be the share price?
If a project's net present value (NPV) is zero, then its internal rate of return (IRR) will be:
A two year Government bond has a face value of $100, a yield of 0.5% and a fixed coupon rate of 0.5%, paid semi-annually. What is its price?
Question 39 DDM, perpetuity with growth A stock is expected to pay the following dividends:
After year 4, the annual dividend will grow in perpetuity at 5% pa, so;
The required return on the stock is 10% pa. Both the growth rate and required return are given as effective annual rates. What is the current price of the stock?
Question 40 DDM, perpetuity with growth A stock is expected to pay the following dividends:
After year 4, the annual dividend will grow in perpetuity at 5% pa, so;
The required return on the stock is 10% pa. Both the growth rate and required return are given as effective annual rates. What will be the price of the stock in three and a half years (t = 3.5)?
Question 41 DDM, income and capital returns The following is the Dividend Discount Model (DDM) used to price stocks: ### P_0 = \frac{d_1}{r-g} ###Assume that the assumptions of the DDM hold and that the time period is measured in years. Which of the following is equal to the expected dividend in 3 years, ## d_3 ##?
Question 42 interest only loan You just signed up for a 30 year interest-only mortgage with monthly payments of $3,000 per month. The interest rate is 6% pa which is not expected to change. How much did you borrow? After 15 years, just after the 180th payment at that time, how much will be owing on the mortgage? The interest rate is still 6% and is not expected to change. Remember that the mortgage is interest-only and that mortgage payments are paid in arrears (at the end of the month).
Question 43 pay back period A project to build a toll road will take 3 years to complete, costing three payments of $50 million, paid at the start of each year (at times 0, 1, and 2). After completion, the toll road will yield a constant $10 million at the end of each year forever with no costs. So the first payment will be at t=4. The required return of the project is 10% pa given as an effective nominal rate. All cash flows are nominal. What is the payback period?
The required return of a project is 10%, given as an effective annual rate. Assume that the cash flows shown in the table are paid all at once at the given point in time. What is the Net Present Value (NPV) of the project?
Question 45 profitability index The required return of a project is 10%, given as an effective annual rate. Assume that the cash flows shown in the table are paid all at once at the given point in time. What is the Profitability Index (PI) of the project?
Question 46 NPV, annuity due The phone company Telstra have 2 mobile service plans on offer which both have the same amount of phone call, text message and internet data credit. Both plans have a contract length of 24 months and the monthly cost is payable in advance. The only difference between the two plans is that one is a:
Neither plan has any additional payments at the start or end. The only difference between the plans is the phone, so what is the implied cost of the phone as a present value? Assume that the discount rate is 2% per month given as an effective monthly rate, the same high interest rate on credit cards.
Question 47 implicit interest rate in wholesale credit A wholesale horticulture nursery offers credit to its customers. Customers are given 60 days to pay for their goods, but if they pay immediately they will get a 3% discount. What is the effective interest rate implicit in the discount being offered? Assume 365 days in a year and that all customers pay either immediately or on the 60th day. All rates given below are effective annual rates.
In Australia, nominal yields on semi-annual coupon paying Government Bonds with 2 years until maturity are currently 2.83% pa. The inflation rate is currently 2.2% pa, given as an APR compounding per quarter. The inflation rate is not expected to change over the next 2 years. What is the real yield on these bonds, given as an APR compounding every 6 months?
Most listed Australian companies pay dividends twice per year, the 'interim' and 'final' dividends, which are roughly 6 months apart. You are an equities analyst trying to value the company BHP. You decide to use the Dividend Discount Model (DDM) as a starting point, so you study BHP's dividend history and you find that BHP tends to pay the same interim and final dividend each year, and that both grow by the same rate. You expect BHP will pay a $0.55 interim dividend in six months and a $0.55 final dividend in one year. You expect each to grow by 4% next year and forever, so the interim and final dividends next year will be $0.572 each, and so on in perpetuity. Assume BHP's cost of equity is 8% pa. All rates are quoted as nominal effective rates. The dividends are nominal cash flows and the inflation rate is 2.5% pa. What is the current price of a BHP share?
A stock pays semi-annual dividends. It just paid a dividend of $10. The growth rate in the dividend is 1% every 6 months, given as an effective 6 month rate. You estimate that the stock's required return is 21% pa, as an effective annual rate. Using the dividend discount model, what will be the share price?
Question 52 IRR, pay back period A three year project's NPV is negative. The cash flows of the project include a negative cash flow at the very start and positive cash flows over its short life. The required return of the project is 10% pa. Select the most correct statement.
A two year Government bond has a face value of $100, a yield of 2.5% pa and a fixed coupon rate of 0.5% pa, paid semi-annually. What is its price?
A stock is expected to pay the following dividends:
After year 4, the annual dividend will grow in perpetuity at -5% pa. Note that this is a negative growth rate, so the dividend will actually shrink. So,
The required return on the stock is 10% pa. Both the growth rate and required return are given as effective annual rates. What is the current price of the stock?
A stock is expected to pay the following dividends:
After year 4, the annual dividend will grow in perpetuity at -5% pa. Note that this is a negative growth rate, so the dividend will actually shrink. So,
The required return on the stock is 10% pa. Both the growth rate and required return are given as effective annual rates. What will be the price of the stock in four and a half years (t = 4.5)?
Which of the following statements about risk free government bonds is NOT correct? Hint: Total return can be broken into income and capital returns as follows: ###\begin{aligned} r_\text{total} &= \frac{c_1}{p_0} + \frac{p_1-p_0}{p_0} \\ &= r_\text{income} + r_\text{capital} \end{aligned} ### The capital return is the growth rate of the price.
Question 57 interest only loan You just borrowed $400,000 in the form of a 25 year interest-only mortgage with monthly payments of $3,000 per month. The interest rate is 9% pa which is not expected to change. You actually plan to pay more than the required interest payment. You plan to pay $3,300 in mortgage payments every month, which your mortgage lender allows. These extra payments will reduce the principal and the minimum interest payment required each month. At the maturity of the mortgage, what will be the principal? That is, after the last (300th) interest payment of $3,300 in 25 years, how much will be owing on the mortgage?
A project to build a toll bridge will take two years to complete, costing three payments of $100 million at the start of each year for the next three years, that is at t=0, 1 and 2. After completion, the toll bridge will yield a constant $50 million at the end of each year for the next 10 years. So the first payment will be at t=3 and the last at t=12. After the last payment at t=12, the bridge will be given to the government. The required return of the project is 21% pa given as an effective annual nominal rate. All cash flows are real and the expected inflation rate is 10% pa given as an effective annual rate. Ignore taxes. The Net Present Value is:
The required return of a project is 10%, given as an effective annual rate. Assume that the cash flows shown in the table are paid all at once at the given point in time. What is the Net Present Value (NPV) of the project?
Question 60 pay back period The required return of a project is 10%, given as an effective annual rate. What is the payback period of the project in years? Assume that the cash flows shown in the table are received smoothly over the year. So the $121 at time 2 is actually earned smoothly from t=1 to t=2.
In Australia, domestic university students are allowed to buy concession tickets for the bus, train and ferry which sell at a discount of 50% to full-price tickets. The Australian Government do not allow international university students to buy concession tickets, they have to pay the full price. Some international students see this as unfair and they are willing to pay for fake university identification cards which have the concession sticker. What is the most that an international student would be willing to pay for a fake identification card? Assume that international students:
Approach this question from a purely financial view point, ignoring the illegality, embarrassment and the morality of committing fraud.
Question 62 implicit interest rate in wholesale credit A wholesale building supplies business offers credit to its customers. Customers are given 60 days to pay for their goods, but if they pay within 7 days they will get a 2% discount. What is the effective interest rate implicit in the discount being offered? Assume 365 days in a year and that all customers pay on either the 7th day or the 60th day. All rates given below are effective annual rates.
Question 63 bond pricing, NPV, market efficiency The theory of fixed interest bond pricing is an application of the theory of Net Present Value (NPV). Also, a 'fairly priced' asset is not over- or under-priced. Buying or selling a fairly priced asset has an NPV of zero. Considering this, which of the following statements is NOT correct?
In Germany, nominal yields on semi-annual coupon paying Government Bonds with 2 years until maturity are currently 0.04% pa. The inflation rate is currently 1.4% pa, given as an APR compounding per quarter. The inflation rate is not expected to change over the next 2 years. What is the real yield on these bonds, given as an APR compounding every 6 months?
Question 65 annuity with growth, needs refinement Which of the below formulas gives the present value of an annuity with growth? Hint: The equation of a perpetuity without growth is: ###V_\text{0, perp without growth} = \frac{C_\text{1}}{r}### The formula for the present value of an annuity without growth is derived from the formula for a perpetuity without growth. The idea is than an annuity with T payments from t=1 to T inclusive is equivalent to a perpetuity starting at t=1 with fixed positive cash flows, plus a perpetuity starting T periods later (t=T+1) with fixed negative cash flows. The positive and negative cash flows after time period T cancel each other out, leaving the positive cash flows between t=1 to T, which is the annuity. ###\begin{aligned} V_\text{0, annuity} &= V_\text{0, perp without growth from t=1} - V_\text{0, perp without growth from t=T+1} \\ &= \dfrac{C_\text{1}}{r} - \dfrac{ \left( \dfrac{C_\text{T+1}}{r} \right) }{(1+r)^T} \\ &= \dfrac{C_\text{1}}{r} - \dfrac{ \left( \dfrac{C_\text{1}}{r} \right) }{(1+r)^T} \\ &= \dfrac{C_\text{1}}{r}\left(1 - \dfrac{1}{(1+r)^T}\right) \\ \end{aligned}### The equation of a perpetuity with growth is: ###V_\text{0, perp with growth} = \dfrac{C_\text{1}}{r-g}###
Government bonds currently have a return of 5% pa. A stock has an expected return of 6% pa and the market return is 7% pa. What is the beta of the stock?
Question 67 CFFA, interest tax shield Here are the Net Income (NI) and Cash Flow From Assets (CFFA) equations: ###NI=(Rev-COGS-FC-Depr-IntExp).(1-t_c)### ###CFFA=NI+Depr-CapEx - \varDelta NWC+IntExp### What is the formula for calculating annual interest expense (IntExp) which is used in the equations above? Select one of the following answers. Note that D is the value of debt which is constant through time, and ##r_D## is the cost of debt.
Question 68 WACC, CFFA, capital budgeting A manufacturing company is considering a new project in the more risky services industry. The cash flows from assets (CFFA) are estimated for the new project, with interest expense excluded from the calculations. To get the levered value of the project, what should these unlevered cash flows be discounted by? Assume that the manufacturing firm has a target debt-to-assets ratio that it sticks to.
Question 70 payout policy Due to floods overseas, there is a cut in the supply of the mineral iron ore and its price increases dramatically. An Australian iron ore mining company therefore expects a large but temporary increase in its profit and cash flows. The mining company does not have any positive NPV projects to begin, so what should it do? Select the most correct answer.
Stock A has a beta of 0.5 and stock B has a beta of 1. Which statement is NOT correct?
Question 72 CAPM, portfolio beta, portfolio risk
What is the beta of the above portfolio?
Question 73 portfolio risk, standard deviation
What is the standard deviation (not variance) of the above portfolio? Note that the stocks' covariance is given, not correlation.
A company has:
What is the company's after-tax weighted average cost of capital (WACC)? Assume a classical tax system.
Government bonds currently have a return of 5%. A stock has a beta of 2 and the market return is 7%. What is the expected return of the stock?
Question 77 interest tax shield The equations for Net Income (NI, also known as Earnings or Net Profit After Tax) and Cash Flow From Assets (CFFA, also known as Free Cash Flow to the Firm) per year are: ###NI=(Rev-COGS-FC-Depr-IntExp).(1-t_c)### ###CFFA=NI+Depr-CapEx - \varDelta NWC+IntExp### For a firm with debt, what is the amount of the interest tax shield per year?
Question 78 WACC, capital structure A company issues a large amount of bonds to raise money for new projects of similar risk to the company's existing projects. The net present value (NPV) of the new projects is positive but small. Assume a classical tax system. Which statement is NOT correct?
Which statement is the most correct?
Question 82 portfolio return
What is the expected return of the above portfolio?
Question 83 portfolio risk, standard deviation
What is the standard deviation (not variance) of returns of the above portfolio?
Question 84 WACC, capital structure, capital budgeting A firm is considering a new project of similar risk to the current risk of the firm. This project will expand its existing business. The cash flows of the project have been calculated assuming that there is no interest expense. In other words, the cash flows assume that the project is all-equity financed. In fact the firm has a target debt-to-equity ratio of 1, so the project will be financed with 50% debt and 50% equity. To find the levered value of the firm's assets, what discount rate should be applied to the project's unlevered cash flows? Assume a classical tax system.
A company has:
What is the company's after-tax weighted average cost of capital (WACC) in a classical tax system?
Treasury bonds currently have a return of 5% pa. A stock has a beta of 0.5 and the market return is 10% pa. What is the expected return of the stock?
Question 87 fully amortising loan, APR You want to buy an apartment worth $500,000. You have saved a deposit of $50,000. The bank has agreed to lend you the $450,000 as a fully amortising mortgage loan with a term of 25 years. The interest rate is 6% pa and is not expected to change. What will be your monthly payments?
A firm can issue 3 year annual coupon bonds at a yield of 10% pa and a coupon rate of 8% pa. The beta of its levered equity is 2. The market's expected return is 10% pa and 3 year government bonds yield 6% pa with a coupon rate of 4% pa. The market value of equity is $1 million and the market value of debt is $1 million. The corporate tax rate is 30%. What is the firm's after-tax WACC? Assume a classical tax system.
Question 89 WACC, CFFA, interest tax shield A retail furniture company buys furniture wholesale and distributes it through its retail stores. The owner believes that she has some good ideas for making stylish new furniture. She is considering a project to buy a factory and employ workers to manufacture the new furniture she's designed. Furniture manufacturing has more systematic risk than furniture retailing. Her furniture retailing firm's after-tax WACC is 20%. Furniture manufacturing firms have an after-tax WACC of 30%. Both firms are optimally geared. Assume a classical tax system. Which method(s) will give the correct valuation of the new furniture-making project? Select the most correct answer.
According to the theory of the Capital Asset Pricing Model (CAPM), total variance can be broken into two components, systematic variance and idiosyncratic variance. Which of the following events would be considered the most diversifiable according to the theory of the CAPM?
Question 91 WACC, capital structure A firm has a debt-to-assets ratio of 50%. The firm then issues a large amount of equity to raise money for new projects of similar systematic risk to the company's existing projects. Assume a classical tax system. Which statement is correct?
Question 92 CAPM, SML, CML Which statement(s) are correct? (i) All stocks that plot on the Security Market Line (SML) are fairly priced. (ii) All stocks that plot above the Security Market Line (SML) are overpriced. (iii) All fairly priced stocks that plot on the Capital Market Line (CML) have zero idiosyncratic risk. Select the most correct response:
Question 93 correlation, CAPM, systematic risk A stock's correlation with the market portfolio increases while its total risk is unchanged. What will happen to the stock's expected return and systematic risk?
Question 94 leverage, capital structure, real estate Your friend just bought a house for $400,000. He financed it using a $320,000 mortgage loan and a deposit of $80,000. In the context of residential housing and mortgages, the 'equity' tied up in the value of a person's house is the value of the house less the value of the mortgage. So the initial equity your friend has in his house is $80,000. Let this amount be E, let the value of the mortgage be D and the value of the house be V. So ##V=D+E##. If house prices suddenly fall by 10%, what would be your friend's percentage change in equity (E)? Assume that the value of the mortgage is unchanged and that no income (rent) was received from the house during the short time over which house prices fell. Remember: ### r_{0\rightarrow1}=\frac{p_1-p_0+c_1}{p_0} ### where ##r_{0-1}## is the return (percentage change) of an asset with price ##p_0## initially, ##p_1## one period later, and paying a cash flow of ##c_1## at time ##t=1##.
Question 95 interest tax shield The equations for Net Income (NI, also known as Earnings or Net Profit After Tax) and Cash Flow From Assets (CFFA, also known as Free Cash Flow to the Firm) per year are: ###NI=(Rev-COGS-FC-Depr-IntExp).(1-t_c)### ###CFFA=NI+Depr-CapEx - \varDelta NWC+IntExp### For a firm with debt, what is the formula for the present value of interest tax shields if the tax shields occur in perpetuity? You may assume:
Question 97 WACC, no explanation A company has:
What is the company's after-tax Weighted Average Cost of Capital (WACC)? Assume a classical tax system.
Question 98 capital structure, CAPM A firm changes its capital structure by issuing a large amount of debt and using the funds to repurchase shares. Its assets are unchanged. Ignore interest tax shields. According to the Capital Asset Pricing Model (CAPM), which statement is correct?
A firm changes its capital structure by issuing a large amount of debt and using the funds to repurchase shares. Its assets are unchanged. Assume that:
According to Miller and Modigliani's theory, which statement is correct?
A company selling charting and technical analysis software claims that independent academic studies have shown that its software makes significantly positive abnormal returns. Assuming the claim is true, which statement(s) are correct? (I) Weak form market efficiency is broken. (II) Semi-strong form market efficiency is broken. (III) Strong form market efficiency is broken. (IV) The asset pricing model used to measure the abnormal returns (such as the CAPM) had mis-specification error so the returns may not be abnormal but rather fair for the level of risk. Select the most correct response:
Question 101 payout policy, no explanation An established mining firm announces that it expects large losses over the following year due to flooding which has temporarily stalled production at its mines. Which statement(s) are correct? (i) If the firm adheres to a full dividend payout policy it will not pay any dividends over the following year. (ii) If the firm wants to signal that the loss is temporary it will maintain the same level of dividends. It can do this so long as it has enough retained profits. (iii) By law, the firm will be unable to pay a dividend over the following year because it cannot pay a dividend when it makes a loss. Select the most correct response:
Question 102 option, hedging A company runs a number of slaughterhouses which supply hamburger meat to McDonalds. The company is afraid that live cattle prices will increase over the next year, even though there is widespread belief in the market that they will be stable. What can the company do to hedge against the risk of increasing live cattle prices? Which statement(s) are correct? (i) buy call options on live cattle. (ii) buy put options on live cattle. (iii) sell call options on live cattle. Select the most correct response:
Below are 4 option graphs. Note that the y-axis is payoff at maturity (T). What options do they depict? List them in the order that they are numbered.
Assume that there exists a perfect world with no transaction costs, no asymmetric information, no taxes, no agency costs, equal borrowing rates for corporations and individual investors, the ability to short the risk free asset, semi-strong form efficient markets, the CAPM holds, investors are rational and risk-averse and there are no other market frictions. For a firm operating in this perfect world, which statement(s) are correct? (i) When a firm changes its capital structure and/or payout policy, share holders' wealth is unaffected. (ii) When the idiosyncratic risk of a firm's assets increases, share holders do not expect higher returns. (iii) When the systematic risk of a firm's assets increases, share holders do not expect higher returns. Select the most correct response:
Question 105 NPV, risk, market efficiency A person is thinking about borrowing $100 from the bank at 7% pa and investing it in shares with an expected return of 10% pa. One year later the person intends to sell the shares and pay back the loan in full. Both the loan and the shares are fairly priced. What is the Net Present Value (NPV) of this one year investment? Note that you are asked to find the present value (##V_0##), not the value in one year (##V_1##).
A fairly priced stock has an expected return of 15% pa. Treasury bonds yield 5% pa and the market portfolio's expected return is 10% pa. What is the beta of the stock?
Question 107 interest only loan You want to buy an apartment worth $300,000. You have saved a deposit of $60,000. The bank has agreed to lend you $240,000 as an interest only mortgage loan with a term of 30 years. The interest rate is 6% pa and is not expected to change. What will be your monthly payments?
Question 110 CAPM, SML, NPV The security market line (SML) shows the relationship between beta and expected return. Buying investment projects that plot above the SML would lead to:
According to the theory of the Capital Asset Pricing Model (CAPM), total risk can be broken into two components, systematic risk and idiosyncratic risk. Which of the following events would be considered a systematic, undiversifiable event according to the theory of the CAPM?
Question 113 WACC, CFFA, capital budgeting The US firm Google operates in the online advertising business. In 2011 Google bought Motorola Mobility which manufactures mobile phones. Assume the following:
You are a manager at Motorola. You must value a project for making mobile phones. Which method(s) will give the correct valuation of the mobile phone manufacturing project? Select the most correct answer. The mobile phone manufacturing project's:
Question 115 capital structure, leverage, WACC A firm has a debt-to-assets ratio of 50%. The firm then issues a large amount of debt to raise money for new projects of similar market risk to the company's existing projects. Assume a classical tax system. Which statement is correct?
Question 116 capital structure, CAPM A firm changes its capital structure by issuing a large amount of equity and using the funds to repay debt. Its assets are unchanged. Ignore interest tax shields. According to the Capital Asset Pricing Model (CAPM), which statement is correct?
A firm can issue 5 year annual coupon bonds at a yield of 8% pa and a coupon rate of 12% pa. The beta of its levered equity is 1. Five year government bonds yield 5% pa with a coupon rate of 6% pa. The market's expected dividend return is 4% pa and its expected capital return is 6% pa. The firm's debt-to-equity ratio is 2:1. The corporate tax rate is 30%. What is the firm's after-tax WACC? Assume a classical tax system.
A company has:
The corporate tax rate is 30%. All returns and yields are given as effective annual rates. What is the company's after-tax Weighted Average Cost of Capital (WACC)? Assume a classical tax system.
Your friend claims that by reading 'The Economist' magazine's economic news articles, she can identify shares that will have positive abnormal expected returns over the next 2 years. Assuming that her claim is true, which statement(s) are correct? (i) Weak form market efficiency is broken. (ii) Semi-strong form market efficiency is broken. (iii) Strong form market efficiency is broken. (iv) The asset pricing model used to measure the abnormal returns (such as the CAPM) is either wrong (mis-specification error) or is measured using the wrong inputs (data errors) so the returns may not be abnormal but rather fair for the level of risk. Select the most correct response:
Question 120 credit risk, payout policy A newly floated farming company is financed with senior bonds, junior bonds, cumulative non-voting preferred stock and common stock. The new company has no retained profits and due to floods it was unable to record any revenues this year, leading to a loss. The firm is not bankrupt yet since it still has substantial contributed equity (same as paid-up capital). On which securities must it pay interest or dividend payments in this terrible financial year?
You have just sold an 'in the money' 6 month European put option on the mining company BHP at an exercise price of $40 for a premium of $3. Which of the following statements best describes your situation?
Below are 4 option graphs. Note that the y-axis is payoff at maturity (T). What options do they depict? List them in the order that they are numbered
Question 124 option, hedging You operate a cattle farm that supplies hamburger meat to the big fast food chains. You buy a lot of grain to feed your cattle, and you sell the fully grown cattle on the livestock market. You're afraid of adverse movements in grain and livestock prices. What options should you buy to hedge your exposures in the grain and cattle livestock markets? Select the most correct response:
Question 125 option, speculation, market efficiency Suppose that the US government recently announced that subsidies for fresh milk producers will be gradually phased out over the next year. Newspapers say that there are expectations of a 40% increase in the spot price of fresh milk over the next year. Option prices on fresh milk trading on the Chicago Mercantile Exchange (CME) reflect expectations of this 40% increase in spot prices over the next year. Similarly to the rest of the market, you believe that prices will rise by 40% over the next year. What option trades are likely to be profitable, or to be more specific, result in a positive Net Present Value (NPV)? Assume that:
What is the Internal Rate of Return (IRR) of the project detailed in the table below? Assume that the cash flows shown in the table are paid all at once at the given point in time. All answers are given as effective annual rates.
Question 127 interest expense A zero coupon bond that matures in 6 months has a face value of $1,000. The firm that issued this bond is trying to forecast its income statement for the year. It needs to calculate the interest expense of the bond this year. The bond is highly illiquid and hasn't traded on the market. But the finance department have assessed the bond's fair value to be $950 and this is its book value right now at the start of the year. Assume that:
What will be the interest expense of the bond this year for the purpose of forecasting the income statement?
Question 128 debt terminology, needs refinement
Question 129 debt terminology
Question 130 debt terminology
Question 131 APR, effective rate Calculate the effective annual rates of the following three APR's:
All answers are given in the same order: ##r_\text{credit card, eff yrly}##, ##r_\text{bond, eff yrly}##, ##r_\text{stock, eff yrly}##
Question 133 bond pricing A bond maturing in 10 years has a coupon rate of 4% pa, paid semi-annually. The bond's yield is currently 6% pa. The face value of the bond is $100. What is its price?
Question 134 fully amortising loan, APR You want to buy an apartment worth $400,000. You have saved a deposit of $80,000. The bank has agreed to lend you the $320,000 as a fully amortising mortgage loan with a term of 30 years. The interest rate is 6% pa and is not expected to change. What will be your monthly payments?
Question 135 credit card, APR, no explanation Your credit card shows a $600 debt liability. The interest rate is 24% pa, payable monthly. You can't pay any of the debt off, except in 6 months when it's your birthday and you'll receive $50 which you'll use to pay off the credit card. If that is your only repayment, how much will the credit card debt liability be one year from now?
Question 136 income and capital returns A stock was bought for $8 and paid a dividend of $0.50 one year later (at t=1 year). Just after the dividend was paid, the stock price was $7 (at t=1 year). What were the total, capital and dividend returns given as effective annual rates? The choices are given in the same order: ##r_\text{total}##, ##r_\text{capital}##, ##r_\text{dividend}##.
Question 137 NPV, Annuity The following cash flows are expected:
What is the NPV of the cash flows if the discount rate is 10% given as an effective annual rate?
Question 138 bond pricing, premium par and discount bonds Bonds A and B are issued by the same Australian company. Both bonds yield 7% pa, and they have the same face value ($100), maturity, seniority, and payment frequency. The only difference is that bond A pays coupons of 10% pa and bond B pays coupons of 5% pa. Which of the following statements is true about the bonds' prices?
Question 139 implicit interest rate in wholesale credit A wholesale shop offers credit to its customers. The customers are given 21 days to pay for their goods. But if they pay straight away (now) they get a 1% discount. What is the effective interest rate given to customers who pay in 21 days? All rates given below are effective annual rates. Assume 365 days in a year.
Question 141 time calculation, APR, effective rate You're trying to save enough money to buy your first car which costs $2,500. You can save $100 at the end of each month starting from now. You currently have no money at all. You just opened a bank account with an interest rate of 6% pa payable monthly. How many months will it take to save enough money to buy the car? Assume that the price of the car will stay the same over time.
A text book publisher is thinking of asking some teachers to write a new textbook at a cost of $100,000, payable now. The book would be written, printed and ready to sell to students in 2 years. It will be ready just before semester begins. A cash flow of $100 would be made from each book sold, after all costs such as printing and delivery. There are 600 students per semester. Assume that every student buys a new text book. Remember that there are 2 semesters per year and students buy text books at the beginning of the semester. Assume that text book publishers will sell the books at the same price forever and that the number of students is constant. If the discount rate is 8% pa, given as an effective annual rate, what is the NPV of the project?
Question 145 NPV, APR, annuity due A student just won the lottery. She won $1 million in cash after tax. She is trying to calculate how much she can spend per month for the rest of her life. She assumes that she will live for another 60 years. She wants to withdraw equal amounts at the beginning of every month, starting right now. All of the cash is currently sitting in a bank account which pays interest at a rate of 6% pa, given as an APR compounding per month. On her last withdrawal, she intends to have nothing left in her bank account. How much can she withdraw at the beginning of each month?
Question 146 APR, effective rate A three year corporate bond yields 12% pa with a coupon rate of 10% pa, paid semi-annually. Find the effective six month yield, effective annual yield and the effective daily yield. Assume that each month has 30 days and that there are 360 days in a year. All answers are given in the same order: ##r_\text{eff semi-annual}##, ##r_\text{eff yearly}##, ##r_\text{eff daily}##.
Question 148 DDM, income and capital returns The following equation is the Dividend Discount Model, also known as the 'Gordon Growth Model' or the 'Perpetuity with growth' equation. ### p_0 = \frac{d_1}{r - g} ### Which expression is NOT equal to the expected dividend yield?
Question 149 fully amortising loan, APR You want to buy an apartment priced at $500,000. You have saved a deposit of $50,000. The bank has agreed to lend you the $450,000 as a fully amortising loan with a term of 30 years. The interest rate is 6% pa and is not expected to change. What will be your monthly payments?
Question 150 DDM, effective rate A share just paid its semi-annual dividend of $10. The dividend is expected to grow at 2% every 6 months forever. This 2% growth rate is an effective 6 month rate. Therefore the next dividend will be $10.20 in six months. The required return of the stock is 10% pa, given as an effective annual rate. What is the price of the share now?
Question 151 income and capital returns A share was bought for $30 (at t=0) and paid its annual dividend of $6 one year later (at t=1). Just after the dividend was paid, the share price fell to $27 (at t=1). What were the total, capital and income returns given as effective annual rates? The choices are given in the same order: ##r_\text{total}## , ##r_\text{capital}## , ##r_\text{dividend}##.
Question 152 NPV, Annuity The following cash flows are expected:
What is the NPV of the cash flows if the discount rate is 10% given as an effective annual rate?
Question 153 bond pricing, premium par and discount bonds Bonds X and Y are issued by different companies, but they both pay a semi-annual coupon of 10% pa and they have the same face value ($100) and maturity (3 years). The only difference is that bond X and Y's yields are 8 and 12% pa respectively. Which of the following statements is true?
Question 154 implicit interest rate in wholesale credit, no explanation A wholesale vitamin supplements store offers credit to its customers. Customers are given 30 days to pay for their goods, but if they pay within 5 days they will get a 1% discount. What is the effective interest rate implicit in the discount being offered? Assume 365 days in a year and that all customers pay on either the 5th day or the 30th day. All of the below answer choices are given as effective annual interest rates.
You are a banker about to grant a 2 year loan to a customer. The loan's principal and interest will be repaid in a single payment at maturity, sometimes called a zero-coupon loan, discount loan or bullet loan. You require a real return of 6% pa over the two years, given as an effective annual rate. Inflation is expected to be 2% this year and 4% next year, both given as effective annual rates. You judge that the customer can afford to pay back $1,000,000 in 2 years, given as a nominal cash flow. How much should you lend to her right now?
Question 156 APR, effective rate A 2 year government bond yields 5% pa with a coupon rate of 6% pa, paid semi-annually. Find the effective six month rate, effective annual rate and the effective daily rate. Assume that each month has 30 days and that there are 360 days in a year. All answers are given in the same order: ##r_\text{eff semi-annual}##, ##r_\text{eff yrly}##, ##r_\text{eff daily}##.
Question 158 DDM, income and capital returns The following equation is the Dividend Discount Model, also known as the 'Gordon Growth Model' or the 'Perpetuity with growth' equation. ###p_0=\frac{d_1}{r_\text{eff}-g_\text{eff}}### Which expression is NOT equal to the expected capital return?
Question 159 bond pricing A three year bond has a fixed coupon rate of 12% pa, paid semi-annually. The bond's yield is currently 6% pa. The face value is $100. What is its price?
Question 160 interest only loan You want to buy an apartment priced at $500,000. You have saved a deposit of $50,000. The bank has agreed to lend you the $450,000 as an interest only loan with a term of 30 years. The interest rate is 6% pa and is not expected to change. What will be your monthly payments?
A share just paid its semi-annual dividend of $10. The dividend is expected to grow at 2% every 6 months forever. This 2% growth rate is an effective 6 month rate. Therefore the next dividend will be $10.20 in six months. The required return of the stock 10% pa, given as an effective annual rate. What is the price of the share now?
Question 162 income and capital returns A share was bought for $10 (at t=0) and paid its annual dividend of $0.50 one year later (at t=1). Just after the dividend was paid, the share price was $11 (at t=1). What was the total return, capital return and income return? Calculate your answers as effective annual rates. The choices are given in the same order: ##r_\text{total}##, ##r_\text{capital}##, ##r_\text{dividend}##.
Question 163 bond pricing, premium par and discount bonds Bonds X and Y are issued by different companies, but they both pay a semi-annual coupon of 10% pa and they have the same face value ($100), maturity (3 years) and yield (10%) as each other. Which of the following statements is true?
Question 164 implicit interest rate in wholesale credit A wholesale store offers credit to its customers. Customers are given 60 days to pay for their goods, but if they pay immediately they will get a 1.5% discount. What is the effective interest rate implicit in the discount being offered? Assume 365 days in a year and that all customers pay either immediately or the 60th day. All of the below answer choices are given as effective annual interest rates.
Question 165 DDM, PE ratio, payout ratio For certain shares, the forward-looking Price-Earnings Ratio (##P_0/EPS_1##) is equal to the inverse of the share's total expected return (##1/r_\text{total}##). For what shares is this true? Use the general accounting definition of 'payout ratio' which is dividends per share (DPS) divided by earnings per share (EPS) and assume that all cash flows, earnings and rates are real rather than nominal. A company's forward-looking PE ratio will be the inverse of its total expected return on equity when it has a:
Question 166 DDM, no explanation A stock pays annual dividends. It just paid a dividend of $3. The growth rate in the dividend is 4% pa. You estimate that the stock's required return is 10% pa. Both the discount rate and growth rate are given as effective annual rates. Using the dividend discount model, what will be the share price?
A project's net present value (NPV) is negative. Select the most correct statement.
Question 168 bond pricing A four year bond has a face value of $100, a yield of 6% and a fixed coupon rate of 12%, paid semi-annually. What is its price?
Question 169 NPV, DDM, no explanation A stock is expected to pay the following dividends:
After year 4, the dividend will grow in perpetuity at 4% pa. The required return on the stock is 10% pa. Both the growth rate and required return are given as effective annual rates. What is the current price of the stock?
Question 170 NPV, DDM, no explanation A stock is expected to pay the following dividends:
After year 4, the dividend will grow in perpetuity at 4% pa. The required return on the stock is 10% pa. Both the growth rate and required return are given as effective annual rates. What will be the price of the stock in 5 years (t = 5), just after the dividend at that time has been paid?
Question 171 DDM, income and capital returns The following is the Dividend Discount Model used to price stocks: ### p_0=\frac{d_1}{r-g} ### Which of the following statements about the Dividend Discount Model is NOT correct?
Question 172 fully amortising loan, APR You just signed up for a 30 year fully amortising mortgage loan with monthly payments of $2,000 per month. The interest rate is 9% pa which is not expected to change. How much did you borrow? After 5 years, how much will be owing on the mortgage? The interest rate is still 9% and is not expected to change.
Find Candys Corporation's Cash Flow From Assets (CFFA), also known as Free Cash Flow to the Firm (FCFF), over the year ending 30th June 2013.
Note: all figures are given in millions of dollars ($m).
Question 174 profitability index A project has the following cash flows:
What is the Profitability Index (PI) of the project? Assume that the cash flows shown in the table are paid all at once at the given point in time. The required return is 10% pa, given as an effective annual rate.
Question 175 pay back period, no explanation A project has the following cash flows. Normally cash flows are assumed to happen at the given time. But here, assume that the cash flows are received smoothly over the year. So the $250 at time 2 is actually earned smoothly from t=1 to t=2:
What is the payback period of the project in years?
Why is Capital Expenditure (CapEx) subtracted in the Cash Flow From Assets (CFFA) formula? ###CFFA=NI+Depr-CapEx - \Delta NWC+IntExp###
Question 177 implicit interest rate in wholesale credit A furniture distributor offers credit to its customers. Customers are given 25 days to pay for their goods, but if they pay immediately they will get a 1% discount. What is the effective interest rate implicit in the discount being offered? Assume 365 days in a year and that all customers pay either immediately or on the 25th day. All rates given below are effective annual rates.
Question 179 bond pricing, capital raising A firm wishes to raise $20 million now. They will issue 8% pa semi-annual coupon bonds that will mature in 5 years and have a face value of $100 each. Bond yields are 6% pa, given as an APR compounding every 6 months, and the yield curve is flat. How many bonds should the firm issue?
Details of two different types of light bulbs are given below:
The real discount rate is 5%, given as an effective annual rate. Assume that all cash flows are real. The inflation rate is 3% given as an effective annual rate. Find the Equivalent Annual Cost (EAC) of the low-energy and conventional light bulbs. The below choices are listed in that order.
Question 181 DDM, no explanation A stock pays annual dividends. It just paid a dividend of $5. The growth rate in the dividend is 1% pa. You estimate that the stock's required return is 8% pa. Both the discount rate and growth rate are given as effective annual rates. Using the dividend discount model, what will be the share price?
Question 183 bond pricing A five year bond has a face value of $100, a yield of 12% and a fixed coupon rate of 6%, paid semi-annually. What is the bond's price?
A stock is expected to pay the following dividends:
After year 4, the dividend will grow in perpetuity at 4% pa. The required return on the stock is 10% pa. Both the growth rate and required return are given as effective annual rates. What is the current price of the stock?
Question 185 NPV, DDM, no explanation A stock is expected to pay the following dividends:
After year 4, the dividend will grow in perpetuity at 4% pa. The required return on the stock is 10% pa. Both the growth rate and required return are given as effective annual rates. What will be the price of the stock in 5 years (t = 5), just after the dividend at that time has been paid?
Question 186 DDM, income and capital returns Here's the Dividend Discount Model, used to price stocks: ### p_0=\frac{d_1}{r-g} ### All rates are effective annual rates and the cash flows (##d_1##) are received every year. Note that the r and g terms in the above DDM could also be labelled: ###r = r_{\text{total, 0}\rightarrow\text{1yr, eff 1yr}}### ###g = r_{\text{capital, 0}\rightarrow\text{1yr, eff 1yr}}### Which of the following statements is NOT correct?
Question 187 fully amortising loan, APR You just signed up for a 30 year fully amortising mortgage with monthly payments of $1,000 per month. The interest rate is 6% pa which is not expected to change. How much did you borrow? After 20 years, how much will be owing on the mortgage? The interest rate is still 6% and is not expected to change.
Find Trademark Corporation's Cash Flow From Assets (CFFA), also known as Free Cash Flow to the Firm (FCFF), over the year ending 30th June 2013.
Note: all figures are given in millions of dollars ($m).
A project has the following cash flows:
The required return on the project is 10%, given as an effective annual rate. What is the Internal Rate of Return (IRR) of this project? The following choices are effective annual rates. Assume that the cash flows shown in the table are paid all at once at the given point in time.
Question 190 pay back period A project has the following cash flows:
What is the payback period of the project in years? Normally cash flows are assumed to happen at the given time. But here, assume that the cash flows are received smoothly over the year. So the $500 at time 2 is actually earned smoothly from t=1 to t=2.
Harvey Norman the large retailer often runs sales advertising 2 years interest free when you purchase its products. This offer can be seen as a free personal loan from Harvey Norman to its customers. Assume that banks charge an interest rate on personal loans of 12% pa given as an APR compounding per month. This is the interest rate that Harvey Norman deserves on the 2 year loan it extends to its customers. Therefore Harvey Norman must implicitly include the cost of this loan in the advertised sale price of its goods. If you were a customer buying from Harvey Norman, and you were paying immediately, not in 2 years, what is the minimum percentage discount to the advertised sale price that you would insist on? (Hint: if it makes it easier, assume that you’re buying a product with an advertised price of $100).
Question 194 bond pricing, capital raising A firm wishes to raise $8 million now. They will issue 7% pa semi-annual coupon bonds that will mature in 10 years and have a face value of $100 each. Bond yields are 10% pa, given as an APR compounding every 6 months, and the yield curve is flat. How many bonds should the firm issue?
Question 195 equivalent annual cash flow An industrial chicken farmer grows chickens for their meat. Chickens:
The required return of the chicken farm is 0.5% given as an effective weekly rate. Ignore taxes and the fixed costs of the factory. Ignore the chicken’s welfare and other environmental and ethical concerns. Find the equivalent weekly cash flow of slaughtering a chicken at 6 weeks and at 10 weeks so the farmer can figure out the best time to slaughter his chickens. The choices below are given in the same order, 6 and 10 weeks.
Question 196 DDM, no explanation A share pays annual dividends. It just paid a dividend of $2. The growth rate in the dividend is 3% pa. You estimate that the stock's required return is 8% pa. Both the discount rate and growth rate are given as effective annual rates. Using the dividend discount model, what is the share price?
Question 197 credit risk, bank accepted bill A highly levered risky firm is trying to raise more debt. The types of debt being considered, in no particular order, are senior bonds, junior bonds, bank accepted bills, promissory notes and bank loans. Which of these forms of debt is the safest from the perspective of the debt investors who are thinking of investing in the firm's new debt?
Question 198 NPV, DDM, no explanation A stock is expected to pay the following dividends:
After year 4, the dividend will grow in perpetuity at 5% pa. The required return of the stock is 10% pa. Both the growth rate and required return are given as effective annual rates. What is the current price of the stock?
Question 199 NPV, DDM, no explanation A stock is expected to pay the following dividends:
After year 4, the dividend will grow in perpetuity at 5% pa. The required return of the stock is 10% pa. Both the growth rate and required return are given as effective annual rates. What will be the price of the stock in 7 years (t = 7), just after the dividend at that time has been paid?
Question 200 NPV, no explanation A stock is expected to pay the following dividends:
After year 4, the dividend will grow in perpetuity at 5% pa. The required return of the stock is 10% pa. Both the growth rate and required return are given as effective annual rates. If all of the dividends since time period zero were deposited into a bank account yielding 8% pa as an effective annual rate, how much money will be in the bank account in 2.5 years (in other words, at t=2.5)?
Question 201 DDM, income and capital returns The following is the Dividend Discount Model (DDM) used to price stocks: ###P_0=\dfrac{C_1}{r-g}### If the assumptions of the DDM hold, which one of the following statements is NOT correct? The long term expected:
Question 202 DDM, payout policy Currently, a mining company has a share price of $6 and pays constant annual dividends of $0.50. The next dividend will be paid in 1 year. Suddenly and unexpectedly the mining company announces that due to higher than expected profits, all of these windfall profits will be paid as a special dividend of $0.30 in 1 year. If investors believe that the windfall profits and dividend is a one-off event, what will be the new share price? If investors believe that the additional dividend is actually permanent and will continue to be paid, what will be the new share price? Assume that the required return on equity is unchanged. Choose from the following, where the first share price includes the one-off increase in earnings and dividends for the first year only ##(P_\text{0 one-off})## , and the second assumes that the increase is permanent ##(P_\text{0 permanent})##: Note: When a firm makes excess profits they sometimes pay them out as special dividends. Special dividends are just like ordinary dividends but they are one-off and investors do not expect them to continue, unlike ordinary dividends which are expected to persist.
Question 203 fully amortising loan, APR You just signed up for a 30 year fully amortising mortgage loan with monthly payments of $1,500 per month. The interest rate is 9% pa which is not expected to change. How much did you borrow? After 10 years, how much will be owing on the mortgage? The interest rate is still 9% and is not expected to change.
Question 204 time calculation, fully amortising loan, APR You just signed up for a 30 year fully amortising mortgage loan with monthly payments of $1,500 per month. The interest rate is 9% pa which is not expected to change. To your surprise, you can actually afford to pay $2,000 per month and your mortgage allows early repayments without fees. If you maintain these higher monthly payments, how long will it take to pay off your mortgage?
Question 205 depreciation tax shield, CFFA There are a number of ways that assets can be depreciated. Generally the government's tax office stipulates a certain method. But if it didn't, what would be the ideal way to depreciate an asset from the perspective of a businesses owner?
Question 206 CFFA, interest expense, interest tax shield Interest expense (IntExp) is an important part of a company's income statement (or 'profit and loss' or 'statement of financial performance'). How does an accountant calculate the annual interest expense of a fixed-coupon bond that has a liquid secondary market? Select the most correct answer: Annual interest expense is equal to:
For a bond that pays fixed semi-annual coupons, how is the annual coupon rate defined, and how is the bond's annual income yield from time 0 to 1 defined mathematically? Let: ##P_0## be the bond price now, ##F_T## be the bond's face value, ##T## be the bond's maturity in years, ##r_\text{total}## be the bond's total yield, ##r_\text{income}## be the bond's income yield, ##r_\text{capital}## be the bond's capital yield, and ##C_t## be the bond's coupon at time t in years. So ##C_{0.5}## is the coupon in 6 months, ##C_1## is the coupon in 1 year, and so on.
Find UniBar Corp's Cash Flow From Assets (CFFA), also known as Free Cash Flow to the Firm (FCFF), over the year ending 30th June 2013.
Note: all figures are given in millions of dollars ($m).
Find Piano Bar's Cash Flow From Assets (CFFA), also known as Free Cash Flow to the Firm (FCFF), over the year ending 30th June 2013.
Note: all figures are given in millions of dollars ($m).
Assume that the Gordon Growth Model (same as the dividend discount model or perpetuity with growth formula) is an appropriate method to value real estate. The rule of thumb in the real estate industry is that properties should yield a 5% pa rental return. Many investors also regard property to be as risky as the stock market, therefore property is thought to have a required total return of 9% pa which is the average total return on the stock market including dividends. Assume that all returns are effective annual rates and they are nominal (not reduced by inflation). Inflation is expected to be 2% pa. You're considering purchasing an investment property which has a rental yield of 5% pa and you expect it to have the same risk as the stock market. Select the most correct statement about this property.
Question 211 equivalent annual cash flow You're advising your superstar client 40-cent who is weighing up buying a private jet or a luxury yacht. 40-cent is just as happy with either, but he wants to go with the more cost-effective option. These are the cash flows of the two options:
What's unusual about 40-cent is that he is so famous that he will actually be able to sell his jet or yacht for the same price as it was bought since the next generation of superstar musicians will buy it from him as a status symbol. Bank interest rates are 10% pa, given as an effective annual rate. You can assume that 40-cent will live for another 60 years and that when the jet or yacht's life is at an end, he will buy a new one with the same details as above. Would you advise 40-cent to buy the or the ? Note that the effective monthly rate is ##r_\text{eff monthly}=(1+0.1)^{1/12}-1=0.00797414##
Question 212 rights issue In mid 2009 the listed mining company Rio Tinto announced a 21-for-40 renounceable rights issue. Below is the chronology of events:
All things remaining equal, what would you expect Rio Tinto's stock price to open at on the first day that it trades ex-rights (17/6/2009)? Ignore the time value of money since time is negligibly short. Also ignore taxes.
The coupon rate of a fixed annual-coupon bond is constant (always the same). What can you say about the income return (##r_\text{income}##) of a fixed annual coupon bond? Remember that: ###r_\text{total} = r_\text{income} + r_\text{capital}### ###r_\text{total, 0 to 1} = \frac{c_1}{p_0} + \frac{p_1-p_0}{p_0}### Assume that there is no change in the bond's total annual yield to maturity from when it is issued to when it matures. Select the most correct statement. From its date of issue until maturity, the income return of a fixed annual coupon:
Question 214 rights issue In late 2003 the listed bank ANZ announced a 2-for-11 rights issue to fund the takeover of New Zealand bank NBNZ. Below is the chronology of events:
All things remaining equal, what would you expect ANZ's stock price to open at on the first day that it trades ex-rights (29/10/2003)? Ignore the time value of money since time is negligibly short. Also ignore taxes.
A stock just paid its annual dividend of $9. The share price is $60. The required return of the stock is 10% pa as an effective annual rate. What is the implied growth rate of the dividend per year?
Question 217 NPV, DDM, multi stage growth model A stock is expected to pay a dividend of $15 in one year (t=1), then $25 for 9 years after that (payments at t=2 ,3,...10), and on the 11th year (t=11) the dividend will be 2% less than at t=10, and will continue to shrink at the same rate every year after that forever. The required return of the stock is 10%. All rates are effective annual rates. What is the price of the stock now?
Question 219 profitability index A project has the following cash flows:
The required return of a project is 10%, given as an effective annual rate. Assume that the cash flows shown in the table are paid all at once at the given point in time. What is the Profitability Index (PI) of the project?
Question 220 pay back period, no explanation A project has the following cash flows. Normally cash flows are assumed to happen at the given time. But here, assume that the cash flows are received smoothly over the year. So the $105 at time 2 is actually earned smoothly from t=1 to t=2:
What is the payback period of the project in years?
You're considering making an investment in a particular company. They have preference shares, ordinary shares, senior debt and junior debt. Which is the safest investment? Which has the highest expected returns?
Question 222 fully amortising loan, APR You just agreed to a 30 year fully amortising mortgage loan with monthly payments of $2,500. The interest rate is 9% pa which is not expected to change. How much did you borrow? After 10 years, how much will be owing on the mortgage? The interest rate is still 9% and is not expected to change. The below choices are given in the same order.
Cash Flow From Assets (CFFA) can be defined as:
A firm has forecast its Cash Flow From Assets (CFFA) for this year and management is worried that it is too low. Which one of the following actions will lead to a higher CFFA for this year (t=0 to 1)? Only consider cash flows this year. Do not consider cash flows after one year, or the change in the NPV of the firm. Consider each action in isolation.
Find World Bar's Cash Flow From Assets (CFFA), also known as Free Cash Flow to the Firm (FCFF), over the year ending 30th June 2013.
Note: all figures above and below are given in millions of dollars ($m).
Question 228 DDM, NPV, risk, market efficiency A very low-risk stock just paid its semi-annual dividend of $0.14, as it has for the last 5 years. You conservatively estimate that from now on the dividend will fall at a rate of 1% every 6 months. If the stock currently sells for $3 per share, what must be its required total return as an effective annual rate? If risk free government bonds are trading at a yield of 4% pa, given as an effective annual rate, would you consider buying or selling the stock? The stock's required total return is:
Question 229 bond pricing An investor bought two fixed-coupon bonds issued by the same company, a zero-coupon bond and a 7% pa semi-annual coupon bond. Both bonds have a face value of $1,000, mature in 10 years, and had a yield at the time of purchase of 8% pa. A few years later, yields fell to 6% pa. Which of the following statements is correct? Note that a capital gain is an increase in price.
Question 230 bond pricing, capital raising A firm wishes to raise $10 million now. They will issue 6% pa semi-annual coupon bonds that will mature in 8 years and have a face value of $1,000 each. Bond yields are 10% pa, given as an APR compounding every 6 months, and the yield curve is flat. How many bonds should the firm issue? All numbers are rounded up.
A fairly priced stock has a beta that is the same as the market portfolio's beta. Treasury bonds yield 5% pa and the market portfolio's expected return is 10% pa. What is the expected return of the stock?
A stock has a beta of 0.5. Its next dividend is expected to be $3, paid one year from now. Dividends are expected to be paid annually and grow by 2% pa forever. Treasury bonds yield 5% pa and the market portfolio's expected return is 10% pa. All returns are effective annual rates. What is the price of the stock now?
Question 233 bond pricing A four year bond has a face value of $100, a yield of 9% and a fixed coupon rate of 6%, paid semi-annually. What is its price?
Question 234 debt terminology An 'interest only' loan can also be called a:
Question 235 SML, NPV, CAPM, risk The security market line (SML) shows the relationship between beta and expected return. Investment projects that plot on the SML would have:
Question 238 CFFA, leverage, interest tax shield A company increases the proportion of debt funding it uses to finance its assets by issuing bonds and using the cash to repurchase stock, leaving assets unchanged. Ignoring the costs of financial distress, which of the following statements is NOT correct:
Question 240 negative gearing, interest tax shield Unrestricted negative gearing is allowed in Australia, New Zealand and Japan. Negative gearing laws allow income losses on investment properties to be deducted from a tax-payer's pre-tax personal income. Negatively geared investors benefit from this tax advantage. They also hope to benefit from capital gains which exceed the income losses. For example, a property investor buys an apartment funded by an interest only mortgage loan. Interest expense is $2,000 per month. The rental payments received from the tenant living on the property are $1,500 per month. The investor can deduct this income loss of $500 per month from his pre-tax personal income. If his personal marginal tax rate is 46.5%, this saves $232.5 per month in personal income tax. The advantage of negative gearing is an example of the benefits of:
One of Miller and Modigliani's (M&M's) important insights is that a firm's managers should not try to achieve a particular level of leverage in a world with zero taxes and perfect information since investors can make their own leverage. Therefore corporate capital structure policy is irrelevant since investors can achieve their own desired leverage at the personal level by borrowing or lending on their own. This principal of 'home-made' or 'do-it-yourself' leverage can also be applied to other topics. Read the following statements to decide which are true: (I) Payout policy: a firm's managers should not try to achieve a particular pattern of equity payout. (II) Agency costs: a firm's managers should not try to minimise agency costs. (III) Diversification: a firm's managers should not try to diversify across industries. (IV) Shareholder wealth: a firm's managers should not try to maximise shareholders' wealth. Which of the above statement(s) are true?
Question 244 CAPM, SML, NPV, risk Examine the following graph which shows stocks' betas ##(\beta)## and expected returns ##(\mu)##: Assume that the CAPM holds and that future expectations of stocks' returns and betas are correctly measured. Which statement is NOT correct?
Investors expect Australia's central bank, the RBA, to leave the policy rate unchanged at their next meeting. Then unexpectedly, the policy rate is reduced due to fears that Australia's GDP growth is slowing. What do you expect to happen to Australia's exchange rate? Direct and indirect quotes are given from the perspective of an Australian. The Australian dollar will:
Question 247 cross currency interest rate parity, no explanation In the so called 'Swiss Loans Affair' of the 1980's, Australian banks offered loans denominated in Swiss Francs to Australian farmers at interest rates as low as 4% pa. This was far lower than interest rates on Australian Dollar loans which were above 10% due to very high inflation in Australia at the time. In the late-1980's there was a large depreciation in the Australian Dollar. The Australian Dollar nearly halved in value against the Swiss Franc. Many Australian farmers went bankrupt since they couldn't afford the interest payments on the Swiss Franc loans because the Australian Dollar value of those payments nearly doubled. The farmers accused the banks of promoting Swiss Franc loans without making them aware of the risks. What fundamental principal of finance did the Australian farmers (and the bankers) fail to understand?
Question 248 CAPM, DDM, income and capital returns The total return of any asset can be broken down in different ways. One possible way is to use the dividend discount model (or Gordon growth model): ###p_0 = \frac{c_1}{r_\text{total}-r_\text{capital}}### Which, since ##c_1/p_0## is the income return (##r_\text{income}##), can be expressed as: ###r_\text{total}=r_\text{income}+r_\text{capital}### So the total return of an asset is the income component plus the capital or price growth component. Another way to break up total return is to use the Capital Asset Pricing Model: ###r_\text{total}=r_\text{f}+β(r_\text{m}- r_\text{f})### ###r_\text{total}=r_\text{time value}+r_\text{risk premium}### So the risk free rate is the time value of money and the term ##β(r_\text{m}- r_\text{f})## is the compensation for taking on systematic risk. Using the above theory and your general knowledge, which of the below equations, if any, are correct? (I) ##r_\text{income}=r_\text{time value}## (II) ##r_\text{income}=r_\text{risk premium}## (III) ##r_\text{capital}=r_\text{time value}## (IV) ##r_\text{capital}=r_\text{risk premium}## (V) ##r_\text{income}+r_\text{capital}=r_\text{time value}+r_\text{risk premium}## Which of the equations are correct?
Question 249 equivalent annual cash flow, effective rate conversion Details of two different types of desserts or edible treats are given below:
The advantage of low-sugar treats is that a person only needs to pay the dentist $2,000 for fillings and root canal therapy once every 15 years. Whereas with high-sugar treats, that treatment needs to be done every 5 years. The real discount rate is 10%, given as an effective annual rate. Assume that there are 365 days in every year and that all cash flows are real. The inflation rate is 3% given as an effective annual rate. Find the equivalent annual cash flow (EAC) of the high-sugar treats and low-sugar treats, including dental costs. The below choices are listed in that order. Ignore the pain of dental therapy, personal preferences and other factors.
Question 250 NPV, Loan, arbitrage table Your neighbour asks you for a loan of $100 and offers to pay you back $120 in one year. You don't actually have any money right now, but you can borrow and lend from the bank at a rate of 10% pa. Rates are given as effective annual rates. Assume that your neighbour will definitely pay you back. Ignore interest tax shields and transaction costs. The Net Present Value (NPV) of lending to your neighbour is $9.09. Describe what you would do to actually receive a $9.09 cash flow right now with zero net cash flows in the future.
You have $100,000 in the bank. The bank pays interest at 10% pa, given as an effective annual rate. You wish to consume an equal amount now (t=0) and in one year (t=1) and have nothing left in the bank at the end (t=1). How much can you consume at each time?
You have $100,000 in the bank. The bank pays interest at 10% pa, given as an effective annual rate. You wish to consume an equal amount now (t=0), in one year (t=1) and in two years (t=2), and still have $50,000 in the bank after that (t=2). How much can you consume at each time?
You just started work at your new job which pays $48,000 per year. The human resources department have given you the option of being paid at the end of every week or every month. Assume that there are 4 weeks per month, 12 months per year and 48 weeks per year. Bank interest rates are 12% pa given as an APR compounding per month. What is the dollar gain over one year, as a net present value, of being paid every week rather than every month?
Question 254 time calculation, APR Your main expense is fuel for your car which costs $100 per month. You just refueled, so you won't need any more fuel for another month (first payment at t=1 month). You have $2,500 in a bank account which pays interest at a rate of 6% pa, payable monthly. Interest rates are not expected to change. Assuming that you have no income, in how many months time will you not have enough money to fully refuel your car?
Question 255 bond pricing In these tough economic times, central banks around the world have cut interest rates so low that they are practically zero. In some countries, government bond yields are also very close to zero. A three year government bond with a face value of $100 and a coupon rate of 2% pa paid semi-annually was just issued at a yield of 0%. What is the price of the bond?
Question 256 APR, effective rate A 2 year corporate bond yields 3% pa with a coupon rate of 5% pa, paid semi-annually. Find the effective monthly rate, effective six month rate, and effective annual rate. ##r_\text{eff monthly}##, ##r_\text{eff 6 month}##, ##r_\text{eff annual}##.
Question 257 bond pricing A 10 year bond has a face value of $100, a yield of 6% pa and a fixed coupon rate of 8% pa, paid semi-annually. What is its price?
Question 259 fully amortising loan, APR You want to buy a house priced at $400,000. You have saved a deposit of $40,000. The bank has agreed to lend you $360,000 as a fully amortising loan with a term of 30 years. The interest rate is 8% pa payable monthly and is not expected to change. What will be your monthly payments?
A share just paid its semi-annual dividend of $5. The dividend is expected to grow at 1% every 6 months forever. This 1% growth rate is an effective 6 month rate. Therefore the next dividend will be $5.05 in six months. The required return of the stock 8% pa, given as an effective annual rate. What is the price of the share now?
Question 261 income and capital returns A share was bought for $4 and paid an dividend of $0.50 one year later (at t=1 year). Just after the dividend was paid, the share price fell to $3.50 (at t=1 year). What were the total return, capital return and income returns given as effective annual rates? The answer choices are given in the same order: ##r_\text{total}##, ##r_\text{capital}##, ## r_\text{income}##
Question 262 income and capital returns A 90-day $1 million Bank Accepted Bill (BAB) was bought for $990,000 and sold 30 days later for $996,000 (at t=30 days). What was the total return, capital return and income return over the 30 days it was held? Despite the fact that money market instruments such as bills are normally quoted with simple interest rates, please calculate your answers as compound interest rates, specifically, as effective 30-day rates, which is how the below answer choices are listed. ##r_\text{total}##, ##r_\text{capital}##, ## r_\text{income}##
Question 263 DDM, income and capital returns A company's shares just paid their annual dividend of $2 each. The stock price is now $40 (just after the dividend payment). The annual dividend is expected to grow by 3% every year forever. The assumptions of the dividend discount model are valid for this company. What do you expect the effective annual dividend yield to be in 3 years (dividend yield from t=3 to t=4)?
The following equation is the Dividend Discount Model, also known as the 'Gordon Growth Model' or the 'Perpetuity with growth' equation. ###P_0=\frac{d_1}{r-g}### A stock pays dividends annually. It just paid a dividend, but the next dividend (##d_1##) will be paid in one year. According to the DDM, what is the correct formula for the expected price of the stock in 2.5 years?
Question 265 APR, Annuity On his 20th birthday, a man makes a resolution. He will deposit $30 into a bank account at the end of every month starting from now, which is the start of the month. So the first payment will be in one month. He will write in his will that when he dies the money in the account should be given to charity. The bank account pays interest at 6% pa compounding monthly, which is not expected to change. If the man lives for another 60 years, how much money will be in the bank account if he dies just after making his last (720th) payment?
Question 266 bond pricing, premium par and discount bonds Bonds X and Y are issued by the same company. Both bonds yield 10% pa, and they have the same face value ($100), maturity, seniority, and payment frequency. The only difference is that bond X pays coupons of 6% pa and bond Y pays coupons of 8% pa. Which of the following statements is true?
Question 267 term structure of interest rates A European company just issued two bonds, a
What is the company's forward rate over the fourth year (from t=3 to t=4)? Give your answer as an effective annual rate, which is how the above bond yields are quoted.
Question 268 time calculation, APR You're trying to save enough money for a deposit to buy a house. You want to buy a house worth $400,000 and the bank requires a 20% deposit ($80,000) before it will give you a loan for the other $320,000 that you need. You currently have no savings, but you just started working and can save $2,000 per month, with the first payment in one month from now. Bank interest rates on savings accounts are 4.8% pa with interest paid monthly and interest rates are not expected to change. How long will it take to save the $80,000 deposit? Round your answer up to the nearest month.
Question 269 time calculation, APR A student won $1m in a lottery. Currently the money is in a bank account which pays interest at 6% pa, given as an APR compounding per month. She plans to spend $20,000 at the beginning of every month from now on (so the first withdrawal will be at t=0). After each withdrawal, she will check how much money is left in the account. When there is less than $500,000 left, she will donate that remaining amount to charity. In how many months will she make her last withdrawal and donate the remainder to charity?
Question 270 real estate, DDM, effective rate conversion You own an apartment which you rent out as an investment property. What is the price of the apartment using discounted cash flow (DCF, same as NPV) valuation? Assume that:
All things remaining equal, according to the capital asset pricing model, if the systematic variance of an asset increases, its required return will increase and its price will decrease. What is the relationship between the price of a call or put option and the total, systematic and idiosyncratic variance of the underlying asset that the option is based on? Select the most correct answer. Call and put option prices increase when the:
Suppose you had $100 in a savings account and the interest rate was 2% per year. After 5 years, how much do you think you would have in the account if you left the money to grow?
Question 273 CFFA, capital budgeting Value the following business project to manufacture a new product.
Notes
Assumptions
What is the expected net present value (NPV) of the project?
Question 274 derivative terminology, option
Question 275 derivative terminology, future
Question 276 derivative terminology, option
Question 277 derivative terminology, future
Question 279 diversification
Question 280 equivalent annual cash flow You own a nice suit which you wear once per week on nights out. You bought it one year ago for $600. In your experience, suits used once per week last for 6 years. So you expect yours to last for another 5 years. Your younger brother said that retro is back in style so he wants to wants to borrow your suit once a week when he goes out. With the increased use, your suit will only last for another 4 years rather than 5. What is the present value of the cost of letting your brother use your current suit for the next 4 years? Assume: that bank interest rates are 10% pa, given as an effective annual rate; you will buy a new suit when your current one wears out and your brother will not use the new one; your brother will only use your current suit so he will only use it for the next four years; and the price of a new suit never changes.
Question 281 equivalent annual cash flow You just bought a nice dress which you plan to wear once per month on nights out. You bought it a moment ago for $600 (at t=0). In your experience, dresses used once per month last for 6 years. Your younger sister is a student with no money and wants to borrow your dress once a month when she hits the town. With the increased use, your dress will only last for another 3 years rather than 6. What is the present value of the cost of letting your sister use your current dress for the next 3 years? Assume: that bank interest rates are 10% pa, given as an effective annual rate; you will buy a new dress when your current one wears out; your sister will only use the current dress, not the next one that you will buy; and the price of a new dress never changes.
Question 282 expected and historical returns, income and capital returns You're the boss of an investment bank's equities research team. Your five analysts are each trying to find the expected total return over the next year of shares in a mining company. The mining firm:
Assume that:
Question 283 portfolio risk, correlation, needs refinement Three important classes of investable risky assets are:
Assume that the correlation between total returns on:
You are considering investing all of your wealth in one or more of these asset classes. Which portfolio will give the lowest total risk? You are restricted from shorting any of these assets. Disregard returns and the risk-return trade-off, pretend that you are only concerned with minimising risk.
Question 284 covariance, correlation The following table shows a sample of historical total returns of shares in two different companies A and B.
What is the historical sample covariance (##\hat{\sigma}_{A,B}##) and correlation (##\rho_{A,B}##) of stock A and B's total effective annual returns?
Question 285 covariance, portfolio risk Two risky stocks A and B comprise an equal-weighted portfolio. The correlation between the stocks' returns is 70%. If the variance of stock A's returns increases but the:
Which of the following statements is NOT correct?
Question 286 bill pricing A 30-day Bank Accepted Bill has a face value of $1,000,000. The interest rate is 2.5% pa and there are 365 days in the year. What is its price now?
Question 287 bond pricing A 30 year Japanese government bond was just issued at par with a yield of 1.7% pa. The fixed coupon payments are semi-annual. The bond has a face value of $100. Six months later, just after the first coupon is paid, the yield of the bond increases to 2% pa. What is the bond's new price?
There are many ways to write the ordinary annuity formula. Which of the following is NOT equal to the ordinary annuity formula?
Find Scubar Corporation's Cash Flow From Assets (CFFA), also known as Free Cash Flow to the Firm (FCFF), over the year ending 30th June 2013.
Note: All figures are given in millions of dollars ($m). The cash flow from assets was:
Question 292 standard deviation, risk Find the sample standard deviation of returns using the data in the table:
The returns above and standard deviations below are given in decimal form.
Question 295 inflation, real and nominal returns and cash flows, NPV When valuing assets using discounted cash flow (net present value) methods, it is important to consider inflation. To properly deal with inflation: (I) Discount nominal cash flows by nominal discount rates. (II) Discount nominal cash flows by real discount rates. (III) Discount real cash flows by nominal discount rates. (IV) Discount real cash flows by real discount rates. Which of the above statements is or are correct?
Question 296 CFFA, interest tax shield Which one of the following will decrease net income (NI) but increase cash flow from assets (CFFA) in this year for a tax-paying firm, all else remaining constant? Remember: ###NI=(Rev-COGS-FC-Depr-IntExp).(1-t_c )### ###CFFA=NI+Depr-CapEx - ΔNWC+IntExp###
Question 297 implicit interest rate in wholesale credit You just bought $100,000 worth of inventory from a wholesale supplier. You are given the option of paying within 5 days and receiving a 2% discount, or paying the full price within 60 days. You actually don't have the cash to pay within 5 days, but you could borrow it from the bank (as an overdraft) at 10% pa, given as an effective annual rate. In 60 days you will have enough money to pay the full cost without having to borrow from the bank. What is the implicit interest rate charged by the wholesale supplier, given as an effective annual rate? Also, should you borrow from the bank in 5 days to pay the supplier and receive the discount? Or just pay the full price on the last possible date? Assume that there are 365 days per year.
Question 298 interest only loan A prospective home buyer can afford to pay $2,000 per month in mortgage loan repayments. The central bank recently lowered its policy rate by 0.25%, and residential home lenders cut their mortgage loan rates from 4.74% to 4.49%. How much more can the prospective home buyer borrow now that interest rates are 4.49% rather than 4.74%? Give your answer as a proportional increase over the original amount he could borrow (##V_\text{before}##), so: ###\text{Proportional increase} = \frac{V_\text{after}-V_\text{before}}{V_\text{before}} ###Assume that:
Question 299 equivalent annual cash flow Carlos and Edwin are brothers and they both love Holden Commodore cars. Carlos likes to buy the latest Holden Commodore car for $40,000 every 4 years as soon as the new model is released. As soon as he buys the new car, he sells the old one on the second hand car market for $20,000. Carlos never has to bother with paying for repairs since his cars are brand new. Edwin also likes Commodores, but prefers to buy 4-year old cars for $20,000 and keep them for 11 years until the end of their life (new ones last for 15 years in total but the 4-year old ones only last for another 11 years). Then he sells the old car for $2,000 and buys another 4-year old second hand car, and so on. Every time Edwin buys a second hand 4 year old car he immediately has to spend $1,000 on repairs, and then $1,000 every year after that for the next 10 years. So there are 11 payments in total from when the second hand car is bought at t=0 to the last payment at t=10. One year later (t=11) the old car is at the end of its total 15 year life and can be scrapped for $2,000. Assuming that Carlos and Edwin maintain their love of Commodores and keep up their habits of buying new ones and second hand ones respectively, how much larger is Carlos' equivalent annual cost of car ownership compared with Edwin's? The real discount rate is 10% pa. All cash flows are real and are expected to remain constant. Inflation is forecast to be 3% pa. All rates are effective annual. Ignore capital gains tax and tax savings from depreciation since cars are tax-exempt for individuals.
Question 300 NPV, opportunity cost What is the net present value (NPV) of undertaking a full-time Australian undergraduate business degree as an Australian citizen? Only include the cash flows over the duration of the degree, ignore any benefits or costs of the degree after it's completed. Assume the following:
The NPV of costs from undertaking the university degree is:
Question 301 leverage, capital structure, real estate Your friend just bought a house for $1,000,000. He financed it using a $900,000 mortgage loan and a deposit of $100,000. In the context of residential housing and mortgages, the 'equity' or 'net wealth' tied up in a house is the value of the house less the value of the mortgage loan. Assuming that your friend's only asset is his house, his net wealth is $100,000. If house prices suddenly fall by 15%, what would be your friend's percentage change in net wealth? Assume that:
Which of the following statements about the weighted average cost of capital (WACC) is NOT correct?
Question 303 WACC, CAPM, CFFA There are many different ways to value a firm's assets. Which of the following will NOT give the correct market value of a levered firm's assets ##(V_L)##? Assume that:
Where: ###r_\text{WACC before tax} = r_D.\frac{D}{V_L} + r_{EL}.\frac{E_L}{V_L} = \text{Weighted average cost of capital before tax}### ###r_\text{WACC after tax} = r_D.(1-t_c).\frac{D}{V_L} + r_{EL}.\frac{E_L}{V_L} = \text{Weighted average cost of capital after tax}### ###NI_L=(Rev-COGS-FC-Depr-\mathbf{IntExp}).(1-t_c) = \text{Net Income Levered}### ###CFFA_L=NI_L+Depr-CapEx - \varDelta NWC+\mathbf{IntExp} = \text{Cash Flow From Assets Levered}### ###NI_U=(Rev-COGS-FC-Depr).(1-t_c) = \text{Net Income Unlevered}### ###CFFA_U=NI_U+Depr-CapEx - \varDelta NWC= \text{Cash Flow From Assets Unlevered}###
Which one of the following is NOT usually considered an 'investable' asset for long-term wealth creation?
Question 305 option, short selling, speculation You believe that the price of a share will fall significantly very soon, but the rest of the market does not. The market thinks that the share price will remain the same. Assuming that your prediction will soon be true, which of the following trades is a bad idea? In other words, which trade will NOT make money or prevent losses?
Question 306 risk, standard deviation Let the standard deviation of returns for a share per month be ##\sigma_\text{monthly}##. What is the formula for the standard deviation of the share's returns per year ##(\sigma_\text{yearly})##? Assume that returns are independently and identically distributed (iid) so they have zero auto correlation, meaning that if the return was higher than average today, it does not indicate that the return tomorrow will be higher or lower than average.
Question 307 risk, variance Let the variance of returns for a share per month be ##\sigma_\text{monthly}^2##. What is the formula for the variance of the share's returns per year ##(\sigma_\text{yearly}^2)##? Assume that returns are independently and identically distributed (iid) so they have zero auto correlation, meaning that if the return was higher than average today, it does not indicate that the return tomorrow will be higher or lower than average.
Question 308 risk, standard deviation, variance, no explanation A stock's standard deviation of returns is expected to be:
What is the expected standard deviation of the stock per year ##(\sigma_\text{annual})##? Assume that returns are independently and identically distributed (iid) and therefore have zero auto-correlation.
Question 309 stock pricing, ex dividend date A company announces that it will pay a dividend, as the market expected. The company's shares trade on the stock exchange which is open from 10am in the morning to 4pm in the afternoon each weekday. When would the share price be expected to fall by the amount of the dividend? Ignore taxes. The share price is expected to fall during the:
Question 310 foreign exchange rate
Question 311 foreign exchange rate When someone says that they're "buying American dollars" (USD), what type of asset are they probably buying? They're probably buying:
Question 313 foreign exchange rate, American and European terms
Question 314 foreign exchange rate, American and European terms
Question 316 foreign exchange rate, American and European terms
Question 317 foreign exchange rate, American and European terms
Question 318 foreign exchange rate, American and European terms
Investors expect the Reserve Bank of Australia (RBA) to keep the policy rate steady at their next meeting. Then unexpectedly, the RBA announce that they will increase the policy rate by 25 basis points due to fears that the economy is growing too fast and that inflation will be above their target rate of 2 to 3 per cent. What do you expect to happen to Australia's exchange rate in the short term? The Australian dollar is likely to:
Investors expect the Reserve Bank of Australia (RBA) to decrease the overnight cash rate at their next meeting. Then unexpectedly, the RBA announce that they will keep the policy rate unchanged. What do you expect to happen to Australia's exchange rate in the short term? The Australian dollar is likely to:
The market expects the Reserve Bank of Australia (RBA) to increase the policy rate by 25 basis points at their next meeting. Then unexpectedly, the RBA announce that they will increase the policy rate by 50 basis points due to high future GDP and inflation forecasts. What do you expect to happen to Australia's exchange rate in the short term? The Australian dollar will:
The market expects the Reserve Bank of Australia (RBA) to decrease the policy rate by 25 basis points at their next meeting. Then unexpectedly, the RBA announce that they will decrease the policy rate by 50 basis points due to fears of a recession and deflation. What do you expect to happen to Australia's exchange rate? The Australian dollar will:
The market expects the Reserve Bank of Australia (RBA) to increase the policy rate by 25 basis points at their next meeting. As expected, the RBA increases the policy rate by 25 basis points. What do you expect to happen to Australia's exchange rate in the short term? The Australian dollar will:
Question 324 foreign exchange rate The Chinese government attempts to fix its exchange rate against the US dollar and at the same time use monetary policy to fix its interest rate at a set level. To be able to fix its exchange rate and interest rate in this way, what does the Chinese government actually do?
Which of the above statements is or are true?
Question 325 foreign exchange rate In the 1997 Asian financial crisis many countries' exchange rates depreciated rapidly against the US dollar (USD). The Thai, Indonesian, Malaysian, Korean and Filipino currencies were severely affected. The below graph shows these Asian countries' currencies in USD per one unit of their currency, indexed to 100 in June 1997. Of the statements below, which is NOT correct? The Asian countries':
A fairly priced stock has an expected return equal to the market's. Treasury bonds yield 5% pa and the market portfolio's expected return is 10% pa. What is the stock's beta?
Question 327 bill pricing, simple interest rate, no explanation On 27/09/13, three month Swiss government bills traded at a yield of -0.2%, given as a simple annual yield. That is, interest rates were negative. If the face value of one of these 90 day bills is CHF1,000,000 (CHF represents Swiss Francs, the Swiss currency), what is the price of one of these bills?
Question 328 bond pricing, APR A 10 year Australian government bond was just issued at par with a yield of 3.9% pa. The fixed coupon payments are semi-annual. The bond has a face value of $1,000. Six months later, just after the first coupon is paid, the yield of the bond decreases to 3.65% pa. What is the bond's new price?
Question 331 DDM, income and capital returns The following equation is the Dividend Discount Model, also known as the 'Gordon Growth Model' or the 'Perpetuity with growth' equation. ### p_0= \frac{c_1}{r-g} ### Which expression is equal to the expected dividend return?
Question 332 bond pricing, premium par and discount bonds Bonds X and Y are issued by the same US company. Both bonds yield 6% pa, and they have the same face value ($100), maturity, seniority, and payment frequency. The only difference is that bond X pays coupons of 8% pa and bond Y pays coupons of 12% pa. Which of the following statements is true?
Question 333 DDM, time calculation When using the dividend discount model, care must be taken to avoid using a nominal dividend growth rate that exceeds the country's nominal GDP growth rate. Otherwise the firm is forecast to take over the country since it grows faster than the average business forever. Suppose a firm's nominal dividend grows at 10% pa forever, and nominal GDP growth is 5% pa forever. The firm's total dividends are currently $1 billion (t=0). The country's GDP is currently $1,000 billion (t=0). In approximately how many years will the company's total dividends be as large as the country's GDP?
Which option position has the possibility of unlimited potential losses?
Question 335 foreign exchange rate, American and European terms Investors expect Australia's central bank, the RBA, to reduce the policy rate at their next meeting due to fears that the economy is slowing. Then unexpectedly, the policy rate is actually kept unchanged. What do you expect to happen to Australia's exchange rate?
Question 336 forward foreign exchange rate, no explanation The Australian cash rate is expected to be 6% pa while the US federal funds rate is expected to be 4% pa over the next 3 years, both given as effective annual rates. The current exchange rate is 0.80 AUD per USD. What is the implied 3 year forward foreign exchange rate?
A fast-growing firm is suitable for valuation using a multi-stage growth model. It's nominal unlevered cash flow from assets (##CFFA_U##) at the end of this year (t=1) is expected to be $1 million. After that it is expected to grow at a rate of:
Assume that:
What is the levered value of this fast growing firm's assets?
Question 338 market efficiency, CAPM, opportunity cost, technical analysis A man inherits $500,000 worth of shares. He believes that by learning the secrets of trading, keeping up with the financial news and doing complex trend analysis with charts that he can quit his job and become a self-employed day trader in the equities markets. What is the expected gain from doing this over the first year? Measure the net gain in wealth received at the end of this first year due to the decision to become a day trader. Assume the following:
Measure the net gain over the first year as an expected wealth increase at the end of the year.
Economic statistics released this morning were a surprise: they show a strong chance of consumer price inflation (CPI) reaching 5% pa over the next 2 years. This is much higher than the previous forecast of 3% pa. A vanilla fixed-coupon 2-year risk-free government bond was issued at par this morning, just before the economic news was released. What is the expected change in bond price after the economic news this morning, and in the next 2 years? Assume that:
Question 340 market efficiency, opportunity cost A managed fund charges fees based on the amount of money that you keep with them. The fee is 2% of the start-of-year amount, but it is paid at the end of every year. This fee is charged regardless of whether the fund makes gains or losses on your money. The fund offers to invest your money in shares which have an expected return of 10% pa before fees. You are thinking of investing $100,000 in the fund and keeping it there for 40 years when you plan to retire. What is the Net Present Value (NPV) of investing your money in the fund? Note that the question is not asking how much money you will have in 40 years, it is asking: what is the NPV of investing in the fund? Assume that:
Question 341 Multiples valuation, PE ratio Estimate Microsoft's (MSFT) share price using a price earnings (PE) multiples approach with the following assumptions and figures only:
Source: Google Finance 28 Feb 2014.
Question 342 CFFA, capital budgeting A new company's Firm Free Cash Flow (FFCF, same as CFFA) is forecast in the graph below. To value the firm's assets, the terminal value needs to be calculated using the perpetuity with growth formula: ###V_{\text{terminal, }t-1} = \dfrac{FFCF_{\text{terminal, }t}}{r-g}### Which point corresponds to the best time to calculate the terminal value?
Question 343 CFFA, capital budgeting An old company's Firm Free Cash Flow (FFCF, same as CFFA) is forecast in the graph below. To value the firm's assets, the terminal value needs to be calculated using the perpetuity with growth formula: ###V_{\text{terminal, }t-1} = \dfrac{FFCF_{\text{terminal, }t}}{r-g}### Which point corresponds to the best time to calculate the terminal value?
Question 344 CFFA, capital budgeting A new company's Firm Free Cash Flow (FFCF, same as CFFA) is forecast in the graph below. To value the firm's assets, the terminal value needs to be calculated using the perpetuity with growth formula: ###V_{\text{terminal, }t-1} = \dfrac{FFCF_{\text{terminal, }t}}{r-g}### Which point corresponds to the best time to calculate the terminal value?
Question 345 capital budgeting, break even, NPV
Notes
Assumptions
Find the break even unit production (Q) per year to achieve a zero Net Income (NI) and Net Present Value (NPV), respectively. The answers below are listed in the same order.
Question 346 NPV, annuity due Your poor friend asks to borrow some money from you. He would like $1,000 now (t=0) and every year for the next 5 years, so there will be 6 payments of $1,000 from t=0 to t=5 inclusive. In return he will pay you $10,000 in seven years from now (t=7). What is the net present value (NPV) of lending to your friend? Assume that your friend will definitely pay you back so the loan is risk-free, and that the yield on risk-free government debt is 10% pa, given as an effective annual rate.
Question 348 PE ratio, Multiples valuation Estimate the US bank JP Morgan's share price using a price earnings (PE) multiples approach with the following assumptions and figures only:
Note: Figures sourced from Google Finance on 24 March 2014.
Question 349 CFFA, depreciation tax shield Which one of the following will decrease net income (NI) but increase cash flow from assets (CFFA) in this year for a tax-paying firm, all else remaining constant? Remember: ###NI = (Rev-COGS-FC-Depr-IntExp).(1-t_c )### ###CFFA=NI+Depr-CapEx - \Delta NWC+IntExp###
Find Sidebar Corporation's Cash Flow From Assets (CFFA), also known as Free Cash Flow to the Firm (FCFF), over the year ending 30th June 2013.
Note: All figures are given in millions of dollars ($m). The cash flow from assets was:
Over the next year, the management of an unlevered company plans to:
Assume that:
How much new equity financing will the company need? In other words, what is the value of new shares that will need to be issued?
Question 352 income and capital returns, DDM, real estate Two years ago Fred bought a house for $300,000. Now it's worth $500,000, based on recent similar sales in the area. Fred's residential property has an expected total return of 8% pa. He rents his house out for $2,000 per month, paid in advance. Every 12 months he plans to increase the rental payments. The present value of 12 months of rental payments is $23,173.86. The future value of 12 months of rental payments one year ahead is $25,027.77. What is the expected annual growth rate of the rental payments? In other words, by what percentage increase will Fred have to raise the monthly rent by each year to sustain the expected annual total return of 8%?
Question 354 PE ratio, Multiples valuation Which firms tend to have low forward-looking price-earnings (PE) ratios? Only consider firms with positive earnings, disregard firms with negative earnings and therefore negative PE ratios.
Question 355 DDM, stock pricing Stocks in the United States usually pay quarterly dividends. For example, the retailer Wal-Mart Stores paid a $0.47 dividend every quarter over the 2013 calendar year and plans to pay a $0.48 dividend every quarter over the 2014 calendar year. Using the dividend discount model and net present value techniques, calculate the stock price of Wal-Mart Stores assuming that:
What is the current stock price?
Question 356 NPV, Annuity Your friend overheard that you need some cash and asks if you would like to borrow some money. She can lend you $5,000 now (t=0), and in return she wants you to pay her back $1,000 in two years (t=2) and every year after that for the next 5 years, so there will be 6 payments of $1,000 from t=2 to t=7 inclusive. What is the net present value (NPV) of borrowing from your friend? Assume that banks loan funds at interest rates of 10% pa, given as an effective annual rate.
Question 358 PE ratio, Multiples valuation Estimate the Chinese bank ICBC's share price using a backward-looking price earnings (PE) multiples approach with the following assumptions and figures only. Note that the renminbi (RMB) is the Chinese currency, also known as the yuan (CNY).
Note: Figures sourced from Google Finance on 25 March 2014. Share prices are from the Shanghai stock exchange.
Which one of the following will have no effect on net income (NI) but decrease cash flow from assets (CFFA or FFCF) in this year for a tax-paying firm, all else remaining constant? Remember: ###NI=(Rev-COGS-FC-Depr-IntExp).(1-t_c )### ###CFFA=NI+Depr-CapEx - ΔNWC+IntExp###
Find Ching-A-Lings Corporation's Cash Flow From Assets (CFFA), also known as Free Cash Flow to the Firm (FCFF), over the year ending 30th June 2013.
Note: All figures are given in millions of dollars ($m). The cash flow from assets was:
Over the next year, the management of an unlevered company plans to:
Assume that:
How much new equity financing will the company need? In other words, what is the value of new shares that will need to be issued?
Question 362 income and capital returns, DDM, real estate Three years ago Frederika bought a house for $400,000. Now it's worth $600,000, based on recent similar sales in the area. Frederika's residential property has an expected total return of 7% pa. She rents her house out for $2,500 per month, paid in advance. Every 12 months she plans to increase the rental payments. The present value of 12 months of rental payments is $29,089.48. The future value of 12 months of rental payments one year ahead is $31,125.74. What is the expected annual capital yield of the property?
Question 365 DDM, stock pricing Stocks in the United States usually pay quarterly dividends. For example, the software giant Microsoft paid a $0.23 dividend every quarter over the 2013 financial year and plans to pay a $0.28 dividend every quarter over the 2014 financial year. Using the dividend discount model and net present value techniques, calculate the stock price of Microsoft assuming that:
What is the current stock price?
Question 366 opportunity cost, NPV, CFFA Your friend is trying to find the net present value of an investment which:
The investment has a total required return of 10% pa due to its moderate level of undiversifiable risk. Your friend is aware of the importance of opportunity costs and the time value of money, but he is unsure of how to find the NPV of the project. He knows that the opportunity cost of investing the $1m in the project is the expected gain from investing the money in shares instead. Like the project, shares also have an expected return of 10% since they have moderate undiversifiable risk. This opportunity cost is $0.1m ##(=1m \times 10\%)## which occurs in one year (t=1). He knows that the time value of money should be accounted for, and this can be done by finding the present value of the cash flows in one year. Your friend has listed a few different ways to find the NPV which are written down below. Method 1: ##-1m + \dfrac{1.1m}{(1+0.1)^1} ## Method 2: ##-1m + 1.1m - 1m \times 0.1 ## Method 3: ##-1m + \dfrac{1.1m}{(1+0.1)^1} - 1m \times 0.1 ## Which of the above calculations give the correct NPV? Select the most correct answer.
Question 367 CFFA, interest tax shield There are many ways to calculate a firm's free cash flow (FFCF), also called cash flow from assets (CFFA). Some include the annual interest tax shield in the cash flow and some do not. Which of the below FFCF formulas include the interest tax shield in the cash flow? ###(1) \quad FFCF=NI + Depr - CapEx -ΔNWC + IntExp### ###(2) \quad FFCF=NI + Depr - CapEx -ΔNWC + IntExp.(1-t_c)### ###(3) \quad FFCF=EBIT.(1-t_c )+ Depr- CapEx -ΔNWC+IntExp.t_c### ###(4) \quad FFCF=EBIT.(1-t_c) + Depr- CapEx -ΔNWC### ###(5) \quad FFCF=EBITDA.(1-t_c )+Depr.t_c- CapEx -ΔNWC+IntExp.t_c### ###(6) \quad FFCF=EBITDA.(1-t_c )+Depr.t_c- CapEx -ΔNWC### ###(7) \quad FFCF=EBIT-Tax + Depr - CapEx -ΔNWC### ###(8) \quad FFCF=EBIT-Tax + Depr - CapEx -ΔNWC-IntExp.t_c### ###(9) \quad FFCF=EBITDA-Tax - CapEx -ΔNWC### ###(10) \quad FFCF=EBITDA-Tax - CapEx -ΔNWC-IntExp.t_c###The formulas for net income (NI also called earnings), EBIT and EBITDA are given below. Assume that depreciation and amortisation are both represented by 'Depr' and that 'FC' represents fixed costs such as rent. ###NI=(Rev - COGS - Depr - FC - IntExp).(1-t_c )### ###EBIT=Rev - COGS - FC-Depr### ###EBITDA=Rev - COGS - FC### ###Tax =(Rev - COGS - Depr - FC - IntExp).t_c= \dfrac{NI.t_c}{1-t_c}###
Question 368 interest tax shield, CFFA A method commonly seen in textbooks for calculating a levered firm's free cash flow (FFCF, or CFFA) is the following: ###\begin{aligned} FFCF &= (Rev - COGS - Depr - FC - IntExp)(1-t_c) + \\ &\space\space\space+ Depr - CapEx -\Delta NWC + IntExp(1-t_c) \\ \end{aligned}###
Question 369 interest tax shield, CFFA One formula for calculating a levered firm's free cash flow (FFCF, or CFFA) is to use earnings before interest and tax (EBIT). ###\begin{aligned} FFCF &= (EBIT)(1-t_c) + Depr - CapEx -\Delta NWC + IntExp.t_c \\ &= (Rev - COGS - Depr - FC)(1-t_c) + Depr - CapEx -\Delta NWC + IntExp.t_c \\ \end{aligned} \\###
Question 370 capital budgeting, NPV, interest tax shield, WACC, CFFA
Notes
Assumptions
What is the net present value (NPV) of the project?
Question 371 interest tax shield, CFFA One method for calculating a firm's free cash flow (FFCF, or CFFA) is to ignore interest expense. That is, pretend that interest expense ##(IntExp)## is zero: ###\begin{aligned} FFCF &= (Rev - COGS - Depr - FC - IntExp)(1-t_c) + Depr - CapEx -\Delta NWC + IntExp \\ &= (Rev - COGS - Depr - FC - 0)(1-t_c) + Depr - CapEx -\Delta NWC - 0\\ \end{aligned}###
Question 374 debt terminology Which of the following statements is NOT equivalent to the yield on debt? Assume that the debt being referred to is fairly priced, but do not assume that it's priced at par.
Question 375 interest tax shield, CFFA One formula for calculating a levered firm's free cash flow (FFCF, or CFFA) is to use net operating profit after tax (NOPAT). ###\begin{aligned} FFCF &= NOPAT + Depr - CapEx -\Delta NWC \\ &= (Rev - COGS - Depr - FC)(1-t_c) + Depr - CapEx -\Delta NWC \\ \end{aligned} \\###
Question 376 leverage, capital structure, no explanation
Question 377 leverage, capital structure
Question 378 leverage, capital structure, no explanation
Question 379 leverage, capital structure, payout policy
Question 380 leverage, capital structure
Question 384 option, real option Which of the following is the least useful method or model to calculate the value of a real option in a project?
Question 385 Merton model of corporate debt, real option, option A risky firm will last for one period only (t=0 to 1), then it will be liquidated. So it's assets will be sold and the debt holders and equity holders will be paid out in that order. The firm has the following quantities: ##V## = Market value of assets. ##E## = Market value of (levered) equity. ##D## = Market value of zero coupon bonds. ##F_1## = Total face value of zero coupon bonds which is promised to be paid in one year. The levered equity graph above contains bold labels a to e. Which of the following statements about those labels is NOT correct?
Question 386 Merton model of corporate debt, real option, option A risky firm will last for one period only (t=0 to 1), then it will be liquidated. So it's assets will be sold and the debt holders and equity holders will be paid out in that order. The firm has the following quantities: ##V## = Market value of assets. ##E## = Market value of (levered) equity. ##D## = Market value of zero coupon bonds. ##F_1## = Total face value of zero coupon bonds which is promised to be paid in one year. The risky corporate debt graph above contains bold labels a to e. Which of the following statements about those labels is NOT correct?
Question 387 real option, option One of the reasons why firms may not begin projects with relatively small positive net present values (NPV's) is because they wish to maximise the value of their:
Question 388 real option, option A moped is a bicycle with pedals and a little motor that can be switched on to assist the rider. Mopeds are useful for quick transport using the motor, and for physical exercise when using the pedals unassisted. This offers the rider:
Question 389 real option, option You're thinking of starting a new cafe business, but you're not sure if it will be profitable. You have to decide what type of cups, mugs and glasses you wish to buy. You can pay to have your cafe's name printed on them, or just buy the plain un-marked ones. For marketing reasons it's better to have the cafe name printed. But the plain un-marked cups, mugs and glasses maximise your:
Question 390 real option, option Some financially minded people insist on a prenuptial agreement before committing to marry their partner. This agreement states how the couple's assets should be divided in case they divorce. Prenuptial agreements are designed to give the richer partner more of the couples' assets if they divorce, thus maximising the richer partner's:
Question 391 real option, option
Question 392 real option, option
Question 393 real option, option
Question 394 real option, option
Question 395 real option, option The cheapest mobile phones available tend to be those that are 'locked' into a cell phone operator's network. Locked phones can not be used with other cell phone operators' networks. Locked mobile phones are cheaper than unlocked phones because the locked-in network operator helps create a monopoly by:
Question 396 real option, option Your firm's research scientists can begin an exciting new project at a cost of $10m now, after which there’s a:
The firm's cost of capital is 10% pa. What's the present value (at t=0) of the option to expand in year 5?
Question 397 financial distress, leverage, capital structure, NPV A levered firm has a market value of assets of $10m. Its debt is all comprised of zero-coupon bonds which mature in one year and have a combined face value of $9.9m. Investors are risk-neutral and therefore all debt and equity holders demand the same required return of 10% pa. Therefore the current market capitalisation of debt ##(D_0)## is $9m and equity ##(E_0)## is $1m. A new project presents itself which requires an investment of $2m and will provide a:
The project can be funded using the company's excess cash, no debt or equity raisings are required. What would be the new market capitalisation of equity ##(E_\text{0, with project})## if shareholders vote to proceed with the project, and therefore should shareholders proceed with the project?
A levered firm has zero-coupon bonds which mature in one year and have a combined face value of $9.9m. Investors are risk-neutral and therefore all debt and equity holders demand the same required return of 10% pa. In one year the firm's assets will be worth:
A new project presents itself which requires an investment of $2m and will provide a certain cash flow of $3.3m in one year. The firm doesn't have any excess cash to make the initial $2m investment, but the funds can be raised from shareholders through a fairly priced rights issue. Ignore all transaction costs. Should shareholders vote to proceed with the project and equity raising? What will be the gain in shareholder wealth if they decide to proceed?
Question 399 option, no explanation A European call option will mature in ##T## years with a strike price of ##K## dollars. The underlying asset has a price of ##S## dollars. What is an expression for the payoff at maturity ##(f_T)## in dollars from owning (being long) the call option?
Question 400 option, no explanation A European put option will mature in ##T## years with a strike price of ##K## dollars. The underlying asset has a price of ##S## dollars. What is an expression for the payoff at maturity ##(f_T)## in dollars from owning (being long) the put option?
Question 404 income and capital returns, real estate One and a half years ago Frank bought a house for $600,000. Now it's worth only $500,000, based on recent similar sales in the area. The expected total return on Frank's residential property is 7% pa. He rents his house out for $1,600 per month, paid in advance. Every 12 months he plans to increase the rental payments. The present value of 12 months of rental payments is $18,617.27. The future value of 12 months of rental payments one year in the future is $19,920.48. What is the expected annual rental yield of the property? Ignore the costs of renting such as maintenance, real estate agent fees and so on.
Question 406 leverage, WACC, margin loan, portfolio return One year ago you bought $100,000 of shares partly funded using a margin loan. The margin loan size was $70,000 and the other $30,000 was your own wealth or 'equity' in the share assets. The interest rate on the margin loan was 7.84% pa. Over the year, the shares produced a dividend yield of 4% pa and a capital gain of 5% pa. What was the total return on your wealth? Ignore taxes, assume that all cash flows (interest payments and dividends) were paid and received at the end of the year, and all rates above are effective annual rates. Hint: Remember that wealth in this context is your equity (E) in the house asset (V = D+E) which is funded by the loan (D) and your deposit or equity (E).
Question 408 leverage, portfolio beta, portfolio risk, real estate, CAPM You just bought a house worth $1,000,000. You financed it with an $800,000 mortgage loan and a deposit of $200,000. You estimate that:
What is the beta of the equity (the $200,000 deposit) that you have in your house? Also, if the risk free rate is 5% pa and the market portfolio's return is 10% pa, what is the expected return on equity in your house? Ignore taxes, assume that all cash flows (interest payments and rent) were paid and received at the end of the year, and all rates are effective annual rates.
Question 409 NPV, capital structure, capital budgeting A pharmaceutical firm has just discovered a valuable new drug. So far the news has been kept a secret. The net present value of making and commercialising the drug is $200 million, but $600 million of bonds will need to be issued to fund the project and buy the necessary plant and equipment. The firm will release the news of the discovery and bond raising to shareholders simultaneously in the same announcement. The bonds will be issued shortly after. Once the announcement is made and the bonds are issued, what is the expected increase in the value of the firm's assets (ΔV), market capitalisation of debt (ΔD) and market cap of equity (ΔE)? The triangle symbol is the Greek letter capital delta which means change or increase in mathematics. Ignore the benefit of interest tax shields from having more debt. Remember: ##ΔV = ΔD+ΔE##
Question 410 CAPM, capital budgeting The CAPM can be used to find a business's expected opportunity cost of capital: ###r_i=r_f+β_i (r_m-r_f)### What should be used as the risk free rate ##r_f##?
Question 411 WACC, capital structure A firm plans to issue equity and use the cash raised to pay off its debt. No assets will be bought or sold. Ignore the costs of financial distress. Which of the following statements is NOT correct, all things remaining equal?
Question 412 enterprise value, no explanation A large proportion of a levered firm's assets is cash held at the bank. The firm is financed with half equity and half debt. Which of the following statements about this firm's enterprise value (EV) and total asset value (V) is NOT correct?
Question 413 CFFA, interest tax shield, depreciation tax shield There are many ways to calculate a firm's free cash flow (FFCF), also called cash flow from assets (CFFA). One method is to use the following formulas to transform net income (NI) into FFCF including interest and depreciation tax shields: ###FFCF=NI + Depr - CapEx -ΔNWC + IntExp### ###NI=(Rev - COGS - Depr - FC - IntExp).(1-t_c )### Another popular method is to use EBITDA rather than net income. EBITDA is defined as: ###EBITDA=Rev - COGS - FC### One of the below formulas correctly calculates FFCF from EBITDA, including interest and depreciation tax shields, giving an identical answer to that above. Which formula is correct?
Question 414 PE ratio, pay back period, no explanation A mature firm has constant expected future earnings and dividends. Both amounts are equal. So earnings and dividends are expected to be equal and unchanging. Which of the following statements is NOT correct?
Question 415 income and capital returns, real estate, no explanation You just bought a residential apartment as an investment property for $500,000. You intend to rent it out to tenants. They are ready to move in, they would just like to know how much the monthly rental payments will be, then they will sign a twelve-month lease. You require a total return of 8% pa and a rental yield of 5% pa. What would the monthly paid-in-advance rental payments have to be this year to receive that 5% annual rental yield? Also, if monthly rental payments can be increased each year when a new lease agreement is signed, by how much must you increase rents per year to realise the 8% pa total return on the property? Ignore all taxes and the costs of renting such as maintenance costs, real estate agent fees, utilities and so on. Assume that there will be no periods of vacancy and that tenants will promptly pay the rental prices you charge. Note that the first rental payment will be received at t=0. The first lease agreement specifies the first 12 equal payments from t=0 to 11. The next lease agreement can have a rental increase, so the next twelve equal payments from t=12 to 23 can be higher than previously, and so on forever.
A residential real estate investor believes that house prices will grow at a rate of 5% pa and that rents will grow by 2% pa forever. All rates are given as nominal effective annual returns. Assume that:
Which one of the following statements is NOT correct? Over time:
Question 417 NPV, market efficiency, DDM A managed fund charges fees based on the amount of money that you keep with them. The fee is 2% of the end-of-year amount, paid at the end of every year. This fee is charged regardless of whether the fund makes gains or losses on your money. The fund offers to invest your money in shares which have an expected return of 10% pa before fees. You are thinking of investing $100,000 in the fund and keeping it there for 40 years when you plan to retire. How much money do you expect to have in the fund in 40 years? Also, what is the future value of the fees that the fund expects to earn from you? Give both amounts as future values in 40 years. Assume that:
The below answer choices list your expected wealth in 40 years and then the fund's expected wealth in 40 years.
Question 418 capital budgeting, NPV, interest tax shield, WACC, CFFA, CAPM
Notes
Assumptions
What is the net present value (NPV) of the project?
Notes
Assumptions
What is the net present value (NPV) of the project?
Acquirer firm plans to launch a takeover of Target firm. The deal is expected to create a present value of synergies totaling $105 million. A cash offer will be made that pays the fair price for the target's shares plus 75% of the total synergy value. The cash will be paid out of the firm's cash holdings, no new debt or equity will be raised.
Ignore transaction costs and fees. Assume that the firms' debt and equity are fairly priced, and that each firms' debts' risk, yield and values remain constant. The acquisition is planned to occur immediately, so ignore the time value of money. Calculate the merged firm's share price and total number of shares after the takeover has been completed.
Acquirer firm plans to launch a takeover of Target firm. The deal is expected to create a present value of synergies totaling $105 million. A scrip offer will be made that pays the fair price for the target's shares plus 75% of the total synergy value.
Ignore transaction costs and fees. Assume that the firms' debt and equity are fairly priced, and that each firms' debts' risk, yield and values remain constant. The acquisition is planned to occur immediately, so ignore the time value of money. Calculate the merged firm's share price and total number of shares after the takeover has been completed.
Acquirer firm plans to launch a takeover of Target firm. The firms operate in different industries and the CEO's rationale for the merger is to increase diversification and thereby decrease risk. The deal is not expected to create any synergies. An 80% scrip and 20% cash offer will be made that pays the fair price for the target's shares. The cash will be paid out of the firms' cash holdings, no new debt or equity will be raised.
Ignore transaction costs and fees. Assume that the firms' debt and equity are fairly priced, and that each firms' debts' risk, yield and values remain constant. The acquisition is planned to occur immediately, so ignore the time value of money. Calculate the merged firm's share price and total number of shares after the takeover has been completed.
Acquirer firm plans to launch a takeover of Target firm. The deal is expected to create a present value of synergies totaling $105 million. A 40% scrip and 60% cash offer will be made that pays the fair price for the target's shares plus 75% of the total synergy value. The cash will be paid out of the firm's cash holdings, no new debt or equity will be raised.
Ignore transaction costs and fees. Assume that the firms' debt and equity are fairly priced, and that each firms' debts' risk, yield and values remain constant. The acquisition is planned to occur immediately, so ignore the time value of money. Calculate the merged firm's share price and total number of shares after the takeover has been completed.
Acquirer firm plans to launch a takeover of Target firm. The deal is expected to create a present value of synergies totaling $2 million. A cash offer will be made that pays the fair price for the target's shares plus 70% of the total synergy value. The cash will be paid out of the firm's cash holdings, no new debt or equity will be raised.
Ignore transaction costs and fees. Assume that the firms' debt and equity are fairly priced, and that each firms' debts' risk, yield and values remain constant. The acquisition is planned to occur immediately, so ignore the time value of money. Calculate the merged firm's share price and total number of shares after the takeover has been completed.
Acquirer firm plans to launch a takeover of Target firm. The deal is expected to create a present value of synergies totaling $2 million. A scrip offer will be made that pays the fair price for the target's shares plus 70% of the total synergy value.
Ignore transaction costs and fees. Assume that the firms' debt and equity are fairly priced, and that each firms' debts' risk, yield and values remain constant. The acquisition is planned to occur immediately, so ignore the time value of money. Calculate the merged firm's share price and total number of shares after the takeover has been completed.
Acquirer firm plans to launch a takeover of Target firm. The deal is expected to create a present value of synergies totaling $0.5 million, but investment bank fees and integration costs with a present value of $1.5 million is expected. A 10% cash and 90% scrip offer will be made that pays the fair price for the target's shares only. Assume that the Target and Acquirer agree to the deal. The cash will be paid out of the firms' cash holdings, no new debt or equity will be raised.
Assume that the firms' debt and equity are fairly priced, and that each firms' debts' risk, yield and values remain constant. The acquisition is planned to occur immediately, so ignore the time value of money. Calculate the merged firm's share price and total number of shares after the takeover has been completed.
Question 430 option, no explanation A European call option will mature in ##T## years with a strike price of ##K## dollars. The underlying asset has a price of ##S## dollars. What is an expression for the payoff at maturity ##(f_T)## in dollars from having written (being short) the call option?
Question 431 option, no explanation A European put option will mature in ##T## years with a strike price of ##K## dollars. The underlying asset has a price of ##S## dollars. What is an expression for the payoff at maturity ##(f_T)## in dollars from having written (being short) the put option?
Question 432 option, option intrinsic value, no explanation An American style call option with a strike price of ##K## dollars will mature in ##T## years. The underlying asset has a price of ##S## dollars. What is an expression for the current intrinsic value in dollars from owning (being long) the American style call option? Note that the intrinsic value of an option does not subtract the premium paid to buy the option.
A risky firm will last for one period only (t=0 to 1), then it will be liquidated. So it's assets will be sold and the debt holders and equity holders will be paid out in that order. The firm has the following quantities: ##V## = Market value of assets. ##E## = Market value of (levered) equity. ##D## = Market value of zero coupon bonds. ##F_1## = Total face value of zero coupon bonds which is promised to be paid in one year. What is the payoff to equity holders at maturity, assuming that they keep their shares until maturity?
Question 434 Merton model of corporate debt, real option, option A risky firm will last for one period only (t=0 to 1), then it will be liquidated. So it's assets will be sold and the debt holders and equity holders will be paid out in that order. The firm has the following quantities: ##V## = Market value of assets. ##E## = Market value of (levered) equity. ##D## = Market value of zero coupon bonds. ##F_1## = Total face value of zero coupon bonds which is promised to be paid in one year. What is the payoff to debt holders at maturity, assuming that they keep their debt until maturity?
Question 435 option, no explanation
Question 436 option, no explanation
Question 437 option, no explanation
Question 438 option, no explanation
Question 439 option, no explanation
Question 440 option, no explanation
Question 441 DDM, income and capital returns A fairly valued share's current price is $4 and it has a total required return of 30%. Dividends are paid annually and next year's dividend is expected to be $1. After that, dividends are expected to grow by 5% pa in perpetuity. All rates are effective annual returns. What is the expected dividend income paid at the end of the second year (t=2) and what is the expected capital gain from just after the first dividend (t=1) to just after the second dividend (t=2)? The answers are given in the same order, the dividend and then the capital gain.
Question 442 economic depreciation, no explanation A fairly valued share's current price is $4 and it has a total required return of 30%. Dividends are paid annually and next year's dividend is expected to be $1. After that, dividends are expected to grow by 5% pa. All rates are effective annual returns. What is the expected dividend cash flow, economic depreciation, and economic income and economic value added (EVA) that will be earned over the second year (from t=1 to t=2) and paid at the end of that year (t=2)?
A small private company has a single shareholder. This year the firm earned a $100 profit before tax. All of the firm's after tax profits will be paid out as dividends to the owner. The corporate tax rate is 30% and the sole shareholder's personal marginal tax rate is 45%. The Australian imputation tax system applies because the company generates all of its income in Australia and pays corporate tax to the Australian Tax Office. Therefore all of the company's dividends are fully franked. The sole shareholder is an Australian for tax purposes and can therefore use the franking credits to offset his personal income tax liability. What will be the personal tax payable by the shareholder and the corporate tax payable by the company?
Question 449 personal tax on dividends, classical tax system A small private company has a single shareholder. This year the firm earned a $100 profit before tax. All of the firm's after tax profits will be paid out as dividends to the owner. The corporate tax rate is 30% and the sole shareholder's personal marginal tax rate is 45%. The United States' classical tax system applies because the company generates all of its income in the US and pays corporate tax to the Internal Revenue Service. The shareholder is also an American for tax purposes. What will be the personal tax payable by the shareholder and the corporate tax payable by the company?
Question 450 CAPM, risk, portfolio risk, no explanation The accounting identity states that the book value of a company's assets (A) equals its liabilities (L) plus owners equity (OE), so A = L + OE. The finance version states that the market value of a company's assets (V) equals the market value of its debt (D) plus equity (E), so V = D + E. Therefore a business's assets can be seen as a portfolio of the debt and equity that fund the assets. Let ##\sigma_\text{V total}^2## be the total variance of returns on assets, ##\sigma_\text{V syst}^2## be the systematic variance of returns on assets, and ##\sigma_\text{V idio}^2## be the idiosyncratic variance of returns on assets, and ##\rho_\text{D idio, E idio}## be the correlation between the idiosyncratic returns on debt and equity. Which of the following equations is NOT correct?
The first payment of a constant perpetual annual cash flow is received at time 5. Let this cash flow be ##C_5## and the required return be ##r##. So there will be equal annual cash flows at time 5, 6, 7 and so on forever, and all of the cash flows will be equal so ##C_5 = C_6 = C_7 = ...## When the perpetuity formula is used to value this stream of cash flows, it will give a value (V) at time:
Question 452 limited liability, expected and historical returns What is the lowest and highest expected share price and expected return from owning shares in a company over a finite period of time? Let the current share price be ##p_0##, the expected future share price be ##p_1##, the expected future dividend be ##d_1## and the expected return be ##r##. Define the expected return as: ##r=\dfrac{p_1-p_0+d_1}{p_0} ## The answer choices are stated using inequalities. As an example, the first answer choice "(a) ##0≤p<∞## and ##0≤r< 1##", states that the share price must be larger than or equal to zero and less than positive infinity, and that the return must be larger than or equal to zero and less than one.
Question 453 DDM, income and capital returns The perpetuity with growth equation is: ###P_0=\dfrac{C_1}{r-g}### Which of the following is NOT equal to the expected capital return as an effective annual rate?
Question 454 NPV, capital structure, capital budgeting A mining firm has just discovered a new mine. So far the news has been kept a secret. The net present value of digging the mine and selling the minerals is $250 million, but $500 million of new equity and $300 million of new bonds will need to be issued to fund the project and buy the necessary plant and equipment. The firm will release the news of the discovery and equity and bond raising to shareholders simultaneously in the same announcement. The shares and bonds will be issued shortly after. Once the announcement is made and the new shares and bonds are issued, what is the expected increase in the value of the firm's assets ##(\Delta V)##, market capitalisation of debt ##(\Delta D)## and market cap of equity ##(\Delta E)##? Assume that markets are semi-strong form efficient. The triangle symbol ##\Delta## is the Greek letter capital delta which means change or increase in mathematics. Ignore the benefit of interest tax shields from having more debt. Remember: ##\Delta V = \Delta D+ \Delta E##
A fairly priced unlevered firm plans to pay a dividend of $1 next year (t=1) which is expected to grow by 3% pa every year after that. The firm's required return on equity is 8% pa. The firm is thinking about reducing its future dividend payments by 10% so that it can use the extra cash to invest in more projects which are expected to return 8% pa, and have the same risk as the existing projects. Therefore, next year's dividend will be $0.90. No new equity or debt will be issued to fund the new projects, they'll all be funded by the cut in dividends. What will be the stock's new annual capital return (proportional increase in price per year) if the change in payout policy goes ahead? Assume that payout policy is irrelevant to firm value (so there's no signalling effects) and that all rates are effective annual rates.
Question 456 inflation, effective rate In the 'Austin Powers' series of movies, the character Dr. Evil threatens to destroy the world unless the United Nations pays him a ransom (video 1, video 2). Dr. Evil makes the threat on two separate occasions:
If Dr. Evil's demands are equivalent in real terms, in other words $1 million will buy the same basket of goods in 1969 as $100 billion would in 1997, what was the implied inflation rate over the 28 years from 1969 to 1997? The answer choices below are given as effective annual rates:
Question 459 interest only loan, inflation In Australia in the 1980's, inflation was around 8% pa, and residential mortgage loan interest rates were around 14%. In 2013, inflation was around 2.5% pa, and residential mortgage loan interest rates were around 4.5%. If a person can afford constant mortgage loan payments of $2,000 per month, how much more can they borrow when interest rates are 4.5% pa compared with 14.0% pa? Give your answer as a proportional increase over the amount you could borrow when interest rates were high ##(V_\text{high rates})##, so: ###\text{Proportional increase} = \dfrac{V_\text{low rates}-V_\text{high rates}}{V_\text{high rates}} ### Assume that:
Question 460 bond pricing, premium par and discount bonds Below are some statements about loans and bonds. The first descriptive sentence is correct. But one of the second sentences about the loans' or bonds' prices is not correct. Which statement is NOT correct? Assume that interest rates are positive. Note that coupons or interest payments are the periodic payments made throughout a bond or loan's life. The face or par value of a bond or loan is the amount paid at the end when the debt matures.
Question 461 book and market values, ROE, ROA, market efficiency One year ago a pharmaceutical firm floated by selling its 1 million shares for $100 each. Its book and market values of equity were both $100m. Its debt totalled $50m. The required return on the firm's assets was 15%, equity 20% and debt 5% pa. In the year since then, the firm:
Which of the following statements is NOT correct? All statements are about current figures, not figures one year ago. Hint: Book return on assets (ROA) and book return on equity (ROE) are ratios that accountants like to use to measure a business's past performance. ###\text{ROA}= \dfrac{\text{Net income}}{\text{Book value of assets}}### ###\text{ROE}= \dfrac{\text{Net income}}{\text{Book value of equity}}### The required return on assets ##r_V## is a return that financiers like to use to estimate a business's future required performance which compensates them for the firm's assets' risks. If the business were to achieve realised historical returns equal to its required returns, then investment into the business's assets would have been a zero-NPV decision, which is neither good nor bad but fair. ###r_\text{V, 0 to 1}= \dfrac{\text{Cash flow from assets}_\text{1}}{\text{Market value of assets}_\text{0}} = \dfrac{CFFA_\text{1}}{V_\text{0}}### Similarly for equity and debt.
Question 462 equivalent annual cash flow You own some nice shoes which you use once per week on date nights. You bought them 2 years ago for $500. In your experience, shoes used once per week last for 6 years. So you expect yours to last for another 4 years. Your younger sister said that she wants to borrow your shoes once per week. With the increased use, your shoes will only last for another 2 years rather than 4. What is the present value of the cost of letting your sister use your current shoes for the next 2 years? Assume: that bank interest rates are 10% pa, given as an effective annual rate; you will buy a new pair of shoes when your current pair wears out and your sister will not use the new ones; your sister will only use your current shoes so she will only use it for the next 2 years; and the price of new shoes never changes.
Question 463 PE ratio, Multiples valuation Private equity firms are known to buy medium sized private companies operating in the same industry, merge them together into a larger company, and then sell it off in a public float (initial public offering, IPO). If medium-sized private companies trade at PE ratios of 5 and larger listed companies trade at PE ratios of 15, what return can be achieved from this strategy? Assume that:
Question 464 mispriced asset, NPV, DDM, market efficiency A company advertises an investment costing $1,000 which they say is underpriced. They say that it has an expected total return of 15% pa, but a required return of only 10% pa. Assume that there are no dividend payments so the entire 15% total return is all capital return. Assuming that the company's statements are correct, what is the NPV of buying the investment if the 15% return lasts for the next 100 years (t=0 to 100), then reverts to 10% pa after that time? Also, what is the NPV of the investment if the 15% return lasts forever? In both cases, assume that the required return of 10% remains constant. All returns are given as effective annual rates. The answer choices below are given in the same order (15% for 100 years, and 15% forever):
Question 465 NPV, perpetuity The boss of WorkingForTheManCorp has a wicked (and unethical) idea. He plans to pay his poor workers one week late so that he can get more interest on his cash in the bank. Every week he is supposed to pay his 1,000 employees $1,000 each. So $1 million is paid to employees every week. The boss was just about to pay his employees today, until he thought of this idea so he will actually pay them one week (7 days) later for the work they did last week and every week in the future, forever. Bank interest rates are 10% pa, given as a real effective annual rate. So ##r_\text{eff annual, real} = 0.1## and the real effective weekly rate is therefore ##r_\text{eff weekly, real} = (1+0.1)^{1/52}-1 = 0.001834569## All rates and cash flows are real, the inflation rate is 3% pa and there are 52 weeks per year. The boss will always pay wages one week late. The business will operate forever with constant real wages and the same number of employees. What is the net present value (NPV) of the boss's decision to pay later?
A firm has 1 million shares which trade at a price of $30 each. The firm is expected to announce earnings of $3 million at the end of the year and pay an annual dividend of $1.50 per share. What is the firm's (forward looking) price/earnings (PE) ratio?
Question 472 quick ratio, accounting ratio A firm has current assets totaling $1.5b of which cash is $0.25b and inventories is $0.5b. Current liabilities total $2b of which accounts payable is $1b. What is the firm's quick ratio, also known as the acid test ratio?
Question 473 market capitalisation of equity The below screenshot of Commonwealth Bank of Australia's (CBA) details were taken from the Google Finance website on 7 Nov 2014. Some information has been deliberately blanked out. What was CBA's market capitalisation of equity?
The below screenshot of Commonwealth Bank of Australia's (CBA) details were taken from the Google Finance website on 7 Nov 2014. Some information has been deliberately blanked out. What was CBA's backwards-looking price-earnings ratio?
Question 475 payout ratio, dividend, no explanation The below screenshot of Commonwealth Bank of Australia's (CBA) details were taken from the Google Finance website on 7 Nov 2014. Some information has been deliberately blanked out. What was CBA's approximate payout ratio over the 2014 financial year? Note that the firm's interim and final dividends were $1.83 and $2.18 respectively over the 2014 financial year.
Question 477 income and capital returns An asset's total expected return over the next year is given by: ###r_\text{total} = \dfrac{c_1+p_1-p_0}{p_0} ### Where ##p_0## is the current price, ##c_1## is the expected income in one year and ##p_1## is the expected price in one year. The total return can be split into the income return and the capital return. Which of the following is the expected capital return?
Question 479 perpetuity with growth, DDM, NPV Discounted cash flow (DCF) valuation prices assets by finding the present value of the asset's future cash flows. The single cash flow, annuity, and perpetuity equations are very useful for this. Which of the following equations is the 'perpetuity with growth' equation?
Question 480 NPV, real estate, DDM What type of present value equation is best suited to value a residential house investment property that is expected to pay constant rental payments forever? Note that 'constant' has the same meaning as 'level' in this context.
This annuity formula ##\dfrac{C_1}{r}\left(1-\dfrac{1}{(1+r)^3} \right)## is equivalent to which of the following formulas? Note the 3. In the below formulas, ##C_t## is a cash flow at time t. All of the cash flows are equal, but paid at different times.
Question 482 market capitalisation of equity The below screenshot of Microsoft's (MSFT) details were taken from the Google Finance website on 28 Nov 2014. Some information has been deliberately blanked out. What was MSFT's market capitalisation of equity?
The below screenshot of Microsoft's (MSFT) details were taken from the Google Finance website on 28 Nov 2014. Some information has been deliberately blanked out. What was MSFT's backwards-looking price-earnings ratio?
Question 484 payout ratio, dividend, no explanation The below screenshot of Microsoft's (MSFT) details were taken from the Google Finance website on 28 Nov 2014. Some information has been deliberately blanked out. What was MSFT's approximate payout ratio over the last year? Note that MSFT's past four quarterly dividends were $0.31, $0.28, $0.28 and $0.28.
Question 485 capital budgeting, opportunity cost, sunk cost A young lady is trying to decide if she should attend university or not. The young lady's parents say that she must attend university because otherwise all of her hard work studying and attending school during her childhood was a waste. What's the correct way to classify this item from a capital budgeting perspective when trying to decide whether to attend university? The hard work studying at school in her childhood should be classified as:
Question 486 capital budgeting, opportunity cost, sunk cost A young lady is trying to decide if she should attend university. Her friends say that she should go to university because she is more likely to meet a clever young man than if she begins full time work straight away. What's the correct way to classify this item from a capital budgeting perspective when trying to find the Net Present Value of going to university rather than working? The opportunity to meet a desirable future spouse should be classified as:
Question 487 capital budgeting, opportunity cost, sunk cost A young lady is trying to decide if she should attend university or begin working straight away in her home town. The young lady's grandma says that she should not go to university because she is less likely to marry the local village boy whom she likes because she will spend less time with him if she attends university. What's the correct way to classify this item from a capital budgeting perspective when trying to decide whether to attend university? The cost of not marrying the local village boy should be classified as:
Question 488 income and capital returns, payout policy, payout ratio, DDM Two companies BigDiv and ZeroDiv are exactly the same except for their dividend payouts. BigDiv pays large dividends and ZeroDiv doesn't pay any dividends. Currently the two firms have the same earnings, assets, number of shares, share price, expected total return and risk. Assume a perfect world with no taxes, no transaction costs, no asymmetric information and that all assets including business projects are fairly priced and therefore zero-NPV. All things remaining equal, which of the following statements is NOT correct?
Question 489 NPV, IRR, pay back period, DDM A firm is considering a business project which costs $11m now and is expected to pay a constant $1m at the end of every year forever. Assume that the initial $11m cost is funded using the firm's existing cash so no new equity or debt will be raised. The cost of capital is 10% pa. Which of the following statements about net present value (NPV), internal rate of return (IRR) and payback period is NOT correct?
Question 491 capital budgeting, opportunity cost, sunk cost A man is thinking about taking a day off from his casual painting job to relax. He just woke up early in the morning and he's about to call his boss to say that he won't be coming in to work. But he's thinking about the hours that he could work today (in the future) which are:
A firm has 2m shares and a market capitalisation of equity of $30m. The firm just announced earnings of $5m and paid an annual dividend of $0.75 per share. What is the firm's (backward looking) price/earnings (PE) ratio?
Question 496 NPV, IRR, pay back period A firm is considering a business project which costs $10m now and is expected to pay a single cash flow of $12.1m in two years. Assume that the initial $10m cost is funded using the firm's existing cash so no new equity or debt will be raised. The cost of capital is 10% pa. Which of the following statements about net present value (NPV), internal rate of return (IRR) and payback period is NOT correct?
Question 497 income and capital returns, DDM, ex dividend date A stock will pay you a dividend of $10 tonight if you buy it today. Thereafter the annual dividend is expected to grow by 5% pa, so the next dividend after the $10 one tonight will be $10.50 in one year, then in two years it will be $11.025 and so on. The stock's required return is 10% pa. What is the stock price today and what do you expect the stock price to be tomorrow, approximately?
Question 498 NPV, Annuity, perpetuity with growth, multi stage growth model A business project is expected to cost $100 now (t=0), then pay $10 at the end of the third (t=3), fourth, fifth and sixth years, and then grow by 5% pa every year forever. So the cash flow will be $10.5 at the end of the seventh year (t=7), then $11.025 at the end of the eighth year (t=8) and so on perpetually. The total required return is 10℅ pa. Which of the following formulas will NOT give the correct net present value of the project?
Question 499 NPV, Annuity Some countries' interest rates are so low that they're zero. If interest rates are 0% pa and are expected to stay at that level for the foreseeable future, what is the most that you would be prepared to pay a bank now if it offered to pay you $10 at the end of every year for the next 5 years? In other words, what is the present value of five $10 payments at time 1, 2, 3, 4 and 5 if interest rates are 0% pa?
The below graph shows a project's net present value (NPV) against its annual discount rate. For what discount rate or range of discount rates would you accept and commence the project? All answer choices are given as approximations from reading off the graph.
Question 501 NPV, IRR, pay back period The below graph shows a project's net present value (NPV) against its annual discount rate. Which of the following statements is NOT correct?
Question 502 NPV, IRR, mutually exclusive projects An investor owns an empty block of land that has local government approval to be developed into a petrol station, car wash or car park. The council will only allow a single development so the projects are mutually exclusive. All of the development projects have the same risk and the required return of each is 10% pa. Each project has an immediate cost and once construction is finished in one year the land and development will be sold. The table below shows the estimated costs payable now, expected sale prices in one year and the internal rates of returns (IRR's).
Which project should the investor accept?
Question 503 DDM, NPV, stock pricing A share currently worth $100 is expected to pay a constant dividend of $4 for the next 5 years with the first dividend in one year (t=1) and the last in 5 years (t=5). The total required return is 10% pa. What do you expected the share price to be in 5 years, just after the dividend at that time has been paid?
Read the following financial statements and calculate the firm's free cash flow over the 2014 financial year.
Note: all figures are given in millions of dollars ($m). The firm's free cash flow over the 2014 financial year was:
Question 505 equivalent annual cash flow A low-quality second-hand car can be bought now for $1,000 and will last for 1 year before it will be scrapped for nothing. A high-quality second-hand car can be bought now for $4,900 and it will last for 5 years before it will be scrapped for nothing. What is the equivalent annual cost of each car? Assume a discount rate of 10% pa, given as an effective annual rate. The answer choices are given as the equivalent annual cost of the low-quality car and then the high quality car.
Question 508 income and capital returns Which of the following equations is NOT equal to the total return of an asset? Let ##p_0## be the current price, ##p_1## the expected price in one year and ##c_1## the expected income in one year.
Question 509 bond pricing Calculate the price of a newly issued ten year bond with a face value of $100, a yield of 8% pa and a fixed coupon rate of 6% pa, paid annually. So there's only one coupon per year, paid in arrears every year.
Question 510 bond pricing Calculate the price of a newly issued ten year bond with a face value of $100, a yield of 8% pa and a fixed coupon rate of 6% pa, paid semi-annually. So there are two coupons per year, paid in arrears every six months.
Question 511 capital budgeting, CFFA Find the cash flow from assets (CFFA) of the following project.
Note 1: Due to the project, the firm also anticipates finding some rare diamonds which will give before-tax revenues of $1m at the end of the year. Note 2: The land that will be mined actually has thermal springs and a family of koalas that could be sold to an eco-tourist resort for an after-tax amount of $3m right now. However, if the mine goes ahead then this natural beauty will be destroyed. Note 3: The mining equipment will have a book value of $1m at the end of the year for tax purposes. However, the equipment is expected to fetch $2.5m when it is sold. Find the project's CFFA at time zero and one. Answers are given in millions of dollars ($m), with the first cash flow at time zero, and the second at time one.
Question 512 capital budgeting, CFFA Find the cash flow from assets (CFFA) of the following project.
Note 1: The equipment will have a book value of $4m at the end of the project for tax purposes. However, the equipment is expected to fetch $0.9 million when it is sold at t=2. Note 2: Due to the project, the firm will have to purchase $0.8m of inventory initially, which it will sell at t=1. The firm will buy another $0.8m at t=1 and sell it all again at t=2 with zero inventory left. The project will have no effect on the firm's current liabilities. Find the project's CFFA at time zero, one and two. Answers are given in millions of dollars ($m).
A stock is expected to pay its next dividend of $1 in one year. Future annual dividends are expected to grow by 2% pa. So the first dividend of $1 will be in one year, the year after that $1.02 (=1*(1+0.02)^1), and a year later $1.0404 (=1*(1+0.02)^2) and so on forever. Its required total return is 10% pa. The total required return and growth rate of dividends are given as effective annual rates. Calculate the current stock price.
A stock just paid a dividend of $1. Future annual dividends are expected to grow by 2% pa. The next dividend of $1.02 (=1*(1+0.02)^1) will be in one year, and the year after that the dividend will be $1.0404 (=1*(1+0.02)^2), and so on forever. Its required total return is 10% pa. The total required return and growth rate of dividends are given as effective annual rates. Calculate the current stock price.
A stock is just about to pay a dividend of $1 tonight. Future annual dividends are expected to grow by 2% pa. The next dividend of $1 will be paid tonight, and the year after that the dividend will be $1.02 (=1*(1+0.02)^1), and a year later 1.0404 (=1*(1+0.04)^2) and so on forever. Its required total return is 10% pa. The total required return and growth rate of dividends are given as effective annual rates. Calculate the current stock price.
The following cash flows are expected:
What is the NPV of the cash flows if the discount rate is 10% given as an effective annual rate?
Question 521 NPV, Annuity The following cash flows are expected:
What is the NPV of the cash flows if the discount rate is 10% given as an effective annual rate?
A residential investment property has an expected nominal total return of 6% pa and nominal capital return of 2.5% pa. Inflation is expected to be 2.5% pa. All of the above are effective nominal rates and investors believe that they will stay the same in perpetuity. What are the property's expected real total, capital and income returns? The answer choices below are given in the same order.
A low-growth mature stock has an expected nominal total return of 6% pa and nominal capital return of 2% pa. Inflation is expected to be 3% pa. All of the above are effective nominal rates and investors believe that they will stay the same in perpetuity. What are the stock's expected real total, capital and income returns? The answer choices below are given in the same order.
Question 527 income and capital returns Total cash flows can be broken into income and capital cash flows. What is the name given to the cash flow generated from selling shares at a higher price than they were bought?
Question 528 DDM, income and capital returns The perpetuity with growth formula, also known as the dividend discount model (DDM) or Gordon growth model, is appropriate for valuing a company's shares. ##P_0## is the current share price, ##C_1## is next year's expected dividend, ##r## is the total required return and ##g## is the expected growth rate of the dividend. ###P_0=\dfrac{C_1}{r-g}### The below graph shows the expected future price path of the company's shares. Which of the following statements about the graph is NOT correct?
If housing rents are constrained from growing more than the maximum target inflation rate, and houses can be priced as a perpetuity of growing net rental cash flows, then what is the implication for house prices, all things remaining equal? Select the most correct answer. Background: Since 1990, many central banks across the world have become 'inflation targeters'. They have adopted a policy of trying to keep inflation in a predictable narrow range, with the hope of encouraging long-term lending to fund more investment and maintain higher GDP growth. Australia's central bank, the Reserve Bank of Australia (RBA), has specifically stated their inflation target range is between 2 and 3% pa. Some Australian residential property market commentators suggest that because rental costs comprise a large part of the Australian consumer price index (CPI), rent costs across the nation cannot significantly exceed the maximum inflation target range of 3% pa without the prices of other goods growing by less than the target range for long periods, which is unlikely.
Question 530 Annuity, annuity due, no explanation You are promised 20 payments of $100, where the first payment is immediate (t=0) and the last is at the end of the 19th year (t=19). The effective annual discount rate is ##r##. Which of the following equations does NOT give the correct present value of these 20 payments?
Question 532 mutually exclusive projects, NPV, IRR An investor owns a whole level of an old office building which is currently worth $1 million. There are three mutually exclusive projects that can be started by the investor. The office building level can be:
All of the development projects have the same risk so the required return of each is 10% pa. The table below shows the estimated cash flows and internal rates of returns (IRR's).
Which project should the investor accept?
Question 533 NPV, no explanation You have $100,000 in the bank. The bank pays interest at 10% pa, given as an effective annual rate. You wish to consume twice as much now (t=0) as in one year (t=1) and have nothing left in the bank at the end. How much can you consume at time zero and one? The answer choices are given in the same order.
Question 534 NPV, no explanation You have $100,000 in the bank. The bank pays interest at 10% pa, given as an effective annual rate. You wish to consume half as much now (t=0) as in one year (t=1) and have nothing left in the bank at the end. How much can you consume at time zero and one? The answer choices are given in the same order.
Question 535 DDM, real and nominal returns and cash flows, stock pricing You are an equities analyst trying to value the equity of the Australian telecoms company Telstra, with ticker TLS. In Australia, listed companies like Telstra tend to pay dividends every 6 months. The payment around August is called the final dividend and the payment around February is called the interim dividend. Both occur annually.
Judging by TLS's dividend history and prospects, you estimate that the nominal dividend growth rate will be 1% pa. Assume that TLS's total nominal cost of equity is 6% pa. The dividends are nominal cash flows and the inflation rate is 2.5% pa. All rates are quoted as nominal effective annual rates. Assume that each month is exactly one twelfth (1/12) of a year, so you can ignore the number of days in each month. Calculate the current TLS share price.
Question 537 PE ratio, Multiples valuation, no explanation Estimate the French bank Societe Generale's share price using a backward-looking price earnings (PE) multiples approach with the following assumptions and figures only. Note that EUR is the euro, the European monetary union's currency.
Note: Figures sourced from Google Finance on 27 March 2015.
Question 544 bond pricing, capital raising, no explanation A firm wishes to raise $10 million now. They will issue 6% pa semi-annual coupon bonds that will mature in 3 years and have a face value of $100 each. Bond yields are 5% pa, given as an APR compounding every 6 months, and the yield curve is flat. How many bonds should the firm issue?
Which of the following statements about the capital and income returns of a 25 year fully amortising loan asset is correct? Assume that the yield curve (which shows total returns over different maturities) is flat and is not expected to change. Over the 25 years from issuance to maturity, a fully amortising loan's expected annual effective:
A firm pays out all of its earnings as dividends. Because of this, the firm has no real growth in earnings, dividends or stock price since there is no re-investment back into the firm to buy new assets and make higher earnings. The dividend discount model is suitable to value this company. The firm's revenues and costs are expected to increase by inflation in the foreseeable future. The firm has no debt. It operates in the services industry and has few physical assets so there is negligible depreciation expense and negligible net working capital required. Which of the following statements about this firm's PE ratio is NOT correct? The PE ratio should: Note: The inverse of x is 1/x.
Question 548 equivalent annual cash flow, time calculation, no explanation An Apple iPhone 6 smart phone can be bought now for $999. An Android Kogan Agora 4G+ smart phone can be bought now for $240. If the Kogan phone lasts for one year, approximately how long must the Apple phone last for to have the same equivalent annual cost? Assume that both phones have equivalent features besides their lifetimes, that both are worthless once they've outlasted their life, the discount rate is 10% pa given as an effective annual rate, and there are no extra costs or benefits from either phone.
An Apple iPhone 6 smart phone can be bought now for $999. An Android Samsung Galaxy 5 smart phone can be bought now for $599. If the Samsung phone lasts for four years, approximately how long must the Apple phone last for to have the same equivalent annual cost? Assume that both phones have equivalent features besides their lifetimes, that both are worthless once they've outlasted their life, the discount rate is 10% pa given as an effective annual rate, and there are no extra costs or benefits from either phone.
Question 550 fully amortising loan, interest only loan, APR Many Australian home loans that are interest-only actually require payments to be made on a fully amortising basis after a number of years. You decide to borrow $600,000 from the bank at an interest rate of 4.25% pa for 25 years. The payments will be interest-only for the first 10 years (t=0 to 10 years), then they will have to be paid on a fully amortising basis for the last 15 years (t=10 to 25 years). Assuming that interest rates will remain constant, what will be your monthly payments over the first 10 years from now, and then the next 15 years after that? The answer options are given in the same order.
Question 551 fully amortising loan, time calculation, APR You just entered into a fully amortising home loan with a principal of $600,000, a variable interest rate of 4.25% pa and a term of 25 years. Immediately after settling the loan, the variable interest rate suddenly falls to 4% pa! You can't believe your luck. Despite this, you plan to continue paying the same home loan payments as you did before. How long will it now take to pay off your home loan? Assume that the lower interest rate was granted immediately and that rates were and are now again expected to remain constant. Round your answer up to the nearest whole month.
Question 552 bond pricing, income and capital returns An investor bought a 10 year 2.5% pa fixed coupon government bond priced at par. The face value is $100. Coupons are paid semi-annually and the next one is in 6 months. Six months later, just after the coupon at that time was paid, yields suddenly and unexpectedly fell to 2% pa. Note that all yields above are given as APR's compounding semi-annually. What was the bond investors' historical total return over that first 6 month period, given as an effective semi-annual rate?
Question 553 bond pricing, income and capital returns An investor bought a 20 year 5% pa fixed coupon government bond priced at par. The face value is $100. Coupons are paid semi-annually and the next one is in 6 months. Six months later, just after the coupon at that time was paid, yields suddenly and unexpectedly rose to 5.5% pa. Note that all yields above are given as APR's compounding semi-annually. What was the bond investors' historical total return over that first 6 month period, given as an effective semi-annual rate?
Question 554 inflation, real and nominal returns and cash flows On his 20th birthday, a man makes a resolution. He will put $30 cash under his bed at the end of every month starting from today. His birthday today is the first day of the month. So the first addition to his cash stash will be in one month. He will write in his will that when he dies the cash under the bed should be given to charity. If the man lives for another 60 years, how much money will be under his bed if he dies just after making his last (720th) addition? Also, what will be the real value of that cash in today's prices if inflation is expected to 2.5% pa? Assume that the inflation rate is an effective annual rate and is not expected to change. The answers are given in the same order, the amount of money under his bed in 60 years, and the real value of that money in today's prices.
Question 555 capital budgeting, CFFA Find the cash flow from assets (CFFA) of the following project.
Note 1: Due to the project, the firm will have to purchase $40m of inventory initially (at t=0). Half of this inventory will be sold at t=1 and the other half at t=2. Note 2: The equipment will have a book value of $2m at the end of the project for tax purposes. However, the equipment is expected to fetch $1m when it is sold. Assume that the full capital loss is tax-deductible and taxed at the full corporate tax rate. Note 3: The project will be fully funded by equity which investors will expect to pay dividends totaling $10m at the end of each year. Find the project's CFFA at time zero, one and two. Answers are given in millions of dollars ($m).
Question 556 portfolio risk, portfolio return, standard deviation An investor wants to make a portfolio of two stocks A and B with a target expected portfolio return of 12% pa.
The correlation coefficient between stock A and B's expected returns is 70%. What will be the annual standard deviation of the portfolio with this 12% pa target return?
Question 557 portfolio weights, portfolio return An investor wants to make a portfolio of two stocks A and B with a target expected portfolio return of 6% pa.
What portfolio weights should the investor have in stocks A and B respectively?
Question 558 portfolio weights, portfolio return, short selling An investor wants to make a portfolio of two stocks A and B with a target expected portfolio return of 16% pa.
What portfolio weights should the investor have in stocks A and B respectively?
Question 560 standard deviation, variance, needs refinement The standard deviation and variance of a stock's annual returns are calculated over a number of years. The units of the returns are percent per annum ##(\% pa)##. What are the units of the standard deviation ##(\sigma)## and variance ##(\sigma^2)## of returns respectively? Hint: Visit Wikipedia to understand the difference between percentage points ##(\text{pp})## and percent ##(\%)##.
Question 561 covariance, correlation The covariance and correlation of two stocks X and Y's annual returns are calculated over a number of years. The units of the returns are in percent per annum ##(\% pa)##. What are the units of the covariance ##(\sigma_{X,Y})## and correlation ##(\rho_{X,Y})## of returns respectively? Hint: Visit Wikipedia to understand the difference between percentage points ##(\text{pp})## and percent ##(\%)##.
What is the covariance of a variable X with itself? The cov(X, X) or ##\sigma_{X,X}## equals:
What is the correlation of a variable X with itself? The corr(X, X) or ##\rho_{X,X}## equals:
What is the covariance of a variable X with a constant C? The cov(X, C) or ##\sigma_{X,C}## equals:
What is the correlation of a variable X with a constant C? The corr(X, C) or ##\rho_{X,C}## equals:
Question 567 stock split, capital structure A company conducts a 4 for 3 stock split. What is the percentage change in the stock price and the number of shares outstanding? The answers are given in the same order.
Question 568 rights issue, capital raising, capital structure A company conducts a 1 for 5 rights issue at a subscription price of $7 when the pre-announcement stock price was $10. What is the percentage change in the stock price and the number of shares outstanding? The answers are given in the same order. Ignore all taxes, transaction costs and signalling effects.
Question 569 personal tax The average weekly earnings of an Australian adult worker before tax was $1,542.40 per week in November 2014 according to the Australian Bureau of Statistics. Therefore average annual earnings before tax were $80,204.80 assuming 52 weeks per year. Personal income tax rates published by the Australian Tax Office are reproduced for the 2014-2015 financial year in the table below:
The above rates do not include the Medicare levy of 2%. Exclude the Medicare levy from your calculations How much personal income tax would you have to pay per year if you earned $80,204.80 per annum before-tax?
Question 570 foreign exchange rate An American wishes to convert USD 1 million to Australian dollars (AUD). The exchange rate is 0.8 USD per AUD. How much is the USD 1 million worth in AUD?
Question 571 foreign exchange rate An Indonesian lady wishes to convert 1 million Indonesian rupiah (IDR) to Australian dollars (AUD). Exchange rates are 13,125 IDR per USD and 0.79 USD per AUD. How many AUD is the IDR 1 million worth?
A man just sold a call option to his counterparty, a lady. The man has just now:
Which one of the following statements about option contracts is NOT correct?
Which of the following statements about option contracts is NOT correct? For every:
If trader A has sold the right that allows counterparty B to buy the underlying asset from him at maturity if counterparty B wants then trader A is:
Question 590 future, market efficiency Which of the following statements about futures contracts on shares is NOT correct, assuming that markets are efficient? When an equity future is first negotiated (at t=0):
Question 591 short selling, future, option After doing extensive fundamental analysis of a company, you believe that their shares are overpriced and will soon fall significantly. The market believes that there will be no such fall. Which of the following strategies is NOT a good idea, assuming that your prediction is true?
Question 592 future, margin call A trader buys one December futures contract on orange juice. Each contract is for the delivery of 10,000 pounds. The current futures price is $1.20 per pound. The initial margin is $5,000 per contract, and the maintenance margin is $4,000 per contract. What is the smallest price change would that would lead to a margin call for the buyer?
Question 593 future, arbitrage table The price of gold is currently $700 per ounce. The forward price for delivery in 1 year is $800. An arbitrageur can borrow money at 10% per annum given as an effective discrete annual rate. Assume that gold is fairly priced and the cost of storing gold is zero. What is the best way to conduct an arbitrage in this situation? The best arbitrage strategy requires zero capital, has zero risk and makes money straight away. An arbitrageur should sell 1 forward on gold and:
Question 595 future, continuously compounding rate A 2-year futures contract on a stock paying a continuous dividend yield of 3% pa was bought when the underlying stock price was $10 and the risk free rate was 10% per annum with continuous compounding. Assume that investors are risk-neutral, so the stock's total required return is the risk free rate. Find the forward price ##(F_2)## and value of the contract ##(V_0)## initially. Also find the value of the contract in 6 months ##(V_{0.5})## if the stock price rose to $12.
Question 596 future, continuously compounding rate An equity index is currently at 5,000 points. The 2 year futures price is 5,400 points and the total required return is 8% pa with continuous compounding. Each index point is worth $25. What is the implied continuous dividend yield as a continuously compounded rate per annum?
Question 597 future, continuously compounding rate A stock is expected to pay a dividend of $5 per share in 1 month and $5 again in 7 months. The stock price is $100, and the risk-free rate of interest is 10% per annum with continuous compounding. The yield curve is flat. Assume that investors are risk-neutral. An investor has just taken a short position in a one year forward contract on the stock. Find the forward price ##(F_1)## and value of the contract ##(V_0)## initially. Also find the value of the short futures contract in 6 months ##(V_\text{0.5, SF})## if the stock price fell to $90.
Question 598 future, tailing the hedge, cross hedging The standard deviation of monthly changes in the spot price of lamb is $0.015 per pound. The standard deviation of monthly changes in the futures price of live cattle is $0.012 per pound. The correlation between the spot price of lamb and the futures price of cattle is 0.4. It is now January. A lamb producer is committed to selling 1,000,000 pounds of lamb in May. The spot price of live cattle is $0.30 per pound and the June futures price is $0.32 per pound. The spot price of lamb is $0.60 per pound. The producer wants to use the June live cattle futures contracts to hedge his risk. Each futures contract is for the delivery of 50,000 pounds of cattle. How many live cattle futures should the lamb farmer sell to hedge his risk? Round your answer to the nearest whole number of contracts.
Question 599 bond pricing On 22-Mar-2013 the Australian Government issued series TB139 treasury bonds with a combined face value $23.4m, listed on the ASX with ticker code GSBG25. The bonds mature on 21-Apr-2025, the fixed coupon rate is 3.25% pa and coupons are paid semi-annually on the 21st of April and October of each year. Each bond's face value is $1,000. At market close on Friday 11-Sep-2015 the bonds' yield was 2.736% pa. At market close on Monday 14-Sep-2015 the bonds' yield was 2.701% pa. Both yields are given as annualised percentage rates (APR's) compounding every 6 months. For convenience, assume 183 days in 6 months and 366 days in a year. What was the historical total return over those 3 calendar days between Friday 11-Sep-2015 and Monday 14-Sep-2015? There are 183 calendar days from market close on the last coupon 21-Apr-2015 to the market close of the next coupon date on 21-Oct-2015. Between the market close times from 21-Apr-2015 to 11-Sep-2015 there are 143 calendar days. From 21-Apr-2015 to 14-Sep-2015 there are 146 calendar days. From 14-Sep-2015 there were 20 coupons remaining to be paid including the next one on 21-Oct-2015. All of the below answers are given as effective 3 day rates.
Question 600 foreign exchange rate A Chinese man wishes to convert AUD 1 million into Chinese Renminbi (RMB, also called the Yuan (CNY)). The exchange rate is 6.35 RMB per USD, and 0.72 USD per AUD. How much is the AUD 1 million worth in RMB?
Question 601 foreign exchange rate, American and European terms
Question 602 foreign exchange rate, American and European terms
Question 603 foreign exchange rate, American and European terms
Question 604 inflation, real and nominal returns and cash flows Apples and oranges currently cost $1 each. Inflation is 5% pa, and apples and oranges are equally affected by this inflation rate. Note that when payments are not specified as real, as in this question, they're conventionally assumed to be nominal. Which of the following statements is NOT correct?
Question 605 cross currency interest rate parity, foreign exchange rate
Question 607 debt terminology
Question 608 debt terminology
Question 609 debt terminology
Question 610 debt terminology
Question 611 debt terminology
Question 612 debt terminology
Question 613 debt terminology
Question 614 debt terminology
Question 615 debt terminology
Question 616 idiom, debt terminology, bond pricing "Buy low, sell high" is a phrase commonly heard in financial markets. It states that traders should try to buy assets at low prices and sell at high prices. Traders in the fixed-coupon bond markets often quote promised bond yields rather than prices. Fixed-coupon bond traders should try to:
To value a business's assets, the free cash flow of the firm (FCFF, also called CFFA) needs to be calculated. This requires figures from the firm's income statement and balance sheet. For what figures is the balance sheet needed? Note that the balance sheet is sometimes also called the statement of financial position.
Question 620 bond pricing, income and capital returns Let the 'income return' of a bond be the coupon at the end of the period divided by the market price now at the start of the period ##(C_1/P_0)##. The expected income return of a premium fixed coupon bond is:
Question 622 expected and historical returns, risk An economy has only two investable assets: stocks and cash. Stocks had a historical nominal average total return of negative two percent per annum (-2% pa) over the last 20 years. Stocks are liquid and actively traded. Stock returns are variable, they have risk. Cash is riskless and has a nominal constant return of zero percent per annum (0% pa), which it had in the past and will have in the future. Cash can be kept safely at zero cost. Cash can be converted into shares and vice versa at zero cost. The nominal total return of the shares over the next year is expected to be:
Question 625 dividend re-investment plan, capital raising Which of the following statements about dividend re-investment plans (DRP's) is NOT correct?
Question 627 CAPM, SML, NPV, Jensens alpha Assets A, B, M and ##r_f## are shown on the graphs above. Asset M is the market portfolio and ##r_f## is the risk free yield on government bonds. Which of the below statements is NOT correct?
Question 628 CAPM, SML, risk Assets A, B, M and ##r_f## are shown on the graphs above. Asset M is the market portfolio and ##r_f## is the risk free yield on government bonds. Assume that investors can borrow and lend at the risk free rate. Which of the below statements is NOT correct?
Question 630 mispriced asset, NPV, DDM, market efficiency A company advertises an investment costing $1,000 which they say is underpriced. They say that it has an expected total return of 15% pa, but a required return of only 10% pa. Of the 15% pa total expected return, the dividend yield is expected to always be 7% pa and rest is the capital yield. Assuming that the company's statements are correct, what is the NPV of buying the investment if the 15% total return lasts for the next 100 years (t=0 to 100), then reverts to 10% after that time? Also, what is the NPV of the investment if the 15% return lasts forever? In both cases, assume that the required return of 10% remains constant, the dividends can only be re-invested at 10% pa and all returns are given as effective annual rates. The answer choices below are given in the same order (15% for 100 years, and 15% forever):
Question 632 foreign exchange rate, no explanation Below is a graph of the USD against the JPY and EUR from 1980 to 2015, compiled by the RBA. Select the correct statement about what occurred between 1980 and 2015. Note that in 1980 the euro was around 1.3 USD per EUR and the Yen was around 250 JPY per USD.
Question 633 personal tax In 2014 the median starting salaries of male and female Australian bachelor degree accounting graduates aged less than 25 years in their first full-time industry job was $50,000 before tax, according to Graduate Careers Australia. See page 9 of this report. Personal income tax rates published by the Australian Tax Office are reproduced for the 2014-2015 financial year in the table below.
The above rates do not include the Medicare levy of 2%. Exclude the Medicare levy from your calculations How much personal income tax would you have to pay per year if you earned $50,000 per annum before-tax?
Question 634 continuously compounding rate A $100 stock has a continuously compounded expected total return of 10% pa. Its dividend yield is 2% pa with continuous compounding. What do you expect its price to be in one year?
Question 635 continuously compounding rate A $100 stock has a continuously compounded expected total return of 10% pa. Its dividend yield is 2% pa with continuous compounding. What do you expect its price to be in 2.5 years?
Question 641 future, no explanation Which of the below formulas gives the payoff at maturity ##(f_T)## from being long a future? Let the underlying asset price at maturity be ##S_T## and the locked-in futures price be ##K_T##.
Question 642 future, no explanation Which of the below formulas gives the payoff at maturity ##(f_T)## from being short a future? Let the underlying asset price at maturity be ##S_T## and the locked-in futures price be ##K_T##.
Question 643 future, no explanation A trader buys one crude oil futures contract on the CME expiring in one year with a locked-in futures price of $38.94 per barrel. If the trader doesn’t close out her contract before expiry then in one year she will have the:
Question 644 future, no explanation A trader sells one crude oil futures contract on the CME expiring in one year with a locked-in futures price of $38.94 per barrel. The crude oil spot price is $40.33. If the trader doesn’t close out her contract before expiry then in one year she will have the:
Question 645 option, no explanation A trader buys one crude oil European style call option contract on the CME expiring in one year with an exercise price of $44 per barrel for a price of $6.64. The crude oil spot price is $40.33. If the trader doesn’t close out her contract before maturity, then at maturity she will have the:
Question 646 open interest, trade volume, future Alice, Bob, Chris and Delta are traders in the futures market. The following trades occur over a single day in a newly-opened equity index future that matures in one year which the exchange just made available. 1. Alice buys a future from Bob. 2. Chris buys a future from Delta. 3. Delta buys a future from Alice. These were the only trades made in this equity index future. What was the trading volume and what is the open interest?
Question 647 open interest, trade volume, future Alice, Bob, Chris and Delta are traders in the futures market. The following trades occur over a single day in a newly-opened equity index future that matures in one year which the exchange just made available. 1. Alice buys a future from Bob. 2. Chris buys a future from Delta. 3. Delta buys a future from Bob. These were the only trades made in this equity index future. What was the trading volume and what is the open interest?
Question 648 margin call, future A trader buys a one year futures contract on crude oil. The contract is for the delivery of 1,000 barrels. The current futures price is $38.94 per barrel. The initial margin is $3,410 per contract, and the maintenance margin is $3,100 per contract. What is the smallest price change that would lead to a margin call for the buyer?
Question 649 margin call, future A trader sells a one year futures contract on crude oil. The contract is for the delivery of 1,000 barrels. The current futures price is $38.94 per barrel. The initial margin is $3,410 per contract, and the maintenance margin is $3,100 per contract. What is the smallest price change that would lead to a margin call for the seller?
Question 650 future, closing out future contract In February a company sold one December 40,000 pound (about 18 metric tons) lean hog futures contract. It closed out its position in May. The spot price was $0.68 per pound in February. The December futures price was $0.70 per pound when the trader entered into the contract in February, $0.60 when he closed out his position in May, and $0.55 when the contract matured in December. What was the total profit?
Question 652 future, continuously compounding rate An equity index is currently at 5,200 points. The 6 month futures price is 5,300 points and the total required return is 6% pa with continuous compounding. Each index point is worth $25. What is the implied dividend yield as a continuously compounded rate per annum?
Question 653 future, continuously compounding rate An equity index is currently at 4,800 points. The 1.5 year futures price is 5,100 points and the total required return is 6% pa with continuous compounding. Each index point is worth $25. What is the implied dividend yield as a continuously compounded rate per annum?
Question 658 CFFA, income statement, balance sheet, no explanation To value a business's assets, the free cash flow of the firm (FCFF, also called CFFA) needs to be calculated. This requires figures from the firm's income statement and balance sheet. For what figures is the income statement needed? Note that the income statement is sometimes also called the profit and loss, P&L, or statement of financial performance.
Question 660 fully amortising loan, interest only loan, APR How much more can you borrow using an interest-only loan compared to a 25-year fully amortising loan if interest rates are 6% pa compounding per month and are not expected to change? If it makes it easier, assume that you can afford to pay $2,000 per month on either loan. Express your answer as a proportional increase using the following formula: ###\text{Proportional Increase} = \dfrac{V_\text{0,interest only}}{V_\text{0,fully amortising}} - 1###
Question 661 systematic and idiosyncratic risk, CAPM A stock's total standard deviation of returns is 20% pa. The market portfolio's total standard deviation of returns is 15% pa. The beta of the stock is 0.8. What is the stock's diversifiable standard deviation?
A company conducts a 10 for 3 stock split. What is the percentage increase in the stock price and the number of shares outstanding? The answers are given in the same order.
Question 666 rights issue, capital raising A company conducts a 2 for 3 rights issue at a subscription price of $8 when the pre-announcement stock price was $9. Assume that all investors use their rights to buy those extra shares. What is the percentage increase in the stock price and the number of shares outstanding? The answers are given in the same order.
Question 668 buy and hold, market efficiency, idiom A quote from the famous investor Warren Buffet: "Much success can be attributed to inactivity. Most investors cannot resist the temptation to constantly buy and sell." Buffet is referring to the buy-and-hold strategy which is to buy and never sell shares. Which of the following is a disadvantage of a buy-and-hold strategy? Assume that share markets are semi-strong form efficient. Which of the following is NOT an advantage of the strict buy-and-hold strategy? A disadvantage of the buy-and-hold strategy is that it reduces:
Question 669 beta, CAPM, risk Which of the following is NOT a valid method for estimating the beta of a company's stock? Assume that markets are efficient, a long history of past data is available, the stock possesses idiosyncratic and market risk. The variances and standard deviations below denote total risks.
Question 670 fixed for floating interest rate swap A company can invest funds in a five year project at LIBOR plus 50 basis points pa. The five-year swap rate is 4% pa. What fixed rate of interest can the company earn over the next five years by using the swap?
Question 671 future, forward, hedging
A stock has a beta of 1.5. The market's expected total return is 10% pa and the risk free rate is 5% pa, both given as effective annual rates. What do you think will be the stock's expected return over the next year, given as an effective annual rate?
Question 673 CAPM, beta, expected and historical returns A stock has a beta of 1.5. The market's expected total return is 10% pa and the risk free rate is 5% pa, both given as effective annual rates. In the last 5 minutes, bad economic news was released showing a higher chance of recession. Over this time the share market fell by 1%. The risk free rate was unchanged. What do you think was the stock's historical return over the last 5 minutes, given as an effective 5 minute rate?
Question 674 CAPM, beta, expected and historical returns A stock has a beta of 1.5. The market's expected total return is 10% pa and the risk free rate is 5% pa, both given as effective annual rates. Over the last year, bad economic news was released showing a higher chance of recession. Over this time the share market fell by 1%. So ##r_{m} = (P_{0} - P_{-1})/P_{-1} = -0.01##, where the current time is zero and one year ago is time -1. The risk free rate was unchanged. What do you think was the stock's historical return over the last year, given as an effective annual rate?
Question 675 option, option profit, no explanation Which of the below formulas gives the profit ##(\pi)## from being long a call option? Let the underlying asset price at maturity be ##S_T##, the exercise price be ##X_T## and the option price be ##f_{LC,0}##. Note that ##S_T##, ##X_T## and ##f_{LC,0}## are all positive numbers.
Question 676 option, option profit, no explanation Which of the below formulas gives the profit ##(\pi)## from being short a call option? Let the underlying asset price at maturity be ##S_T##, the exercise price be ##X_T## and the option price be ##f_{LC,0}##. Note that ##S_T##, ##X_T## and ##f_{LC,0}## are all positive numbers.
Question 677 option, option profit, no explanation Which of the below formulas gives the profit ##(\pi)## from being long a put option? Let the underlying asset price at maturity be ##S_T##, the exercise price be ##X_T## and the option price be ##f_{LP,0}##. Note that ##S_T##, ##X_T## and ##f_{LP,0}## are all positive numbers.
Question 678 option, option profit, no explanation Which of the below formulas gives the profit ##(\pi)## from being short a put option? Let the underlying asset price at maturity be ##S_T##, the exercise price be ##X_T## and the option price be ##f_{LP,0}##. Note that ##S_T##, ##X_T## and ##f_{LP,0}## are all positive numbers.
Question 679 option, no explanation A trader sells one crude oil European style call option contract on the CME expiring in one year with an exercise price of $44 per barrel for a price of $6.64. The crude oil spot price is $40.33. If the trader doesn’t close out her contract before maturity, then at maturity she will have the:
Question 680 option, no explanation A trader buys one crude oil European style put option contract on the CME expiring in one year with an exercise price of $44 per barrel for a price of $6.64. The crude oil spot price is $40.33. If the trader doesn’t close out her contract before maturity, then at maturity she will have the:
Question 681 no explanation A trader sells one crude oil European style put option contract on the CME expiring in one year with an exercise price of $44 per barrel for a price of $6.64. The crude oil spot price is $40.33. If the trader doesn’t close out her contract before maturity, then at maturity she will have the:
Question 682 open interest, trade volume, future Alice, Bob, Chris and Delta are traders in the futures market. The following trades occur over a single day in a newly-opened equity index future that matures in one year which the exchange just made available. 1. Alice buys a future from Bob. 2. Chris buys a future from Delta. 3. Bob buys a future from Chris. These were the only trades made in this equity index future. What was the trading volume and what is the open interest?
Question 683 open interest, trade volume, future Alice, Bob, Chris and Delta are traders in the futures market. The following trades occur over a single day in a newly-opened equity index future that matures in one year which the exchange just made available. 1. Alice buys a future from Bob. 2. Chris buys a future from Delta. 3. Alice buys a future from Chris. These were the only trades made in this equity index future. What was the trading volume and what is the open interest?
Question 684 future, arbitrage, no explanation An equity index stands at 100 points and the one year equity futures price is 102. The equity index is expected to have a dividend yield of 4% pa. Assume that investors are risk-neutral so their total required return on the shares is the same as the risk free Treasury bond yield which is 10% pa. Both are given as discrete effective annual rates. Assuming that the equity index is fairly priced, an arbitrageur would recognise that the equity futures are:
Question 685 future, arbitrage, no explanation An equity index stands at 100 points and the one year equity futures price is 107. The equity index is expected to have a dividend yield of 3% pa. Assume that investors are risk-neutral so their total required return on the shares is the same as the risk free Treasury bond yield which is 10% pa. Both are given as discrete effective annual rates. Assuming that the equity index is fairly priced, an arbitrageur would recognise that the equity futures are:
Question 688 future, hedging A pig farmer in the US is worried about the price of hogs falling and wants to lock in a price now. In one year the pig farmer intends to sell 1,000,000 pounds of hogs. Luckily, one year CME lean hog futures expire on the exact day that he wishes to sell his pigs. The futures have a notional principal of 40,000 pounds (about 18 metric tons) and currently trade at a price of 63.85 cents per pound. The underlying lean hogs spot price is 77.15 cents per pound. The correlation between the futures price and the underlying hogs price is one and the standard deviations are both 4 cents per pound. The initial margin is USD1,500 and the maintenance margin is USD1,200 per futures contract. Which of the below statements is NOT correct?
Question 689 future, hedging An equity index fund manager controls a USD1 billion diversified equity portfolio with a beta of 1.3. The equity manager fears that a global recession will begin in the next year, causing equity prices to tumble. The market does not think that this will happen. If the fund manager wishes to reduce her portfolio beta to 0.5, how many S&P500 futures should she sell? The US market equity index is the S&P500. One year CME futures on the S&P500 currently trade at 2,062 points and the spot price is 2,091 points. Each point is worth $250. How many one year S&P500 futures contracts should the fund manager sell?
A trader just bought a European style put option on CBA stock. The current option premium is $2, the exercise price is $75, the option matures in one year and the spot CBA stock price is $74. Which of the following statements is NOT correct?
Question 692 future, hedging, no explanation The standard deviation of monthly changes in the spot price of corn is 50 cents per bushel. The standard deviation of monthly changes in the futures price of corn is 40 cents per bushel. The correlation between the spot price of corn and the futures price of corn is 0.9. It is now March. A corn chip manufacturer is committed to buying 250,000 bushels of corn in May. The spot price of corn is 381 cents per bushel and the June futures price is 399 cents per bushel. The corn chip manufacturer wants to use the June corn futures contracts to hedge his risk. Each futures contract is for the delivery of 5,000 bushels of corn. One bushel is about 127 metric tons. How many corn futures should the corn chip manufacturer buy to hedge his risk? Round your answer to the nearest whole number of contracts. Remember to tail the hedge.
Information about three risk free Government bonds is given in the table below.
Based on the above government bonds' yields to maturity, which of the below statements about the spot zero rates and forward zero rates is NOT correct?
Which of the below statements about utility is NOT generally accepted by economists? Most people are thought to:
Question 699 utility, risk aversion, utility function, gamble Mr Blue, Miss Red and Mrs Green are people with different utility functions. Each person has $50 of initial wealth. A coin toss game is offered to each person at a casino where the player can win or lose $50. Each player can flip a coin and if they flip heads, they receive $50. If they flip tails then they will lose $50. Which of the following statements is NOT correct?
Question 700 utility, risk aversion, utility function, gamble Mr Blue, Miss Red and Mrs Green are people with different utility functions. Each person has $50 of initial wealth. A coin toss game is offered to each person at a casino where the player can win or lose $50. Each player can flip a coin and if they flip heads, they receive $50. If they flip tails then they will lose $50. Which of the following statements is NOT correct?
Question 701 utility, risk aversion, utility function, gamble Mr Blue, Miss Red and Mrs Green are people with different utility functions. Each person has $50 of initial wealth. A coin toss game is offered to each person at a casino where the player can win or lose $50. Each player can flip a coin and if they flip heads, they receive $50. If they flip tails then they will lose $50. Which of the following statements is NOT correct?
Question 702 utility, risk aversion, utility function, gamble Mr Blue, Miss Red and Mrs Green are people with different utility functions. Each person has $50 of initial wealth. A coin toss game is offered to each person at a casino where the player can win or lose $50. Each player can flip a coin and if they flip heads, they receive $50. If they flip tails then they will lose $50. Which of the following statements is NOT correct?
Question 703 utility, risk aversion, utility function, gamble Mr Blue, Miss Red and Mrs Green are people with different utility functions. Each person has $500 of initial wealth. A coin toss game is offered to each person at a casino where the player can win or lose $500. Each player can flip a coin and if they flip heads, they receive $500. If they flip tails then they will lose $500. Which of the following statements is NOT correct?
Question 704 utility, risk aversion, utility function, gamble Mr Blue, Miss Red and Mrs Green are people with different utility functions. Each person has $256 of initial wealth. A coin toss game is offered to each person at a casino where the player can win or lose $256. Each player can flip a coin and if they flip heads, they receive $256. If they flip tails then they will lose $256. Which of the following statements is NOT correct?
Question 706 utility, risk aversion, utility function Mr Blue, Miss Red and Mrs Green are people with different utility functions. Note that a fair gamble is a bet that has an expected value of zero, such as paying $0.50 to win $1 in a coin flip with heads or nothing if it lands tails. Fairly priced insurance is when the expected present value of the insurance premiums is equal to the expected loss from the disaster that the insurance protects against, such as the cost of rebuilding a home after a catastrophic fire. Which of the following statements is NOT correct?
Question 709 continuously compounding rate, APR Which of the following interest rate quotes is NOT equivalent to a 10% effective annual rate of return? Assume that each year has 12 months, each month has 30 days, each day has 24 hours, each hour has 60 minutes and each minute has 60 seconds. APR stands for Annualised Percentage Rate.
Question 715 return distribution If a variable, say X, is normally distributed with mean ##\mu## and variance ##\sigma^2## then mathematicians write ##X \sim \mathcal{N}(\mu, \sigma^2)##. If a variable, say Y, is log-normally distributed and the underlying normal distribution has mean ##\mu## and variance ##\sigma^2## then mathematicians write ## Y \sim \mathbf{ln} \mathcal{N}(\mu, \sigma^2)##. The below three graphs show probability density functions (PDF) of three different random variables Red, Green and Blue. Select the most correct statement:
Question 716 return distribution The below three graphs show probability density functions (PDF) of three different random variables Red, Green and Blue. Which of the below statements is NOT correct?
Question 717 return distribution The below three graphs show probability density functions (PDF) of three different random variables Red, Green and Blue. Let ##P_1## be the unknown price of a stock in one year. ##P_1## is a random variable. Let ##P_0 = 1##, so the share price now is $1. This one dollar is a constant, it is not a variable. Which of the below statements is NOT correct? Financial practitioners commonly assume that the shape of the PDF represented in the colour:
Question 718 arithmetic and geometric averages The symbol ##\text{GDR}_{0\rightarrow 1}## represents a stock's gross discrete return per annum over the first year. ##\text{GDR}_{0\rightarrow 1} = P_1/P_0##. The subscript indicates the time period that the return is mentioned over. So for example, ##\text{AAGDR}_{1 \rightarrow 3}## is the arithmetic average GDR measured over the two year period from years 1 to 3, but it is expressed as a per annum rate. Which of the below statements about the arithmetic and geometric average GDR is NOT correct?
Fred owns some Commonwealth Bank (CBA) shares. He has calculated CBA’s monthly returns for each month in the past 20 years using this formula: ###r_\text{t monthly}=\ln \left( \dfrac{P_t}{P_{t-1}} \right)###He then took the arithmetic average and found it to be 1% per month using this formula: ###\bar{r}_\text{monthly}= \dfrac{ \displaystyle\sum\limits_{t=1}^T{\left( r_\text{t monthly} \right)} }{T} =0.01=1\% \text{ per month}###He also found the standard deviation of these monthly returns which was 5% per month: ###\sigma_\text{monthly} = \dfrac{ \displaystyle\sum\limits_{t=1}^T{\left( \left( r_\text{t monthly} - \bar{r}_\text{monthly} \right)^2 \right)} }{T} =0.05=5\%\text{ per month}###Which of the below statements about Fred’s CBA shares is NOT correct? Assume that the past historical average return is the true population average of future expected returns.
Question 724 return distribution, mean and median returns
Question 725 return distribution, mean and median returns
Question 726 return distribution, mean and median returns
Question 727 inflation, real and nominal returns and cash flows The Australian Federal Government lends money to domestic students to pay for their university education. This is known as the Higher Education Contribution Scheme (HECS). The nominal interest rate on the HECS loan is set equal to the consumer price index (CPI) inflation rate. The interest is capitalised every year, which means that the interest is added to the principal. The interest and principal does not need to be repaid by students until they finish study and begin working. Which of the following statements about HECS loans is NOT correct?
Question 730 DDM, income and capital returns, no explanation A stock’s current price is $1. Its expected total return is 10% pa and its long term expected capital return is 4% pa. It pays an annual dividend and the next one will be paid in one year. All rates are given as effective annual rates. The dividend discount model is thought to be a suitable model for the stock. Ignore taxes. Which of the following statements about the stock is NOT correct?
Question 731 DDM, income and capital returns, no explanation In the dividend discount model (DDM), share prices fall when dividends are paid. Let the high price before the fall be called the peak, and the low price after the fall be called the trough. ###P_0=\dfrac{C_1}{r-g}### Which of the following statements about the DDM is NOT correct?
An investor bought a bond for $100 (at t=0) and one year later it paid its annual coupon of $1 (at t=1). Just after the coupon was paid, the bond price was $100.50 (at t=1). Inflation over the past year (from t=0 to t=1) was 3% pa, given as an effective annual rate. Which of the following statements is NOT correct? The bond investment produced a:
Question 733 DDM, income and capital returns A share’s current price is $60. It’s expected to pay a dividend of $1.50 in one year. The growth rate of the dividend is 0.5% pa and the stock’s required total return is 3% pa. The stock’s price can be modeled using the dividend discount model (DDM): ##P_0=\dfrac{C_1}{r-g}## Which of the following methods is NOT equal to the stock’s expected price in one year and six months (t=1.5 years)? Note that the symbolic formulas shown in each line below do equal the formulas with numbers. The formula is just repeated with symbols and then numbers in case it helps you to identify the incorrect statement more quickly.
An equities analyst is using the dividend discount model to price a company's shares. The company operates domestically and has no plans to expand overseas. It is part of a mature industry with stable positive growth prospects. The analyst has estimated the real required return (r) of the stock and the value of the dividend that the stock just paid a moment before ##(C_\text{0 before})##. What is the highest perpetual real growth rate of dividends (g) that can be justified? Select the most correct statement from the following choices. The highest perpetual real expected growth rate of dividends that can be justified is the country's expected:
Question 736 debt terminology You bought a house, primarily funded using a home loan from a bank. Which of the following statements is NOT correct?
Question 739 real and nominal returns and cash flows, inflation There are a number of different formulas involving real and nominal returns and cash flows. Which one of the following formulas is NOT correct? All returns are effective annual rates. Note that the symbol ##\approx## means 'approximately equal to'.
Question 740 real and nominal returns and cash flows, DDM, inflation Taking inflation into account when using the DDM can be hard. Which of the following formulas will NOT give a company's current stock price ##(P_0)##? Assume that the annual dividend was just paid ##(C_0)##, and the next dividend will be paid in one year ##(C_1)##.
Question 741 APR, effective rate A home loan company advertises an interest rate of 4.5% pa, payable monthly. Which of the following statements about the interest rate is NOT correct?
Question 746 pay back period A stock is expected to pay a dividend of $1 in one year. Its future annual dividends are expected to grow by 10% pa. So the first dividend of $1 is in one year, and the year after that the dividend will be $1.1 (=1*(1+0.1)^1), and a year later $1.21 (=1*(1+0.1)^2) and so on forever. Its required total return is 30% pa. The total required return and growth rate of dividends are given as effective annual rates. The stock is fairly priced. Calculate the pay back period of buying the stock and holding onto it forever, assuming that the dividends are received as at each time, not smoothly over each year.
Question 747 DDM, no explanation A share will pay its next dividend of ##C_1## in one year, and will continue to pay a dividend every year after that forever, growing at a rate of ##g##. So the next dividend will be ##C_2=C_1 (1+g)^1##, then ##C_3=C_2 (1+g)^1##, and so on forever. The current price of the share is ##P_0## and its required return is ##r## Which of the following is NOT equal to the expected share price in 2 years ##(P_2)## just after the dividend at that time ##(C_2)## has been paid?
Question 748 income and capital returns, DDM, ex dividend date A stock will pay you a dividend of $2 tonight if you buy it today. Thereafter the annual dividend is expected to grow by 3% pa, so the next dividend after the $2 one tonight will be $2.06 in one year, then in two years it will be $2.1218 and so on. The stock's required return is 8% pa. What is the stock price today and what do you expect the stock price to be tomorrow, approximately?
A real estate agent says that the price of a house in Sydney Australia is approximately equal to the gross weekly rent times 1000. What type of valuation method is the real estate agent using?
Question 750 PE ratio, Multiples valuation Itau Unibanco is a major listed bank in Brazil with a market capitalisation of equity equal to BRL 85.744 billion, EPS of BRL 3.96 and 2.97 billion shares on issue. Banco Bradesco is another major bank with total earnings of BRL 8.77 billion and 2.52 billion shares on issue. Estimate Banco Bradesco's current share price using a price-earnings multiples approach assuming that Itau Unibanco is a comparable firm. Note that BRL is the Brazilian Real, their currency. Figures sourced from Google Finance on the market close of the BVMF on 24 July 2015.
Question 751 NPV, Annuity Telsa Motors advertises that its Model S electric car saves $570 per month in fuel costs. Assume that Tesla cars last for 10 years, fuel and electricity costs remain the same, and savings are made at the end of each month with the first saving of $570 in one month from now. The effective annual interest rate is 15.8%, and the effective monthly interest rate is 1.23%. What is the present value of the savings?
Question 753 NPV, perpetuity, DDM, no explanation The following cash flows are expected:
What is the NPV of the cash flows if the discount rate is 10% given as an effective annual rate?
Question 754 fully amortising loan, interest only loan How much more can you borrow using an interest-only loan compared to a 25-year fully amortising loan if interest rates are 4% pa compounding per month and are not expected to change? If it makes it easier, assume that you can afford to pay $2,000 per month on either loan. Express your answer as a proportional increase using the following formula: ###\text{Proportional Increase} = \dfrac{V_\text{0,interest only}}{V_\text{0,fully amortising}} - 1###
Question 755 bond pricing, capital raising A firm wishes to raise $50 million now. They will issue 7% pa semi-annual coupon bonds that will mature in 6 years and have a face value of $100 each. Bond yields are 5% pa, given as an APR compounding every 6 months, and the yield curve is flat. How many bonds should the firm issue?
Question 756 bond pricing, capital raising, no explanation A firm wishes to raise $50 million now. They will issue 5% pa semi-annual coupon bonds that will mature in 3 years and have a face value of $100 each. Bond yields are 6% pa, given as an APR compounding every 6 months, and the yield curve is flat. How many bonds should the firm issue?
Question 757 bond pricing, capital raising, no explanation A firm wishes to raise $50 million now. They will issue 5% pa semi-annual coupon bonds that will mature in 10 years and have a face value of $100 each. Bond yields are 5% pa, given as an APR compounding every 6 months, and the yield curve is flat. How many bonds should the firm issue?
Question 758 time calculation, fully amortising loan, no explanation Two years ago you entered into a fully amortising home loan with a principal of $1,000,000, an interest rate of 6% pa compounding monthly with a term of 25 years. Then interest rates suddenly fall to 4.5% pa (t=0), but you continue to pay the same monthly home loan payments as you did before. How long will it now take to pay off your home loan? Measure the time taken to pay off the home loan from the current time which is 2 years after the home loan was first entered into. Assume that the lower interest rate was given to you immediately after the loan repayment at the end of year 2, which was the 24th payment since the loan was granted. Also assume that rates were and are expected to remain constant.
Question 759 time calculation, fully amortising loan, no explanation Five years ago you entered into a fully amortising home loan with a principal of $500,000, an interest rate of 4.5% pa compounding monthly with a term of 25 years. Then interest rates suddenly fall to 3% pa (t=0), but you continue to pay the same monthly home loan payments as you did before. How long will it now take to pay off your home loan? Measure the time taken to pay off the home loan from the current time which is 5 years after the home loan was first entered into. Assume that the lower interest rate was given to you immediately after the loan repayment at the end of year 5, which was the 60th payment since the loan was granted. Also assume that rates were and are expected to remain constant.
Question 760 time calculation, interest only loan, no explanation Five years ago (##t=-5## years) you entered into an interest-only home loan with a principal of $500,000, an interest rate of 4.5% pa compounding monthly with a term of 25 years. Then interest rates suddenly fall to 3% pa (##t=0##), but you continue to pay the same monthly home loan payments as you did before. Will your home loan be paid off by the end of its remaining term? If so, in how many years from now? Measure the time taken to pay off the home loan from the current time which is 5 years after the home loan was first entered into. Assume that the lower interest rate was given to you immediately after the loan repayment at the end of year 5, which was the 60th payment since the loan was granted. Also assume that rates were and are expected to remain constant.
Question 761 NPV, annuity due, no explanation The phone company Optus have 2 mobile service plans on offer which both have the same amount of phone call, text message and internet data credit. Both plans have a contract length of 24 months and the monthly cost is payable in advance. The only difference between the two plans is that one is a:
Neither plan has any additional payments at the start or end. Assume that the discount rate is 1% per month given as an effective monthly rate. The only difference between the plans is the phone, so what is the implied cost of the phone as a present value? Given that the latest smart phone actually costs $600 to purchase outright from another retailer, should you commit to the BYO plan or the bundled plan?
Question 762 equivalent annual cash flow, no explanation Radio-Rentals.com offers the Apple iphone 5S smart phone for rent at $12.95 per week paid in advance on a 2 year contract. After renting the phone, you must return it to Radio-Rentals. Kogan.com offers the Apple iphone 5S smart phone for sale at $699. You estimate that the phone will last for 3 years before it will break and be worthless. Currently, the effective annual interest rate is 11.351%, the effective monthly interest rate 0.9% and the effective weekly interest rate is 0.207%. Assume that there are exactly 52 weeks per year and 12 months per year. Find the equivalent annual cost of renting the phone and also buying the phone. The answers below are listed in the same order.
Question 763 multi stage growth model, DDM A stock is expected to pay its first dividend of $20 in 3 years (t=3), which it will continue to pay for the next nine years, so there will be ten $20 payments altogether with the last payment in year 12 (t=12). From the thirteenth year onward, the dividend is expected to be 4% more than the previous year, forever. So the dividend in the thirteenth year (t=13) will be $20.80, then $21.632 in year 14, and so on forever. The required return of the stock is 10% pa. All rates are effective annual rates. Calculate the current (t=0) stock price.
Question 764 bond pricing, no explanation A 4.5% fixed coupon Australian Government bond was issued at par in mid-April 2009. Coupons are paid semi-annually in arrears in mid-April and mid-October each year. The face value is $1,000. The bond will mature in mid-April 2020, so the bond had an original tenor of 11 years. Today is mid-September 2015 and similar bonds now yield 1.9% pa. What is the bond's new price? Note: there are 10 semi-annual coupon payments remaining from now (mid-September 2015) until maturity (mid-April 2020); both yields are given as APR's compounding semi-annually; assume that the yield curve was flat before the change in yields, and remained flat afterwards as well.
Question 765 bond pricing, no explanation An investor bought a 5 year government bond with a 2% pa coupon rate at par. Coupons are paid semi-annually. The face value is $100. Calculate the bond's new price 8 months later after yields have increased to 3% pa. Note that both yields are given as APR's compounding semi-annually. Assume that the yield curve was flat before the change in yields, and remained flat afterwards as well.
Question 766 CFFA, WACC, interest tax shield, DDM Use the below information to value a levered company with constant annual perpetual cash flows from assets. The next cash flow will be generated in one year from now, so a perpetuity can be used to value this firm. Both the operating and firm free cash flows are constant (but not equal to each other).
What is the value of the levered firm including interest tax shields?
Question 769 short selling, idiom, no explanation "Buy low, sell high" is a well-known saying. It suggests that investors should buy low then sell high, in that order. How would you re-phrase that saying to describe short selling?
Question 773 CFFA, WACC, interest tax shield, DDM Use the below information to value a levered company with constant annual perpetual cash flows from assets. The next cash flow will be generated in one year from now, so a perpetuity can be used to value this firm. Both the operating and firm free cash flows are constant (but not equal to each other).
What is the value of the levered firm including interest tax shields?
Question 774 leverage, WACC, real estate One year ago you bought a $1,000,000 house partly funded using a mortgage loan. The loan size was $800,000 and the other $200,000 was your wealth or 'equity' in the house asset. The interest rate on the home loan was 4% pa. Over the year, the house produced a net rental yield of 2% pa and a capital gain of 2.5% pa. Assuming that all cash flows (interest payments and net rental payments) were paid and received at the end of the year, and all rates are given as effective annual rates, what was the total return on your wealth over the past year? Hint: Remember that wealth in this context is your equity (E) in the house asset (V = D+E) which is funded by the loan (D) and your deposit or equity (E).
Question 775 utility, utility function Below is a graph of 3 peoples’ utility functions, Mr Blue (U=W^(1/2) ), Miss Red (U=W/10) and Mrs Green (U=W^2/1000). Assume that each of them currently have $50 of wealth. Which of the following statements about them is NOT correct? (a) Mr Blue would prefer to invest his wealth in a well diversified portfolio of stocks rather than a single stock, assuming that all stocks had the same total risk and return.
The market's expected total return is 10% pa and the risk free rate is 5% pa, both given as effective annual rates. A stock has a beta of 0.5. In the last 5 minutes, the federal government unexpectedly raised taxes. Over this time the share market fell by 3%. The risk free rate was unchanged. What do you think was the stock's historical return over the last 5 minutes, given as an effective 5 minute rate?
Fred owns some BHP shares. He has calculated BHP’s monthly returns for each month in the past 30 years using this formula: ###r_\text{t monthly}=\ln \left( \dfrac{P_t}{P_{t-1}} \right)###He then took the arithmetic average and found it to be 0.8% per month using this formula: ###\bar{r}_\text{monthly}= \dfrac{ \displaystyle\sum\limits_{t=1}^T{\left( r_\text{t monthly} \right)} }{T} =0.008=0.8\% \text{ per month}###He also found the standard deviation of these monthly returns which was 15% per month: ###\sigma_\text{monthly} = \dfrac{ \displaystyle\sum\limits_{t=1}^T{\left( \left( r_\text{t monthly} - \bar{r}_\text{monthly} \right)^2 \right)} }{T} =0.15=15\%\text{ per month}###Assume that the past historical average return is the true population average of future expected returns and the stock's returns calculated above ##(r_\text{t monthly})## are normally distributed. Which of the below statements about Fred’s BHP shares is NOT correct?
Question 780 mispriced asset, NPV, DDM, market efficiency, no explanation A company advertises an investment costing $1,000 which they say is under priced. They say that it has an expected total return of 15% pa, but a required return of only 10% pa. Of the 15% pa total expected return, the dividend yield is expected to be 4% pa and the capital yield 11% pa. Assume that the company's statements are correct. What is the NPV of buying the investment if the 15% total return lasts for the next 100 years (t=0 to 100), then reverts to 10% after that time? Also, what is the NPV of the investment if the 15% return lasts forever? In both cases, assume that the required return of 10% remains constant, the dividends can only be re-invested at 10% pa and all returns are given as effective annual rates. The answer choices below are given in the same order (15% for 100 years, and 15% forever):
Question 781 NPV, IRR, pay back period You're considering a business project which costs $11m now and is expected to pay a single cash flow of $11m in one year. So you pay $11m now, then one year later you receive $11m. Assume that the initial $11m cost is funded using the your firm's existing cash so no new equity or debt will be raised. The cost of capital is 10% pa. Which of the following statements about the net present value (NPV), internal rate of return (IRR) and payback period is NOT correct?
Question 782 portfolio return, portfolio weights An investor owns a portfolio with:
Today there was a:
No dividends were paid on either stock. What was the total historical portfolio return on this day? All returns above and answer options below are given as effective daily rates.
Question 783 open interest, trade volume, future Alice, Bob, Chris and Delta are traders in the futures market. The following trades occur over a single day in a newly-opened equity index future that matures in one year which the exchange just made available. 1. Alice buys 2 futures from Bob. 2. Chris buys 3 futures from Delta. 3. Delta buys 5 futures from Alice. Which of the following statements is NOT correct?
Information about three risk free Government bonds is given in the table below.
Based on the above government bonds' yields to maturity, which of the below statements about the spot zero rates and forward zero rates is NOT correct?
Question 785 fixed for floating interest rate swap, non-intermediated swap The below table summarises the borrowing costs confronting two companies A and B.
Firm A wishes to borrow at a floating rate and Firm B wishes to borrow at a fixed rate. Design a non-intermediated swap that benefits firm A only. What will be the swap rate?
Question 786 fixed for floating interest rate swap, intermediated swap The below table summarises the borrowing costs confronting two companies A and B.
Firm A wishes to borrow at a floating rate and Firm B wishes to borrow at a fixed rate. Design an intermediated swap (which means there will actually be two swaps) that nets a bank 0.1% and shares the remaining swap benefits between Firms A and B equally. Which of the following statements about the swap is NOT correct?
Question 787 fixed for floating interest rate swap, intermediated swap The below table summarises the borrowing costs confronting two companies A and B.
Firm A wishes to borrow at a floating rate and Firm B wishes to borrow at a fixed rate. Design an intermediated swap (which means there will actually be two swaps) that nets a bank 0.15% and grants the remaining swap benefits to Firm A only. Which of the following statements about the swap is NOT correct?
Question 788 rights issue, capital raising A firm wishes to raise $100 million now. The firm's current market value of equity is $300m and the market price per share is $5. They estimate that they'll be able to issue shares in a rights issue at a subscription price of $4. All answers are rounded to 6 decimal places. Ignore the time value of money and assume that all shareholders exercise their rights. Which of the following statements is NOT correct?
Question 789 rights issue, capital raising A firm wishes to raise $30 million now. The firm's current market value of equity is $60m and the market price per share is $20. They estimate that they'll be able to issue shares in a rights issue at a subscription price of $15. Ignore the time value of money and assume that all shareholders exercise their rights. Which of the following statements is NOT correct?
A bank buys 1000 European put options on a $10 non-dividend paying stock at a strike of $12. The bank wishes to hedge this exposure. The bank can trade the underlying stocks and European call options with a strike price of 7 on the same stock with the same maturity. Details of the call and put options are given in the table below. Each call and put option is on a single stock.
Which of the following statements is NOT correct?
The following quotes are most closely related to which financial concept?
Question 799 LVR, leverage, accounting ratio In the home loan market, the acronym LVR stands for Loan to Valuation Ratio. If you bought a house worth one million dollars, partly funded by an $800,000 home loan, then your LVR was 80%. The LVR is equivalent to which of the following ratios?
Question 804 CFFA, WACC, interest tax shield, DDM Use the below information to value a levered company with annual perpetual cash flows from assets that grow. The next cash flow will be generated in one year from now. Note that ‘k’ means kilo or 1,000. So the $30k is $30,000.
Which of the following statements is NOT correct?
Question 805 short selling Short selling is a way to make money from falling prices. In what order must the following steps be completed to short-sell an asset? Let Tom, Dick and Harry be traders in the share market.
Select the statement with the correct order of steps.
You work in Asia and just woke up. It looked like a nice day but then you read the news and found out that last night the American share market fell by 10% while you were asleep due to surprisingly poor macro-economic world news. You own a portfolio of liquid stocks listed in Asia with a beta of 1.6. When the Asian equity markets open, what do you expect to happen to your share portfolio? Assume that the capital asset pricing model (CAPM) is correct and that the market portfolio contains all shares in the world, of which American shares are a big part. Your portfolio beta is measured against this world market portfolio. When the Asian equity market opens for trade, you would expect your portfolio value to:
Question 808 Markowitz portfolio theory, portfolio return A graph of assets’ expected returns ##(\mu)## versus standard deviations ##(\sigma)## is given in the below diagram. Each letter corresponds to a separate coloured area. The portfolios at the boundary of the areas, on the black lines, are excluded from each area. Assume that all assets represented in this graph are fairly priced, and that all risky assets can be short-sold. Which of the following statements about this graph and Markowitz portfolio theory is NOT correct?
Question 812 rights issue A firm is about to conduct a 2-for-7 rights issue with a subscription price of $10 per share. They haven’t announced the capital raising to the market yet and the share price is currently $13 per share. Assume that every shareholder will exercise their rights, the cash raised will simply be put in the bank, and the rights issue is completed so quickly that the time value of money can be ignored. Disregard signalling, taxes and agency-related effects. Which of the following statements about the rights issue is NOT correct? After the rights issue is completed:
Question 813 market efficiency The famous investor Warren Buffett is one of few portfolio managers who appears to have consistently beaten the market. His company Berkshire Hathaway (BRK) appears to have outperformed the US S&P500 market index, shown in the graph below. Read the below statements about Warren Buffett and the implications for the Efficient Markets Hypothesis (EMH) theory of Eugene Fama. Assume that the first sentence is true. Analyse the second sentence and select the answer option which is NOT correct. In other words, find the false statement in the second sentence.
Question 814 expected and historical returns
Question 815 expected and historical returns
Question 816 expected and historical returns
Question 817 expected and historical returns, income and capital returns Over the last year, a constant-dividend-paying stock's price fell, while it's future expected dividends and profit remained the same. Assume that:
Which of the following statements is NOT correct? The stock's:
Question 820 option, future, no explanation What derivative position are you exposed to if you have the obligation to sell the underlying asset at maturity, so you will definitely be forced to sell the underlying asset?
You just paid $4 for a 3 month European style call option on a stock currently priced at $47 with a strike price of $50. The stock’s next dividend will be $1 in 4 months’ time. Note that the dividend is paid after the option matures. Which of the below statements is NOT correct?
Question 824 option, no explanation A put option written on a risky non-dividend paying stock will mature in one month. As is normal, assume that the option's exercise price is non-zero and positive ##(K>0)## and the stock has limited liability ##(S>0)##. Which of the following statements is NOT correct? The put option's:
An equity index fund manager controls a USD500 million diversified equity portfolio with a beta of 0.9. The equity manager expects a significant rally in equity prices next year. The market does not think that this will happen. If the fund manager wishes to increase his portfolio beta to 1.5, how many S&P500 futures should he buy? The US market equity index is the S&P500. One year CME futures on the S&P500 currently trade at 2,155 points and the spot price is 2,180 points. Each point is worth $250. The number of one year S&P500 futures contracts that the fund manager should buy is:
Question 826 future, basis risk, hedging On 1 February 2016 you were told that your refinery company will need to purchase oil on 1 July 2016. You were afraid of the oil price rising between now and then so you bought some August 2016 futures contracts on 1 February 2016 to hedge against changes in the oil price. On 1 February 2016 the oil price was $40 and the August 2016 futures price was $43. It's now 1 July 2016 and oil price is $45 and the August 2016 futures price is $46. You bought the spot oil and closed out your futures position on 1 July 2016. What was the effective price paid for the oil, taking into account basis risk? All spot and futures oil prices quoted above and below are per barrel.
Question 827 future, basis risk, no explanation You intend to use futures on oil to hedge the risk of purchasing oil. There is no cross-hedging risk. Oil pays no dividends but it’s costly to store. Which of the following statements about basis risk in this scenario is NOT correct?
Question 828 future, future valuation, no explanation You bought a 1.5 year (18 month) futures contract on oil. Oil storage costs are 4% pa continuously compounded and oil pays no dividends. The futures contract is entered into when the oil price is $40 per barrel and the risk-free rate of interest is 10% per annum with continuous compounding. Which of the following statements is NOT correct?
Question 829 option, future, delta, gamma, theta, no explanation Below are some statements about futures and European-style options on non-dividend paying stocks. Assume that the risk free rate is always positive. Which of these statements is NOT correct? All other things remaining equal:
Question 830 option, delta, gamma, no explanation Below are some statements about European-style options on non-dividend paying stocks. Assume that the risk free rate is always positive. Which of these statements is NOT correct?
Question 832 option, Black-Scholes-Merton option pricing A 12 month European-style call option with a strike price of $11 is written on a dividend paying stock currently trading at $10. The dividend is paid annually and the next dividend is expected to be $0.40, paid in 9 months. The risk-free interest rate is 5% pa continuously compounded and the standard deviation of the stock’s continuously compounded returns is 30 percentage points pa. The stock's continuously compounded returns are normally distributed. Using the Black-Scholes-Merton option valuation model, determine which of the following statements is NOT correct.
Which of the following statements about an option (either a call or put) and its underlying stock is NOT correct?
Question 838 option, put call parity A stock, a call, a put and a bond are available to trade. The call and put options' underlying asset is the stock they and have the same strike prices, ##K_T##. Being long the call and short the stock is equivalent to being:
Question 839 option, put call parity A stock, a call, a put and a bond are available to trade. The call and put options' underlying asset is the stock they and have the same strike prices, ##K_T##. You are currently long the stock. You want to hedge your long stock position without actually trading the stock. How would you do this?
Question 840 gross domestic product Calculate Australia’s GDP over the 2016 calendar year using the below table:
Source: ABS 5206.0 Australian National Accounts: National Income, Expenditure and Product. Table 3. Expenditure on Gross Domestic Product (GDP), Current prices. Over the 2016 calendar year, Australia’s GDP was:
Question 841 gross domestic product, government spending The government spends money on:
When calculating GDP, the ‘government spending’ component is supposed to include:
An Australian-owned company produces milk in New Zealand and exports all of it to China. If the price of the milk increases, which of the following would increase?
Question 849 credit card, APR, no explanation You just spent $1,000 on your credit card. The interest rate is 24% pa compounding monthly. Assume that your credit card account has no fees and no minimum monthly repayment. If you can't make any interest or principal payments on your credit card debt over the next year, how much will you owe one year from now?
Question 850 gross domestic product, gross domestic product per capita Below is a table showing some countries’ GDP, population and GDP per capita.
Source: "GDP and its breakdown at current prices in US Dollars" United Nations Statistics Division. December 2016. Using this data only, which one of these countries’ citizens have the highest living standards?
Question 851 labour force, no explanation Below is a table showing some figures about the Australian labour force.
Source: ABS 6202.0 Labour Force, Australia, Apr 2017 What do you estimate is the size of working age population in thousands (‘000)?
Question 854 speculation motive for keeping money, no explanation What is the speculation motive for keeping money? The speculation motive encourages people to keep money available:
Question 856 credit terms, no explanation Your supplier’s credit terms are "1/10 net 30". Which of the following statements about these credit terms is NOT correct? If you intend to buy an item from your supplier for a tag price of $100 and you:
Question 857 DuPont formula, accounting ratio The DuPont formula is: ###\dfrac{\text{Net Profit}}{\text{Sales}} \times \dfrac{\text{Sales}}{\text{Total Assets}} \times \dfrac{\text{Total Assets}}{\text{Owners' Equity}}### Which of the following statements about the DuPont formula is NOT correct?
Question 858 indirect security, intermediated finance, no explanation Which of the following transactions involves an ‘indirect security’ using a ‘financial intermediary’?
Question 859 money supply, no explanation The below table shows Australian monetary aggregates. Note that ‘M3’ is the sum of all the figures in the table and ‘ADI’ stands for Authorised Deposit-taking Institution such as a bank, building society or credit union.
Source: RBA Statistical Table D3 Monetary Aggregates. Which of the following statements is NOT correct?
Question 861 open interest, closing out future contract, no explanation Alice, Bob, Chris and Delta are traders in the futures market. The following trades occur over a single day in a newly-opened equity index future that matures in one year which the exchange just made available. 1. Alice buys 2 future from Bob. 2. Chris buys 5 futures from Delta. 3. Chris buys 9 futures from Bob. These were the only trades made in this equity index future. Which of the following statements is NOT correct?
Question 863 option, binomial option pricing A one year European-style call option has a strike price of $4. The option's underlying stock pays no dividends and currently trades at $5. The risk-free interest rate is 10% pa continuously compounded. Use a single step binomial tree to calculate the option price, assuming that the price could rise to $8 ##(u = 1.6)## or fall to $3.125 ##(d = 1/1.6)## in one year. The call option price now is:
Question 864 option, binomial option pricing A one year European-style put option has a strike price of $4. The option's underlying stock pays no dividends and currently trades at $5. The risk-free interest rate is 10% pa continuously compounded. Use a single step binomial tree to calculate the option price, assuming that the price could rise to $8 ##(u = 1.6)## or fall to $3.125 ##(d = 1/1.6)## in one year. The put option price now is:
Question 865 option, Black-Scholes-Merton option pricing A one year European-style call option has a strike price of $4. The option's underlying stock currently trades at $5, pays no dividends and its standard deviation of continuously compounded returns is 47% pa. The risk-free interest rate is 10% pa continuously compounded. Use the Black-Scholes-Merton formula to calculate the option price. The call option price now is:
Question 866 option, Black-Scholes-Merton option pricing A one year European-style put option has a strike price of $4. The option's underlying stock currently trades at $5, pays no dividends and its standard deviation of continuously compounded returns is 47% pa. The risk-free interest rate is 10% pa continuously compounded. Use the Black-Scholes-Merton formula to calculate the option price. The put option price now is:
What is the Cash Conversion Cycle for a firm with a:
All answer options are in days:
Question 869 economic order quantity A Queensland farmer grows strawberries in greenhouses and supplies Australian supermarkets all year round. The farmer must decide how often he should contract the truck driver to deliver his strawberries and how many boxes to send on each delivery. The farmer:
Which of the following statements about the Economic Order Quantity is NOT correct?
Question 870 income and capital returns An Apple (NASDAQ:AAPL) stock was purchased by an investor for $120 and one year later was sold for $150. A dividend of $4 was also collected at the end of the year just before the stock was sold. Which of the following statements about the stock investment is NOT correct? Ignore taxes. Over the year, the investor made a: .
The Capital Asset Pricing Model (CAPM) and the Single Index Model (SIM) are single factor models whose only risk factor is the market portfolio’s return. Say a Solar electricity generator company and a Beach bathing chair renting company are influenced by two factors, the market portfolio return and cloud cover in the sky. When it's sunny and not cloudy, both the Solar and Beach companies’ stock prices do well. When there’s dense cloud cover and no sun, both do poorly. Assume that cloud coverage risk is a systematic risk that cannot be diversified and that cloud cover has zero correlation with the market portfolio’s returns. Which of the following statements about these two stocks is NOT correct? The CAPM and SIM:
Question 877 arithmetic and geometric averages, utility, utility function Gross discrete returns in different states of the world are presented in the table below. A gross discrete return is defined as ##P_1/P_0##, where ##P_0## is the price now and ##P_1## is the expected price in the future. An investor can purchase only a single asset, A, B, C or D. Assume that a portfolio of assets is not possible.
Which of the following statements about the different assets is NOT correct? Asset:
Question 878 foreign exchange rate, American and European terms
Question 879 margin loan, Basel accord The risk-weight on "Margin lending against listed instruments on recognised exchanges" is 20% according to APRA's interpretation of the Basel 3 Accord in 'Prudential Standard APS 112 Capital Adequacy: Standardised Approach to Credit Risk, Attachment A: Risk-weights for on-balance sheet assets'. A bank is considering lending a $100,000 margin loan secured by an ASX-listed stock. How much regulatory capital will the bank require to grant this loan under the Basel 3 Accord? Ignore the capital conservation buffer and the off-balance sheet exposure.
Question 883 monetary policy, impossible trinity, foreign exchange rate It’s often thought that the ideal currency or exchange rate regime would: 1. Be fixed against the USD; 2. Be convertible to and from USD for traders and investors so there are open goods, services and capital markets, and; 3. Allow independent monetary policy set by the country’s central bank, independent of the US central bank. So the country can set its own interest rate independent of the US Federal Reserve’s USD interest rate. However, not all of these characteristics can be achieved. One must be sacrificed. This is the 'impossible trinity'. Which of the following exchange rate regimes sacrifices convertibility?
According to the impossible trinity, a currency can only have two of these three desirable traits: be fixed against the USD; convertible to and from USD for traders and investors so there are open goods, services and capital markets; and allow independent monetary policy set by the country’s central bank, independent of the US central bank. Which of the following exchange rate regimes sacrifices fixing the exchange rate to the USD? In other words, which regime uses a floating exchange rate?
Question 885 foreign exchange rate, no explanation A Brazilian lady wishes to convert 1 million Brazilian Real (BRL) into Chinese Renminbi (RMB, also called the Yuan or CNY). The exchange rate is 3.42 BRL per USD and 6.27 RMB per USD. How much is the BRL 1 million worth in RMB?
Question 886 foreign exchange rate, no explanation A British man wants to calculate how many British pounds (GBP) he needs to buy a 1 million euro (EUR) apartment in Germany. The exchange rate is 1.42 USD per GBP and 1.23 USD per EUR. What is the EUR 1 million equivalent to in GBP?
Question 887 foreign exchange rate, no explanation Examine the graph of the AUD versus the USD, EUR and JPY. Note that RHS means right hand side and LHS left hand side which indicates which axis each line corresponds to. Assume inflation rates in each country were equal over the time period 1984 to 2018. Which of the following statements is NOT correct?
Question 889 cross currency interest rate parity, no explanation Judging by the graph, in 2018 the USD short term interest rate set by the US Federal Reserve is higher than the JPY short term interest rate set by the Bank of Japan, which is higher than the EUR short term interest rate set by the European central bank. At the latest date shown in 2018: ##r_{USD}>r_{JPY}>r_{EUR}## Assume that each currency’s yield curve is flat at the latest date shown in 2018, so interest rates are expected to remain at their current level into the future. Which of the following statements is NOT correct? Over time you would expect the:
Question 890 foreign exchange rate, monetary policy, no explanation The market expects the Reserve Bank of Australia (RBA) to increase the policy rate by 25 basis points at their next meeting. The current exchange rate is 0.8 USD per AUD. Then unexpectedly, the RBA announce that they will increase the policy rate by 50 basis points due to increased fears of inflation. What do you expect to happen to Australia's exchange rate on the day when the surprise announcement is made? The Australian dollar is likely to suddenly:
Question 891 foreign exchange rate, monetary policy, no explanation Suppose the market expects the Bank of Japan (BoJ) to decrease their short term interest rate by 15 basis points at their next meeting. The current short term interest rate is -0.1% pa and the exchange rate is 100 JPY per USD. Then unexpectedly, the BoJ announce that they will leave the short term interest rate unchanged. What do you expect to happen to Japan’s exchange rate on the day when the surprise announcement is made? The Japanese Yen (JPY) is likely to suddenly:
The Chinese central bank has the largest amount of foreign currency reserves. What could the large amounts of foreign exchange reserves held by the Chinese government be used for in a currency crisis? China's currency is called the Renminbi (RMB) or Yuan (CNY). In a Chinese currency crisis the Chinese government is likely to use its FX reserves to:
Question 893 balance of payments, current account This question is about the Balance of Payments. Australia's current account as a percent of nominal gross domestic product (GDP) per annum is shown in the graph below. Assume that all foreign and domestic assets are either debt which makes interest income or equity which makes dividend income, and vice versa for liabilities which cost interest and dividend payments, respectively. Which of the following statements is NOT correct?
Question 895 comparative advantage in trade, production possibilities curve Adam and Bella are the only people on a remote island. Luckily there are Coconut and Date palm trees on the island that grow delicious fruit. The problem is that harvesting the fruit takes a lot of work. Adam can pick 7 coconuts per hour, 6 dates per hour or any linear combination of coconuts and dates. For example, he could pick 3.5 coconuts and 3 dates per hour. Bella can pick 3 coconuts per hour, 5 dates per hour or any linear combination. For example, she could pick 1.5 coconuts and 2.5 dates per hour. This information is summarised in the table and graph:
Which of the following statements is NOT correct?
Question 900 Basel accord Which of the following statements about the Basel 3 minimum capital requirements is NOT correct? Common equity tier 1 (CET1) comprises the highest quality components of capital that fully satisfy all of the following characteristics:
Question 901 Basel accord The below graph from the RBA shows the phase-in of the Basel 3 minimum regulatory capital requirements under the Basel Committee on Banking Supervision (BCBS) on the left panel and in Australia under the Australian Prudential Regulatory Authority (APRA) on the right panel. Which of the following statements about the Basel 3 minimum regulatory capital requirements as at 2019 is NOT correct? All minimum amounts exclude the 2.5% counter-cyclical buffer. The Basel 3 minimum regulatory capital requirement as a percent of Risk Weighted Assets (RWA) is:
Question 902 Basel accord Below is a table of the 'Risk-weights for residential mortgages' as shown in APRA Basel 3 Prudential Standard APS 112 Capital Adequacy: Standardised Approach to Credit Risk January 2013.
A bank is considering granting a home loan to a man to buy a house worth $1.25 million using his own funds and the loan. The loan would be standard with no lenders mortgage insurance (LMI) and an LVR of 80%. What is the minimum regulatory capital that the bank requires to grant the home loan under the Basel 3 Accord? Ignore the capital conservation buffer.
A six month European-style call option on the S&P500 stock index has a strike price of 2800 points. The underlying S&P500 stock index currently trades at 2700 points, has a continuously compounded dividend yield of 2% pa and a standard deviation of continuously compounded returns of 25% pa. The risk-free interest rate is 5% pa continuously compounded. Use the Black-Scholes-Merton formula to calculate the option price. The call option price now is:
A six month European-style call option on six month S&P500 index futures has a strike price of 2800 points. The six month futures price on the S&P500 index is currently at 2740.805274 points. The futures underlie the call option. The S&P500 stock index currently trades at 2700 points. The stock index underlies the futures. The stock index's standard deviation of continuously compounded returns is 25% pa. The risk-free interest rate is 5% pa continuously compounded. Use the Black-Scholes-Merton formula to calculate the option price. The call option price now is:
For an asset's price to double from say $1 to $2 in one year, what must its effective annual return be? Note that an effective annual return is also called a net discrete return per annum. If the price now is ##P_0## and the price in one year is ##P_1## then the effective annul return over the next year is: ###r_\text{effective annual} = \dfrac{P_1 - P_0}{P_0} = \text{NDR}_\text{annual}###
Question 913 bill pricing, money market A 90 day bank bill has a face value of $100,000. Investor A bought the bill when it was first issued at a simple yield to maturity of 3% pa and sold it 20 days later to Investor B who expected to earn a simple yield to maturity of 5% pa. Investor B held it until maturity. Which of the following statements is NOT correct?
Question 914 bill pricing, money market, return types A bank bill was bought for $99,000 and sold for $100,000 thirty (30) days later. There are 365 days in the year. Which of the following formulas gives the simple interest rate per annum over those 30 days? Note: To help you identify which is the correct answer without doing any calculations yourself, the formulas used to calculate the numbers are given.
Question 916 future, future valuation A stock is expected to pay its semi-annual dividend of $1 per share for the foreseeable future. The current stock price is $40 and the continuously compounded risk free rate is 3% pa for all maturities. An investor has just taken a long position in a 12-month futures contract on the stock. The last dividend payment was exactly 4 months ago. Therefore the next $1 dividend is in 2 months, and the $1 dividend after is 8 months from now. Which of the following statements about this scenario is NOT correct?
Stutzer’s Portfolio Performance Indicator (PPI) ranks portfolios similarly to what other performance metric, assuming that the portfolios’ continuously compounded returns (LGDR’s) are normally distributed?
Capital Asset Pricing Model (CAPM) and the Single Index Model (SIM) are single factor models whose only risk factor is the market portfolio’s return. Say a Taxi company and an Umbrella company are influenced by two factors, the market portfolio return and rainfall. When it rains, both the Taxi and Umbrella companies’ stock prices do well. When there’s no rain, both do poorly. Assume that rainfall risk is a systematic risk that cannot be diversified and that rainfall has zero correlation with the market portfolio’s returns. Which of the following statements about these two stocks is NOT correct? The CAPM and SIM:
The arithmetic average and standard deviation of returns on the ASX200 accumulation index over the 24 years from 31 Dec 1992 to 31 Dec 2016 were calculated as follows: ###\bar{r}_\text{yearly} = \dfrac{ \displaystyle\sum\limits_{t=1992}^{24}{\left( \ln \left( \dfrac{P_{t+1}}{P_t} \right) \right)} }{T} = \text{AALGDR} =0.0949=9.49\% \text{ pa}### ###\sigma_\text{yearly} = \dfrac{ \displaystyle\sum\limits_{t=1992}^{24}{\left( \left( \ln \left( \dfrac{P_{t+1}}{P_t} \right) - \bar{r}_\text{yearly} \right)^2 \right)} }{T} = \text{SDLGDR} = 0.1692=16.92\text{ pp pa}### Assume that the log gross discrete returns are normally distributed and that the above estimates are true population statistics, not sample statistics, so there is no standard error in the sample mean or standard deviation estimates. Also assume that the standardised normal Z-statistic corresponding to a one-tail probability of 2.5% is exactly -1.96. Which of the following statements is NOT correct? If you invested $1m today in the ASX200, then over the next 4 years:
The arithmetic average continuously compounded or log gross discrete return (AALGDR) on the ASX200 accumulation index over the 24 years from 31 Dec 1992 to 31 Dec 2016 is 9.49% pa. The arithmetic standard deviation (SDLGDR) is 16.92 percentage points pa. Assume that the log gross discrete returns are normally distributed and that the above estimates are true population statistics, not sample statistics, so there is no standard error in the sample mean or standard deviation estimates. Also assume that the standardised normal Z-statistic corresponding to a one-tail probability of 2.5% is exactly -1.96. If you had a $1 million fund that replicated the ASX200 accumulation index, in how many years would the median dollar value of your fund first be expected to lie outside the 95% confidence interval forecast?
The arithmetic average continuously compounded or log gross discrete return (AALGDR) on the ASX200 accumulation index over the 24 years from 31 Dec 1992 to 31 Dec 2016 is 9.49% pa. The arithmetic standard deviation (SDLGDR) is 16.92 percentage points pa. Assume that the log gross discrete returns are normally distributed and that the above estimates are true population statistics, not sample statistics, so there is no standard error in the sample mean or standard deviation estimates. Also assume that the standardised normal Z-statistic corresponding to a one-tail probability of 2.5% is exactly -1.96. If you had a $1 million fund that replicated the ASX200 accumulation index, in how many years would the mean dollar value of your fund first be expected to lie outside the 95% confidence interval forecast?
The arithmetic average continuously compounded or log gross discrete return (AALGDR) on the ASX200 accumulation index over the 24 years from 31 Dec 1992 to 31 Dec 2016 is 9.49% pa. The arithmetic standard deviation (SDLGDR) is 16.92 percentage points pa. Assume that the log gross discrete returns are normally distributed and that the above estimates are true population statistics, not sample statistics, so there is no standard error in the sample mean or standard deviation estimates. Also assume that the standardised normal Z-statistic corresponding to a one-tail probability of 2.5% is exactly -1.96. If you had a $1 million fund that replicated the ASX200 accumulation index, in how many years would the mode dollar value of your fund first be expected to lie outside the 95% confidence interval forecast? Note that the mode of a log-normally distributed future price is: ##P_{T \text{ mode}} = P_0.e^{(\text{AALGDR} - \text{SDLGDR}^2 ).T} ##
The arithmetic average continuously compounded or log gross discrete return (AALGDR) on the ASX200 accumulation index over the 24 years from 31 Dec 1992 to 31 Dec 2016 is 9.49% pa. The arithmetic standard deviation (SDLGDR) is 16.92 percentage points pa. Assume that the data are sample statistics, not population statistics. Assume that the log gross discrete returns are normally distributed. What is the standard error of your estimate of the sample ASX200 accumulation index arithmetic average log gross discrete return (AALGDR) over the 24 years from 1992 to 2016?
Question 930 arbitrage table, future, no explanation A non-dividend paying stock has a current price of $20. The risk free rate is 5% pa given as a continuously compounded rate. A 2 year futures contract on the stock has a futures price of $24. You suspect that the futures contract is mis-priced and would like to conduct a risk-free arbitrage that requires zero capital. Which of the following steps about arbitraging the situation is NOT correct?
Question 931 confidence interval, normal distribution A stock's returns are normally distributed with a mean of 10% pa and a standard deviation of 20 percentage points pa. What is the 90% confidence interval of returns over the next year? Note that the Z-statistic corresponding to a one-tail:
The 90% confidence interval of annual returns is between:
Question 932 confidence interval, normal distribution A stock's returns are normally distributed with a mean of 10% pa and a standard deviation of 20 percentage points pa. What is the 95% confidence interval of returns over the next year? Note that the Z-statistic corresponding to a one-tail:
The 95% confidence interval of annual returns is between:
Question 933 confidence interval, normal distribution A stock has an expected return of 10% pa and you're 90% sure that over the next year, the return will be between -15% and 35%. The stock's returns are normally distributed. Note that the Z-statistic corresponding to a one-tail:
What is the stock’s standard deviation of returns in percentage points per annum (pp pa)?
Question 934 standard deviation, risk Which of the following statements about an asset’s standard deviation of returns is NOT correct? All other things remaining equal, the higher the asset’s standard deviation of returns:
You're thinking of buying an investment property that costs $1,000,000. The property's rent revenue over the next year is expected to be $50,000 pa and rent expenses are $20,000 pa, so net rent cash flow is $30,000. Assume that net rent is paid annually in arrears, so this next expected net rent cash flow of $30,000 is paid one year from now. The year after, net rent is expected to fall by 2% pa. So net rent at year 2 is expected to be $29,400 (=30,000*(1-0.02)^1). The year after that, net rent is expected to rise by 1% pa. So net rent at year 3 is expected to be $29,694 (=30,000*(1-0.02)^1*(1+0.01)^1). From year 3 onwards, net rent is expected to rise at 2.5% pa forever. So net rent at year 4 is expected to be $30,436.35 (=30,000*(1-0.02)^1*(1+0.01)^1*(1+0.025)^1). Assume that the total required return on your investment property is 6% pa. Ignore taxes. All returns are given as effective annual rates. What is the net present value (NPV) of buying the investment property?
Question 936 CAPM, WACC, IRR You work for XYZ company and you’ve been asked to evaluate a new project which has double the systematic risk of the company’s other projects. You use the Capital Asset Pricing Model (CAPM) formula and input the treasury yield ##(r_f )##, market risk premium ##(r_m-r_f )## and the company’s asset beta risk factor ##(\beta_{XYZ} )## into the CAPM formula which outputs a return. This return that you’ve just found is:
The market's expected total return is 10% pa and the risk free rate is 5% pa, both given as effective annual rates. A stock has a beta of 0.7. What do you think will be the stock's expected return over the next year, given as an effective annual rate?
The market's expected total return is 10% pa and the risk free rate is 5% pa, both given as effective annual rates. A stock has a beta of 0.7. In the last 5 minutes, bad economic news was released showing a higher chance of recession. Over this time the share market fell by 2%. The risk free rate was unchanged. What do you think was the stock's historical return over the last 5 minutes, given as an effective 5 minute rate?
Question 939 CAPM, systematic and idiosyncratic risk A common phrase heard in financial markets is that ‘high risk investments deserve high returns’. To make this statement consistent with the Capital Asset Pricing Model (CAPM), a high amount of what specific type of risk deserves a high return? Investors deserve high returns when they buy assets with high:
A stock has a beta of 1.2. Its next dividend is expected to be $20, paid one year from now. Dividends are expected to be paid annually and grow by 1.5% pa forever. Treasury bonds yield 3% pa and the market portfolio's expected return is 7% pa. All returns are effective annual rates. What is the price of the stock now?
Last year, two friends Lev and Nolev each bought similar investment properties for $1 million. Both earned net rents of $30,000 pa over the past year. They funded their purchases in different ways:
Both Lev and Nolev also work in high-paying jobs and are subject personal marginal tax rates of 45%. Which of the below statements about the past year is NOT correct?
Question 944 stock split, bonus issue, stock dividend
Question 945 stock split, bonus issue, stock dividend
Question 946 stock split, bonus issue, stock dividend
Question 947 arbitrage table, option, no explanation A non-dividend paying stock has a current price of $20. The risk free rate is 5% pa given as a continuously compounded rate. Options on the stock are currently priced at $5 for calls and $5.55 for puts where both options have a 2 year maturity and an exercise price of $24. You suspect that the call option contract is mis-priced and would like to conduct a risk-free arbitrage that requires zero capital. Which of the following steps about arbitraging the situation is NOT correct?
Question 948 VaR, expected shortfall Below is a historical sample of returns on the S&P500 capital index.
Assume that the one-tail Z-statistic corresponding to a probability of 99.9% is exactly 3.09. Which of the following statements is NOT correct? Based on the historical data, the 99.9% daily:
Question 949 future, contango
Question 950 future, backwardation
Question 951 option, in the money option
Question 952 option, in the money option
Question 953 option, out of the money option
Question 954 option, at the money option
Question 955 option, out of the money option
A bank sells a European call option on a non-dividend paying stock and delta hedges on a daily basis. Below is the result of their hedging, with columns representing consecutive days. Assume that there are 365 days per year and interest is paid daily in arrears.
In the last column when there are 55 days left to maturity there are missing values. Which of the following statements about those missing values is NOT correct?
Question 957 Annuity, NPV The present value of an annuity of 3 annual payments of $5,000 in arrears (at the end of each year) is $12,434.26 when interest rates are 10% pa compounding annually. If the same amount of $12,434.26 is put in the bank at the same interest rate of 10% pa compounded annually and the same cash flow of $5,000 is withdrawn at the end of every year, how much money will be in the bank in 3 years, just after that third $5,000 payment is withdrawn?
Question 958 confidence interval, normal distribution A stock's returns are normally distributed with a mean of 8% pa and a standard deviation of 15 percentage points pa. What is the 99% confidence interval of returns over the next year? Note that the Z-statistic corresponding to a one-tail:
The 99% confidence interval of annual returns is between:
Last year, two friends Gear and Nogear invested in residential apartments. Each invested $1 million of their own money (their net wealth). Apartments cost $1,000,000 last year and they earned net rents of $30,000 pa over the last year. Net rents are calculated as rent revenues less the costs of renting such as property maintenance, land tax and council rates. However, interest expense and personal income taxes are not deducted from net rents. Gear and Nogear funded their purchases in different ways:
Both Gear and Nogear also work in high-paying jobs and are subject personal marginal tax rates of 45%. Which of the below statements about the past year is NOT correct?
Question 960 DDM, stock pricing You are an equities analyst trying to value the equity of the Australian supermarket conglomerate Woolworths, with ticker WOW. In Australia, listed companies like Woolworths tend to pay dividends every 6 months. The payment around September is the final dividend and the payment around March is called the interim dividend. Both occur annually.
What should be the current share price of WOW?
Question 962 foreign exchange rate, real estate
Which city has the most expensive apartment, measured in United States Dollars (USD)? Pay attention to the FX quotes.
Question 964 monetary policy, impossible trinity, foreign exchange rate It’s often thought that the ideal currency or exchange rate regime would: 1. Be fixed against the USD; 2. Be convertible to and from USD for traders and investors so there are open goods, services and capital markets, and; 3. Allow independent monetary policy set by the country’s central bank, independent of the US central bank. So the country can set its own interest rate independent of the US Federal Reserve’s USD interest rate. However, not all of these characteristics can be achieved. One must be sacrificed. This is the 'impossible trinity'. Which of the following exchange rate regimes sacrifices independent monetary policy?
Observe the below graph of Chinese foreign exchange reserves held by the central bank, as well as the Chinese currency the Yuan (CNY, also called the Renminbi, RMB) against the US Dollar. Note the inverted y-axis scale on the Yuan exchange rate graph. Which of the below statements is NOT correct?
Question 966 foreign exchange rate, no explanation A Malaysian man wishes to convert 1 million Malaysian Ringgit (MYR) into Indian Rupees (IND). The exchange rate is 4.2 MYR per USD and 71 IND per USD. How much is the MYR 1 million worth in IND?
Question 967 foreign exchange rate, no explanation A New Zealand lady wants to calculate how many New Zealand Dollars (NZD) she needs to buy a 1 million Australian dollar (AUD) house in Sydney, Australia. The exchange rate is 0.69 USD per NZD and 0.72 USD per AUD. What is the AUD 1 million equivalent to in NZD?
Question 969 foreign exchange rate, no explanation RBA analyst Adam Hamilton wrote in the December 2018 Bulletin article ‘Understanding Exchange Rates and Why They Are Important’ the following passage about bilateral exchange rates: A bilateral exchange rate refers to the value of one currency relative to another. It is the most commonly referenced type of exchange rate. Most bilateral exchange rates are quoted against the US dollar (USD), as it is the most traded currency globally. Looking at the Australian dollar (AUD), the AUD/USD exchange rate gives you the amount of US dollars that you will receive for each Australian dollar that you convert (or sell). For example, an AUD/USD exchange rate of 0.75 means that you will get US75 cents for every 1 AUD. An appreciation of the Australian dollar is an increase in its value compared with a foreign currency. This means that each Australian dollar buys you more foreign currency than before. Equivalently, if you are buying an item that is priced in foreign currency it will now cost you less in Australian dollars than before. If there is a depreciation of the Australian dollar, the opposite is true. Based on this information, which of the following statements is NOT correct?
Question 971 foreign exchange rate, no explanation Suppose the current Australian exchange rate is 0.8 USD per AUD. If you think that the AUD will appreciate against the USD, contrary to the rest of the market, how could you profit? Right now you should:
Question 972 foreign exchange rate, no explanation Examine the below graphs. The first graph shows daily FX turnover in the world by both the public (government) and private sectors. The second graph 'Official Reserve Assets' shows the FX reserves of the Australian central bank, the RBA. The third graph's top panel shows the FX reserves of the Chinese central bank, the PBoC. Assume that the AUD and USD are priced at parity so 1 AUD = 1 USD. Which of the following statements is NOT correct?
Question 973 foreign exchange rate, monetary policy, no explanation Suppose the market expects the Reserve Bank of Australia (RBA) to increase the policy rate by 25 basis points at their next meeting. The current exchange rate is 0.8 USD per AUD. Then unexpectedly, the RBA announce that they will leave the policy rate unchanged due to increasing unemployment and fears of a potential recession. What do you expect to happen to Australia's exchange rate on the day when the surprise announcement is made? The Australian dollar is likely to:
Question 974 foreign exchange rate, monetary policy, no explanation Suppose the market expects the Bank of Japan (BoJ) to increase their short term interest rate by 15 basis points at their next meeting. The current short term interest rate is -0.1% pa and the exchange rate is 100 JPY per USD. As expected, the BoJ announce that they will increase short term interest rate by 15 basis points. What do you expect to happen to Japan’s exchange rate on the day when the announcement is made? The Japanese Yen (JPY) is likely to:
Arthur and Bindi are the only people on a remote island. Luckily there are Coconut and Date palm trees on the island that grow delicious fruit. The problem is that harvesting the fruit takes a lot of work. Arthur can pick 1 coconut per hour, 4 dates per hour or any linear combination of coconuts and dates. For example, he could pick 0.5 coconuts and 2 dates per hour. Bindi can pick 2 coconuts per hour, 1 date per hour or any linear combination. For example, she could pick 0.5 coconuts and 0.75 dates per hour. This information is summarised in the table and graph:
Which of the following statements is NOT correct?
Question 979 balance of payments, current account, no explanation This question is about the Balance of Payments. Assume that all foreign and domestic assets are either debt which makes interest income or equity which makes dividend income, and vice versa for liabilities which cost interest and dividend payments, respectively. Which of the following statements is NOT correct?
Question 980 balance of payments, current account, no explanation Observe the below graph of the US current account surplus as a proportion of GDP. Define lending as buying (or saving or investing in) debt and equity assets. The sum of US ‘net private saving’ plus ‘net general government lending’ equals the US:
Question 981 margin loan, Basel accord, credit conversion factor Margin loans secured by listed stock have a Basel III risk weight of 20%. For margin loans that cannot be immediately cancelled by banks and asked to be repaid, the credit conversion factor (CCF) is 20%. Suppose you have a stock portfolio worth $500,000, financed by:
How much regulatory capital must the bank hold due to your margin loan? Assume that the bank wishes to pay dividends to its shareholders, so include the 2.5% capital conservation buffer in your calculations.
Question 982 corporate financial decision theory, Lintner In his survey paper from 1956, John Lintner stated: “A prudent foresighted management will always do its best to plan ahead in all aspects of financial policy to avoid getting into such uncomfortable situations where dividends have to be cut substantially below those which the company's previous practice would lead stockholders to expect on the basis of current earnings.” This is a statement about which decision made by financial managers?
A company manager is thinking about the firm's book assets-to-equity ratio, also called the 'equity multiplier' in the DuPont formula: ###\text{Equity multiplier} = \dfrac{\text{Total Assets}}{\text{Owners' Equity}}###What's the name of the decision that the manager is thinking about? In other words, the assets-to-equity ratio is the main subject of what decision? Note: DuPont formula for analysing book return on equity: ###\begin{aligned} \text{ROE} &= \dfrac{\text{Net Profit}}{\text{Sales}} \times \dfrac{\text{Sales}}{\text{Total Assets}} \times \dfrac{\text{Total Assets}}{\text{Owners' Equity}} \\ &= \text{Net profit margin} \times \text{Total asset turnover} \times \text{Equity multiplier} \\ \end{aligned}###
When does the ‘principal-agent problem’ occur? Is it when: I. The principal has conflicting incentives (moral hazard); II. The agent has conflicting incentives (moral hazard); III. The principal has incomplete information about the agent (asymmetric information); or IV. The agent has incomplete information about the principal (asymmetric information)? The principal-agent problem occurs when statements:
Question 988 variance, covariance, beta, CAPM, risk, no explanation
Which of the following statements about the above table which is used to calculate Apple's equity beta is NOT correct?
Question 989 PE ratio, Multiples valuation, leverage, accounting ratio A firm has 20 million stocks, earnings (or net income) of $100 million per annum and a 60% debt-to-equity ratio where both the debt and asset values are market values rather than book values. Similar firms have a PE ratio of 12. Which of the below statements is NOT correct based on a PE multiples valuation?
Question 990 Multiples valuation, EV to EBITDA ratio, enterprise value A firm has: 2 million shares; $200 million EBITDA expected over the next year; $100 million in cash (not included in EV); 1/3 market debt-to-assets ratio is (market assets = EV + cash); 4% pa expected dividend yield over the next year, paid annually with the next dividend expected in one year; 2% pa expected dividend growth rate; 40% expected payout ratio over the next year;10 times EV/EBITDA ratio. 30% corporate tax rate. The stock can be valued using the EV/EBITDA multiple, dividend discount model, Gordon growth model or PE multiple. Which of the below statements is NOT correct based on an EV/EBITDA multiple valuation?
The required return of a building project is 10%, given as an effective annual rate. Assume that the cash flows shown in the table are paid all at once at the given point in time. The building firm is just about to start the project and the client has signed the contract. Initially the firm will pay $100 to the sub-contractors to carry out the work and then will receive an $11 payment from the client in one year and $121 when the project is finished in 2 years. Ignore credit risk. But the building company is considering selling the project to a competitor at different points in time and is pondering the minimum price that they should sell it for.
Which of the below statements is NOT correct? The project is worth:
Question 992 inflation, real and nominal returns and cash flows You currently have $100 in the bank which pays a 10% pa interest rate. Oranges currently cost $1 each at the shop and inflation is 5% pa which is the expected growth rate in the orange price. This information is summarised in the table below, with some parts missing that correspond to the answer options. All rates are given as effective annual rates. Note that when payments are not specified as real, as in this question, they're conventionally assumed to be nominal.
Which of the following statements is NOT correct? Your:
Question 993 inflation, real and nominal returns and cash flows In February 2020, the RBA cash rate was 0.75% pa and the Australian CPI inflation rate was 1.8% pa. You currently have $100 in the bank which pays a 0.75% pa interest rate. Apples currently cost $1 each at the shop and inflation is 1.8% pa which is the expected growth rate in the apple price. This information is summarised in the table below, with some parts missing that correspond to the answer options. All rates are given as effective annual rates. Note that when payments are not specified as real, as in this question, they're conventionally assumed to be nominal.
Which of the following statements is NOT correct? Your:
Find the Macaulay duration of a 2 year 5% pa annual fixed coupon bond which has a $100 face value and currently has a yield to maturity of 8% pa. The Macaulay duration is:
Find the Macaulay duration of a 2 year 5% pa semi-annual fixed coupon bond which has a $100 face value and currently has a yield to maturity of 8% pa. The Macaulay duration is:
Question 996 duration, CAPM Assume that the market portfolio has a duration of 15 years and an individual stock has a duration of 20 years. What can you say about the stock's beta with respect to the market portfolio? The stock's beta is likely to be:
Question 999 duration, duration of a perpetuity with growth, CAPM, DDM A stock has a beta of 0.5. Its next dividend is expected to be $3, paid one year from now. Dividends are expected to be paid annually and grow by 2% pa forever. Treasury bonds yield 5% pa and the market portfolio's expected return is 10% pa. All returns are effective annual rates. What is the Macaulay duration of the stock now?
Question 1000 duration, duration of a perpetuity with growth An unlevered firm cuts its dividends and re-invests in zero-NPV projects with the same risk as its existing projects. This decreases the dividend yield, but increases the firm's equity's dividend growth rate and duration, while its total required return on equity remains unchanged. The equity can be valued as a perpetuity and the duration of a perpetuity is given below: ###D_\text{Macaulay} = \dfrac{1+r}{r-g}###What will be the effect on the stock's CAPM beta? Assume that there's no change in the risk free rate or market risk premium. The company's equity beta will:
A hedge fund issued zero coupon bonds with a combined $1 billion face value due to be paid in 3 years. The promised yield to maturity is currently 6% pa given as a continuously compounded return (or log gross discrete return, ##LGDR=\ln[P_T/P_0] \div T##). The hedge fund owns stock assets worth $1.1 billion now which are expected to have a 10% pa arithmetic average log gross discrete return ##(\text{AALGDR} = \sum\limits_{t=1}^T{\left( \ln[P_t/P_{t-1}] \right)} \div T)## and 30pp pa standard deviation (SDLGDR) in the future. Analyse the hedge fund using the Merton model of corporate equity as an option on the firm's assets. The risk free government bond yield to maturity is currently 5% pa given as a continuously compounded return or LGDR. Which of the below statements is NOT correct? All figures are rounded to the sixth decimal place.
Question 1004 CFFA, WACC, interest tax shield, DDM Use the below information to value a mature levered company with growing annual perpetual cash flows and a constant debt-to-assets ratio. The next cash flow will be generated in one year from now, so a perpetuity can be used to value this firm. The firm's debt funding comprises annual fixed coupon bonds that all have the same seniority and coupon rate. When these bonds mature, new bonds will be re-issued, and so on in perpetuity. The yield curve is flat.
Which of the following statements is NOT correct?
Question 1006 CAPM, beta, leverage, WACC, real estate Four retail business people compete in the same city. They are all exactly the same except that they have different ways of funding or leasing the shop real estate needed to run their retail business. The two main assets that retail stores need are:
Lease contract prices are fixed for the term of the lease and based on expectations of the future state of the economy. When leases end, a new lease contract is negotiated and the lease cost may be higher or lower depending on the state of the economy and demand and supply if the economy is:
Which retail business person will have the LOWEST beta of equity (or net wealth)?
Question 1007 WACC, leverage, CFFA, EFCF An analyst is valuing a levered company whose owners insist on keeping the dollar amount of debt funding fixed. So the company cannot issue or repay its debt, its dollar value must remain constant. Any funding gaps will be met with equity. The analyst is wondering, as he changes inputs into his valuation, such as the forecast growth rate of sales, then asset values and other things will change. This makes it hard to figure out which values can be held constant and would therefore make good model inputs, rather than outputs which vary depending on the inputs. Assume that the cost of debt (yield) remains constant and the company’s asset beta will also remain constant since any expansion (or downsize) will involve buying (or selling) more of the same assets. Which of the following values can be assumed to stay constant when projected sales growth increases?
Question 1008 WACC, leverage, CFFA, EFCF An analyst is valuing a levered company whose owners insist on keeping a constant market debt to assets ratio into the future. The analyst is wondering how asset values and other things in her model will change when she changes the forecast sales growth rate. Which of the below values will increase as the forecast growth rate of sales increases, with the debt to assets ratio remaining constant? Assume that the cost of debt (yield) remains constant and the company’s asset beta will also remain constant since any expansion (or downsize) will involve buying (or selling) more of the same assets. The analyst should expect which value or ratio to increase when the forecast growth rate of sales increases and the debt to assets ratio remains unchanged? In other words, which of the following values will NOT remain constant?
Question 1009 lemons problem, asymmetric information, adverse selection Akerlof’s 1970 paper ‘The Market for "Lemons": Quality Uncertainty and the Market Mechanism’ provides a famous example of asymmetric information leading to market failure. This example is commonly known as the ‘Lemons Problem’. Imagine that half of all second hand cars are:
Car buyers can’t tell the difference between lemon and plum cars. Car sellers know whether their car is a lemon or a plum since they’ve driven the car for a long time. However, plum car owners cannot prove their cars’ higher quality to buyers. Also, lemon car owners are known to dis-honestly claim that their cars are plums. What will be the market price of second hand cars?
Question 1011 winners curse, no explanation A teacher fills up a large jar with coins. The jar is auctioned among a large class of wealthy accounting students who have never studied economics or finance. The auction is conducted in the English style, which is as an open-outcry ascending auction. The winning bidder will pay slightly more than the second highest bidder's private valuation, but less than their own private valuation. The jar of coins is not allowed to be weighed by students and is filled with different-valued coins so it’s difficult to value. Therefore there is a wide distribution of bidders’ fair value estimates. Students’ bids are purely profit-driven, there is no fame to be gained by being the winner or loser. Assume that each bidder bids up to their personal estimate of the fair value of the jar of coins without observing the number of other bidders during the auction. The winning bidder is likely to:
Question 1012 moral hazard, principal agent problem, asymmetric information When does the ‘principal-agent problem’ occur? Is it when: I. The principal has conflicting incentives (moral hazard); II. The agent has conflicting incentives (moral hazard); III. The principal has incomplete information about the agent (asymmetric information); or IV. The agent has incomplete information about the principal (asymmetric information)? The principal-agent problem occurs when the following statements are true:
A firm is floating its stock in an IPO and its underwriter has received the following bids, listed in order from highest to lowest share price:
Suppose that the firm's owner wishes to sell all of their 8 million shares, so no new money will be raised and no money will re-invested back into the firm. Which of the following statements is NOT correct?
A firm is floating its stock in an IPO and its underwriter has received the following bids, listed in order from highest to lowest share price:
Suppose that the firm's owner wishes to raise $6 million to expand the business by selling new stock in the initial public offering (IPO). The owner currently holds 8 million stock which are not for sale. Which of the following statements is NOT correct?
Question 1015 RBA cash rate, monetary policy Reserve Bank of Australia (RBA) Governor Phil Lowe says that the RBA cash rate is the interest rate in the Australian:
Question 1016 RBA cash rate, monetary policy RBA Governor Phil Lowe says that if the economy is growing very strongly, then prices might be growing too:
Question 1017 RBA cash rate, monetary policy RBA Governor Phil Lowe says that when the RBA raise interest rates, homeowners' mortgage loan interest expense will be:
Question 1018 RBA cash rate, monetary policy, foreign exchange rate RBA Governor Phil Lowe says that when the RBA raises the cash rate, the Australian dollar (AUD) tends to:
Question 1019 RBA cash rate, monetary policy, wealth effect RBA Governor Phil Lowe says that when the RBA raise the cash rate, asset prices tend to:
Question 1020 Federal funds rate, monetary policy, dot plot US Federal Reserve Chair Jerome Powell showed the 'dot plot' of Federal Open Market Committee (FOMC) members' estimated future Fed fund rates following their quarterly summary of economic projections on 15 Dec 2021. The dot plot shows that committee members intended to make monetary policy more:
US Fed Chair Jerome Powell held a news conference following the 25-26 January 2022 FOMC meeting. Nick Timiraos reporting for The Wall Street Journal asked: "Raising rates and reducing the balance sheet both restrain the economy, both tighten monetary policy. How should we think about the relationship between the two? For example, how much passive runoff is equal to every quarter percentage point increase in your benchmark rate?" Jerome Powell replied: "So, again, we think of the balance sheet as moving in a predictable manner, sort of in the background, and that the active tool meeting to meeting is not -- both of them, it's the federal funds rate. There are rules of thumbs. I'm reluctant to land on one of them that equate this. And there's also an element of uncertainty around the balance sheet. I think we have a much better sense, frankly, of how rate increases affect financial conditions and, hence, economic conditions. Balance sheet is still a relatively new thing for the markets and for us, so we're less certain about that." (US Fed, 2022) When Nick Timiraos mentioned 'reducing the balance sheet', he's referring to:
Below is a graph of 10-year US treasury fixed coupon bond yields (red), inflation-indexed bond yields (green) and the 'breakeven' inflation rate (blue). Note that inflation-indexed bonds are also called treasury inflation protected securities (TIPS) in the US. In other countries they're called inflation-linked bonds (ILB's). For more information, see PIMCO's great article about inflation linked bonds here. The 10 year breakeven inflation rate (blue) equals the:
Question 1024 inflation linked bond, bond pricing PIMCO gives the following example of an Inflation Linked Bond (ILB), called Treasury Inflation Protected Securities (TIPS) in the US.
Forecast the semi-annual coupon paid in 10 years based on the bond details given above. The 20th semi-annual coupon, paid in 10 years, is expected to be:
Question 1025 real and nominal returns and cash flows What proportion of managers are evaluating projects correctly, based on table 8 from Meier and Tarhan's (2006) survey of corporate managers?
Table 8 footnote: The rows in this cross-tabulation show whether the firm uses a nominal or real hurdle rate, the columns indicate whether cash flows are calculated in nominal or real terms. The fractions denote the number of firms for each combination relative to the total of 123 respondents that responded to both separate survey questions. What proportion of managers are evaluating projects correctly?
Question 1026 CFFA, WACC, interest tax shield Meier and Tarhan (2006) conducted an interesting survey of corporate managers. The results are copied in Table 7 below. What proportion of managers are evaluating levered projects correctly?
The rows of the cross-tabulation indicate what the self-reported hurdle rate represents and the columns denote five different ways to calculate cash flows, (i) to (v), plus the “other” category. Each cell then displays the fraction of all 113 respondents for a given combination of what the hurdle rate represents and how the firm calculates its cash flows when evaluating a project. The definitions of the cash flow calculations (i)-(v) are as follows: (i) Earnings before interest and after taxes (EBIAT) + depreciation (ii) Earnings before interest and after taxes (EBIAT) + depreciation – capital expenditures – net change in working capital (iii) Earnings (iv) Earnings + depreciation (v) Earnings + depreciation – capital expenditures – net change in working capital Assume that the WACC is after tax, the required return on unlevered equity is the WACC before tax, all projects are levered, the benefit of interest tax shields should be included in the valuation, earnings = net profit after tax (NPAT) and EBIAT = EBIT*(1-tc) which is often also called net operating profit after tax (NOPAT). What proportion of managers are evaluating levered projects correctly?
Below is a table showing GMO's 2016 estimates of different assets' durations, appearing in Slater (2017). If you were certain that interest rates would fall more than the market expects, into what asset might you allocate more funds?
Question 1028 duration, beta, CAPM, DDM A stock has a beta of 0.5. Its next dividend is expected to be $3, paid one year from now. Dividends are expected to be paid annually and grow by 2% pa forever. Treasury bonds yield 3% pa and the market risk premium (MRP) is 6% pa. All returns are effective annual rates. Which of the following statements is NOT correct?
Question 1029 Buffett ratio Tesla CEO Elon Musk asked a question to ARK Invest CEO Cathie Wood on 6 April 2021: "What do you think of the unusually high ratio of the S&P market cap to GDP?", to which Cathie Wood replied. What are the units of this S&P500 market cap to GDP ratio, commonly known as the Buffett ratio?
Question 1030 Multiples valuation, no explanation Read these quotes from Adir Shiffman's 26 July 2021 article in the AFR 'Roll up, roll up and make a mint off Amazon sellers'. "Amazon sellers outsource their warehousing and logistics to the tech giant in a model known as “fulfilled by Amazon”, or FBA. Joining FBA provides access to one of the world’s largest global warehousing operations and even a fleet of Boeing 747 cargo jets. Just as significantly, FBA sellers can much more easily qualify for Amazon’s Prime program, which guarantees free and fast shipping to members." "Companies want to acquire and integrate a selection, or in business parlance, do a 'roll-up'." "More than 100 companies are now racing to roll-up FBA sellers, and almost all have launched since 2017. At least a dozen of these boast war chests of more than $US100 million. The largest, Thrasio, was founded in 2018 and has raised more than $US1.7 billion. Thrasio targets businesses with high quality and differentiated products that generate $US1 to $US100 million in revenue annually" (Shiffman, 2021). If Thrasio's total funds available to spend on the roll up is $1.7 billion, and it's buying targets at price-to-revenue multiples of 2, what's the largest number of firms with $50 million of annual revenue that it could buy?
Question 1031 Multiples valuation Investment bank Canaccord's Think Childcare (TNK) initiation of coverage states: "What's the Differentiator? TNK are operators, not consolidators - Other listed childcare companies have led highly successful consolidation strategies involving multiple arbitrage combined with scale benefits and operating efficiencies. TNK’s focus is on operating the centres to the best of their individual potentials..." (Canaccord, 2016). Multiples arbitrage involves:
Question 1032 inflation, percent of sales forecasting, no explanation Investment bank Canaccord's Think Childcare (TNK) initiation of coverage states: "Building lease costs – Rent expense is the second largest cost and TNK reported rent/sales of 12.1%, within the industry range that we typically see as 12-14% of sales. TNK lease all their properties and do not intend to own property. Leases are generally long term with 10-15 year terms and additional options. Although terms vary across properties and landlords, rental increases are generally tied to the consumer price index (CPI)" (Canaccord, 2016). Assuming that sales grow faster than the CPI, when Canaccord forecast TNK's building lease costs using the 'percent of sales' method, that proportion should:
Question 1033 DDM, Multiples valuation, CAPM Here's an excerpt from an interview between Magellan fund co-founder Hamish Douglass and AFR reporter Vesna Poljak, which appeared in the Australian Financial Review article ‘It's all about interest rates: Hamish Douglass’, 19 July 2019: Take a business growing at 4 per cent a year, with a cost of equity of 10 per cent based off a 5 per cent risk-free rate and a 5 per cent market risk premium: you would value that at around 16.6 times free cashflow. Now take a business growing at the same rate, with a 4 per cent risk free rate. At a 9 per cent cost of equity that would command a 20 times multiple, he says. At a 3 per cent risk-free rate, the cost of equity is 8 per cent, and the multiple is 25. Finally at 2 per cent – 'which is where the world is at the moment' – the same business would be worth around 33 times free cashflow. In August 2021, the RBA overnight cash rate and 3 year Australian government treasury bond yield were both 0.1% pa. If this low risk-free yield was expected to persist forever, what approximate equity price-to-cashflow multiple would that imply for a business expected to grow at 4% pa in perpetuity with a 5% equity risk premium?
Question 1034 duration, monetary policy, inflation, market efficiency On 18 March 2022 the AFR's James Thomson wrote: "In a world where the bombs are still falling in Ukraine and the Fed is just getting started on what looks likely to be a year-long cycle of rising interest rates, it would take a certain amount of bravery to embrace the sort of high-tech, long duration plays that Wood favours" (Thomson, 2022). Which of the following US macro-economic data releases is most likely to cause Cathie Wood's ARK ETF share price to fall?
Question 1036 Minsky financial instability hypothesis, leverage Hyman Minsky, author of 'The Financial Instability Hypothesis' (1992), wrote: In particular, over a protracted period of good times, capitalist economies tend to move from a financial structure dominated by hedge finance units to a structure in which there is large weight to units engaged in speculative and Ponzi finance. Furthermore, if an economy with a sizeable body of speculative financial units is in an inflationary state, and the authorities attempt to exorcise inflation by monetary constraint, then speculative units will become Ponzi units and the net worth of previously Ponzi units will quickly evaporate. Consequently, units with cash flow shortfalls will be forced to try to make position by selling out position. This is likely to lead to a collapse of asset values. Which of the below statements explaining this quote is NOT correct?
Question 1037 gross domestic product, no explanation What effect is being referred to in the following quote from the MARTIN model description? Economy-wide models also account for feedback between economic variables. For example, an increase in aggregate demand will encourage firms to hire more workers, which raises employment and lowers the unemployment rate. The tightening of the labour market is likely to lead to an increase in wages growth. The resulting increase in household incomes is likely to lead to an increase in consumption, further raising aggregate demand. (Ballantyne et al, 2019) The name of the effect being referred to is:
Question 1038 fire sale, leverage, no explanation Listen to 'Lessons and Questions from the GFC' on 6 December 2018 by RBA Deputy Governor Guy Debelle from 17:58 to 20:08 or read the below transcript: Guy Debelle talks about the GFC and says that the Australian government’s guarantee of wholesale debt and deposits on 12 October 2008 was "introduced to facilitate the flow of credit to the real economy at a reasonable price and, in some cases, alleviate the need for asset fire sales, which have the capacity to tip markets and the economy into a worse equilibrium... The crisis very much demonstrated the critical importance of keeping the lending flowing. The lesson is that countries that did that fared better than countries that didn't. That lesson is relevant to the situation today in Australia, where there is a risk that a reduced appetite to lend will overly curtail borrowing with consequent effects for the Australian economy." (Debelle, 2019) When assets are sold in a fire sale, there’s usually a large increase in the:
Question 1040 monetary policy, business cycle
Question 1041 monetary policy, business cycle
Question 1042 monetary policy, business cycle
Question 1043 fiscal policy, business cycle
Question 1044 leverage, capital structure, beta A levered firm has only 2 assets on its balance sheet with the below market values and CAPM betas. The risk free rate is 3% pa and the market risk premium is 5% pa. Assume that the CAPM is correct and all assets are fairly priced.
Which of the following statements is NOT correct?
Question 1045 payout policy, leverage, capital structure, beta A levered firm has only 2 assets on its balance sheet with the below market values and CAPM betas. The risk free rate is 3% pa and the market risk premium is 5% pa. Assume that the CAPM is correct and all assets are fairly priced.
The firm then pays out all of its cash as a dividend. Assume that the beta and yield on the loan liability remain unchanged. Ignore taxes, transaction costs, signalling, information asymmetries and other frictions. Which of the following statements is NOT correct? This event led to a:
Question 1046 leverage, capital structure, no explanation A levered firm has only 2 assets on its balance sheet with the below market values and CAPM betas. The risk free rate is 3% pa and the market risk premium is 5% pa. Assume that the CAPM is correct and all assets are fairly priced.
The firm then pays off (retires) all of its loan liabilities using its cash. Ignore interest tax shields. Which of the following statements is NOT correct? All answers are given to 6 decimal places. This event led to a:
Question 1049 sensitivity analysis, WACC, DDM An analyst has prepared a discounted cash flow model to value a firm's share price. A sensitivity analysis data table with ‘conditional formatting’ shading is shown below. The table shows how changes in the weighted average cost of capital (WACC, left column) and terminal value growth rate (top row) affect the firm's model-estimated share price. The base case estimates are shown in bold. Which of the following statements is NOT correct? The model-estimated share price would normally be expected to:
In Miller's 1977 article 'Debt and Taxes', he argues that interest tax shields are likely to benefit who? Note that this 1977 article is contrary to his past research findings with Modigliani (1958), modern textbooks and common practice by valuers. Miller (1977) concludes that the benefits of interest tax shields are likely to benefit:
Read the below quote for background, or skip it to answer the question immediately. In his 31 August 2021 article 'The rich get richer and rates get lower', Robert Armstrong states that:
Which of the following statements about this quote is NOT correct?
Question 1053 bond pricing, monetary policy, supply and demand In his 31 August 2021 article 'The rich get richer and rates get lower', Robert Armstrong states that: "Savings chase returns, so when there are more savings and the same number of places to put them, rates of return must fall" (Armstrong, 2021). If all savings (loanable funds) are invested in fixed coupon government and corporate bonds, this is equivalent to saying that an increase in:
Question 1054 leverage, LVR An asset price suddenly increased by 10%. Multiplication by which of the following leverage ratios will give the proportional increase in equity or net wealth? In other words, the asset capital return over a short time multiplied by what ratio will give the equity capital return over that same short time?
Question 1056 CFFA, no explanation Which of the following formulas for the carrying or net amount of 'intangible assets' such as patents from the balance sheet is correct? Assume that now is time 1 and last year is time 0, and that 'IntangibleAssets' is a carrying value net of accumulated depreciation.
Question 1057 balance sheet, no explanation Which of the following formulas for 'contributed equity' from the balance sheet is correct? Assume that now is time 1 and last year is time 0. Assume that book equity consists of contributed equity, retained profits and reserves only.
Question 1058 book and market values, enterprise value, balance sheet Here is a table from Canaccord's 'sum of the parts' valuation of INCR. Note that the firm INCR is unlevered (interest bearing debt = 0). The third column from the left is labelled 'Value (US$ MM)'. For the 'Israel' and 'EU Export' opportunities, these values are most likely to be:
Acquirer firm plans to launch a takeover of Target firm. The deal is expected to create a present value of synergies totaling $1 billion, corresponding to extra earnings of $0.05 billion per year.
Assume that:
Which of the following statements is NOT correct? The merged firm will have: |