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 fairly priced stock has an expected return of 15% pa. Treasury bonds yield 5% pa and the market portfolio's expected return is 10% pa. What is the beta of the stock?
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?
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).
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 $6m now (t=0) and fall by $6m 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?
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.
Which of the following statements about call options is NOT correct?
The risk-weight on "Margin lending against listed instruments on recognised exchanges" is 20% according to APRA's interpretation of the Basel 3 Accord in 'Prudential Standard APS 112 Capital Adequacy: Standardised Approach to Credit Risk, Attachment A: Risk-weights for on-balance sheet assets'.
A bank is considering lending a $100,000 margin loan secured by an ASX-listed stock. How much regulatory capital will the bank require to grant this loan under the Basel 3 Accord? Ignore the capital conservation buffer and the off-balance sheet exposure.