Cass Undergraduate School

BSc (Hons) Degree in Banking and International Finance BSc (Hons) Degree in Business Studies BSc (Hons) Degree in Management BSc (Hons) Degree in Accounting and Finance

BS2100

Principles of Finance 10:00 12:15

Part 2 Examination

21 January 2013

Important note for students regarding past exam papers Past exam papers are published for illustrative purposes only. They can be used as a study aid but do not provide a definitive guide to either the format of the next exam, the topics that will be examined or the style of questions that will be set. Students should not expect their own exam to be directly comparable with previous papers. Remember that a degree requires an amount of selfstudy, reading around topics, and lateral thinking particularly at the higher level modules and for higher marks. Specific guidance for your exam will be given by the lecturer. Instructions to students: Answer ALL questions The number of marks allocated is shown at the top page of each section. Please place all answers on the optical scanning sheet provided following carefully the instructions on that form. You MUST use 1 optical scanning sheet for Section A, and one for Section B. This examination paper consists of 18 printed pages including the title page. Materials: Number of answer books to be provided: 1 2 Multiple Choice Answers Sheet Only the Casio calculators FX-83 (MS, ES or GT+) or FX-85 (MS, ES or GT+) are permitted for use in this exam. Dictionaries are not permitted. This examination paper MAY NOT be removed from the examination room. External Examiner: Professor Simon Wolfe Internal Examiner: Dr Peter Hahn

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Section A 60 marks Questions 1 - 40, 1.5 Mark Correct, -.4 Mark Incorrect (No Marks if left blank)
Question 1 The following are important functions of financial markets: I) Source of financing; II) Provide liquidity; III) Reduce risk; IV) Source of information a. b. c. d. I only I and II only I, II, III, and IV IV only

Question 2 If a partnership borrowed money from a bank or issued a bond________ a. The partners would be liable to pay back all the money if the partnership failed b. The partners wouldnt be liable to pay back the money at all c. The partners wouldnt benefit from any tax deductions on the interest payments d. Both b. and c.

Question 3 The reason (s) that a corporation, theoretically, has infinite life is: a. Limited liability b. Separation of ownership and management c. Double taxation d. All of the above

Question 4 All of the following are examples of financial assets except: a. b. c. d. Common stock Bank loan Preferred stock There are no exceptions

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Question 5 Informational asymmetry refers to the differences in information regarding the value of an investment among, for example: I) Shareholders; II) Managers; III) Bondholders a. b. c. d. I and II only II and III only I and III only I, II, and III

Question 6 You own Omea Direct and are borrowing money from the bank for 3 years (principal payable at the end) at 8% interest per annum. The bank gives you the choice of interest payment periods to give you flexibility. Which do you chose? a. b. c. d. Monthly Quarterly Annually They are all the same

Question 7 Which of the following statements about the relationship between interest rates and bond prices is false? I) There is an inverse relationship between bond prices and interest rates. II) There is a direct relationship between bond prices and interest rates. III) The price of short-term bonds fluctuates more than the price of long-term bonds for a given change in interest rates. (Assuming that coupon rate is the same for both) IV) The price of long-term bonds fluctuates more than the price of short-term bonds for a given change in interest rates. (Assuming that the coupon rate is the same for both) a. b. c. d. I and IV only I and III only II and III only None of the given statements are false

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Question 8 Your broker calls and advises Greek government bonds (in Euros) are available at 650 over. This means a. The purchase price is 106.50 or 106,500 for every 100,000 bond you buy b. German government bonds for similar maturities have a YTM of 6.5% lower c. The bonds offer a current yield of 6.50% above German government bonds of similar maturities. d. None of the above

Question 9 You have a choice of buying three Bunds due in 2016 with the same yield. If you want the longest duration which do you choose? a. b. c. d. 2% coupon 3% coupon Zero coupon They all have the same duration

Question 10 Expected return from a share investment is calculated using a. b. c. d. Inflation Capital Dividends Both b. and c.

Question 11 For investors, the preferred in preferred shares is a reference to their right to preference in __________ over common shares. a. Voting b. Liquidation c. Dividends d. All of the above

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Question 12 All of the following statements are true regarding financing with shares and bonds except: a. choosing to finance with bonds, rather than with shares, dilutes ownership or control of the corporation. b. choosing to finance with bonds, rather than with shares, results in higher earnings per share under normal conditions. c. bond interest must be paid in unprofitable years, but share dividends do not have to be paid. d. bonds are a higher financial risk than shares to the issuing corporation.

Question 13 Evaluating a single project with an upfront investment and four succeeding positive cash flows, IRR has what advantage over the payback method? a. b. c. d. Includes a measure of risk. Includes multiple discount rates. Includes an inflation adjustment None of the above.

Question 14 Seasonality can be argued as the observance of companies___________. a. Borrowing to pay off invoices for goods b. Borrowing to when industry downturns occur c. Borrowing at floating rates of interest in the hope of rates declining d. Both a. and c.

Question 15 Share buy-backs or repurchases are a. a Non-cash form of dividend b. disliked by investors because they lower share prices c. able to achieve different balance sheet accounting than cash dividends d. none of the above

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Question 16 Unique risk is also called: a. b. c. d. Unsystematic risk Diversifiable risk Firm specific risk All of the above

Question 17 If a stock is overpriced it would plot: a. b. c. d. Above the security market line Below the security market line On the security market line On the Y-axis

Question 18 Investments A and B both offer an expected rate of return of 12%. If the standard deviation of A is 27% and that of B is 24%, then investors would: a. b. c. d. Prefer A to B Prefer B to A Prefer a portfolio of A and B Cannot answer without knowing investor's risk preferences

Question 19 Fizzy Co. has an R2 and of 0.7 and 0.8, respectively. Still Co. has an R2 and of 0.5 and 1.2, respectively. This suggests (relative to share price): a. Still has a larger risk premium than Fizzy. b. Fizzy has a higher correlation coefficient with the market than Still. c. Fizzy has greater market risk and unique risk than Still. d. Still has greater market risk and unique risk than Fizzy.

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Question 20 A lawyer works for a firm that advises corporate firms planning to sue other corporations for antitrust damages. He finds that he can "beat the market" by short selling the stock of the firm that will be sued. This finding is in violation of the: a. b. c. d. Weak form market efficiency Semi-strong form market efficiency Strong form market efficiency None of the above

Question 21 If the efficient market hypothesis holds, investors should expect: I) To receive a fair price for their security II) To earn a normal rate of return on their investments III) To be able to pick stocks that will outperform the market a. b. c. d. I only II only III only I and II only

Question 22 According to the efficient market hypothesis predictable cycles in stock price movements: I) Persist for a long time II) Self destruct as soon as investors recognize them III) Never appear as the stock price movements are random a. b. c. d. I only II only III only I, II, and III

Question 23 Arbitrage is a. An investment strategy that guarantees a (real) return without risk b. A strategy that exploits a market inefficiency until the market becomes efficient c. The guaranteed returns available after a Merger (M&A) is announced. d. a. and b.

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Question 24 If the markets are efficient, which of the following investors should have above normal returns on assets over time? a. Those who choose their stocks by throwing darts at a list of stocks found in the financial pages of a newspaper. b. Analysts who spend considerable time evaluating the best stocks to buy. c. Mutual fund managers who manage other people's money for a living. d. None of the above.

Question 25 Random Walk Theory suggests buying ____________shares while Efficient Markets Theory suggests selling__________shares. a. b. c. d. Undervalued, any Any, undervalued Any, overvalued Overvalued, undervalued

Question 26 Prospect Theory suggests that if the average investor bought two shares last year each for 50 and today needs 30 and they are worth 30 and 70 each, he/she will sell the 70 share. This is because a. b. c. d. The likelihood of the 70 going up further is remote The likelihood of the 30 going down further is remote The way we emotionally deal with gains and losses is different When choosing a number at random, we generally choose the higher number.

Question 27 As there is limited to no economic rationale for share splits, firms must believe splitting their shares will lead to an increased share value. a. b. c. d. True False Cant be generalised Need more information

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The figure below pertains to the following two questions:

Question 28 The figure above depicts the a. b. c. d. Position diagram for buyer of a call option Profit diagram for the writer of a call option Position diagram for the buyer of a put option Profit diagram for the writer of a put option

Question 29 On the figure above, the point where the diagonal line crosses the horizontal (share price) line is known as the a. b. c. d. Profit point Breakeven point Exercise price Call-Put Axis

Question 30 An advantage of forward contracts is a. b. c. d. contracts are private and customized performance is guaranteed by clearing houses trading is less costly and governed by more rules none are correct

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Question 31 In which of the following is the creditworthiness of the trading parties a major concern? a. b. c. d. Swaps Futures Forwards Both a and c

Question 32 The owner of a regular exchange-listed put-option on the stock: a. Has the right to buy 100 shares of the underlying stock at the exercise price b. Has the right to sell 100 shares of the underlying stock at the exercise price c. Has the obligation to buy 100 shares of the underlying stock at the exercise price d. Has the obligation to sell 100 shares of the underlying stock at the exercise price

Question 33 If the volatility of the underlying asset decreases, then the: a. Value of the put option will increase, but the value of the call option will decrease b. Value of the put option will decrease, but the value of the call option will increase c. Value of both the put and call option will increase d. Value of both the put and call option will decrease

Question 34 When a firm hedges a risk it is: a. Eliminating the risk b. Transferring risk to someone else c. Making the government assume the risk d. None of the above

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Question 35 The risk manager needs to come up with answers to the following questions: I) What are the major risks that the company is facing and what are the possible consequences? II) Is the company being paid for taking these risks? III) Should we worry about risk at all as risk is God-given? IV) How should risks be controlled? a. I only b. I and II only c. I, II and IV only d. III only

Question 36 In theory, Futures prices differ from Spot prices by which one of the following factors? a. b. c. d. The systematic risk The risk premium The spread The cost of carry

Question 37 An option that can be exercised any time before expiration is called a. b. c. d. A European option An American option A call option A put option

Question 38 Option prices ________________ as time to expiration________________ and as the risk of the underlying asset ________________ . a. b. c. d. decrease; increases; increases increase; increases; increases increase; decreases; increases increase; decreases; decreases

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Question 39 Suppose an investor buys one share of stock and a put option on the stock. What will be the value of her investment on the final exercise date if the stock price is below the exercise price? (Ignore transaction costs) a. The value of two shares of stock b. The value of one share of stock plus the exercise price c. The exercise price. d. The value of one share of stock minus the exercise price

Question 40 The following are examples of disguised options for firms: I) Acquiring growth opportunities II) Ability of the firm to terminate a project when it is no longer profitable III) Options that are associated with corporate securities that provide flexibility to change the terms of the issues a. I only b. II only c. I and III only d. I, II, and III

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Section B - 40 MARKS Questions 41 - 60, 2 Marks Correct, -0.5 Mark Incorrect (No Marks if left blank)
Question 1 The buyer of a call option has the right to exercise, but the writer of the call option has: a. The choice to offset with a put option b. The obligation to deliver the shares at exercise price c. The choice to deliver shares or take a cash payoff d. The choice of exercising the call or not

Question 2 In June 2015, an investor buys a call option on Siemens stock with an exercise of price of 65 and expiring in January 2016. If the stock price in June 2015 is 60, then this option is: I) In-the-money II) Out-of-the-money III) Under-the top

a. I only b. II only c. III only d. II and III only

Question 3 If the present value of the cash flow X is 300, and the present value cash flow Y 200, then the present value of the combined cash flow is: a. b. c. d. 500 300 250 200

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Question 4 You would like to have enough money saved to receive a 70,000 per year perpetuity after retirement so that you and your family can lead a good life. How much would you need to save in your retirement fund to achieve this goal (assume that the perpetuity payments starts on the day of retirement. The interest rate is 8%)? a. b. c. d. 945,000 875,000 735,000 700,000

Question 5 If the 5-year spot rate is 10% and the 4-year spot rate is 9%, what is the oneyear forward rate of interest four years from now? a. b. c. d. 14.1% 9.5% 1.0% 11.0%

Question 6 An initial investment of 400,000 will produce an end of year cash flow of 480,000. What is the NPV of the project at a discount rate of 20%? a. 80,000 b. 20,000 c. 0 (zero) d. -20,000

Question 7 If the nominal interest rate per year is 8% and the inflation rate is 5%, what is the real rate of interest? a. b. c. d. 2.9% 3.0% 4.0% 6.0%

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Question 8 A bond with duration of 5.7 years has a yield to maturity of 9%. The bond's volatility is: a. b. c. d. 0.5 % 3.3% 5.2 % 9.0 %

Question 9 Old Look's stock has had -5%, 9% and 20% rates of return during the last three years respectively; calculate the average rate of return for the stock. a. b. c. d. 8% per year 9% per year 11% per year None of the above

Question 10 In one year Macaroon S.A. stockholders expect to receive an annual dividend of 5 per share and then sell for 115 dollars per share. If the required rate of return for the stock is 20%, what is the current value of the stock?

a. 100 b. 120 c. 95 d. 110

Question 11 Haberman Robotics PLC retains 40% of its earnings and distributes the remaining 60%. The return on equity is 12% per year, the cost of equity capital is 10%, and interest rates are 5%. According to the Gordon Growth Model, what is the annual rate of dividend growth used to value the company? a. b. c. d. 4.8% 6.0% 10.5% 60.0%

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Question 12 Storey Company is investing in a giant crane. It is expected to cost 6.0 million in initial investment and it is expected to generate an end of year cash flow of 3.0 million each year for three years. Calculate the NPV at 12% (approximately).

a. b. c. d.

2.4 million 1.2 million 0.80 million 0.20 million

Question 13 If the beta of Exxon Mobil is 0.65, risk-free rate is 4% and the market rate of return is 14%, calculate the expected rate of return from Exxon: a. 2.6% b. 10.5% c. 13.1% d. 6.5%

Use this information for the following two questions. Suppose an investor has equal amounts in a) a portfolio with an expected return of 14% and a standard deviation of returns of 30% and b) Gilts with a 2% YTM.

Question 14 Calculate her expected return a. -2.2% b. 8% c. 9% d. 16%

Question 15 Calculate her standard deviation a. 0.5% b. 6.6% c. 11.0% d. 15.0%

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Question 16 Given the following information about a stock: beta = 0.9; risk-free rate = 4%; market rate of return = 14%; and Expected rate of return on the stock = 13%. Then the stock is: a. b. c. d. Overpriced Under priced Correctly priced Cannot be determined

Question 17 The spot price of wheat is $2.70/bushel. One-year futures price is $2.70/bushel. If the risk-free rate is 5%, calculate the net convenience yield. a. +5.0% b. +100% c. -5.0% d. -100%

Question 18 You have purchased 100 call options on Half Hollow Homes, a real estate developer. The total price paid was 300. The exercise price is 56 per share and the current share price is 54 per share. Two months later the options expire with a share price of 58 (and you exercise). Your total profit is a. b. c. d. -50 -100 200 400

Question 19 The CAC 40 (Paris Large Stock Index) spot price is 3838.02. The interest rate is 2.0% and the dividend yield on the CAC 40 is 4.0%, both are expressed annually. The index volatility is 0.50, also expressed annually. What is the expected price of the 3-month CAC 40 futures contract? a. b. c. d. 3761.26 3818.83 3857.21 3914.78

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Question 20 The spot price of Florida orange juice is $2.90 per ton. The risk-free rate is 2% and the net convenience yield is 4%. You want to negotiate a one-year forward, what would you expect the forward price to be? a. b. c. d. $2.84 $2.93 $3.04 $3.18

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