ACFI204：Financial Management

SECTION A

Q1: The alpha in the Single Index Model is

a) The risk-free rate.

b) The sensitivity of the stock with respect to movements in the market return.

c) The expected return on the stock if the return on the market is zero.

d) The unpredictable component within the model.

Q2: Firms anticipating buying an asset in the future can hedge against price exposure using futures contracts by:

a) Taking a short position in N futures contracts.

b) Taking a long-position in N futures contracts.

c) Searching for arbitrage opportunities and taking relevant positions in futures contracts.

d) Ignoring futures markets altogether.

Q3: You are short 500 put options on GOOGLE stock with a strike price of $78.95. The price of each option on the CBOE is $2.67. What is the stock price at maturity if the profit on the position is -$2640:

a) $85.00

b) $71.00

c) $70.00

d) $78.95

Q4: What is the Net Present Value of a project that costs £37,000,000 to set up, generates cash flows of £12,000,000 for the next 4 years and has no scrap value? The cost of capital for the firm is 10%.

a) -£8.5 million

b) £8.5 million

c) -£1.04 million

d) £1.04 million

Q5: If the risk-free rate is 5% per annum and the expected market return is 10% per annum, what is the equilibrium expected return of a stock with a beta equal to 2?

a) 15%

b) 10%

c) 20%

d) 25%

Q6: What is the portfolio standard deviation for a portfolio investing 60% of wealth into an asset with a standard deviation of 12% and the remaining 40% of wealth into an asset with a standard deviation of 10%? The correlation between the asset returns is 0.

a) 6.68%

b) 7.68%

c) 8.68%

d) 9.68%

Q7: POODLE INC’s stock is not going to pay a dividend for the first 3 years. Then from year 4 POODLE INC will pay a $3.50 dividend with dividends expected to grow at 5% per annum thereafter. IF the cost of capital is 11%, what is the price of POODLE INC’s stock?

a) £58.33

b) £38.43

c) £42.65

d) £34.62

Q8: Basis is defined as

a) The difference between the futures price now and the future price a month ago.

b) The difference between the future and spot price.

c) The difference between the spot price now and the spot price a month ago.

d) The difference between the spot and futures price.

Q9: ARTO PLC are offering a 3 for 2 rights issue to its existing shareholders. The current price of ARTO PLC stocks are £23. They are offering the 3 new shares at a 20% discount to the current stock price. Assuming the price of existing stocks does not change before the rights issue occurs, what is the theoretical ex-rights share-price?

a) £23.00

b) £20.00

c) £20.24

d) £18.40

Q10: The single index model estimated on OKAY stock provides a beta of 0.90 and the variance of the residual is 23. If the variance of the market return is 12, what is the Rsquared of the regression?

a) 31.95%

b) 29.71%

c) 63.30%

d) 60.82%

SECTION B

Question One

You are a Financial Manager at MAVIC PLC, a bicycle wheel manufacturing firm located in the UK. Currently, the firm’s ordinary shares have a market value of £40m. The firm’s equity has a beta of 1.355, the expected market return is 18.75% per annum and the risk-free rate is 1.30% per annum. The firm’s current market value of debt is £53m with 135,000 zero coupon bonds in issue that mature in 7 years. Each bond has a par value of £1000 and corporate taxes are 23% per annum.

MAVIC PLC is considering moving its manufacturing to a domestic warehouse and has the following three contract options for a piece of new machinery:

Required:

a) Compute the Net-Present Value for the three contract alternatives and make a recommendation. [40 marks]

b) Calculate the Internal Rate of Return for Contract 1 and 2. Comment on whether you are able to make a choice between these contracts using only Internal Rate of Return. [10 marks]

c) Supposing the firm’s bond price falls by £100, and the beta falls to 1.25. Compute the new weighted average cost of capital and comment on how this will change the NPV of the three contracts. [20 marks]

d) If MAVIC issues 15 million 12% CUM IRRD preference shares with a notional value of £1.00 and a current market value of £27m, what is the firm’s Weighted Average Cost of Capital? You may use the original data provided above for equity and debt. [30 marks]

Question Two

You are an Investment Analyst at MSC INC. On 06/08/2021 a new client has tasked you with investing $150m in the following two US corporate bonds holding $100m in AM and the remaining $50m in BT:

Your client instructs you that they wish to benefit from changes in the yield to maturity and insists that you actively manage the portfolio moving funds on a daily basis.

On the 07/08/2021 the Federal Reserve announces an imminent increase in the Federal Funds rate by 2%. Your analysis indicates that the yield to maturities on AM and BT bonds will both rise by 100% of the announced increase in the Federal Funds rate.

Required:

a) Compute the Price, Duration, Modified Duration and Convexity factor of AM and BT bonds using the information in the table above. [30 marks]

b) Calculate the Duration and Modified Duration of your bond portfolio. If you expect a large fall in interest rates, how would you change the amount invested in each bond and why? [20 marks]

c) Produce forecasts of the respective price changes in each individual bond and compute the assumed portfolio value at the end of trading on 07/08/2021 using only modified Duration. [20 marks]

d) Accounting for convexity, produce forecasts of the respective price changes in each individual bond and compute the assumed portfolio value at the end of trading on 07/08/2021. Explain the importance of accounting for convexity in terms of the estimation error in your expected portfolio value at the end of trading 07/08/2021. [30 marks]

Question Three

ROUBAIX INC is a large multinational conglomerate operating predominantly in the USA, the UK, and Hong Kong. They have both ordinary and preference shares listed on each of the major stock exchanges. That is, the S&P500, the FTSE All Share, and the Hang Seng Indexes.

ROUBAIX INC’s financial statements for 2020 report earnings of $170m, £155m and HK$123m in the US, UK, and Hong Kong respectively. ROUBAIX INC has 45m class A ordinary shares outstanding on the S&P500 has just paid total dividends on these stocks of $281m. This dividend payment is anticipated to remain constant for the next 7 years and then there will be no dividend payment from year 8 onward. The required rate of return demanded by investors in the US market is 7.50%.

ROUBAIX INC has 12.5m class A ordinary shares outstanding on the FTSE All Share has just paid a dividend of £1.00 per share, dividend growth is expected to be 4% per annum over the next 5 years. From year 6 onwards, dividend growth will change to 6% per annum indefinitely. The required rate of return demanded by investors in the UK market is 10%.

ROUBAIX INC has 18m ordinary shares outstanding on the Hang Seng is expected to pay a dividend next period of HK$6.50 with dividends growing at 5% per annum for the next 8 years. Thereafter, there will be no dividend payments and the cost of capital on this market is 12%.

Preference shares issued on these markets each have a notional value of 1 unit of currency. The dividend rates on stocks listed on the US, UK, and Hong Kong exchanges are 10%, 9% and 12% respectively. The required rate of return for preference shares are 3%, 4% and 4.50% on the US, UK and Hong Kong stock exchanges respectively.

Required:

a) For each stock market, calculate the price of ROUBAIX INC’s ordinary shares, the price of preference shares, and their price-to-earnings ratios. [60 marks]

b) Provide an interpretation of the price-to-earnings ratio and comment on these ratios for ROUBAIX’s stocks listed on each exchange. [10 marks]

c) Calculate the price of a 6-month at-the-money call and put option for ROUBAIX’s UK stock. The annualised volatility of the stock is 25% per annum, and the riskfree rate is 0.65% per annum. Note: you may ignore dividend payments in your calculation. [30 marks]