Fight Finance

Question 100  market efficiency, technical analysis, joint hypothesis problem

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:

(a) Only III is true.

(b) Only II and III are true.

(c) Only I, II and III are true.

(d) Only IV is true.

(e) Either I, II and III are true, or IV is true, or they are all true.

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:

• Only the spot price is expected to increase and there is no change in expected volatility or other variables that affect option prices.
• No taxes, transaction costs, information asymmetry, bid-ask spreads or other market frictions.

(a) Buy one year call options on fresh milk.

(b) Buy one year put options on fresh milk.

(c) Sell one year call options on fresh milk.

(d) All of the above option trades are likely to have a positive NPV.

(e) None of the above option trades are likely to have a positive NPV.

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?

(a) The dividend yield is equal to ##(r-g)##.

(b) The dividend yield is equal to ##\left( \dfrac{d_1}{p_0} \right)##.

(c) The total return of the stock is equal to ##(r)##.

(d) The total return of the stock is equal to ##\left( \dfrac{d_1+p_0.g}{p_0} \right)##.

(e) The total return of the stock is equal to ##(r+g)##.

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}###

Does this annual FFCF or the annual interest tax shield?

Question 504  CFFA

Read the following financial statements and calculate the firm's free cash flow over the 2014 financial year.

UBar Corp
Income Statement for
year ending 30th June 2014
	$m
Sales	293
COGS	200
Rent expense	15
Gas expense	8
Depreciation	10
EBIT	60
Interest expense	0
Taxable income	60
Taxes	18
Net income	42

UBar Corp
Balance Sheet
as at 30th June	2014	2013
	$m	$m
Assets
Cash	30	29
Accounts receivable	5	7
Pre-paid rent expense	1	0
Inventory	50	46
PPE	290	300
Total assets	376	382
Liabilities
Trade payables	20	18
Accrued gas expense	3	2
Non-current liabilities	0	0
Contributed equity	212	212
Retained profits	136	150
Asset revaluation reserve	5	0
Total L and OE	376	382

 

Note: all figures are given in millions of dollars ($m).

The firm's free cash flow over the 2014 financial year was:

(a) $51

(b) $52

(c) $58

(d) $61

(e) $62

Question 603  foreign exchange rate, American and European terms

Vietnamese people usually quote the Vietnamese Dong in VND per 1 USD. For example, in October 2015 the Vietnamese Dong was 22,300 VND per USD. Is this an or terms quote?

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?

(a)##-1 < \text{Red} < \infty## if Red is log-normally distributed.

(b) ##-2 < \text{Green} < 2## if Green is normally distributed.

(c) ##0 < \text{Blue} < \infty## if Blue is log-normally distributed.

(d) If the Green distribution is normal, then the mode = median = mean.

(e) If the Red and Blue distributions are log-normal, then the mode < median < mean.

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?

(a) The real interest rate is zero.

(b) The nominal amount owing on the loan will increase at the inflation rate over time, if there are no extra payments or borrowings.

(c) The real amount owing on the loan in today's money will remain the same over time, if there are no extra payments or borrowings.

(d) The interest rate on the HECS loan advantages rich domestic students because they are able to pay off their debt sooner and avoid paying as much HECS interest.

(e) The interest rate on the HECS loan advantages all domestic students because the alternative of borrowing from the bank to pay for education would usually attract a higher interest rate.

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).

Data on a Levered Firm with Perpetual Cash Flows
Item abbreviation	Value	Item full name
##\text{OFCF}##	$100m	Operating free cash flow
##\text{FFCF or CFFA}##	$112m	Firm free cash flow or cash flow from assets (includes interest tax shields)
##g##	0% pa	Growth rate of OFCF and FFCF
##\text{WACC}_\text{BeforeTax}##	7% pa	Weighted average cost of capital before tax
##\text{WACC}_\text{AfterTax}##	6.25% pa	Weighted average cost of capital after tax
##r_\text{D}##	5% pa	Cost of debt
##r_\text{EL}##	9% pa	Cost of levered equity
##D/V_L##	50% pa	Debt to assets ratio, where the asset value includes tax shields
##t_c##	30%	Corporate tax rate

 

What is the value of the levered firm including interest tax shields?

(a) $431.111m

(b) $444.444m

(c) $485m

(d) $515.464m

(e) $1600m

Question 881  Nixon Shock, Bretton Woods, foreign exchange rate, foreign exchange system history, no explanation

In the ‘Nixon Shock’ on August 15, 1971, the United States government:

(a) Floated the USD.

(b) Cancelled the international convertibility of the USD into gold.

(c) Cancelled the international convertibility of the USD into other currencies such as the GBP.

(d) Revalued the USD higher (an appreciation of the USD) against gold and other foreign currencies.

(e) Banned imports into the US.