Fight Finance

Question 305  option, short selling, speculation

You believe that the price of a share will fall significantly very soon, but the rest of the market does not. The market thinks that the share price will remain the same. Assuming that your prediction will soon be true, which of the following trades is a bad idea? In other words, which trade will NOT make money or prevent losses?

(a) Sell all existing stock that you own.

(b) Short sell the stock.

(c) Buy put options on the stock.

(d) Sell put options on the stock.

(e) Sell call options on the stock.

Question 344  CFFA, capital budgeting

A new company's Firm Free Cash Flow (FFCF, same as CFFA) is forecast in the graph below.

To value the firm's assets, the terminal value needs to be calculated using the perpetuity with growth formula:

###V_{\text{terminal, }t-1} = \dfrac{FFCF_{\text{terminal, }t}}{r-g}###

Which point corresponds to the best time to calculate the terminal value?

(a) Point A.

(b) Point B.

(c) Point C.

(d) Any of the points.

(e) None of the points.

Question 368  interest tax shield, CFFA

A method commonly seen in textbooks for calculating a levered firm's free cash flow (FFCF, or CFFA) is the following:

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

Does this annual FFCF or the annual interest tax shield?

Question 450  CAPM, risk, portfolio risk, no explanation

The accounting identity states that the book value of a company's assets (A) equals its liabilities (L) plus owners equity (OE), so A = L + OE.

The finance version states that the market value of a company's assets (V) equals the market value of its debt (D) plus equity (E), so V = D + E.

Therefore a business's assets can be seen as a portfolio of the debt and equity that fund the assets.

Let ##\sigma_\text{V total}^2## be the total variance of returns on assets, ##\sigma_\text{V syst}^2## be the systematic variance of returns on assets, and ##\sigma_\text{V idio}^2## be the idiosyncratic variance of returns on assets, and ##\rho_\text{D idio, E idio}## be the correlation between the idiosyncratic returns on debt and equity.

Which of the following equations is NOT correct?

(a) ##r_V = \dfrac{D}{V}.r_D + \dfrac{E}{V}.r_E##

(b) ##\beta_V = \dfrac{D}{V}.\beta_D + \dfrac{E}{V}.\beta_E##

(c) ##\sigma_\text{V syst}^2 = \left(\dfrac{D}{V}\right)^2.\sigma_\text{D syst}^2 + \left(\dfrac{E}{V}\right)^2.\sigma_\text{E syst}^2##

(d) ##\sigma_\text{V idio}^2 = \left(\dfrac{D}{V}\right)^2.\sigma_\text{D idio}^2 + \left(\dfrac{E}{V}\right)^2.\sigma_\text{E idio}^2 + 2.\dfrac{D}{V}.\dfrac{E}{V}.\rho_\text{D idio, E idio}.\sigma_\text{D idio}.\sigma_\text{E idio}##

(e) ##\sigma_\text{V total}^2 = \left(\dfrac{D}{V}\right)^2.\sigma_\text{D total}^2 + \left(\dfrac{E}{V}\right)^2.\sigma_\text{E total}^2##

Question 470  accounting ratio, no explanation

Which of the following statements is NOT correct?

(a) A firm's quick ratio will always be equal to or less than its current ratio.

(b) A firm will have positive net working capital if it has a current ratio that's greater than one.

(c) A firm's gross margin will be greater than or equal to its operating margin, which will be greater than or equal to its net profit margin.

(d) A firm's fixed asset turnover will be less than or equal to asset turnover.

(e) A firm's debt to equity ratio will always be greater than or equal to its debt to assets ratio.

Question 589  future, contango, market efficiency

In general, stock prices tend to rise. What does this mean for futures on equity?

(a) Equity futures prices tend to be higher than spot prices. This is called contango.

(b) Equity futures prices tend to be equal to spot prices.

(c) Equity futures are generally under-priced.

(d) Equity futures are generally over-priced.

(e) Long equity futures traders tend to make more money than short equity futures traders.

Question 678  option, option profit, no explanation

Which of the below formulas gives the profit ##(\pi)## from being short a put option? Let the underlying asset price at maturity be ##S_T##, the exercise price be ##X_T## and the option price be ##f_{LP,0}##. Note that ##S_T##, ##X_T## and ##f_{LP,0}## are all positive numbers.

(a) ##\pi_{SP}=-max⁡(S_T-X_T,0) - f_{LP,0}##

(b) ##\pi_{SP}=-max⁡(X_T-S_T,0) + f_{LP,0}##

(c) ##\pi_{SP}=max⁡(S_T-X_T,0) - f_{LP,0}##

(d) ##\pi_{SP}=max⁡(X_T-S_T,0) + f_{LP,0}##

(e) ##\pi_{SP}=max(X_T-S_T,0) - f_{LP,0}##

Question 778  CML, systematic and idiosyncratic risk, portfolio risk, CAPM

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?

(a) The risk free security has zero systematic variance and zero idiosyncratic variance.

(b) The market portfolio has zero idiosyncratic variance.

(c) Any portfolio comprised of the market portfolio and risk free security has zero idiosyncratic variance.

(d) Portfolios that plot on the CML must only be comprised of the risk free security and the market portfolio.

(e) Portfolios that plot on the CML have some idiosyncratic variance and some systematic variance.

Question 879  margin loan, Basel accord

The risk-weight on "Margin lending against listed instruments on recognised exchanges" is 20% according to APRA's interpretation of the Basel 3 Accord in 'Prudential Standard APS 112 Capital Adequacy: Standardised Approach to Credit Risk, Attachment A: Risk-weights for on-balance sheet assets'.

A bank is considering lending a $100,000 margin loan secured by an ASX-listed stock. How much regulatory capital will the bank require to grant this loan under the Basel 3 Accord? Ignore the capital conservation buffer and the off-balance sheet exposure.

(a) $100,000.

(b) $28,000.

(c) $20,000.

(d) $8,000.

(e) $1,600.

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.