Core Activity C - Recommend finance strategies

Question 1

What beta should be used in CAPM ?

Answer 1

Market implied beta ?

Question 2

What are the 3 bases for valuation ?

Answer 2

Assets

Earnings

Cash flows

Question 3

What considerations need to be taken when valuing a business ?

Answer 3

Intention after purchase
If selling, why?

Question 4

What’s a weekness of CAPM

Answer 4

It’s relies on historical covariance which is not always representative of future events

Question 5

How does holt approach beta?

Answer 5

HOLT doesn’t like beta as it doesn’t make sense to use a historical beta to predict a stocks foreward risk

Instead inputs an expected return by measuring the average return anticipated by all stocks. Form specific adjustments are then made for exposure to size and leverage factors that define the estimate

Question 6

What’s another weekness of CAPM ?

Answer 6

It’s reliance on historical average of the ERP

Question 7

What does a beta of 1 mean?

Answer 7

A beta of 1 means the stock moves in line with market movements

A beta of greater than 1 means the stock moves more aggressively than the market leading to more upside potential and downside in bearish periods

A beta of less than 1 means the stock is more defensive than the market

Beta of - are assets that are not correlated to the market and move in opposite directions… eg gold

Question 8

What is the formula for CAPM?

Answer 8

E (R) = RF + B * (RM-RF)

E (r) = expected return

RM = market return

Question 9

Ow can CAPM be used to deter min discount rates?

Answer 9

Review graph and review beta to determine the expected return using the security market line (S&P 500)

Below line = overvalued

Above line = undervalued

Question 10

What are the three classifications for foreign exchange risk?

Answer 10

Economic, transaction & translation

Question 11

How can we determine if currency hedging is required ?

Answer 11

Perform time series regression analysis to understand historic currency volatility

Question 12

What does IRP state ?

Answer 12

Interest rate parity between two countries can indicate Fx volatility

Question 13

How can IRP be used to forecast exchange rates ?

Answer 13

Use the government bond yields and the IRP formula to forecast future rates in line with the bond yields

Question 14

How else can foreign currency risks be calculated relative to purchasing power ?

Answer 14

PPP - replacing interest rate figure with inflation rate

Question 15

How is TVM expanded into Fx

Answer 15

Fished effect

Question 16

What could be reason for slight differences between IRP and PPP?

Answer 16

Transaction costs

Specific items

Government intervention

Question 17

What else is IRP useful for ?

Answer 17

An unbiased predictor of future rates … all the foreword contractors in place for hedging May impact future rates ‘self fulfilling prophecy’

Question 18

How can we measure Fx risk?

Answer 18

Use standard deviation for currency pair and estimate downside risk based VaR ( Value at risk)

Vat calculates maximum possible risk due to normal market movements in a given period for a given level of probability

Question 19

How else can VaR be a useful tool for rotomyne ?

Answer 19

It can also be used to ad confidence to commodity price volatility as well as Fx

Question 20

Why are Fx and commodities useful for IRP PPP and VaR?

Answer 20

Accessible historical data

Question 21

What’s the bid price ?

Answer 21

Highest the buyer is willing to pay

Question 22

What’s the ask price ?

Answer 22

Lowest the seller is willing to accept

Question 23

What’s the bid ask spread ?

Answer 23

Profit made by the bank or broker

Question 24

What does wider spread suggest ?

Answer 24

Lower liquidity an more risk

Question 25

What are the 3 steps involved in setting up a futures hedge ?

Answer 25

Which contracts are appropriate?
This means date / ending on or as soon as possible after

How many contracts?
Quantity / closest match

Buy or sell?
If receiving funds in future the futures hedge is sell

Question 26

What’s an example of hedging translation exposure?

Answer 26

Matching the currency of assets and liabilities

Question 27

Where is further practical example required ?

Answer 27

Money market hedge for Fx

Question 28

What are 2 base rate benchmarks that now replace LIBOR ?

Answer 28

SOFR (secured overnight finance rate, US)

SONIA (sterling overnight index average)

Question 29

What tools can be used to hedge interest rate risk?

Answer 29

Interest rate futures

Interest rate options

Interest rate swaps

Question 30

What’s the difference between futures and forward contracts ?

Answer 30

Futures are off the shelf products and cheaper but not always perfect in terms of size

Forward contracts are customisable and more expensive but don’t leave any exposure as it’s built to cover the entire bet to the penny.

Question 31

What’s the difference between an option and a futures contract ?

Answer 31

Options gives the right, but not the obligation

Future is an obligation

Question 32

What’s a call option ?

Answer 32

Right to buy futures contracts (and receive interest)

Used by lenders

Question 33

What’s a put option ?

Answer 33

Right to sell futures contracts (and pay interest)

used by borrowers

Question 34

What’s the minimum equity value required to be listed on NYSE and LSE?

Answer 34

60m

700,000?