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section B questions were unexpected…i would not say it was difficult but as it was surprising it required more time to plan the right approach for answer..considering the exam time pressure it was challenging…particularly Q no.3 took my all reading and planning time and finally i decided not to answer it…so 15 minute was lost..and i started getting panic…so couldn’t attempt to my ability..
it wont matter…as your registration number will serve as your identity…
missing to tick the box is not a problem provided you bubbled question number at top of answer sheet for each question…
hey do you remember your answer to Q1…what annuity factor you arrived at…I remember for operating surplus i calculated 14.11 by applying 4% growth and 10% cost of capital..what figure you arrived at?hey give me clear table of strike price…and also tell me how much he wish to invest $400 or $400 million..and what is the maximum interest rate he wishes to receive?
so i should learn that finance risk cannot be diversified by shareholders no matter how many different types of shares it invest in?
i wonder what would happen if business risk is zero at generating 15% return(unrealistic assumption but just for illustration)..will shareholders be still affected if business uses cheap debt (say 10%)..and hence increase its gearing? I think in this situation shareholders would increase demand of shares increasing share price..(because they would get more return than previously and in long term due to increase in share price their required return would be same as 15%)so i guess there is relation between business risk and finance risk…for low business risk(stable cash flows) shareholders would be less concerned about finance risk compared to high business risk (relatively less stable cash flows)..
if i had assumed pilot Q2 quotation being indirect as per basic rule …and solve accordingly..
will i get full marks for it or not?
based on real life exchange rate knowledge and basic rule..this is obviously conflicting..
under this circumstances do we have choice of considering it as any (direct or indirect)?that is really pissing me me as well….I am in Nepal and only book available to me is FTC..which not even cover 50% of exam question..
though some help has been received from this website..it still not sufficient..ACCA needs to provide full online resources support so that at least we have good chance of passing based on internet study…(especially for those students outside UK)i don’t know which one to follow…its cracking my head help me clearing this confusion dude…
check this: https://www.forexrealm.com/forex-articles/quotations-and-spread.html
what do you about pilot paper Q2..quotation …is it direct or indirect quotation?ha ha i m laughing at investopedia…the link you referred really says what u say..but again from the same source (investopedia) i got inverse of what u say..
check this: https://www.investopedia.com/terms/d/directquote.asphey thanx for giving your time to answering my question…but i m still confused about finance risk…is it systematic risk or company specific risk(unsystematic risk)..
if it unsystematic why CAPM use equity beta(combination of business risk and finance risk) when actually well-diversified shareholders in perfect market should only concern about purely systematic risk…The BBS Stores equity beta is currently 1·824. A representative portfolio of commercial property companies has an equity beta of 1·25 and an average market gearing (adjusted for tax) of 50%.
This information in question gives us clue that BBS stores has two different type of assets have two different equity beta..one for retail (stores is assumed to do retail business) and commercial property generating different return from its main business of retail..
if you degear proxy equity beta of commercial property of 1.25 using average tax adjusted market gearing ,you would get asset beta equal to 0.625..remember the formula is asset beta = equity beta*(1-w’d) where w’d is tax adjusted market gearing which is given in question so 1.25(1-0.5)=0.625.
i didn’t understand your third question..
Vd means debt which is long and medium term financial liabilities…There is no doubt that in pilot paper Q2 “The current Euro/sterling exchange rate is EUR 0.6900 to the pound” is indirect quotation because home currency is pound and foreign currency is Euro..basic rule says that Direct quotation is where the cost of one unit of foreign currency is given in units of local currency, whereas indirect quotation is where the cost of one unit of local currency is given in units of foreign currency…and in this question EUR 0.69 to the pound means:
1 pound(local currency)=0.69 Euro(foreign currency)
but when looking at answer it has been used as direct rate i.e 1 Euro = 0.69 pound….either quotation given in question is mistake or answer is wrong in interpreting the quotation…this is my opinion based on my internet surfing…from 200*(Rf+ERP)-100*Rf =Rf*100 + 2*100*ERP
I understood how you arrived 200*(Rf+ERP)-100*Rf but by splitting it into Rf*100 + 2*100*ERP how could you say 2 is beta…$200 is our investment in stock market..what is logic of splitting it into 2*100 and saying 2 is beta..if it is true then i would like to split this into 4*50 to say 4 is beta…ha ha funny..never mind
its just i didn’t get any sense in it….i may b wrong please clarify
anyway my question is if shareholders are only concerned about systematic risk..why we use equity beta instead of asset beta in CAPM..as equity beta includes firms specific risk(finance risk) which is unsystematic risk..isn’t it?In FCFE model,,FCFE is made of dividend and retained earning….whereas in dividend model..we value future expected dividend..common is cost of equity…
using zero growth assumption in both model…we would find different answer FCFE model gives $6.3 billion and dividend model gives 4.049…(this is because of FCFE being more than dividend)…
Now what u said would become basis of our comment..you said
“Ideally, FCFE model should give the same answer as the dividend model”Note: To prove this statement growth rate used in dividend model should be higher than FCFE model to arrive equal value..(unless FCFE is equal to dividend)
Firstly as we don’t have information regarding expected growth rate in FCFE and Dividend..we assumed zero in both of them..In reality growth rates would be different for FCFE and for dividend..this is because growth of 2% in FCFE would grow dividend for than 2% (unless FCFE is equal to dividend)..
so difference between two value in this example is due to assumption of same growth rate (i.e is zero) in both model..if we had assumed constant growth of 2.5% in dividend then (270*1.025/(.06668-.025)=6.63 billion approx..it will be same result given by FCFE model..
But in question..what we should focus is that FCFE model gives higher value than market capitalization..so either we comment that current level of FCFE is not expected to be sustainable in future by investors..or to comment more closely we should use dividend model..which would give value slight lower than market capitalization..our comment would now be more precise than by using FCFE model..we would now be able to comment investor is expecting little growth in dividend..If shareholders have well-diversified portfolio why should they be concerned about company’s specific risk that is finance risk?
Why equity beta is used in CAPM instead of using asset beta to calculate cost of equity?1 answer:
Return on fixed capital employed helps to identify how economically firm has used its working capital policy..investment in working capital does not contribute to overall firm’s return..like cash,stock,debtors does not generate return in itself…but if these investment are financed by current liabilities..then our investment from equity and debt will go to non-current asset only due to which return on capital employed and return on Fixed capital employed would be the same..In other words if current ratio is equal to one then our capital employed(debt+equity) will equal to Fixed asset capital(investment in Non-current Assets)..but if our current ratio is more than 1(this means firm has invested in current assets) then ROCE would be lower than ROFCE and vice-versa..in the exam question ROCE is higher than ROFCE…because current ratio is less than 1(which means company has generated extra return due to finance from current liabilities which has ho cost attached with it)..
2. answer:
you can do what u r proposing..but the problem is in question..taking profit after tax as $860 million would be wrong because the tax calculation is wrong in question (30% of 1170=351) in question it is 310..if we correct profit after tax it would be $819 million and adding interest cost net of tax would give $875 million..
3.answer
even in semi-efficient market..we should assume that market does price business correctly which is question comes to 4.16 billion..using FCFE its comes $6.3 billion approx..this would suggest that existing investors doest not expect current FCFE to continue in perpetuity or it could be that even FCFE would be generated in perpetuity it would be lower than existing level…or it may be that investor is valuing expected future dividend rather than FCFE..assuming dividend remains constant value would be 4.049 which slight lower than current market capitalization..so they expect little growth..as per our evaluation of suitable target for acquisition..we should base our decision (to acquire this company) on our growth prediction of target’s future expected dividend and probability of prediction being correct using simulation analysis..
this is how we could comment when using FCFE as valuation…thanks for reply…but still i m confused..let me ask you to solve a question for me..
Anjan Plc asset’s market value is $55million..it wishes to raise $10 million to finance new project..repayable at the end of year 3 from now..its asset volatility is 40% p.a..
Bank’s base rate is 5.25%…level of recovery on default is 70%..
what interest rate per annum bank would charge to compensate its perceived level of risk.?our aim is to hedge our position as on today (1st January) I am sure you would not be in hedged position if you use Feb option coz you are relying on money market hedge or other derivatives for 1 month time lag…there could be so many what if question..like
1. what if there is policy to use only option for hedging..?
2. what if company does not have access to money market for GBP depositing?
3. Even if company has access to money market hedge why not to use it from 1st day instead of using option and then money market hedge..what is logic of using two hedge technique for one transaction..?
4. Also we are uncertain on 1 Jan what would be forward rate or future price at end of Feb…
5..Again if we intended to rely on other derivatives for 1 month time lag…why not to use them from very 1st day…instead of first using option(costly than other derivative) and other derivative for 1 month time lag…
6..I would again like to stress my point that if spot price were to increase both on Feb end and March end…say 1.45 at Feb end and 1.47 at Mar end…as i calculated earlier it would be far beneficial to use may option..
In conclusion considering above uncertainty as of today 1st Jan using Feb option would only hedge upto Feb end..after that relying on other derivative as on today is like taking risk as on today…why not to pay little extra premium(1344-1050)=$294 to hedge our position till our exposure date..i.e till 31 march..
I would again raise one important point behind my argument that using May option would not mean that i would lose advantage of exercising at 31 march..even if it is European option (selling at 31 march would nearly equate to exercising due to difference in change in spot price not equaling to change in option price..this would be minor)…
finally I would still stick to my decision to use May option as better hedging as on today 1st Jan….by using Feb option we would be exposed to 1 month time lag…
if spot price were to more than 1.42 at Feb end say 1.45…you would exercise at 1.42 total cost (62500*1.42=88750+1050=$89800+interest loss as you calculated 1331.25) gives total cost of $91131.25.
if spot price at end of march will be say 1.47…i would be able to sell my option to not only cover my premium but some extra gain as well..precise calculation involve using BSM model..i wont use here…but my total cost would be (62500*1.47=91875- gain on option which would be made of intrinsic value + time value)…if we take only intrinsic value (1.47-1.42) *62500=$3125 less premium initially paid $1344) gain on option would be $1781…then total cost would be 91875-1781=$90034 which is less then using Feb option…
option gives right without obligation to lock our position….buying may option at exercise price of 1.42 effectively gives us right to lock our position at march even if we cannot exercise it..(because we could return to our exercise price of 1.42 by making profit on sale)..by buying may option i am not gambling on premium..i am just ensuring my forex risk is hedged till march with just one transaction and hence at lower cost and less complex than by using two transactions)
Frankly speaking as treasurer i would use option only when my exposure is uncertain(or when other derivatives are not available)…coz my aim would be to hedge not speculate..so I am assuming on these examples that paying GPB 62500 is uncertain..say today is 1st january and as a US trader if i need to buy GBP 62,500 at end of March to pay my suppliers…why would i buy Feb option leaving still 1 month of exposure and as you said use money market hedge or other derivative for 1 month time lag..
If you mean exercising Feb option at Feb end and depositing GPB for 1 month in GPB money market generating interest and withdrawing at end of march to pay suppliers..then i would be exposed to GPB interest rate fall between now to deposit day..this would be more complex..as it would involve two techniques to hedge my position..
why not to prefer may option?…and selling in march to cancel out my risk..which would hedge my position with least effort then to what u propose…selling would nearly equate to exercising..coz if it seems exercising is beneficial at end of march..than that benefit would be included in its increased price..so selling and exercising would mean same except little difference that may be caused by basis risk…but for this little basis risk why to get expose to more risk by entering two transaction instead of one….hi sosologos,
you said we cannot lock our position at the very beginning. I am sorry i could not understand this…could u please elaborate..
if i pay premium to buy european options and at the day of transaction could not exercise to offset my loss on commercial transaction…i can realise the benefit of exercising through selling options and receiving premium which would be more than what premium i paid while buying..then only risk left would be basis risk or size of contract risk.. correct me if i am wrongIn these type of situation we are allowed to make reasonable assumptions..we will get full marks for it…but remember our assumptions should be reasonable,,even though there is trend of repayment but it would be difficult to predict precisely the amount of repayment in next six years..so considering the situation i would make assumption of no further repayment…
but it does not mean you cannot make assumption of repayment in future..but considering uncertainty due to lack of further information..it is better we make former assumption..and calculate the required figure..however you should be given credit even if you calculate on the basis of assumption of repayment.hey..new marking system directs us not to write across the center of margin of answer booklet..what does that mean..please help me to understand it
hey sosologos,
you said..”If it is an European option, it is useless to buy the May one because you must buy the foreign currency at the spot market in March. You merely waste money to buy an option that you will never exercise..”
I think even if we cannot exercise May European option on 1st march,,we can sell it in option market to realise the gain..if we made loss on commercial transaction..and vice versa..what do u say..correct me if i m wrong