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SEMESTER 1 EXAMINATIONS 2019-20

INTRODUCTION TO FINANCE

1.

(a) Compare and contrast in detail the characteristics of a common share and a bond. (30 marks)

(b) Discuss in detail the factors that affect the market value of a bond. (45 marks).

 (c) Suppose you bought a ten-year long-term bond one year ago.  The bond pays £10,000 at the end of the year for ten years and then returns the face value at the end of the tenth year.  When you bought the bond the market interest rate (yield to maturity) was 8% per year and the face value of the bond is £100,000.  You have received the first coupon payment, but the market interest has also increased to 10% per year, and you are thinking of selling the bond.

(i) What price do you expect to receive? (15 marks)

(ii) What price would you have received if the market interest rate had fallen to 6% per year? (10 marks)     

2.

(a) “Presence of a risk-free asset is essential for the CAPM”.  Do you agree? Discuss in detail.  (50 marks)

(b) “A portfolio made up of only two risky assets can have zero risk.” Do you agree?  Discuss in detail.        (50 marks)                      

3.

(a) Define the following

(i) Capital budgeting (5 marks)

(ii) Conventional project (5 marks)

(iii) Independent project (5 marks)

(iv) Non-conventional project (5 marks)

(b) Provide a detail comparison between the Net Present Value (NPV) and modified Internal Rate of Return (IRR). (30 marks)

(c) Use the following information to answer this part of the question.

Consider three investments options A, B and C.  All cash flows are in nominal terms.

All payments are made at the end of the year.  If the market interest rate is 10% per year,

Calculate the modified internal rate of return (MIRR) and the net present value (NPV) of the three options.  Please show all calculations. (25 marks)

(b) Consider two investment options: X and Y.  End of the year cash flows are in nominal terms for X and in real terms for Y are as follows:

All payments are made at the end of the year.  If the nominal interest rate 10% per year and the real interest rate is 7% per year,

(i) Calculate the REAL net present value options of X and Y and explain which option would you pick?  Please show all calculations including the annual real cash flows for option X.  (25 marks)

4.

(a) Explain and discuss in detail the axioms of choice.  (50 marks)

(b) Travel Company X has just bought a new cruise ship for 20 million pounds.  The corporation is in the process of buying insurance for the ship.  They have been told that during the next 12 months, there is 1% chance that fire will destroy the ship completely reducing the value to zero, 1% chance that ship will sink reducing the value to zero, 3% chance that bad weather will damage the ship to make it useless and reduce the value to 2 million, 5% chance that bad weather will damage the ship to some extend and reduce the value to 15 million and there 90% chance that nothing will happen and the ship will maintain its value. Suppose the utility function of wealth of Company X is log (W), where W is wealth.  How much insurance should Company X pay for the ship?  Show all calculations. (35 marks) 

     (c) Suppose your utility function of wealth is equal to –W^-1 and the level of       your wealth is £20,000.  How much are you willing to pay to avoid the following gamble?  A 70% chance of losing £5000 and a 30% chance of winning £10,000. Show all calculations. (15 marks)