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Workbook Questions Flashcards

1
Q

What is the financial objective of a profit making company?

A

Maximising shareholder wealth

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2
Q

One of the most important financial management potential conflicts is between shareholders (_____) and directors (_____)

A

Principals
Agents

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3
Q

What are the ESG objectives?

A

Environmental, social and governance

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4
Q

Poor environmental behaviour can lead to what? (3)

A

Fines
Loss of reputation
Legal claims

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5
Q

Poor governance can lead to what? (3)

A

Poor decision making
Taking on too much risk
Fraud

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6
Q

Define payback

A

The time taken for cash inflows from a project to equal the cash outflows

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7
Q

Payback decision rule:
Accept if payback ___ target

A

<

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8
Q
  1. Define ARR
  2. Give both formulas for ARR
  3. For ARR, profit is before or after depreciation?
A
  1. Accounting rate of return
  2. i) (average annual profit from investment) / (initial investment) * 100
    ii) (average annual profit from investment) / (average investment) * 100, where average investment = (initial outlay + scrap value) / 2
  3. After
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9
Q

ARR decision rule:
accept if ARR __ target

A

>

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10
Q

Define NPV

A

Net Present Value: the maximum an investor would pay for a given set of cash flows compared to the actual amount he/she is being asked to pay

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11
Q

NPV decision rule:
Accept is NPV is _____ (usually)

A

Positive

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12
Q

Define IRR

A

Internal rate of return: a cost of capital at which the NPV of a project is £0

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13
Q

IRR decision rule:
Accept if IRR % __ cost of capital (usually)

A

>

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14
Q

Give the IRR interpolation formula using two discount rates

A

IRR = a + (NPVa / (NPVa - NPVb)) * (b - a)

a = the lower discount rate giving NPVa
b = the higher discount rate giving NPVb

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15
Q

Define relevant cash flows

A

Future, incremental, cash flows arising from the decision being made

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16
Q

The figures out into NPV working must be relevant to the decision being considered:
1) cash flows only, ie _____ should be ignored
2) _____ amounts only
3) ______ relevant costs only
4) finance related cash flows
5) _____ costs, ie include costs incurred or revenue lost from diverting existing resources from their existing use

A

Depreciation
Future
Directly
Opportunity

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17
Q

Does working capital form part of the taxable cash flows?

A

Yes

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18
Q

What are the two effects taxation has on investment appraisal?

A
  1. Tax payments on operating profit
  2. Tax benefit from capital allowances on capital expenditure
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19
Q

Calculate capital allowances at ____ on a reducing balance basis

A

18%

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20
Q

Are there capital allowances in the year of sale?

A

No; a balancing allowance/charge is calculated instead

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21
Q

Corporation tax is assumed to be paid at ____

A

25%

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22
Q

Although large companies make tax payments in four equal instalments during the accounting year, what do we assume for examination purposes?

A

The whole tax payment is to be made at the end of the year to which it relates

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23
Q

True or false:
The tax rate can be assumed to be constant over the life of the project

A

True

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24
Q

True or false:
It should be assumed that working capital flows have no tax effects

A

True

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25
Q

What are the real rates of interest?

A

The rates of interest that would be required in the absence of inflation in the economy

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26
Q

Give the Fischer Equation

A

(1 + m) = (1 + r) * (1 + i)

m = money (nominal) rate
r = real (effective) rate
i = general inflation rate

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27
Q

The money method uses the money (nominal rate). Give two issues with this methodology

A
  1. General inflation may not be constant
  2. Longer term estimates become more prone to error
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28
Q

What are the four environmental costs to consider?

A
  1. Environmental prevention costs
  2. Environmental appraisal costs
  3. Environmental internal failure costs
  4. Environmental external failure costs
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29
Q

When is the equivalent annual cost (EAC) the quickest way to determine the optimal replacement cycle?

Give the EAC formula

A

When cash flows do not inflate

EAC = (NPV of one cycle of replacement) / (AF for this cycle length)

AF = annuity factor

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30
Q

Define capital rationing

A

The situation where insufficient funds exist to undertake all positive NPV projects, so a choice must be made between projects

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31
Q

What is the difference between hard rationing and soft rationing?

A

Hard rationing: external limits exist on funds available

Soft rationing: internal constraints are imposed

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32
Q

Profitability Index (PI) = ?

A

NPV / Outlay (outlay is the funds required)

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33
Q

Define an indivisible project

A

A project which must either be completed in full or not at all

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34
Q

Rank the following in correct order

A) implement and control
B) determine mission and objectives
C) analyse the current position of the business
D) identify and select strategies

A

C), B), D), A)

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35
Q

Define Shareholder Value Analysis (SVA)

A

The process of analysing the activities of a business to identify how they will result in increasing shareholder wealth

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36
Q

Below are four key drivers of value for SVA. What are the remaining three?

Sales growth rate
Operating profit margin
Corporation tax rate
Investment in non-current assets

A

Investment in working capital
Cost of capital
Life of projected cash flows

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37
Q

Real option equation:

Project worth = Traditional NPV + ?

A

Value of any real options

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38
Q

Overseas investment can include political risk, product risk and _____ risk

A

Cultural

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39
Q

What is the difference between risk and uncertainty?

A

Risk: probabilities are both known and can be quantified

Uncertainty: possible outcomes are known but probabilities are unknown

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40
Q

The following techniques are used for handling what?

1) setting a maximum payback period for projects
2) increasing the discount rate subjectively in order to submit the project to a higher ‘hurdle’ rate in investment appraisal
3) making prudent estimates of outcomes to assess the worst possible situation
4) assessing the best and worst possible situations
5) using sensitivity analysis to measure the margin of safety on input data

A

Uncertainty

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41
Q

Sensitivity analysis equation?

A

Sensitivity = (NPV of project) / (PV of cash flows subject to uncertainty) * 100%

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42
Q

Sensitivity analysis is a formalised approach to incorporating ______ ______ in the project evaluation

A

Alternative forecasts

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43
Q

Strengths of sensitivity analysis:

  1. Presented in a form which facilitates subjective ______
  2. Identifies areas which are _____ to success
  3. The theory is not ______
A

Judgement
Critical
Complicated

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44
Q

Weaknesses of sensitivity analysis:

  1. Only one _____ at a time can be analysed
  2. If assumes that changes to ____ can be made indecently
  3. It only identifies how far a variable needs to change, it does not look at the…?
  4. It provides information on the basis of which decisions can be made, it does not …?
A
  1. Factor
  2. Variables
  3. Probability of such a change
  4. Point directly to the correct decision
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45
Q

What two types of data does predictive analytics use to create predictions about the future?

A

Historic and current

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46
Q

Define linear regression

A

A statistical technique which quantifies the relationship between a dependent variable and an independent variable so that forecasts can be made

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47
Q

Linear regression advantages:

  1. They are ___ to use and _____ to explain
  2. Can be used to predict the impacting of expanding variables beyond _____ estimates
A

Simple, easy
Current

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48
Q

Limitations of regression analysis:

  1. Not always a ______ relationship between variables and outcomes
  2. _______ models are needed to consider multiple variables
  3. _______ relationship between variables and outcomes may be identified
  4. The data collected may be _____ or there may be a large error variable
A

Linear
Complex
Spurious
Inaccurate

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49
Q

Define decision trees

A

A statistical technique used to identify the impact of different decisions and variables on the outcome of an investment

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50
Q

Two advantages and disadvantages of decision trees

A
  1. Simple decision trees are easy to explain and logical to use
  2. Can be used to analyse different outcomes based on a number of variables
  3. Variables have to be simplified and restricted to avoid over complicating the decision tree
  4. Large decision trees can be difficult to interpret
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51
Q

Define simulation

A

A technique which allows the effect of more than one variable changing at the same time to be assessed

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52
Q

What is the Monte Carlo simulation?

A

A simulation technique based on the use of random numbers and probability statistics to investigate problems

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53
Q

If outcomes are less widely dispersed about the mean, the standard deviation will be ______

A

Smaller

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54
Q

Advantages of simulation:

  1. It gives more ______ about possible outcomes
  2. It gives more information about the impact of ____ costs on new ventures
  3. It is useful for problems which cannot be solved ______
A

Information
Environmental
Analytically

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55
Q

Limitations of simulation:

  1. Only obtains information, not a technique for _______ making
  2. Can be ______ due to complexity
  3. Requires _____ to be made about probability distributions which may turn out to be inaccurate
A

Decision
Expensive
Assumptions

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56
Q

Define selection bias

A

When data is not selected randomly and leads to a sample that is not representative of the population

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57
Q

Define self-selection bias

A

Occurs when individuals select themselves to be part of a sample

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58
Q

Define observer bias

A

Occurs when observing and recording results and relates to interpretation

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59
Q

Define cognitive bias

A

Relates to human perception and includes bias depending on how data is presented

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60
Q

The higher the standard deviation, the…?

Give the excel function for this

A

Wider the data spread and the greater the risk of the expected return

=STDEV

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61
Q

Give the coefficient of variation equation

What does a higher percentage of this mean?

A

Standard deviation / mean * 100

The wider the dispersion of data around the mean

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62
Q

What is a normal distribution?

A

Any distribution of data which is symmetrical around the mean

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63
Q

Define portfolio

A

A combination of investments

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64
Q

What type of risk can be eliminated by diversification?

Which risk can’t?

A

Unsystematic/specific risk

Systematic/market risk cannot be eliminated by diversification

65
Q

Give the Capital Asset Pricing Model (CAPM) equation

A

rj = rf + Bj (rm - rf)

rj = required rate of return on investment j
rf = risk-free rate of interest
rm = return on the market portfolio
Bj = index of systematic risk for security j

66
Q

For CAPM:

Shares with higher betas are termed ______
Shares with betas of less than 1 are termed ______

A

Aggressive
Defensive

67
Q

The great advantage of using the CAPM for project appraisal is that it clearly how’s that the discount rate should be related to…?

A

The projects risk

68
Q

What is the use of CAPM?

A

In the setting of minimum required returns for new capital investment projects

69
Q

Issues with the alpha value in CAPM:

Reflects only ______, abnormal returns
Will tend towards ____

A

Temporary
Zero

70
Q

CAPM: if the alpha value is positive, what will happen?

A

Investors not already holding shares will be tempted to buy. Current investors will hold shares

71
Q

The arbitrage pricing model (APM) assumes what?

A

That the return on each security is based on a number of independent factors

72
Q

In what way is Arbitrage Pricing Theory (APT) similar to CAPM?

A

It assumes that investors are fully diversified, so only systematic risks influence the returns

73
Q

Give the APT general model:

A

E(ri) = rf + (E(rA) - rf)BA + (E(rB) - rf)BB + ….

(E(rA) - rf)BA = risk premium on factor A, etc. for rest

74
Q

What are the three factors that Fama and French suggest are for the APM?

A
  1. Return on the market portfolio less the risk free interest of interest
  2. Size factor measured as the difference in return between a portfolio of the smallest stocks and a portfolio of the largest stocks
  3. The value factor: a share with a high balance sheet (book) value per share when compared to the market share price will have a higher return than a share with a low book value compared to the market price
75
Q

Define derivative

A

A financial security whose value is derived from the value and characteristics of an underlying security

76
Q

Define a forward contract

A

A binding agreement to exchange a set amount of goods at a set future date at a price agreed today

77
Q

Define a future

A

A standardised contract to buy or sell a specific amount of a commodity, currency or financial instrument at a particular price on a stipulated future date

78
Q

What is the difference between a forward and a future?

A

A future is traded on an organised exchange

79
Q

Define hedge efficiency.

Give the formula for it

A

The extent of risk neutralisation that the hedge delivers

Gain in futures / loss on portfolio * 100%

80
Q

What is the difference between a future and a forward?

A

The holder of an option can choose whether or not to go through with the transaction and buy or sell the asset

81
Q

A _____ option, means an investor is entitled to buy the shares at the exercise price within the specified period

A

Call

82
Q

A _____ option means an investor has the right to sell the shares at the exercise price within the specified period

A

Put

83
Q

The cost of an option to a purchaser is known as the option ______

A

Premium

84
Q

What’s an over-the-top (OTC) for options mean?

A

Options may be traded on an exchange or agreed between two parties

85
Q

If a company buys a put option on shares, what are they doing?

A

Buying an option to sell the shares

86
Q

The intrinsic value of an option is computed by assuming that what?

A

It’s expiry date is today

87
Q

‘In the money’ options would be exercised and have an intrinsic value equal to the difference between the ______ price and the current ______ price

A

Exercise
Share

88
Q

When are ‘out of the money’ options not exercised?

A

When they have zero intrinsic value

89
Q

How is the time value for an option computed?

A

The difference between actual value and intrinsic value

90
Q

Three factors impact the time value of an option, which are the time period to expiry of the option, volatility if the underlying share price and what?

A

The general level of interest rates

91
Q

Who is responsible for managing the company’s cash and borrowings in order to repay debts as they fall due and to minimise the risks surrounding interest payments and receipts?

A

Corporate treasurers

92
Q

What is a Forward Rate Agreement (FRA)?

A

An FRA allows borrowers or lenders to fix their future rate of interest

93
Q

A borrower will _____ a FRA whilst an investor will _____ a FRA

A

Buy
Sell

94
Q

5.75-5.70 means that you can fix a _____ rate at 5.75% and a _____ rate at 5.70%

A

Borrowing
Deposit

95
Q

Borrowers will wish to hedge against an interest rate by selling futures now and by…?

A

Buying futures in the day that the interest rate is fixed

96
Q

What is maturity mismatch?

Give the formula

A

Maturity mismatch occurs if the actual period of lending or borrowing does not match the notional period of the futures contract (3 months)

Number of futures contracts = (amount of actual loan or deposit / futures contract size) * (length of loan / 3 months)

97
Q

How is the pricing of an interest rate futures contract determined?

A

By the interest rate (r) and is calculated as (100 - r)

98
Q

What is an interest rate swap?

A

A contractual arrangement for two organisations to exchange future interest rate payments

99
Q

What is the purpose of an interest rate swap?

A

To switch from paying one type of interest (E.g. fixed) to another (E.g. floating) much more cheaply than renegotiating existing debt

100
Q

A risk of swaps is that the counterparty will ______ before completion of the agreement

A

Default

101
Q

A risk of swaps is that it may lead to _______ _____ of the party involved being misleading

A

Financial statements

102
Q

What is the spot rate?

A

The exchange rate currently offered on a particular currency quoted for immediate delivery of the currency

103
Q

(Exchange rates): what is a direct quote?

A

The amount of domestic currency required to buy one unit of foreign currency

104
Q

(Exchange rates) what is an indirect quote?

A

The amount of foreign currency needed to buy one unit of domestic currency

105
Q

Define transaction risk (exchange rates)

A

The risk of adverse exchange rate movements occurring in the course of normal international trading transactions

106
Q

Define translation risk (exchange rates)

A

The risk that the organisation will make exchange losses when the accounting results of its foreign branches or subsidiaries are translated into the home currency

107
Q

Define economic risk (exchange rates)

A

The effect of exchange rate movements on the international competitiveness of a company

108
Q

A forward exchange contract is:

A) an immediately firm and ____ contract
B) at a rate of exchange _____ at the time the contract is made
C) for for the purchase or sale of a ______ quantity of a stated foreign currency
D) for performance at a _____ time which is agreed

A

Binding
Fixed
Specified
Future

109
Q

Option forward contracts are forward exchange contracts where the customer has the option to call for the performance of the contract of either which two?

A

1) any date from the contract being made up to a specified date in the future, or
2) at any date between two dates both in the future

110
Q

Give the forward rate formula (exchange rates)

A

Spot rate * (1 + if) / (1 + iuk)

if = overseas interest rate
iuk= domestic interest rate

111
Q

What does interest rate parity theory state?

A

That the difference between the spot rate and forward rate can be predicted by the difference in interest rates between the two countries

112
Q

To buy a currency futures contract is agreeing to _____ the contract currency

A

Receive

113
Q

Whose position is riskier: debt holders or shareholders?

Why?

A

The shareholders’ position is riskier- they suffer the downside of any loss but also expect a higher rate of return

114
Q

Dividend payout ratio equation = ?

A

Dividend / (earnings after tax and preference dividends)

115
Q

What is the theoretical ex-rights price?

A

The price at which the shares will settle after the rights issue has been made

116
Q

Give the ex-rights price equation

A

= (market value of shares pre-rights issue + rights proceeds + project NPV) / (number of shares ex-rights)

= (PV of new total dividends) / (number of shares ex-rights)

(If acquisition doesn’t give NPV of the project in which the funds are invested, assume it is nil)

117
Q

Value of right = _______ - _________

A

Value of right = TERP - right price

118
Q

What are the two ways of issuing new shares?

A
  1. Through an issuing house (investment bank)
  2. Direct offer, which is direct to the general public
119
Q

Define underwriting

A

The process whereby in exchange for a fixed fee, usually 1-2% of the total finance to be raised, an institution or group of institutions will undertake to purchase any securities not subscribed for by the public

120
Q

Dividend yield ratio?

A

(Dividend per share) / (market price per share) * 100

121
Q

Earnings per share ratio?

A

(Profits distributable to ordinary shareholders) / (number of ordinary shares issued)

122
Q

Price-earnings ratio?

What does this reflect?

A

(Market price per share) / EPS

This reflects the market’s appraisal of the share’s future prospects - the more highly regarded a company, the higher will be its share price and its P/E ratio

123
Q

Total shareholder return = ?

A

Dividend yield + capital gain

124
Q

Define venture capital

A

The provision of risk bearing capital, usually provided in return for an equity stake, to companies with high growth potential

125
Q

What is an Initial Coin Offering?

A

The investor receives a token, for a share or for a utility
Payment is made in a cryptocurrency
A ‘white paper’ is issued providing details of the venture and the tokens

126
Q

Define loan stock

A

Debt capital in the form of securities

127
Q

Coupon interest rate equation?

A

Coupon rate * nominal value of the stock

128
Q

Define convertible loans

A

Fixed return securities (either secured or unsecured) which may be converted, at the option of the holder, into ordinary shares in the same company

129
Q

Define loan stock with warrants

A

Loan sticks which cannot themselves be converted into equity, but give the holder the right to subscribe at fixed future dates for ordinary shares at a predetermined price

130
Q

Gearing ratio equation?

A

Debt / equity
Or
Debt / (debt + equity)

131
Q

Interest cover equation?

A

(Earnings Before Interest and Taxes) / Interest

132
Q

Give the three forms of finance available in international money markets, and define each

A

Eurocurrency: short-term borrowing and lending in currencies other than that of the country in which the bank is based in

International bond market: where bonds are issued by large companies or sovereign governments and sold to international investors

International syndicated loans market: for very large medium to long term loans. Syndicated loans spread the credit risk among participating lenders

133
Q

It is often easier for a large multinational to raise very large sums quickly on the ______ markets than in a _____ financial market

A

International
Domestic

134
Q

True or false:
Eurocurrency loans generally require no security

A

True

135
Q

Core components of green loan principles:
1. Loan proceeds are used for _____ projects
2. Process for project evaluation and selection is ______ communicated
3. Proceeds of a green loan are ______ tracked
4. Borrowers should provide ___ ____ ____ information on the use of proceeds

A

Green
Clearly
Appropriately
Up to date

136
Q

What is an issue with automatic (algorithmic) trading on electronic share dealing platforms with volatility?

A

If a number of algorithms all react to news released to the market in the same way, it can lead to stock market volatility, which can reduce the efficiency of the stock market

137
Q

What are the three forms of efficiency identified by the efficient market hypothesis?

A

Weak form, semi-strong form and strong form

138
Q

Give the three traits of weak form efficiency in the EMH

A
  1. Share price reflects information about past price movements
  2. Share prices follow a random walk
  3. Future price movements cannot be predicted from past price movements
139
Q

Give the three traits of semi-strong form efficiency in the EMH

A
  1. Share prices incorporate all publicly available information
  2. The market cannot be beaten by examining publicly available information- it will already be incorporated in share prices
  3. The market can only be beaten if an investor has inside information
140
Q

Give the two traits of strong form efficiency in the EMH

A
  1. Share prices reflect all information, published or not
  2. No investor could beat the market by having superior information as it does not exist
141
Q

What does behavioural finance suggest could significantly affect share price movements

A

Irrational investor behaviour

142
Q

The Gordon Growth Model:
The current share price is totally determined by the _______ dividends, discounted at the investor’a required rate of return

A

Anticipated

143
Q

Gordon Growth Model:
What are the two most convenient assumptions about dividends?

Give the formula for each of these

A

Dividends remain constant:
P0= D0 / Ke
Or
Ke= D0 / P0

Dividends grow at constant rate:
Ke= ((D0(1+g)) / P0) + g

P0= ex-dividend market value of equity
D0= dividend paid at time 0
Ke= equity investors’ required rate of return

144
Q

When is the cum-div stage (dividends)?

A

The period prior to the payment of dividends, where the price rises in anticipation of the payment

145
Q

What is the growth rate formula for dividends?

A

N * ((newest dividend) / (oldest dividend))^0.5 - 1

N= periods of growth

146
Q

Why does the issuing of a bonus issue makes shares more attractive?

A

The fall in price makes the shares more attractive to buy/sell

147
Q

What is the earnings retention model equation?

A

g = rb
r= earnings / (opening book value of equity)

g= growth rate in future dividends
r= the return on equity
b= the proportion of profits retained

148
Q

Problems with the earnings retention model:
1. Its reliance on ______ profits
2. The assumption that r and b will be ______
3. ________ can substantially distort the accounting rate of return if assets are valued on an historical cost basis
4. The model assumes all new finance comes from ______ - it therefore ignores the use of debt in a company’s capital structure

A

Accounting
Constant
Inflation
Equity

149
Q

What are three issues with the assumptions of the dividend valuation model?

A
  1. Shares have value because of dividends
  2. Dividends either do not grow or grow at a constant rate
  3. Future dividends estimates are based on historical data
150
Q

Give the capital asset pricing model (CAPM). Additionally, describe it

A

ke = rf + Bj * (rm - rf)

Bj = the beta which measures a share’a (systematic) risk
rm = the return on the market
rf = the risk-free rate of interest

The CAPM provides a relationship between risk and return

151
Q

Net of tax cost of debt = pre-tax cost of debt * ?

A

(1-T)

152
Q

Give the irredeemable debt equation

A

kd = Interest * (1-T) / P0

P0= price of bind ex-interest
Interest= interest paid on the bond
kd= required return of debt holder

153
Q

Give the weighted average cost of capital (WACC) equation

A

k = ((MVe * ke) + (MVd * kd)) / (MVe + MVd)

MVe = total market value of issued shares (market capitalisation)
MVd = total market value of debt

154
Q

The Weighted Average Cost of Capital (WACC) can only be used for project appraisal if:
1. The historical proportions of debt and equity are…?
2. The business risk is…?
3. The finance is not project specific

A

Not to be changed
Not to be changed (same for both parts)

155
Q

Define business risk

A

The variability in earnings before interest and tax associated with the industrial sector in which a firm operates

156
Q

Define financial risk

A

The additional variability in returns as a result of having fixed-interest debt in the capital structure

157
Q

Define operating gearing

A

The extent to which a firm’a operating costs are fixed, as opposed to variable, measured by establishing the ratio of total contribution to earnings before interest and tax (EBIT)

158
Q

Define financial gearing

A

The extent to which debt is used in the capital structure

159
Q

Give the two ways of measuring financial gearing

A
  1. Capital terms:
    Debt/equity or debt/(equity+debt)
  2. Income terms using interest cover:
    EBIT/Interest

FM (2 decks)

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