Final 2018, questions and answers PDF

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FM102: Personal Financial Planning Faculty of Business and Economics / School of Accounting & Finance Mid Semester Test Semester 2, 2018 Face-to-Face & Blended Mode Duration of Exam: 2 hours + 10 minutes Reading Time: 10 minutes Writing Time: 2 hours Instructions: 1. Read ALL instructions carefully before you begin. 2. Note that this is a closed book examination. You are not permitted to access any books, notes or other written materials. 3. You are not permitted to use any electronic gadget except for a silent non-programmable calculator. 4. For Section A, record all your answers on the separate Multiple Choice Answer Sheet provided. Section B is to be answered on the Answer Sheet provided. 5. Ensure to you write your name, student ID number and tutorial group in the space provided on the answer booklet. 6. Any additional page(s) used must be properly numbered and stapled to the main answer sheet. 7. Summary of Questions. Answer ALL questions. Section

Guideline

Total Marks

Time Allocation

A

Multiple choice

25

45

B

Calculations

35

75

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Section A: Multiple Choice | 25 marks | 45 Minutes 1. Generally accepted finance principles would support which of the following statements? A. B. C. D.

‘High return generally equals high risk’ ‘High return generally equals low risk’ ‘High risk is generally inversely related to high return’ ‘Low return generally equals high risk’

ANSWER: A 2. To adequately meet required income needs in retirement it is generally accepted that people will need approximately what percentage of their pre-retirement income? A. B. C. D.

More than 90 per cent 60 to 70 per cent 40 to 50 per cent Less than 40 per cent

ANSWER: B 3. Given an understanding of interest-rate risk, an existing fixed-interest investor in bonds would be affected in which of the following way(s) if the market interest rates on bonds were to rise from 8% to 10%? A. B. C. D.

interest receipts from the bonds would rise and the market price of the bond would also rise interest receipts from the bonds would fall and the market price of the bond would also fall interest receipts from the bonds would be unaffected and the market price of the bond would rise interest receipts from the bonds would be unaffected and the market price of the bond would fall

ANSWER: D 4. Market volatility as a component of interest-rate risk: A. B. C. D.

Affects the amount of interest payments received on a fixed-interest investment Affects the value of a fixed-interest investment at its maturity date Affects the value of a fixed-interest investment sold before its maturity date Both A and B

ANSWER: C 5. The lowest level of business activity occurs during which of the following phases in the business cycle? A. Boom or expansion phase B. Recession phase C. Recovery phase D. Contraction phase ANSWER: B 6. A personal balance sheet would not generally include: A. B. C. D.

Dividends received during a period. A motor vehicle. A collection of rare banknotes. 5 year loan from BSP Bank. Page 2 of 13

ANSWER: A 7. The debt-service ratio shows monthly debt commitments as a percentage of: A. B. C. D.

Before-tax monthly income. Total liabilities. After-tax monthly income. None of the above.

ANSWER: C 8. If you were to deposit $850 today into an investment account earning 6% p.a. compounded annually, approximately how much will you have in your account at the end of 5 years? A. B. C. D.

$1,165 $1,137 $1,206 $620

ANSWER: B 9. A loan is made to a borrower at a specified nominal interest rate. In order for the loan to be fully repaid over a specified term: A. Periodic repayments would be the same whether they were made at the start or end of each period. B. Periodic repayments would be greater if they were made at the start rather than at the end of each period. C. Periodic repayments would be greater if they were made at the end rather than at the start of each period. D. Whether periodic repayments would be greater if they were made at the start or at the end of each period would depend on the specified interest rate. ANSWER: C 10. The greater the initial investment the: A. B. C. D.

Greater the future value at a given interest rate and given number of periods. Lower the future value at a given interest rate and given number of periods. Future value will be the same at a given interest rate and given number of periods. All of the above.

ANSWER: A 11. The enterprising or aggressive investor is characterised by: A. Speculation. B. Their willingness to devote time and care to the selection of sound and attractive investments even though they may not be fully trained experts in the field. C. The conservation of capital. D. Risk-aversion. ANSWER: B

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12. Cash investments aim to provide: A. B. C. D.

A capital guarantee. Returns that fully offset the investor from the impacts of inflation. Income, liquidity and stable returns. Both B and C.

ANSWER: C 13. Elena is seeking to invest her regular monthly salary savings of $400 into a suitable investment. ANZ bank has offered her the best interest rate in the market, a rate of 8% p.a. compounded monthly. How much will Elena approximately accumulate in total from her ongoing savings after a period of 4 years? A. B. C. D.

$22,000 $19,200 $22,540 $20,736

ANSWER: C 14. In terms of loss aversion theory it is generally accepted that investors: A. B. C. D.

Consider losses far more desirable than equivalent gains. Have a degree of aversion to losses which is counter to efficient market theory. Are more likely to sell losing stocks than winning stocks. All of the above.

ANSWER: B 15. Which of the following statement is false regarding investment scams: A. B. C. D.

Investors being provided with a product disclosure statement. The promise of returns equivalent to bank deposits. A password or bank account details are required. Investments are often locally based.

ANSWER: A, B or D 16. The relationship between nominal rates and real rates of return in times of rising inflationary levels results in: A. B. C. D.

Real rates exceeding nominal rates of return. Nominal rates exceeding real rates of return. Both nominal and real rates of return being equal. Real rates being positively related to inflationary levels

ANSWER: B 17. Money market securities generally have a term: A. B. C. D.

Less than that of the capital market. Greater than that of the capital market. Equal to that of the capital market. Of at least 5 years.

ANSWER: A Page 4 of 13

18. The yield curve: A. Typically has a normal shape which slopes downward to the right. B. Is a graph of interest rates relative to their risk. C. May be flat when short-term and long-term rates are virtually the same, and a humped yield curve may occur when medium-term rates are higher. D. All of the above. ANSWER: C 19. The capital asset pricing model (CAPM): A. B. C. D.

Recognises a positive relationship between risk and return. Uses beta as the relevant measure of market risk. Requires a value for the risk-free rate. All of the above.

ANSWER: D 20. Technical analysts: A. Use forecasts of future data based on company fundamentals to make financial decisions. B. Examine the current price of a company in order to identify patterns of price movements. C. Prepare graphs of past price movements in order to isolate buy and sell points which are used to make financial decisions. D. Both B and C. ANSWER: D 21. An example of direct property investment is: A. B. C. D.

John is a registered investor in a listed real estate investment trust. Jill holds units in an unlisted property trust. James is the registered owner of a commercial property. Jenny is a member of a private property syndicate.

ANSWER: C 22. A characteristic of property is: A. B. C. D.

It is generally regarded as an intangible form of investment. It is generally regarded as an illiquid form of investment. Returns may comprise income but not capital. Entry costs and exit costs can be relatively low.

ANSWER: B 23. Mortgage funds: A. B. C. D.

Provide opportunities for capital growth returns for investors. Will increase their loan-to-value ratio the relatively higher the risk of the borrower. Are a relatively illiquid investment at least in the early periods after issue. Both A and B.

ANSWER: C 24. The NPV of an investment will approximately be ______________ that requires an initial outlay of $10,000 at a discount rate of 6% and provides end-of-year cash flows of: Page 5 of 13

Year 1: $3,000 | Year 2: $11,000 | Year 3: ($1,500) A. B. C. D.

$1,361 $11,361 $9,424 $2,500

ANSWER: A 25. Establishing a market value for older buildings is more problematic using the: A. B. C. D.

Cost approach. Direct comparison approach. Capitalisation approach. Both A and B.

ANSWER: A

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Section B: Calculations | 35 marks | 75 Minutes Question 1 (10 marks) (Show all working clearly. Round off answers to 2d.p.) At the commencement of the current financial year (01/07/18) Serevi invested $70,000 in a 2-year ‘Bula Gold’ fixed deposit product at Kontiki Finance Ltd. The Bula-Gold fixed deposit pays semi-annual interest of 5.7% p.a. The interest income received by Serevi is reinvested into his fixed deposit which is a condition under the Bula-Gold product. All monies owed to Serevi will only be paid at maturity. On maturity, the following applies as per Serevi’s Bula-Gold product specification:  

The investment provides a bonus interest amount of $500 for all investments that have a balance at maturity that exceeds their initial investment by more than 12%. Interest income derived from investment is subject to a 40% marginal tax rate in the first year and 30% in the second year.

Serevi requires your assistance in calculating the following: a. Total Gross Interest Income (excluding any bonus interest) received on the investment. (2m) b. Based on your answer in (a) above, is he eligible for any bonus interest? Justify your answer. (2m) c. Total tax payable. (4m) d. Total after-tax net interest income received from his investment. (2m) a.

Gross Interest Income:

Gross Interest Income:

b.

n

FV = PV(1 + i) 70,000 x (1.029^4) 78,327.67 78,327.67 - 70,000 $8,327.67

Bonus Interest:

Not eligible. amount: $0 Investment at maturity does not exceed by more than 12% in comparison to the initial investment $70,000. 12% of $70,000 = $8,400; Increase in investment at maturity is only $8,328, hence not eligible for bonus interest. $8,400 > $8,328

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c.

Total Tax Payable: 1st yr: 70,000 x (1.029^2) 74,046.86

Income @ end of 1st yr: Tax Rate: Tax Payable (1st yr):

2nd yr: 74,046.86 x (1.029^2) 78,327.67

74,047 - 70,000 4,046.86 40% 1,619

78,328 - 74,047 4,280.82 0 4,280.82 Tax Rate: 30% Tax Payable (2nd yr): 1,284

Income @ end of 1st yr: add Interest Bonus:

Total Tax Payable:

d.

Total after-tax net interest income: Gross Interest Income: (3,544 + 4,223) Total Tax Payable: (from (c) above)

1,619 + 1,284 = $2,903

$8,328 $2,903 $5,425

Question 2 (7 marks) (Show all working clearly. Round off answers to 2d.p.) You are planning to purchase a house which is currently selling at a market value of $180,000. Since your current accumulated savings account balance is quite healthy, you plan to make a cash down payment of 20% and finance the balance with a mortgage loan for 25 years at a fixed interest rate of 8.25% p.a. a. Calculate the effective interest rate. (2m) b. Calculate your end of month repayments under the mortgage loan. (3m) c. Calculate the total interest payable under this agreement. (2m)

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cost down payment (20%) loan required term in yrs interest p.a monthly repayments

180,000 36,000 144,000 25 8.25% ??

a. effective interest rate:

((1+(0.0825/12))^12)-1 8.57% b. monthly repayments: PVA = 144, 000 = C * [1 - (1+ ((0.0069/12)^-300))]/(0.0069/12) C= $ 1,135.37 c. total interest:

(1,135.37 * 300) - 144,000 $ 196,611.00

Question 3 (10 marks) (Show all working clearly. Round off answers to 2d.p.) Rebecca recently commenced an investment portfolio which includes assets Gold, Silver and Bronze about which Rebecca acquired the following financial information as to the likely returns at various probabilities: Probability of Return (%) 20 30 40 10

Likely Return on Gold (%) 6 9 16 18

Likely Return on Silver (%) 4 7 10 14

Likely Return on Bronze (%) 9 14 19 26

a. Calculate the expected return for each asset. (3m) b. Calculate the expected return of the portfolio comprising of each asset weighted as follows. (2m)

Asset Gold Silver Bronze

Weight (%) 20 55 25

c. Rebecca needs your expertise in ranking the assets in her investment portfolio according to the level of risk, from highest to lowest. She managed to calculate the Standard Deviation of Gold and Silver as a measure of risk. Calculate the SD of Bronze. (2.5m) Asset

SD (%) Page 9 of 13

Gold Silver Bronze

5.68 4.30 ?

d. Referring to your answer in (C) above, rank each asset according to its risk & return from highest to the lowest. You can use the following table as a guide. After ranking the assets accordingly, in not more than a sentence, explain to Rebecca the concept of Risk-Return relationship? (2.5m) Rank 1 2 3

Asset

SD (%)

Probability of Like ly Re turn Return (%) on Gold (%) 20 30 40 10

E(R) (%)

Like ly Re turn Like ly Re turn on Silver (%) on Bronze (%)

6 9 16 18

4 7 10 14

9 14 19 26

a. E(R)GOLD

(0.2*0.06)+(0.3*0.09)+(0.4*0.16)+(0.1*0.18) 12.1%

E(R)SILVER

(0.2*0.04)+(0.3*0.07)+(0.4*0.10)+(0.1*0.14) 8.3%

E(R)BRONZE

b. E(R)GSB

c. SDBRONZE

(0.2*0.09)+(0.3*0.14)+(0.4*0.19)+(0.1*0.26) 16.2% (0.121*0.2)+(0.083*0.55)+(0.162*0.25) 11.04% n

 

( X

i

2  E ( R) / n  1

i 1

[(9 - 16.2)2 + (14 - 16.2)2 + (19 - 16.2)2 + (26 - 16.2)2] / (4 – 1) 53.52 SQR(53.52) 7.32 d.

Asse t Bronze Gold Silver

SD (%) 7.32 5.68 4.30

E(R) (%) 16.2 12.1 8.3

Relationship: represents a trade-off, i.e. the higher the risk, the higher the return.

Question 4 (8 marks) (Show all working clearly. Round off answers to 2d.p.) Two firms report the following data about its shares: Firm APPLE GOOGLE

RoE (%) 9 13

Payout (%) 65 45

Beta 0.9 1.3

The risk-free rate is 4.5%, the market risk premium is 5%. Page 10 of 13

Growth rate (%) 2.5 5.5

Market (P/E) 6.36 6.66

a. Calculate the fundamental P/E ratios for both shares. (6m) b. As an investor in the market, classify the shares as either a ‘buy’ or a ‘sell’ share. (2m) Firm APPLE GOOGLE E(R) APPLE

RoE (%) Payout (%) 9 65 13 45 4.5% + 0.9(5%) 9%

Beta 0.9 1.3

Growth rate (%) 2.5 5.5

Market (P/E) 6.36 6.66

E(R) GOOGLE 4.5% + 1.3(5%) 11%

a. P/E Ratios: P/E APPLE

[0.65(1.025)] / (0.09 - .025) 10.25

P/E GOOGLE [0.45(1.055)] / (0.11 - .055) 8.63 b. P/E APPLE

Market P/E < Fundamental P/E, therefore buy more Apple shares since market price is undervalued. 6.36 < 10.25

P/E GOOGLE Market P/E < Fundamental P/E, therefore buy more Google shares since market price is undervalued. 6.66 < 8.63

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** The End **

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n

 

(X

i

2  E (R ) / n 1

P / E  Payoutrati o * (1  growth ) ( r  g )

i 1

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