TERM 2 AY2010-11 Mid-Term Test 5th Mar 2011

Student Name: _______________________________________________ Student ID: _________________________________________________

FNCE102
FINANCIAL INSTRUMENTS, INSTITUTIONS AND MARKETS

INSTRUCTIONS TO CANDIDATES

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The time allowed for this test paper is 2 hours. This test paper contains 1 section with 20 MCQ questions of 2 marks each (except Qn 1 & Qn 2 of 6 marks each). Please select an option from A to E and write it in the [ ____________ ]. There are a total of Nine (9) pages including this instruction sheet.

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Question 1 Nice Plants Ltd is a young company with a very aggressive growth plan. The next 3 years is expected to be market penetrating with dividends to grow at a rate of 15% pa. In the 4th year, growth of dividends will slow to 13% pa. After that, a constant growth rate of 8% pa is expected. What is this companys stock price today if the required rate of return is 12% pa? Assume that the amount of dividends just paid is the same as that for a zero growth stock of another company with an expected return of 7.5% pa and price today of $200.

A) $125.20 B) $506.18 C) $674.90 D) $861.80 E) $1,219.90 Solution: B

[ ____________ ]

Expected rate of return (zero growth stock) = Dividend / Stock Price = $15/$200 = 7.5% Step 1: Calculate the sum of the PVs of the dividends in the supernormal growth period. D0 = $15 D1 = $15 (1.15) = $17.25 2 D2 = $15 (1.15) = $19.8375 D3 = $15 (1.15)3 = $22.8131 D4 = $15 (1.15)3 (1.13) = 25.7788 D5 = $15 (1.15)3 (1.13) (1.08) = 27.8411

PVD1 = $15.4018 PVD2 = $15.8143 PVD3 = $16.2379 PVD4 = $16.3829

Step 2: Find the PV of the constant growth stock price at the end of Year 4. P4 = D5 / (r g) = 27.8411 / (12% - 8%) = $696.0275 At time 0: PVP4 = $442.3381 Step 3: Sum of all PVs = PV (D1, D2, D3, D4, P4) = $506.175

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Question 2 Fishy Pond Company issued 3 year bonds with face value of $2,000. It pays coupons on a semiannual basis at 10% pa. 1-year interest rates for the next 3 years are expected to be 5% pa, 3% pa, and 4% pa, and the 2-yr & 3-yr liquidity premiums are 2% pa & 3% pa respectively. Calculate the duration of Fishy Pond Companys bonds. Assume: (i) the required rate of return on Fishy Pond Companys bonds is the 3-year long-term bond rate (ii) investors are indifferent about bonds with different maturities

A) 0.55 years B) 0.96 years C) 1.25 years D) 1.85 years E) 2.69 years Solution: E Average of ST i/r for Yrs 1,2,3 (Expectations theory) = (5% + 3% + 4%)/3} = 4% = required rate of return pa Coupon per period = 10%/2 x $2,000 = $100 Cashflow No. 1 2 3 4 5 6 Time 0.5 1.0 1.5 2.0 2.5 3.0 Cashflow Amt 100 100 100 100 100 2,100 PVCF ($) 98.04 96.12 94.23 92.38 90.57 1,864.74 Total = 2,336.09

[ ____________ ]

PVCF x t 49.02 96.12 141.35 184.77 226.43 5,594.22 Total = 6,291.91

Duration = 6,291.91 / 2,336.09 = 2.69 years

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Question 3 A Financial Institution is going to liquidate some of its assets (listed below) at short notice. The sale values are listed in the table below. Calculate the 1 year liquidity index for these assets.

Asset Stock A Bond B Loan C Fixed asset D

Face Value ($) 25 million 25 million 60 million 20 million

1 year sale value ($) 30 million 35 million 65 million 30 million

Current sale value ($) 20 million 22 million 45 million 15 million

A) 0.15 B) 0.65 C) 0.89 D) 1.57 E) 1.92 Solution: B Liquidity Index = (25/130)(20/30) + (25/130)(22/35) + (60/130)(45/65) + (20/130)(15/30) = 0.6455

Question 4 Which of the following is true? A) Singapore corporate bonds are actively traded in the secondary market. B) SGS are issued in Singapore primarily to finance a budget deficit. C) All SGS applications must be submitted through any of the approved SGS primary dealers. D) SGS Treasury bills are quoted as premiums on top of par value. E) SGS Treasury bills have coupons. Solution: C The rest are false because: A) Singapore corporate bonds are inactively traded in the secondary market. B) SGS are issued in Singapore not primarily to finance a budget deficit. D) SGS Treasury bills are quoted as discounts from par value. E) SGS Treasury bills are zero coupon.

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Question 5 Figure (a) Figure (b)

Which of the following is true? A) A reversal pattern is shown in Figure (a). B) Figure (b) shows a head and shoulders which is a continuous pattern. C) Figure (a) shows a bear flag. D) Figure (b) shows a wedge continuous pattern. E) An inverted head and shoulders is shown in Figure (b). Solution: C The rest are false because: A) Figure (a) is a continuous pattern. B) Figure (b) shows a head and shoulders reversal pattern. D) There is no wedge pattern here. E) There is no inverted head and shoulders pattern here. Question 6 Which of the following is not an example of an Undertaking commonly found in Corporate Loan Agreements? A) No material adverse change in principal business B) Negative pledge C) Non-disposal of core assets D) Gearing ratio must not be less than 2 times E) None of the above. Solution: D

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Question 7 i) A bond pays $10,000 annually for 5 years (in arrears) from today at an interest rate of 6% compounded annually. ii) A bond pays $10,000 quarterly for 5 years (upfront) from today at an interest rate of 6% compounded quarterly.

Calculate the Present values of the above securities.

A) $1,223.64, $12,789.90 B) $42,123.64, $174,261.68 C) $2,123.64, $54,261.68 D) $100,123.64, $2,269.80 E) $69,562.64, $897,261.68

[ ____________ ]

Solution: B i) ii) PV = $10,000 (PVIFA 6%, 5) = $42,123.64 PV = $10,000 (PVIFA 1.5%, 20) (1+6%/4) = $174,261.68

Use this paragraph for Questions 8 & 9 & 10

On 1 June 1998, True Star Company sold $250 million of convertible bonds. The bonds had a 20year maturity, a 4.75% pa coupon rate, and a $1,100 par value. The conversion price was set at $67.25. The bonds were given a Triple A rating; straight nonconvertible debentures of Triple A rating and Triple B rating yielded about 8.55% p.a. and 9.25% p.a. respectively at that time. Question 8 Calculate the conversion value today (5 Mar 2011) if newspapers report current stock price at $35.25. A) $178.90 B) $237.05 C) $322.69 D) $576.69 E) $999.89

[ ____________ ]

Question 9

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Calculate the straight bond value on 1 December 2011. A) $80.90 B) $291.65 C) $317.30 D) $689.95 E) $897.94 [ ____________ ] Question 10 Calculate the floor value of the bond on 1 December 2011. A) $18.90 B) $291.65 C) $897.94 D) $997.95 E) None of the above.

[ ____________ ]

Solution: (D) & (E) & (E) i) Conversion value = Conversion Ratio x prevailing stock price = ($1,100/$67.25) x $35.25 = 16.36 x $35.25 = $576.69 ii) Maturity = 1998 + 20 = 2018 No. of Years remaining to maturity = 2018 2011.5 = 6.5 years Straight bond value = Coupon (PVIFA 8.55%, 6.5) + $1,100 (PVIF 8.55%, 6.5) Coupon payment = 4.75% x $1,100 = $52.25 Straight bond value = Coupon (PVIFA 8.55%, 6.5) + $1,100 (PVIF 8.55%, 6.5) = $897.94 iii) Not enough information to find Floor Value of Bond. Need prevailing stock price on 1 Dec 2011.

Question 11 Which of the following is described as direct finance? A) You borrow $200,000 from your grandfather. B) You buy bonds of Company A through a securities firm. C) You invest in a unit trust. D) You set up a credit line with a finance company. E) You take out a mortgage loan from your local bank.

Solution: A

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Question 12 Which are characteristics of Money market instruments? (i) High default risk (ii) Small denominations (iii) High transaction costs (iv) Liquid

A) i, ii only B) i, iii only C) iii only D) iv only E) All (i) to (iv) Solution: D Question 13 The major types of Money market instruments traded in Singapore include:

(i) Treasury Bills (ii) Negotiable certificates of deposits (iii) Stocks (iv) Bills of exchange (v) LT convertible bonds A) i, ii only B) i, ii, iii, iv only C) i, ii, iv only D) i, ii, iv, v only E) All the instruments listed. Solution: C Stocks & LT convertible bond are LT instruments. Question 14 Which of the following is true? A) Shares on the Main Board of SGX have high price volatility because they are all of small companies in the electronics sector. B) Trading in any quantity less than 1 board lot is called odd lot trading. C) SESDAQ was set up to help companies with paid-up capital of at least S$15mil list shares. D) In Singapore, all share transactions must be conducted with physical share certificates. E) Share price indices such as The Straits Times Index comprises a fixed composition of companies which cannot be changed. [ ____________ ]

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Solution: B The rest are false because: (A) Shares on SESDAQ of SGX have high price volatility because they are of small companies in the electronics sector. (C) Companies on Main Board have a paid-up capital of at least S$15mil. (D) Trading in Singapore is scripless. (E) Share price indices such as The Straits Times Index is a good market indicator because it represents different performing industries in the economy. The composition of companies can change and are not fixed. Question 15 Which of the following can complete the following sentence? Liquidity risk exposure _________________ . (i) May lead to insolvency problems. (ii) Is the risk of having insufficient cash on hand for a bank to meet deposit withdrawals & loan demand. (iii) Is the risk of obtaining additional borrowings at low cost. (iv) Can be measured by ratio comparisons. A) i, ii only B) i, ii, iii only C) i, iii only D) i, ii, iv only E) All (i) to (iv) Solution: D (iii) is incorrect because: (iii) Is the risk of obtaining additional borrowings at high cost.

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Use this paragraph for Questions 16 & 17

Original Juice Ltd paid dividends of $5 recently. Today its stock price is $85 and dividends are expected to grow at a constant rate of g. (Assume required rate of return is 10%).

Question 16 What is the dividend yield 3 years from now?

A) 1.80% B) 3.80% C) 5.80% D) 6.11% E) 10.05% Solution: D P0 = D1 / (r g) = [D0 (1 + g)] / (r g) $85 = [$5 (1 + g)] / (10% - g) g = 3.89% Div yield (t3) = D3 / P2 = [D0 (1+g)3] / P2 = 6.11% P2 = D3 / (r g) = [D0 (1+g)3] / (10% - 3.89%) = $91.76 Question 17 What is the capital gains yield 5 years from now? A) 1.89% B) 3.89% C) 5.15% D) 8.35% E) 9.54% Solution: B P0 = D1 / (r g) = [D0 (1 + g)] / (r g) $85 = [$5 (1 + g)] / (10% - g) g = 3.89%

[ ____________ ]

[ ____________ ]

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Question 18 Which of the following is false regarding the revamp of SGXs listing rules? A) The value proposition for the sponsors is that they now have the mandate to admit companies. B) SESDAQ is a sponsor-supervised board. C) A Continuing Sponsor only engages in Continuing Activities. D) A prospectus is not required for Catalist listings. E) The Main Boards focus will be both Size and Quality. [ ____________ ] Solution: B Catalist is a sponsor-supervised board. Question 19 Calculate the duration for the following bond: Term = 2 years Par value = $1,000 YTM = 8% pa Bonds 2nd cashflow = $1,060 Assume bond only has 2 cashflows.

A) 1.563 years B) 1.678 years C) 1.942 years D) 1.709 years E) 1.999 years Solution: C

Time t 1 2 Total

CFt 60 1, 060

PV of CFt 55.56 908.78 964.33

(PV of CFt) x t 55.56 1,817.56 1,873.12

Duration = 1,873.12 / 964.33 = 1.942 years

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Question 20 Table (a): T-bill rates Maturity Mar 10, 2000 Mar 17, 2000 Apr 15, 2000 Apr 21, 2000 May 10, 2000 May 15, 2000

Rate A 2.18 2.20 2.21 2.22 2.25 2.27

Rate B 2.20 2.22 2.23 2.25 2.26 2.28

Assume today is Mar 2, 2000. Calculate the ask price of a zero-coupon T-bill with face value of S$20,000 with maturity on Apr 21, 2000, by referring to the Table (a) above. A) S$13,939.18 B) S$14,959.30 C) S$19,939.18 D) S$25,332.20 E) US$28,332.20 Solution: C Use Discount Yield formula. Id = [(P1 P0) / P1] x 365/h Where: Id = 2.22% (choose lower rate for ask rate) P1 = S$20,000 P0 = ask price = S$19,939.18 h = 50 days to maturity = 29 + 21 365 calendar days is used because S$ denominated T-bills

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