CFA

Question 1

Corporate Governance

Answer 1

A system of internal controls and procedures through which companies are managed

Question 2

NPV Net Present Value

Answer 2

Initial outlay (negative) plus every cash flow discounted to today

Question 3

IRR (Internal Rate of Return)

Answer 3

Rate needed for all cash flows of a period to equal the initial outlay

Question 4

Payback Period

Answer 4

Time it takes for cash flows of a project to equal initially outlay. Cash flows can be discounted (discounted payback period)

Question 5

AAR (Average Accounting Rate of Return)

Answer 5

Average of cash flows / average book value

Question 6

PI (Profitability Index)

Answer 6

Present values of future cash flows / initial outlay

Question 7

Cross Over Rate

Answer 7

The rate (cost of capital) at which the NPV of two projects are equal

Question 8

Cost of Capital

Answer 8

Rate of return that the suppliers or providers of capital need to agree on investing, also known as their opportunity cost

Question 9

WACC (Weighted Average Cost of Capital)

Answer 9

Marginal cost of capital = WACC = (Wd)(Rd)(1-t) + (Wp)(Rp) + (We)+(Re)

Question 10

Tax Shield

Answer 10

Interest expense * tax rate

Question 11

Target Capital Structure

Answer 11

Capital structure that the company aims to maintain

Question 12

D/E ratio to weight

Answer 12

Wd = D / (D + E) or (D / E) / (1 + D/E)

Question 13

Current market price of bond

Answer 13

Po = sum of payments discounted to today plus future value discounted to today

Question 14

YTM (Yield to Maturity)

Answer 14

Interest rate needed for bond’s current market value to become future value at a given number of periods and payment amounts

Question 15

Debt rating approach

Answer 15

Using yields of similarly rated bonds to estimate cost of debt when current market prices are not available

Question 16

Cost of preferred stock (perpetuity)

Answer 16

Dividend per share / current price of stock

Question 17

Current value of preferred stock (perpetuity)

Answer 17

Dividend per share / cost of preferred stock

Question 18

Perpetuity

Answer 18

Noncallable, nonconvertible, no maturity date, dividends paid at a fixed rate, preferred stock value

Question 19

Cost of Equity Capital

Answer 19

Rate of return required by common stock holders

Question 20

CAPM (Capital Asset Pricing Model)

Answer 20

States that the expected rate of return from a stock equals the risk free interest rate plus a premium for bearing risk

re = Rf + Bi[E(Rm) - Rf]

Question 21

Dividend discount model approach

Answer 21

Value of a stock equals present value of expected future dividends

Po = D1 / re - g

Question 22

Bond yield plus risk premium approach

Answer 22

Re = rd + risk premium

Question 23

CAPM company’s cost of equity

Answer 23

Ri = a + bRmt

Company’s stock returns = estimate of the intercept + beta*market returns over a given period

Question 24

Pure play method to estimate beta

Answer 24

Take beta of similar publicly traded company, unlever the financial risk (leverage) and lever in financial risk of project under study

Unlever = 1 / 1 + ((1-t) D/W)

Question 25

CRP (Country Risk Premium)

Answer 25

(Sovereign yield spread * (annualised standard deviation of equity index) / (annualised s.d of sovereign bond market in terms of the developed market currency))

Question 26

Break point

Answer 26

(Amount of capital at which a component’s cost of capital changes) / proportion of new capital raised from the component)