Finance 1- 2012

Seat No:

I I I

(Do NOT write your name anywhere on this exam booklet)

THE UNIVERSITY OF MELBOURNE EXAMINATION - SEMESTER TWO 2012

FACULTY OF ECONOMICS AND COMMERCE

SUBJECT NUMBER: FNCE10001 SUBJECT NAME: FINANCE I COMMON CONTENT: NONE EXAM DURATION: 2 HOURS READING TIME: 15 MINUTES TOTAL MARKS: 100 NO. OF PAGES: 17 (including cover page, blank pages, and formula page) AUTHORIZED MATERIALS 1. This is a CLOSED BOOK exam. Students are NOT permitted to have any materials in their possession. 2. Non-programmable calculators are permitted. Calculators with the ability to enter and/or retrieve text are NOT permitted. 3. Students are NOT permitted to use a foreign language dictionary. INSTRUCTIONS TO INVIGILATORS 1. Students should be provided ONLY with this booklet. 2. Students are to write answers ONLY in the spaces provided in this booklet. 3. Writing is NOT permitted during reading time. 4. This booklet must be COLLECTED at the end of the exam. INSTRUCTIONS TO STUDENTS 1. Write ONLY your seat number and student number in the boxes at the top of this cover page. 2. Do NOT detach any pages (EXCLUDING the attached formula pages) from this booklet. Exams with missing pages will NOT be marked. 3. The following is required: Total Questions Total Marks Required 10100 Attempt ALL questions 4. All questions are worth 10 marks. 5. Writing is NOT permitted during reading time. 6. Answers must ONLY be written on Question pages in this booklet. All other writing will NOT be marked. 7. For full credit show ALL your calculations including formulas used. BAILLIEU LIBRARY 1. This paper may be lodged with the library.

E U 0 I xammers se my Question 1 2 3 4 5 6 7 8 9 10 Number

Maximum 8 6 10 10 16 6 12 6 6 4 Marks Marks

Received

1

11 12 Total

4 12 100

Finance 1 - 2012

Question 1 (6 + 2 = 8 marks) a) (6 marks) Suppose that one month ago your firm entered into a 1:4 FRA with Westpac Bank at an agreed rate of 4.5% p.a. on principal of $1 million. Today the 90-day interest rate is 5% p.a. Which party makes the payment? What is value of the payment?

b) (2 marks) For the past twenty years, Japan has had reliably lower interest rates than Australia. Briefly explain why an Australian firm might not want to borrow from Japanese debt markets.

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Finance 1- 2012

Question 2 (6 marks) As a promotion to entice you to buy their cars, Toyota is offering 0% p.a. financing for 60 months. Honda is offering 4% p.a. financing for 60 months. You are choosing between a $30,000 Toyota and a $28,000 Honda. For either car, you would make 60 monthly repayments (like a five-year mortgage) with no down payment.

In terms of your monthly payments, which car is cheaper? (Hint: use the annuity formula)

Question 3 (2 + 2 + 2 + 4 = 10 marks) a) (2 marks) Suppose you have two bonds with identical face values, coupon rates, and maturities. Will they always have the same yield? Why or why not?

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Finance 1 - 2012

b) (2 marks) What does it mean to say there is "price risk" with an investment in a series of short-term debt securities?

c) (2 marks) When a bond's real yield turns out to be less than zero, would an investor have been better off holding cash rather than the bond? Why or why not?

d) (4 marks) What is the price of a bond maturing in exactly two years paying coupons of 6% p.a. if the yield is currently 4% p.a. and the face value is $100?

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Finance 1 - 2012

Question 4 (5 + 5 = 10 marks)

a) (5 marks) Fill in the following table:

Commodity

AUD USD fPY

AUD 1.0262 C')

E USD 78.17 ~

~

fPY

b) (5 marks) Calculate the 90-day forward points for the Australian dollar (AUD) in terms of the Great Britain Pound (GBP) given a spot rate AUD/GBP 0.7 and 90-day interest rates of 2% p.a. in England and 4% p.a. in Australia. England uses a 360-day count convention while Australia uses a 365-day count convention.

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Finance 1 - 2012

Question 5 (5 + 5 + 6 = 16 marks) a) (5 marks) Apple currently trades at a price of $661.31 on earnings per share of $42.55 over the past year. Facebook currently trades at a price of $22.27 on earnings per share of $0.29 over the past year.

e Why are their pie ratios different? e If Facebook traded at the same pie ratio as Apple, what would its price

be?

b) (5 marks) National Australia Bank (NAB) has just paid its annual dividend of $2.50 per share. Its stock is currently trading at $30. Dividend growth at NAB is 3% per annum. The discount rate, adjusted for NAB's risk, is 12% per annum. Based on Gordon's Growth Model, should you be buying/selling NAB shares?

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Finance 1 - 2012

c) (6 marks) Spectrum Group International recently announced a 1-for-1.4 rights issue at a subscription price of $1.90 per new share. Just before the ex-rights date, Spectrum shares traded at a cum-rights price of $2. Calculate the ex-rights price of Spectrum shares and the value of the rights on the ex-rights date.

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Finance 1- 2012

Question #6 (3 + 3 = 6 marks) a) (3 marks) Explain how bank accepted bills are issued. Name all the parties to the transaction(s), and how each party benefits from the transaction(s).

b) (3 marks) What risks are involved for each party?

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Finance 1 - 2012

Question #7 (6 + 6 = 12 marks) Your company needs to raise money for some short-term investments. You decide a bill facility is the best means of raising funds. You want to raise $25,000,000 with 90-day notes over a 1 year period starting January 1st. At the rollover dates, you want to use cash to settle the difference between the amount you owe and the proceeds from issuing another $25,000,000 bill. a) (6 marks) What are your cash outflows and inflows at issuance, each rollover date, and year end, if interest rates and bank fees are as follows? Assume 365 days in a year. January: Interest rate - 5.5%, bank fee - 1% April: Interest rate - 6.5%, bank fee - 1% July: Interest rate - 4%, bank fee - .5% October: Interest rate - 2.5%, bank fee - .5%

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Finance 1 - 2012

b) (6 marks) How much does the bank make in fees (in dollars) from each issuance?

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Finance 1 - 2012

Question #8 (3 + 3 = 6 marks) a) (3 marks) A friend recommended that you buy a stock because "the price keeps going up". Using the efficient market hypothesis, explain why you would (or would not) follow your friend's advice.

b) (3 marks) Your friend comes back to you and says that she knows from a corporate insider that the stock will go up after a merger announcement next week. What would the different forms of market efficiency say about your ability to profit from this information?

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Finance 1 - 2012

Question #9 (3 + 3 = 6 marks) a) (3 marks) Standard and Poor's recently downgraded Spain's credit rating from BBB+ to BBB-. How does this impact the country's ability to raise money through debt?

b) (3 marks) Imagine Spain gets downgraded by two more grades to BB. Aside from just dropping two grades, what special considerations would Spain face with a rating of BB?

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Finance 1 - 2012

Question #10 (4 marks) Identify and explain a potential conflict of interest that ratings agencies face. Be sure to describe all the parties involved and the incentives the ratings agencies face.

Question #11 (4 marks) Name three ways in which primary market participants benefit from the existence of secondary markets. Use complete sentences, and be specific!

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Finance 1 - 2012

Question #12 (4 + 4 + 4 = 12 marks) a) (4 marks) Today, you are thinking of buying stock in a firm that pays a quarterly dividend of $2. The trading price of the stock is $35. The CEO has announced that in one year (after four quarterly dividend payments) the firm will cut dividends to $1 for a period of 6 months to meet the firm's cash needs. After the 6 months of reduced dividends, the dividends will start growing at a rate of 1.5% per quarter. How much will the stock's dividend be six years after it starts growing?

b) (4 marks) How much are you willing to pay for this stock today if your discount rate (cost of equity) is 9% p.a.? Assume the stock's value is based entirely off of dividend payments. .

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Finance 1 - 2012

c) (4 marks) Would you buy this stock? Explain your answer.

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Finance 1 - 2012

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Finance 1 - 2012

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