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Dear Mr Moffat,
On the exam they asked us to analyze the following statement:
Assuming the beta of debt to be zero understates financial risk during re-gearing, or smth like this.
I marked this one as wrong, because if i am not mistaken, we use beta of debt in calculation of asset beta, we use asset beta during ungearing, and asset beta represents business risk, not financial risk, am i right?
Thanks!
i think it understates financial risk during ungearing, but not during gearing back, as the exam stated
It is difficult for me without seeing the exact question.
However when re-gearing (to calculate the equity beta), then it means using the asset beta formula ‘backwards’.
So the equity beta = (((Ve + Vd(1-T)) / Ve) x asset beta) – (Vd(1-T) x debt beta)
By assuming the debt beta is zero, we end up with a higher equity beta then we would otherwise.
So I would agree with you – assuming it to be zero overstates the financial risk.Thank You, dear Mr Moffat! Thank You very much. The last points I would like to clarify, are:
A) whether market segmentation explains kinks in yield curves
B) money market deposits are short term loans between organizations such as banks – is this right?
C) factoring improves efficiency of receivables management in the company?
D) borrowers buy futures expecting interest rate increase and then sell them – is this one right?
E) one statement claimed that expected values are calculated for projects with several outcomes that occur ONCE – is this right?These were the most difficult ones. Thank You in advance
A) Yes – it is one of the possible reasons (see the Lecture Notes
B) They are short-term and are organisations such as banks (but not restricted to being between banks)
C) Yes (hopefully 🙂 )
D) No – they sell futures if they expect interest rates to rise (and buy them back later)
E) This is a difficult one. They can be calculated whether the outcomes occur once or are repeated. As far as projects are concerned, certainly it is usually when the outcome only occurs once.
Thank You very much! On the last one, i just thought that expected values do not occur once, they occur over several times, thats ehy i marked it wrong :/
Mr Moffat, so there is a chance of my choice being true? I just remembered this from F5, that expected values for projects with several outcomes do not occur once, they occur over many times.
I can’t really answer without seeing the exact question.
Usually expected values are used for one-off projects.If they used for one-off projects, they never actually occur, that was my logic though 🙂 btw, Sir, we saying re-gearing we mean gearing equity beta, am I right? The point stated: Assuming beta of debt to be zero understates financial risk during gearing equity beta
Do share options always value good performance?
Sorry for loading You, Sir, just feel really nervous about the exam, especially when they wont publish mcqs!
In answer to your first post:
For one-off projects, it is true – the expected value will not actually occur.
Re-gearing a beta means calculating the equity beta from the asset beta for a particular level of gearing.
In answer to your second question:
Not necessarily – it depends on the scheme for awarding share options, and how ‘good performance’ is defined.
However, giving share options to directors/employees certainly will encourage them to work towards improving the market value of the shares, which is a primary goal for any business.
Dear Mr Moffat, so, to conclude, if they say that assuming beta of debt to be zero understates financial risk during gearing equity beta, then its false?
How many marks would I lose if the question asked to calculate total market value using various models, but i calculated (correctly) market value per share instead?
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