Compilation

Question 1

What must be considered when thinking of investing abroad?

Answer 1

• Trading risk
• -> Liquidity risk: may take longer to get to them so longer to pay
• -> practical risks: can it get shipped there, will it get damaged?
• -> Credit risk
• Government stability
• Economic risk and stability
• Currency risk
• Cultural risk
• Taxation to pay/ stamp duty?
• Any restrictions on import?
• Is there a competitive advantage of being in that company?

Question 2

When stating whether to accept a project based on the NPV - what should you include?

Answer 2

Yes you should accept
BECAUSE the NPV is +ve
This suggests the project is financially viable and will increase SH wealth which is the ultimate objective of the company

Question 3

What is the money rate?

Answer 3

Money market rate = real rate x inflation

Question 4

What are the limitations of expected values?

Answer 4

• Ignores risk
• Does not give most likely result (may not even be possible)
• Discrete outcomes
• Subjective probabilities

Question 5

What are the adv and limitations of sensitivity analysis?

Answer 5

Adv

• Facilitates subjective judgement
• Identifies areas critical to the success of the project
• Relatively straight forward to do

Limitations

• Assumes variables change independently from each other
• Doesn’t assess the likelihood of the variable changing
• Doesn’t identify a correct decision

Question 6

What is the solution to some of the limitations of sensitivity analysis?

Answer 6

Monte Carlo Simulation
- Overcomes the limitation that Sensitivity analysis assumes that variables move independently with each other

Uses math modelling to produce a probability distribution

• Done by specifying the major variables and the relationship between them
• Then you simulate the env multiple times to create a probability distribution

Question 7

What is specific risk and systematic risk?

Answer 7

Specific risk is risk that can be diversified away - i.e. industry/market risk

Systematic risk affects the whole market in the same way (though to different degrees)

Question 8

Should management diversify their portfolio?

Answer 8

NO - rational and reasonable SH will already diversify their portfolio so there is no need to
Creates an agency problem as directors/man may want to diversify to protect their own job

Question 9

What is Rm - Rf?

Answer 9

Equity risk premium

Question 10

What do you use CAPM for?

Answer 10

• to find required rate of return for a project that has a diff risk to current operations
• Inv use to determine whether to invest into a company (i.e. can they pay less than they should?)

Question 11

What are the limitations to CAPM?

Answer 11

• May be difficult to find similar listed companies
• If valuing a private company, reducing % due to lack of marketability is subjective 15-40%
• Using gvmt treasury bonds for Rf is not 100% true- they aren’t completely risk free and all have different rates depending on many factors
• Rm in practice actually use historic cost rather than future expected returned
• Single period model: only looks at next 12 months
• Assumes investors are fully diversified

Question 12

What are the alternatives to CAPM?

Answer 12

APT - arbitrage pricing theory : CAPM on steroids looks at lots of diff variables

Bond yield plus premium approach - Logic- uses the interest rate they can borrow at as their risk is reflected in this, then add a fixed premium

Dividend revaluation model - completely diff. Looks at predicted future dividends and compared to share price to measure what return was actually achieved

Question 13

Give an example of an APT?

Answer 13

Fama and French model which identified size value & momentum as additional factors to systematic risk that can affect the rate of return

Fundamental beta - idea that if there is greater risk in the company, more money should be retained

• The greater risk can be caused by
• • Nature of the business operations
• • Level of financial gearing

Question 14

What are the adv/disadv for Monte Carlo simulation?

Answer 14

Adv 
- Takes multiple variables into account 
- Creates a probability distribution 
- Takes probabilities into account 
Disadv
- Not a technique for making a decision 
- Can be time consuming and expensive 
- Certain assumptions that need to eb made could be unreliable

Question 15

Adv and disadv of acquisition?

Answer 15

Adv 
- Quicker 
- Synergy 
- Reduced Competition
- Vertical synergy/ protection
- Increase SH wealth if successful 
Disadv 
- Synergy must be sought after, not automatic 
- Restructuring costs after acquisition may be significantly 
- May overpay