University of Aberdeen Session 2021-2022

Alternative Assessment Test for the Degree of MA

FI2004 – Business Finance 2

Date: Tuesday, 7th December 2021, 10am to 12:30pm

Online

RUBRIC: PLEASE READ WITH CARE

MULTIPLE CHOICE and SHORT ANSWER QUESTIONS

Where a question is in several parts, the percentage or mark indicated shows

the proportion of time you may wish to spend on that part.
Each question makes an equal contribution to the final grade.

Please submit your answer to the SafeAssign submission link on My

Aberdeen, within the course FI2004.
Late submissions will not be marked.

Please note that the university regulations on academic misconduct still apply
irrespective of the format the assessment is delivered.

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 MULTIPLE CHOICE and SHORT ANSWER QUESTIONS

Part 1 – Multiple Choice Questions

Choose the one alternative that best completes the statement or answers the question.

Questions 1 to 16 carries an equal weight of 0.55 (2.5%)

1. If the present value of cash flow X is $240, and the present value of cash flow Y is $160,
then the present value of the combined cash flows is:

A) $240.
B) $160.
C) $80.
D) $400.

2. What is the present value of the following cash flows at a discount rate of 9 percent?

Year 1 Year 2 Year 3

$100,000 $150,000 $200,000

A) $372,431.81
B) $450,000.00
C) $405,950.68
D) $412,844.04

3. What is the net present value of the following cash flow sequence at a discount rate of 11
percent?

t=0 t=1 t=2

-120,000 300,000 -100,000

A) $69,108.03
B) $231,432.51
C) $80,000.00
D) $88,000.00

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4. You would like to have enough money saved after your retirement such that you and your
heirs can receive $100,000 per year in perpetuity. How much would you need to have
saved at the time of your retirement in order to achieve this goal? (Assume that the
perpetuity payments start one year after the date of your retirement. The annual interest
rate is 12.5 percent.)

A) $1,000,000
B) $10,000,000
C) $800,000
D) $1,125,000

5. If the cash flows for project Z are C0 = -1,000; C1 = 600; C2 = 720; and C3 = 2,000,
calculate the discounted payback period for the project at a discount rate of 20 percent.

A) 1 year
B) 2 years
C) 3 years
D) >3 years

6. The following are some of the shortcomings of the IRR method except

A) IRR is conceptually easy to communicate.

B) projects can have multiple IRRs.
C) IRR cannot distinguish between a borrowing project and a lending project.
D) it is very cumbersome to evaluate mutually exclusive projects using the IRR method.

7. Project Y has following cash flows: C0 = -800, C1 = +5,000, and C2 = -5,000. Calculate
the IRRs for the project.

A) 25 percent and 400 percent.

B) 125 percent and 500 percent.
C) -44 percent and 11.6 percent.
D) No IRRs exist for this project.

8. The type of the risk that can be eliminated by diversification is called

A) market risk.
B) unique risk.
C) interest rate risk.
D) default risk.

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 9. The volatility of a bond is given by

A) duration/(1 + yield) only.

B) slope of the curve relating the bond price to the interest rate only.
C) yield to maturity only.
D) duration/(1 + yield) and slope of the curve relating the bond price to the interest rate
only.

10. Which bond is more sensitive to an interest rate change of 0.75 percent?

Bond A: YTM = 4.00%, maturity = 8 years, coupon = 6% or $60, par value = $1,000.
Bond B: YTM = 3.50%, maturity = 5 years, coupon = 7% or $70, par value = $1,000.

A) Bond A
B) Bond B
C) Both are equally sensitive.
D) Cannot be determined

11. The writer of a call option hopes that the stock price will:

A) decrease.
B) increase.
C) split.
D) produce quarterly cash dividends.

12. If you own a call and a put on a stock with the same exercise price and exercise date,
your payoffs:

A) will be positive only if the stock price rises.

B) will be positive only if the stock price declines.
C) will always be positive and will increase with the size of the stock price change.
D) will always be positive but will be larger if the stock price is relatively stable.

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 13. What is the option buyer's total profit or loss per share if a call option is purchased for $5,
has a $50 exercise price, and the stock is valued at $53 at expiration?

A) −$5
B) −$2
C) $3
D) $8

14. An investor purchased a share of stock for $42 and at the same time paid $2 to purchase a
put option on the stock with an exercise price of $40. What is her profit or loss if the stock is
worth $30 at expiration?

A) $6
B) −$6
C) −$4
D) $4

15. How much must the stock be worth at expiration in order for the buyer of a call option to
break even if the exercise price is $50 and the cost of the call was $4?

A) $46
B) $50
C) $52
D) $54

16. Put-call parity states that:

A) Price of stock + price of call = price of put + PV (exercise price)

B) Price of stock + PV(exercise price) = price of call + price of put
C) Price of stock + price of put = price of call + PV(exercise price)
D) Price of stock = price of put + price of call − exercise price

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Part 2 – Short Answer Questions

Questions 17 to 20 carries an equal weight of 3.3 (15%)

17. Consider the following information about three equities:

State of Probability of Rate of returns if state occurs

economy state of economy Equity A Equity B Equity C
Boom 0.25 0.24 0.36 0.55
Good 0.50 0.17 0.13 0.09
Bust 0.25 0.00 −0.28 −0.45

If your portfolio is invested 40 per cent each in A and B and 20 per cent in C, what is the
portfolio expected return? The variance? The standard deviation?
Ans.
The portfolio expected return for boom: (0.4x0.24)+(0.4x0.36)+(0.2x0.55)= 0.35
The portfolio expected return for good: (0.4x0.17)+(0.4x0.13)+(0.2x0.09)= 0.138
The portfolio expected return for bust: (0.4x0.00)+(0.4x-0.28)+(0.2x-0.45)= -0.202
The variance for boom is:
The variance for good is
The variance for bust is
The standard deviation for boom is

18. Write a short essay in which you compare the relative advantages and shortcomings of
Discounted Cashflow (DCF) and REAL options analysis. Does the latter always replace
the former?
Ans. DCF is also called ‘present value models’ and it is based on the idea that the
value of an asset equals to the present value of all future monetary benefits. An ad-
vantage of DCF is that it is relatively easy to use when the future cash benefits are
known or can be forecasted. Moreover, another advantage of DCF is that it relies on
free cash flow instead of accounting numbers and it has multiple different models in
order to reflect the different growth stages. On the other hand, DCF isn’t that good
because it is based on assumptions like growth rate, required return on equity and
future cash flows which makes it unreliable. Additionally, it is difficult to forecast
cash flows in cyclical businesses so the DCF has many limitations. In oppositions,
the real options analysis is rather useful because it has economic value which can be
used to make decisions which contrasts DCF’s assumptions and estimations.

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 19. Explain why international stocks may have high standard deviations but low betas.
Ans. Volatility is an important factor when deciding upon potential investments;
high volatility investments often have high returns, but they can also lead to greater
losses. Standard deviation is often put against an investments annual rate of return
to measure volatility therefore, standard deviation measures risks (both systematic
and unsystematic). Beta measures only systematic risk hence standard deviations
tend to be higher than betas.

20. What is the relationship between interest rates and bond prices?

Ans. Bonds have an inverse relationship to interest rates. When the interest rates rise, bond
prices fall because the cost of borrowing money increases due to the hike in interests rates.
Similarly, when the interest rate falls, bond prices increase because borrowing money is
relatively easy hence people tend to invest more.

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Statistical formulas

Expected returns, two-asset portfolio:

Portfolio Variance formula:

Covariance:

Correlation coefficient:

The Black-Sholes Formulas

89End of Examination
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