Fight Finance

Question 12  bond pricing

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.

Would you like to her bond or politely ?

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:

(a) The company is increasing its debt-to-assets and debt-to-equity ratios. These are types of 'leverage' or 'gearing' ratios.

(b) The company will pay less tax to the government due to the benefit of interest tax shields.

(c) The company's net income, also known as earnings or net profit after tax, will fall.

(d) The company's expected levered firm free cash flow (FFCF or CFFA) will be higher due to tax shields.

(e) The company's expected levered equity free cash flow (EFCF) will not change.

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###

(a) 77.6034%

(b) 30.3779%

(c) 28.8603%

(d) 22.3966%

(e) 7.5304%

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:

(a) Green is a stock's continuously compounded rate of return, also called the log gross discrete return. ##r_\text{cc} = \ln(P_1/P_0)##

(b) Blue is a stock's future price, ##P_1##

(c) Blue is a stock's gross discrete return. ##\text{GDR} = P_1/P_0##

(d) Blue is a stock's effective rate of return. ##r_\text{eff} = (P_1-P_0)/P_0##

(e) Red is a stock's net discrete return. ##\text{NDR} = \text{GDR}-1##

Question 719  mean and median returns, return distribution, arithmetic and geometric averages, continuously compounding rate

A stock has an arithmetic average continuously compounded return (AALGDR) of 10% pa, a standard deviation of continuously compounded returns (SDLGDR) of 80% pa and current stock price of $1. Assume that stock prices are log-normally distributed. The graph below summarises this information and provides some helpful formulas.

In one year, what do you expect the median and mean prices to be? The answer options are given in the same order.

(a) P1median = $1.105171,   P1mean = $1.521962

(b) P1median = $1.1,             P1mean = $1.42

(c) P1median = $1.521962,   P1mean = $1.105171

(d) P1median = $0.802519,   P1mean = $1.105171

(e) P1median = $1.42,           P1mean = $1.1

Question 734  real and nominal returns and cash flows, inflation, DDM, no explanation

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:

(a) Inflation rate.

(b) Nominal GDP growth rate.

(c) Real GDP growth rate.

(d) Nominal total return on the share market index.

(e) Real total return on the share market index.

Question 801  negative gearing, leverage, capital structure, no explanation

The following steps set out the process of ‘negative gearing’ an investment property in Australia. Which of these steps or statements is NOT correct? To successfully achieve negative gearing on an investment property:

(a) Buy an investment property with low expected future capital gains and high rental income, funded using a low proportion of debt (mortgage loan);

(b) Rent the investment property to a tenant;

(c) Negative gearing is achieved when the property investment’s annual taxable profit is negative, due to the loan’s interest expense being greater than the net rent (rental revenue less the renting expenses such as maintenance);

(d) Deduct the property’s income loss from the investor’s separate personal wage from labour. This means that the investor will pay less personal income tax than if they didn’t make the levered property investment;

(e) The investment property will be a positive-NPV investment if the capital gains are greater than the income losses on an after-tax, risk-adjusted, present-value basis.

Question 815  expected and historical returns

If future required returns fall, and future expected cash flows remain the same, then prices will , or remain the ?

Question 867  limited liability, business structure

Which one of the following businesses is likely to be a public company in Australia, judging by its name?

(a) Joe Bloggs

(b) Jane Doe

(c) Bloggs and Doe

(d) Bloggs Ltd

(e) Doe Pty Ltd

Question 987  interest tax shield, capital structure, debt terminology

What creates interest tax shields for a company?

(a) Debt assets.

(b) Debt funding.

(c) Equity assets.

(d) Equity funding.

(e) None of the above.