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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?



Question 188  CFFA

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).



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?



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?



Question 463  PE ratio, Multiples valuation

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.



Question 726  return distribution, mean and median returns

If a stock's expected future prices are log-normally distributed, what will be bigger, the stock's or future price? Or would you expect them to be ?


Question 747  DDM, no explanation

A share will pay its next dividend of ##C_1## in one year, and will continue to pay a dividend every year after that forever, growing at a rate of ##g##. So the next dividend will be ##C_2=C_1 (1+g)^1##, then ##C_3=C_2 (1+g)^1##, and so on forever.

The current price of the share is ##P_0## and its required return is ##r##

Which of the following is NOT equal to the expected share price in 2 years ##(P_2)## just after the dividend at that time ##(C_2)## has been paid?



Question 956  option, Black-Scholes-Merton option pricing, delta hedging, hedging

A bank sells a European call option on a non-dividend paying stock and delta hedges on a daily basis. Below is the result of their hedging, with columns representing consecutive days. Assume that there are 365 days per year and interest is paid daily in arrears.

Delta Hedging a Short Call using Stocks and Debt
 
Description Symbol Days to maturity (T in days)
    60 59 58 57 56 55
Spot price ($) S 10000 10125 9800 9675 10000 10000
Strike price ($) K 10000 10000 10000 10000 10000 10000
Risk free cont. comp. rate (pa) r 0.05 0.05 0.05 0.05 0.05 0.05
Standard deviation of the stock's cont. comp. returns (pa) σ 0.4 0.4 0.4 0.4 0.4 0.4
Option maturity (years) T 0.164384 0.161644 0.158904 0.156164 0.153425 0.150685
Delta N[d1] = dc/dS 0.552416 0.582351 0.501138 0.467885 0.550649 0.550197
Probability that S > K at maturity in risk neutral world N[d2] 0.487871 0.51878 0.437781 0.405685 0.488282 0.488387
Call option price ($) c 685.391158 750.26411 567.990995 501.487157 660.982878 ?
Stock investment value ($) N[d1]*S 5524.164129 5896.301781 4911.152036 4526.788065 5506.488143 ?
Borrowing which partly funds stock investment ($) N[d2]*K/e^(r*T) 4838.772971 5146.037671 4343.161041 4025.300909 4845.505265 ?
Interest expense from borrowing paid in arrears ($) r*N[d2]*K/e^(r*T) 0.662891 0.704985 0.594994 0.551449 ?
Gain on stock ($) N[d1]*(SNew - SOld) 69.052052 -189.264008 -62.642245 152.062648 ?
Gain on short call option ($) -1*(cNew - cOld) -64.872952 182.273114 66.503839 -159.495721 ?
Net gain ($) Gains - InterestExpense 3.516209 -7.695878 3.266599 -7.984522 ?
 
Gamma Γ = d^2c/dS^2 0.000244 0.00024 0.000255 0.00026 0.000253 0.000255
Theta θ = dc/dT 2196.873429 2227.881353 2182.174706 2151.539751 2266.589184 2285.1895
 

 

In the last column when there are 55 days left to maturity there are missing values. Which of the following statements about those missing values is NOT correct?



Question 972  foreign exchange rate, no explanation

Examine the below graphs. The first graph shows daily FX turnover in the world by both the public (government) and private sectors. The second graph 'Official Reserve Assets' shows the FX reserves of the Australian central bank, the RBA. The third graph's top panel shows the FX reserves of the Chinese central bank, the PBoC.

Assume that the AUD and USD are priced at parity so 1 AUD = 1 USD.

Which of the following statements is NOT correct?



Question 986  initial public offering, capital raising

In an initial public offering (IPO), a: