PART A

Question 1:

You wish to borrow $3 million in the form of a fully amortising home loan with a term of 20 years. The interest rate is 5.35% pa compounding monthly and is not expected to change. What will be your monthly payments?

(a) $20,383.29

(b) $35,447.05

(c) $25,389.50

(d) $33,333.90

(e) $25,591.35

Question 2:

How much could you borrow from the bank using a 25-year fully amortising home loan at an interest rate of 3.8% pa compounding monthly if you can afford to make monthly payments of $4,000? Assume a constant interest rate. The amount that you could borrow now is:

(a) $917,710.70

(b) $523,562.99

(c) $750,000.00

(d) $900,000.00

(e) $773,909.11

Question 3:

You wish to borrow $650,000 in the form of an interest-only home loan with a term of 25 years. The interest rate is 4.8% pa compounding monthly and is not expected to change. What will be your monthly payments?

(a) $2600.00

(b) $1,536.20

(c) $1,666.67

(d) $2,000.00

(e) $2,864.98

Question 4:

A certificate of deposit priced at $67,500 with a $100,000 face value matures in 90 days. What is its yield as a simple annual rate? Assume 365 days per year. Its promised simple annualised yield to maturity is:

(a) 3.1122% pa

(b) 3.088% pa

(c) 1.5228% pa

(d) 1.9527% pa

(e) 0.7513% pa

Question 5:

Share A and Share B are both priced at $50 per share. Share A has a P/E ratio of 17, while Share B has a P/E ratio of 24. Which is the more attractive investment, considering everything else to be the same.

(a) Share A is the less attractive investment because it has a lower P/E ratio. This is because the lower the P/E ratio, the smaller the amount of earnings supporting the share price. This makes Share A less attractive investment than Share B.

(b) Share B is the more attractive investment because it has a higher P/E ratio. This is because the higher the P/E ratio, the larger the amount of earnings supporting the share price. This makes share B a more attractive investment than Share A.

(c) Share A is the more attractive investment because it has a lower P/E ratio. This is because the lower the P/E ratio, the larger the amount of earnings supporting the share price. This makes Share A a more attractive investment than Share B.

(d) Share B is the less attractive investment because it has a higher P/E ratio. This is because the higher the P/E ratio, the smaller the amount of earnings supporting the share price. This makes Share B less attractive investment than Share A.

(e) Share A is the more attractive investment because it has a lower P/E ratio. This is because the lower the P/E ratio, the smaller the amount of earnings supporting the share price. This makes Share A less attractive investment than Share B.

Question 6:

Underestimated Ltd’s ordinary shares currently sell for $36 per share. The company believes that its shares should really sell for $54 per share. If the company just paid an annual dividend of $2 per share and the company expects those dividends to increase by 8 per cent per year forever (and this is common knowledge to the market), what is the current cost of ordinary equity for the company and what does the company believe is a more appropriate cost of ordinary equity for the company?

(a) 15% and 12%

(b) 14% and 12%

(c) 19% and 14%

(d) 20% and 15%

(e) 18% and 12%

Question 7:

You're the CEO of an investment bank's equities research team. Your five analysts are each trying to find the expected total return over the next year of shares in a mining company.

The mining firm has the following information:

• Is regarded as a mature company since it's quite stable in size and was floated around 35 years ago. It is not a high-growth company;

• Share price is very sensitive to changes in the price of the market portfolio, economic growth, the exchange rate and commodities prices. Due to this, its standard deviation of total returns is much higher than that of the market index;

 Experienced tough times in the last 15 years due to unexpected falls in commodity prices.

• Shares are traded in an active liquid market.

Your team of analysts present their findings, and everyone has different views. While there's no definitive true answer, whose calculation of the expected total return is the most plausible? Assume that, the analysts' source data is correct and true, but their inferences might be wrong. Also all returns and yields are given as effective annual nominal rates.

(a) Blair says 4% pa since he calculated that this was the average total return on the mining stock over the last 15 years.

(b) Rachel says 3% pa since she calculated that this was the average growth rate of the share price over the last 15 years.

(c) Bob says 6% pa since he calculated that this was the average growth rate of the share market price index (not the accumulation index) over the last 15 years.

(d) Clair says 15% pa since she calculated that this was the discount rate implied by the dividend discount model using the current share price, forecast dividend in one year and a 3% growth rate in dividends thereafter, which is the expected long term inflation rate.

(e) Eve says 5% pa since she calculated that this was the average total yield on government bonds over the last 15 years. She says that this is also the expected total yield implied by current prices on one year government bonds.

Question 8:

Assume a project has different cash flows. In year 0, 1, 2, 3 and 4 the cash flows are -$250, $10, $0, $750 and -50 respectively. Assume that the cash flows are received smoothly over the year find the projects payback period.

(a) 1.80

(b) 2.11

(c) 3.32

(d) 1.25

(e) 2.32

Question 9:

Perpetual Ltd. has issued bonds that never require the principal amount to be repaid to investors. Correspondingly, Perpetual Ltd must make interest payments into the infinite future. If the bondholders receive annual payments of $75 and the current price of the bonds is $882.35, what is the after-tax cost of this borrowing for Perpetual Ltd if the corporate tax rate is 30 per cent?

(a) 2.65%

(b) 9.75%

(c) 5.95%

(d) 2.35%

(e) 6.50%

Question 10:

You are considering investing $1000 in a complete portfolio. The complete portfolio is composed of Treasury notes that pay 5% and a risky portfolio, P, constructed with two risky securities X and Y. The optimal weights of X and Y in P are 60% and 40% respectively. X has an expected rate of return of 14% and Y has an expected rate of return of 10%. If you decide to hold 25% of your complete portfolio in the risky portfolio and 75% in the Treasury notes then calculate the dollar values of your positions in X and Y respectively?

(a) 250 and 950

(b) 640 and 350

(c) 150 and 100

(d) 250 and 150

(e) 263 and 350

Question 11:

Suppose today you could buy a 15 year zero coupon bond for $420. If you purchase the bond at that price and hold it to maturity, and interest rate compounded quarterly, what is your YTM per quarter and per year? Assume face value is $1000.

(a) 2.95% quarterly and 5.90% p.a.

(b) 3.93% quarterly and 7.86% p.a.

(c) *1.46% quarterly and 5.83% p.a.

(d) 1.93% quarterly and 5.86% p.a.

(e) 2.95% quarterly and 5.85% p.a.

Question 12:

The Australian mining company BHP’s share price is $33 and there are a total of 5,323,690,000 shares outstanding. Suppose BHP just announced that they were going to sell a gold mine worth $3,000,000,000, and distribute all proceeds to shareholders in the form of a special dividend. If you owned 4,000 shares, how much in total would your special dividend be? The special dividend from the 4,000 shares that you own would be:

(a) $12.4

(b) $4,555.54

(c) $2,254.08

(d) $1,502.72

(e) $10,647.38

Question 13:

A stock's returns are normally distributed with a mean of 10% pa and a standard deviation of 20 percentage points pa. What is the 95% confidence interval of returns over the next year?

Note that the Z-statistic corresponding to a one-tail:

• 90% normal probability density function is 1.282.

• 95% normal probability density function is 1.645.

• 97.5% normal probability density function is 1.960.

The 95% confidence interval of annual returns is between:

(a) 30% and -10% pa.

(b) 32.9% and -32.9% pa.

(c) 35.64% and -15.64% pa.

(d) 42.9% and -22.9% pa.

(e) 49.2% and -29.2% pa.

Question 14:

Consider two shares, A and B. Share A has an expected return of 10% and a beta of 1.20. Share B has an expected return of 14% and a beta of 1.80. The expected market rate of return is 9% and the risk-free rate is 5%. Which security would be considered a better buy and why? Choose one of the following options.

(a) A is a better buy because it offers an expected return of 2.4% greater than B; and Jensen alpha is 0.118% for A and 0.2% for B respectively.

(b) B is a better buy because it offers an expected return of 2.4% greater than A; and Jensen alpha is 1.8% for B and 0.2% for A respectively.

(c) B is a better buy because it offers an expected return of 2.4% greater than A; and Jensen alpha is 11.8% for B and 2% for A respectively.

(d) A is a better buy because it offers an expected return of 0.24% greater than B; and Jensen alpha is 11.8% for A and 2% for B respectively.

(e) A is a better buy because it offers an expected return of 0.25% greater than B; and Jensen alpha is 25.5% for A and 22% for B respectively.

Question 15:

Suppose you have signed a lease to rent a large four bedrooms house for 2 years. You have been offered two alternatives. The first alternative is, you could pay an upfront rent for 2 years of $52,000. The second alternative is, you have signed a lease to rent an apartment for two years. The lease requires you to make payments of $2500 per month, payable at the start of each month, for 24 months. The first rental payment is due immediately. Assume the interest rate is 15% p.a. convertible monthly. Calculate the present value of the rental cash flow and identify which of the alternative is cheaper. Based on your calculation which of the following statement is true.

(a) The PV of rental payments is $50,000, which is less than the first alternative by $2000; hence, the second alternative should be chosen as it is cheap.

(b) The PV of rental payments is $51,560.59, which is less than the first alternative by 439.41; hence, the second alternative should be chosen as it is cheap.

(c) The PV of rental payments is $52,205.09, which is more than the first alternative by 205.09; hence, the first alternative should be chosen as it is cheap.

(d) The PV of rental payments is $55,205.09, which is more than the first alternative by $3205.09; hence, the first alternative should be chosen as it is cheap.

(e) The PV of rental payments is $52,605.09, which is more than the first alternative by $605.09; hence, the first alternative should be chosen as it is cheap.

Question 16:

A company conducts a 9 for 2 stock split. What is the percentage increase in the stock price and the number of shares outstanding? The answers are given in the same order.

(a) -78%, 350.00%

(b) -70%, 333.33%

(c) -70%, 233.33%

(d) -57.14%, 233.33%

(e) 233.33%, -70%

Question 17:

A European company just issued two bonds, as shown below:

- 3 year zero coupon bonds are trading at a yield to maturity (YTM) of 8% pa, and a

- 4 year zero coupon bonds are trading at a yield to maturity (YTM) of 10% pa.

What is the company's forward rate over the fourth year? Give your answer as an effective annual rate, which is how the above bond yields are quoted.

(a) 0.0374

(b) 0.0604

(c) 0.1623

(d) 0.1250

(e) 0.1411

Question 18:

A graph of assets’ expected returns (μ)(μ) versus standard deviations (σ)(σ) is given in the graph below. The CML is the capital market line.

Which of the following statements about this graph, Markowitz portfolio theory and the Capital Asset Pricing Model (CAPM) theory is NOT correct?

(a) The market portfolio M has systematic risk only. It’s a fully diversified portfolio comprised of all individual risky assets. The market portfolio is usually assumed to be the equity index, such as the ASX200 in Australia or the S&P500 in the US.

(b) The risk free security has no risk at all. Government bonds are usually assumed to be the risk-free security.

(c) Portfolio combinations of the market portfolio and risk free security will not plot on the CML and will have systematic risk only. They will have no diversifiable risk.

(d) The portfolios on the CML with a return above risk free have maximum return for any given level of risk.

(e) The individual assets and portfolios with returns less than the risk free rate are overpriced, have a negative Jensen’s alpha, positive beta and should be sold.

Question 19:

A fairly priced unlevered firm plans to pay a dividend of $2 next year (t=1) which is expected to grow by 3% pa every year after that. The firm's required return on equity is 12% 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 12% pa, and have the same risk as the existing projects. Therefore, next year's dividend will be $1.80. 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 and that all rates are effective annual rates.

(a) 0.053 p.a.

(b) 0.098 p.a.

(c) 0.085 p.a.

(d) 0.057 p.a.

(e) 0.049 p.a.

Question 20:

XYZ Corporation is expected to pay a dividend in Year 1 of $3.00, a dividend in Year 2 of $2.00, and a dividend in Year 3 of $1.00. After Year 3, dividends are expected to decline at the rate of 2% per year. An appropriate required return for the shares is 8%. How much the shares should be worth today.

(a) $16.85

(b) $18.85

(c) $13.95

(d) $13.07

(e) $18.58