The below screenshot of Commonwealth Bank of Australia's (CBA) details were taken from the Google Finance website on 7 Nov 2014. Some information has been deliberately blanked out.

What was CBA's market capitalisation of equity?

The below screenshot of Microsoft's (MSFT) details were taken from the Google Finance website on 28 Nov 2014. Some information has been deliberately blanked out.

What was MSFT's market capitalisation of equity?

Which of the following statements about book and market equity is **NOT** correct?

**Question 461** book and market values, ROE, ROA, market efficiency

One year ago a pharmaceutical firm floated by selling its 1 million shares for $100 each. Its book and market values of equity were both $100m. Its debt totalled $50m. The required return on the firm's assets was 15%, equity 20% and debt 5% pa.

In the year since then, the firm:

- Earned net income of $29m.
- Paid dividends totaling $10m.
- Discovered a valuable new drug that will lead to a massive 1,000 times increase in the firm's net income in 10 years after the research is commercialised. News of the discovery was publicly announced. The firm's systematic risk remains unchanged.

Which of the following statements is **NOT** correct? All statements are about current figures, not figures one year ago.

**Hint**: Book return on assets (ROA) and book return on equity (ROE) are ratios that accountants like to use to measure a business's *past* performance.

###\text{ROA}= \dfrac{\text{Net income}}{\text{Book value of assets}}###

###\text{ROE}= \dfrac{\text{Net income}}{\text{Book value of equity}}###

The required return on assets ##r_V## is a return that financiers like to use to estimate a business's *future* required performance which compensates them for the firm's assets' risks. If the business were to achieve realised historical returns equal to its required returns, then investment into the business's assets would have been a zero-NPV decision, which is neither good nor bad but fair.

###r_\text{V, 0 to 1}= \dfrac{\text{Cash flow from assets}_\text{1}}{\text{Market value of assets}_\text{0}} = \dfrac{CFFA_\text{1}}{V_\text{0}}###

Similarly for equity and debt.

**Question 498** NPV, Annuity, perpetuity with growth, multi stage growth model

A business project is expected to cost $100 now (t=0), then pay $10 at the end of the third (t=3), fourth, fifth and sixth years, and then grow by 5% pa every year forever. So the cash flow will be $10.5 at the end of the seventh year (t=7), then $11.025 at the end of the eighth year (t=8) and so on perpetually. The total required return is 10℅ pa.

Which of the following formulas will **NOT** give the correct net present value of the project?

A stock is expected to pay a dividend of $15 in one year (t=1), then $25 for 9 years after that (payments at t=2 ,3,...10), and on the 11th year (t=11) the dividend will be 2% less than at t=10, and will continue to shrink at the same rate every year after that forever. The required return of the stock is 10%. All rates are effective annual rates.

What is the price of the stock now?

Discounted cash flow (DCF) valuation prices assets by finding the present value of the asset's future cash flows. The single cash flow, annuity, and perpetuity equations are very useful for this.

Which of the following equations is the 'perpetuity with growth' equation?

The following equation is called the Dividend Discount Model (DDM), Gordon Growth Model or the perpetuity with growth formula: ### P_0 = \frac{ C_1 }{ r - g } ###

What is ##g##? The value ##g## is the long term expected:

For a price of $13, Carla will sell you a share which will pay a dividend of $1 in one year and every year after that forever. The required return of the stock is 10% pa.

The first payment of a constant perpetual annual cash flow is received at time 5. Let this cash flow be ##C_5## and the required return be ##r##.

So there will be equal annual cash flows at time 5, 6, 7 and so on forever, and all of the cash flows will be equal so ##C_5 = C_6 = C_7 = ...##

When the perpetuity formula is used to value this stream of cash flows, it will give a value (V) at time:

For a price of $1040, Camille will sell you a share which just paid a dividend of $100, and is expected to pay dividends every year forever, growing at a rate of 5% pa.

So the next dividend will be ##100(1+0.05)^1=$105.00##, and the year after it will be ##100(1+0.05)^2=110.25## and so on.

The required return of the stock is 15% pa.

The following equation is the Dividend Discount Model, also known as the 'Gordon Growth Model' or the 'Perpetuity with growth' equation.

### P_{0} = \frac{C_1}{r_{\text{eff}} - g_{\text{eff}}} ###

What would you call the expression ## C_1/P_0 ##?

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:

A stock **just paid** its annual dividend of $9. The share price is $60. The required return of the stock is 10% pa as an effective annual rate.

What is the implied growth rate of the dividend per year?

**Question 497** income and capital returns, DDM, ex dividend date

A stock will pay you a dividend of $**10** **tonight** if you buy it **today**. Thereafter the annual dividend is expected to grow by **5**% pa, so the next dividend after the $10 one tonight will be $10.50 in one year, then in two years it will be $11.025 and so on. The stock's required return is **10**% pa.

What is the stock price today and what do you expect the stock price to be tomorrow, approximately?

The following equation is the Dividend Discount Model, also known as the 'Gordon Growth Model' or the 'Perpetuity with growth' equation.

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

A stock pays dividends annually. It just paid a dividend, but the next dividend (##d_1##) will be paid in one year.

According to the DDM, what is the correct formula for the expected price of the stock in 2.5 years?

In the dividend discount model:

###P_0 = \dfrac{C_1}{r-g}###

The return ##r## is supposed to be the:

Two years ago Fred bought a house for $**300,000**.

Now it's worth $**500,000**, based on recent similar sales in the area.

Fred's residential property has an expected total return of **8**% pa.

He rents his house out for $**2,000** per month, paid in advance. Every 12 months he plans to increase the rental payments.

The present value of 12 months of rental payments is $**23,173.86**.

The future value of 12 months of rental payments one year ahead is $**25,027.77**.

What is the expected annual growth rate of the rental payments? In other words, by what percentage increase will Fred have to raise the monthly rent by each year to sustain the expected annual total return of 8%?

**Question 50** DDM, stock pricing, inflation, real and nominal returns and cash flows

Most listed Australian companies pay dividends twice per year, the 'interim' and 'final' dividends, which are roughly 6 months apart.

You are an equities analyst trying to value the company BHP. You decide to use the Dividend Discount Model (DDM) as a starting point, so you study BHP's dividend history and you find that BHP tends to pay the same interim and final dividend each year, and that both grow by the same rate.

You expect BHP will pay a $0.55 interim dividend in six months and a $0.55 final dividend in one year. You expect each to grow by 4% next year and forever, so the interim and final dividends next year will be $0.572 each, and so on in perpetuity.

Assume BHP's cost of equity is 8% pa. All rates are quoted as nominal effective rates. The dividends are nominal cash flows and the inflation rate is 2.5% pa.

What is the current price of a BHP share?

A stock is expected to pay the following dividends:

Cash Flows of a Stock | ||||||

Time (yrs) | 0 | 1 | 2 | 3 | 4 | ... |

Dividend ($) | 0.00 | 1.00 | 1.05 | 1.10 | 1.15 | ... |

After year 4, the annual dividend will grow in perpetuity at 5% pa, so;

- the dividend at t=5 will be $1.15(1+0.05),
- the dividend at t=6 will be $1.15(1+0.05)^2, and so on.

The required return on the stock is 10% pa. Both the growth rate and required return are given as effective annual rates. What is the current price of the stock?

A stock is expected to pay the following dividends:

Cash Flows of a Stock | ||||||

Time (yrs) | 0 | 1 | 2 | 3 | 4 | ... |

Dividend ($) | 0.00 | 1.00 | 1.05 | 1.10 | 1.15 | ... |

After year 4, the annual dividend will grow in perpetuity at 5% pa, so;

- the dividend at t=5 will be $1.15(1+0.05),
- the dividend at t=6 will be $1.15(1+0.05)^2, and so on.

The required return on the stock is 10% pa. Both the growth rate and required return are given as effective annual rates.

What will be the price of the stock in three and a half years (t = 3.5)?

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 ##?

The following equation is the Dividend Discount Model, also known as the 'Gordon Growth Model' or the 'Perpetuity with growth' equation.

### p_0 = \frac{d_1}{r - g} ###

Which expression is **NOT** equal to the expected dividend yield?

###p_0=\frac{d_1}{r_\text{eff}-g_\text{eff}}###

Which expression is **NOT** equal to the expected capital return?

**Question 535** DDM, real and nominal returns and cash flows, stock pricing

You are an equities analyst trying to value the equity of the Australian telecoms company Telstra, with ticker TLS. In Australia, listed companies like Telstra tend to pay dividends every **6** months. The payment around August is called the final dividend and the payment around February is called the interim dividend. Both occur annually.

- Today is mid-
**March 2015**. - TLS's last interim dividend of $
**0.15**was one month ago in mid-**February 2015**. - TLS's last final dividend of $
**0.15**was seven months ago in mid-**August 2014**.

Judging by TLS's dividend history and prospects, you estimate that the nominal dividend growth rate will be **1**% pa. Assume that TLS's total nominal cost of equity is **6**% pa. The dividends are nominal cash flows and the inflation rate is **2.5**% pa. All rates are quoted as nominal effective annual rates. Assume that each month is exactly one twelfth (1/12) of a year, so you can ignore the number of days in each month.

Calculate the current TLS share price.

Estimate the US bank JP Morgan's share price using a price earnings (PE) multiples approach with the following assumptions and figures only:

- The major US banks JP Morgan Chase (JPM), Citi Group (C) and Wells Fargo (WFC) are comparable companies;
- JP Morgan Chase's historical earnings per share (EPS) is $
**4.37**; - Citi Group's share price is $
**50.05**and historical EPS is $**4.26**; - Wells Fargo's share price is $
**48.98**and historical EPS is $**3.89**.

Note: Figures sourced from Google Finance on 24 March 2014.

Estimate the Chinese bank ICBC's share price using a backward-looking price earnings (PE) multiples approach with the following assumptions and figures only. Note that the renminbi (RMB) is the Chinese currency, also known as the yuan (CNY).

- The 4 major Chinese banks ICBC, China Construction Bank (CCB), Bank of China (BOC) and Agricultural Bank of China (ABC) are comparable companies;
- ICBC 's historical earnings per share (EPS) is RMB
**0.74**; - CCB's backward-looking PE ratio is
**4.59**; - BOC 's backward-looking PE ratio is
**4.78**; - ABC's backward-looking PE ratio is also
**4.78**;

Note: Figures sourced from Google Finance on 25 March 2014. Share prices are from the Shanghai stock exchange.

Which of the following statements is **NOT** equivalent to the **yield** on debt?

Assume that the debt being referred to is fairly priced, but do not assume that it's priced at par.

Your friend is trying to find the net present value of a project. The project is expected to last for just one year with:

- a negative cash flow of
**-**$**1**million initially (t=0), and - a positive cash flow of $
**1.1**million in one year (t=1).

The project has a total required return of 10% pa due to its moderate level of undiversifiable risk.

Your friend is aware of the importance of opportunity costs and the time value of money, but he is unsure of how to find the NPV of the project.

He knows that the opportunity cost of investing the $1m in the project is the expected gain from investing the money in shares instead. Like the project, shares also have an expected return of 10% since they have moderate undiversifiable risk. This opportunity cost is $0.1m ##(=1m \times 10\%)## which occurs in one year (t=1).

He knows that the time value of money should be accounted for, and this can be done by finding the present value of the cash flows in one year.

Your friend has listed a few different ways to find the NPV which are written down below.

(I) ##-1m + \dfrac{1.1m}{(1+0.1)^1} ##

(II) ##-1m + \dfrac{1.1m}{(1+0.1)^1} - \dfrac{1m}{(1+0.1)^1} \times 0.1 ##

(III) ##-1m + \dfrac{1.1m}{(1+0.1)^1} - \dfrac{1.1m}{(1+0.1)^1} \times 0.1 ##

(IV) ##-1m + 1.1m - \dfrac{1.1m}{(1+0.1)^1} \times 0.1 ##

(V) ##-1m + 1.1m - 1.1m \times 0.1 ##

Which of the above calculations give the correct NPV? Select the most correct answer.

A young lady is trying to decide if she should attend university or not.

The young lady's parents say that she must attend university because otherwise all of her hard work studying and attending school during her childhood was a waste.

What's the correct way to classify this item from a capital budgeting perspective when trying to decide whether to attend university?

The hard work studying at school in her childhood should be classified as:

A young lady is trying to decide if she should attend university. Her friends say that she should go to university because she is more likely to meet a clever young man than if she begins full time work straight away.

What's the correct way to classify this item from a capital budgeting perspective when trying to find the Net Present Value of going to university rather than working?

The opportunity to meet a desirable future spouse should be classified as:

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 man has taken a day off from his casual painting job to relax.

It's the end of the day and he's thinking about the hours that he could have spent working (in the past) which are now:

What is the net present value (NPV) of undertaking a full-time Australian undergraduate business degree as an Australian citizen? Only include the cash flows over the duration of the degree, ignore any benefits or costs of the degree after it's completed.

Assume the following:

- The degree takes
**3**years to complete and all students pass all subjects. - There are
**2**semesters per year and**4**subjects per semester. - University fees per subject per semester are
**$1,277**, paid at the**start**of each semester. Fees are expected to stay constant for the next 3 years. - There are
**52**weeks per year. - The first semester is just about to start (t=0). The first semester lasts for 19 weeks (t=
**0**to**19**). - The second semester starts immediately afterwards (t=19) and lasts for another 19 weeks (t=
**19**to**38**). - The summer holidays begin after the second semester ends and last for
**14**weeks (t=**38**to**52**). Then the first semester begins the next year, and so on. - Working full time at the grocery store instead of studying full-time pays
**$20**/hr and you can work**35**hours per week. Wages are paid at the**end**of each week. - Full-time students can work full-time during the summer holiday at the grocery store for the same rate of $20/hr for 35 hours per week. Wages are paid at the end of each week.
- The discount rate is
**9.8%**pa. All rates and cash flows are real. Inflation is expected to be**3%**pa. All rates are effective annual.

The NPV of costs from undertaking the university degree is:

Which of the below statements about effective rates and annualised percentage rates (APR's) is **NOT** correct?

Which of the following statements about effective rates and annualised percentage rates (APR's) is **NOT** correct?

A credit card offers an interest rate of 18% pa, compounding monthly.

Find the effective monthly rate, effective annual rate and the effective daily rate. Assume that there are 365 days in a year.

All answers are given in the same order:

### r_\text{eff monthly} , r_\text{eff yearly} , r_\text{eff daily} ###

A European bond paying annual coupons of 6% offers a yield of 10% pa.

Convert the yield into an effective monthly rate, an effective annual rate and an effective daily rate. Assume that there are 365 days in a year.

All answers are given in the same order:

### r_\text{eff, monthly} , r_\text{eff, yearly} , r_\text{eff, daily} ###

Calculate the effective annual rates of the following three APR's:

- A credit card offering an interest rate of 18% pa, compounding monthly.
- A bond offering a yield of 6% pa, compounding semi-annually.
- An annual dividend-paying stock offering a return of 10% pa compounding annually.

All answers are given in the same order:

##r_\text{credit card, eff yrly}##, ##r_\text{bond, eff yrly}##, ##r_\text{stock, eff yrly}##

**Question 49** inflation, real and nominal returns and cash flows, APR, effective rate

In Australia, nominal yields on **semi**-annual coupon paying Government Bonds with 2 years until maturity are currently **2.83**% pa.

The inflation rate is currently **2.2**% pa, given as an APR compounding per **quarter**. The inflation rate is not expected to change over the next 2 years.

What is the real yield on these bonds, given as an APR compounding every 6 months?

**Question 64** inflation, real and nominal returns and cash flows, APR, effective rate

In Germany, nominal yields on **semi**-annual coupon paying Government Bonds with 2 years until maturity are currently **0.04**% pa.

The inflation rate is currently **1.4**% pa, given as an APR compounding per **quarter**. The inflation rate is not expected to change over the next 2 years.

What is the real yield on these bonds, given as an APR compounding every 6 months?

On his 20th birthday, a man makes a resolution. He will deposit $**30** into a bank account at the **end** of every month starting from now, which is the start of the month. So the first payment will be in one month. He will write in his will that when he dies the money in the account should be given to charity.

The bank account pays interest at **6**% pa compounding **monthly**, which is not expected to change.

If the man lives for another **60** years, how much money will be in the bank account if he dies just after making his last (720th) payment?

You want to buy an apartment priced at $300,000. You have saved a deposit of $30,000. The bank has agreed to lend you the $270,000 as a **fully amortising** loan with a term of 25 years. The interest rate is 12% pa and is not expected to change.

What will be your monthly payments? Remember that mortgage loan payments are paid in arrears (at the end of the month).

You want to buy an apartment worth $500,000. You have saved a deposit of $50,000. The bank has agreed to lend you the $450,000 as a **fully amortising** mortgage loan with a term of 25 years. The interest rate is 6% pa and is not expected to change.

What will be your monthly payments?

You want to buy an apartment worth $400,000. You have saved a deposit of $80,000. The bank has agreed to lend you the $320,000 as a **fully amortising** mortgage loan with a term of 30 years. The interest rate is 6% pa and is not expected to change. What will be your monthly payments?

You want to buy an apartment priced at $500,000. You have saved a deposit of $50,000. The bank has agreed to lend you the $450,000 as a **fully amortising** loan with a term of 30 years. The interest rate is 6% pa and is not expected to change. What will be your monthly payments?

You just signed up for a 30 year **fully amortising** mortgage loan with monthly payments of $2,000 per month. The interest rate is 9% pa which is not expected to change.

How much did you borrow? After 5 years, how much will be owing on the mortgage? The interest rate is still 9% and is not expected to change.

You just signed up for a 30 year **fully amortising** mortgage with monthly payments of $1,000 per month. The interest rate is 6% pa which is not expected to change.

How much did you borrow? After 20 years, how much will be owing on the mortgage? The interest rate is still 6% and is not expected to change.

You just signed up for a 30 year **fully amortising** mortgage loan with monthly payments of $1,500 per month. The interest rate is 9% pa which is not expected to change.

How much did you borrow? After 10 years, how much will be owing on the mortgage? The interest rate is still 9% and is not expected to change.

You just signed up for a 30 year **fully amortising** mortgage loan with monthly payments of $1,500 per month. The interest rate is 9% pa which is not expected to change.

To your surprise, you can actually afford to pay $2,000 per month and your mortgage allows early repayments without fees. If you maintain these higher monthly payments, how long will it take to pay off your mortgage?

You just agreed to a 30 year **fully amortising** mortgage loan with monthly payments of $2,500. The interest rate is 9% pa which is not expected to change.

How much did you borrow? After 10 years, how much will be owing on the mortgage? The interest rate is still 9% and is not expected to change. The below choices are given in the same order.

You want to buy a house priced at $400,000. You have saved a deposit of $40,000. The bank has agreed to lend you $360,000 as a **fully amortising** loan with a term of 30 years. The interest rate is 8% pa payable monthly and is not expected to change.

What will be your monthly payments?

You want to buy an apartment priced at $300,000. You have saved a deposit of $30,000. The bank has agreed to lend you the $270,000 as an **interest only** loan with a term of 25 years. The interest rate is 12% pa and is not expected to change.

What will be your monthly payments? Remember that mortgage payments are paid in arrears (at the end of the month).

You just signed up for a 30 year **interest-only** mortgage with monthly payments of $3,000 per month. The interest rate is 6% pa which is not expected to change.

How much did you borrow? After 15 years, just after the 180th payment at that time, how much will be owing on the mortgage? The interest rate is still 6% and is not expected to change. Remember that the mortgage is interest-only and that mortgage payments are paid in arrears (at the end of the month).

You want to buy an apartment worth $300,000. You have saved a deposit of $60,000.

The bank has agreed to lend you $240,000 as an **interest only** mortgage loan with a term of 30 years. The interest rate is 6% pa and is not expected to change. What will be your monthly payments?

You want to buy an apartment priced at $500,000. You have saved a deposit of $50,000. The bank has agreed to lend you the $450,000 as an **interest only** loan with a term of 30 years. The interest rate is 6% pa and is not expected to change. What will be your monthly payments?

**Question 239** income and capital returns, inflation, real and nominal returns and cash flows, interest only loan

A bank grants a borrower an **interest-only** residential mortgage loan with a very large 50% deposit and a **nominal** interest rate of **6%** that is not expected to change. Assume that inflation is expected to be a **constant 2%** pa over the life of the loan. Ignore credit risk.

From the bank's point of view, what is the long term expected **nominal capital** return of the loan asset?

A prospective home buyer can afford to pay $2,000 per month in mortgage loan repayments. The central bank recently lowered its policy rate by 0.25%, and residential home lenders cut their mortgage loan rates from 4.74% to 4.49%.

How much more can the prospective home buyer borrow now that interest rates are **4.49%** rather than **4.74%**? Give your answer as a proportional increase over the original amount he could borrow (##V_\text{before}##), so:

Assume that:

- Interest rates are expected to be
**constant**over the life of the loan. - Loans are
**interest-only**and have a life of 30 years. - Mortgage loan payments are made every month in arrears and all interest rates are given as annualised percentage rates compounding per month.

In Australia in the 1980's, inflation was around 8% pa, and residential mortgage loan interest rates were around 14%.

In 2013, inflation was around 2.5% pa, and residential mortgage loan interest rates were around 4.5%.

If a person can afford constant mortgage loan payments of $**2,000** per month, how much more can they borrow when interest rates are **4.5**% pa compared with **14.0**% pa?

Give your answer as a proportional increase over the amount you could borrow when interest rates were high ##(V_\text{high rates})##, so:

###\text{Proportional increase} = \dfrac{V_\text{low rates}-V_\text{high rates}}{V_\text{high rates}} ###

Assume that:

- Interest rates are expected to be constant over the life of the loan.
- Loans are
**interest-only**and have a life of**30**years. - Mortgage loan payments are made every month in arrears and all interest rates are given as annualised percentage rates (
**APR**'s) compounding per**month**.

You just borrowed $400,000 in the form of a 25 year **interest-only** mortgage with monthly payments of $3,000 per month. The interest rate is 9% pa which is not expected to change.

You actually plan to pay more than the required interest payment. You plan to pay $3,300 in mortgage payments every month, which your mortgage lender allows. These extra payments will reduce the principal and the minimum interest payment required each month.

At the maturity of the mortgage, what will be the principal? That is, after the last (300th) interest payment of $3,300 in 25 years, how much will be owing on the mortgage?

Calculate the price of a newly issued **ten** year bond with a face value of $**100**, a yield of **8**% pa and a fixed coupon rate of **6**% pa, paid **annually**. So there's only one coupon per year, paid in arrears every year.

Calculate the price of a newly issued **ten** year bond with a face value of $**100**, a yield of **8**% pa and a fixed coupon rate of **6**% pa, paid **semi**-annually. So there are two coupons per year, paid in arrears every six months.

For a price of $100, Vera will sell you a 2 year bond paying semi-annual coupons of 10% pa. The face value of the bond is $100. Other bonds with similar risk, maturity and coupon characteristics trade at a yield of 8% pa.

For a price of $95, Nicole will sell you a 10 year bond paying semi-annual coupons of 8% pa. The face value of the bond is $100. Other bonds with the same risk, maturity and coupon characteristics trade at a yield of 8% pa.

Bonds X and Y are issued by the same US company. Both bonds yield **10**% pa, and they have the same face value ($100), maturity, seniority, and payment frequency.

The only difference is that bond X and Y's **coupon rates** are **8** and **12**% pa respectively. Which of the following statements is true?

Bonds A and B are issued by the same company. They have the same face value, maturity, seniority and coupon payment frequency. The only difference is that bond A has a 5% coupon rate, while bond B has a 10% coupon rate. The yield curve is flat, which means that yields are expected to stay the same.

Which bond would have the higher current price?

A two year Government bond has a face value of $100, a yield of 0.5% and a fixed coupon rate of 0.5%, paid semi-annually. What is its price?

**Question 48** IRR, NPV, bond pricing, premium par and discount bonds, market efficiency

The theory of fixed interest bond pricing is an application of the theory of Net Present Value (NPV). Also, a 'fairly priced' asset is not over- or under-priced. Buying or selling a fairly priced asset has an NPV of zero.

Considering this, which of the following statements is **NOT** correct?

A two year Government bond has a face value of $100, a yield of 2.5% pa and a fixed coupon rate of 0.5% pa, paid semi-annually. What is its price?

**Question 56** income and capital returns, bond pricing, premium par and discount bonds

Which of the following statements about risk free government bonds is **NOT** correct?

**Hint:** Total return can be broken into income and capital returns as follows:

###\begin{aligned} r_\text{total} &= \frac{c_1}{p_0} + \frac{p_1-p_0}{p_0} \\ &= r_\text{income} + r_\text{capital} \end{aligned} ###

The capital return is the growth rate of the price.

The income return is the periodic cash flow. For a bond this is the coupon payment.

The theory of fixed interest bond pricing is an application of the theory of Net Present Value (NPV). Also, a 'fairly priced' asset is not over- or under-priced. Buying or selling a fairly priced asset has an NPV of zero.

Considering this, which of the following statements is **NOT** correct?

A bond maturing in 10 years has a coupon rate of 4% pa, paid semi-annually. The bond's yield is currently 6% pa. The face value of the bond is $100. What is its price?

Bonds A and B are issued by the same Australian company. Both bonds yield 7% pa, and they have the same face value ($100), maturity, seniority, and payment frequency.

The only difference is that bond A pays coupons of 10% pa and bond B pays coupons of 5% pa. Which of the following statements is true about the bonds' prices?

Bonds X and Y are issued by different companies, but they both pay a semi-annual coupon of **10**% pa and they have the same face value ($100) and maturity (3 years).

The only difference is that bond X and Y's **yields** are **8** and **12**% pa respectively. Which of the following statements is true?

A three year bond has a fixed coupon rate of 12% pa, paid semi-annually. The bond's yield is currently 6% pa. The face value is $100. What is its price?

Bonds X and Y are issued by different companies, but they both pay a semi-annual coupon of 10% pa and they have the same face value ($100), maturity (3 years) and yield (10%) as each other.

Which of the following statements is true?

A four year bond has a face value of $100, a yield of 6% and a fixed coupon rate of 12%, paid semi-annually. What is its price?

Which one of the following bonds is trading at a discount?

A firm wishes to raise $20 million now. They will issue 8% pa semi-annual coupon bonds that will mature in 5 years and have a face value of $100 each. Bond yields are 6% pa, given as an APR compounding every 6 months, and the yield curve is flat.

How many bonds should the firm issue?

A five year bond has a face value of $100, a yield of 12% and a fixed coupon rate of 6%, paid semi-annually.

What is the bond's price?

Which one of the following bonds is trading at par?

A firm wishes to raise $8 million now. They will issue 7% pa semi-annual coupon bonds that will mature in 10 years and have a face value of $100 each. Bond yields are 10% pa, given as an APR compounding every 6 months, and the yield curve is flat.

How many bonds should the firm issue?

**Question 207** income and capital returns, bond pricing, coupon rate, no explanation

For a bond that pays fixed semi-annual coupons, how is the annual coupon rate defined, and how is the bond's annual income yield from time 0 to 1 defined mathematically?

Let: ##P_0## be the bond price now,

##F_T## be the bond's face value,

##T## be the bond's maturity in years,

##r_\text{total}## be the bond's total yield,

##r_\text{income}## be the bond's income yield,

##r_\text{capital}## be the bond's capital yield, and

##C_t## be the bond's coupon at time t in years. So ##C_{0.5}## is the coupon in 6 months, ##C_1## is the coupon in 1 year, and so on.

**Question 213** income and capital returns, bond pricing, premium par and discount bonds

The coupon rate of a fixed annual-coupon bond is constant (always the same).

What can you say about the income return (##r_\text{income}##) of a fixed annual coupon bond? Remember that:

###r_\text{total} = r_\text{income} + r_\text{capital}###

###r_\text{total, 0 to 1} = \frac{c_1}{p_0} + \frac{p_1-p_0}{p_0}###

Assume that there is no change in the bond's total annual yield to maturity from when it is issued to when it matures.

Select the most correct statement.

From its date of issue until maturity, the **income return** of a fixed annual coupon:

Which one of the following bonds is trading at a premium?

An investor bought two fixed-coupon bonds issued by the same company, a zero-coupon bond and a 7% pa semi-annual coupon bond. Both bonds have a face value of $1,000, mature in 10 years, and had a yield at the time of purchase of 8% pa.

A few years later, yields fell to 6% pa. Which of the following statements is correct? Note that a capital gain is an increase in price.

A firm wishes to raise $10 million now. They will issue 6% pa semi-annual coupon bonds that will mature in 8 years and have a face value of $1,000 each. Bond yields are 10% pa, given as an APR compounding every 6 months, and the yield curve is flat.

How many bonds should the firm issue?

A four year bond has a face value of $100, a yield of 9% and a fixed coupon rate of 6%, paid semi-annually. What is its price?

In these tough economic times, central banks around the world have cut interest rates so low that they are practically zero. In some countries, government bond yields are also very close to zero.

A three year government bond with a face value of $100 and a coupon rate of 2% pa paid semi-annually was just issued at a yield of 0%. What is the price of the bond?

A 10 year bond has a face value of $100, a yield of 6% pa and a fixed coupon rate of 8% pa, paid semi-annually. What is its price?

Bonds X and Y are issued by the same company. Both bonds yield 10% pa, and they have the same face value ($100), maturity, seniority, and payment frequency.

The only difference is that bond X pays coupons of 6% pa and bond Y pays coupons of 8% pa. Which of the following statements is true?

A **30** year Japanese government bond was just issued at **par** with a yield of **1.7**% pa. The fixed coupon payments are **semi-annual**. The bond has a face value of $**100**.

**Six months** later, just **after** the first coupon is paid, the yield of the bond increases to **2**% pa. What is the bond's **new** price?

There are many different ways to value a firm's assets. Which of the following will **NOT** give the correct market value of a levered firm's assets ##(V_L)##? Assume that:

- The firm is financed by listed common stock and vanilla annual fixed coupon bonds, which are both traded in a liquid market.
- The bonds' yield is equal to the coupon rate, so the bonds are issued at par. The yield curve is flat and yields are not expected to change. When bonds mature they will be rolled over by issuing the same number of new bonds with the same expected yield and coupon rate, and so on forever.
- Tax rates on the dividends and capital gains received by investors are equal, and capital gains tax is paid every year, even on unrealised gains regardless of when the asset is sold.
- There is no re-investment of the firm's cash back into the business. All of the firm's excess cash flow is paid out as dividends so real growth is zero.
- The firm operates in a mature industry with zero real growth.
- All cash flows and rates in the below equations are real (not nominal) and are expected to be stable forever. Therefore the perpetuity equation with no growth is suitable for valuation.

Where:

###r_\text{WACC before tax} = r_D.\frac{D}{V_L} + r_{EL}.\frac{E_L}{V_L} = \text{Weighted average cost of capital before tax}### ###r_\text{WACC after tax} = r_D.(1-t_c).\frac{D}{V_L} + r_{EL}.\frac{E_L}{V_L} = \text{Weighted average cost of capital after tax}### ###NI_L=(Rev-COGS-FC-Depr-\mathbf{IntExp}).(1-t_c) = \text{Net Income Levered}### ###CFFA_L=NI_L+Depr-CapEx - \varDelta NWC+\mathbf{IntExp} = \text{Cash Flow From Assets Levered}### ###NI_U=(Rev-COGS-FC-Depr).(1-t_c) = \text{Net Income Unlevered}### ###CFFA_U=NI_U+Depr-CapEx - \varDelta NWC= \text{Cash Flow From Assets Unlevered}###A **10** year Australian government bond was just issued at **par** with a yield of **3.9**% pa. The fixed coupon payments are **semi-annual**. The bond has a face value of $**1,000**.

**Six months** later, just **after** the first coupon is paid, the yield of the bond decreases to **3.65**% pa. What is the bond's **new price**?

Bonds X and Y are issued by the same US company. Both bonds yield **6**% pa, and they have the same face value ($100), maturity, seniority, and payment frequency.

The only difference is that bond X pays coupons of **8**% pa and bond Y pays coupons of **12**% pa. Which of the following statements is true?

Below are some statements about loans and bonds. The first descriptive sentence is correct. But one of the second sentences about the loans' or bonds' prices is not correct. Which statement is **NOT** correct? Assume that interest rates are positive.

Note that coupons or interest payments are the periodic payments made throughout a bond or loan's life. The face or par value of a bond or loan is the amount paid at the end when the debt matures.

Find Candys Corporation's Cash Flow From Assets (CFFA), also known as Free Cash Flow to the Firm (FCFF), over the year ending 30th June 2013.

Candys Corp | ||

Income Statement for | ||

year ending 30th June 2013 | ||

$m | ||

Sales | 200 | |

COGS | 50 | |

Operating expense | 10 | |

Depreciation | 20 | |

Interest expense | 10 | |

Income before tax | 110 | |

Tax at 30% | 33 | |

Net income | 77 | |

Candys Corp | ||

Balance Sheet | ||

as at 30th June | 2013 | 2012 |

$m | $m | |

Assets | ||

Current assets | 220 | 180 |

PPE | ||

Cost | 300 | 340 |

Accumul. depr. | 60 | 40 |

Carrying amount | 240 | 300 |

Total assets | 460 | 480 |

Liabilities | ||

Current liabilities | 175 | 190 |

Non-current liabilities | 135 | 130 |

Owners' equity | ||

Retained earnings | 50 | 60 |

Contributed equity | 100 | 100 |

Total L and OE | 460 | 480 |

Note: all figures are given in millions of dollars ($m).

Why is Capital Expenditure (CapEx) subtracted in the Cash Flow From Assets (CFFA) formula?

###CFFA=NI+Depr-CapEx - \Delta NWC+IntExp###

A firm has forecast its Cash Flow From Assets (CFFA) for this year and management is worried that it is too low. Which one of the following actions will lead to a higher CFFA for this year (t=0 to 1)? Only consider cash flows this year. Do not consider cash flows after one year, or the change in the NPV of the firm. Consider each action in isolation.

A company increases the proportion of debt funding it uses to finance its assets by issuing bonds and using the cash to repurchase stock, leaving assets unchanged.

Ignoring the costs of financial distress, which of the following statements is **NOT** correct:

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###Find Sidebar Corporation's Cash Flow From Assets (CFFA), also known as Free Cash Flow to the Firm (FCFF), over the year ending 30th June 2013.

Sidebar Corp | ||

Income Statement for | ||

year ending 30th June 2013 | ||

$m | ||

Sales | 405 | |

COGS | 100 | |

Depreciation | 34 | |

Rent expense | 22 | |

Interest expense | 39 | |

Taxable Income | 210 | |

Taxes at 30% | 63 | |

Net income | 147 | |

Sidebar Corp | ||

Balance Sheet | ||

as at 30th June | 2013 | 2012 |

$m | $m | |

Inventory | 70 | 50 |

Trade debtors | 11 | 16 |

Rent paid in advance | 4 | 3 |

PPE | 700 | 680 |

Total assets | 785 | 749 |

Trade creditors | 11 | 19 |

Bond liabilities | 400 | 390 |

Contributed equity | 220 | 220 |

Retained profits | 154 | 120 |

Total L and OE | 785 | 749 |

Note: All figures are given in millions of dollars ($m).

The cash flow from assets was:

Over the next year, the management of an unlevered company plans to:

- Achieve firm free cash flow (FFCF or CFFA) of $1m.
- Pay dividends of $1.8m
- Complete a $1.3m share buy-back.
- Spend $0.8m on new buildings without buying or selling any other fixed assets. This capital expenditure is included in the CFFA figure quoted above.

Assume that:

- All amounts are received and paid at the end of the year so you can ignore the time value of money.
- The firm has sufficient retained profits to pay the dividend and complete the buy back.
- The firm plans to run a very tight ship, with no excess cash above operating requirements currently or over the next year.

How much new equity financing will the company need? In other words, what is the value of new shares that will need to be issued?

Which one of the following will have no effect on net income (NI) but decrease cash flow from assets (CFFA or FFCF) 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 - ΔNWC+IntExp###Find Ching-A-Lings Corporation's Cash Flow From Assets (CFFA), also known as Free Cash Flow to the Firm (FCFF), over the year ending 30th June 2013.

Ching-A-Lings Corp | ||

Income Statement for | ||

year ending 30th June 2013 | ||

$m | ||

Sales | 100 | |

COGS | 20 | |

Depreciation | 20 | |

Rent expense | 11 | |

Interest expense | 19 | |

Taxable Income | 30 | |

Taxes at 30% | 9 | |

Net income | 21 | |

Ching-A-Lings Corp | ||

Balance Sheet | ||

as at 30th June | 2013 | 2012 |

$m | $m | |

Inventory | 49 | 38 |

Trade debtors | 14 | 2 |

Rent paid in advance | 5 | 5 |

PPE | 400 | 400 |

Total assets | 468 | 445 |

Trade creditors | 4 | 10 |

Bond liabilities | 200 | 190 |

Contributed equity | 145 | 145 |

Retained profits | 119 | 100 |

Total L and OE | 468 | 445 |

Note: All figures are given in millions of dollars ($m).

The cash flow from assets was:

Over the next year, the management of an **unlevered** company plans to:

- Make $
**5**m in sales, $**1.9m**in net income and $**2**m in equity free cash flow (EFCF). - Pay dividends of $
**1**m. - Complete a $
**1.3**m share buy-back.

Assume that:

- All amounts are received and paid at the end of the year so you can ignore the time value of money.
- The firm has sufficient retained profits to legally pay the dividend and complete the buy back.
- The firm plans to run a very tight ship, with no excess cash above operating requirements currently or over the next year.

How much new equity financing will the company need? In other words, what is the value of new shares that will need to be issued?

Read the following financial statements and calculate the firm's free cash flow over the 2014 financial year.

UBar Corp | ||

Income Statement for | ||

year ending 30th June 2014 | ||

$m | ||

Sales | 293 | |

COGS | 200 | |

Rent expense | 15 | |

Gas expense | 8 | |

Depreciation | 10 | |

EBIT | 60 | |

Interest expense | 0 | |

Taxable income | 60 | |

Taxes | 18 | |

Net income | 42 | |

UBar Corp | ||

Balance Sheet | ||

as at 30th June | 2014 | 2013 |

$m | $m | |

Assets | ||

Cash | 30 | 29 |

Accounts receivable | 5 | 7 |

Pre-paid rent expense | 1 | 0 |

Inventory | 50 | 46 |

PPE | 290 | 300 |

Total assets | 376 | 382 |

Liabilities | ||

Trade payables | 20 | 18 |

Accrued gas expense | 3 | 2 |

Non-current liabilities | 0 | 0 |

Contributed equity | 212 | 212 |

Retained profits | 136 | 150 |

Asset revaluation reserve | 5 | 0 |

Total L and OE | 376 | 382 |

Note: all figures are given in millions of dollars ($m).

The firm's free cash flow over the 2014 financial year was:

Find Trademark Corporation's Cash Flow From Assets (CFFA), also known as Free Cash Flow to the Firm (FCFF), over the year ending 30th June 2013.

Trademark Corp | ||

Income Statement for | ||

year ending 30th June 2013 | ||

$m | ||

Sales | 100 | |

COGS | 25 | |

Operating expense | 5 | |

Depreciation | 20 | |

Interest expense | 20 | |

Income before tax | 30 | |

Tax at 30% | 9 | |

Net income | 21 | |

Trademark Corp | ||

Balance Sheet | ||

as at 30th June | 2013 | 2012 |

$m | $m | |

Assets | ||

Current assets | 120 | 80 |

PPE | ||

Cost | 150 | 140 |

Accumul. depr. | 60 | 40 |

Carrying amount | 90 | 100 |

Total assets | 210 | 180 |

Liabilities | ||

Current liabilities | 75 | 65 |

Non-current liabilities | 75 | 55 |

Owners' equity | ||

Retained earnings | 10 | 10 |

Contributed equity | 50 | 50 |

Total L and OE | 210 | 180 |

Note: all figures are given in millions of dollars ($m).

Find UniBar Corp's Cash Flow From Assets (CFFA), also known as Free Cash Flow to the Firm (FCFF), over the year ending 30th June 2013.

UniBar Corp | ||

Income Statement for | ||

year ending 30th June 2013 | ||

$m | ||

Sales | 80 | |

COGS | 40 | |

Operating expense | 15 | |

Depreciation | 10 | |

Interest expense | 5 | |

Income before tax | 10 | |

Tax at 30% | 3 | |

Net income | 7 | |

UniBar Corp | ||

Balance Sheet | ||

as at 30th June | 2013 | 2012 |

$m | $m | |

Assets | ||

Current assets | 120 | 90 |

PPE | ||

Cost | 360 | 320 |

Accumul. depr. | 40 | 30 |

Carrying amount | 320 | 290 |

Total assets | 440 | 380 |

Liabilities | ||

Current liabilities | 110 | 60 |

Non-current liabilities | 190 | 180 |

Owners' equity | ||

Retained earnings | 95 | 95 |

Contributed equity | 45 | 45 |

Total L and OE | 440 | 380 |

Note: all figures are given in millions of dollars ($m).

Find Piano Bar's Cash Flow From Assets (CFFA), also known as Free Cash Flow to the Firm (FCFF), over the year ending 30th June 2013.

Piano Bar | ||

Income Statement for | ||

year ending 30th June 2013 | ||

$m | ||

Sales | 310 | |

COGS | 185 | |

Operating expense | 20 | |

Depreciation | 15 | |

Interest expense | 10 | |

Income before tax | 80 | |

Tax at 30% | 24 | |

Net income | 56 | |

Piano Bar | ||

Balance Sheet | ||

as at 30th June | 2013 | 2012 |

$m | $m | |

Assets | ||

Current assets | 240 | 230 |

PPE | ||

Cost | 420 | 400 |

Accumul. depr. | 50 | 35 |

Carrying amount | 370 | 365 |

Total assets | 610 | 595 |

Liabilities | ||

Current liabilities | 180 | 190 |

Non-current liabilities | 290 | 265 |

Owners' equity | ||

Retained earnings | 90 | 90 |

Contributed equity | 50 | 50 |

Total L and OE | 610 | 595 |

Note: all figures are given in millions of dollars ($m).

Find World Bar's Cash Flow From Assets (CFFA), also known as Free Cash Flow to the Firm (FCFF), over the year ending 30th June 2013.

World Bar | ||

Income Statement for | ||

year ending 30th June 2013 | ||

$m | ||

Sales | 300 | |

COGS | 150 | |

Operating expense | 50 | |

Depreciation | 40 | |

Interest expense | 10 | |

Taxable income | 50 | |

Tax at 30% | 15 | |

Net income | 35 | |

World Bar | ||

Balance Sheet | ||

as at 30th June | 2013 | 2012 |

$m | $m | |

Assets | ||

Current assets | 200 | 230 |

PPE | ||

Cost | 400 | 400 |

Accumul. depr. | 75 | 35 |

Carrying amount | 325 | 365 |

Total assets | 525 | 595 |

Liabilities | ||

Current liabilities | 150 | 205 |

Non-current liabilities | 235 | 250 |

Owners' equity | ||

Retained earnings | 100 | 100 |

Contributed equity | 40 | 40 |

Total L and OE | 525 | 595 |

Note: all figures above and below are given in millions of dollars ($m).

Find Scubar Corporation's Cash Flow From Assets (CFFA), also known as Free Cash Flow to the Firm (FCFF), over the year ending 30th June 2013.

Scubar Corp | ||

Income Statement for | ||

year ending 30th June 2013 | ||

$m | ||

Sales | 200 | |

COGS | 60 | |

Depreciation | 20 | |

Rent expense | 11 | |

Interest expense | 19 | |

Taxable Income | 90 | |

Taxes at 30% | 27 | |

Net income | 63 | |

Scubar Corp | ||

Balance Sheet | ||

as at 30th June | 2013 | 2012 |

$m | $m | |

Inventory | 60 | 50 |

Trade debtors | 19 | 6 |

Rent paid in advance | 3 | 2 |

PPE | 420 | 400 |

Total assets | 502 | 458 |

Trade creditors | 10 | 8 |

Bond liabilities | 200 | 190 |

Contributed equity | 130 | 130 |

Retained profits | 162 | 130 |

Total L and OE | 502 | 458 |

Note: All figures are given in millions of dollars ($m).

The cash flow from assets was:

Find the cash flow from assets (CFFA) of the following project.

One Year Mining Project Data | ||

Project life | 1 year | |

Initial investment in building mine and equipment | $9m | |

Depreciation of mine and equipment over the year | $8m | |

Kilograms of gold mined at end of year | 1,000 | |

Sale price per kilogram | $0.05m | |

Variable cost per kilogram | $0.03m | |

Before-tax cost of closing mine at end of year | $4m | |

Tax rate | 30% | |

Note 1: Due to the project, the firm also anticipates finding some rare diamonds which will give before-tax revenues of $1m at the end of the year.

Note 2: The land that will be mined actually has thermal springs and a family of koalas that could be sold to an eco-tourist resort for an after-tax amount of $3m right now. However, if the mine goes ahead then this natural beauty will be destroyed.

Note 3: The mining equipment will have a book value of $1m at the end of the year for tax purposes. However, the equipment is expected to fetch $2.5m when it is sold.

Find the project's CFFA at time zero and one. Answers are given in millions of dollars ($m), with the first cash flow at time zero, and the second at time one.

Find the cash flow from assets (CFFA) of the following project.

Project Data | ||

Project life | 2 years | |

Initial investment in equipment | $6m | |

Depreciation of equipment per year for tax purposes | $1m | |

Unit sales per year | 4m | |

Sale price per unit | $8 | |

Variable cost per unit | $3 | |

Fixed costs per year, paid at the end of each year | $1.5m | |

Tax rate | 30% | |

Note 1: The equipment will have a book value of $4m at the end of the project for tax purposes. However, the equipment is expected to fetch $0.9 million when it is sold at t=2.

Note 2: Due to the project, the firm will have to purchase $0.8m of inventory initially, which it will sell at t=1. The firm will buy another $0.8m at t=1 and sell it all again at t=2 with zero inventory left. The project will have no effect on the firm's current liabilities.

Find the project's CFFA at time zero, one and two. Answers are given in millions of dollars ($m).

Value the following business project to manufacture a new product.

Project Data | ||

Project life | 2 yrs | |

Initial investment in equipment | $6m | |

Depreciation of equipment per year | $3m | |

Expected sale price of equipment at end of project | $0.6m | |

Unit sales per year | 4m | |

Sale price per unit | $8 | |

Variable cost per unit | $5 | |

Fixed costs per year, paid at the end of each year | $1m | |

Interest expense per year | 0 | |

Tax rate | 30% | |

Weighted average cost of capital after tax per annum | 10% | |

**Notes**

- The firm's current assets and current liabilities are $3m and $2m respectively right now. This net working capital will not be used in this project, it will be used in other unrelated projects.

Due to the project, current assets (mostly inventory) will grow by $2m initially (at t = 0), and then by $0.2m at the end of the first year (t=1).

Current liabilities (mostly trade creditors) will increase by $0.1m at the end of the first year (t=1).

At the end of the project, the net working capital accumulated due to the project can be sold for the same price that it was bought. - The project cost $0.5m to research which was incurred one year ago.

**Assumptions**

- All cash flows occur at the start or end of the year as appropriate, not in the middle or throughout the year.
- All rates and cash flows are real. The inflation rate is 3% pa.
- All rates are given as effective annual rates.
- The business considering the project is run as a 'sole tradership' (run by an individual without a company) and is therefore eligible for a 50% capital gains tax discount when the equipment is sold, as permitted by the Australian Tax Office.

What is the expected net present value (NPV) of the project?

**Question 295** inflation, real and nominal returns and cash flows, NPV

When valuing assets using discounted cash flow (net present value) methods, it is important to consider inflation. To properly deal with inflation:

(I) Discount nominal cash flows by nominal discount rates.

(II) Discount nominal cash flows by real discount rates.

(III) Discount real cash flows by nominal discount rates.

(IV) Discount real cash flows by real discount rates.

Which of the above statements is or are correct?

In the 'Austin Powers' series of movies, the character Dr. Evil threatens to destroy the world unless the United Nations pays him a ransom (video 1, video 2). Dr. Evil makes the threat on two separate occasions:

- In 1969 he demands a ransom of $1 million (=10^6), and again;
- In 1997 he demands a ransom of $100 billion (=10^11).

If Dr. Evil's demands are equivalent in real terms, in other words $1 million will buy the same basket of goods in 1969 as $100 billion would in 1997, what was the implied inflation rate over the **28** years from 1969 to 1997?

The answer choices below are given as effective annual rates:

**Question 353** income and capital returns, inflation, real and nominal returns and cash flows, real estate

A residential investment property has an expected **nominal** total return of **6**% pa and nominal capital return of **3**% pa.

Inflation is expected to be **2**% pa. All rates are given as effective annual rates.

What are the property's expected **real** total, capital and income returns? The answer choices below are given in the same order.

**Question 407** income and capital returns, inflation, real and nominal returns and cash flows

A stock has a **real** expected total return of **7**% pa and a real expected capital return of **2**% pa.

Inflation is expected to be **2**% pa. All rates are given as effective annual rates.

What is the **nominal** expected total return, capital return and dividend yield? The answers below are given in the same order.

**Question 155** inflation, real and nominal returns and cash flows, Loan, effective rate conversion

You are a banker about to grant a 2 year loan to a customer. The loan's principal and interest will be repaid in a single payment at maturity, sometimes called a zero-coupon loan, discount loan or bullet loan.

You require a **real** return of **6**% pa over the two years, given as an effective annual rate. Inflation is expected to be **2**% this year and **4**% next year, both given as effective annual rates.

You judge that the customer can afford to pay back $**1,000,000** in **2** years, given as a **nominal** cash flow. How much should you lend to her right now?

**Question 444** investment decision, corporate financial decision theory

The investment decision primarily affects which part of a business?

**Question 446** working capital decision, corporate financial decision theory

The working capital decision primarily affects which part of a business?

**Question 445** financing decision, corporate financial decision theory

The financing decision primarily affects which part of a business?

**Question 447** payout policy, corporate financial decision theory

Payout policy is most closely related to which part of a business?

**Question 443** corporate financial decision theory, investment decision, financing decision, working capital decision, payout policy

Business people make lots of important decisions. Which of the following is the **most** important long term decision?

You're considering making an investment in a particular company. They have preference shares, ordinary shares, senior debt and junior debt.

Which is the safest investment? Which will give the highest returns?

A newly floated farming company is financed with senior bonds, junior bonds, cumulative non-voting preferred stock and common stock. The new company has no retained profits and due to floods it was unable to record any revenues this year, leading to a loss. The firm is not bankrupt yet since it still has substantial contributed equity (same as paid-up capital).

On which securities must it pay interest or dividend payments in this terrible financial year?

Which business structure or structures have the advantage of limited liability for equity investors?

**Question 452** limited liability, expected and historical returns

What is the lowest and highest expected share price and expected return from owning shares in a **company** over a finite period of time?

Let the current share price be ##p_0##, the expected future share price be ##p_1##, the expected future dividend be ##d_1## and the expected return be ##r##. Define the expected return as:

##r=\dfrac{p_1-p_0+d_1}{p_0} ##

The answer choices are stated using inequalities. As an example, the first answer choice "(a) ##0≤p<∞## and ##0≤r< 1##", states that the share price must be larger than or equal to zero and less than positive infinity, and that the return must be larger than or equal to zero and less than one.

Estimate Microsoft's (MSFT) share price using a price earnings (PE) multiples approach with the following assumptions and figures only:

- Apple, Google and Microsoft are comparable companies,
- Apple's (AAPL) share price is $526.24 and historical EPS is $40.32.
- Google's (GOOG) share price is $1,215.65 and historical EPS is $36.23.
- Micrsoft's (MSFT) historical earnings per share (EPS) is $2.71.

Source: Google Finance 28 Feb 2014.

Which of the following investable assets are **NOT** suitable for valuation using PE multiples techniques?

Which firms tend to have **low** forward-looking price-earnings (PE) ratios?

Only consider firms with positive earnings, disregard firms with negative earnings and therefore negative PE ratios.

Which of the following investable assets are **NOT** suitable for valuation using PE multiples techniques?

Which firms tend to have **high** forward-looking price-earnings (PE) ratios?

Which firms tend to have **low** forward-looking price-earnings (PE) ratios? Only consider firms with positive PE ratios.

Private equity firms are known to buy medium sized private companies operating in the same industry, merge them together into a larger company, and then sell it off in a public float (initial public offering, IPO).

If medium-sized private companies trade at PE ratios of **5** and larger listed companies trade at PE ratios of **15**, what return can be achieved from this strategy?

Assume that:

- The medium-sized companies can be bought, merged and sold in an IPO instantaneously.
- There are no costs of finding, valuing, merging and restructuring the medium sized companies. Also, there is no competition to buy the medium-sized companies from other private equity firms.
- The large merged firm's earnings are the sum of the medium firms' earnings.
- The only reason for the difference in medium and large firm's PE ratios is due to the illiquidity of the medium firms' shares.
- Return is defined as: ##r_{0→1} = (p_1-p_0+c_1)/p_0## , where time zero is just before the merger and time one is just after.

You own an apartment which you rent out as an investment property.

What is the price of the apartment using discounted cash flow (DCF, same as NPV) valuation?

Assume that:

- You just signed a contract to rent the apartment out to a tenant for the next 12 months at $2,000 per month, payable in advance (at the start of the month, t=0). The tenant is just about to pay you the first $2,000 payment.
- The contract states that monthly rental payments are fixed for 12 months. After the contract ends, you plan to sign another contract but with rental payment increases of 3%. You intend to do this every year.

So rental payments will increase at the start of the 13th month (t=12) to be $2,060 (=2,000(1+0.03)), and then they will be constant for the next 12 months.

Rental payments will increase again at the start of the 25th month (t=24) to be $2,121.80 (=2,000(1+0.03)^{2}), and then they will be constant for the next 12 months until the next year, and so on. - The required return of the apartment is 8.732% pa, given as an effective annual rate.
- Ignore all taxes, maintenance, real estate agent, council and strata fees, periods of vacancy and other costs. Assume that the apartment will last forever and so will the rental payments.

**Question 488** income and capital returns, payout policy, payout ratio, DDM

Two companies BigDiv and ZeroDiv are exactly the same except for their dividend payouts.

BigDiv pays large dividends and ZeroDiv doesn't pay any dividends.

Currently the two firms have the same earnings, assets, number of shares, share price, expected total return and risk.

Assume a perfect world with no taxes, no transaction costs, no asymmetric information and that all assets including business projects are fairly priced and therefore zero-NPV.

All things remaining equal, which of the following statements is **NOT** correct?

The boss of WorkingForTheManCorp has a wicked (and unethical) idea. He plans to pay his poor workers one week late so that he can get more interest on his cash in the bank.

Every week he is supposed to pay his 1,000 employees $1,000 each. So $**1** million is paid to employees every week.

The boss was just about to pay his employees today, until he thought of this idea so he will actually pay them one week (**7** days) later for the work they did last week and every week in the future, forever.

Bank interest rates are **10**% pa, given as a real effective annual rate. So ##r_\text{eff annual, real} = 0.1## and the real effective weekly rate is therefore ##r_\text{eff weekly, real} = (1+0.1)^{1/52}-1 = 0.001834569##

All rates and cash flows are real, the inflation rate is **3**% pa and there are **52** weeks per year. The boss will always pay wages one week late. The business will operate forever with constant real wages and the same number of employees.

What is the net present value (**NPV**) of the boss's decision to pay later?

**Question 31** DDM, perpetuity with growth, effective rate conversion

What is the NPV of the following series of cash flows when the discount rate is **5**% given as an effective **annual** rate?

The first payment of $10 is in 4 years, followed by payments every 6 months forever after that which shrink by 2% every 6 months. That is, the growth rate every 6 months is actually **negative 2%**, given as an effective **6 month** rate. So the payment at ## t=4.5 ## years will be ## 10(1-0.02)^1=9.80 ##, and so on.

A share just paid its semi-annual dividend of $10. The dividend is expected to grow at 2% every 6 months forever. This 2% growth rate is an effective **6 month** rate. Therefore the next dividend will be $10.20 in six months. The required return of the stock 10% pa, given as an effective **annual** rate.

What is the price of the share now?

A stock pays annual dividends which are expected to continue forever. It just paid a dividend of $10. The growth rate in the dividend is 2% pa. You estimate that the stock's required return is 10% pa. Both the discount rate and growth rate are given as effective annual rates. Using the dividend discount model, what will be the share price?

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 stock pays semi-annual dividends. It just paid a dividend of $10. The growth rate in the dividend is 1% every 6 months, given as an effective **6 month** rate. You estimate that the stock's required return is 21% pa, as an effective **annual** rate.

Using the dividend discount model, what will be the share price?

Your friend just bought a house for $400,000. He financed it using a $320,000 mortgage loan and a deposit of $80,000.

In the context of residential housing and mortgages, the 'equity' tied up in the value of a person's house is the value of the house less the value of the mortgage. So the initial equity your friend has in his house is $80,000. Let this amount be E, let the value of the mortgage be D and the value of the house be V. So ##V=D+E##.

If house prices suddenly fall by **10**%, what would be your friend's percentage change in equity (E)? Assume that the value of the mortgage is unchanged and that no income (rent) was received from the house during the short time over which house prices fell.

Remember:

### r_{0\rightarrow1}=\frac{p_1-p_0+c_1}{p_0} ###

where ##r_{0-1}## is the return (percentage change) of an asset with price ##p_0## initially, ##p_1## one period later, and paying a cash flow of ##c_1## at time ##t=1##.

Your friend just bought a house for $**1,000,000**. He financed it using a $**900,000** mortgage loan and a deposit of $**100,000**.

In the context of residential housing and mortgages, the 'equity' or 'net wealth' tied up in a house is the value of the house less the value of the mortgage loan. Assuming that your friend's only asset is his house, his net wealth is $100,000.

If house prices suddenly fall by **15%**, what would be your friend's percentage change in net wealth?

Assume that:

- No income (rent) was received from the house during the short time over which house prices fell.
- Your friend will not declare bankruptcy, he will always pay off his debts.

One year ago you bought $**100,000** of shares partly funded using a margin loan. The margin loan size was $**70,000** and the other $**30,000** was your own wealth or 'equity' in the share assets.

The interest rate on the margin loan was **7.84**% pa.

Over the year, the shares produced a dividend yield of **4**% pa and a capital gain of **5**% pa.

What was the **total** return on your **wealth**? Ignore taxes, assume that all cash flows (interest payments and dividends) were paid and received at the end of the year, and all rates above are effective annual rates.

Hint: Remember that wealth in this context is your equity (E) in the house asset (V = D+E) which is funded by the loan (D) and your deposit or equity (E).

Here are the Net Income (NI) and Cash Flow From Assets (CFFA) equations:

###NI=(Rev-COGS-FC-Depr-IntExp).(1-t_c)###

###CFFA=NI+Depr-CapEx - \varDelta NWC+IntExp###

What is the formula for calculating annual interest expense (IntExp) which is used in the equations above?

Select one of the following answers. Note that D is the value of debt which is constant through time, and ##r_D## is the cost of debt.

Interest expense (IntExp) is an important part of a company's income statement (or 'profit and loss' or 'statement of financial performance').

How does an **accountant** calculate the annual interest expense of a fixed-coupon bond that has a liquid secondary market? Select the most correct answer:

Annual interest expense is equal to:

Which one of the following will increase the Cash Flow From Assets in this year for a tax-paying firm, all else remaining constant?

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 - ΔNWC+IntExp###A manufacturing company is considering a new project in the more risky services industry. The cash flows from assets (CFFA) are estimated for the new project, with interest expense excluded from the calculations. To get the levered value of the project, what should these unlevered cash flows be discounted by?

Assume that the manufacturing firm has a target debt-to-assets ratio that it sticks to.

A retail furniture company buys furniture wholesale and distributes it through its retail stores. The owner believes that she has some good ideas for making stylish new furniture. She is considering a project to buy a factory and employ workers to manufacture the new furniture she's designed. Furniture manufacturing has more systematic risk than furniture retailing.

Her furniture retailing firm's after-tax WACC is 20%. Furniture manufacturing firms have an after-tax WACC of 30%. Both firms are optimally geared. Assume a classical tax system.

Which method(s) will give the correct valuation of the new furniture-making project? Select the most correct answer.

The US firm Google operates in the online advertising business. In 2011 Google bought Motorola Mobility which manufactures mobile phones.

Assume the following:

- Google had a 10% after-tax weighted average cost of capital (WACC) before it bought Motorola.
- Motorola had a 20% after-tax WACC before it merged with Google.
- Google and Motorola have the same level of gearing.
- Both companies operate in a classical tax system.

You are a manager at Motorola. You must value a project for making mobile phones. Which method(s) will give the correct valuation of the mobile phone manufacturing project? Select the most correct answer.

The mobile phone manufacturing project's:

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}###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}###

One formula for calculating a levered firm's free cash flow (FFCF, or CFFA) is to use earnings before interest and tax (EBIT).

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

One method for calculating a firm's free cash flow (FFCF, or CFFA) is to ignore interest expense. That is, pretend that interest expense ##(IntExp)## is zero:

###\begin{aligned} FFCF &= (Rev - COGS - Depr - FC - IntExp)(1-t_c) + Depr - CapEx -\Delta NWC + IntExp \\ &= (Rev - COGS - Depr - FC - 0)(1-t_c) + Depr - CapEx -\Delta NWC - 0\\ \end{aligned}###

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} \\###

**Question 413** CFFA, interest tax shield, depreciation tax shield

There are many ways to calculate a firm's free cash flow (FFCF), also called cash flow from assets (CFFA).

One method is to use the following formulas to transform net income (NI) into FFCF including interest and depreciation tax shields:

###FFCF=NI + Depr - CapEx -ΔNWC + IntExp###

###NI=(Rev - COGS - Depr - FC - IntExp).(1-t_c )###

Another popular method is to use EBITDA rather than net income. EBITDA is defined as:

###EBITDA=Rev - COGS - FC###

One of the below formulas correctly calculates FFCF from EBITDA, including interest and depreciation tax shields, giving an identical answer to that above. Which formula is correct?

Select the most correct statement from the following.

'Chartists', also known as 'technical traders', believe that:

Fundamentalists who analyse company financial reports and news announcements (but who don't have inside information) will make positive abnormal returns if:

**Question 100** market efficiency, technical analysis, joint hypothesis problem

A company selling charting and technical analysis software claims that independent academic studies have shown that its software makes significantly positive abnormal returns. Assuming the claim is true, which statement(s) are correct?

(I) Weak form market efficiency is broken.

(II) Semi-strong form market efficiency is broken.

(III) Strong form market efficiency is broken.

(IV) The asset pricing model used to measure the abnormal returns (such as the CAPM) had mis-specification error so the returns may not be abnormal but rather fair for the level of risk.

Select the most correct response:

**Question 119** market efficiency, fundamental analysis, joint hypothesis problem

Your friend claims that by reading 'The Economist' magazine's economic news articles, she can identify shares that will have positive abnormal expected returns over the next 2 years. Assuming that her claim is true, which statement(s) are correct?

(i) Weak form market efficiency is broken.

(ii) Semi-strong form market efficiency is broken.

(iii) Strong form market efficiency is broken.

(iv) The asset pricing model used to measure the abnormal returns (such as the CAPM) is either wrong (mis-specification error) or is measured using the wrong inputs (data errors) so the returns may not be abnormal but rather fair for the level of risk.

Select the most correct response:

**Question 338** market efficiency, CAPM, opportunity cost, technical analysis

A man inherits $**500,000** worth of shares.

He believes that by learning the secrets of trading, keeping up with the financial news and doing complex trend analysis with charts that he can quit his job and become a self-employed day trader in the equities markets.

What is the expected gain from doing this over the first year? Measure the net gain in wealth received at the end of this first year due to the decision to become a day trader. Assume the following:

- He earns $
**60,000**pa in his current job, paid in a lump sum at the end of each year. - He enjoys examining share price graphs and day trading just as much as he enjoys his current job.
- Stock markets are weak form and semi-strong form efficient.
- He has no inside information.
- He makes
**1**trade every day and there are**250**trading days in the year. Trading costs are $**20**per trade. His broker invoices him for the trading costs at the end of the year. - The shares that he currently owns and the shares that he intends to trade have the same level of systematic risk as the market portfolio.
- The market portfolio's expected return is
**10**% pa.

Measure the **net gain** over the **first** year as an expected wealth increase at the **end** of the year.

A person is thinking about borrowing $100 from the bank at 7% pa and investing it in shares with an expected return of 10% pa. One year later the person will sell the shares and pay back the loan in full. Both the loan and the shares are fairly priced.

What is the Net Present Value (NPV) of this one year investment? Note that you are asked to find the present value (##V_0##), not the value in one year (##V_1##).

**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 managed fund charges fees based on the amount of money that you keep with them. The fee is **2**% of the **start**-of-year amount, but it is paid at the **end** of every year.

This fee is charged regardless of whether the fund makes gains or losses on your money.

The fund offers to invest your money in shares which have an expected return of **10**% pa before fees.

You are thinking of investing $**100,000** in the fund and keeping it there for **40** years when you plan to retire.

What is the Net Present Value (NPV) of investing your money in the fund? Note that the question is **not** asking how much money you will have in 40 years, it is asking: what is the **NPV** of investing in the fund? Assume that:

- The fund has no private information.
- Markets are weak and semi-strong form efficient.
- The fund's transaction costs are negligible.
- The cost and trouble of investing your money in shares by yourself, without the managed fund, is negligible.

**Question 416** real estate, market efficiency, income and capital returns, DDM, CAPM

A residential real estate investor believes that house prices will grow at a rate of **5**% pa and that rents will grow by **2**% pa forever.

All rates are given as nominal effective annual returns. Assume that:

- His forecast is true.
- Real estate is and always will be fairly priced and the capital asset pricing model (CAPM) is true.
- Ignore all costs such as taxes, agent fees, maintenance and so on.
- All rental income cash flow is paid out to the owner, so there is no re-investment and therefore no additions or improvements made to the property.
- The non-monetary benefits of owning real estate and renting remain constant.

Which one of the following statements is **NOT** correct? Over time:

A company advertises an investment costing $**1,000** which they say is underpriced. They say that it has an expected total return of **15**% pa, but a required return of only **10**% pa. Assume that there are no dividend payments so the entire 15% total return is all capital return.

Assuming that the company's statements are correct, what is the **NPV** of buying the investment if the 15% return lasts for the next **100** years (t=0 to 100), then reverts to 10% pa after that time? Also, what is the NPV of the investment if the 15% return lasts forever?

In both cases, assume that the required return of 10% remains constant. All returns are given as effective annual rates.

The answer choices below are given in the same order (15% for 100 years, and 15% forever):

A managed fund charges fees based on the amount of money that you keep with them. The fee is **2**% of the **end**-of-year amount, paid at the **end** of every year.

This fee is charged regardless of whether the fund makes gains or losses on your money.

The fund offers to invest your money in shares which have an expected return of **10%** pa before fees.

You are thinking of investing $**100,000** in the fund and keeping it there for **40** years when you plan to retire.

How much money do you expect to have in the fund in 40 years? Also, what is the future value of the fees that the fund expects to earn from you? Give both amounts as future values in 40 years. Assume that:

- The fund has no private information.
- Markets are weak and semi-strong form efficient.
- The fund's transaction costs are negligible.
- The cost and trouble of investing your money in shares by yourself, without the managed fund, is negligible.
- The fund invests its fees in the same companies as it invests your funds in, but with no fees.

The below answer choices list your expected wealth in 40 years and then the fund's expected wealth in 40 years.

When someone says that they're "buying American dollars" (USD), what type of asset are they probably buying? They're probably buying:

An Indonesian lady wishes to convert 1 million Indonesian rupiah (IDR) to Australian dollars (AUD). Exchange rates are 13,125 IDR per USD and 0.79 USD per AUD. How many AUD is the IDR 1 million worth?

**Question 315** foreign exchange rate, American and European terms

If the current AUD exchange rate is USD 0.9686 = AUD 1, what is the European terms quote of the AUD against the USD?

**Question 319** foreign exchange rate, monetary policy, American and European terms

Investors expect the Reserve Bank of Australia (RBA) to keep the policy rate steady at their next meeting.

Then unexpectedly, the RBA announce that they will increase the policy rate by 25 basis points due to fears that the economy is growing too fast and that inflation will be above their target rate of 2 to 3 per cent.

What do you expect to happen to Australia's exchange rate in the short term? The Australian dollar is likely to:

**Question 321** foreign exchange rate, monetary policy, American and European terms

The market expects the Reserve Bank of Australia (RBA) to increase the policy rate by 25 basis points at their next meeting.

Then unexpectedly, the RBA announce that they will increase the policy rate by 50 basis points due to high future GDP and inflation forecasts.

What do you expect to happen to Australia's exchange rate in the short term? The Australian dollar will:

**Question 246** foreign exchange rate, forward foreign exchange rate, cross currency interest rate parity

Suppose the Australian cash rate is expected to be **8.15**% pa and the US federal funds rate is expected to be **3.00**% pa over the next **2** years, both given as nominal effective annual rates. The current exchange rate is at parity, so **1** USD = **1** AUD.

What is the implied **2** year forward foreign exchange rate?

The Chinese government attempts to fix its exchange rate against the US dollar and at the same time use monetary policy to fix its interest rate at a set level.

To be able to fix its exchange rate and interest rate in this way, what does the Chinese government actually do?

- Adopts capital controls to prevent financial arbitrage by private firms and individuals.
- Adopts the same interest rate (monetary policy) as the United States.
- Fixes inflation so that the domestic real interest rate is equal to the United States' real interest rate.

Which of the above statements is or are true?

The average weekly earnings of an Australian adult worker before tax was $1,542.40 per week in November 2014 according to the Australian Bureau of Statistics. Therefore average annual earnings before tax were $**80,204.80** assuming 52 weeks per year. Personal income tax rates published by the Australian Tax Office are reproduced for the 2014-2015 financial year in the table below:

Taxable income | Tax on this income |
---|---|

0 – $18,200 | Nil |

$18,201 – $37,000 | 19c for each $1 over $18,200 |

$37,001 – $80,000 | $3,572 plus 32.5c for each $1 over $37,000 |

$80,001 – $180,000 | $17,547 plus 37c for each $1 over $80,000 |

$180,001 and over | $54,547 plus 45c for each $1 over $180,000 |

The above rates do not include the Medicare levy of 2%. Exclude the Medicare levy from your calculations

How much personal income tax would you have to pay per year if you earned $80,204.80 per annum before-tax?

**Question 449** personal tax on dividends, classical tax system

A small private company has a single shareholder. This year the firm earned a $**100** profit **before** tax. All of the firm's after tax profits will be paid out as dividends to the owner.

The corporate tax rate is **30**% and the sole shareholder's personal marginal tax rate is **45**%.

The United States' **classical tax system** applies because the company generates all of its income in the US and pays corporate tax to the Internal Revenue Service. The shareholder is also an American for tax purposes.

What will be the personal tax payable by the shareholder and the corporate tax payable by the company?

**Question 448** franking credit, personal tax on dividends, imputation tax system

A small private company has a single shareholder. This year the firm earned a $**100** profit **before** tax. All of the firm's after tax profits will be paid out as dividends to the owner.

The corporate tax rate is **30**% and the sole shareholder's personal marginal tax rate is **45**%.

The Australian **imputation tax system** applies because the company generates all of its income in Australia and pays corporate tax to the Australian Tax Office. Therefore all of the company's dividends are fully franked. The sole shareholder is an Australian for tax purposes and can therefore use the franking credits to offset his personal income tax liability.

What will be the personal tax payable by the shareholder and the corporate tax payable by the company?

A company announces that it will pay a dividend, as the market expected. The company's shares trade on the stock exchange which is open from 10am in the morning to 4pm in the afternoon each weekday. When would the share price be expected to fall by the amount of the dividend? Ignore taxes.

The share price is expected to fall during the:

Currently, a mining company has a share price of $6 and pays constant annual dividends of $0.50. The next dividend will be paid in 1 year. Suddenly and unexpectedly the mining company announces that due to higher than expected profits, all of these windfall profits will be paid as a special dividend of $0.30 in 1 year.

If investors believe that the windfall profits and dividend is a one-off event, what will be the new share price? If investors believe that the additional dividend is actually permanent and will continue to be paid, what will be the new share price? Assume that the required return on equity is unchanged. Choose from the following, where the first share price includes the one-off increase in earnings and dividends for the first year only ##(P_\text{0 one-off})## , and the second assumes that the increase is permanent ##(P_\text{0 permanent})##:

Note: When a firm makes excess profits they sometimes pay them out as special dividends. Special dividends are just like ordinary dividends but they are one-off and investors do not expect them to continue, unlike ordinary dividends which are expected to persist.

A mining firm has just discovered a new mine. So far the news has been kept a secret.

The net present value of digging the mine and selling the minerals is $**250** million, but $**500** million of new equity and $**300** million of new bonds will need to be issued to fund the project and buy the necessary plant and equipment.

The firm will release the news of the discovery and equity and bond raising to shareholders simultaneously in the same announcement. The shares and bonds will be issued shortly after.

Once the announcement is made and the new shares and bonds are issued, what is the expected increase in the value of the firm's assets ##(\Delta V)##, market capitalisation of debt ##(\Delta D)## and market cap of equity ##(\Delta E)##? Assume that markets are semi-strong form efficient.

The triangle symbol ##\Delta## is the Greek letter capital delta which means change or increase in mathematics.

Ignore the benefit of interest tax shields from having more debt.

Remember: ##\Delta V = \Delta D+ \Delta E##

**Question 568** rights issue, capital raising, capital structure

A company conducts a **1** for **5** rights issue at a subscription price of $**7** when the pre-announcement stock price was $**10**. What is the percentage change in the stock price and the number of shares outstanding? The answers are given in the same order. Ignore all taxes, transaction costs and signalling effects.

In late 2003 the listed bank ANZ announced a 2-for-11 rights issue to fund the takeover of New Zealand bank NBNZ. Below is the chronology of events:

- 23/10/2003. Share price closes at $18.30.
- 24/10/2003. 2-for-11 rights issue announced at a subscription price of $13. The proceeds of the rights issue will be used to acquire New Zealand bank NBNZ. Trading halt announced in morning before market opens.
- 28/10/2003. Trading halt lifted. Last (and only) day that shares trade cum-rights. Share price opens at $18.00 and closes at $18.14.
- 29/10/2003. Shares trade ex-rights.

All things remaining equal, what would you expect ANZ's stock price to open at on the first day that it trades ex-rights (29/10/2003)? Ignore the time value of money since time is negligibly short. Also ignore taxes.

Diversification is achieved by investing in a large amount of stocks. What type of risk is reduced by diversification?

According to the theory of the Capital Asset Pricing Model (CAPM), total risk can be broken into two components, systematic risk and idiosyncratic risk. Which of the following events would be considered a systematic, undiversifiable event according to the theory of the CAPM?

A fairly priced stock has an expected return equal to the market's. Treasury bonds yield 5% pa and the market portfolio's expected return is 10% pa. What is the stock's beta?

The security market line (SML) shows the relationship between beta and expected return.

Investment projects that plot **above** the SML would have:

Stock A has a beta of 0.5 and stock B has a beta of 1. Which statement is **NOT** correct?

A stock's correlation with the market portfolio increases while its total risk is unchanged. What will happen to the stock's expected return and systematic risk?

Assets A, B, M and ##r_f## are shown on the graphs above. Asset M is the market portfolio and ##r_f## is the risk free yield on government bonds. Which of the below statements is **NOT** correct?

Assets A, B, M and ##r_f## are shown on the graphs above. Asset M is the market portfolio and ##r_f## is the risk free yield on government bonds. Assume that investors can borrow and lend at the risk free rate. Which of the below statements is **NOT** correct?

A stock has a beta of **1.5**. The market's expected total return is **10**% pa and the risk free rate is **5**% pa, both given as effective annual rates.

What do you think will be the stock's expected return over the next year, given as an effective annual rate?

A stock has a beta of **1.5**. The market's expected total return is **10**% pa and the risk free rate is **5**% pa, both given as effective annual rates.

In the last 5 minutes, bad economic news was released showing a higher chance of recession. Over this time the share market **fell** by **1**%. The risk free rate was unchanged.

What do you think was the stock's historical return over the last 5 minutes, given as an effective 5 minute rate?

A stock has a beta of **1.5**. The market's expected total return is **10**% pa and the risk free rate is **5**% pa, both given as effective annual rates.

Over the last year, bad economic news was released showing a higher chance of recession. Over this time the share market **fell** by **1**%. The risk free rate was unchanged.

What do you think was the stock's historical return over the **last year**, given as an effective annual rate?

A firm changes its capital structure by issuing a large amount of equity and using the funds to repay debt. Its assets are unchanged. Ignore interest tax shields.

According to the Capital Asset Pricing Model (CAPM), which statement is correct?

The CAPM can be used to find a business's expected opportunity cost of capital:

###r_i=r_f+β_i (r_m-r_f)###

What should be used as the risk free rate ##r_f##?

Which of the following statements about the weighted average cost of capital (WACC) is **NOT** correct?

**Question 418** capital budgeting, NPV, interest tax shield, WACC, CFFA, CAPM

Project Data | ||

Project life | 1 year | |

Initial investment in equipment | $8m | |

Depreciation of equipment per year | $8m | |

Expected sale price of equipment at end of project | 0 | |

Unit sales per year | 4m | |

Sale price per unit | $10 | |

Variable cost per unit | $5 | |

Fixed costs per year, paid at the end of each year | $2m | |

Interest expense in first year (at t=1) | $0.562m | |

Corporate tax rate | 30% | |

Government treasury bond yield | 5% | |

Bank loan debt yield | 9% | |

Market portfolio return | 10% | |

Covariance of levered equity returns with market | 0.32 | |

Variance of market portfolio returns | 0.16 | |

Firm's and project's debt-to-equity ratio |
50% | |

**Notes**

- Due to the project, current assets will increase by $
**6**m now (t=0) and fall by $**6**m at the end (t=1). Current liabilities will not be affected.

**Assumptions**

- The debt-to-equity ratio will be kept constant throughout the life of the project. The amount of interest expense at the end of each period has been correctly calculated to maintain this constant debt-to-equity ratio.
- Millions are represented by 'm'.
- All cash flows occur at the start or end of the year as appropriate, not in the middle or throughout the year.
- All rates and cash flows are real. The inflation rate is 2% pa. All rates are given as effective annual rates.
- The project is undertaken by a firm, not an individual.

What is the net present value (NPV) of the project?

**Question 559** variance, standard deviation, covariance, correlation

Which of the following statements about standard statistical mathematics notation is **NOT** correct?

Diversification in a portfolio of two assets works best when the correlation between their returns is:

All things remaining equal, the variance of a portfolio of two positively-weighted stocks **rises** as:

Portfolio Details | ||||||

Stock | Expected return |
Standard deviation |
Correlation ##(\rho_{A,B})## |
Dollars invested |
||

A | 0.1 | 0.4 | 0.5 | 60 | ||

B | 0.2 | 0.6 | 140 | |||

What is the standard deviation (not variance) of the above portfolio?

Two risky stocks A and B comprise an equal-weighted portfolio. The correlation between the stocks' returns is 70%.

If the variance of stock A **increases** but the:

- Prices and expected returns of each stock stays the same,
- Variance of stock B's returns stays the same,
- Correlation of returns between the stocks stays the same.

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

All things remaining equal, the higher the correlation of returns between two stocks:

An investor wants to make a portfolio of two stocks A and B with a target expected portfolio return of **6**% pa.

- Stock A has an expected return of
**5**% pa. - Stock B has an expected return of
**10**% pa.

What portfolio weights should the investor have in stocks A and B respectively?

**Question 556** portfolio risk, portfolio return, standard deviation

An investor wants to make a portfolio of two stocks A and B with a target expected portfolio return of **12**% pa.

- Stock A has an expected return of
**10**% pa and a standard deviation of**20**% pa. - Stock B has an expected return of
**15**% pa and a standard deviation of**30**% pa.

The correlation coefficient between stock A and B's expected returns is **70**%.

What will be the annual standard deviation of the portfolio with this 12% pa target return?

What is the correlation of a variable X with itself?

The corr(X, X) or ##\rho_{X,X}## equals:

What is the correlation of a variable X with a constant C?

The corr(X, C) or ##\rho_{X,C}## equals:

The covariance and correlation of two stocks X and Y's annual returns are calculated over a number of years. The units of the returns are in percent per annum ##(\% pa)##.

What are the units of the covariance ##(\sigma_{X,Y})## and correlation ##(\rho_{X,Y})## of returns respectively?

**Hint**: Visit Wikipedia to understand the difference between percentage points ##(\text{pp})## and percent ##(\%)##.

Let the standard deviation of returns for a share per month be ##\sigma_\text{monthly}##.

What is the formula for the standard deviation of the share's returns per year ##(\sigma_\text{yearly})##?

Assume that returns are independently and identically distributed (iid) so they have zero auto correlation, meaning that if the return was higher than average today, it does not indicate that the return tomorrow will be higher or lower than average.

A firm has a debt-to-equity ratio of 25%. What is its debt-to-assets ratio?

A company issues a large amount of bonds to raise money for new projects of similar risk to the company's existing projects. The net present value (NPV) of the new projects is positive but small. Assume a classical tax system. Which statement is **NOT** correct?

A firm has a debt-to-assets ratio of 50%. The firm then issues a large amount of equity to raise money for new projects of similar systematic risk to the company's existing projects. Assume a classical tax system. Which statement is correct?

A firm has a debt-to-assets ratio of 50%. The firm then issues a large amount of debt to raise money for new projects of similar risk to the company's existing projects. Assume a classical tax system. Which statement is correct?

**Question 337** capital structure, interest tax shield, leverage, real and nominal returns and cash flows, multi stage growth model

A fast-growing firm is suitable for valuation using a multi-stage growth model.

It's **nominal** unlevered cash flow from assets (##CFFA_U##) at the end of this year (**t=1**) is expected to be $**1** million. After that it is expected to grow at a rate of:

**12**% pa for the next two years (from t=1 to 3),**5**% over the fourth year (from t=3 to 4), and**-1**% forever after that (from t=4 onwards). Note that this is a negative one percent growth rate.

Assume that:

- The nominal WACC
**after**tax is**9.5**% pa and is not expected to change. - The nominal WACC
**before**tax is**10**% pa and is not expected to change. - The firm has a target debt-to-
**equity**ratio that it plans to maintain. - The inflation rate is
**3**% pa. - All rates are given as
**nominal**effective annual rates.

What is the levered value of this fast growing firm's assets?

**Question 35** bond pricing, zero coupon bond, term structure of interest rates, forward interest rate

A European company just issued two bonds, a

- 1 year zero coupon bond at a yield of 8% pa, and a
- 2 year zero coupon bond at a yield of 10% pa.

What is the company's forward rate over the second year (from t=1 to t=2)? Give your answer as an effective annual rate, which is how the above bond yields are quoted.

**Question 143** bond pricing, zero coupon bond, term structure of interest rates, forward interest rate

An Australian company just issued two bonds:

- A 6-month zero coupon bond at a yield of 6% pa, and
- A 12 month zero coupon bond at a yield of 7% pa.

What is the company's forward rate from 6 to 12 months? Give your answer as an APR compounding every 6 months, which is how the above bond yields are quoted.

**Question 96** bond pricing, zero coupon bond, term structure of interest rates, forward interest rate

An Australian company just issued two bonds:

- A 1 year zero coupon bond at a yield of 8% pa, and
- A 2 year zero coupon bond at a yield of 10% pa.

What is the forward rate on the company's debt from years 1 to 2? Give your answer as an APR compounding every **6** months, which is how the above bond yields are quoted.

You're trying to save enough money to buy your first car which costs $2,500. You can save $100 at the end of each month starting from now. You currently have no money at all. You just opened a bank account with an interest rate of 6% pa payable monthly.

How many months will it take to save enough money to buy the car? Assume that the price of the car will stay the same over time.

Your main expense is fuel for your car which costs $100 per month. You just refueled, so you won't need any more fuel for another month (first payment at t=1 month).

You have $2,500 in a bank account which pays interest at a rate of 6% pa, payable monthly. Interest rates are not expected to change.

Assuming that you have no income, in how many months time will you not have enough money to **fully** refuel your car?

You really want to go on a back packing trip to Europe when you finish university. Currently you have $**1,500** in the bank. Bank interest rates are **8**% pa, given as an APR compounding per month. If the holiday will cost $**2,000**, how long will it take for your bank account to reach that amount?

**Question 370** capital budgeting, NPV, interest tax shield, WACC, CFFA

Project Data | ||

Project life | 2 yrs | |

Initial investment in equipment | $600k | |

Depreciation of equipment per year | $250k | |

Expected sale price of equipment at end of project | $200k | |

Revenue per job | $12k | |

Variable cost per job | $4k | |

Quantity of jobs per year | 120 | |

Fixed costs per year, paid at the end of each year | $100k | |

Interest expense in first year (at t=1) | $16.091k | |

Interest expense in second year (at t=2) | $9.711k | |

Tax rate | 30% | |

Government treasury bond yield | 5% | |

Bank loan debt yield | 6% | |

Levered cost of equity | 12.5% | |

Market portfolio return | 10% | |

Beta of assets | 1.24 | |

Beta of levered equity | 1.5 | |

Firm's and project's debt-to-equity ratio |
25% | |

**Notes**

- The project will require an immediate purchase of $
**50**k of inventory, which will all be sold at cost when the project ends. Current liabilities are negligible so they can be ignored.

**Assumptions**

- The debt-to-equity ratio will be kept constant throughout the life of the project. The amount of interest expense at the end of each period has been correctly calculated to maintain this constant debt-to-equity ratio. Note that interest expense is different in each year.
- Thousands are represented by 'k' (kilo).
- All cash flows occur at the start or end of the year as appropriate, not in the middle or throughout the year.
- All rates and cash flows are nominal. The inflation rate is 2% pa.
- All rates are given as effective annual rates.
- The 50% capital gains tax discount is not available since the project is undertaken by a firm, not an individual.

What is the net present value (NPV) of the project?

Which of the following equations is **NOT** equal to the total return of an asset?

Let ##p_0## be the current price, ##p_1## the expected price in one year and ##c_1## the expected income in one year.

Total cash flows can be broken into income and capital cash flows.

What is the name given to the cash flow generated from selling shares at a higher price than they were bought?

**Question 524** risk, expected and historical returns, bankruptcy or insolvency, capital structure, corporate financial decision theory, limited liability

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

**Question 578** inflation, real and nominal returns and cash flows

Which of the following statements about inflation is **NOT** correct?

**Question 576** inflation, real and nominal returns and cash flows

What is the present value of a **nominal** payment of $1,000 in 4 years? The **nominal** discount rate is 8% pa and the inflation rate is 2% pa.

**Question 543** price gains and returns over time, IRR, NPV, income and capital returns, effective return

For an asset price to **triple** every **5** years, what must be the expected future capital return, given as an effective annual rate?

**Question 522** income and capital returns, real and nominal returns and cash flows, inflation, real estate

A residential investment property has an expected nominal total return of **6**% pa and nominal capital return of **2.5**% pa. Inflation is expected to be **2.5**% pa.

All of the above are effective **nominal** rates and investors believe that they will stay the same in perpetuity.

What are the property's expected **real** total, capital and income returns?

The answer choices below are given in the same order.

**Question 523** income and capital returns, real and nominal returns and cash flows, inflation

A low-growth mature stock has an expected nominal total return of **6**% pa and nominal capital return of **2**% pa. Inflation is expected to be **3**% pa.

All of the above are effective **nominal** rates and investors believe that they will stay the same in perpetuity.

What are the stock's expected **real** total, capital and income returns?

The answer choices below are given in the same order.

A credit card company advertises an interest rate of 18% pa, payable monthly. Which of the following statements about the interest rate is **NOT** correct? All rates are given to four decimal places.

A project's NPV is positive. Select the most correct statement:

**Question 455** income and capital returns, payout policy, DDM, market efficiency

A fairly priced **unlevered** firm plans to pay a dividend of $**1** next year (t=1) which is expected to grow by **3**% pa every year after that. The firm's required return on equity is **8**% pa.

The firm is thinking about reducing its future dividend payments by **10**% so that it can use the extra cash to invest in more projects which are expected to return **8**% pa, and have the same risk as the existing projects. Therefore, next year's dividend will be $**0.90**.

What will be the stock's new annual **capital** return (proportional increase in price per year) if the change in payout policy goes ahead?

Assume that payout policy is irrelevant to firm value and that all rates are effective annual rates.

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

Which of the following statements about futures contracts on shares is **NOT** correct, assuming that markets are efficient?

When an equity future is first negotiated (at t=0):

The efficient markets hypothesis (EMH) and no-arbitrage pricing theory is most closely related to which of the following concepts?

A company advertises an investment costing $**1,000** which they say is underpriced. They say that it has an expected total return of **15**% pa, but a required return of only **10**% pa. Of the **15**% pa total expected return, the dividend yield is expected to always be **7**% pa and rest is the capital yield.

Assuming that the company's statements are correct, what is the NPV of buying the investment if the **15**% total return lasts for the next 100 years (t=0 to 100), then reverts to **10**% after that time? Also, what is the NPV of the investment if the 15% return lasts forever?

In both cases, assume that the required return of 10% remains constant, the dividends can only be re-invested at **10**% pa and all returns are given as effective annual rates.

The answer choices below are given in the same order (15% for 100 years, and 15% forever):

**Question 668** buy and hold, market efficiency, idiom

A quote from the famous investor Warren Buffet: "Much success can be attributed to inactivity. Most investors cannot resist the temptation to constantly buy and sell."

Buffet is referring to the buy-and-hold strategy which is to buy and never sell shares. Which of the following is a disadvantage of a buy-and-hold strategy? Assume that share markets are semi-strong form efficient. Which of the following is **NOT** an advantage of the strict buy-and-hold strategy? A disadvantage of the buy-and-hold strategy is that it reduces:

"Buy low, sell high" is a phrase commonly heard in financial markets. It states that traders should try to buy assets at low prices and sell at high prices.

Traders in the fixed-coupon bond markets often quote promised bond yields rather than prices. Fixed-coupon bond traders should try to:

A stock's required total return will **increase** when its:

To value a business's assets, the free cash flow of the firm (FCFF, also called CFFA) needs to be calculated. This requires figures from the firm's income statement and balance sheet. For what figures is the balance sheet needed? Note that the balance sheet is sometimes also called the statement of financial position.

Let the 'income return' of a bond be the coupon at the end of the period divided by the market price now at the start of the period ##(C_1/P_0)##. The expected income return of a **premium** fixed coupon bond is:

An economy has only two investable assets: stocks and cash.

Stocks had a historical nominal average total return of negative two percent per annum (-2% pa) over the last 20 years. Stocks are liquid and actively traded. Stock returns are variable, they have risk.

Cash is riskless and has a nominal constant return of zero percent per annum (0% pa), which it had in the past and will have in the future. Cash can be kept safely at zero cost. Cash can be converted into shares and vice versa at zero cost.

The nominal total return of the shares over the **next** year is **expected** to be:

**Question 624** franking credit, personal tax on dividends, imputation tax system, no explanation

Which of the following statements about Australian franking credits is **NOT** correct? Franking credits:

**Question 625** dividend re-investment plan, capital raising

Which of the following statements about dividend re-investment plans (DRP's) is **NOT** correct?

**Question 626** cross currency interest rate parity, foreign exchange rate, forward foreign exchange rate

The Australian cash rate is expected to be **2**% pa over the next one year, while the Japanese cash rate is expected to be **0**% pa, both given as nominal effective annual rates. The current exchange rate is **100** JPY per AUD.

What is the implied **1** year forward foreign exchange rate?

Which of the following statements about yield curves is **NOT** correct?

**Question 657** systematic and idiosyncratic risk, CAPM, no explanation

A stock's **required** total return will **decrease** when its:

**Question 658** CFFA, income statement, balance sheet, no explanation

To value a business's assets, the free cash flow of the firm (FCFF, also called CFFA) needs to be calculated. This requires figures from the firm's income statement and balance sheet. For what figures is the income statement needed? Note that the income statement is sometimes also called the profit and loss, P&L, or statement of financial performance.

**Question 659** APR, effective rate, effective rate conversion, no explanation

A home loan company advertises an interest rate of 9% pa, payable monthly. Which of the following statements about the interest rate is **NOT** correct? All rates are given with an accuracy of 4 decimal places.

How much more can you borrow using an **interest-only** loan compared to a **25**-year **fully amortising** loan if interest rates are **6**% pa compounding per month and are not expected to change? If it makes it easier, assume that you can afford to pay $2,000 per month on either loan. Express your answer as a proportional increase using the following formula:

A stock's total standard deviation of returns is **20**% pa. The market portfolio's total standard deviation of returns is **15**% pa. The beta of the stock is **0.8**.

What is the stock's **diversifiable** standard deviation?

**Question 662** APR, effective rate, effective rate conversion, no explanation

Which of the following interest rate labels does **NOT** make sense?

A firm has a debt-to-assets ratio of **20**%. What is its debt-to-**equity** ratio?

**Question 664** real and nominal returns and cash flows, inflation, no explanation

What is the present value of **real** payments of $100 every year forever, with the first payment in one year? The **nominal** discount rate is 7% pa and the inflation rate is 4% pa.

A company conducts a **10** for **3** stock split. What is the percentage increase in the stock price and the number of shares outstanding? The answers are given in the same order.

A company conducts a **2** for **3** rights issue at a subscription price of $**8** when the pre-announcement stock price was $**9**. Assume that all investors use their rights to buy those extra shares.

What is the percentage increase in the stock price and the number of shares outstanding? The answers are given in the same order.

Which of the following is **NOT** a valid method for estimating the beta of a company's stock? Assume that markets are efficient, a long history of past data is available, the stock possesses idiosyncratic and market risk. The variances and standard deviations below denote total risks.

**Question 667** forward foreign exchange rate, foreign exchange rate, cross currency interest rate parity, no explanation

The Australian cash rate is expected to be **2**% pa over the next one year, while the US cash rate is expected to be **0**% pa, both given as nominal effective annual rates. The current exchange rate is **0.73** USD per AUD.

What is the implied 1 year USD per AUD forward foreign exchange rate?