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business
principles corporate finance

Questions and Answers of Principles Corporate Finance

What is the drawback of the β coefficient?
A shareholder requires a rate of return that is twice as high on a share with a β coefficient that is twice as high as that of another share. True or false?
What does a low-risk premium indicate?
On the graph on page 427, does the Alcatel-Lucent share seem under- or overvalued to you? What about the Daimler share? 14- 12- 10- Expected return (%) Steria EADS Peugeot Air France Rhodia
What is the strong point of the APT compared with the CAPM? And the weak point?
Will liquidity premiums tend to rise or fall during a crash? Why?
What does a negative liquidity premium indicate?
The standard deviation of the earnings on Bouygues shares is 40%, while for Siemens it is only 28%. However, Bouygues has a β of 1.13 and Siemens of 1.7. Explain how this is possible.
Explain why an investor would be prepared to require a lower return on a risk-free share for a share with a negative β.
How do you explain the fact that rates of return required by investors may be identical for two groups of totally different activities (oil and IT services for example) as long as they have the same
An experiment was recently carried out where a child, an astrologer and a financial analyst were each given €10,000 to invest for eight years. Who do you think achieved the best results?
When is the cost of capital equal to the cost of equity? Can the cost of capital be equal to the cost of debt?
Why does the cost of capital constitute a direct link between return on capital expenditure and the returns required by capital investors?
Why is the cost of capital not an accounting concept?
What is the cost of capital equal to?
Is the cost of equity equal to the return on the shares?
What is the cost of reserves equal to? And the cost of depreciation?
How many costs of capital are there in a company that has diversified into different(business) sectors but not geographic areas? What about if it has done so within each of the company’s divisions?
Can a company that invests in projects on which the returns are lower than its cost of capital continue to obtain resources through cash flow? Through debt? Through capital increases?
A listed company launches a takeover bid on another company at a price that is far too high. According to the cost of capital theory, what should the sanction be?
What is the difference between the zero coupon curve and the yield curve?
Why is a yield curve showing higher long-term interest rates than short-term rates(rising curve) called a normal curve?
What risk are we talking about when we say that government bonds are risk-free?
What is the “reinvestment risk”?
You observe the following prices for different bonds (note that the coupons on all of them have just been paid)(a) Calculate the return on each of these bonds.(b) Reconstruct the zero coupon curve at
In 2009 you notice that the yields to maturity of the same company’s two bonds, 5% of 2013 and 9% of 2013, are selling at 87.44 and 100.71, respectively, and the resulting yield to maturity is
Why is the bond rating important?
What is the default risk?
What is the “character” of a bond issuer?
What should a credit analyst consider as the basic of credit risk?
Should the analysis of covenants in high-yield corporate issues be carried out separately from other characteristics?
In an article in a popular daily publication, a statement similar to the following was made: “Repurchase agreements are extremely risky vehicles”. Explain why this statement is ambiguous.
Is project financing based on the personal and real guarantees of the sponsors?
What services can be offered as part of factoring?
In a securitisation transaction, is a company that transfers assets to an SPV at risk if these assets do not cover the debts of the SPV?
Why is adjustment necessary?
Define growth stock and yield stock.
What are the growth prospects for a company that pays out all of its profits?
Does a “high” P/E necessarily mean that the company is experiencing high growth?
What assumptions must be made for inverse P/E to provide an approximate estimate of required rate of return?
Will a change in required rate of return have a greater impact on a company that pays out 75% of its profits than a company that has a payout ratio of 5%, but which should increase to 75% in 25 years?
Will a share with a higher than average required rate of return for the same risk, be undervalued or overvalued?
What is dividend growth that is higher per share than for the total amount of dividends paid out a sign of? What is dividend growth that is higher for the total amount of dividends paid out than the
Is a company’s earnings growth the most important criteria defining a growth stock?
What does a PBR that is much higher than 1 mean?
Define a call or put option.
What are the six criteria for determining the value of an option?
What does the delta of an option indicate?
What impact will a rise in volatility have on the value of a call option? And a drop in interest rates? And payment of a dividend? And the extension of the maturity of an option? And an upward
Can you set the sale of a call option off against the purchase of a put option on the same underlying asset at the same maturity?
How would this investor find counterparties?
Show how, in the end, the investor always pays too much for the option. Why is this statement absurd?
Of the following four transactions, which carries the most risk:◦ purchase of a call option;◦ sale of a call option;◦ purchase of a put option;◦ sale of a put option;Why?
Time value is the anticipation of intrinsic value being stronger than it is now. However, intrinsic value can drop. Why then can time value not be negative?
In concrete terms, what does the difficulty in valuing an option boil down to?
Why are options particularly well suited to arbitrage strategies? And speculation?
Show how the purchase of an option and the sale of another option can protect you against the risk of a drop in the value of the underlying share, without costing you anything if you give up the
If you hold stock options on the shares in your company, would you be pleased to see the company paying out large dividends? Why?
In your view, what is the main contribution of the Black–Scholes model?
The Schauspielhaus in Berlin sells tickets thirty minutes before the start of every concert that has been sold out, known as Nacheinlasskarten.Holders of these tickets are entitled to occupy any free
You wish to value a call option on the Faurecia share (which does not pay dividends) after 6 months with a strike price of €35 and a 6-month duration. You do not know what volatility to factor in.
Redo the exercise above, assuming in the first case that the Faurecia share rises to €40 or falls to €25. What is the impact on the value of the option? What basic feature of the option have you
Can any financial product normally make it possible to obtain resources at below market cost?
Define: convertible bond, bond with equity warrants, preference share, investment certificate and bond redeemable in shares.
The bond market yield is 7%. A company issues a bond with equity warrants at a gross yield to maturity of 3% assuming the warrants are not exercised. What is the cost of this product? What is the
Is a convertible bond more costly to the issuing company than a bond with equity warrants?
Which is (are) the most appropriate financial product(s) for the following companies:◦ a company that wants to raise fresh equity capital immediately but does not want to risk losing control;◦ a
Rank convertible bonds, investment certificates, bonds with equity warrants, preference shares and new ordinary shares in terms of:◦ actual or potential dilution;◦ achieved rate of return;◦
Which product would appear to be a case of “tails I win, heads you lose”?
Show that if managers think their company’s shares are undervalued, there is a better product to issue than a convertible bond.
Show that if managers think their company’s shares are overvalued, there is a better product to issue than a convertible bond.
Given your answers to Questions 8 and 9, how do you explain the existence of convertible bonds?
True or false:(a) The higher the conversion premium, the higher the yield on a convertible bond.(b) The higher the volatility of the underlying share, the higher the conversion premium.(c) A rise in
Why isn’t a bond redeemable in shares attractive to financial investors?
Why is there a good chance that preference shares will be worth less than the same issuer’s ordinary shares, despite the preferences accorded to them?
Company X has capital of 2million shares that are currently trading at BC2000 per share. On its balance sheet it has a liability for an issue of convertible bonds with the following
What is a prospectus used for?
Why does it take longer to set up a share issuance than a bond issue?
What financial product can a greenshoe be compared to?
Why is the timetable for a first issue for a company issuing a high yield bond much longer than for the issue of a standard bond?
Which placement procedure carries the most risk for a bank? Why?
Describe two different methods used for calculating the value of a subscription right.
Will a shareholder who subscribes a capital increase with a pre-emptive subscription right become poorer if the share price drops after the operation? Why?
Which party is the bank which places the shares working for – the issuer or the investor subscribing the shares?
Which is more costly for an issuer – an underwritten deal or a bought deal? Why?
Why can convertible bonds be placed so quickly?
Immediately after bonds are placed on the market, the price rises. What is the good news for the issuer? And the bad news? Which is the most important?
What combination of two options would give you the total position payoff shown in Figure 18-1? (You may assume that any sloped lines are at a 45-degree angle to the horizontal).a. Short call (E =
Everything else held constant, and considering a group of options all written on the same underlying stock, which of the following sets of parameters would result in a put option with the highest
You are evaluating a 20-year bond that carries an 8 percent coupon rate, a current price of $1,234, and pays interest quarterly. How would this bond's Yield to Maturity (YTM) be quoted in the
You are contemplating buying stock in FMS Corp. FMS just paid a quarterly dividend of $1.00, and you expect future quarterly dividends to decline at a rate of 5 percent per quarter indefinitely. If
In the Capital Asset Pricing Model formula, the expected return to the market portfolio, E(RM), represents the:a. X variableb. Y variablec. Sloped. None of the above
Given the probabilities of expected states of the economy shown here, and the expected returns to stocks A and B in those states, what is the standard deviation of a portfolio with weights of 40
Stock W has an expected return of 12.4 percent and a beta of 1.8. If the expected market return is 10 percent, what is the risk-free rate?a. -5.6%b. 3.0%c. 5.6%d. 7.0%
Suppose that noncollege-graduates earn a salary of $25,000 per year in your hometown, and that salary will never change. If you go to college for four years, foregoing four years worth of that
First Strike Software has 7 percent coupon bonds on the market with 10 years to maturity. The bonds make semiannual payments and currently sell for 94 percent of par. What is the effective annual
KAD Enterprises, Inc. is growing quickly. Dividends are expected to grow at a 50 percent rate for the next year, at a 30 percent rate for the following year, and at a 15 percent rate for the year
What quoted rate, if compounded weekly, would give you an effective annual rate of 8.5 percent?a. 7.5817%b. 8.1644%c. 9.8763%d. 10.0032%
You have just arranged for a $157,000 mortgage to finance the purchase of a large tract of land. The mortgage has a 7.65 percent APR, and it calls for monthly payments over the next 20 years.
You are evaluating a new cookie-baking oven. The Cookie Munster costs \($90,000,\) has a seven-year life, and has an annual Operating Cash Flow (OCF), after tax, of -\($8,000\) per year. If your

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