Fight Finance

Total cash flows can be broken into income and capital cash flows. What is the name given to the income cash flow from owning shares?

An asset's total expected return over the next year is given by:

###r_\text{total} = \dfrac{c_1+p_1-p_0}{p_0} ###

Where ##p_0## is the current price, ##c_1## is the expected income in one year and ##p_1## is the expected price in one year. The total return can be split into the income return and the capital return.

Which of the following is the expected capital return?

Total cash flows can be broken into income and capital cash flows.

What is the name given to the cash flow generated from selling shares at a higher price than they were bought?

Which of the following equations is NOT equal to the total return of an asset?

Let ##p_0## be the current price, ##p_1## the expected price in one year and ##c_1## the expected income in one year.

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?

The following equation is the Dividend Discount Model, also known as the 'Gordon Growth Model' or the 'Perpetuity with growth' equation.

### p_{0} = \frac{c_1}{r_{\text{eff}} - g_{\text{eff}}} ###

What is the discount rate '## r_\text{eff} ##' in this equation?

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} ##.

A share was bought for $10 (at t=0) and paid its annual dividend of $0.50 one year later (at t=1). Just after the dividend was paid, the share price was $11 (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{dividend}##.

A share was bought for $4 and paid an dividend of $0.50 one year later (at t=1 year).

Just after the dividend was paid, the share price fell to $3.50 (at t=1 year). What were the total return, capital return and income returns given as effective annual rates? The answer choices are given in the same order:

##r_\text{total}##, ##r_\text{capital}##, ## r_\text{income}##

The following equation is the Dividend Discount Model, also known as the 'Gordon Growth Model' or the 'Perpetuity with growth' equation.

### p_0= \frac{c_1}{r-g} ###

Which expression is equal to the expected dividend return?

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?

A bond maturing in 10 years has a coupon rate of 4% pa, paid semi-annually. The bond's yield is currently 6% pa. The face value of the bond is $100. What is its price?

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?

Economic statistics released this morning were a surprise: they show a strong chance of consumer price inflation (CPI) reaching 5% pa over the next 2 years.

This is much higher than the previous forecast of 3% pa.

A vanilla fixed-coupon 2-year risk-free government bond was issued at par this morning, just before the economic news was released.

What is the expected change in bond price after the economic news this morning, and in the next 2 years? Assume that:

• Inflation remains at 5% over the next 2 years.
• Investors demand a constant real bond yield.
• The bond price falls by the (after-tax) value of the coupon the night before the ex-coupon date, as in real life.

Bonds X and Y are issued by the same US company. Both bonds yield 6% pa, and they have the same face value ($100), maturity, seniority, and payment frequency.

The only difference is that bond X pays coupons of 8% pa and bond Y pays coupons of 12% pa. Which of the following statements is true?

Former Reserve Bank of Australia (RBA) Governor Phil Lowe says that the RBA cash rate is the interest rate in the Australian:

Former RBA Governor Phil Lowe says that if the economy is growing very strongly, then prices might be growing too:

Former RBA Governor Phil Lowe says that when the RBA raise interest rates, homeowners' mortgage loan interest expense will be:

RBA Governor Phil Lowe says that when the RBA raises the cash rate (by surprise), the Australian dollar (AUD) tends to:

Former RBA Governor Phil Lowe says that when the RBA raise the cash rate, asset prices tend to:

US Federal Reserve Chair Jerome Powell showed the 'dot plot' of Federal Open Market Committee (FOMC) members' estimated future Fed fund rates following their quarterly summary of economic projections on 15 Dec 2021. The dot plot shows that committee members intended to make monetary policy more:

Below is the Australian central bank’s cash rate.

From 2011 to 2017 the Australian central bank has implemented:

Imagine that the interest rate on your savings account was 1% per year and inflation was 2% per year.

You currently have $100 in the bank which pays a 10% pa interest rate.

Oranges currently cost $1 each at the shop and inflation is 5% pa which is the expected growth rate in the orange price.

This information is summarised in the table below, with some parts missing that correspond to the answer options. All rates are given as effective annual rates. Note that when payments are not specified as real, as in this question, they're conventionally assumed to be nominal.

Which of the following statements is NOT correct? Your:

In February 2020, the RBA cash rate was 0.75% pa and the Australian CPI inflation rate was 1.8% pa.

You currently have $100 in the bank which pays a 0.75% pa interest rate.

Apples currently cost $1 each at the shop and inflation is 1.8% pa which is the expected growth rate in the apple price.

This information is summarised in the table below, with some parts missing that correspond to the answer options. All rates are given as effective annual rates. Note that when payments are not specified as real, as in this question, they're conventionally assumed to be nominal.

Which of the following statements is NOT correct? Your:

A residential investment property has an expected nominal total return of 8% pa and nominal capital return of 3% pa.

Inflation is expected to be 2% pa. All rates are given as effective annual rates.

What are the property's expected real total, capital and income returns? The answer choices below are given in the same order.

A stock has a real expected total return of 7% pa and a real expected capital return of 2% pa.

Inflation is expected to be 2% pa. All rates are given as effective annual rates.

What is the nominal expected total return, capital return and dividend yield? The answers below are given in the same order.

A residential investment property has an expected nominal total return of 6% pa and nominal capital return of 2.5% pa. Inflation is expected to be 2.5% pa.

All of the above are effective nominal rates and investors believe that they will stay the same in perpetuity.

What are the property's expected real total, capital and income returns?

The answer choices below are given in the same order.

A low-growth mature stock has an expected nominal total return of 6% pa and nominal capital return of 2% pa. Inflation is expected to be 3% pa.

All of the above are effective nominal rates and investors believe that they will stay the same in perpetuity.

What are the stock's expected real total, capital and income returns?

The answer choices below are given in the same order.

How can a nominal cash flow be precisely converted into a real cash flow?

What is the present value of a nominal payment of $100 in 5 years? The real discount rate is 10% pa and the inflation rate is 3% pa.

What is the present value of a nominal payment of $1,000 in 4 years? The nominal discount rate is 8% pa and the inflation rate is 2% pa.

What is the present value of a real payment of $500 in 2 years? The nominal discount rate is 7% pa and the inflation rate is 4% pa.

Apples and oranges currently cost $1 each. Inflation is 5% pa, and apples and oranges are equally affected by this inflation rate. Note that when payments are not specified as real, as in this question, they're conventionally assumed to be nominal.

Which of the following statements is NOT correct?

An investor bought a bond for $100 (at t=0) and one year later it paid its annual coupon of $1 (at t=1). Just after the coupon was paid, the bond price was $100.50 (at t=1). Inflation over the past year (from t=0 to t=1) was 3% pa, given as an effective annual rate.

Which of the following statements is NOT correct? The bond investment produced a:

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:

There are a number of different formulas involving real and nominal returns and cash flows. Which one of the following formulas is NOT correct? All returns are effective annual rates. Note that the symbol ##\approx## means 'approximately equal to'.

If someone says "my shares rose by 10% last year", what do you assume that they mean? The effective annual:

If the nominal gold price is expected to increase at the same rate as inflation which is 3% pa, which of the following statements is NOT correct?

What proportion of managers are evaluating projects correctly, based on table 8 from Meier and Tarhan's (2006) survey of corporate managers?

Table 8 footnote: The rows in this cross-tabulation show whether the firm uses a nominal or real hurdle rate, the columns indicate whether cash flows are calculated in nominal or real terms. The fractions denote the number of firms for each combination relative to the total of 123 respondents that responded to both separate survey questions.

What proportion of managers are evaluating projects correctly?

Below is a graph of 10-year US treasury fixed coupon bond yields (red), inflation-indexed bond yields (green) and the 'breakeven' inflation rate (blue). Note that inflation-indexed bonds are also called treasury inflation protected securities (TIPS) in the US. In other countries they're called inflation-linked bonds (ILB's). For more information, see PIMCO's great article about inflation linked bonds here.

The 10 year breakeven inflation rate (blue) equals the:

If the breakeven inflation rate was far above the US Fed's long term 2% average inflation target, the Fed would be expected to:

PIMCO gives the following example of an Inflation Linked Bond (ILB), called Treasury Inflation Protected Securities (TIPS) in the US.

How do ILBs work?

An ILB’s explicit link to a nationally-recognized inflation measure means that any increase in price levels directly translates into higher principal values. As a hypothetical example, consider a $1,000 20-year U.S. TIPS with a 2.5% coupon (1.25% on semiannual basis), and an inflation rate of 4%. The principal on the TIPS note will adjust upward on a daily basis to account for the 4% inflation rate. At maturity, the principal value will be $2,208 (4% per year, compounded semiannually). Additionally, while the coupon rate remains fixed at 2.5%, the dollar value of each interest payment will rise, as the coupon will be paid on the inflation-adjusted principal value. The first semiannual coupon of 1.25% paid on the inflation-adjusted principal of $1,020 is $12.75, while the final semiannual interest payment will be 1.25% of $2,208, which is $27.60.

Forecast the semi-annual coupon paid in 10 years based on the bond details given above. The 20th semi-annual coupon, paid in 10 years, is expected to be:

An Indonesian lady wishes to convert 1 million Indonesian rupiah (IDR) to Australian dollars (AUD). Exchange rates are 13,125 IDR per USD and 0.79 USD per AUD. How many AUD is the IDR 1 million worth?

If the current AUD exchange rate is USD 0.9686 = AUD 1, what is the European terms quote of the AUD against the USD?

Investors expect the Reserve Bank of Australia (RBA) to keep the policy rate steady at their next meeting.

Then unexpectedly, the RBA announce that they will increase the policy rate by 25 basis points due to fears that the economy is growing too fast and that inflation will be above their target rate of 2 to 3 per cent.

What do you expect to happen to Australia's exchange rate in the short term? The Australian dollar is likely to:

The market expects the Reserve Bank of Australia (RBA) to increase the policy rate by 25 basis points at their next meeting.

Then unexpectedly, the RBA announce that they will increase the policy rate by 50 basis points due to high future GDP and inflation forecasts.

What do you expect to happen to Australia's exchange rate in the short term? The Australian dollar will:

An American wishes to convert USD 1 million to Australian dollars (AUD). The exchange rate is 0.8 USD per AUD. How much is the USD 1 million worth in AUD?

A Chinese man wishes to convert AUD 1 million into Chinese Renminbi (RMB, also called the Yuan (CNY)). The exchange rate is 6.35 RMB per USD, and 0.72 USD per AUD. How much is the AUD 1 million worth in RMB?

Investors expect the Reserve Bank of Australia (RBA) to decrease the overnight cash rate at their next meeting.

Then unexpectedly, the RBA announce that they will keep the policy rate unchanged.

What do you expect to happen to Australia's exchange rate in the short term? The Australian dollar is likely to:

The market expects the Reserve Bank of Australia (RBA) to decrease the policy rate by 25 basis points at their next meeting.

Then unexpectedly, the RBA announce that they will decrease the policy rate by 50 basis points due to fears of a recession and deflation.

What do you expect to happen to Australia's exchange rate? The Australian dollar will:

The market expects the Reserve Bank of Australia (RBA) to increase the policy rate by 25 basis points at their next meeting.

As expected, the RBA increases the policy rate by 25 basis points.

What do you expect to happen to Australia's exchange rate in the short term? The Australian dollar will:

In the 1997 Asian financial crisis many countries' exchange rates depreciated rapidly against the US dollar (USD). The Thai, Indonesian, Malaysian, Korean and Filipino currencies were severely affected. The below graph shows these Asian countries' currencies in USD per one unit of their currency, indexed to 100 in June 1997.

Of the statements below, which is NOT correct? The Asian countries':

Which business structure or structures have the advantage of limited liability for equity investors?

What is the lowest and highest expected share price and expected return from owning shares in a company over a finite period of time?

Let the current share price be ##p_0##, the expected future share price be ##p_1##, the expected future dividend be ##d_1## and the expected return be ##r##. Define the expected return as:

##r=\dfrac{p_1-p_0+d_1}{p_0} ##

The answer choices are stated using inequalities. As an example, the first answer choice "(a) ##0≤p<∞## and ##0≤r< 1##", states that the share price must be larger than or equal to zero and less than positive infinity, and that the return must be larger than or equal to zero and less than one.

Which of the following statements is NOT correct? Borrowers:

Which of the following statements is NOT correct? Lenders:

Which of the following statements is NOT correct? Bond investors:

Which of the following statements is NOT correct? Lenders:

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

You bought a house, primarily funded using a home loan from a bank. Which of the following statements is NOT correct?

Your friend just bought a house for $400,000. He financed it using a $320,000 mortgage loan and a deposit of $80,000.

In the context of residential housing and mortgages, the 'equity' tied up in the value of a person's house is the value of the house less the value of the mortgage. So the initial equity your friend has in his house is $80,000. Let this amount be E, let the value of the mortgage be D and the value of the house be V. So ##V=D+E##.

If house prices suddenly fall by 10%, what would be your friend's percentage change in equity (E)? Assume that the value of the mortgage is unchanged and that no income (rent) was received from the house during the short time over which house prices fell.

Remember:

### r_{0\rightarrow1}=\frac{p_1-p_0+c_1}{p_0} ###

where ##r_{0-1}## is the return (percentage change) of an asset with price ##p_0## initially, ##p_1## one period later, and paying a cash flow of ##c_1## at time ##t=1##.

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.

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).

You just bought a house worth $1,000,000. You financed it with an $800,000 mortgage loan and a deposit of $200,000.

You estimate that:

• The house has a beta of 1;
• The mortgage loan has a beta of 0.2.

What is the beta of the equity (the $200,000 deposit) that you have in your house?

Also, if the risk free rate is 5% pa and the market portfolio's return is 10% pa, what is the expected return on equity in your house? Ignore taxes, assume that all cash flows (interest payments and rent) were paid and received at the end of the year, and all rates are effective annual rates.

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

Last year, two friends Lev and Nolev each bought similar investment properties for $1 million. Both earned net rents of $30,000 pa over the past year. They funded their purchases in different ways:

• Lev used $200,000 of his own money and borrowed $800,000 from the bank in the form of an interest-only loan with an interest rate of 5% pa.
• Nolev used $1,000,000 of his own money, he has no mortgage loan on his property.

Both Lev and Nolev also work in high-paying jobs and are subject personal marginal tax rates of 45%.

Which of the below statements about the past year is NOT correct?

Last year, two friends Gear and Nogear invested in residential apartments. Each invested $1 million of their own money (their net wealth).

Apartments cost $1,000,000 last year and they earned net rents of $30,000 pa over the last year. Net rents are calculated as rent revenues less the costs of renting such as property maintenance, land tax and council rates. However, interest expense and personal income taxes are not deducted from net rents.

Gear and Nogear funded their purchases in different ways:

• Gear used $1,000,000 of her own money and borrowed $4,000,000 from the bank in the form of an interest-only loan with an interest rate of 5% pa to buy 5 apartments.
• Nogear used $1,000,000 of his own money to buy one apartment. He has no mortgage loan on his property.

Both Gear and Nogear also work in high-paying jobs and are subject personal marginal tax rates of 45%.

Which of the below statements about the past year is NOT correct?

A firm has 20 million stocks, earnings (or net income) of $100 million per annum and a 60% debt-to-equity ratio where both the debt and asset values are market values rather than book values. Similar firms have a PE ratio of 12.

Which of the below statements is NOT correct based on a PE multiples valuation?

Use the below information to value a levered company with constant annual perpetual cash flows from assets. The next cash flow will be generated in one year from now, so a perpetuity can be used to value this firm. Both the operating and firm free cash flows are constant (but not equal to each other).

What is the value of the levered firm including interest tax shields?

Use the below information to value a levered company with constant annual perpetual cash flows from assets. The next cash flow will be generated in one year from now, so a perpetuity can be used to value this firm. Both the operating and firm free cash flows are constant (but not equal to each other).

What is the value of the levered firm including interest tax shields?

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. Note that ‘k’ means kilo or 1,000. So the $30k is $30,000.

Which of the following statements is NOT correct?

A stock has a beta of 0.5. Its next dividend is expected to be $3, paid one year from now. Dividends are expected to be paid annually and grow by 2% pa forever. Treasury bonds yield 5% pa and the market portfolio's expected return is 10% pa. All returns are effective annual rates.

What is the price of the stock now?

A stock has a beta of 1.2. Its next dividend is expected to be $20, paid one year from now.

Dividends are expected to be paid annually and grow by 1.5% pa forever.

Treasury bonds yield 3% pa and the market portfolio's expected return is 7% pa. All returns are effective annual rates.

What is the price of the stock now?

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.

What do you think will be the stock's expected return over the next year, given as an effective annual rate?

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?

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.

Over the last year, bad economic news was released showing a higher chance of recession. Over this time the share market fell by 1%. So ##r_{m} = (P_{0} - P_{-1})/P_{-1} = -0.01##, where the current time is zero and one year ago is time -1. The risk free rate was unchanged.

What do you think was the stock's historical return over the last year, given as an effective annual rate?

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 0.7.

What do you think will be the stock's expected return over the next year, given as an effective annual rate?

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 0.7.

In the last 5 minutes, bad economic news was released showing a higher chance of recession. Over this time the share market fell by 2%. 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?

A firm changes its capital structure by issuing a large amount of equity and using the funds to repay debt. Its assets are unchanged. Ignore interest tax shields.

According to the Capital Asset Pricing Model (CAPM), which statement is 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?

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?

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?

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 world 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:

Examine the graphs below. Assume that asset A is a single stock. Which of the following statements is NOT correct? Asset A:

A common phrase heard in financial markets is that ‘high risk investments deserve high returns’. To make this statement consistent with the Capital Asset Pricing Model (CAPM), a high amount of what specific type of risk deserves a high return?

Investors deserve high returns when they buy assets with high:

Which of the following statements about the above table which is used to calculate Apple's equity beta is NOT correct?

A levered firm has only 2 assets on its balance sheet with the below market values and CAPM betas. The risk free rate is 3% pa and the market risk premium is 5% pa. Assume that the CAPM is correct and all assets are fairly priced.

The firm then pays off (retires) all of its loan liabilities using its cash. Ignore interest tax shields.

Which of the following statements is NOT correct? All answers are given to 6 decimal places. This event led to a:

A person is thinking about borrowing $100 from the bank at 7% pa and investing it in shares with an expected return of 10% pa. One year later the person intends to sell the shares and pay back the loan in full. Both the loan and the shares are fairly priced.

What is the Net Present Value (NPV) of this one year investment? Note that you are asked to find the present value (##V_0##), not the value in one year (##V_1##).

A very low-risk stock just paid its semi-annual dividend of $0.14, as it has for the last 5 years. You conservatively estimate that from now on the dividend will fall at a rate of 1% every 6 months.

If the stock currently sells for $3 per share, what must be its required total return as an effective annual rate?

If risk free government bonds are trading at a yield of 4% pa, given as an effective annual rate, would you consider buying or selling the stock?

The stock's required total return is:

Fundamentalists who analyse company financial reports and news announcements (but who don't have inside information) will make positive abnormal returns if:

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 residential real estate investor believes that house prices will grow at a rate of 5% pa and that rents will grow by 2% pa forever.

All rates are given as nominal effective annual returns. Assume that:

• His forecast is true.
• Real estate is and always will be fairly priced and the capital asset pricing model (CAPM) is true.
• Ignore all costs such as taxes, agent fees, maintenance and so on.
• All rental income cash flow is paid out to the owner, so there is no re-investment and therefore no additions or improvements made to the property.
• The non-monetary benefits of owning real estate and renting remain constant.

Which one of the following statements is NOT correct? Over time:

Here's an excerpt from an interview between Magellan fund co-founder Hamish Douglass and AFR reporter Vesna Poljak, which appeared in the Australian Financial Review article ‘It's all about interest rates: Hamish Douglass’, 19 July 2019:

Take a business growing at 4 per cent a year, with a cost of equity of 10 per cent based off a 5 per cent risk-free rate and a 5 per cent market risk premium: you would value that at around 16.6 times free cashflow.

Now take a business growing at the same rate, with a 4 per cent risk free rate. At a 9 per cent cost of equity that would command a 20 times multiple, he says.

At a 3 per cent risk-free rate, the cost of equity is 8 per cent, and the multiple is 25.

Finally at 2 per cent – 'which is where the world is at the moment' – the same business would be worth around 33 times free cashflow.

In August 2021, the RBA overnight cash rate and 3 year Australian government treasury bond yield were both 0.1% pa. If this low risk-free yield was expected to persist forever, what approximate equity price-to-cashflow multiple would that imply for a business expected to grow at 4% pa in perpetuity with a 5% equity risk premium?

Hyman Minsky, author of 'The Financial Instability Hypothesis' (1992), wrote:

In particular, over a protracted period of good times, capitalist economies tend to move from a financial structure dominated by hedge finance units to a structure in which there is large weight to units engaged in speculative and Ponzi finance. Furthermore, if an economy with a sizeable body of speculative financial units is in an inflationary state, and the authorities attempt to exorcise inflation by monetary constraint, then speculative units will become Ponzi units and the net worth of previously Ponzi units will quickly evaporate. Consequently, units with cash flow shortfalls will be forced to try to make position by selling out position. This is likely to lead to a collapse of asset values.

Which of the below statements explaining this quote is NOT correct?

Listen to 'Lessons and Questions from the GFC' on 6 December 2018 by RBA Deputy Governor Guy Debelle from 17:58 to 20:08 or read the below transcript:

Guy Debelle talks about the GFC and says that the Australian government’s guarantee of wholesale debt and deposits on 12 October 2008 was "introduced to facilitate the flow of credit to the real economy at a reasonable price and, in some cases, alleviate the need for asset fire sales, which have the capacity to tip markets and the economy into a worse equilibrium... The crisis very much demonstrated the critical importance of keeping the lending flowing. The lesson is that countries that did that fared better than countries that didn't. That lesson is relevant to the situation today in Australia, where there is a risk that a reduced appetite to lend will overly curtail borrowing with consequent effects for the Australian economy." (Debelle, 2019)

When assets are sold in a fire sale, there’s usually a large increase in the:

Which of the following statements about Macaulay duration is NOT correct? The Macaulay duration:

Below is a table showing GMO's 2016 estimates of different assets' durations, appearing in Slater (2017).

If you were certain that interest rates would fall more than the market expects, into what asset might you allocate more funds?

Find the Macaulay duration of a 2 year 5% pa annual fixed coupon bond which has a $100 face value and currently has a yield to maturity of 8% pa. The Macaulay duration is:

Find the Macaulay duration of a 2 year 5% pa semi-annual fixed coupon bond which has a $100 face value and currently has a yield to maturity of 8% pa. The Macaulay duration is:

Which of the following statements about Macaulay duration is NOT correct? The Macaulay duration:

A fixed coupon bond’s modified duration is 20 years, and yields are currently 10% pa compounded annually. Which of the following statements about the bond is NOT correct?

Which of the following statements about bond convexity is NOT correct?

Assume that the market portfolio has a duration of 15 years and an individual stock has a duration of 20 years.

What can you say about the stock's (single factor CAPM) beta with respect to the market portfolio? The stock's beta is likely to be:

A stock has a beta of 0.5. Its next dividend is expected to be $3, paid one year from now. Dividends are expected to be paid annually and grow by 2% pa forever. Treasury bonds yield 5% pa and the market portfolio's expected return is 10% pa. All returns are effective annual rates.

What is the Macaulay duration of the stock now?

A stock has a beta of 0.5. Its next dividend is expected to be $3, paid one year from now. Dividends are expected to be paid annually and grow by 2% pa forever. Treasury bonds yield 3% pa and the market risk premium (MRP) is 6% pa. All returns are effective annual rates.

Which of the following statements is NOT correct?

Which of the following statements about vanilla floating coupon bonds is NOT correct? A vanilla floating coupon bond's:

Canaccord conducts a sensitivity analysis of the Israeli pharmaceutical firm InterCure's (INCR) estimated share price in figure 33 on page 30:

https://canaccordgenuity.bluematrix.com/sellside/EmailDocViewer?encrypt=a555719b-412b-4cc7-8528-505c27fb1e82&mime=PDF&co=Canaccordgenuity&id=mbottomley@cgf.com&source=libraryview&htmlToPdf=ture

Estimate the Macaulay duration of INCR's equity. The Macaulay duration is approximately:

When does the ‘principal-agent problem’ occur? Is it when:

I. The principal has conflicting incentives (moral hazard);

II. The agent has conflicting incentives (moral hazard);

III. The principal has incomplete information about the agent (asymmetric information); or

IV. The agent has incomplete information about the principal (asymmetric information)?

The principal-agent problem occurs when the following statements are true:

The ‘Lemons Problem’ is likely to more adversely affect the desirability of which type of investment?

A teacher fills up a large jar with coins. The jar is auctioned among a large class of wealthy accounting students who have never studied economics or finance.

The auction is conducted in the English style, which is as an open-outcry ascending auction. This means that the winning bidder is able to bid, win and pay slightly more than the second highest bidder's private valuation, but less than their own private valuation.

The jar of coins is not allowed to be weighed by students and is filled with different-valued coins so it’s difficult to value. Therefore there is a wide distribution of bidders’ fair value estimates. Students’ bids are purely profit-driven, there is no fame to be gained by being the winner or loser.

Assume that each bidder bids up to their personal estimate of the fair value of the jar of coins without observing the number of other bidders during the auction. The winning bidder is likely to:

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:

Which of the following statements about futures is NOT correct?

You believe that the price of a share will fall significantly very soon, but the rest of the market does not. The market thinks that the share price will remain the same. Assuming that your prediction will soon be true, which of the following trades is a bad idea? In other words, which trade will NOT make money or prevent losses?

A man just sold a call option to his counterparty, a lady. The man has just now:

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?

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?

An American style 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 style call option? Note that the intrinsic value of an option does not subtract the premium paid to buy the option.

Which one of the following statements about option contracts is NOT correct?

Which of the following statements about option contracts is NOT correct? For every:

If trader A has sold the right that allows counterparty B to buy the underlying asset from him at maturity if counterparty B wants then trader A is:

After doing extensive fundamental analysis of a company, you believe that their shares are overpriced and will soon fall significantly. The market believes that there will be no such fall.

Which of the following strategies is NOT a good idea, assuming that your prediction is true?

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 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##.

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:

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:

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

Which of the following statements about European call options on non-dividend paying stocks is NOT correct?

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:

Below are 4 option graphs. Note that the y-axis is payoff at maturity (T). What options do they depict? List them in the order that they are numbered.

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:

A one year European-style call option has a strike price of $4.

The option's underlying stock currently trades at $5, pays no dividends and its standard deviation of continuously compounded returns is 47% pa.

The risk-free interest rate is 10% pa continuously compounded.

Use the Black-Scholes-Merton formula to calculate the option price. The call option price now is:

A one year European-style put option has a strike price of $4.

The option's underlying stock currently trades at $5, pays no dividends and its standard deviation of continuously compounded returns is 47% pa.

The risk-free interest rate is 10% pa continuously compounded.

Use the Black-Scholes-Merton formula to calculate the option price. The put option price now is:

Which of the following quantities from the Black-Scholes-Merton option pricing formula gives the Delta of a European call option?

Where:

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?

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.

The levered equity graph above contains bold labels a to e. Which of the following statements about those labels is NOT correct?

In the Merton model of corporate debt, buying a levered company's shares is equivalent to:

In the Merton model of corporate debt, buying a levered company's debt is equivalent to buying the company's assets and:

Which of the below statements about utility is NOT generally accepted by economists? Most people are thought to:

Mr Blue, Miss Red and Mrs Green are people with different utility functions. Which of the statements about the 3 utility functions is NOT correct?

Mr Blue, Miss Red and Mrs Green are people with different utility functions. Which of the statements about the 3 utility functions is NOT correct?

Mr Blue, Miss Red and Mrs Green are people with different utility functions. Which of the statements about the 3 utility functions is NOT correct?

Mr Blue, Miss Red and Mrs Green are people with different utility functions.

Each person has $50 of initial wealth. A coin toss game is offered to each person at a casino where the player can win or lose $50. Each player can flip a coin and if they flip heads, they receive $50. If they flip tails then they will lose $50. Which of the following statements is NOT correct?

Mr Blue, Miss Red and Mrs Green are people with different utility functions.

Each person has $50 of initial wealth. A coin toss game is offered to each person at a casino where the player can win or lose $50. Each player can flip a coin and if they flip heads, they receive $50. If they flip tails then they will lose $50. Which of the following statements is NOT correct?

Mr Blue, Miss Red and Mrs Green are people with different utility functions.

Each person has $50 of initial wealth. A coin toss game is offered to each person at a casino where the player can win or lose $50. Each player can flip a coin and if they flip heads, they receive $50. If they flip tails then they will lose $50. Which of the following statements is NOT correct?

Mr Blue, Miss Red and Mrs Green are people with different utility functions.

Each person has $500 of initial wealth. A coin toss game is offered to each person at a casino where the player can win or lose $500. Each player can flip a coin and if they flip heads, they receive $500. If they flip tails then they will lose $500. Which of the following statements is NOT correct?

Convert a 10% continuously compounded annual rate ##(r_\text{cc annual})## into an effective annual rate ##(r_\text{eff annual})##. The equivalent effective annual rate is:

Which of the following interest rate quotes is NOT equivalent to a 10% effective annual rate of return? Assume that each year has 12 months, each month has 30 days, each day has 24 hours, each hour has 60 minutes and each minute has 60 seconds. APR stands for Annualised Percentage Rate.

A continuously compounded semi-annual return of 5% ##(r_\text{cc 6mth})## is equivalent to a continuously compounded annual return ##(r_\text{cc annual})## of:

An effective monthly return of 1% ##(r_\text{eff monthly})## is equivalent to an effective annual return ##(r_\text{eff annual})## of:

An effective semi-annual return of 5% ##(r_\text{eff 6mth})## is equivalent to an effective annual return ##(r_\text{eff annual})## of:

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:

Which of the following quantities is commonly assumed to be normally distributed?

If a variable, say X, is normally distributed with mean ##\mu## and variance ##\sigma^2## then mathematicians write ##X \sim \mathcal{N}(\mu, \sigma^2)##.

If a variable, say Y, is log-normally distributed and the underlying normal distribution has mean ##\mu## and variance ##\sigma^2## then mathematicians write ## Y \sim \mathbf{ln} \mathcal{N}(\mu, \sigma^2)##.

The below three graphs show probability density functions (PDF) of three different random variables Red, Green and Blue.

Select the most correct statement:

The below three graphs show probability density functions (PDF) of three different random variables Red, Green and Blue.

Which of the below statements is NOT correct?

The symbol ##\text{GDR}_{0\rightarrow 1}## represents a stock's gross discrete return per annum over the first year. ##\text{GDR}_{0\rightarrow 1} = P_1/P_0##. The subscript indicates the time period that the return is mentioned over. So for example, ##\text{AAGDR}_{1 \rightarrow 3}## is the arithmetic average GDR measured over the two year period from years 1 to 3, but it is expressed as a per annum rate.

Which of the below statements about the arithmetic and geometric average GDR is NOT correct?

Fred owns some Commonwealth Bank (CBA) shares. He has calculated CBA’s monthly returns for each month in the past 20 years using this formula:

He then took the arithmetic average and found it to be 1% per month using this formula:

He also found the standard deviation of these monthly returns which was 5% per month:

Which of the below statements about Fred’s CBA shares is NOT correct? Assume that the past historical average return is the true population average of future expected returns.

A stock has an arithmetic average continuously compounded return (AALGDR) of 10% pa, a standard deviation of continuously compounded returns (SDLGDR) of 80% pa and current stock price of $1. Assume that stock prices are log-normally distributed. The graph below summarises this information and provides some helpful formulas.

In one year, what do you expect the median and mean prices to be? The answer options are given in the same order.

Fred owns some BHP shares. He has calculated BHP’s monthly returns for each month in the past 30 years using this formula:

He then took the arithmetic average and found it to be 0.8% per month using this formula:

He also found the standard deviation of these monthly returns which was 15% per month:

Assume that the past historical average return is the true population average of future expected returns and the stock's returns calculated above ##(r_\text{t monthly})## are normally distributed. Which of the below statements about Fred’s BHP shares is NOT correct?

The arithmetic average continuously compounded or log gross discrete return (AALGDR) on the ASX200 accumulation index over the 24 years from 31 Dec 1992 to 31 Dec 2016 is 9.49% pa.

The arithmetic standard deviation (SDLGDR) is 16.92 percentage points pa.

Assume that the data are sample statistics, not population statistics. Assume that the log gross discrete returns are normally distributed.

What is the standard error of your estimate of the sample ASX200 accumulation index arithmetic average log gross discrete return (AALGDR) over the 24 years from 1992 to 2016?

A hedge fund issued zero coupon bonds with a combined $1 billion face value due to be paid in 3 years. The promised yield to maturity is currently 6% pa given as a continuously compounded return (or log gross discrete return, ##LGDR=\ln[P_T/P_0] \div T##).

The hedge fund owns stock assets worth $1.1 billion now which are expected to have a 10% pa arithmetic average log gross discrete return ##(\text{AALGDR} = \sum\limits_{t=1}^T{\left( \ln[P_t/P_{t-1}] \right)} \div T)## and 30pp pa standard deviation (SDLGDR) in the future.

Analyse the hedge fund using the Merton model of corporate equity as an option on the firm's assets.

The risk free government bond yield to maturity is currently 5% pa given as a continuously compounded return or LGDR.

Which of the below statements is NOT correct? All figures are rounded to the sixth decimal place.