Deck 5: Direct Investment Fixed Interest and Shares

Question 1

Focusing an investment portfolio with ethical investments:

A) allow investors to integrate personal values and social concerns with their investment objectives.
B) potentially creates adverse diversification issues for the investor increasing their investment risk exposure
C) both a and b
D) is not likely to be constrained by a lack of information available from many companies regarding this issue.

Answer 1

C

Question 2

Money market securities generally have a term:

A) less than that of the capital market.
B) greater than that of the capital market.
C) equal to that of the capital market.
D) of at least 5 years.

Answer 2

A

Question 3

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 3

C

Question 4

The capital asset pricing model (CAPM):

A) recognises a positive relationship between risk and return.
B) uses beta as the relevant measure of market risk.
C) requires a value for the risk-free rate.
D) all of the above.

Question 5

The ASX Trade platform facilitates share trading in Australia based on:

A) time-price priority.
B) price-volume priority.
C) price-time priority.
D) none of the above.

Question 6

The electronic transfer and settlement system for representing share ownership in Australia is referred to as:

A) CHECKERS.
B) CARDS.
C) CHESS.
D) SFE.

Question 7

Examples of market risk factors include:

A) an oil spill by an exploration company resulting in a large fine.
B) the death of a key director of a company.
C) safety concerns leading to union activities undertaken in a particular industry.
D) none of the above.

Question 8

An example of an issue of a financial security in the primary market would be:

A) the acquisition of shares in a company from an existing investor purchased on the ASX.
B) shares arising as a result of a dividend reinvestment plan.
C) shares arising from participating in a rights issue.
D) both b and c

Question 9

The effect of a change in the general level of interest rates on the capital values of traded fixed-interest securities is such that:

A) a fall in the general level of interest rates will normally promote decreases in the capital values of traded fixed-interest securities.
B) holders of these securities will enjoy an appreciation in capital values when the general level of interest rates falls.
C) there is a positive relationship between the general level of interest rates and the capital values of traded fixed-interest securities.
D) both a and c

Question 10

Contributing ordinary shares:

A) may be cumulative, participating or redeemable.
B) are shares issued on the understanding that dividends will not be payable until a future specified date when a particular project becomes profitable.
C) are completely paid up when initially issued.
D) are not completely paid up when initially issued.

Question 11

Using sustainable growth rates:

A) seeks to overcome the limitations of using past growth rates as a reliable indicator of future growth rates.
B) requires companies to have a retention ratio of less than 100%.
C) both a and b
D) none of the above.

Question 12

Characteristics of preference shares include:

A) cumulative shareholders retaining priority over profits until all outstanding dividends have been paid.
B) participating shareholders having priority for dividends and have potential access to additional dividends after ordinary shareholders have been paid.
C) redeemable shareholders having their shares bought back or redeemed at their face value at the discretion of the company at a certain date.
D) all the above.

Question 13

Investing in precious metals:

A) is often undertaken as a hedge against inflation.
B) provides both income and capital returns to investors.
C) is subject to significant supply and demand pressures.
D) both a and c

Question 14

CAPM says: (nominate the incorrect statement):

A) the expected return on a share is equal to the risk-free rate plus the amount of beta multiplied by the risk premium.
B) if investors wish to buy a particular share, the expected return must, at least, be equal to the return they would earn if they invested in a risk-free asset.
C) investors need to be compensated for taking risk, they will not be compensated for total risk, just the unsystematic risk.
D) beta and the risk premium multiplied together, plus the risk-free rate, provide the expected return of the share.

Question 15

In terms of the asset classes of cash and fixed interest, nominate the incorrect statement:

A) Cash may be invested on the short term money market at the cash rate and is more liquid than fixed interest.
B) The essential feature of most fixed interest investments is that the interest rate is set at the start of the period and the principal is fixed.
C) Cash is always regarded as a riskier investment than fixed interest.
D) None of the above.

Question 16

The relationship between nominal rates and real rates of return in times of rising inflationary levels results in:

A) real rates exceeding nominal rates of return.
B) nominal rates exceeding real rates of return.
C) both nominal and real rates of return being equal.
D) real rates being positively related to inflationary levels.

Question 17

Technical analysts:

A) use forecasts of future data based on company fundamentals to make financial decisions.
B) examine the past price history 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

Question 18

The Gordon dividend discount model has a number of problems which include:

A) the required rate of return must be greater than the expected growth rate. If this is not the case, then the model will estimate a negative value for the share price (which is impossible).
B) if the expected growth rate is really greater than the required rate of return, then the Gordon growth model is not appropriate for valuation.
C) this model assumes that the fundamentals of the firm will remain constant over time.
D) all of the above.

Question 19

Market forces are the primary determinant of share prices in the secondary market with prices increasing arising from:

A) excess levels of buying pressure over selling pressure.
B) excess levels of selling pressure over buying pressure.
C) equilibrium levels of buying and selling pressure.
D) either b or c

Question 20

In terms of discount securities nominate the incorrect statement:

A) Instruments such as BABs are discount securities in that their selling prices are less than (at a discount to) their face values.
B) The face value of the security is sold at a discount so that the amount paid on maturity is equal to the face value of the security.
C) Pays a coupon or interest payment monthly until maturity.
D) All of the above.

Question 21

Outline the general characteristics of the Securities Market Line (SML).

Question 22

At the commencement of the current financial year Rene Silverwater invested $70,000 in a 2-year 'snowball' fixed deposit providing an interest rate of 5% p.a. with interest paid half-yearly. The interest paid is reinvested back into the fixed deposit which is the basis for the 'snowball' description. On maturity, 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 10%. Rene is subject to a 40% marginal tax rate for interest income derived in the first year and 30% for the second year.
Rene has sought your assistance in determining whether he would be eligible for the interest bonus and also to calculate his total after-tax net income from the investment.

Question 23

Briefly explain how lenders use the cash rate when setting interest rates.

Question 24

Mickey Ronaldo purchased a 180 day Commonwealth Treasury Note (T-note) having a face value of $100,000 on 15 April 2014. The purchase price of the T-note was $96,730.
a) Calculate Mickey's annualised nominal rate of return based on the face value of the T-note.
b) Calculate Mickey's annualised nominal rate of return based on the purchase price of the T-note.
c) Which of the above annualised nominal rates of return is more representative of Mickey's actual rate of investment return?

Question 25

Explain the relationship between the cash rate and the real cash rate. Illustrate your discussion by calculating the real rate of return for a 1-year term deposit that provides for the following 3-monthly interest rates over its term: 1 to 3 months - 5% p.a., 4 to 6 months - 7% p.a., 7 to 9 months - 6% p.a. and 10 to 12 months - 7% p.a. Inflation rates over this period are as follows: 1 to 3 months - 2% p.a., 4 to 6 months - 3% p.a., 7 to 9 months - 4% p.a. and 10 to 12 months - 5% p.a.

Question 26

Outline the primary differences between ordinary and preference shares.

Question 27

Who are the primary regulators of the Australian financial system?

Question 28

What characteristics are typically associated with ethical investments?

Question 29

You have assessed the following information for Kid's Apparel Ltd. based on your expectations of the company over the next financial year:
Operating profit (before-tax) $13.8 million
Taxable income $10 million
Company tax rate 30%
Authorised share capital 10 million
Issued share capital 7.5 million
Current share price $21.60
Based on the information provided, calculate the company's price/earnings (P/E) ratio and comment on the company's growth prospects given that the industry average P/E ratio is 12 times.