Fight Finance

Question 71  CAPM, risk

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

(a) Stock A has less systematic risk than stock B, so stock A's return should be less than stock B's.

(b) Stock B has the same systematic risk as the market, so its return should be the same as the market's.

(c) Stock B has the same beta as the market, so it also has the same total risk as the market.

(d) If stock A and B were combined in a portfolio with weights of 50% each, the beta of the portfolio would be 0.75.

(e) Stocks A and B have more systematic risk than the risk free security (government bonds) so their return should be greater than the risk free rate.

Question 127  interest expense

A zero coupon bond that matures in 6 months has a face value of $1,000.

The firm that issued this bond is trying to forecast its income statement for the year. It needs to calculate the interest expense of the bond this year.

The bond is highly illiquid and hasn't traded on the market. But the finance department have assessed the bond's fair value to be $950 and this is its book value right now at the start of the year.

Assume that:

• the firm uses the 'effective interest method' to calculate interest expense.
• the market value of the bond is the same as the book value.
• the firm is only interested in this bond's interest expense. Do not include the interest expense for a new bond issued to refinance the current one, as would normally happen.

What will be the interest expense of the bond this year for the purpose of forecasting the income statement?

(a) $0

(b) $50.0000

(c) $51.3158

(d) $102.6316

(e) $1,000.0000

Question 248  CAPM, DDM, income and capital returns

The total return of any asset can be broken down in different ways. One possible way is to use the dividend discount model (or Gordon growth model):

###p_0 = \frac{c_1}{r_\text{total}-r_\text{capital}}###

Which, since ##c_1/p_0## is the income return (##r_\text{income}##), can be expressed as:

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

So the total return of an asset is the income component plus the capital or price growth component.

Another way to break up total return is to use the Capital Asset Pricing Model:

###r_\text{total}=r_\text{f}+β(r_\text{m}- r_\text{f})###

###r_\text{total}=r_\text{time value}+r_\text{risk premium}###

So the risk free rate is the time value of money and the term ##β(r_\text{m}- r_\text{f})## is the compensation for taking on systematic risk.

Using the above theory and your general knowledge, which of the below equations, if any, are correct?

(I) ##r_\text{income}=r_\text{time value}##

(II) ##r_\text{income}=r_\text{risk premium}##

(III) ##r_\text{capital}=r_\text{time value}##

(IV) ##r_\text{capital}=r_\text{risk premium}##

(V) ##r_\text{income}+r_\text{capital}=r_\text{time value}+r_\text{risk premium}##

Which of the equations are correct?

(a) I, IV and V only.

(b) II, III and V only.

(c) V only.

(d) All are true.

(e) None are true.

Question 547  PE ratio, Multiples valuation, DDM, income and capital returns, no explanation

A firm pays out all of its earnings as dividends. Because of this, the firm has no real growth in earnings, dividends or stock price since there is no re-investment back into the firm to buy new assets and make higher earnings. The dividend discount model is suitable to value this company.

The firm's revenues and costs are expected to increase by inflation in the foreseeable future. The firm has no debt. It operates in the services industry and has few physical assets so there is negligible depreciation expense and negligible net working capital required.

Which of the following statements about this firm's PE ratio is NOT correct? The PE ratio should:

(a) Equal the inverse of the firm's nominal income return.

(b) Equal the inverse of the firm's real total return.

(c) Equal the inverse of the firm's real capital return.

(d) Equal the expected payback period of an investor who intends to buy the firm's equity at the current price.

(e) Be lower than that of faster growing firms that pay lower dividends and re-invest in themselves.

Note: The inverse of x is 1/x.

Question 551  fully amortising loan, time calculation, APR

You just entered into a fully amortising home loan with a principal of $600,000, a variable interest rate of 4.25% pa and a term of 25 years.

Immediately after settling the loan, the variable interest rate suddenly falls to 4% pa! You can't believe your luck. Despite this, you plan to continue paying the same home loan payments as you did before. How long will it now take to pay off your home loan?

Assume that the lower interest rate was granted immediately and that rates were and are now again expected to remain constant. Round your answer up to the nearest whole month.

(a) 301 months

(b) 288 months

(c) 271 months

(d) 270 months

(e) 75 months

Question 566  capital structure, capital raising, rights issue, on market repurchase, dividend, stock split, bonus issue

A company's share price fell by 20% and its number of shares rose by 25%. Assume that there are no taxes, no signalling effects and no transaction costs.

Which one of the following corporate events may have happened?

(a) $1 cash dividend when the pre-announcement stock price was $5.

(b) On-market buy-back of 20% of the company's outstanding stock.

(c) 5 for 4 stock split.

(d) 1 for 5 bonus issue.

(e) 1 for 4 rights issue at a subscription price of $3 when the pre-announcement stock price was $5.

Question 650  future, closing out future contract

In February a company sold one December 40,000 pound (about 18 metric tons) lean hog futures contract. It closed out its position in May.

The spot price was $0.68 per pound in February. The December futures price was $0.70 per pound when the trader entered into the contract in February, $0.60 when he closed out his position in May, and $0.55 when the contract matured in December.

What was the total profit?

(a) $2,000

(b) $3,200

(c) $4,000

(d) $5,200

(e) $6,000

Question 652  future, continuously compounding rate

An equity index is currently at 5,200 points. The 6 month futures price is 5,300 points and the total required return is 6% pa with continuous compounding. Each index point is worth $25.

What is the implied dividend yield as a continuously compounded rate per annum?

(a) 5.7145% pa

(b) 4.0952% pa

(c) 3.8096% pa

(d) 2.1904% pa

(e) 1.9048% pa

Question 827  future, basis risk, no explanation

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?

(a) Basis risk makes hedges more risky.

(b) Basis risk can only lead to worse than expected effective dollar prices.

(c) Basis risk only occurs when the future is closed out early, before it matures.

(d) ‘The basis’ is defined as the underlying spot price less the futures price quote ##(S_t - F_{t,T})##.

(e) The futures price of oil will tend to be higher than the spot price due to storage costs, so the basis will tend to be positive for hedgers who long futures contracts.

Question 857  DuPont formula, accounting ratio

The DuPont formula is:

###\dfrac{\text{Net Profit}}{\text{Sales}} \times \dfrac{\text{Sales}}{\text{Total Assets}} \times \dfrac{\text{Total Assets}}{\text{Owners' Equity}}###

Which of the following statements about the DuPont formula is NOT correct?

(a) The DuPont formula gives the book Return on Equity (ROE).

(b) The net profit to sales ratio is called the ‘gross profit margin’.

(c) The sales to total assets ratio is called the ‘total asset turnover’ ratio.

(d) The total assets to owners' equity ratio is called the ‘equity multiplier’.

(e) The equity multiplier and ROE will rise if the firm uses more leverage by replacing equity with debt.