As2114 2021 QP

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Cass Undergraduate Programme

BSc Actuarial Science


BSc Finance with Actuarial Science
BSc Mathemetical Science

AS2114 Fundamentals of Finance


Stage 2 Examination

January 2021 2 hours 15 mins


Instructions to students:

Candidates should answer ALL questions.

If you believe a question to be ambiguous you are advised to make reasonable


assumptions provided they are consistent with the facts given in the question.
State any such assumptions clearly in your answer and proceed. If you believe
there to be an error in the question state this and proceed.

This paper consists of 8 printed pages including the title page and the Taxation
Rules (available at the end of the paper).

Materials:

This paper should be handwritten on lined paper

All assessment will need to be submitted to the Moodle dropbox as one single pdf file

All submissions must be labelled in the correct format of your Student ID followed by a
full stop followed by the module code:
o 9digitnumber.ModuleCode (shown on the cover of all assessment as two letters
followed by four numbers)

Any queries should be addressed to: cass-ug-examinations@city.ac.uk

Internal Examiner: Naaguesh Appadu


External Examiner:

Page 1 of 8
Question 1

Which of the following best explains the logic behind attaching a warrant to a
bond issue?

(a) Issuing warrants will enable the company to repay the bonds from the
associated share issue.
(b) The lender may be prepared to accept a lower rate of interest in return for the
capital appreciation offered by the warrant.
(c) Warrants motivate the shareholders by offering the opportunity to spread the
risks associated with investment.
(d) In an ideal world, the warrants will expire before they can be exercised.
(2 Marks)

Question 2

A Brazilian trader is due to receive a substantial receipt in Euros in three months’


time. Which of the following best explains why the trader might use a currency
option rather than a currency future to hedge this transaction?

(a) The value of currency futures can be highly volatile.


(b) The counterparty to a financial future might default and leave the position
exposed.
(c) An option will provide scope for an upside if the Euro strengthens.
(d) An option will provide scope for an upside if the Euro weakens.
(2 Marks)
Question 3

Which of the following is NOT true of Eurobonds?

(a) They are issued in Euros.


(b) They can be issued by a company or government.
(c) They are traded through banks.
(d) They are international bonds.
(2 Marks)

Question 4

A quoted company made a substantial rights issue. A shareholder who had a


substantial shareholding did not wish to take up the right to buy shares and forgot
to sell those rights.
Which of the following best describes the effects of this forgetful shareholder’s
actions?

(a) The forgetful shareholder was worse off because of the rights issue and the
other shareholders were unaffected.
(b) The forgetful shareholder was worse off because of the rights issue and the
other shareholders were better off.
(c) The forgetful shareholder was unaffected by the rights issue and the other
shareholders were better off.
(d) The forgetful shareholder was unaffected by the rights issue and the other
shareholders were worse off.
(2 Marks)

Page 2 of 8
Question 5
Which of the following best supports the assertion that the payment of a dividend
signals confidence on the part of the directors?

(a) The dividend is paid out of past profits that have actually been earned.
(b) The directors are keen to receive dividends from their own shareholdings.
(c) The directors have to find the cash with which to pay the dividend.
(d) The shareholders will react badly to the non-payment of a dividend.
(2 Marks)

Question 6
Why should an eligible bill of exchange be regarded as a very secure
investment?

(a) The issuer is eligible to issue secure bills of exchange.


(b) The holder of the bill is eligible to claim repayment in full at any time.
(c) The bill has been guaranteed by a bank.
(d) The bill has been drafted by an eligible intermediary.
(2 Marks)

Page 3 of 8
Question 7

Share issues are often, but not always, underwritten.

Explain the factors that have to be considered by the directors in deciding


whether or not to have an issue underwritten.

(5 Marks)

Question 8

Savannah recently inherited a substantial sum of money. Her friend Nick is a


successful businessman who owns a small IT firm. Nick is a sole trader. He has
offered Savannah the opportunity to become a sleeping partner in his business.
She will invest £225,000 of her inheritance in return for a partnership share of 33%
of all future profits. She will not take any part in the running of the business. The
business is profitable and is struggling to keep up with demand, so the expansion
will probably be successful.

Describe the risks that Savannah will be taking on if she enters into this
arrangement with Nick.

(5 Marks)

Page 4 of 8
Question 9 (A)

Dynamic Trader plc is an international conglomerate construction company that


specialises in building, construction and refurbishment of residential properties.
Dynamic Trader plc is based in the UK. Amrit is one of ten project managers of the
UK head office. Each project manager overlooks 30 projects in one year. Each
project brings an average revenue of £50,000. The total costs of all projects for the
period 2020/2021 are £10million. Dynamic Trader Plc has also two subsidiaries in
Europe, one in Cyprus and the other one is in Greece. The Greek subsidiary has
a taxable profit of £2m while the subsidiary in Cyprus has a taxable profit of £2.3m
for the period 2020/2021. The corporation tax rate for Greece is 29% and that of
Cyprus is 12.5%.

(a) Calculate how much tax Dynamic Trader plc will need to pay for the period
2020/2021.
(Show your calculations for UK, Greece and Cyprus and explain the relevant rules)
(4 Marks)
Question 9 (B)

Amrit has over 20 years of experience and earns £95,000 in wages in the
2020/2021 tax year. Over the years, he has invested his extra savings in buying
shares in various firms. In this calendar year, he is expected to receive a total
dividend of £7,500. Out of the total dividends, £1,500 are from ISAs.

In July 2020, Amrit sadly loses his mother to Covid-19. Amrit’s mother left a will
which states that £50,000 of her estate should be bequeathed to Cancer Research
UK, a charitable institution, with the remainder of her wealth to be bequeathed to
Amrit. Moreover, Amrit’s mum had £75,000 as ISA and £350,000 in her current
account.

(b) Calculate the tax paid by Amrit.


(Explain all the steps and assumptions(rules) in your calculations)

(6 Marks)

Total (10 Marks)

Page 5 of 8
Question 10

Kirkland Signature plc is considering a six-year project that has been proposed by
the company’s director. A customer is about to sell a specialised grinding machine
that has become surplus to requirements. This type of machine is quite expensive
and second-hand machines are rarely sold on the open market. The machine has
an expected remaining useful life of six years and has been checked and certified
by an independent engineer.

The director proposes to buy the used machine for £4 million and to use it to
manufacture a new product for which Kirkland Signature plc owns some patent
rights and which cannot be manufactured in an economic manner without such
equipment. The director proposes taking out a six-year lease on a factory building
and using an employment agency to provide labour for the six-year period. The
director estimates that it would be necessary to invest a further £1 million at the
start of the first year in addition to buying the machine.

The director has drafted the following inflows and outflows of the project:
£m
Revenue 2.6
Raw materials (0.4)
Labour and operating costs (0.5)
Other running costs (0.5)

It is anticipated that raw materials, recurring labour and operating costs and other
running costs, such as the cost of electricity and maintenance costs, will be paid
annually at the end of each year.

Revenues will be received at the end of the each of the next six years.

The director has shown this proposal to a potential lender, who has agreed to lend
Kirkland Signature plc £5 million at an interest rate of 7% per annum (p.a.) This
loan will be secured on Kirkland Signature plc’s existing assets because the
grinding machine is deemed to be too specialised to be a suitable form of security.

The sales director proposes that the project should be evaluated at a required rate
of return of 7% p.a. because it will be financed by means of a self-contained loan
package upon which that rate will be charged. The finance director believes that
the project should be evaluated at a much higher rate than 7% p.a., but cannot
state the specific rate that should be charged without conducting a further analysis.

(a) Calculate the net present value and the profitability index of the project using a
discount rate of 7% p.a. and ignoring tax.

(6 Marks)

(b) Explain why the required rate of return might be higher than the 7% rate charged
by the bank on the funding for the project.
(4 Marks)

Total (10 Marks)

Page 6 of 8
Question 11 (A)

Big Joe Plc., the entertainment conglomerate, has a beta of 1.61. Part of the
reason for a high beta is the debt left over from Joe Plc’s leverage buyout of Big
Plc in 2009, which amounted to £10billion in 2015. The debt outstanding is as
follows: the market value of Bond A is £3billion and the other two bonds, Bond B
and Bond C, have equal amounts. The respective hurdle rates are 6.6%, 6.1% and
5.9%. The risk-free rate is 1.9% and the equity risk premium is 4.1%. The marginal
tax rate is 19%.
The market value of equity of Big Joe Plc in 2015 was also £10billion. The marginal
tax rate was 20%.

(a) Estimate the WACC.

(6 Marks)

(b) Estimate the unlevered beta for Big Joe Plc.

(2 Marks)

(c) Estimate the effect of reducing the debt ratio by 10% each year for the next
two years on the beta of the stock.
(4 Marks)

Question 11 (B)

The CFO of Stealth Computer Services, a growing software company, has


approached you for some advice regarding the beta of his company. He subscribes
to a service that estimates Stealth Computer Services’ beta each year. He has
noticed that the beta estimates have gone down every year from the period 2011
till 2015. In 2011 the beta was 2.15 and in 2015, the beta has gone down to 1.20.
He would like answers to the following questions:

(a) Is this decline in beta unusual for a growing firm?

(3 Marks)

(b) Is the beta likely to keep decreasing over time?

(3 Marks)

Total (18 Marks)

Page 7 of 8
Taxation Rules 2020/2021

These rules apply to examinations set in respect of the academic year 2020-2021 and are
based on the taxation rates for the United Kingdom in the tax year 2020-2021.

Personal Allowance £12,500

Personal allowance reduction threshold £100,000

Basic rate tax band £12,501-£50,000

Basic rate tax 20%

Higher rate tax band £50,001-£150,000

Higher rate tax 40%

Additional rate tax band £150,000

Additional rate tax 45%

Capital gains tax rates (Basic Band) 10% Chargeable asset, 18% higher rate

Capital gains tax rates (Highest Band) 20% Chargeable asset, 28% higher rate

Corporation tax 19%

Capital gains tax allowance £12,300

Inheritance tax allowance 325,000

Standard Inheritance tax rate 40%

Dividend Allowance £2000

Dividend: Basic rate 7.5%

Dividend: Higher rate 32.5%

Dividend: Additional rate 38.1%

Page 8 of 8

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