Practice Questions for Final Exam

Question 1
How much could you borrow from the bank using a 25-year fully amortising home loan at an interest
rate of 3.8% pa compounding monthly if you can afford to make monthly payments of $4,000?
Assume a constant interest rate. The amount that you could borrow now is:
(a) $917,710.70
(b) $523,562.99
(c) $750,000.00
(d) $900,000.00
(e) *773,909.11

Question 2
The yield to maturity of a bond is the discount rate that makes the present value of the coupon and
principal payments
(a) exceed the price of the bond.
(b) equal to zero.
(c) *equal to the price of the bond.
(d) less than the price of the bond.
(e) None of the listed answers

Question 3
You are considering investing $1000 in a complete portfolio. The complete portfolio is composed of
Treasury notes that pay 5% and a risky portfolio, P, constructed with two risky securities X and Y. The
optimal weights of X and Y in P are 60% and 40% respectively. X has an expected rate of return of
14% and Y has an expected rate of return of 10%. If you decide to hold 25% of your complete portfolio
in the risky portfolio and 75% in the Treasury notes then calculate the dollar values of your positions in
X and Y respectively?
(a) 250 and 950
(b) 640 and 350
(c) *150 and 100
(d) 250 and 150
(e) 263 and 350
Question 4
Which of the following statements about Capital Asset Pricing Model (CAPM) theory is NOT
correct? (S1, 2019)
(a) The market portfolio M has systematic risk only. It’s a fully diversified portfolio comprised of all
individual risky assets. The market portfolio is usually assumed to be the equity index, such as the
ASX200 in Australia or the S&P500 in the US.
(b) The risk free security has no risk at all. Government bonds are usually assumed to be the risk-free
security.
(c) *Portfolio combinations of the market portfolio and risk free security will not plot on the CML and
will have systematic risk only. They will have no diversifiable risk.
(d) The portfolios on the CML with a return above risk free have maximum return for any given level
of risk.
(e) The individual assets and portfolios with returns less than the risk free rate are overpriced, have a
negative Jensen’s alpha, positive beta and should be sold.

Question 5
The saying "A dollar saved is two dollars earned" would be more fully explained if it said:

(a) A dollar of after-tax income saved is equivalent to the first two dollars of pre-tax income earned if
your average tax rate is 50%.

(b) A dollar of pre-tax income saved is equivalent to the first two dollars of pre-tax income earned if
your average tax rate is 50%.

(c) A dollar of after-tax income saved is equivalent to an additional two dollars of after-tax income
earned if your average tax rate is 50%.

(d) A dollar of pre-tax income saved is equivalent to an additional two dollars of pre-tax income
earned if your marginal tax rate is 50%.

(e) *A dollar of after-tax income saved is equivalent to an additional two dollars of pre-tax income
earned if your marginal tax rate is 50%.
Question 6
Which of the following statements about a firm’s debt and equity is NOT correct?

(a) Debt assets such as bonds and loans are lower risk investments than shares.

(b) *Bonds and loans usually have higher expected returns than shares because they have first claim
on the firm’s assets.

(c) Firms' past realised debt returns are usually lower than their past realised share returns.

(d) In the event of bankruptcy, debt holders are paid in full before equity holders are paid anything.

(e) If a firm makes very high profits and cash flows, the debt holders are still only paid the interest
and principal payments that they’re promised and no more. For this reason, returns on debt have a
maximum.

Question 7
Assume a company is funded by both equity and debt. Company is funded by $100m worth of 3 years
bond priced at par and pay fixed coupon of 8%p.a. Company has 2 million shares with a market value
of $75 each. The shares’ expected dividend yield is 5% pa and total required return is 15% pa. Find
the pre-tax WACC?

(a) 0.450
(b) 0.153
(c) 0.705
(d) 0.881
(e) *0.122
Question 8
Assume a company market capitalisation is 200mm and its overall no of shares is 10million. The
company just paid a $2 dividend for ordinary shares and dividend is expected to grow at a rate of 3%
into the foreseeable future. Find the cost of equity capital of ABC?
(a) 15.55%
(b) 10.92 %
(c) *13.30%
(d) 18.68%
(e) 19.70%

Question 9
ANZ Insurance Ltd. issued a fixed-rate perpetual preference share 5 years ago and placed it privately
with institutional investors. The share was issued at $50.00 per share with a $2.85 dividend. If the
company were to issue preference shares today, the yield would be 4.65 per cent. The share’s current
value is
(a) $25.55
(b) $26.92
(c) *$61.30
(d) $40.18
(e) $56.20

Question 10
The cash flow for year 0 1 and 2 is -$1000, 0 and $1360? What is the internal rate of return if all
answers are given as effective annual rate?
(a) *16.62%
(b) 10.50%
(c) 15.65%
(d) 12.35%
(e) 11.78%
Short answer questions
Question 1
Explain how the imputation tax system varies from classical tax system? Using a table show an
example to demonstrated your reasoning. (5 marks)

Under the classical tax system the tax was imposed both at the company level and at the individual
level (shareholders) so there was double taxation. However imputation tax system erodes double
taxation where the company pays tax and the shareholders also pay tax based on their personal tax
rate but they receive tax paid by company in the form of franking credit or tax credit or dividend
imputation credit. The additional personal tax payable is computed as:

D (t/1-tc)*(tp-tc)

Show using a table – you my get some idea from the example on slide 30 to 31 in lecture 1or page
(586) in text use your own example using different no. not the same as the textbook or lecture
slides.

Question 2
Currently the term structure is as follows: one-year bonds yield 7%, two-year bonds yield 8% three-
year bonds and greater maturity bonds all yield 9%. You are choosing between one-two- and three-
year maturity bonds all paying annual coupons of 8%, once a year. Which bond should you buy if you
strongly believe that at year end the yield curve will be flat.

Solution:
You should buy the three-year bond because it will offer a 9% holding period return over the next
year, which is greater than the return on either of the other bonds, as shown below:
Maturity One year Two years Three years
YTM at beginning of year 7.00% 8.00% 9.00%
Beginning of year price $1,009.35 $1,000.00 $974.69
End of year price (at 9% YTM) $1,000.00 $990.83 $982.41
Capital gain −$ 9.35 −$ 9.17 $7.72
Coupon $80.00 $80.00 $80.00
One year total $ return $70.65 $70.83 $87.72
One year total rate of return 7.00% 7.08% 9.00%