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 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?

There are many ways to write the ordinary annuity formula.

Which of the following is **NOT** equal to the ordinary annuity formula?

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 381** Merton model of corporate debt, option, real option

In the Merton model of corporate debt, buying a levered company's debt is equivalent to buying risk free government bonds and:

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:

- Rented out to a tenant for one year at $0.1m paid immediately, and then sold for $0.99m in one year.
- Refurbished into more modern commercial office rooms at a cost of $1m now, and then sold for $2.4m when the refurbishment is finished in one year.
- Converted into residential apartments at a cost of $2m now, and then sold for $3.4m when the conversion is finished in one year.

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).

Mutually Exclusive Projects | |||

Project | Cash flow now ($) |
Cash flow in one year ($) |
IRR (% pa) |

Rent then sell as is | -900,000 | 990,000 | 10 |

Refurbishment into modern offices | -2,000,000 | 2,400,000 | 20 |

Conversion into residential apartments | -3,000,000 | 3,400,000 | 13.33 |

Which project should the investor accept?

**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?

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 778** CML, systematic and idiosyncratic risk, portfolio risk, CAPM, no explanation

The capital market line (CML) is shown in the graph below. The total standard deviation is denoted by σ and the expected return is μ. Assume that markets are efficient so all assets are fairly priced.

Which of the below statements is **NOT** correct?

**Question 796** option, Black-Scholes-Merton option pricing, option delta, no explanation

Which of the following quantities from the Black-Scholes-Merton option pricing formula gives the risk-neutral **probability** that a European **call** option will be exercised?