2017 Past Paper

Question 1

What is the formula for growing perpetuity?

Answer 1

= D/r-g
D = dividend/coupon
r= discount rate
g = growth rate

Question 2

True/False
If the discount rate is 10%, a growing perpetuity that pays an initial cash flow of £20 starting one year from now, which grows at 5% thereafter, has present value equal to £400.

Answer 2

TRUE
400 = 20 / 0.1-0.05

PV = CF/r - g

Question 3

True/False
If the discount rate is 10%, the present value, as of today, of £1331 in three years is equal to £1000.

Answer 3

TRUE
1331/1.1^3
Discounting 1331 to present value to prove it is equal to 1000.

Question 4

True/False
If the discount rate is 8%, the future value, as of period 10, of a cash flow of £100 today is greater than £180.

Answer 4

TRUE
100*(1.08^10) = 215.89

Question 5

True/False
If the present value of a perpetuity that pays a fixed cash flow of £5 is equal to £45, the discount rate is lower than 10%.

Answer 5

False
45 = 5/0.11111
0.1111 > 0.1

Question 6

True/False
The beta of the market portfolio is 1.

Answer 6

TRUE: Covariance with itself equals variance

Question 7

True/False
The expected return on a stock with a beta greater than 1 is larger than the expected return on the market portfolio.

Answer 7

TRUE: CAPM formula

R = rf + B(rm - rf)

R= capital asset expected return

Rf = risk-free rate

B = sensitivity

rm = expected market return

Question 8

True/False
A stock with zero beta has returns that are uncorrelated with market returns.

Answer 8

TRUE: Zero beta means zero covariance with the market.

Question 9

True/False
A stock with positive beta may have lower expected returns than the market portfolio.

Answer 9

TRUE: provided beta is less than 1.

Question 10

If a stock has a beta of 2 and its covariance with the market portfolio is 0.32, the volatility (standard deviation) of the returns of the market portfolio is…

a) 0.16
b) 0.20
c) 0.32
d) 0.4
e) 0.64

Answer 10

0.4

B = cov/var

2 = 0.32/var

0. 32/2 = 0.16
1. 4^2 = 0.16

0.4

Question 11

What are the necessary assumptions of the Modigliani-Miller Theorem?

Answer 11

PERFECT CAPITAL MARKET

• No transaction costs. Financial transactions occur at no cost (e.g. no commissions to intermediaries, no time wasted on planning).
• Equal borrowing/lending costs. Companies and investors should be able to borrow at the same cost.
• Handling of excess cash. It is either paid out in dividends or invested, not squandered.
• No taxes
• No asymmetric information or differences of opinion
• No costs of financial distress

Question 12

How do you calculate equity/debt/asset beta?

Answer 12