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Time for questions and answers

EACH of the sub-questions given below has only one right answer:

*Q 1.Which of the following is not a benefit of a large stock exchange?

A It is possible to ascertain the price which perfectly predicts the fortunes of the company.

B Society benefits as the scarce resource, capital, is allocated to productive uses.

C Shareholders are able to liquidate their funds quickly and at a relatively low cost.

D Firms are able to obtain funds in order to expand.

*Q 2.If the concept of value for money is used to measure performance in a `not for profit' organisation, the criteria used will be:

A Economy, efficiency, equity

B Economy, equity, effectiveness

C Economy, efficiency, effectiveness

D Efficiency, equity, effectiveness

*Q 3.Which of the following statements is true?

A Each year, expansion and growth is financed by means of the issue of new shares.

B Over the past 40 years, the proportion of shares held by individuals has decreased by about 50 per cent.

C Financial institutions, including banks, own more than 40 per cent of the quoted shares in the UK.

D New issues of shares are a more important source of finance for UK firms than retained earnings.

*Q 4.Treasury management is concerned with:

A Funding and liquidity

B Risk management

C Working capital management

D All of these

*Q 5.Which of the following statements is true in a quote-driven stock market trading system?

A Brokers quote both bid and offer prices, investors then purchase securities after reviewing all the brokers' prices, and the transactions are reported to the central computer system.

B Buy and sell orders are entered into a central computer system and investors wishing to buy are matched with people who want to sell their shares.

C The stock exchange publishes buy and sell prices for the quoted shares. This allows brokers to buy and sell from the exchange on behalf of their clients.

D Market-makers post bid and offer prices for shares into the central computer system. Brokers have access to these quotes and contact a market-maker to buy or sell shares.

*Q 6.Which of the following describes an operating lease?

A A contract for a specific time which is usually the expected working life of the asset leased.

B A short-term lease which can be terminated easily.

C An agreement which can be cancelled but the cost is usually prohibitive.

D A lease agreement in which a firm sells assets to a finance house that then allows the firm to continue to use the asset in return for regular payments.

*Q 7.Using CAPM, calculate the required return on a share with a beta of 1.4 when the risk-free rate of return is 8 per cent and the market risk premium has been 10 per cent over a long period of time.

A 11.2 per cent

B 14.0 per cent

C 21.2 per cent

D 22.0 per cent

*Q 8.In the CAPM model, what is systematic risk?

A The risk that cannot be eliminated by diversification and is common to all firms.

B The risk that can be eliminated by diversification.

C The risk that remains when all the hedging techniques have been used by the firm.

D The risk that the whole financial system will be affected by the future of a key financial institution.

*Q 9.A tax shield arises because:

A Some countries, for eg, the tax havens, do not impose taxes on either companies or individuals.

B Interest is treated as an expense by the tax authorities in most countries.

C Losses in previous years are deductible from the taxable income of subsequent years.

D The tax authorities in most countries have double taxation agreements for people who work in one country but are resident in the other.

*Q 10.If the tax paid by companies is 30 per cent, what is the weighted average cost of capital of a company with the following capital structure?

Balance sheet value Cost of finance

Ordinary shares 10 m 20 per cent

Reserves 20 m 20 per cent

Long-term debt 15 m 10 per cent

The par value of the ordinary shares is 50p each and they are currently quoted at 4.50 on the stock exchange. The debt is permanent and its market value is equal to its book value.

A 16.6 per cent

B 18.1 per cent

C 18.5 per cent

D 20 per cent

*Q 11.You are planning to go on a world cruise in ten years. If the cruise costs 18,164 and the interest rate over the next ten years will be 8 per cent per annum, how much will you need to save each quarter?

A 611

B 664

C 677

D 2,707

*Q 12.What is the value of 2,000 received each year in perpetuity, if the interest rate is 16 per cent?

A 12,500

B 16,000C 32,000

D 160,000

*Q 13.The yield curve can be explained by means of the:

A Expectation hypothesis

B Liquidity-preference hypothesis

C Market-segmentation hypothesis

D All three hypotheses

*Q 14.A bond was issued 18 years ago with a par value of 100 and offering a coupon of 8 per cent annually. The next coupon is due in one year and the bond will be redeemed in eight years time. If the rate of interest is currently 15 per cent, what will b e the market price of this bond?

A 35.90

B 68.59

C 86.96

D 135.90

*Q 15. Which of the following factors is not significant when deciding whether to borrow short-term or long-term?

A The predicted availability of finance in the future.

B The yield curve

C The maturity structure of current debt

D The availability of collateral

*Q 16. A firm is considering a proposal to offer a cash discount of 2 per cent to customers if they settle the amounts owing within 10 days. All sales offer 30 days credit currently. What is the annualised compounded cost of a customer forgoing this cash discount?

A 24.83 per cent

B 36.5 per cent

C 37.23 per cent

D 44.6 per cent

*Q 17. Which factors determine the terms of trade credit offered to customers?

A Relative bargaining strength of the customer and supplier.

B The type of product being bought and sold.

C Tradition of the industry.

D All of these.

*Q 18. The Miller-Orr cash model assumes that short-term cash movements cannot be predicted since they change in a random fashion. This means that the following tactics should be used to manage the cash resources of an organisation:

A If the daily variation in cash balances is large, then the control limits should be set far apart.

B If the cost of buying and selling securities is high, then the control limits should be set far apart.

C If the rate of interest is high, the control limits should be set close together.

D All these factors should be considered.

*Q 19. Cash flow forecasts will be affected adversely by which one of the following?

A A reduction in the operating profit as a result of increased rates of depreciation being charged on the firm's plant and machinery.

B A change in purchasing policy so that all cash discounts are now taken and this has reduced the creditors in the balance-sheet.

C A subsidiary has been sold at a substantial loss.

D The working capital cycle has been reduced.

*Q 20. Which one of the following best describes the term `coupon rate' as applied to a debenture?

A The annual interest received on the face value of the units of the debenture.

B The annual interest received divided by the current ex-interest market price of the debenture.

C The rate of return required by an investor from the debenture.

D The total rate of return on a debenture, taking into account capital repayment and interest payments.

*Q 21. The difference between the cost of equity using the dividend growth model and the cost of equity using the CAPM is attributable to which one of the following causes?

A The CAPM calculates return as future share price changes as well as dividend, whereas the dividend growth model allows for expected future dividends only.

B The CAPM allows for a premium for financial risk, which the dividend growth model does not.

C The CAPM allows for a premium for business risk, which the dividend growth model does not.

D The CAPM valuation of the cost of equity is based on expected return, rather than actual returns in any year.

*Q 22. The directors of JC plc are considering raising funds by way of a deep discounted rights issue. Which of the following statements about a deep discounted rights issue is incorrect?

A Earnings per share will increase as a result.

B It will avoid JC plc having to pay underwriting costs.

C JC plc is in financial difficulty.

D There is likely to be a dilution in the ex-rights share price.

*Q 23. LM Ltd is a privately owned trading company. During the year to December 31, 20x8 LM Ltd received 850,000 from debtors, and paid 325,000 to suppliers. Purchases for the three months to the end of December 2Ox7 were 90,000; sales for that period we re 150,000. Purchases for the three months ended December 20x8 were 80,000; sales for that period were 120,000. LM Ltd typically takes 90 days to pay for goods supplied, and allows 90 days credit to customers. Production is scheduled evenly throughout th e year. Stocks increased by 75,000 during the year. The gross profit for the year was:

A 600,000

B 580,000

C 505,000

D 525,000

*Q 24. A participating preference share is a preference share which:

A Has the right to he converted into ordinary shares at some future date.

B Carries forward the right to preferential dividends, if unpaid, from one year to the next.

C Entitles the shareholder to a share of residual profits.

D Entitles the shareholder to a fixed rate of dividend.

*Q 25. Bonds that are issued by a company at a large discount to their eventual redemption value, but on which no interest is paid until redemption, are called:

A Deep discount bonds

B Zero coupon bonds

C Equity bonds

D Floating rate bonds.

Solutions to the multiple choice questions

S 1. -- A: It is not possible to predict the share prices perfectly. Efficient markets mean that the current market prices reflect fully the information that is available.

S 2. -- C: These are the 3 E's that are used widely to measure the performance of non-profit organisations.

S 3. -- B: The importance of institutional investors relative to the total number of investors has resulted in a significant decrease in the proportion of shares held by individuals.

S 4. -- D: Treasury management is concerned with the areas of liquidity, sources of funds, risk management and also the management of working capital.

S 5. -- D: Market makers and brokers are important elements in quote-driven sock market trading systems.

S 6. -- B: Operating leases commit the lessee to a short-term contract and it is not expected that the lease will remain in force for the whole life of the asset.

S 7. -- D: r = rf +a (rm - rf)

= 8 + (1.4 x 10) = 22%

S 8. -- A: Systematic risk remains even in a diversified portfolio of shares.

S 9. -- B: This is a factor that often makes borrowing cheaper than equity when determining the company's cost of capital. Interest is treated as an expense by most tax authorities but dividends are not.

S 10. -- B: Using book values

Equity (10m + 20m) = 30m = 66.67% at 20%

Debt 15m = 33.33% at 7% after tax

WACC = (66.67% x 20%) + (33.30% x 7%) = 16.6%

Using market values

Equity = 20m shares x 4.50 = 90m

Debt= 15m

= 105m

WACC = (20% x 90/105) + 7% x 15/105) = 18.1%

S 11. -- B: Quarterly rate = 2%

Annuity factor over 40 periods is 27.3555

Quarterly investment required = 18,164/27.3555 = 664

S 12. -- A: Present value of a perpetuity = 2,000/0.16 = 12,500

S 13. -- D: All these hypotheses are relevant.

S 14. -- B: Total value = Value of coupon + Terminal value of bond = (8 x 4.4873) + (100 x 0.3269)

= 35.90 + 32.69

= 68.59

S 15. -- D: Collateral provides security to the lender but is not relevant to the short or long-term requirements of the borrower.

S 16. -- D: Using compound interest formula:

V = X(1 + r)|

100 = 98(1 + r)365/20

1.0204 = (1 + r)365/20

1 + r = 1.446

Cost of discount = 44.6%

S 17 -- D: All these factors are relevant to the credit offered by sellers.

S 18. -- D: All three propositions are correct.

S 19. -- B: Setting the amounts owed to

creditors earlier will reduce the cash balance sooner and so will affect the cash forecasts.

S 20. -- A: The coupon rate is the annual interest received on the face value of the debenture.

S 21. -- C: The difference between the two approaches is that CAPM allows for a premium for business risk which the dividend growth model does not.

S 22. A: A deep discounted rights issue should avoid the need for underwriting. There is likely to be a dilution in the ex-rights share price as additional shares have been issued at a discount to the pre-rights shares price. A deep discounted rights iss ue does not necessarily indicate that the company is in financial difficulty.

S 23. -- B:

Closing debtors 120,000

Cash received 850,000

Opening debtors (150,000)

---------

Sales 820,000

=========

Closing creditors 80,000

Cash paid 325,000

Opening creditors (90,000)

--------

Purchases 315,000

=======

Sales 820,000

Cost of sales (315,000-

75,000)= 240,000

-------

Gross profit 580,000

=======

S 24. -- C: A participating preference share entitles the shareholder to a share of residual profits.

S 25. -- B: Bonds on which no interest is payable are called zero coupon bonds.

(Source: CIMA Study System Intermediate Level, courtesy Viva Books Private Limited, New Delhi.)