Fight Finance

Question 14  bond pricing

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.

Would you like to the bond or politely ?

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?

(a) The debt-to-assets (D/V) ratio will increase.

(b) The debt-to-equity ratio (D/E) will increase.

(c) Firm value is likely to have increased due to the higher amount of interest tax shields, assuming that there will not be any costs of financial distress.

(d) The company's after-tax WACC is likely to have decreased.

(e) The company's before-tax WACC is likely to have decreased.

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?

(a) Home-made leverage.

(b) Diversification.

(c) Cross-currency interest rate parity.

(d) Time value of money.

(e) The undiversifiable nature of systematic risk.

Question 308  risk, standard deviation, variance, no explanation

A stock's standard deviation of returns is expected to be:

• 0.09 per month for the first 5 months;
• 0.14 per month for the next 7 months.

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.

(a) ##\sigma_\text{annual} = 0.09 \times 5 + 0.14 \times 7##

(b) ##\sigma_\text{annual} = (0.09 \times 5 + 0.14 \times 7)^{1/2}##

(c) ##\sigma_\text{annual} = (0.09^2 \times 5 + 0.14^2 \times 7)^{1/2}##

(d) ##\sigma_\text{annual} = (1+0.09)^5\times (1+0.14)^7 - 1##

(e) ##\sigma_\text{annual} = \left( \dfrac{0.09^2 \times 5 + 0.14^2 \times 7}{12} \right)^{1/2}##

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) Exports denominated in domestic currency became cheaper to foreigners.

(b) Imports denominated in domestic currency became more expensive.

(c) Citizens would have to pay more in their own currency when holidaying in the US.

(d) USD interest payments on USD fixed-interest bonds became more expensive in their own currency.

(e) Domestic currency interest payments on fixed-interest bonds denominated in domestic currency became cheaper in their own currency.

Question 382  Merton model of corporate debt, real option, option

In the Merton model of corporate debt, buying a levered company's shares is equivalent to:

(a) Buying the company's assets.

(b) Buying a call option on the company's assets.

(c) Buying a put option on the company's assets.

(d) Buying the company's assets and buying a call option on those assets.

(e) Buying the company's assets and buying a put option on those assets.

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?

(a) ##V_0=\dfrac{C_t}{(1+r)^t} ##

(b) ##V_0=\dfrac{C_1}{r}.\left(1-\dfrac{1}{(1+r)^T} \right)= \sum\limits_{t=1}^T \left( \dfrac{C_t}{(1+r)^t} \right) ##

(c) ##V_0=\dfrac{C_1}{r-g}.\left(1-\left(\dfrac{1+g}{1+r}\right)^T \right)= \sum\limits_{t=1}^T \left( \dfrac{C_t.(1+g)^t}{(1+r)^t} \right) ##

(d) ##V_0=\dfrac{C_1}{r} = \sum\limits_{t=1}^\infty \left( \dfrac{C_t}{(1+r)^t} \right) ##

(e) ##V_0=\dfrac{C_1}{r-g} = \sum\limits_{t=1}^\infty \left( \dfrac{C_t.(1+g)^t}{(1+r)^t} \right) ##

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) A sunk cost.

(b) An opportunity cost.

(c) A negative side effect.

(d) A capital expense.

(e) A depreciation expense.

Question 608  debt terminology

You deposit cash into your bank account. Have you or debt?

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###

(a) 63.1508%

(b) 60.0299%

(c) 58.3511%

(d) 36.8492%

(e) 11.5269%