Fight Finance

Question 41  DDM, income and capital returns

The following is the Dividend Discount Model (DDM) used to price stocks:

### P_0 = \frac{d_1}{r-g} ###

Assume that the assumptions of the DDM hold and that the time period is measured in years.

Which of the following is equal to the expected dividend in 3 years, ## d_3 ##?

(a) ## d_1(1+g)^3 ##

(b) ## P_3(r-g) ##

(c) ## d_2(1+g)^2 ##

(d) ## P_0(1+g)^3(r-g) ##

(e) ## P_0(1+g)^2(r-g) ##

Question 139  implicit interest rate in wholesale credit

A wholesale shop offers credit to its customers. The customers are given 21 days to pay for their goods. But if they pay straight away (now) they get a 1% discount.

What is the effective interest rate given to customers who pay in 21 days? All rates given below are effective annual rates. Assume 365 days in a year.

(a) 0.0005

(b) 0.0006

(c) 0.1603

(d) 0.1738

(e) 0.1909

Question 292  standard deviation, risk

Find the sample standard deviation of returns using the data in the table:

Stock Returns
Year	Return pa
2008	0.3
2009	0.02
2010	-0.2
2011	0.4

The returns above and standard deviations below are given in decimal form.

(a) 0.277075

(b) 0.272519

(c) 0.239954

(d) 0.236008

(e) 0.162070

Question 339  bond pricing, inflation, market efficiency, income and capital returns

Economic statistics released this morning were a surprise: they show a strong chance of consumer price inflation (CPI) reaching 5% pa over the next 2 years.

This is much higher than the previous forecast of 3% pa.

A vanilla fixed-coupon 2-year risk-free government bond was issued at par this morning, just before the economic news was released.

What is the expected change in bond price after the economic news this morning, and in the next 2 years? Assume that:

• Inflation remains at 5% over the next 2 years.
• Investors demand a constant real bond yield.
• The bond price falls by the (after-tax) value of the coupon the night before the ex-coupon date, as in real life.

(a) Today the price would have increased significantly.
Over the next 2 years, the bond price is expected to increase, measured on each ex-coupon date.

(b) Today the price would have increased significantly.
Over the next 2 years, the bond price is expected to be unchanged, measured on each ex-coupon date.

(c) Today the price would have been unchanged.
Over the next 2 years, the bond price is expected to increase, measured on each ex-coupon date.

(d) Today the price would have decreased significantly.
Over the next 2 years, the bond price is expected to increase, measured on each ex-coupon date.

(e) Today the price would have decreased significantly.
Over the next 2 years, the bond price is expected to be unchanged, measured on each ex-coupon date.

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 441  DDM, income and capital returns

A fairly valued share's current price is $4 and it has a total required return of 30%. Dividends are paid annually and next year's dividend is expected to be $1. After that, dividends are expected to grow by 5% pa in perpetuity. All rates are effective annual returns.

What is the expected dividend income paid at the end of the second year (t=2) and what is the expected capital gain from just after the first dividend (t=1) to just after the second dividend (t=2)? The answers are given in the same order, the dividend and then the capital gain.

(a) $1.3, $0.26

(b) $1.25, $0.25

(c) $1.1025, $0.2205

(d) $1.05, $0.21

(e) $1, $0.2

Question 687  option, no explanation

Which of the following statements about call options is NOT correct?

(a) Buyers of call options are required to pay an initial margin at the start.

(b) Call options are a zero-sum game in the sense that the winner gains at the expense of the loser.

(c) Buyers of call options have to pay the option price at the start.

(d) Buyers of call options do not care about the credit risk of the original call option seller since the contract is novated by the exchange.

(e) Speculators who sell call options hope that the underlying asset price falls.

Question 737  financial statement, balance sheet, income statement

Where can a publicly listed firm's book value of equity be found? It can be sourced from the company's:

(a) Income statement

(b) Balance sheet

(c) Cash flow statement

(d) Stock exchange data

(e) It's not published, it can only be estimated using multiples or discounted cash flow methods.

Question 863  option, binomial option pricing

A one year European-style call option has a strike price of $4. The option's underlying stock pays no dividends and currently trades at $5. The risk-free interest rate is 10% pa continuously compounded. Use a single step binomial tree to calculate the option price, assuming that the price could rise to $8 ##(u = 1.6)## or fall to $3.125 ##(d = 1/1.6)## in one year. The call option price now is:

(a) 1.336851119

(b) 1.782468159

(c) 1.836881513

(d) 1.969931972

(e) 2.030068028

Question 909  money market, bank accepted bill

By convention, money market securities' yields are always quoted as:

(a) Simple annual rates.

(b) Effective annual rates.

(c) Annualised percentage rates compounding per month

(d) Annualised percentage rates compounding semi-annually

(e) Continuously compounded annual rates.