Finance 1 Question

[MelonBar]

From the 2012 Semester 1 paper:

1. a)

Consider someone offers you $100 in a year's time or an equivalent cash amount today. Roughly, how much money is equivalent to $100 in a year? Explain your reasoning.

This kind of question has come up a few times, can someone point me in the right direction? It looks really simple, but I'm not sure lol

Cheers

[Greatness]

State your assumptions. I would assume an interest rate of 10% p.a. (no particular reason, a pretty easy number to use)
You're comparing $100 today to the discounted value of $100 in 1 years time. So discount the $100. Depending on how many marks it's worth you can probably do a calc with both simple and compound interest - state which one you use. To explain why $100 today is worth more than the discounted value of $100 discuss the notion of time value of money.
How many marks is this worth?

[gummo]

Also a Finance 1 question:

I still don't get what face value means. Is it like a lump sum paid at the end of the loan (no interest rate on the lump sum) or is it like the principal value? Can someone explain?

[MelonBar]

Also a Finance 1 question:

I still don't get what face value means. Is it like a lump sum paid at the end of the loan (no interest rate on the lump sum) or is it like the principal value? Can someone explain?

Sorry I can't help you all I've been doing is blindly inputting values into the formulas without really understanding anything. And well, it hasn't exactly failed me so far lol


I have another exam question.... 2012 9. a)

The Australian dollar in terms of Hong Kong dollars (AUD/HKD) spot exchange rate is currently 8.0287. The 6-month Australian interest rate is 4.25% per annum, while the 6-month Hong Kong interest rate is 0.50% per annum. What is the 6-month AUD/HKD forward exchange rate? Hong Kong and Australia use a 365-day year convention.

Carefully describe the arbitrage that will happen if, overnight, Hong Kong's 6-month interest rates increase to 1.00% per annum while forward rates are still the same as under question 9(a)?

What in the world is arbitrage and how can I calculate it? I swear this isn't on the lecture slides or it is under a different name


EDIT: I forgot to say thank you Greatness! It's a 5 mark question so it's worth it go a bit into detail!

[Watermelon]

Also a Finance 1 question:

I still don't get what face value means. Is it like a lump sum paid at the end of the loan (no interest rate on the lump sum) or is it like the principal value? Can someone explain?

To remember it simply..
Think of the bond equation..

P=(C/r)[1-1/(1+r)^n]+F/(1+r)^n

F is the face (or par) value. It is some payment made at maturity date.
If the bond was a zero coupon bond. And did not pay coupons. C=0. You could see F as just the future value.

Sorry I can't help you all I've been doing is blindly inputting values into the formulas without really understanding anything. And well, it hasn't exactly failed me so far lol


I have another exam question.... 2012 9. a)

The Australian dollar in terms of Hong Kong dollars (AUD/HKD) spot exchange rate is currently 8.0287. The 6-month Australian interest rate is 4.25% per annum, while the 6-month Hong Kong interest rate is 0.50% per annum. What is the 6-month AUD/HKD forward exchange rate? Hong Kong and Australia use a 365-day year convention.

Carefully describe the arbitrage that will happen if, overnight, Hong Kong's 6-month interest rates increase to 1.00% per annum while forward rates are still the same as under question 9(a)?

What in the world is arbitrage and how can I calculate it? I swear this isn't on the lecture slides or it is under a different name


EDIT: I forgot to say thank you Greatness! It's a 5 mark question so it's worth it go a bit into detail!

Arbitrage is simply trying to make a risk free profit. That's a very pooor explanation. but yeah.

9a)
At spot price
1 AUD = 8.0287 HKD

Interest rate at AUD is 0.0425 p.a at 6 months. and HKD is 0.005 p.a at 6 months.

So you expect in 6 months..

1(1+0.0425(1/2)) AUD = 8.0287(1+0.005(1/2)) HKD
1 AUD = 7.88 HKD

AUD/HKD = 7.88 in 6 months.

^ Can somebody check. Very rusty on this.
9b
If HKD interset rate increase to 1% p.a. You can make a 'risk-free' profit assuming forward exchange rate doesn't change.

If this is the future exchange rate. Lock it in for 6 months at AUD/HKD=7.88
Borrow 1000 AUD at 0.0425.
Convert to HKD at spot. 8028.7 HKD and invest at their 6 month 1%.

In six months you get 8068.8435 HKD.
Using your locked in AUD/HKD of 7.88.. convert back to AUD. You'll get 1023.96 AUD.
Since you borrowed at 6 month 0.0425. Pay off your owed interest of 21.25 at 6 months.

Notice that you made $2.71 at the end of it all.
If you used millions instead of 1000s. That's a lot of money.

I haven' done this kind of finance in awhile. So i might hae made numerical mistakes.
But that's just the idea of it. Making exchanges here and there based on mis-pricings to try and make a profit. Which they call 'risk free' or arbitrage.

[gummo]

Thank you, Watermelon (lol)!!!!!

[vcestudent94]

Which P do you use, $0.61 or $0.65?

Australia's largest steelmaker, BlueScope Steel, on Tuesday announced a $600
million capital raising, at $0.40 per share subscription price. The fully
underwritten, 4-for-5 entitlement offer will strengthen the balance sheet and
proceeds will go to repaying debt, the company said. Shares in the company
closed at $0.61 per share yesterday before going into a trading halt today.
On the night before the ex rights date, the BlueScope share price was $0.65. What
is the expected opening price ex rights the next morning? What is the value of the
rights that morning?

[MelonBar]

Watermelon is a bloody rippa legend. Cheers !

[vcestudent94]

Can someone please help with this question:

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. .


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


Thanks

[Watermelon]

Can someone please help with this question:

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. .


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


Thanks

a)
It starts growing at 1.5% per quarter after the 6 months after the 1 year.
But it is only asking how much it will be 6 years after it starts growing.
By compounding:
F=Div*(1+0.015/4)^(4*6)

b)
Remember that the stock price is the net present value of all anticipated future dividend cash flows.

You get $2 each quarter for first year.
You get $1 for two quarters after.
Discount each of these dividends to present value.
Then you get a $1 afterwards growing at 1.5% per quarter.
Remember that you can calculate these future income streams by constant dividend growth model, P=D1/(Ke-g)
Remember that you then have to further discount this PV to the original time.
Sum all these present values together for stock price.

c) If your calculated stock price is above or below $35. Say it that currently, stock is either under or over priced. And state what purchasing or selling decision you would make of that.

There is a lot of calculations in this problem so I think it was neater just to list out key steps.
Isn’t Finance 1 exam tomorrow? :-)
Good luck!

[vcestudent94]

yes its tomorrow Thanks so much for the thorough explanations! Can you give me your final answer to b) to make sure I do the calculations right?