# Fight Finance

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A company has:

• 10 million common shares outstanding, each trading at a price of $90. • 1 million preferred shares which have a face (or par) value of$100 and pay a constant dividend of 9% of par. They currently trade at a price of $120 each. • Debentures that have a total face value of$60,000,000 and a yield to maturity of 6% per annum. They are publicly traded and their market price is equal to 90% of their face value.
• The risk-free rate is 5% and the market return is 10%.
• Market analysts estimate that the company's common stock has a beta of 1.2. The corporate tax rate is 30%.

What is the company's after-tax Weighted Average Cost of Capital (WACC)? Assume a classical tax system.

An established mining firm announces that it expects large losses over the following year due to flooding which has temporarily stalled production at its mines. Which statement(s) are correct?

(i) If the firm adheres to a full dividend payout policy it will not pay any dividends over the following year.

(ii) If the firm wants to signal that the loss is temporary it will maintain the same level of dividends. It can do this so long as it has enough retained profits.

(iii) By law, the firm will be unable to pay a dividend over the following year because it cannot pay a dividend when it makes a loss.

Select the most correct response:

Your credit card shows a $600 debt liability. The interest rate is 24% pa, payable monthly. You can't pay any of the debt off, except in 6 months when it's your birthday and you'll receive$50 which you'll use to pay off the credit card. If that is your only repayment, how much will the credit card debt liability be one year from now?

A 30-day Bank Accepted Bill has a face value of $1,000,000. The interest rate is 8% pa and there are 365 days in the year. What will be its price? A wholesale vitamin supplements store offers credit to its customers. Customers are given 30 days to pay for their goods, but if they pay within 5 days they will get a 1% discount. What is the effective interest rate implicit in the discount being offered? Assume 365 days in a year and that all customers pay on either the 5th day or the 30th day. All of the below answer choices are given as effective annual interest rates. A 90-day Bank Accepted Bill has a face value of$1,000,000. The interest rate is 6% pa and there are 365 days in the year. What is its price?

A stock pays annual dividends. It just paid a dividend of $3. The growth rate in the dividend is 4% pa. You estimate that the stock's required return is 10% pa. Both the discount rate and growth rate are given as effective annual rates. Using the dividend discount model, what will be the share price? A stock is expected to pay the following dividends:  Cash Flows of a Stock Time (yrs) 0 1 2 3 4 ... Dividend ($) 8 8 8 20 8 ...

After year 4, the dividend will grow in perpetuity at 4% pa. The required return on the stock is 10% pa. Both the growth rate and required return are given as effective annual rates.

What is the current price 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 ($) 8 8 8 20 8 ... After year 4, the dividend will grow in perpetuity at 4% pa. The required return on the stock is 10% pa. Both the growth rate and required return are given as effective annual rates. What will be the price of the stock in 5 years (t = 5), just after the dividend at that time has been paid? A project has the following cash flows. Normally cash flows are assumed to happen at the given time. But here, assume that the cash flows are received smoothly over the year. So the$250 at time 2 is actually earned smoothly from t=1 to t=2:

 Project Cash Flows Time (yrs) Cash flow ($) 0 -400 1 200 2 250 What is the payback period of the project in years? A stock pays annual dividends. It just paid a dividend of$5. The growth rate in the dividend is 1% pa. You estimate that the stock's required return is 8% pa. Both the discount rate and growth rate are given as effective annual rates.

Using the dividend discount model, what will be the share price?

A stock is expected to pay the following dividends:

 Cash Flows of a Stock Time (yrs) 0 1 2 3 4 ... Dividend ($) 2 2 2 10 3 ... After year 4, the dividend will grow in perpetuity at 4% pa. The required return on the stock is 10% pa. Both the growth rate and required return are given as effective annual rates. What will be the price of the stock in 5 years (t = 5), just after the dividend at that time has been paid? A share pays annual dividends. It just paid a dividend of$2. The growth rate in the dividend is 3% pa. You estimate that the stock's required return is 8% pa. Both the discount rate and growth rate are given as effective annual rates.

Using the dividend discount model, what is the share price?

A stock is expected to pay the following dividends:

 Cash Flows of a Stock Time (yrs) 0 1 2 3 4 ... Dividend ($) 0 6 12 18 20 ... After year 4, the dividend will grow in perpetuity at 5% pa. The required return of the stock is 10% pa. Both the growth rate and required return are given as effective annual rates. What is the current price of the stock? A stock is expected to pay the following dividends:  Cash Flows of a Stock Time (yrs) 0 1 2 3 4 ... Dividend ($) 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.

What will be the price of the stock in 7 years (t = 7), just after the dividend at that time has been paid?

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)? For a bond that pays fixed semi-annual coupons, how is the annual coupon rate defined, and how is the bond's annual income yield from time 0 to 1 defined mathematically? Let: $P_0$ be the bond price now, $F_T$ be the bond's face value, $T$ be the bond's maturity in years, $r_\text{total}$ be the bond's total yield, $r_\text{income}$ be the bond's income yield, $r_\text{capital}$ be the bond's capital yield, and $C_t$ be the bond's coupon at time t in years. So $C_{0.5}$ is the coupon in 6 months, $C_1$ is the coupon in 1 year, and so on. A project has the following cash flows. Normally cash flows are assumed to happen at the given time. But here, assume that the cash flows are received smoothly over the year. So the$105 at time 2 is actually earned smoothly from t=1 to t=2:

 Project Cash Flows Time (yrs) Cash flow ($) 0 -90 1 30 2 105 What is the payback period of the project in years? Question 245 foreign exchange rate, monetary policy, foreign exchange rate direct quote, no explanation Investors expect Australia's central bank, the RBA, to leave the policy rate unchanged at their next meeting. Then unexpectedly, the policy rate is reduced due to fears that Australia's GDP growth is slowing. What do you expect to happen to Australia's exchange rate? Direct and indirect quotes are given from the perspective of an Australian. The Australian dollar will: In the so called 'Swiss Loans Affair' of the 1980's, Australian banks offered loans denominated in Swiss Francs to Australian farmers at interest rates as low as 4% pa. This was far lower than interest rates on Australian Dollar loans which were above 10% due to very high inflation in Australia at the time. In the late-1980's there was a large depreciation in the Australian Dollar. The Australian Dollar nearly halved in value against the Swiss Franc. Many Australian farmers went bankrupt since they couldn't afford the interest payments on the Swiss Franc loans because the Australian Dollar value of those payments nearly doubled. The farmers accused the banks of promoting Swiss Franc loans without making them aware of the risks. What fundamental principal of finance did the Australian farmers (and the bankers) fail to understand? A stock's standard deviation of returns is expected to be: • 0.09 per month for the first 5 months; • 0.14 per month for the next 7 months. What is the expected standard deviation of the stock per year $(\sigma_\text{annual})$? Assume that returns are independently and identically distributed (iid) and therefore have zero auto-correlation. On 27/09/13, three month Swiss government bills traded at a yield of -0.2%, given as a simple annual yield. That is, interest rates were negative. If the face value of one of these 90 day bills is CHF1,000,000 (CHF represents Swiss Francs, the Swiss currency), what is the price of one of these bills? The Australian cash rate is expected to be 6% pa while the US federal funds rate is expected to be 4% pa over the next 3 years, both given as effective annual rates. The current exchange rate is 0.80 AUD per USD. What is the implied 3 year forward foreign exchange rate? Interest expense on debt is tax-deductible, but dividend payments on equity are not. or ? A levered company's required return on debt is always less than its required return on equity. or ? A European call option will mature in $T$ years with a strike price of $K$ dollars. The underlying asset has a price of $S$ dollars. What is an expression for the payoff at maturity $(f_T)$ in dollars from owning (being long) the call option? A European put option will mature in $T$ years with a strike price of $K$ dollars. The underlying asset has a price of $S$ dollars. What is an expression for the payoff at maturity $(f_T)$ in dollars from owning (being long) the put option? Which of the following companies is most suitable for valuation using PE multiples techniques? Which of the following investable assets is the LEAST suitable for valuation using PE multiples techniques? The perpetuity with growth formula is: $$P_0= \dfrac{C_1}{r-g}$$ Which of the following is NOT equal to the total required return (r)? Question 412 enterprise value, no explanation A large proportion of a levered firm's assets is cash held at the bank. The firm is financed with half equity and half debt. Which of the following statements about this firm's enterprise value (EV) and total asset value (V) is NOT correct? A mature firm has constant expected future earnings and dividends. Both amounts are equal. So earnings and dividends are expected to be equal and unchanging. Which of the following statements is NOT correct? You just bought a residential apartment as an investment property for$500,000.

You intend to rent it out to tenants. They are ready to move in, they would just like to know how much the monthly rental payments will be, then they will sign a twelve-month lease.

You require a total return of 8% pa and a rental yield of 5% pa.

What would the monthly paid-in-advance rental payments have to be this year to receive that 5% annual rental yield?

Also, if monthly rental payments can be increased each year when a new lease agreement is signed, by how much must you increase rents per year to realise the 8% pa total return on the property?

Ignore all taxes and the costs of renting such as maintenance costs, real estate agent fees, utilities and so on. Assume that there will be no periods of vacancy and that tenants will promptly pay the rental prices you charge.

Note that the first rental payment will be received at t=0. The first lease agreement specifies the first 12 equal payments from t=0 to 11. The next lease agreement can have a rental increase, so the next twelve equal payments from t=12 to 23 can be higher than previously, and so on forever.

 Project Data Project life 1 year Initial investment in equipment $6m Depreciation of equipment per year$6m Expected sale price of equipment at end of project 0 Unit sales per year 9m Sale price per unit $8 Variable cost per unit$6 Fixed costs per year, paid at the end of each year $1m Interest expense in first year (at t=1)$0.53m Tax rate 30% Government treasury bond yield 5% Bank loan debt yield 6% Market portfolio return 10% Covariance of levered equity returns with market 0.08 Variance of market portfolio returns 0.16 Firm's and project's debt-to-assets ratio 50%

Notes

1. Due to the project, current assets will increase by $5m now (t=0) and fall by$5m at the end (t=1). Current liabilities will not be affected.

Assumptions

• The debt-to-assets 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 50% capital gains tax discount is not available since the project is undertaken by a firm, not an individual.

What is the net present value (NPV) of the project?

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

What is an expression for the payoff at maturity $(f_T)$ in dollars from having written (being short) the call option?

A European put option will mature in $T$ years with a strike price of $K$ dollars. The underlying asset has a price of $S$ dollars.

What is an expression for the payoff at maturity $(f_T)$ in dollars from having written (being short) the put option?

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.

A risky firm will last for one period only (t=0 to 1), then it will be liquidated. So it's assets will be sold and the debt holders and equity holders will be paid out in that order. The firm has the following quantities:

$V$ = Market value of assets.

$E$ = Market value of (levered) equity.

$D$ = Market value of zero coupon bonds.

$F_1$ = Total face value of zero coupon bonds which is promised to be paid in one year.

What is the payoff to equity holders at maturity, assuming that they keep their shares until maturity?

Will the price of a call option on equity or if the standard deviation of returns (risk) of the underlying shares becomes higher?

Will the price of an out-of-the-money put option on equity or if the standard deviation of returns (risk) of the underlying shares becomes higher?

Two call options are exactly the same, but one matures in one year and the other matures in two years. Which option would you expect to have the higher price, the option which matures or , or should they have the price?

Two put options are exactly the same, but one matures in one year and the other matures in two years. Which option would you expect to have the higher price, the option which matures or , or should they have the price?

Two call options are exactly the same, but one has a low and the other has a high exercise price. Which option would you expect to have the higher price, the option with the or exercise price, or should they have the price?

Two put options are exactly the same, but one has a low and the other has a high exercise price. Which option would you expect to have the higher price, the option with the or exercise price, or should they have the price?

Question 442  economic depreciation, no explanation

A fairly valued share's current price is $4 and it has a total required return of 30%. Dividends are paid annually and next year's dividend is expected to be$1. After that, dividends are expected to grow by 5% pa. All rates are effective annual returns.

What is the expected dividend cash flow, economic depreciation, and economic income and economic value added (EVA) that will be earned over the second year (from t=1 to t=2) and paid at the end of that year (t=2)?

The accounting identity states that the book value of a company's assets (A) equals its liabilities (L) plus owners equity (OE), so A = L + OE.

The finance version states that the market value of a company's assets (V) equals the market value of its debt (D) plus equity (E), so V = D + E.

Therefore a business's assets can be seen as a portfolio of the debt and equity that fund the assets.

Let $\sigma_\text{V total}^2$ be the total variance of returns on assets, $\sigma_\text{V syst}^2$ be the systematic variance of returns on assets, and $\sigma_\text{V idio}^2$ be the idiosyncratic variance of returns on assets, and $\rho_\text{D idio, E idio}$ be the correlation between the idiosyncratic returns on debt and equity.

Which of the following equations is NOT correct?

Which of the following is NOT a valid method to estimate future revenues or costs in a pro-forma income statement when trying to value a company?

A firm pays a fully franked cash dividend of $70 to one of its Australian shareholders who has a personal marginal tax rate of 45%. The corporate tax rate is 30%. What will be the shareholder's personal tax payable due to the dividend payment? Which of the following statements is NOT correct? High risk firms in danger of bankruptcy tend to have: The below screenshot of Commonwealth Bank of Australia's (CBA) details were taken from the Google Finance website on 7 Nov 2014. Some information has been deliberately blanked out. What was CBA's approximate payout ratio over the 2014 financial year? Note that the firm's interim and final dividends were$1.83 and $2.18 respectively over the 2014 financial year. What type of present value equation is best suited to value a residential house investment property that is expected to pay constant rental payments forever? Note that 'constant' has the same meaning as 'level' in this context. The below screenshot of Microsoft's (MSFT) details were taken from the Google Finance website on 28 Nov 2014. Some information has been deliberately blanked out. What was MSFT's approximate payout ratio over the last year? Note that MSFT's past four quarterly dividends were$0.31, $0.28,$0.28 and $0.28. High risk firms in danger of bankruptcy tend to have: The following cash flows are expected: • Constant perpetual yearly payments of$70, with the first payment in 2.5 years from now (first payment at t=2.5).
• A single payment of $600 in 3 years and 9 months (t=3.75) from now. What is the NPV of the cash flows if the discount rate is 10% given as an effective annual rate? How can a nominal cash flow be precisely converted into a real cash flow? If housing rents are constrained from growing more than the maximum target inflation rate, and houses can be priced as a perpetuity of growing net rental cash flows, then what is the implication for house prices, all things remaining equal? Select the most correct answer. Background: Since 1990, many central banks across the world have become 'inflation targeters'. They have adopted a policy of trying to keep inflation in a predictable narrow range, with the hope of encouraging long-term lending to fund more investment and maintain higher GDP growth. Australia's central bank, the Reserve Bank of Australia (RBA), has specifically stated their inflation target range is between 2 and 3% pa. Some Australian residential property market commentators suggest that because rental costs comprise a large part of the Australian consumer price index (CPI), rent costs across the nation cannot significantly exceed the maximum inflation target range of 3% pa without the prices of other goods growing by less than the target range for long periods, which is unlikely. You are promised 20 payments of$100, where the first payment is immediate (t=0) and the last is at the end of the 19th year (t=19). The effective annual discount rate is $r$.

Which of the following equations does NOT give the correct present value of these 20 payments?

You have $100,000 in the bank. The bank pays interest at 10% pa, given as an effective annual rate. You wish to consume twice as much now (t=0) as in one year (t=1) and have nothing left in the bank at the end. How much can you consume at time zero and one? The answer choices are given in the same order. You have$100,000 in the bank. The bank pays interest at 10% pa, given as an effective annual rate.

You wish to consume half as much now (t=0) as in one year (t=1) and have nothing left in the bank at the end.

How much can you consume at time zero and one? The answer choices are given in the same order.

Estimate the French bank Societe Generale's share price using a backward-looking price earnings (PE) multiples approach with the following assumptions and figures only. Note that EUR is the euro, the European monetary union's currency.

• The 4 major European banks Credit Agricole (ACA), Deutsche Bank AG (DBK), UniCredit (UCG) and Banco Santander (SAN) are comparable companies to Societe Generale (GLE);
• Societe Generale's (GLE's) historical earnings per share (EPS) is EUR 2.92;
• ACA's backward-looking PE ratio is 16.29 and historical EPS is EUR 0.84;
• DBK's backward-looking PE ratio is 25.01 and historical EPS is EUR 1.26;
• SAN's backward-looking PE ratio is 14.71 and historical EPS is EUR 0.47;
• UCG's backward-looking PE ratio is 15.78 and historical EPS is EUR 0.40;

Note: Figures sourced from Google Finance on 27 March 2015.

Risk-free government bonds that have coupon rates greater than their yields:

Which one of the below statements about effective rates and annualised percentage rates (APR's) is NOT correct?

A firm wishes to raise $10 million now. They will issue 6% pa semi-annual coupon bonds that will mature in 3 years and have a face value of$100 each. Bond yields are 5% pa, given as an APR compounding every 6 months, and the yield curve is flat.

How many bonds should the firm issue?

Which of the following statements about the capital and income returns of a 25 year fully amortising loan asset is correct?

Assume that the yield curve (which shows total returns over different maturities) is flat and is not expected to change.

Over the 25 years from issuance to maturity, a fully amortising loan's expected annual effective:

Which of the following statements about the capital and income returns of an interest-only loan is correct?

Assume that the yield curve (which shows total returns over different maturities) is flat and is not expected to change.

An interest-only loan's expected:

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:

Note: The inverse of x is 1/x.

An Apple iPhone 6 smart phone can be bought now for $999. An Android Kogan Agora 4G+ smart phone can be bought now for$240.

If the Kogan phone lasts for one year, approximately how long must the Apple phone last for to have the same equivalent annual cost?

Assume that both phones have equivalent features besides their lifetimes, that both are worthless once they've outlasted their life, the discount rate is 10% pa given as an effective annual rate, and there are no extra costs or benefits from either phone.

Many Australian home loans that are interest-only actually require payments to be made on a fully amortising basis after a number of years.

You decide to borrow $600,000 from the bank at an interest rate of 4.25% pa for 25 years. The payments will be interest-only for the first 10 years (t=0 to 10 years), then they will have to be paid on a fully amortising basis for the last 15 years (t=10 to 25 years). Assuming that interest rates will remain constant, what will be your monthly payments for the next 10 years from now, and then the next 15 years after that? The answer options are given in the same order. Who owns a company's shares? The: Technical traders: The efficient markets hypothesis (EMH) and no-arbitrage pricing theory is most closely related to which of the following concepts? Which of the following statements about Australian franking credits is NOT correct? Franking credits: 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? Which of the following statements about yield curves is NOT correct? Below is a graph of the USD against the JPY and EUR from 1980 to 2015, compiled by the RBA. Select the correct statement about what occurred between 1980 and 2015. Note that in 1980 the euro was around 1.3 USD per EUR and the Yen was around 250 JPY per USD. Which of the below formulas gives the payoff $(f)$ at maturity $(T)$ from being long a call option? Let the underlying asset price at maturity be $S_T$ and the exercise price be $X_T$. Which of the below formulas gives the payoff $(f)$ at maturity $(T)$ from being short a call option? Let the underlying asset price at maturity be $S_T$ and the exercise price be $X_T$. Which of the below formulas gives the payoff $(f)$ at maturity $(T)$ from being long a put option? Let the underlying asset price at maturity be $S_T$ and the exercise price be $X_T$. 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 one of the below option and futures contracts gives the possibility of potentially unlimited gains? Which of the below formulas gives the payoff at maturity $(f_T)$ from being long a future? Let the underlying asset price at maturity be $S_T$ and the locked-in futures price be $K_T$. Which of the below formulas gives the payoff at maturity $(f_T)$ from being short a future? Let the underlying asset price at maturity be $S_T$ and the locked-in futures price be $K_T$. A trader buys one crude oil futures contract on the CME expiring in one year with a locked-in futures price of$38.94 per barrel. If the trader doesn’t close out her contract before expiry then in one year she will have the:

A trader sells one crude oil futures contract on the CME expiring in one year with a locked-in futures price of $38.94 per barrel. The crude oil spot price is$40.33. If the trader doesn’t close out her contract before expiry then in one year she will have the:

A trader buys one crude oil European style call option contract on the CME expiring in one year with an exercise price of $44 per barrel for a price of$6.64. The crude oil spot price is $40.33. If the trader doesn’t close out her contract before maturity, then at maturity she will have the: 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? Which of the following statements is NOT correct? Lenders: A stock's required total return will decrease when its: To value a business's assets, the free cash flow of the firm (FCFF, also called CFFA) needs to be calculated. This requires figures from the firm's income statement and balance sheet. For what figures is the income statement needed? Note that the income statement is sometimes also called the profit and loss, P&L, or statement of financial performance. A home loan company advertises an interest rate of 9% pa, payable monthly. Which of the following statements about the interest rate is NOT correct? All rates are given with an accuracy of 4 decimal places. Which of the following interest rate labels does NOT make sense? A firm has a debt-to-assets ratio of 20%. What is its debt-to-equity ratio? What is the present value of real payments of$100 every year forever, with the first payment in one year? The nominal discount rate is 7% pa and the inflation rate is 4% pa.

The Australian cash rate is expected to be 2% pa over the next one year, while the US cash rate is expected to be 0% pa, both given as nominal effective annual rates. The current exchange rate is 0.73 USD per AUD.

What is the implied 1 year USD per AUD forward foreign exchange rate?

Which of the below formulas gives the profit $(\pi)$ from being long a call option? Let the underlying asset price at maturity be $S_T$, the exercise price be $X_T$ and the option price be $f_{LC,0}$. Note that $S_T$, $X_T$ and $f_{LC,0}$ are all positive numbers.

Which of the below formulas gives the profit $(\pi)$ from being short a call option? Let the underlying asset price at maturity be $S_T$, the exercise price be $X_T$ and the option price be $f_{LC,0}$. Note that $S_T$, $X_T$ and $f_{LC,0}$ are all positive numbers.

Which of the below formulas gives the profit $(\pi)$ from being long a put option? Let the underlying asset price at maturity be $S_T$, the exercise price be $X_T$ and the option price be $f_{LP,0}$. Note that $S_T$, $X_T$ and $f_{LP,0}$ are all positive numbers.

Which of the below formulas gives the profit $(\pi)$ from being short a put option? Let the underlying asset price at maturity be $S_T$, the exercise price be $X_T$ and the option price be $f_{LP,0}$. Note that $S_T$, $X_T$ and $f_{LP,0}$ are all positive numbers.

A trader sells one crude oil European style call option contract on the CME expiring in one year with an exercise price of $44 per barrel for a price of$6.64. The crude oil spot price is $40.33. If the trader doesn’t close out her contract before maturity, then at maturity she will have the: A trader buys one crude oil European style put option contract on the CME expiring in one year with an exercise price of$44 per barrel for a price of $6.64. The crude oil spot price is$40.33. If the trader doesn’t close out her contract before maturity, then at maturity she will have the:

A trader sells one crude oil European style put option contract on the CME expiring in one year with an exercise price of $44 per barrel for a price of$6.64. The crude oil spot price is $40.33. If the trader doesn’t close out her contract before maturity, then at maturity she will have the: An equity index stands at 100 points and the one year equity futures price is 102. The equity index is expected to have a dividend yield of 4% pa. Assume that investors are risk-neutral so their total required return on the shares is the same as the risk free Treasury bond yield which is 10% pa. Both are given as discrete effective annual rates. Assuming that the equity index is fairly priced, an arbitrageur would recognise that the equity futures are: An equity index stands at 100 points and the one year equity futures price is 107. The equity index is expected to have a dividend yield of 3% pa. Assume that investors are risk-neutral so their total required return on the shares is the same as the risk free Treasury bond yield which is 10% pa. Both are given as discrete effective annual rates. Assuming that the equity index is fairly priced, an arbitrageur would recognise that the equity futures are: Which of the following statements about call options is NOT correct? A bank quotes an interest rate of 6% pa with quarterly compounding. Note that another way of stating this rate is that it is an annual percentage rate (APR) compounding discretely every 3 months. Which of the following statements about this rate is NOT correct? All percentages are given to 6 decimal places. The equivalent: The standard deviation of monthly changes in the spot price of corn is 50 cents per bushel. The standard deviation of monthly changes in the futures price of corn is 40 cents per bushel. The correlation between the spot price of corn and the futures price of corn is 0.9. It is now March. A corn chip manufacturer is committed to buying 250,000 bushels of corn in May. The spot price of corn is 381 cents per bushel and the June futures price is 399 cents per bushel. The corn chip manufacturer wants to use the June corn futures contracts to hedge his risk. Each futures contract is for the delivery of 5,000 bushels of corn. One bushel is about 127 metric tons. How many corn futures should the corn chip manufacturer buy to hedge his risk? Round your answer to the nearest whole number of contracts. Remember to tail the hedge. Which of the following quantities is commonly assumed to be normally distributed? Which of the following statements about gold is NOT correct? Assume that the gold price increases by inflation. Gold: If a firm makes a profit and pays no dividends, which of the following accounts will increase? A stock’s current price is$1. Its expected total return is 10% pa and its long term expected capital return is 4% pa. It pays an annual dividend and the next one will be paid in one year. All rates are given as effective annual rates. The dividend discount model is thought to be a suitable model for the stock. Ignore taxes. Which of the following statements about the stock is NOT correct?

In the dividend discount model (DDM), share prices fall when dividends are paid. Let the high price before the fall be called the peak, and the low price after the fall be called the trough.

$$P_0=\dfrac{C_1}{r-g}$$

Which of the following statements about the DDM is NOT correct?

An equities analyst is using the dividend discount model to price a company's shares. The company operates domestically and has no plans to expand overseas. It is part of a mature industry with stable positive growth prospects.

The analyst has estimated the real required return (r) of the stock and the value of the dividend that the stock just paid a moment before $(C_\text{0 before})$.

What is the highest perpetual real growth rate of dividends (g) that can be justified? Select the most correct statement from the following choices. The highest perpetual real expected growth rate of dividends that can be justified is the country's expected:

For an asset's price to quintuple every 5 years, what must be its effective annual capital return? Note that a stock's price quintuples when it increases from say $1 to$5.

How many years will it take for an asset's price to triple (increase from say $1 to$3) if it grows by 5% pa?

A share will pay its next dividend of $C_1$ in one year, and will continue to pay a dividend every year after that forever, growing at a rate of $g$. So the next dividend will be $C_2=C_1 (1+g)^1$, then $C_3=C_2 (1+g)^1$, and so on forever.

The current price of the share is $P_0$ and its required return is $r$

Which of the following is NOT equal to the expected share price in 2 years $(P_2)$ just after the dividend at that time $(C_2)$ has been paid?

The following cash flows are expected:

• A perpetuity of yearly payments of $30, with the first payment in 5 years (first payment at t=5, which continues every year after that forever). • One payment of$100 in 6 years and 3 months (t=6.25).

What is the NPV of the cash flows if the discount rate is 10% given as an effective annual rate?

A firm wishes to raise $50 million now. They will issue 7% pa semi-annual coupon bonds that will mature in 6 years and have a face value of$100 each. Bond yields are 5% pa, given as an APR compounding every 6 months, and the yield curve is flat.

How many bonds should the firm issue?

A firm wishes to raise $50 million now. They will issue 5% pa semi-annual coupon bonds that will mature in 3 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?

A firm wishes to raise $50 million now. They will issue 5% pa semi-annual coupon bonds that will mature in 10 years and have a face value of$100 each. Bond yields are 5% pa, given as an APR compounding every 6 months, and the yield curve is flat.

How many bonds should the firm issue?

Two years ago you entered into a fully amortising home loan with a principal of $1,000,000, an interest rate of 6% pa compounding monthly with a term of 25 years. Then interest rates suddenly fall to 4.5% pa (t=0), but you continue to pay the same monthly home loan payments as you did before. How long will it now take to pay off your home loan? Measure the time taken to pay off the home loan from the current time which is 2 years after the home loan was first entered into. Assume that the lower interest rate was given to you immediately after the loan repayment at the end of year 2, which was the 24th payment since the loan was granted. Also assume that rates were and are expected to remain constant. Five years ago you entered into a fully amortising home loan with a principal of$500,000, an interest rate of 4.5% pa compounding monthly with a term of 25 years.

Then interest rates suddenly fall to 3% pa (t=0), but you continue to pay the same monthly home loan payments as you did before. How long will it now take to pay off your home loan? Measure the time taken to pay off the home loan from the current time which is 5 years after the home loan was first entered into.

Assume that the lower interest rate was given to you immediately after the loan repayment at the end of year 5, which was the 60th payment since the loan was granted. Also assume that rates were and are expected to remain constant.

Five years ago ($t=-5$ years) you entered into an interest-only home loan with a principal of $500,000, an interest rate of 4.5% pa compounding monthly with a term of 25 years. Then interest rates suddenly fall to 3% pa ($t=0$), but you continue to pay the same monthly home loan payments as you did before. Will your home loan be paid off by the end of its remaining term? If so, in how many years from now? Measure the time taken to pay off the home loan from the current time which is 5 years after the home loan was first entered into. Assume that the lower interest rate was given to you immediately after the loan repayment at the end of year 5, which was the 60th payment since the loan was granted. Also assume that rates were and are expected to remain constant. The phone company Optus have 2 mobile service plans on offer which both have the same amount of phone call, text message and internet data credit. Both plans have a contract length of 24 months and the monthly cost is payable in advance. The only difference between the two plans is that one is a: • 'Bring Your Own' (BYO) mobile service plan, costing$80 per month. There is no phone included in this plan. The other plan is a:
• 'Bundled' mobile service plan that comes with the latest smart phone, costing $100 per month. This plan includes the latest smart phone. Neither plan has any additional payments at the start or end. Assume that the discount rate is 1% per month given as an effective monthly rate. The only difference between the plans is the phone, so what is the implied cost of the phone as a present value? Given that the latest smart phone actually costs$600 to purchase outright from another retailer, should you commit to the BYO plan or the bundled plan?

Radio-Rentals.com offers the Apple iphone 5S smart phone for rent at $12.95 per week paid in advance on a 2 year contract. After renting the phone, you must return it to Radio-Rentals. Kogan.com offers the Apple iphone 5S smart phone for sale at$699. You estimate that the phone will last for 3 years before it will break and be worthless.

Currently, the effective annual interest rate is 11.351%, the effective monthly interest rate 0.9% and the effective weekly interest rate is 0.207%. Assume that there are exactly 52 weeks per year and 12 months per year.

Find the equivalent annual cost of renting the phone and also buying the phone. The answers below are listed in the same order.

A stock is expected to pay its first dividend of $20 in 3 years (t=3), which it will continue to pay for the next nine years, so there will be ten$20 payments altogether with the last payment in year 12 (t=12).

From the thirteenth year onward, the dividend is expected to be 4% more than the previous year, forever. So the dividend in the thirteenth year (t=13) will be $20.80, then$21.632 in year 14, and so on forever. The required return of the stock is 10% pa. All rates are effective annual rates. Calculate the current (t=0) stock price.

A 4.5% fixed coupon Australian Government bond was issued at par in mid-April 2009. Coupons are paid semi-annually in arrears in mid-April and mid-October each year. The face value is $1,000. The bond will mature in mid-April 2020, so the bond had an original tenor of 11 years. Today is mid-September 2015 and similar bonds now yield 1.9% pa. What is the bond's new price? Note: there are 10 semi-annual coupon payments remaining from now (mid-September 2015) until maturity (mid-April 2020); both yields are given as APR's compounding semi-annually; assume that the yield curve was flat before the change in yields, and remained flat afterwards as well. An investor bought a 5 year government bond with a 2% pa coupon rate at par. Coupons are paid semi-annually. The face value is$100.

Calculate the bond's new price 8 months later after yields have increased to 3% pa. Note that both yields are given as APR's compounding semi-annually. Assume that the yield curve was flat before the change in yields, and remained flat afterwards as well.

The sayings "Don't cry over spilt milk", "Don't regret the things that you can't change" and "What's done is done" are most closely related to which financial concept?

Question 768  accounting terminology, book and market values, no explanation

Accountants and finance professionals have lots of names for the same things which can be quite confusing.

Which of the following groups of items are NOT synonyms?

"Buy low, sell high" is a well-known saying. It suggests that investors should buy low then sell high, in that order.

How would you re-phrase that saying to describe short selling?

Which of the following statements is NOT correct? Assume that all things remain equal. So for example, don't assume that just because a company's dividends and profit rise that its required return will also rise, assume the required return stays the same.

You deposit money into a bank account. Which of the following statements about this deposit is NOT correct?

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?

Which of the following statements about returns is NOT correct? A stock's:

The market's expected total return is 10% pa and the risk free rate is 5% pa, both given as effective annual rates.

A stock has a beta of 0.5.

In the last 5 minutes, the federal government unexpectedly raised taxes. Over this time the share market fell by 3%. 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?

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 company advertises an investment costing $1,000 which they say is under priced. They say that it has an expected total return of 15% pa, but a required return of only 10% pa. Of the 15% pa total expected return, the dividend yield is expected to be 4% pa and the capital yield 11% pa. Assume that the company's statements are correct. What is the NPV of buying the investment if the 15% total return lasts for the next 100 years (t=0 to 100), then reverts to 10% after that time? Also, what is the NPV of the investment if the 15% return lasts forever? In both cases, assume that the required return of 10% remains constant, the dividends can only be re-invested at 10% pa and all returns are given as effective annual rates. The answer choices below are given in the same order (15% for 100 years, and 15% forever): Which of the following quantities from the Black-Scholes-Merton option pricing formula gives the Delta of a European call option? Where: $$d_1=\dfrac{\ln⁡(S_0/K)+(r+\sigma^2/2).T)}{\sigma.\sqrt{T}}$$ $$d_2=d_1-\sigma.\sqrt{T}=\dfrac{\ln⁡(S_0/K)+(r-\sigma^2/2).T)}{\sigma.\sqrt{T}}$$ Which of the following quantities from the Black-Scholes-Merton option pricing formula gives the Delta of a European put option? Which of the following quantities from the Black-Scholes-Merton option pricing formula gives the risk-neutral probability that a European call option will be exercised? 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? The following quotes are most closely related to which financial concept? • “Opportunity is missed by most people because it is dressed in overalls and looks like work” -Thomas Edison • “The only place where success comes before work is in the dictionary” -Vidal Sassoon • “The quickest way to double your money is to fold it in half and put it in your back pocket” -Will Rogers In the home loan market, the acronym LVR stands for Loan to Valuation Ratio. If you bought a house worth one million dollars, partly funded by an$800,000 home loan, then your LVR was 80%. The LVR is equivalent to which of the following ratios?

Which of the following assets would you expect to have the highest required rate of return? All values are current market values.

The following steps set out the process of ‘negative gearing’ an investment property in Australia. Which of these steps or statements is NOT correct? To successfully achieve negative gearing on an investment property:

Which of the following statements about ‘negative gearing’ is NOT correct?

Question 803  capital raising, rights issue, initial public offering, on market repurchase, no explanation

Which one of the following capital raisings or payouts involve the sale of shares to existing shareholders only?

Use the below information to value a levered company with annual perpetual cash flows from assets that grow. The next cash flow will be generated in one year from now, so a perpetuity can be used to value this firm. Note that ‘k’ means kilo or 1,000. So the $30k is$30,000.

 Data on a Levered Firm with Perpetual Cash Flows Item abbreviation Value Item full name $\text{CFFA}_\text{U}$ $30k Cash flow from assets excluding interest tax shields (unlevered) $g$ 1.5% pa Growth rate of cash flow from assets, levered and unlevered $r_\text{D}$ 4% pa Cost of debt $r_\text{EL}$ 16.3% pa Cost of levered equity $D/V_L$ 80% pa Debt to assets ratio, where the asset value includes tax shields $t_c$ 30% Corporate tax rate Which of the following statements is NOT correct? A firm conducts a two-for-one stock split. Which of the following consequences would NOT be expected? You work in Asia and just woke up. It looked like a nice day but then you read the news and found out that last night the American share market fell by 10% while you were asleep due to surprisingly poor macro-economic news. You own a portfolio of liquid stocks listed in Asia with a beta of 1.6. When the Asian equity markets open, what do you expect to happen to your share portfolio? Assume that the capital asset pricing model (CAPM) is correct and that the market portfolio contains all shares in the world, of which American shares are a big part. Your portfolio beta is measured against this world market portfolio. When the Asian equity market opens for trade, you would expect your portfolio value to: A firm is about to conduct a 2-for-7 rights issue with a subscription price of$10 per share. They haven’t announced the capital raising to the market yet and the share price is currently $13 per share. Assume that every shareholder will exercise their rights, the cash raised will simply be put in the bank, and the rights issue is completed so quickly that the time value of money can be ignored. Disregard signalling, taxes and agency-related effects. Which of the following statements about the rights issue is NOT correct? After the rights issue is completed: Which derivatives position has the possibility of unlimited potential gains? Which of the following terms about options are NOT synonyms? 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? You just paid$4 for a 3 month European style call option on a stock currently priced at $47 with a strike price of$50. The stock’s next dividend will be $1 in 4 months’ time. Note that the dividend is paid after the option matures. Which of the below statements is NOT correct? When does a European option's last-traded market price become a sunk cost? A European call option should only be exercised if: A put option written on a risky non-dividend paying stock will mature in one month. As is normal, assume that the option's exercise price is non-zero and positive $(K>0)$ and the stock has limited liability $(S>0)$. Which of the following statements is NOT correct? The put option's: An equity index fund manager controls a USD500 million diversified equity portfolio with a beta of 0.9. The equity manager expects a significant rally in equity prices next year. The market does not think that this will happen. If the fund manager wishes to increase his portfolio beta to 1.5, how many S&P500 futures should he buy? The US market equity index is the S&P500. One year CME futures on the S&P500 currently trade at 2,155 points and the spot price is 2,180 points. Each point is worth$250.

The number of one year S&P500 futures contracts that the fund manager should buy is:

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 the price of oil 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?

Question 828  future, future valuation, no explanation

You bought a 1.5 year (18 month) futures contract on oil. Oil storage costs are 4% pa continuously compounded and oil pays no dividends. The futures contract is entered into when the oil price is $40 per barrel and the risk-free rate of interest is 10% per annum with continuous compounding. Which of the following statements 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? Below are some statements about European-style options on non-dividend paying stocks. Assume that the risk free rate is always positive. Which of these statements is NOT correct? Question 831 option, American option, no explanation Which of the following statements about American-style options is NOT correct? American-style: A 12 month European-style call option with a strike price of$11 is written on a dividend paying stock currently trading at $10. The dividend is paid annually and the next dividend is expected to be$0.40, paid in 9 months. The risk-free interest rate is 5% pa continuously compounded and the standard deviation of the stock’s continuously compounded returns is 30% pa. The stock's continuously compounded returns are normally distributed. Using the Black-Scholes-Merton option valuation model, determine which of the following statements is NOT correct.

Which of the following statements about an option (either a call or put) and its underlying stock is NOT correct?

Which of the following statements about an option (either a call or put) and its underlying stock is NOT correct?

 European Call Option on a non-dividend paying stock Description Symbol Quantity Spot price ($) $S_0$ 20 Strike price ($) $K_T$ 18 Risk free cont. comp. rate (pa) $r$ 0.05 Standard deviation of the stock's cont. comp. returns (pa) $\sigma$ 0.3 Option maturity (years) $T$ 1 Call option price ($) $c_0$ 3.939488 Delta $\Delta = N[d_1]$ 0.747891 $N[d_2]$ $N[d_2]$ 0.643514 Gamma $\Gamma$ 0.053199 Theta ($/year) $\Theta = \partial c / \partial T$ -1.566433

A company has a 95% daily Value at Risk (VaR) of $1 million. The units of this VaR are in: The 95% daily VaR corresponds to the result on the: Calculate Australia’s GDP over the 2016 calendar year using the below table:  Australian Gross Domestic Product Components A$ billion, 2016 Calendar Year from 1 Jan 2016 to 31 Dec 2016 inclusive Consumption Investment Government spending Exports Imports 971 421 320 328 344

Source: ABS 5206.0 Australian National Accounts: National Income, Expenditure and Product. Table 3. Expenditure on Gross Domestic Product (GDP), Current prices.

Australia’s GDP was:

Question 841  gross domestic product, government spending, no explanation

The government spends money on:

• Goods and services such as defence, police, schools, hospitals and roads; and
• Transfer payments (also called welfare) such as the pension, dole, disability support and student support.

When calculating GDP, the ‘government spending’ component is supposed to include:

Which Australian institution is in charge of monetary policy?

The Australian central bank implements monetary policy by directly controlling which interest rate?

Question 844  gross domestic product deflator, consumer price index, inflation, no explanation

An Australian-owned company produces milk in New Zealand and exports all of it to China. If the price of the milk increases, which of the following would increase?

Safe firms with low chances of bankruptcy will tend to have:

Below is the Australian central bank’s cash rate.

From 2011 to 2017 the Australian central bank has implemented:

Below is the Australian federal government’s budget balance as a percent of GDP.

From 2009 to 2016 the Australian federal government has implemented:

Which of the following is NOT the Australian central bank’s responsibility?

You just spent $1,000 on your credit card. The interest rate is 24% pa compounding monthly. Assume that your credit card account has no fees and no minimum monthly repayment. If you can't make any interest or principal payments on your credit card debt over the next year, how much will you owe one year from now? Question 850 gross domestic product, gross domestic product per capita, no explanation Below is a table showing some countries’ GDP, population and GDP per capita.  Countries' GDP and Population GDP Population GDP per capita USD million millions of people USD United States 18,036,648 325 55,492 China 11,158,457 1,383 8,066 Japan 4,383,076 127 34,586 Germany 3,363,600 83 40,623 Norway 500,519 5 95,027 Source: "GDP and its breakdown at current prices in US Dollars" United Nations Statistics Division. December 2016. Using this data only, which one of these countries’ citizens have the highest living standards? Question 851 labour force, no explanation Below is a table showing some figures about the Australian labour force.  Australian Labour Force and Employment Data April 2017 Seasonally Adjusted figures Employed persons ('000) 12 061.9 Unemployed persons ('000) 751.4 Unemployment rate (%) 5.9 Participation rate (%) 64.8 Source: ABS 6202.0 Labour Force, Australia, Apr 2017 What do you estimate is the size of working age population in thousands (‘000)? Question 852 gross domestic product growth, inflation, employment, no explanation When the economy is booming (in an upswing), you tend to see: Which form of production is included in the Gross Domestic Product (GDP) reported by the government statistics agency? Question 854 speculation motive for keeping money, no explanation What is the speculation motive for keeping money? The speculation motive encourages people to keep money available: Question 856 credit terms, no explanation Your supplier’s credit terms are "1/10 net 30". Which of the following statements about these credit terms is NOT correct? If you intend to buy an item from your supplier for a tag price of$100 and you:

Question 857  Du Pont formula, accounting ratio, no explanation

The Du Pont formula is:

$$\dfrac{\text{Net Profit}}{\text{Sales}} \times \dfrac{\text{Sales}}{\text{Total Assets}} \times \dfrac{\text{Total Assets}}{\text{Ordinary Equity}}$$

Which of the following statements about the Du Pont formula is NOT correct?

Question 858  indirect security, intermediated finance, no explanation

Which of the following transactions involves an ‘indirect security’ using a ‘financial intermediary’?

Question 859  money supply, no explanation

The below table shows Australian monetary aggregates. Note that ‘M3’ is the sum of all the figures in the table and ‘ADI’ stands for Authorised Deposit-taking Institution such as a bank, building society or credit union.

 Australian Monetary Aggregates March 2017, AUD billions Currency Current deposits with banks Certificates of deposit issued by banks Term deposits with banks Other deposits with banks Deposits with non-bank ADIs M3 69.3 271.6 207.2 562.3 838.7 36.9 1986.0

Source: RBA Statistical Table D3 Monetary Aggregates.

Which of the following statements is NOT correct?

Question 860  idiom, hedging, speculation, arbitrage, market making, insider trading, no explanation

Which class of derivatives market trader is NOT principally focused on ‘buying low and selling high’?

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 2 future from Bob.

2. Chris buys 5 futures from Delta.

3. Chris buys 9 futures from Bob.

Which of the following statements is NOT correct?

Refer to the below graph when answering the questions.

Which of the following statements is NOT correct?

A one year European-style call option has a strike price of $4. The option's underlying stock pays no dividends and currently trades at$5. The risk-free interest rate is 10% pa continuously compounded. Use the Black-Scholes-Merton formula to calculate the option price, assuming that the stock's standard deviation of continuously compounded returns is 47% pa. The call option price now is:

A one year European-style put option has a strike price of $4. The option's underlying stock pays no dividends and currently trades at$5. The risk-free interest rate is 10% pa continuously compounded. Use the Black-Scholes-Merton formula to calculate the option price, assuming that the stock's standard deviation of continuously compounded returns is 47% pa. The put option price now is: