F3 - Financial Strategy

Question 1

Withholding Tax

Answer 1

Restircts the movement of funds between two foreign countries.

Increases political risk for those firms making overseas investments.

Question 2

Benefits of Leasing

Answer 2

Form of debt finance // Useful in instances where a company has not raised significant capital to fuel operations // Less covenants // Can be cheaper than purchasing outright [Lease vs Buy Decision]

Question 3

Bonds - Coupon Rate vs Yield

Answer 3

Yield is the expected return on the bond. As interest rates increase [yield], the price of the bond decreases.

Coupon Rate is fixed. Will be lower for discounted bonds as the investors sacrifies higher interest payments for capital gains in the future.

Question 4

Lease vs Buy Decision

Answer 4

Post-tax cost of borrowing used to discount the cash flows.

Tax savings relating to the lease should offset the cost of the decision [important to focus on timing of the tax payments - Cumulative Discount Rate may need to be adjusted!].

Question 5

Unsystematic Risk / Systematic Risk / Standard Deviation / Beta

Answer 5

Unsystematic Risk: Risk that is unique too the firm’s context. Investors can diversify this risk away by creating a negatively correlated portfolio [the portfolio effect].

Systematic Risk: Inherent / Market Risk. Risk that the will be a fall in the stock market as a whole.

Beta: Measures the firms sensitivity to market downturns. Includes both Financial and Business Risk. Can be viewed in terms of Equity or Asset Beta.

Standard Deviation: Measures the total risk or variability of returns [inc. both systematic and unsystematic risk].

Question 6

BETA

Assumes the an investors is well diversified…

Answer 6

Equity Beta [Beg] - includes both Financial and Business risk.

Asset Beta [Beu] - Financial risk stripped out. ONLY shows Business risk.

Debt Beta [Bd] - Usually assumed to be 0, but can be calculated using CAPM where kd = Rf + [Rf - Rm]*Bd

Question 7

Financial Risk vs Business Risk + Risk Adjusted Cost of Capital

Answer 7

Financial Risk - risk relating to a firms capital structure

Business Risk - risk relating to a firms operations.

Risk Adjusted Cost of Capital - reflecting the business and financial risk of an investment.

Question 8

g = rb

Answer 8

g = Growth
r = Return on Reinvested Funds
b = Balance Reinvested [as % of Earnings]
1-b = Dividend Payout Ratio

Question 9

Natural Hedge

Answer 9

Matching foreign currency assets with foreign currency liabilities. Form of matching. Helps to reduce translation risk.

Essentially, the cash flow from one should cancel out the cash flow from the other, thus fulfilling the concept of a hedge.

Question 10

Currency Risk

Answer 10

Involves imports, exports, borrowing and investing in foreign currency. Also includes threat of froeign competition within domestic markets!