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Greetings!
Hope you are doing well Mr Moffat.
Below i have compiled list of questions that if you could please assist on. Thank you
1: Speaking of FRA on “interest”, being an OTC it has a default risk that bank might not be able to tender, why the same is not said in interest rate swap with a BANK. It states that there is no counterparty risk if swap is arranged with a bank.
2: The options on interest futures would always be less advantageous compared with futures, when the manager exercises the option being a risk averse. Is this statement true.
3: The swap being a long term in nature could be detrimental it is said that if interest rate behave in the opposite direction of risk. Company is liable to fulfill the obligations for a longer duration, however it was stated in one of the answer that, swap being a long term is an advantage as well. Is it because we dont have to speculate again and again or engage in futures contract again and again.
4:Swap make use of comparative advantage, thats how a swap function in the first place to benefit, if i am understanding the wording correctly.
5: A hostile takeover would only exist in a situation where directors dont have significant stake in the company, e,g if they own 51 % of company or own 40 % percent of company even and no other institutional investor have a massive voting rights to exert influence. All the defense strategies would need not be called for,
Contrary if an institutional investor have lets say 60% percent stake and managing directors dont have any stake. They cant exercise post bid defense strategies as it would require shareholder approval and if shareholder like the sound of premium, then there is nothing the directors can do.
6: The question of securitisation can come up as numerical question as well?
7: 2018 March-June 2018. Tippletine. The business risk changed going into office equipment from electrical goods, why asset beta was not amended or any information given in the question to do so
8: A new investment NPV based on recalculated Wacc( specific to project) and Apv would give same values?
I dont understand why it is said value added or destroyed wording, The net effect of financing cash flows always adds on to the project base case NPV.
In Q5: in the contrary situation the directors have 10 percent stake, they need to have a stake to be the directors *
9: VAR for 95% and 99% corresponding values are -1.65 and -2.33 when mutiplied against with the standard deviation value we deduce the loss in the value of portfolio per annum. I did watch your lecture but couldnt understand how the normal distribution values were derived mentioned above, although i have covered real options, neverthless in exam we would deal with these two confidence level only ? or can we be asked 93 % confidence level. More importantly what is the whole basis for VAR, why fund managers are geared towards the fall in portfolio, when markets could be in bull trend and as fund managers they have expertise to increase value of their portfolio.
10: Scenario
A company is wholly funded by debt and undertakes to expand into another branch for which choses debt to execute the project for which a subsidised loan is given by govt. 2 percent below normal borrowing.
kd is 6 %
How do we determine KE to deduce APV, even if we do, there are no equity holders to begin with?
1. Counterparty risk is the risk that the other party does not meet honour its commitment for whatever reason. If the swap is arranged with a bank or arranged through a bank, then there is no risk of them not honouring their commitment – there remains the default risk of the bank collapsing. It is a very fine distinction and usually counterparty risk and default risk are taken to mean the same.
2. No, the statement is not true.
3. I don’t know what your question is. However futures deals are limited in their duration – they are only short-term.
4. Yes. As I explain in my free lectures, interest rate swaps are only beneficial if the difference between the fixed and floating rates available to each party is different.
5. A hostile takeover is where the management do not want the takeover. If the directors own a significant % of the shares then they do not need defence strategies because they are in a position to block the takeover themselves.
6. Yes, and it has been asked as a calculation (but with precise details of how it was to work).
7. The ungeared cost of equity of Humabuz (in a similar business) was used (calculated using the MM formula). The ungeared cost of equity is determined by the asset beta of Humabuz.
8. Yes, using a project specific WACC would give the same result, but the problem is that the value of the equity be affected by the gearing which in turn would change the gearing. It therefore would need an iterative approach (keeping repeating the exercise) which gets very messy and takes ages.
I don’t know where you are quoting from and the contact of what you are quoting.
Directors are not required to hold any shares to be directors.9. We work backwards from the tables. For 95% we need the answer from the tables to be 95 – 50 = 45% or 0.4500. The nearest value resulting in an answer of 0.4500 is 1.65 std devns. Similarly for 99% we need the answer from the tables to be 99 – 50 = 49% or 0.4900. The nearest value resulting in 0.4900 is 2.33 std devns.
In theory you could be asked for a 93% confidence level, but it would be silly for the examiner to ask it and I don’t believe he ever will.
The market can change from being a bull market to a bear market overnight, and fund managers are not ‘perfect’ anyway – plenty of funds have collapsed in the past. Also VaR is not just relevant to fund managers it is just as relevant to banks with outstanding loans. They need to be in a position to know what the worst that could happen is.10. A company cannot be financed entirely from debt, either in real life or in the exam.
8: “While the adjusted present value method is similar to the discounted cash flow (DCF) methodology, adjusted present cash flow does not capture taxes or other financing effects in a weighted average cost of capital (WACC) or other adjusted discount rates”
I copied the above from investopedia not entirely sure what it means.
5: However in such a case if a shareholder or groups of shareholders who get together and collectively vote more than 50 % and dont authorize a defense strategy such as a spin off to a white knight. Hence in such cases defense strategies are meaningless needing shareholder approval, in case they are satisfied with the initial bid
3: Yes they are short term hence we can keep engaging in futures contract again and again instead of locking into a swap and cant get out of it. How come swap as a long term is beneficial.
8: I noticed in my auditing career that founders were directors of company taking one share each from 2 on incorporation, hence thought so
10: Understood
6: Is there a lecture on it?
10 and 9: Got it
2: Would get back on this
8 The WACC includes the after-tax cost of debt in the calculation and MM state that the only reason the WACC changes with changes in gearing is because of the tax saving on debt interest. With APV that tax saving is accounted for separately. Have you watched my free lectures on APV?
3. Because there is not the need to keep entering into a futures deal.
6 No, because it has only been asked once in the exam and the question gave full instructions. The definition is listed in the notes, and I have explained in detail in answers to questions in this forum (which you can find using the search box).
8 It is quite common for small companies that the directors are also the shareholders, but there is certainly no requirement for that to be the case (as you should remember from Paper LW (was F4)).
I was able to do all the questions hence didnt invest more time in watching lectures and thanks to post being archived, lot of similar problems i ran into were solved by looking at archived posts.
All clear, thanks
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