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Question 99 capital structure, interest tax shield, Miller and Modigliani, trade off theory of capital structure

A firm changes its capital structure by issuing a large amount of debt and using the funds to repurchase shares. Its assets are unchanged.

Assume that:

The firm and individual investors can borrow at the same rate and have the same tax rates.
The firm's debt and shares are fairly priced and the shares are repurchased at the market price, not at a premium.
There are no market frictions relating to debt such as asymmetric information or transaction costs.
Shareholders wealth is measured in terms of utiliity. Shareholders are wealth-maximising and risk-averse. They have a preferred level of overall leverage. Before the firm's capital restructure all shareholders were optimally levered.

According to Miller and Modigliani's theory, which statement is correct?

(a) The firm's share price and shareholder wealth will both decrease. This is because the firm will have more debt and therefore more risk so the discount rate applied to its cash flows will be higher, decreasing the value of the firm and therefore the value of the firm's equity and share price.

(b) The firm's share price and shareholder wealth will both increase. This is because the firm will have more debt which will amplify the returns of equity investors. This will mean that returns on equity can be much higher and investors will pay a premium for this, leading to an increase in the stock price.

(c) The firm's share price and shareholder wealth will both increase since it has more debt and therefore more tax shields.

(d) The firm's share price will increase due to the higher value of tax shields. But shareholder wealth will remain unchanged because capital structure is irrelevant when investors can use home-made leverage to create tax-shields themselves.

(e) The firm's share price and shareholder wealth will both increase. This is because the cost of debt is cheaper than equity, leading to a lower (before and after tax) WACC. This lower WACC will lead to a higher value of the firm and a higher share price.

Question 227 bond pricing, premium par and discount bonds

Which one of the following bonds is trading at a premium?

Question 293 covariance, correlation, portfolio risk

All things remaining equal, the higher the correlation of returns between two stocks:

Question 367 CFFA, interest tax shield

There are many ways to calculate a firm's free cash flow (FFCF), also called cash flow from assets (CFFA). Some include the annual interest tax shield in the cash flow and some do not.

Which of the below FFCF formulas include the interest tax shield in the cash flow?

###(1) \quad FFCF=NI + Depr - CapEx -ΔNWC + IntExp### ###(2) \quad FFCF=NI + Depr - CapEx -ΔNWC + IntExp.(1-t_c)### ###(3) \quad FFCF=EBIT.(1-t_c )+ Depr- CapEx -ΔNWC+IntExp.t_c### ###(4) \quad FFCF=EBIT.(1-t_c) + Depr- CapEx -ΔNWC### ###(5) \quad FFCF=EBITDA.(1-t_c )+Depr.t_c- CapEx -ΔNWC+IntExp.t_c### ###(6) \quad FFCF=EBITDA.(1-t_c )+Depr.t_c- CapEx -ΔNWC### ###(7) \quad FFCF=EBIT-Tax + Depr - CapEx -ΔNWC### ###(8) \quad FFCF=EBIT-Tax + Depr - CapEx -ΔNWC-IntExp.t_c### ###(9) \quad FFCF=EBITDA-Tax - CapEx -ΔNWC### ###(10) \quad FFCF=EBITDA-Tax - CapEx -ΔNWC-IntExp.t_c###

The formulas for net income (NI also called earnings), EBIT and EBITDA are given below. Assume that depreciation and amortisation are both represented by 'Depr' and that 'FC' represents fixed costs such as rent.

###NI=(Rev - COGS - Depr - FC - IntExp).(1-t_c )### ###EBIT=Rev - COGS - FC-Depr### ###EBITDA=Rev - COGS - FC### ###Tax =(Rev - COGS - Depr - FC - IntExp).t_c= \dfrac{NI.t_c}{1-t_c}###

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?

Question 829 option, future, delta, gamma, theta, no explanation

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:

Question 908 effective rate, return types, gross discrete return, return distribution, price gains and returns over time

For an asset's price to double from say $1 to $2 in one year, what must its gross discrete return (GDR) be? If the price now is ##P_0## and the price in one year is ##P_1## then the gross discrete return over the next year is:

###\text{GDR}_\text{annual} = \dfrac{P_1}{P_0}###

Question 931 confidence interval, normal distribution

A stock's returns are normally distributed with a mean of 10% pa and a standard deviation of 20 percentage points pa. What is the 90% confidence interval of returns over the next year? Note that the Z-statistic corresponding to a one-tail:

90% normal probability density function is 1.282.
95% normal probability density function is 1.645.
97.5% normal probability density function is 1.960.

The 90% confidence interval of annual returns is between:

Question 948 VaR, expected shortfall

Below is a historical sample of returns on the S&P500 capital index.

S&P500 Capital Index Daily Returns Ranked from Best to Worst
10,000 trading days from 4th August 1977 to 24 March 2017 based on closing prices.
Rank	Date (DD-MM-YY)	Continuously compounded daily return (% per day)
1	21-10-87	9.23
2	08-03-83	8.97
3	13-11-08	8.3
4	30-09-08	8.09
5	28-10-08	8.01
6	29-10-87	7.28
…	…	…
9980	11-12-08	-5.51
9981	22-10-08	-5.51
9982	08-08-11	-5.54
9983	22-09-08	-5.64
9984	11-09-86	-5.69
9985	30-11-87	-5.88
9986	14-04-00	-5.99
9987	07-10-98	-6.06
9988	08-01-88	-6.51
9989	27-10-97	-6.55
9990	13-10-89	-6.62
9991	15-10-08	-6.71
9992	29-09-08	-6.85
9993	07-10-08	-6.91
9994	14-11-08	-7.64
9995	01-12-08	-7.79
9996	29-10-08	-8.05
9997	26-10-87	-8.4
9998	31-08-98	-8.45
9999	09-10-08	-12.9
10000	19-10-87	-23.36

Mean of all 10,000:		0.0354
Sample standard deviation of all 10,000:		1.2062
Sources: Bloomberg and S&P.

Assume that the one-tail Z-statistic corresponding to a probability of 99.9% is exactly 3.09. Which of the following statements is NOT correct? Based on the historical data, the 99.9% daily:

Question 954 option, at the money option