Fight Finance

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?

(a) -648.51

(b) 60.28

(c) 70.88

(d) 125.51

(e) 200

Question 82  portfolio return

Portfolio Details
Stock	Expected return	Standard deviation	Correlation	Dollars invested
A	0.1	0.4	0.5	60
B	0.2	0.6		140

What is the expected return of the above portfolio?

(a) 0.15

(b) 0.17

(c) 0.1908

(d) 0.2412

(e) 0.34

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?

(a) The Australian dollar will appreciate against the USD, so the 'European terms' quote of the AUD exchange rate (AUD/USD) will increase.

(b) The Australian dollar will depreciate against the USD, so the 'European terms' quote of the AUD exchange rate (AUD/USD) will decrease.

(c) The Australian dollar will appreciate against the USD, so the 'European terms' quote of the AUD exchange rate (AUD/USD) will decrease.

(d) The Australian dollar will depreciate against the USD, so the 'European terms' quote of the AUD exchange rate (AUD/USD) will increase.

(e) The Australian dollar will appreciate against the USD, so the 'American terms' quote of the AUD exchange rate (USD/AUD) will decrease.

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###

(a) An increase in revenue (Rev).

(b) An increase in rent expense (part of fixed costs, FC).

(c) An increase in depreciation expense (Depr).

(d) An decrease in net working capital (ΔNWC).

(e) An increase in dividends.

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:

• $6.6m cash flow with probability 0.5 in the good state of the world, and a
• -$4.4m (notice the negative sign) cash flow with probability 0.5 in the bad state of the world.

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) $2.5m, so they should vote yes.

(b) $2.045455m, so they should vote yes.

(c) $0.9m, so they should vote no.

(d) $0, so they should vote no.

(e) -$0.9m, so they should vote no.

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?

(a) This firm's expected capital return equals zero.

(b) This firm's expected total return and income return are equal.

(c) This firm's forward looking PE ratio will equal the inverse of the firm's expected income return.

(d) This firm's forward looking PE ratio will equal the inverse of the firm's expected capital return.

(e) This firm's forward looking PE ratio is equal to the expected payback period, which is the time it will take for the sum of the cash flows to equal the share price.

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 536  idiom, bond pricing, capital structure, leverage

The expression 'my word is my bond' is often used in everyday language to make a serious promise.

Why do you think this expression uses the metaphor of a bond rather than a share?

(a) Because bonds are higher risk investments than shares.

(b) Because issuers must pay bond holders or face bankruptcy, while payments to shareholders are discretionary.

(c) Because bond holders are paid last in the event of bankruptcy, while shareholders are paid first.

(d) Because bonds always pay higher returns than shares.

(e) Because bonds are generally more liquid than shares.

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.

(a) ##F_1=110.5171, V_0=0, V_\text{0.5, SF}=14.7829##

(b) ##F_1=110.5171, V_0=0, V_\text{0.5, SF}=15.1271##

(c) ##F_1=99.8244, V_0=0, V_\text{0.5, SF}=14.7829##

(d) ##F_1=99.8244, V_0=0, V_\text{0.5, SF}=20.5171##

(e) ##F_1=99.8244, V_0=0, V_\text{0.5, SF}=9.9144##

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:

(a) Remain at 0.8 USD per AUD.

(b) Appreciate against the USD to be, say, 0.81 USD per AUD.

(c) Appreciate against the USD to be, say, 0.79 USD per AUD.

(d) Depreciate against the USD to be, say, 0.81 USD per AUD.

(e) Depreciate against the USD to be, say, 0.79 USD per AUD.