Question practice

Question 1

Interest parity equation

Answer 1

middle spot *(1+ mid UK interest)/(1+Mid US interest) = forward rate

Question 2

Economic risk definition

Answer 2

risk that longer term exchange rate movements may reduce the international competitiveness of a company. it is the risk that the PV of a company’s FCF might be reduced by adverse exchange rate movements

Question 3

Divdend yield equation

Answer 3

= dividend/share price

Question 4

£ interest rates higher than dollar and forward contract premium indicate dollar extpected to

Answer 4

Strengthen

Question 5

Forward contract discount indicate dollar expected to

Answer 5

weaken

Question 6

good for exporter if the £

Answer 6

weakens

Question 7

Time value of options affected by

Answer 7

Time period until expiry
volatility of market price of underlying item
general level of interest rates

Question 8

Predictive analysis definitoin

Answer 8

uses historical and current data to create predictions about the future, could be used to forecast impact of different alternatives

Question 9

Prescriptive analysis

Answer 9

Combines statistical tools used in predictive analysis with AI and algorithms to calculate the optimum outcome from a variety of business decisions. It could be used to identify optimum pricing policy.

Question 10

What are the assumptions of dividend growth model

Answer 10

shares have value because of dividends
dividends either do not grow/grow at constant rate
estimates of future dividends are based on historical data

Question 11

what is incorporated into beta

Answer 11

systematic business risk and financial risk

Question 12

examples of systematic risk

Answer 12

interest rate changes
recession
oil price changes
war

Question 13

Examples of unsystematic risk

Answer 13

chairman resigning,
strikes by employees,
changes in regulations that affect a particular market sector

Question 14

Systematic risk definition

Answer 14

Type of risk all companies are exposed to no matter which market sector they operate in. Cannot be eliminated through diversifiaction

Question 15

Unsystematic risk definition

Answer 15

the risk that affects a particular market sector or individual company, most of this risk can be diversified away by investing in a portfolio of 15-20 randomly selected securities

Question 16

what does portfolio theory show

Answer 16

the only logical portfolio to hold is one which is fully diversified to eliminate all unsystematic risk

Question 17

Stock market reaction to a firm diversifying

Answer 17

may not welcome the diversification, as these companies usually trade at a conglomerate discount. Stock markets may assume the company does not have expertise to operate in new area.

Question 18

Shareholder reaction to a firm diversifying

Answer 18

those holding a well diversified portfolio would not welcome diversification of operations (not doing anything that they haven’t done themselves) and therefore market value might fall.
Un-diversified shareholders may welcome the diversification

Question 19

when valuing company, which methods need to subtract lt debt

Answer 19

EBITDA and FCF

Question 20

What is P/E method useful for

Answer 20

Growth companies, reflects industry sentiment regarding a particular sector

Question 21

Why may using a companies specific PE not be relevant

Answer 21

reflects market sentiment to that particular company, may be better to use an industry average

Question 22

Issue with EV

Answer 22

simplistic and distills lots of information from different value drivers into a single number

Question 23

Why is EV useful

Answer 23

excludes affect of how a company is financed and CAPEX, so can compare companies in the same industry with different levels of CAPEX

Question 24

Assets methods issues

Answer 24

does not take into account earning potential of assets and ignores goodwill, balance sheet values are not always realisable
No guarantee assets sold at NRV
Closure and redundancy costs should be included

Question 25

SVA benefits

Answer 25

evaluates future FCF and is more representative of the true value of a company.

Question 26

SVA issues

Answer 26

relies upon unrealistic assumptions such as estimating future growth rates for the primary period and terminal value, setting time horizons, calculating the discount rate

Question 27

issues valuing start up

Answer 27

no record of profit (often loss making)
unpredictable market acceptance of products
unknown competition
inexperienced management
difficulties valuing digital assets and associated income streams

Question 28

Best method for valuing start up

Answer 28

DCF
despite all problems estimating FCF
can use market multiples but hard to find similar and their multiples and unlikely to have assets/earnings so these are inappropraite

Question 29

Dividend payout ratio

Answer 29

Dividend/earnings

Question 30

Dividend yield

Answer 30

dividend per share/share price

Question 31

EPS

Answer 31

profit after interest tax and pref div/number of ordinary shares

Question 32

PE ratio

Answer 32

share price/EPS

Question 33

interest cover

Answer 33

Operating profit/interst

Question 34

g = br

Answer 34

b = balance of earnings retained
r = return on equity

Question 35

Return on equity

Answer 35

earnings/opening Sh funds

Question 36

Consideration for interest rate futures

Answer 36

maturity mismatch - £ borrowing / 0.5m * loan period / 3m

Question 37

Once SVA value calculated what must be done to get value of equity

Answer 37

add values of short term investment and deduct the market value of debt

Question 38

Opening SH funds

Answer 38

Shares + RE - Earnings + dividends paid