FIN201 Final Exam Sample MULTIPLE CHOICE. 1. Why will banks permit the use of an overdraft as
Question:
MULTIPLE CHOICE.
1. Why will banks permit the use of an overdraft as suitable for funding the purchase of inventory that will quickly be converted into cash?
A. To assist a company in meeting unexpected short-term cash flow problems
B. To assist a company in exploiting short-term opportunities
C. To assist a company through seasonal downturns in liquidity
D. All of the given options
Learning Objective: 10.03 Understand the main forms of short-term bank lending and recognise when each may be suitable to a borrowers needs
Section: 10.03 Short-term borrowing from banks and other financial institutions
2. Which of the following statements with regard to factoring is true?
A. When the customer makes payment, the money initially goes to the factor, which then passes it to the company, plus a factor charge.
B. The discount charged by the factor is generally calculated at a rate approximately equal to the secured overdraft rate.
C. From the factor's viewpoint, the company accelerates its cash inflow from accounts receivable.
D. Some banks and bank subsidiaries may provide factoring.
Learning Objective: 10.04 Understand debtor finance, inventory loans and bridging finance and be able to distinguish between them
Section: 10.03 Short-term borrowing from banks and other financial institutions
3. The interbank overnight rate is:
A.well below the indicator rate for business lending; otherwise, a company could draw on its overdraft to borrow profitably in the cash market.
B.well above the indicator rate for business lending; otherwise, a company could draw on its overdraft to borrow profitably in the cash market.
C.well below the indicator rate for business lending; otherwise, a company could draw on its overdraft to lend profitably in the cash market.
D.well above the indicator rate for business lending; otherwise, a company could draw on its overdraft to lend profitably in the cash market.
Learning Objective: 10.06 Compare and contrast the main features of short-term and long-term debt securities
Section: 10.02 General characteristics of debt
4. The difference between commercial paper and a bill of exchange is that:
A. a bill of exchange is a short-term debt instrument whereas commercial paper is not.
B. in a bill of exchange, the issuer and an acceptor are parties to the instrument, as opposed to only the issuer to a commercial paper instrument.
C. only a bill of exchange can be traded in an active secondary market.
D. none of the given options.
Learning Objective: 10.06 Compare and contrast the main features of short-term and long-term debt securities
Section: 10.05 Debt securities
5.Endorsement means that:
A. if the acceptor is unable to pay the face value on the maturity date, then it is obliged to draw a bill to meet its initial obligations.
B. an agreement between the acceptor and an endorser is reached, whereby the acceptor is obliged to pay the face value on the maturity date if the endorser is unable to pay the subsequent holder of the bill.
C. the endorser has a contingent liability until the bill matures and is paid.
D. none of the given options.
Learning Objective: 10.08 Understand the process of using bills of exchange to raise funds and how bills of exchange are priced Section: 10.05 Debt securities
6. A bank bill:
A. is accepted by institutions other than banks.
B. is regarded as a lower quality bill than a non-bank bill.
C. includes both bank-accepted and bank-endorsed bills.
D. is not normally endorsed if it is sold after being bought in the secondary market.
Learning Objective: 10.08 Understand the process of using bills of exchange to raise funds and how bills of exchange are priced Section: 10.05 Debt securities
7. In a bill discount facility:
A.the borrower undertakes to buy bills of exchange drawn by the bank up to a specified total amount.
B. the bank undertakes to sell bills of exchange drawn by the borrower up to a specified total amount.
C. the bank undertakes to sell bills of exchange drawn by the borrower for an unspecified total amount, usually determined by demand and supply. D. none of the given options.
Learning Objective: 10.08 Understand the process of using bills of exchange to raise funds and how bills of exchange are priced Section: 10.05 Debt securities
8. In a bill acceptance facility:
A. the bank undertakes to accept bills drawn by the borrower up to a specified total amount.
B. the borrower undertakes to accept bills drawn by the bank for an unspecified total amount, usually determined by demand and supply.
C. the borrower undertakes to accept bills drawn by the bank up to a specified total amount.
D. none of the given options.
Learning Objective: 10.08 Understand the process of using bills of exchange to raise funds and how bills of exchange are priced Section: 10.05 Debt securities
9. A fully drawn bill facility:
A. provides a company with an unspecified amount for a specified period.
B. provides a company with a specified amount for a specified period.
C. provides a company with an unspecified amount for an unspecified period.
D. provides a company with a specified amount for an unspecified period.
Learning Objective: 10.08 Understand the process of using bills of exchange to raise funds and how bills of exchange are priced Section: 10.05 Debt securities
10. A revolving credit bill facility is:
A. similar to a fully drawn facility in that the company is permitted to draw on the facility as the funds are required, provided that it does not borrow more than the agreed total amount.
B. different from a bank overdraft in that the company is permitted to draw on the facility as the funds are required, provided that it does not borrow more than the agreed total amount.
C. different from a bank overdraft in that there is an agreed total amount up to which the company can borrow.
D. none of the given options.
Learning Objective: 10.08 Understand the process of using bills of exchange to raise funds and how bills of exchange are priced Section: 10.05 Debt securities
11. Which of the following statements is true?
A. A bank bill is extremely marketable.
B. A non-bank bill may be regarded as almost equivalent to a bank bill.
C. A bank bill that is regarded as being very risky will easily be discounted in the bills market.
D. A bank bill is extremely marketable and a non-bank bill may be regarded as almost equivalent to a bank bill.
Learning Objective: 10.08 Understand the process of using bills of exchange to raise funds and how bills of exchange are priced Section: 10.05 Debt securities
12. An advantage of using debt is that:
A. debtholders have no control over the company's operations.
B. debtholders usually exert no control over the company's operations.
C. interest payments are fixed.
D. a company may borrow without the security of an asset.
Learning Objective: 10.02 Explain the general characteristics of debt
Section: 10.02 General characteristics of debt
13. When comparing debentures and unsecured notes, it can be said that:
A. they are identical securities.
B. a debenture holder is an unsecured creditor whereas an unsecured note holder is a secured creditor.
C. both are an example of unsecured debt.
D. a debenture holder is a secured creditor whereas an unsecured note holder is an unsecured creditor.
Learning Objective: 10.02 Explain the general characteristics of debt
Section: 10.05 Debt securities
14. Interest rates are normally higher on unsecured notes than on debentures because:
A. debenture holders have a prior claim over company assets.
B. debentures are a riskier form of security.
C. unsecured notes are normally secured by a floating charge over assets.
D. unsecured notes are normally secured by a fixed charge over an asset.
Learning Objective: 10.02 Explain the general characteristics of debt
Section: 10.05 Debt securities
15.
A constant payout policy for dividends involves:
A. a constant total amount of dividends paid each year.
B. a constant ratio of dividends to profit and a constant amount of dividends paid from year to year.
C. consideration given to profitable investment proposals.
D. a constant ratio of dividends to profit but not a constant amount of dividends paid from year to year.
Learning Objective: 11.06 Understand the argument that payout decisions may have a role in providing signals to investors
Section: 11.02 Is payout policy important to shareholders?
16.
A reason why management may have a long-term dividend payout ratio is that:
A. investors have a long-term investment horizon.
B. the present value of taxes paid on future dividend income is less than the present value of taxes paid on current dividend income.
C. management views dividends as a function of sustainable profits.
D. it assists management in long-term planning.
Learning Objective: 11.07 Explain the ways in which agency costs can be related to payout decisions Section: 11.02 Is payout policy important to shareholders?
17.
The Modigliani and Miller dividend irrelevance argument does not rest on the assumption that:
A. investors are not indifferent between dividend income and capital gain income.
B. a firm's investment decision is independent of its dividend policy.
C. the costs of acquiring information of a firm's dividend policy are zero.
D. there are no taxes.
Learning Objective: 11.02 Outline the argument that payout policy is irrelevant to shareholders wealth in a perfect capital market with no taxes
Section: 11.02 Is payout policy important to shareholders?
18.
Under the Modigliani and Miller dividend irrelevance argument:
A. dividend policy is a trade-off between cash raised from new operations and new share issues whilst paying dividends.
B. dividend policy is a trade-off between cash raised from new operations and investment outlays whilst paying dividends.
C. dividend policy is a trade-off between retaining profit and making new share issues whilst paying dividends.
D. dividends are paid to maximise shareholder wealth.
Learning Objective: 11.02 Outline the argument that payout policy is irrelevant to shareholders wealth in a perfect capital market with no taxes
Section: 11.02 Is payout policy important to shareholders?
19.
Under the Modigliani and Miller dividend irrelevance argument:
A. a firm's investment decision is a function of the dividend policy.
B. share prices are dependent upon a firm's dividend policy.
C. shareholders prefer capital gain income to dividend income.
D. shareholders are indifferent between the payment of dividends and the retention of profits because cash paid out as dividends can be replaced without cost by issuing additional shares.
Learning Objective: 11.02 Outline the argument that payout policy is irrelevant to shareholders wealth in a perfect capital market with no taxes
Section: 11.02 Is payout policy important to shareholders?
20.
Under the Modigliani and Miller dividend irrelevance argument, a company's value:
A. is independent of its dividend policy.
B. is dependent on its dividend policy.
C. and investment policies are mutually exclusive.
D. and investment policies are independent.
Learning Objective: 11.02 Outline the argument that payout policy is irrelevant to shareholders wealth in a perfect capital market with no taxes
Section: 11.02 Is payout policy important to shareholders?
21.
In a perfect market, dividend policy has no effect on shareholders' wealth because:
A. transactions are costless.
B. any cash paid out as dividends must be replaced by issuing additional shares.
C. directors fix share prices during dividend announcements.
D. any cash paid out as dividends can be costlessly replaced by issuing new shares.
Learning Objective: 11.02 Outline the argument that payout policy is irrelevant to shareholders wealth in a perfect capital market with no taxes
Section: 11.02 Is payout policy important to shareholders?
22.
Which statement most accurately describes dividend irrelevance?
A.Dividends are irrelevant because investors are only interested in company profits, not cash distributions from those profits.
B.For each dollar received as dividends, the original shareholders give up future dividends with a present value of one dollar, which reduces the value of their shares by one dollar.
C.For each dollar received in dividend, the original shareholders give up future dividends with a present value of one dollar, which maintains the value of their shares. D. None of the given options.
Learning Objective: 11.02 Outline the argument that payout policy is irrelevant to shareholders wealth in a perfect capital market with no taxes
Section: 11.02 Is payout policy important to shareholders?
23.
Which of the following is an example of share buybacks?
A. Equal access buybacks
B. Selective buybacks
C. On-market buybacks
D. All of the given options are examples of share buybacks.
Learning Objective: 11.01 Explain why cash payments to shareholders are important and understand some institutional features of dividends and share buybacks
Section: 11.01 Introduction
24.
Assume the current share price of Company A is $4.50 and on the following day these shares will begin trading ex-dividend. If the dividend is 20 cents per share, what is the expected ex-dividend share price?
A. $4.50
B. $4.70
C. $4.30
D. $3.60
Learning Objective: 11.05 Outline the imputation tax system and explain the effects of imputation and capital gains tax on returns to investors
Section: 11.04 Dividends and taxes
25.
Assume the current share price of Company A is $4.50 and on the following day these shares will begin trading ex-dividend. If the dividend is 40 cents per share fully franked, and the company tax rate is 30 per cent, what is the expected ex-dividend share price?
A. $4.10
B. $4.50
C. $3.93
D. $4.03
Learning Objective: 11.05 Outline the imputation tax system and explain the effects of imputation and capital gains tax on returns to investors
Section: 11.04 Dividends and taxes
26.
If taxes on dividend income and capital gains income were a major determinant of dividend payout ratio policies, then under the classical tax system we would expect:
A. there to be many companies with large dividend payout ratios.
B. investors on high marginal tax rates to prefer companies that pay dividends.
C. a target payout ratio large enough to warrant new share issues to finance expenditures.
D. tax-exempt investors, such as super funds, to invest in companies with high dividend payout ratios.
Learning Objective: 11.05 Outline the imputation tax system and explain the effects of imputation and capital gains tax on returns to investors
Section: 11.04 Dividends and taxes
27.
A company may raise funds at a lower cost than otherwise would be the case if:
A. it can design a security that focuses on the disequilibrium that exists between investor demands and the supply of securities.
B. it issues securities that have been in short supply in the market indefinitely.
C. it issues a particular security at a discount.
D. it issues a particular security at a premium.
Learning Objective: 13.03 Explain how financing can be viewed as a marketing problem Section: 13.04 Financing as a marketing problem
28.
Similarities in capital structure can be expected between companies in the same industry since:
A. they tend to face the same variability in cash flows.
B. they tend to replicate each other's policies.
C. they are faced with the same industry legislation.
D. management is often on each other's boards of directors.
Learning Objective: 13.04 Outline the main factors that financial managers should consider when determining a company's financing strategy Section: 13.05 Determining a financing strategy
29.
For companies that are unable to make immediate use of interest deductions, borrowing is likely to have:
A. a positive net tax advantage.
B. a net tax disadvantage.
C. a positive impact on financial distress because of the tax deductibility of interest on debt.
D. a benefit of achieving an optimal capital structure.
Learning Objective: 13.04 Outline the main factors that financial managers should consider when determining a company's financing strategy Section: 13.05 Determining a financing strategy
30.
Maintaining reserve borrowing capacity allows companies the benefit of:
A. financing projects, particularly for those that operate in low-growth industries.
B. maintaining a constant dividend payout policy.
C. overcoming the need to raise funds to finance projects from a new share issue.
D. not rejecting negative NPV projects.
Learning Objective: 13.04 Outline the main factors that financial managers should consider when determining a company's financing strategy Section: 13.05 Determining a financing strategy
31.
Companies that rely heavily on share issues tend to be:
A. small, risky and value-based.
B. large, risky and growing rapidly.
C. small, relatively less risky and growing rapidly.
D. none of the given options.
Learning Objective: 13.01 Outline empirical evidence from recent studies of capital structure Section: 13.01 Introduction
32.
Interest on debt:
A. is taxed more heavily than dividends and capital gains received by shareholders.
B. is deducted from the company's taxable income.
C. is taxed as the corporate tax rate.
D. none of the given options.
Learning Objective: 13.01 Outline empirical evidence from recent studies of capital structure Section: 13.02 Evidence on capital structure
33.
'Tax exhaustion':
A.refers to non-debt tax shields lowering a company's expected marginal tax rate only if they are large enough to reduce its taxable income to zero.
B.refers to non-debt tax shields lowering a company's actual marginal tax rate, thus reducing the expected tax savings on additional debt. C. may indicate low tangible assets.
D. none of the given options.
Learning Objective: 13.01 Outline empirical evidence from recent studies of capital structure Section: 13.02 Evidence on capital structure
34.
Assume that LoPine Ltd, a US-based company (which has a classical taxation system), borrows $10 million at an interest rate of 15 per cent and uses the funds to repurchase shares worth $10 million. Further, assume that the company tax rate is 35 per cent, the marginal income tax rate is 30 per cent and the average tax rate on equity income is 12 per cent. Calculate the net tax savings per year.
A. $192 000
B. $182 000
C. $188 000
D. $172 000
Learning Objective: 13.01 Outline empirical evidence from recent studies of capital structure
Section: 13.02 Evidence on capital structure
35.
Schulman et al. (1996) examined the effects of imputation on corporate leverage in Canada. Which of the following statements is true of their results?
A. The tax changes provide significant benefit for low-dividend companies.
B. High-dividend companies experience a significant increase in leverage.
C. There is only a small effect on the leverage of companies that experienced an operating loss during the study period.
D. None of the given options is true.
Graduate Attributes: Problem solving
Learning Objective: 13.01 Outline empirical evidence from recent studies of capital structure Section: 13.02 Evidence on capital structure
36.
Which of the following statements is true?
A. A company's financial leverage can't affect investment decisions and its operating efficiency.
B. Banks and finance companies have much higher debt/equity ratios than those of retailers and manufacturers.
C. Banks and finance companies have much lower debt/equity ratios than those of retailers and manufacturers.
D. None of the given options is true.
Learning Objective: 13.01 Outline empirical evidence from recent studies of capital structure Section: 13.01 Introduction
37.
Calculate the cost of equity capital using CAPM if the risk-free rate of interest is 5 per cent, the return on the market portfolio is 12 per cent, beta is 0.8 and the franking premium is 2 per cent.
A. 10.6%
B. 14%
C. 12.2%
D. 12%
Learning Objective: 14.05 Estimate the cost of each source of capital and combine these costs into a weighted average cost of capital for a company
Section: 14.05 Estimation of the cost of capital: an extended example
38.
If a company has on issue debentures paying a coupon rate of 12% p.a. and the market yield on similar securities is 18 per cent, what is the correct cost of debt the company should use when estimating the
WACC?
A. None of the given options.
B. 15%
C. 12%
D. 18%
Learning Objective: 14.05 Estimate the cost of each source of capital and combine these costs into a weighted average cost of capital for a company
Section: 14.05 Estimation of the cost of capital: an extended example
39.
What is the effective annual interest rate for a bank overdraft with an interest rate of 15% p.a. paid twice a year?
A. 15%
B. 7.5%
C. 16.4%
D. 15.6%
Learning Objective: 14.05 Estimate the cost of each source of capital and combine these costs into a weighted average cost of capital for a company
Section: 14.05 Estimation of the cost of capital: an extended example
40.
Given that shares have an expected dividend stream of 10 cents in perpetuity and that the current market price of the shares is $2.40, calculate the cost of equity capital of these shares.
A. 8%
B. 12%
C. 10%
D. 4.2%
Learning Objective: 14.05 Estimate the cost of each source of capital and combine these costs into a weighted average cost of capital for a company
Section: 14.05 Estimation of the cost of capital: an extended example
41.
A problem with the dividend growth model is:
A. that it is difficult to estimate the value of any tax credits.
B. that it is difficult to obtain market prices for shares listed on the stock exchange.
C. that it is extremely sensitive to estimates of the future growth rate in dividends.
D. none of the given options.
Learning Objective: 14.05 Estimate the cost of each source of capital and combine these costs into a weighted average cost of capital for a company
Section: 14.05 Estimation of the cost of capital: an extended example
42.
When using the CAPM to estimate the cost of equity for evaluation of investment proposals, the appropriate substitute for the risk-free rate of interest is:
A. the yield on 10-year government bonds.
B. the yield on three-year government bonds.
C. the yield on 90-day treasury notes.
D. the yield on a government security whose term to maturity matches the life of the proposed project.
Learning Objective: 14.04 Understand why the cost of capital for a company is expressed as a weighted average of the costs of all of the company's sources of capital Section: 14.04 Alternative approaches to estimation of the cost of capital
43.
From the estimates, calculate the return on equity (after tax) if Rf = 5%, E(RM) = 13%, franking premium = 3%, beta = 1.5 and the corporate tax rate is 30 per cent.
A. 15.05%
B. 21.5%
C. 18.8%
D. 15%
Learning Objective: 14.05 Estimate the cost of each source of capital and combine these costs into a weighted average cost of capital for a company
Section: 14.05 Estimation of the cost of capital: an extended example
44.
From the following information, calculate the weighted average cost of debt:
A. 7.2%
B. 5.6%
C. 16.5%
D. 8.8%
Learning Objective: 14.05 Estimate the cost of each source of capital and combine these costs into a weighted average cost of capital for a company
Section: 14.04 Alternative approaches to estimation of the cost of capital
45. Calculate the weighted average cost of preference shares and ordinary shares if there are: 1 million preference shares with market value of $2.50 each and an opportunity cost of 10.8%; 10 million ordinary shares with market value of $4.50 each and an opportunity cost of 16.5%.
A. 15.4%
B. 16.9%
C. 16.2%
D. None of the given options.
Learning Objective: 14.05 Estimate the cost of each source of capital and combine these costs into a weighted average cost of capital for a company
Section: 14.05 Estimation of the cost of capital: an extended example
46.
Under what conditions can a company's current capital structure be used to calculate the weights for each source of funds?
A. When implementing a new project will alter a company's capital structure
B. When implementing a new project is not expected to alter a company's capital structure
C. When reliable market weights can be obtained
D. Only when preference shares are not included in the measure for WACC
Learning Objective: 14.04 Understand why the cost of capital for a company is expressed as a
weighted average of the costs of all of the company's sources of capital Section: 14.04 Alternative approaches to estimation of the cost of capital
47.
Under which of the following conditions is it appropriate to estimate a project's cost of capital using the company's cost of capital?
A. When a company is a diversified conglomerate
B. When the systematic risk of a project is similar to that of some other divisions.
C. When a company operates in a sole industry
D. When a company operates in more than one industry but less than five
Learning Objective: 14.08 Estimate the cost of capital for a division of a diversified company Section: 14.06 Project and company cost of capital
48.
Assume that a company consisting of four divisions is considering two investment projects, A and B. A is a project of Division 2 and B is a project of Division 4. The cost of capital for each division is as follows:
If the return on project A is 12.4% and project B is 16.9%, which project(s) will be accepted using the single company cost of capital rate?
A. Projects A and B
B. Only Project A
C. Only Project B
D. Neither Project A nor Project B
Learning Objective: 14.08 Estimate the cost of capital for a division of a diversified company Section: 14.06 Project and company cost of capital
49.
Assume that a company consisting of four divisions is considering two investment projects, A and B. A is a project of Division 2 and B is a project of Division 4. The cost of capital for each division is as follows:
If the return on project A is 12.4% and project B is 16.9%, which project(s) will be accepted using the cost of capital derived for each division?
A. Projects A and B
B. Only Project A
C. Only Project B
D. Neither Project A nor Project B
Learning Objective: 14.08 Estimate the cost of capital for a division of a diversified company Section: 14.06 Project and company cost of capital
50. A consequence for a company that uses a single discount rate to evaluate projects is that:
A. high systematic risk divisions will find it hard to have their projects accepted.
B. low systematic risk divisions will find it easy to have their projects accepted.
C. high systematic risk divisions are likely to stagnate and even close down.
D. the systematic risk of the company will drift upward over time.
Learning Objective: 14.08 Estimate the cost of capital for a division of a diversified company Section: 14.06 Project and company cost of capital
51.Assume that Expansion Ltd is a diversified company that is considering an expansion project in a mining division. The company has a target debt-equity ratio of 1:2 and this ratio will not be affected by the new project. The company's manager has identified Dig-it-out Ltd as a company with the same business risk as the new project (equity beta of 1.5). Dig-it-out has a debt-equity ratio of 1:3. What is the beta estimate of Expansion Ltd?
A. 1.69
B. 1.12
C. 1.5
D. 1.75
Learning Objective: 14.08 Estimate the cost of capital for a division of a diversified company Section: 14.06 Project and company cost of capital
52.
Assume that Expansion Ltd is a diversified company that is considering an expansion project in a mining division. The company has a target debt-equity ratio of 1:2 and this ratio will not be affected by the new project. The company's manager has identified Dig-it-out Ltd as a company with the same business risk as the new project (equity beta of 1.5). Dig-it-out has a debt-equity ratio of 1:3. Estimate the project's cost of equity for Expansion if the risk-free rate of interest is 7 per cent and the risk premium of the market portfolio is 10 per cent.
A. 18.25%
B. 22.0%
C. 24.5%
D. 23.88%
Learning Objective: 14.08 Estimate the cost of capital for a division of a diversified company Section: 14.06 Project and company cost of capital
53. During the year, Success Ltd shares have increased from $8 to $9 and shareholders received a final dividend of 50 cents per share, fully franked at the company tax rate of 30 per cent. Calculate first the conventional rate of return and second, the dividend yield (using the beginning of the year share price) on Success shares.
A. 18.75% and 6.25%
B. 15.18% and 5.5%
C. 18.75% and 5.5%
D. 15.18% and 6.25%
Learning Objective: 14.03 Understand how the cost of capital can be measured under the imputation tax system Section: 14.03 Taxes and the cost of capital
54.
A margin call refers to:
A. the payment of profit by the clearing house to the trader.
B. the demand of funds by the clearing house from each trader to cover losses.
C. the difference between the futures market price and the contract price.
D. the close of a futures contract.
Learning Objective: 17.02 Understand the system of deposits, margins and marking-to-market used by futures exchanges
Section: 17.02 What is a futures contract?
55.
A call option on a futures contract:
A. gives the buyer the right to assume a sold position in the futures.
B. gives the seller the right to assume a sold position in the futures.
C. gives the buyer the right to assume a buy position in the futures.
D. gives the seller the right to assume a buy position in the futures.
Learning Objective: 17.03 Have a basic understanding of the determinants of futures prices Section: 17.03 The Australian Securities Exchange
56.
Assuming perfect convergence, a spot price will be:
A. greater than the futures price, which has a term to maturity of zero.
B. less than the futures price, which has a term to maturity of zero.
C. the cost of holding a commodity in a futures contract from one time period to another.
D. the price of a commodity in a futures contract, which expires today.
Learning Objective: 17.05 Understand and explain the reasons why hedging with futures contracts may be imperfect
Section: 17.05 Futures market strategies: speculating and hedging
57.
It is expected that the price of a futures contract with a term to maturity of zero be:
A. close to zero.
B. less than the spot price.
C. equal to the spot price.
D. more than the spot price.
Learning Objective: 17.03 Have a basic understanding of the determinants of futures prices Section: 17.04 Determinants of futures prices
58. If the spot price and futures price on a gold contract are $553 and $555, respectively, then theoretically the carrying cost should be equal to:
A. $2 or more.
B. between $0 and $2.
C. cannot be determined.
D. $2.
Learning Objective: 17.03 Have a basic understanding of the determinants of futures prices Section: 17.04 Determinants of futures prices
59. Given the following information, calculate the expected arbitrage profit or loss from buying an ounce of gold today for $553 and selling a futures contract that matures in 6 months' time at a price of $570. Assume interest rates are 10% p.a., insurance costs are $20, the risk factor is 5 per cent on the cost of gold, and projected gold production over the next 12 months is 5000 ounces.
A. $0
B. ($31)
C. $17
D. $31
Learning Objective: 17.03 Have a basic understanding of the determinants of futures prices Section: 17.04 Determinants of futures prices
60.
Buying a June bank bill futures contract and simultaneously selling a March bond futures contract is:
A. a typical trading strategy for a scalper.
B. a typical trading strategy for a hedger.
C. an example of a spread.
D. an example of a straddle.
Learning Objective: 17.04 Understand and explain speculation and hedging strategies using futures contracts
61.
Runaway Bank Ltd is expecting a cash inflow of $500 000 in one month, which it intends to invest in 90-day bank bills. Management of the company has chosen to hedge against fluctuations in interest rates by hedging with a bank bill futures contract. When the company enters the hedged position, the yields are 10.4% p.a. (spot) and 10.6% p.a. (futures). When the hedge is reversed, the yields are 7.6% p.a. (spot) and 7.78% p.a. (futures). Including the gain from the futures, what will be the implied yield that Runaway Bank Ltd receives?
A. 8.63%
B. 7.72%
C. 10.42%
D. 10.55%
Learning Objective: 17.08 Understand the valuation of 90-day bank-accepted bill futures contracts and share price index futures contracts
Section: 17.06 Financial futures on the Australian Securities Exchange: the 90-day bank-accepted bill futures contract
62.
Calculate the price of a 10-year bond that has five years to maturity, with face value of $100 000, and coupon interest rate of 8.9% p.a. paid semi-annually, if the required rate of return is 9.9% p.a. (simple interest).
A. $96 130
B. $90 992
C. $95 752
D. $93 193
Learning Objective: 17.07 Explain speculation and hedging strategies using the major financial futures contracts traded on the Australian Securities Exchange
Section: 17.07 Financial futures on the Australian Securities Exchange: the 10-year Treasury bond futures contract
63.
If the share price at the expiry of a call option is less than the exercise price, the call is worth:
A. zero.
B. the difference between the exercise price and the share price.
C. the market price of the share.
D. an undefined amount.
Learning Objective: 18.02 Identify and explain the factors that affect option prices Section: 18.02 Options and option markets
64.
Which of the following enables an arbitrage profit to be made (excluding transaction costs) from a call option if the market price of the underlying share is $5 50, the price of the call is $1 50, and the exercise price is $3 80?
A. Buy the call option, exercise it and sell the underlying share.
B. Buy a put option, exercise it and buy the underlying share.
C. Buy a call option and hold onto it until expiry.
D. Sell a put option now and realise the profit.
Learning Objective: 18.03 Understand and apply basic option pricing theorems, including put-call parity Section: 18.02 Options and option markets
65.
At expiry, a call option is worth:
A. the maximum of the exercise price minus the share price and zero.
B. at least the exercise price.
C. at least the share price.
D. the maximum of the share price minus the exercise price and zero.
Learning Objective: 18.03 Understand and apply basic option pricing theorems, including put-call parity Section: 18.02 Options and option markets
66.
An option that gives the buyer the right to exercise at any time up to the expiry date is called:
A. a put option.
B. an American-type option.
C. a call option.
D. a European-type option.
Learning Objective: 18.01 Understand the major types and characteristics of options and distinguish between options and futures
Section: 18.02 Options and option markets
67.
Which of the following is a potential disadvantage of privately negotiated options?
A. It is often difficult to find a party with whom to contract.
B. It is not possible to reverse out of a contract before the agreed expiry date.
C. It may be necessary to investigate the creditworthiness of the other party.
D. All of the given options are potential disadvantages.
Learning Objective: 18.01 Understand the major types and characteristics of options and distinguish between options and futures
Section: 18.02 Options and option markets
68.
What is the payoff of a call option (bought) with an exercise price of $15.00, if the underlying share price is $16.50, at the expiry date of the option?
A. $15.00
B. Zero
C. $1.00
D. $1.50
Learning Objective: 18.03 Understand and apply basic option pricing theorems, including put-call parity Section: 18.02 Options and option markets
69.
For a put option (bought) with an exercise price of $9.50, the maximum payoff is:
A. $5.00
B. Zero
C. $9.50
D. None of the given options.
Learning Objective: 18.03 Understand and apply basic option pricing theorems, including put-call parity Section: 18.02 Options and option markets
70.
Which of the following statements regarding call options is true?
A.The price paid for a call option should reflect, amongst other factors, the probability that the underlying share price will rise above the exercise price.
B.The price paid for a call option should reflect, amongst other factors, the expected future direction of the share price.
C.The price paid for a call option should reflect, amongst other factors, the probability that the underlying share price will equal the exercise price. D. None of the given options.
Learning Objective: 18.02 Identify and explain the factors that affect option prices Section: 18.02 Options and option markets
71.
A rights issue is an example of:
A. a contingent claim that does not affect a company's capital structure.
B. a put option issued by a company.
C. a call option issued by a company.
D. a redeemable preference share.
Learning Objective: 18.06 Define a contingent claim and explain the option-like features of several contingent claims Section: 18.08 Contingent claims
72. A convertible note is equivalent to ordinary debt plus:
A. a call option on the assets of the company.
B. a call option on the shares of the company.
C. a put option on the assets of the company.
D. a put option on the shares of the company.
Learning Objective: 18.06 Define a contingent claim and explain the option-like features of several contingent claims
Section: 18.08 Contingent claims
73.
The term 'default risk structure of interest rates' refers to the fact that:
A. there is a premium due to uncertainty about the future level of interest rates.
B. interest rates for different maturity ranges are determined independently.
C. at any point in time as the probability of default increases, the required yield on debt decreases.
D. at any point in time as the probability of default increases, the required yield on debt increases.
Learning Objective: 18.06 Define a contingent claim and explain the option-like features of several contingent claims
Section: 18.08 Contingent claims
74.
A problem with the net present value approach to project valuation is that:
A. the opportunity to intervene in a project has a negative NPV.
B. the opportunity to intervene in a project is worthless.
C. it assumes that there is no opportunity for the investing company to intervene in the project after it has begun.
D. it is inferior to the IRR method of project evaluation.
Learning Objective: 18.06 Define a contingent claim and explain the option-like features of several contingent claims
Section: 18.08 Contingent claims
75.
A payoff structure resembling that of a long futures position can be created by:
A.buying a call option and selling a put option, with the same exercise price and premium for both options.
B.selling a call option and buying a put option, with the same exercise price and premium for both options.
C.buying a call option and buying a put option, with the same exercise price and premium for both options.
D.selling a call option and selling a put option, with the same exercise price and premium for both options.
Learning Objective: 18.01 Understand the major types and characteristics of options and distinguish between options and futures
Section: 18.02 Options and option markets
76.
A payoff structure resembling that of a short futures position can be created by:
A.buying a call option and selling a put option, with the same exercise price and premium for both options.
B.selling a call option and buying a put option, with the same exercise price and premium for both options.
C.buying a call option and buying a put option, with the same exercise price and premium for both options.
D.selling a call option and selling a put option, with the same exercise price and premium for both options.
Learning Objective: 18.01 Understand the major types and characteristics of options and distinguish between options and futures
Section: 18.02 Options and option markets
77.
Calculate the price of a European put option if the price of the equivalent European call option is $6 and the share price, exercise price and risk-free rate (continuously compounded) are $30, $28 and 15% p.a., respectively. The options have 6 months to expiry. Assume that put-call parity holds.
A. $10.02
B. $2.05
C. $1.98
D. $9.95
E.$2.97
Learning Objective: 18.03 Understand and apply basic option pricing theorems, including put-call parity Section: 18.02 Options and option markets
78.
Calculate the price of a European call option if the price of the equivalent European put option is $5 and the share price, exercise price and risk-free rate (continuously compounded) are $31, $28 and 12% p.a., respectively. The options have 3 months to expiry.
A. $1.17
B. $8.83
C. $8.82
D. $9.63
E.$1.18
Learning Objective: 18.03 Understand and apply basic option pricing theorems, including put-call parity Section: 18.02 Options and option markets
79.
Calculate the price of a one-month European call option given the following information: the exercise price is $19, the current share price is $20 and the risk-free interest rate is 15% p.a. Furthermore, the share price is expected to be either $25 or $15 at the end of the month. Assume a risk-neutral world.
A. $2.35
B. $2.59
C. $2.81
D. $3.11
Learning Objective: 18.04 Understand the binomial model and the Black-Scholes model of option pricing and calculate option prices using these models
Section: 18.03 Binomial option pricing
80.
Calculate the price of a one-month European put option given the following information: the exercise price is $19, the current share price is $15 and the risk-free interest rate is 12% p.a. Furthermore, the share price is expected to be either $20 or $13 at the end of the month. Assume a risk-neutral world.
A. $2.74
B. $4.12
C. $1.82
D. $1.22
Learning Objective: 18.04 Understand the binomial model and the Black-Scholes model of option pricing and calculate option prices using these models
Section: 18.03 Binomial option pricing
ESSAY Questions1.Share buybacks are sometimes motivated by the desire to increase earnings per share. Baery Ltd recorded an operating profit of $2.7 million in the last financial year. It has 3 million shares on issue and the market price of the shares is $6 each. Baery announces that it will repurchase 10% of each shareholder's shares at $6 per share.
a)Calculate Baery's price-earnings ratio before the buyback
b)An observer comments as follows: 'Baery's buyback should boost its earnings per share from 90 cents to 95 cents, so with the price-earnings ratio remaining the same, the share price should increase'.
i.If the observer's argument is correct, what will Baery's share price be after the buyback?
ii.Critically evaluate the observer's argument. (chapter 11)
2.LGC Ltd converting preference shares have a face value of $20 and are due to convert to ordinary shares on 31 July 2019. Each converting preference share will convert to a number of ordinary shares that is determined by dividing $20 by:
i)An amount equal to the price of LGC ordinary shares on the 31 July 2019, less 5 per cent; or
ii)$20,
whichever yields the greater number of ordinary shares
How many ordinary shares will be received by the holder of one converting preference share if the price of an LGC ordinary share is:
i) $7.50 ii) $10 iii) $15 iv) $20
v) $25? (chpt 10)
3.The chief executive of Caster Ltd, a young company that has just been set up, says: 'we decided to borrow most of the funds needed to establish our operations because high leverage would signal to the markets that we were confident and fully committed to making this business succeed.' Evaluate this strategy, assuming that Caster produces:
a)Security software systems
b)Shampoos and conditioners (chapter 13)
4.Pirexes Ltd has a fixed-rate term loan of $3 million at an interest rate of 8.50% per annum. The company has earnings before interest and tax (EBIT) of $1.8 million per annum. A covenant in the loan agreement specifies that EBIT must be at least 3.5 times greater than the total interest paid on the company's debt. The directors of Pirexes are planning to raise additional debt by borrowing at a variable rate, initially 7.0% per annum. What is the maximum amount that Pirexes can borrow on these terms? (chpt 10)
5.Use the following information to calculate the cost of capital for Lexco Ltd, assuming that investors can remove all systematic risk by diversification.
i) The systematic risk of Lexco Ltd's equity is 0.6 ii) The risk-free interest rate is 8% per annum
iii)The expected rate of return on the market portfolio (including the franking premium) is 13% per annum
iv)The various sources of funds used by Lexco Ltd and their respective market values are as follows:
Source of funds
Market value ($m)
Debt (face value $100)
1
Equity
3
v)The interest rate on the debt is 10% paid annually. The debt, which is due to mature in 8 years' time, has a current market price of $120
vi)The statutory company income tax rate is 30 cents in the dollar vii) The proportion of the tax collected from the company that is claimed by shareholders is
0.60
Under what assumptions is the cost of capital you have calculated for Lexco Ltd in the above appropriate for a proposed project? (chpt 14)
6.Ztak Pty Ltd is a well-established company whose directors have decided to convert to public company status, make a public share issue and list on the stock exchange. The company needs to raise $8,920,000 to expand its operations. Its prospectus forecasts a dividend of 25 cents per share in its first year as a public company and dividends are expected to grow at 5% per annum indefinitely. Shareholders require a return of 15% per annum and the cost of listing amounts to 11% of the gross proceeds from the issue. How many shares must Ztak issue? (chapt 9)
7.The ABC Company has a history of rapid growth, with a rate of return on assets of about 20% per annum. For the past 5 years its dividend-payout ratio has been approximately 60%. A high payout has been justified on the grounds that the company is operated in the shareholders' interests and dividends paid by the company have a beneficial effect on the company's share price. What factors would you take into consideration when deciding on the appropriate dividend policy for the company? Is the current dividend policy justified? (chpt 11)
8.Kerry Ltd has commenced operations with the following capital structure:
Kerry Ltd: statement of financial position as at date of incorporation
($)
Assets
Sundry assets
2,000,000
Liabilities and shareholders' funds
Debentures, 8% (10 years)
600,000
Preference shares, 9%
400,000
Ordinary shares, issued and paid-up, 500,000 at $2
1,000,000
2,000,000
The company's prospectus contains estimates that it will earn $200,000 in the first year and pay dividends of 15 cents per share. Brokers anticipate that dividends will grow at 6% per annum. The shares are currently selling at $3. The statutory company income tax rate is 30 cents in the dollar and the proportion of the tax collected from the company that is claimed by shareholders is 0.60. Calculate the cost of capital for Kerry Ltd. (chapter 14)
Expert Answer:
