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?
Treasury bonds currently have a return of 5% pa. A stock has a beta of 0.5 and the market return is 10% pa. What is the expected return 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 | 6 | 12 | 18 | 20 | ... |
After year 4, the dividend will grow in perpetuity at 5% pa. The required return of the stock is 10% pa. Both the growth rate and required return are given as effective annual rates.
If all of the dividends since time period zero were deposited into a bank account yielding 8% pa as an effective annual rate, how much money will be in the bank account in 2.5 years (in other words, at t=2.5)?
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?
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?
Your firm's research scientists can begin an exciting new project at a cost of $10m now, after which there’s a:
- 70% chance that cash flows will be $1m per year forever, starting in 5 years (t=5). This is the A state of the world.
- 20% chance that cash flows will be $3m per year forever, starting in 5 years (t=5). This is the B state of the world.
- 10% chance of a major break through in which case the cash flows will be $20m per year forever starting in 5 years (t=5), or instead, the project can be expanded by investing another $10m (at t=5) which is expected to give cash flows of $60m per year forever, starting at year 9 (t=9). Note that the perpetual cash flows are either the $20m from year 4 onwards, or the $60m from year 9 onwards after the additional $10m year 5 investment, but not both. This is the C state of the world.
The firm's cost of capital is 10% pa.
What's the present value (at t=0) of the option to expand in year 5?
Mr Blue, Miss Red and Mrs Green are people with different utility functions. Which of the statements about the 3 utility functions is NOT correct?
Below is a table of the 'Risk-weights for residential mortgages' as shown in APRA Basel 3 Prudential Standard APS 112 Capital Adequacy: Standardised Approach to Credit Risk January 2013.
LVR (%) |
Standard eligible mortgages |
Non-standard eligible mortgages |
||
|
Risk-weight (no mortgage insurance) % |
Risk-weight (with at least 40% of the mortgage insured by an acceptable LMI) % |
Risk-weight (no mortgage insurance) % |
Risk-weight (with at least 40% of the mortgage insured by an acceptable LMI) % |
0 – 60 |
35 |
35 |
50 |
35 |
60.01 – 80 |
35 |
35 |
75 |
50 |
80.01 – 90 |
50 |
35 |
100 |
75 |
90.01 – 100 |
75 |
50 |
100 |
75 |
> 100.01 |
100 |
75 |
100 |
100 |
A bank is considering granting a home loan to a man to buy a house worth $1.25 million using his own funds and the loan. The loan would be standard with no lenders mortgage insurance (LMI) and an LVR of 80%.
What is the minimum regulatory capital that the bank requires to grant the home loan under the Basel 3 Accord? Ignore the capital conservation buffer.