Fight Finance

Question 280  equivalent annual cash flow

You own a nice suit which you wear once per week on nights out. You bought it one year ago for $600. In your experience, suits used once per week last for 6 years. So you expect yours to last for another 5 years.

Your younger brother said that retro is back in style so he wants to wants to borrow your suit once a week when he goes out. With the increased use, your suit will only last for another 4 years rather than 5.

What is the present value of the cost of letting your brother use your current suit for the next 4 years?

Assume: that bank interest rates are 10% pa, given as an effective annual rate; you will buy a new suit when your current one wears out and your brother will not use the new one; your brother will only use your current suit so he will only use it for the next four years; and the price of a new suit never changes.

(a) 108.1063

(b) 98.2785

(c) 94.095

(d) 85.5409

(e) 68.3013

Question 318  foreign exchange rate, American and European terms

How is the AUD normally quoted in Australia? Using or terms?

Question 375  interest tax shield, CFFA

One formula for calculating a levered firm's free cash flow (FFCF, or CFFA) is to use net operating profit after tax (NOPAT).

###\begin{aligned} FFCF &= NOPAT + Depr - CapEx -\Delta NWC \\ &= (Rev - COGS - Depr - FC)(1-t_c) + Depr - CapEx -\Delta NWC \\ \end{aligned} \\###

Does this annual FFCF or the annual interest tax shield?

Question 595  future, continuously compounding rate

A 2-year futures contract on a stock paying a continuous dividend yield of 3% pa was bought when the underlying stock price was $10 and the risk free rate was 10% per annum with continuous compounding. Assume that investors are risk-neutral, so the stock's total required return is the risk free rate.

Find the forward price ##(F_2)## and value of the contract ##(V_0)## initially. Also find the value of the contract in 6 months ##(V_{0.5})## if the stock price rose to $12.

(a) ##F_2=11.5027, V_0=0, V_{0.5}=1.5715##

(b) ##F_2=11.5027, V_0=0, V_{0.5}=1.8258##

(c) ##F_2=12.9693, V_0=0, V_{0.5}=1.3218##

(d) ##F_2=12.9693, V_0=0, V_{0.5}=1.3896##

(e) ##F_2=12.9693, V_0=0, V_{0.5}=1.6144##

Question 702  utility, risk aversion, utility function, gamble

Mr Blue, Miss Red and Mrs Green are people with different utility functions.

Each person has $50 of initial wealth. A coin toss game is offered to each person at a casino where the player can win or lose $50. Each player can flip a coin and if they flip heads, they receive $50. If they flip tails then they will lose $50. Which of the following statements is NOT correct?

(a) Mr Blue would enjoy the gamble.

(b) Miss Red would be indifferent to gambling or not.

(c) Mrs Green would dislike the gamble.

(d) Mr Blue's certainty equivalent of the risky gamble is $70.71. This is more than his current wealth which is why he would like to gamble.

(e) Miss Red's certainty equivalent of the risky gamble is $50. This is the same as her current wealth which is why she is indifferent to gambling or not.

Question 831  option, American option, no explanation

Which of the following statements about American-style options is NOT correct? American-style:

(a) Options are always worth more than or equal to equivalent European-style options.

(b) Call options on dividend-paying stocks should sometimes be exercised just before the dividend.

(c) Put options on dividend-paying stocks should sometimes be exercised just after the dividend.

(d) Call options should be exercised now if the intrinsic option value ##(S-K)## is greater than the expected present value of the option’s future payoffs.

(e) Put options should be exercised now if the intrinsic option value ##(K-S)## is less than the expected present value of the option’s future payoffs.

Question 896  comparative advantage in trade, production possibilities curve, no explanation

Adam and Bella are the only people on a remote island. Their production possibility curves are shown in the graph.

Which of the following statements is NOT correct?

(a) Adam has the absolute advantage at picking coconuts.

(b) Adam has the absolute advantage at picking dates.

(c) Adam has the comparative advantage at picking coconuts.

(d) Bella has the comparative advantage at picking coconuts.

Question 903  option, Black-Scholes-Merton option pricing, option on stock index

A six month European-style call option on the S&P500 stock index has a strike price of 2800 points.

The underlying S&P500 stock index currently trades at 2700 points, has a continuously compounded dividend yield of 2% pa and a standard deviation of continuously compounded returns of 25% pa.

The risk-free interest rate is 5% pa continuously compounded.

Use the Black-Scholes-Merton formula to calculate the option price. The call option price now is:

(a) 162.83 points

(b) 220.56 points

(c) 226.43 points

(d) 230.91 points

(e) 317.45 points

Question 975  comparative advantage in trade, production possibilities curve, no explanation

Arthur and Bindi are the only people on a remote island.

Luckily there are Coconut and Date palm trees on the island that grow delicious fruit. The problem is that harvesting the fruit takes a lot of work.

Arthur can pick 1 coconut per hour, 4 dates per hour or any linear combination of coconuts and dates. For example, he could pick 0.5 coconuts and 2 dates per hour.

Bindi can pick 2 coconuts per hour, 1 date per hour or any linear combination. For example, she could pick 0.5 coconuts and 0.75 dates per hour.

This information is summarised in the table and graph:

Harvest Rates Per Hour
	Coconuts	Dates
Arthur	1	4
Bindi	2	1

 

Which of the following statements is NOT correct?

(a) Arthur’s opportunity cost of picking one date per hour is 0.25 coconuts.

(b) Bindi’s opportunity cost of picking one date per hour is 2 coconuts.

(c) Arthur’s opportunity cost of picking one coconut per hour is 4 dates.

(d) Bindi’s opportunity cost of picking one coconut per hour is 2 dates.

(e) The gradients (rise over run) of the lines in the graph are measured in coconuts per one date per hour.

Question 1002  floating coupon bond, bond pricing

Which of the following statements about vanilla floating coupon bonds paying quarterly coupons is NOT correct? A vanilla floating coupon bond's:

(a) Next quarterly dollar coupon is equal to the bond's face value multiplied by the coupon rate, divided by 4.

(b) First coupon is based on the benchmark rate at the time the bond was first issued. Therefore the first quarterly coupon is known for certain when it is issued.

(c) Coupons after the first are based on the benchmark rate at the time of that next coupon's ex-coupon date. Therefore the next quarterly coupon's dollar payment is unknown until its ex-coupon date, which is just a few days before the coupon payment date.

(d) Macaulay duration is equal to the time until the next ex-coupon date.

(e) Price is generally equal to its face value on its ex-coupon dates if there was no change in the bond's risk premium since it was issued.