Principles Of Finance

Principles Of Finance

FIN200 – Principles of Finance
Assignment I

Dear Students,
Please find bellow the questions for the first assignment. This is an individual assignment and although I encourage you to discuss it with classmates, you are expected to submit your works individually before the deadline. This file will be updated as we proceed and I will add questions to this file after every session. Please try to follow the guidelines (e.g. word count) where appropriate. You are expected to submit all of your answers in one file prior to the stated deadline.

Q1.Why has an increasing share of household savings been channelled through financial intermediaries? Hint: Comment on the role of financial intermediaries. (250 words max)

Q2. There are two very similar companies (Company A and Company B), both with an earnings before interest and tax (EBIT) of £400k. The total capital employed by these two companies is £4m:
Company A is funded entirely by equity (all £4m) and has no debt on its balance sheet.
Company B is funded by £2m of equity and £2m of debt, with an interest rate of 7% per year.
The corporate tax rate is 25%.
a) Calculate the interest paid to debtholders and the money left for shareholders after tax (both in £) for the two companies separately.
b) Calculate the % return to shareholders under the two scenarios.
c) Do the owners of the company benefit from employing debt in this case? Does this always hold? Explain. Hint: Comment on “Return on Capital Employed” (100 words max).

Q3. Describe and illustrate, using simplified bank balance sheets, how a bank could find itself with a liquidity crisis and a capital reserve crisis (two different crises). Describe and explain the actions it can take to move back to more prudent liquidity and capital reserve levels after such crises. (250 words max + tables if required)

Q4. Compare and contrast (describe and explain the relative advantages and disadvantages) of an overdraft versus a term loan versus project finance versus a syndicated loan. (250 words max)

Q5.Explain the function of market makers, how they operate and what risks they face. (200 words max + tables if required)

Q6. Explain the nature of the four forms of finance which may be used to purchase a new equipment for a company: hire purchase, leasing, bank term loan and overdraft. Point out their relative advantages and disadvantages. (300 words max)

Q7.
Explain the following key elements to insurance: (250 words max)
(a) asymmetric information;
(b) adverse selection;
(c) moral hazard;
(d) float.

Q8.On 1 March 2011 a company raises finance by agreeing a six-month eurodollar loan for $12 million offered at an interest rate of 2.65 per cent. Calculate the cost of the loan in dollars.
(a) on a 30/360-day count basis (180 days)
(b) on a 365-day count, actual/365 basis (183 days)

Q9.You purchase $4,000 worth of six-month US Treasury bills on the secondary market with a quoted yield per annum of 0.46 per cent. The bills have 28 days to maturity. How much would you pay? Use the actual/360-day count convention.

Q10.The annualised yield on a repo with an initial sale value of £750,000 is 2.31 per cent. The repo has 42 days until maturity. (a) What will be the repurchase price? (b) If the days to maturity are 67, what will be its future purchase price? Use a 360-day count convention throughout.

Q11.As a winner of a lottery you can choose one of the following prizes:
1) £1 million now.
2) £1.7 million at the end of five years.
3) £135,000 a year for ever, starting in one year.
4) £200,000 for each of the next ten years, starting in one year.
If the time value of money is 9 per cent, which is the most valuable prize?

Q12.What is the present value of £100 to be received in ten years’ time when the interest rate (nominal annual) is 11 per cent and (a) annual discounting is used? (b) semi-annual discounting is used?

Q13.Punter buys a car on hire purchase paying five annual instalments of £1,500, the first being an immediate cash deposit. Assuming an interest rate of 8 per cent is being charged by the hire-purchase company, how much is the current cash price of the car?

Q14.Imagine that the market yield to maturity for three-year bonds in a particular risk class is 12 per cent. You buy a bond in that risk class which offers an annual coupon of 10 per cent for the next three years, with the first payment in one year. The bond will be redeemed at par (£100) in three years. How much would you pay for the bond?

Q15.A bond will pay an annual 8.5 per cent coupon until maturity (the next coupon will be paid in one year). The bond matures in seven years.
(a) What will be the market price of the bond if yields to maturity for this risk class fall to 7.5 per cent?
(b) What will be the market price of the bond if yields to maturity for this risk class rise to 18 per cent?

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