# Fight Finance

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

The financing decision primarily affects which part of a business?

Which of the following statements is NOT correct? Money market securities are:

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 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? This annuity formula $\dfrac{C_1}{r}\left(1-\dfrac{1}{(1+r)^3} \right)$ is equivalent to which of the following formulas? Note the 3. In the below formulas, $C_t$ is a cash flow at time t. All of the cash flows are equal, but paid at different times. The following cash flows are expected: • 10 yearly payments of$80, with the first payment in 3 years from now (first payment at t=3).
• 1 payment of $600 in 5 years and 6 months (t=5.5) from now. What is the NPV of the cash flows if the discount rate is 10% given as an effective annual rate? 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?

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? 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?

An investor bought a 10 year 2.5% pa fixed coupon government bond priced at par. The face value is $100. Coupons are paid semi-annually and the next one is in 6 months. Six months later, just after the coupon at that time was paid, yields suddenly and unexpectedly fell to 2% pa. Note that all yields above are given as APR's compounding semi-annually. What was the bond investors' historical total return over that first 6 month period, given as an effective semi-annual rate? 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: A stock is expected to pay its next dividend of$1 in one year. Future annual dividends are expected to grow by 2% pa. So the first dividend of $1 will be in one year, the year after that$1.02 (=1*(1+0.02)^1), and a year later $1.0404 (=1*(1+0.02)^2) and so on forever. Its required total return is 10% pa. The total required return and growth rate of dividends are given as effective annual rates. Calculate the current stock price. A stock just paid a dividend of$1. Future annual dividends are expected to grow by 2% pa. The next dividend of $1.02 (=1*(1+0.02)^1) will be in one year, and the year after that the dividend will be$1.0404 (=1*(1+0.02)^2), and so on forever.

Its required total return is 10% pa. The total required return and growth rate of dividends are given as effective annual rates.

Calculate the current stock 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) 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 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? 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. 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 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:

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

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 young lady is trying to decide if she should attend university or begin working straight away in her home town.

The young lady's grandma says that she should not go to university because she is less likely to marry the local village boy whom she likes because she will spend less time with him if she attends university.

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

The cost of not marrying the local village boy should be classified as:

To receive the dividend you must own the stock when the market closes on which date?

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:

A 2-for-1 stock split is equivalent to a 1-for-1 bonus issue or a 100% stock dividend. or ?

In the below term structure of interest rates equation, all rates are effective annual yields and the numbers in subscript represent the years that the yields are measured over:

$$(1+r_{0-3})^3 = (1+r_{0-1})(1+r_{1-2})(1+r_{2-3})$$

Which of the following statements is NOT correct?

In the below term structure of interest rates equation, all rates are effective annual yields and the numbers in subscript represent the years that the yields are measured over:

$$(1+r_{0-3})^3 = (1+r_{0-1})(1+r_{1-2})(1+r_{2-3})$$

Which of the following statements is NOT correct?

Information about three risk free Government bonds is given in the table below.

 Federal Treasury Bond Data Maturity Yield to maturity Coupon rate Face value Price (years) (pa, compounding semi-annually) (pa, paid semi-annually) ($) ($) 0.5 3% 4% 100 100.4926 1 4% 4% 100 100.0000 1.5 5% 4% 100 98.5720

Based on the above government bonds' yields to maturity, which of the below statements about the spot zero rates and forward zero rates is NOT correct?

Information about three risk free Government bonds is given in the table below.

 Federal Treasury Bond Data Maturity Yield to maturity Coupon rate Face value Price (years) (pa, compounding annually) (pa, paid annually) ($) ($) 1 0% 2% 100 102 2 1% 2% 100 101.9703951 3 2% 2% 100 100

Based on the above government bonds' yields to maturity, which of the below statements about the spot zero rates and forward zero rates is NOT correct?

A share was bought for $20 (at t=0) and paid its annual dividend of$3 one year later (at t=1). Just after the dividend was paid, the share price was $16 (at t=1). What was the total return, capital return and income return? Calculate your answers as effective annual rates. The choices are given in the same order: $r_\text{total},r_\text{capital},r_\text{income}$. Stock A and B's returns have a correlation of 0.3. Which statement is NOT correct? All things remaining equal, the variance of a portfolio of two positively-weighted stocks rises as:  Portfolio Details Stock Expected return Standard deviation Covariance $(\sigma_{A,B})$ Beta Dollars invested A 0.2 0.4 0.12 0.5 40 B 0.3 0.8 1.5 80 What is the standard deviation (not variance) of the above portfolio? Note that the stocks' covariance is given, not correlation. You're the boss of an investment bank's equities research team. Your five analysts are each trying to find the expected total return over the next year of shares in a mining company. The mining firm: • Is regarded as a mature company since it's quite stable in size and was floated around 30 years ago. It is not a high-growth company; • Share price is very sensitive to changes in the price of the market portfolio, economic growth, the exchange rate and commodities prices. Due to this, its standard deviation of total returns is much higher than that of the market index; • Experienced tough times in the last 10 years due to unexpected falls in commodity prices. • Shares are traded in an active liquid market. Your team of analysts present their findings, and everyone has different views. While there's no definitive true answer, whose calculation of the expected total return is the most plausible? Assume that: • The analysts' source data is correct and true, but their inferences might be wrong; • All returns and yields are given as effective annual nominal rates. What is the covariance of a variable X with itself? The cov(X, X) or $\sigma_{X,X}$ equals: What is the correlation of a variable X with a constant C? The corr(X, C) or $\rho_{X,C}$ equals: According to the theory of the Capital Asset Pricing Model (CAPM), total variance can be broken into two components, systematic variance and idiosyncratic variance. Which of the following events would be considered the most diversifiable according to the theory of the CAPM? 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? Diversification is achieved by investing in a large amount of stocks. What type of risk is reduced by diversification? A stock's required total return will decrease when its: The capital market line (CML) is shown in the graph below. The total standard deviation is denoted by σ and the expected return is μ. Assume that markets are efficient so all assets are fairly priced. Which of the below statements is NOT correct? A graph of assets’ expected returns $(\mu)$ versus standard deviations $(\sigma)$ is given in the graph below. The CML is the capital market line. Which of the following statements about this graph, Markowitz portfolio theory and the Capital Asset Pricing Model (CAPM) theory is NOT correct? Examine the following graph which shows stocks' betas $(\beta)$ and expected returns $(\mu)$: Assume that the CAPM holds and that future expectations of stocks' returns and betas are correctly measured. Which statement is NOT correct? The security market line (SML) shows the relationship between beta and expected return. Investment projects that plot on the SML would have: 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? 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. The equations for Net Income (NI, also known as Earnings or Net Profit After Tax) and Cash Flow From Assets (CFFA, also known as Free Cash Flow to the Firm) per year are: $$NI=(Rev-COGS-FC-Depr-IntExp).(1-t_c)$$ $$CFFA=NI+Depr-CapEx - \varDelta NWC+IntExp$$ For a firm with debt, what is the amount of the interest tax shield per year? The equations for Net Income (NI, also known as Earnings or Net Profit After Tax) and Cash Flow From Assets (CFFA, also known as Free Cash Flow to the Firm) per year are: $$NI=(Rev-COGS-FC-Depr-IntExp).(1-t_c)$$ $$CFFA=NI+Depr-CapEx - \varDelta NWC+IntExp$$ For a firm with debt, what is the formula for the present value of interest tax shields if the tax shields occur in perpetuity? You may assume: • the value of debt (D) is constant through time, • The cost of debt and the yield on debt are equal and given by $r_D$. • the appropriate rate to discount interest tax shields is $r_D$. • $\text{IntExp}=D.r_D$ You work for XYZ company and you’ve been asked to evaluate a new project which has double the systematic risk of the company’s other projects. You use the Capital Asset Pricing Model (CAPM) formula and input the treasury yield $(r_f )$, market risk premium $(r_m-r_f )$ and the company’s asset beta risk factor $(\beta_{XYZ} )$ into the CAPM formula which outputs a return. This return that you’ve just found is: A firm issues debt and uses the funds to buy back equity. Assume that there are no costs of financial distress or transactions costs. Which of the following statements about interest tax shields is NOT correct? 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: 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. No new equity or debt will be issued to fund the new projects, they'll all be funded by the cut in dividends. 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 (so there's no signalling effects) and that all rates are effective annual rates. A 3-for-2 stock split is equivalent to a 1-for-2 bonus issue or a 200% stock dividend. or ? A company conducts a 4 for 3 stock split. What is the percentage change in the stock price and the number of shares outstanding? The answers are given in the same order. Question 513 stock split, reverse stock split, stock dividend, bonus issue, rights issue Which of the following statements is NOT correct? 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? 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): Question 598 future, tailing the hedge, cross hedging The standard deviation of monthly changes in the spot price of lamb is$0.015 per pound. The standard deviation of monthly changes in the futures price of live cattle is $0.012 per pound. The correlation between the spot price of lamb and the futures price of cattle is 0.4. It is now January. A lamb producer is committed to selling 1,000,000 pounds of lamb in May. The spot price of live cattle is$0.30 per pound and the June futures price is $0.32 per pound. The spot price of lamb is$0.60 per pound.

The producer wants to use the June live cattle futures contracts to hedge his risk. Each futures contract is for the delivery of 50,000 pounds of cattle.

How many live cattle futures should the lamb farmer sell to hedge his risk? Round your answer to the nearest whole number of contracts.

Alice, Bob, Chris and Delta are traders in the futures market. The following trades occur over a single day in a newly-opened equity index future that matures in one year which the exchange just made available.

1. Alice buys a future from Bob.

2. Chris buys a future from Delta.

3. Delta buys a future from Alice.

These were the only trades made in this equity index future. What was the trading volume and what is the open interest?

Which of the following statements about futures is NOT correct?

What derivative position are you exposed to if you have the obligation to sell the underlying asset at maturity, so you will definitely be forced to sell the underlying asset?

On 1 February 2016 you were told that your refinery company will need to purchase oil on 1 July 2016. You were afraid of the oil price rising between now and then so you bought some August 2016 futures contracts on 1 February 2016 to hedge against changes in the oil price. On 1 February 2016 the oil price was $40 and the August 2016 futures price was$43.

It's now 1 July 2016 and oil price is $45 and the August 2016 futures price is$46. You bought the spot oil and closed out your futures position on 1 July 2016.

What was the effective price paid for the oil, taking into account basis risk? All spot and futures oil prices quoted above and below are per barrel.

You intend to use futures on oil to hedge the risk of purchasing oil. There is no cross-hedging risk. Oil pays no dividends but it’s costly to store. Which of the following statements about basis risk in this scenario is NOT correct?

Below are some statements about futures and European-style options on non-dividend paying stocks. Assume that the risk free rate is always positive. Which of these statements is NOT correct? All other things remaining equal:

A company runs a number of slaughterhouses which supply hamburger meat to McDonalds. The company is afraid that live cattle prices will increase over the next year, even though there is widespread belief in the market that they will be stable. What can the company do to hedge against the risk of increasing live cattle prices? Which statement(s) are correct?

(i) buy call options on live cattle.

(ii) buy put options on live cattle.

(iii) sell call options on live cattle.

Select the most correct response:

You have just sold an 'in the money' 6 month European put option on the mining company BHP at an exercise price of $40 for a premium of$3.

Which of the following statements best describes your situation?

All things remaining equal, according to the capital asset pricing model, if the systematic variance of an asset increases, its required return will increase and its price will decrease.
If the idiosyncratic variance of an asset increases, its price will be unchanged.

What is the relationship between the price of a call or put option and the total, systematic and idiosyncratic variance of the underlying asset that the option is based on? Select the most correct answer.

Call and put option prices increase when the:

Which one of the following is NOT usually considered an 'investable' asset for long-term wealth creation?

Question 432  option, option intrinsic value, no explanation

An American call option with a strike price of $K$ dollars will mature in $T$ years. The underlying asset has a price of $S$ dollars.

What is an expression for the current intrinsic value in dollars from owning (being long) the American call option? Note that the intrinsic value of an option does not subtract the premium paid to buy the option.

Which of the below formulas gives the payoff $(f)$ at maturity $(T)$ from being short a put option? Let the underlying asset price at maturity be $S_T$ and the exercise price be $X_T$.

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

Which of the following quantities from the Black-Scholes-Merton option pricing formula gives the risk-neutral probability that a European put option will be exercised?