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2023 FTX3044F Test 1

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FTX3044F

FINANCE IIA

TIME: 90 MINUTES + 23 MARCH 2023 MARKS: 75


5 MINUTES READING

PLEASE READ THE FOLLOWING INSTRUCTIONS VERY CAREFULLY

1. All cell phones must be switched off for the duration of the test and placed in your bags
out of sight underneath your chair.

2. Please fill in your personal details on the attendance slip and leave this on your desk
with your student card.

3. Complete your personal details on the cover of all answer books before the start of the
test.

4. Sections A and B should be answered in one answer book, and Section C in a


second answer book. You must hand in both books at the end of the test.

5. Do not open this test paper until instructed to do so. You may not write anything
on your test paper or in your answer books before the start of the test or once you have
been instructed to stop writing.

6. From the time the first test paper is distributed to the class and until the last test answer
book is collected you may not talk to any other student. This is a standard university
policy and anyone contravening this rule will be disqualified.

7. Written answers must be completed in blue or black ink only. The university allows
workings to be in pencil although we encourage you to do these in pen and clearly
mark them.

8. No questions will be answered by the invigilators during the test. Make whatever
assumptions you deem appropriate and clearly state these in your answer.

This test paper consists of 8 pages including the cover page and formula
sheet.

Page 1 of 8
SECTION A (24 marks, 29 minutes)

Required:
There are 8 questions in this section each worth 3 marks. There is no negative
marking. Select the most correct option. You do not need to explain your answer.

1. When an investor borrows part of the investment cost it is known as:


a) A margin transaction.
b) A short sale.
c) Going long.
d) A limit order.

2. In a price weighted average stock market indicator series (index), the following type
of stock has the greatest influence:
a) The stock with the highest price.
b) The stock with the lowest price.
c) The stock with the highest market capitalisation.
d) The stock with the lowest market capitalisation.

3. Financial markets, such as stock markets, are incredibly useful from a societal
perspective. The following is true about stock markets:
a) They do not provide information useful for capital allocation decisions.
b) Stock markets are synonymous with capitalism. Therefore, you do not find stock
markets in countries ruled by communist parties.
c) Only shares can be traded on stock markets.
d) A strong focus on potential returns only is the best way to succeed on the stock
market.

4. If you place a limit order to sell 100 shares of stock at $55 when the current price is
$62, how much will you receive for each share if the price drops to $50?
a) $55.
b) $62.
c) $50.
d) You cannot tell from the information given.

Page 2 of 8
5. You were provided with spreadsheet models to explore margin trading and short
selling. In addition, your lecturer illustrated how to use the command Data Table to
easily do sensitivity analyses. The following is true of that application:
a) Data Table can be used to analyse the impact of varying three or more input
variables.
b) Sensitivity analysis of the short selling model demonstrated that a higher margin
percentage amplifies potential gains and losses more.
c) To implement the one-dimensional Data Table command in your example, one
must highlight the area outlined in the dark border.

Return on
investment
-50.00%
80
90
Stock 100
price 110
120
130
140

d) To implement the one-dimensional Data Table command in your example, one


must highlight the area outlined in the dark border.

Return on
investment
-50.00%
80
90
Stock 100
price 110
120
130
140

6. If the economy is growing, firms with high operating leverage will experience:
a) higher increases in profits than firms with low operating leverage.
b) similar increases in profits as firms with low operating leverage.
c) smaller increases in profits than firms with low operating leverage.
d) no change in profits.

Page 3 of 8
7. Fiscal policy generally has a _______ direct impact than monetary policy on the
economy, and the formulation and implementation of fiscal policy is ______ than
that of monetary policy.
a) more; quicker
b) more; slower
c) less; quicker
d) less; slower

8. The Fan Company is expected to pay a dividend of R3.50 in the coming year.
Dividends are expected to grow at a rate of 10% per year. The risk-free rate of
return is 5%, and the expected return on the market portfolio is 13%. The stock is
trading in the market today at a price of R90.00. What is the market-capitalisation
rate for the company?
a) 13.6%
b) 13.9%
c) 15.6%
d) 16.9%

Page 4 of 8
SECTION B (16 marks, 19 minutes)

This section comprises 3 questions totalling 16 marks. Answer all questions.

QUESTION 1 (5 marks)

Mzani Solar Ltd has just posted an EPS of R20 per share. The capitalisation rate is
9.5% and ROE is 13%.

Required:

a) Suppose Mzani expects to pay out 70% of EPS as dividends, what will the value
of the share be, assuming the share price is equal to its intrinsic value?
(3 marks)

b) Determine the PVGO of the share. (2 marks)

QUESTION 2 (6 marks)

The Covey firm produces widgets and sells them at R1 each. The firm has total fixed
costs of R500,000 and variable costs of 50 cents per widget. The corporate tax rate is
28%. If the economy is strong, the firm will sell 1,200,000 widgets. If the economy
enters a recession, the firm will sell 1,100,000 widgets.

Required:

a) If the economy is strong, what will the after-tax profit of the firm be? (2 marks)

b) If the economy enters a recession, from being strong, what will the after-tax profit
of the firm be? (2 marks)

c) Calculate the firm’s degree of operating leverage and interpret it. (2 marks)

QUESTION 3 (5 marks)

Required:

a) List and briefly describe the three main approaches to valuing a business.
(3 marks)

b) Explain how credit growth increases the value of a business. (2 marks)

Page 5 of 8
SECTION C (35 marks, 42 minutes)

This section comprises 3 questions totalling 35 marks. Answer all questions.

QUESTION 1 (10 marks)

Sally Smith bought 1000 shares of Curro Ltd. on a 55% initial margin one month ago
when the shares were selling at R9.00 per share. The shares are currently selling at
R8.00 per share. The maintenance margin is 30%.

Required:

a) Why would anybody want to make use of margin trading? (2 marks)

b) Is margin trading riskier than trading without margin? Explain. (2 marks)

c) Calculate Sally’s initial investment from her own capital. (1 mark)

d) Calculate Sally’s overall return on investment if she was to sell her shares today.
Transaction costs can be ignored. (2 marks)

e) What is the trigger share price just before Sally would receive a margin call?
(2 marks)

f) True or false. Is this loss making of Sally’s an example of a so-called short


squeeze? (1 mark)

QUESTION 2 (5 marks)

You have all been encouraged to participate in the JSE Investment Challenge. Rule
20 of the JSE Investment Challenge for 2023 is short and simply reads “Boom or bust
will apply.”

Required:

a) Explain what this possibly means and identify implications of this rule. (4 marks)

b) Why are so many companies that are listed on the JSE choosing to also dual list
on A2X Markets? (1 mark)

Page 6 of 8
QUESTION 3 (20 marks)

The shares of Prosus N.V. trade on both the JSE and A2X Markets. You have the
following bids and offers available on the two exchanges:

JSE (PRX)
Bid volume Bid price (Rands) Offer volume Offer price (Rands)
1200 1296.46 800 1297.12
500 1296.20 1100 1297.48
300 1295.97 1600 1298.10

A2X (PRX)
Bid volume Bid price (Rands) Offer volume Offer price (Rands)
250 1298.73 700 1299.12
800 1298.34 900 1299.38
300 1297.40 1200 1299.99

Required:

a) What is the meaning of the “PRX” in brackets next to each exchange’s name?
(1 mark)

b) Explain the meaning of the “N.V.” after Prosus’ name? (2 marks)

c) If you are wanting to sell your 1000 Prosus N.V. shares then what order will you
place (bid or offer on what exchange and at what price)? (3 marks)

d) Assume that the average share price is R1300 per share for the 1000 shares sold.
Calculate the total explicit costs of the transaction if sold on the JSE. You can
assume your broker charges 0.5% (ex-VAT) brokerage (minimum R99), the Strate
settlement fee is 0.005787% (ex-VAT) (minimum R10.19 and maximum R73.49)
and the investor protection levy is 0.0002% (ex-VAT). Securities transfer tax is
0.25%. (5 marks)

e) For some reason Strate charges more on A2X Markets than on the JSE. Explain
why that could be. (1 mark)

f) Explain whether an arbitrage opportunity is available in this example. Does that


opportunity remain if it is given that one cannot sell a share bought on one
exchange on another exchange? (2 marks)

g) What is the maximum Rand amount of riskless profit available if it is given that
transaction costs can be ignored, that long and short positions are possible on both
exchanges, and that only the information on this page is to be used. (4 marks)

h) Give a possible rational reason why the price of the same asset might differ slightly
between different markets. (2 marks)

THE END

Page 7 of 8
Useful Formulae

𝐷𝐷𝑜𝑜 (1+𝑔𝑔) 𝐷𝐷1


𝑉𝑉0 = =
𝑘𝑘−𝑔𝑔 𝑘𝑘−𝑔𝑔

𝐸𝐸1
𝑃𝑃0 = 𝑘𝑘
+ 𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃

𝐾𝐾 = 𝑅𝑅𝑓𝑓 + 𝑏𝑏(𝐾𝐾𝑚𝑚 − 𝑅𝑅𝑓𝑓 )

𝐹𝐹𝐹𝐹
𝐷𝐷𝐷𝐷𝐷𝐷 = 1 +
𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃𝑃

%𝑐𝑐ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑖𝑖𝑖𝑖 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝


𝐷𝐷𝐷𝐷𝐷𝐷 =
% 𝑐𝑐ℎ𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 𝑖𝑖𝑖𝑖 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠

𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺𝐺ℎ = 𝑅𝑅𝑅𝑅𝑅𝑅 ∗ 𝑏𝑏

Page 8 of 8

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