Actuarial Society of India

Subject 108 - Finance and Financial Reporting November 2001 Examinations

1 In certain circumstances the Stock Exchange may grant a quotation for a company even though the company is not making any new shares or existing shares available to the market. This method of obtaining a quotation is known as: A placing B tender issue C introduction D prospectus issue [2] 2 Given that, Earnings per share = Rs 50 Dividend cover = 2.5 Published dividend yield = 3.2% The price of ordinary shares implied by the above data is A Rs 78 B Rs 625 C Rs 1,563 D Rs 3,906 3 An ordinary share may have a high dividend yield because A dividend cover is high B PE ratio is low C dividend growth prospects are poor D stock market is booming

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4 Which of the following would be the most likely outcome of a one percent decrease in interest rates? A the value of a low coupon bond would increase by more than the value of a high coupon bond with the same maturity B the value of a low coupon bond would increase by less than the value of a high coupon bond with the same maturity C the value of a low coupon bond would decrease by more than the value of a high coupon bond with the same maturity D the value of a low coupon bond would decrease by less than the value of a high coupon bond with the same maturity [2] 5 Which of the following is true in the process of issue of shares? A share issues must be underwritten B the underwriters profit depends on the success of the issue C underwriters may never become the owners of a substantial proportion of the issue D shares can not be issued in a bear market [2]

6 For which one of the following purposes is it not normally permissible to apply a share premium account? A writing off the preliminary expenses of forming a company B writing off the premium payable on redemption of shares C writing off the expenses incurred in an issue of shares D writing off the expenses incurred in issuing loan stock [2] 7 A taxpayer paid Rs 12,000 for an asset in April 1991 when the Retail Price Index (RPI) was 133.1. The taxpayer spent Rs 3,000 on enhancements in July 1994 when the RPI was 144.0. The asset was sold in July 1997 for Rs 23,000 when the RPI was 156.2. What is the chargeable gain after indexation on this sale? A Rs 5,397 B Rs 5,663 C Rs 6,729 D Rs 8,000 [2] 8 Which of the following would you normally expect to produce the highest running yield? A Ordinary shares B Preference shares C Loan stock D Convertible loan stock [2] 9 The price of a share is Rs 240 The exercise price of a put option is Rs 300 and the premium is Rs 20. What is the intrinsic value of the option? A Rs 20 B 0 C Rs 40 D Rs 60 [2] 10 It is unusual for companies to issue preference shares because A the ordinary shareholders would be pleased if the company cannot pay its preference dividend B tax relief cannot be claimed on preference dividends as they are post tax item C they are very expensive source of finance D they rank ahead of shareholders [2] 11 A government security stands below par. Which one of the following is true? A The net redemption yield is greater than the gross redemption yield B The gross redemption yield is greater than the running yield C It is partly paid D It is a long dated security [2] 12 Which one of the following would increase the premium for a call option? A lower interest rates

B very volatile underlying asset and shorter period to expiry C very volatile underlying asset and longer period to expiry D less volatile underlying asset and lower interest rate

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13 A convertible unsecured loan stock A ranks alongside creditors in a winding up B entitles holders to purchase ordinary shares in the company on a fixed date (or dates) in the future C gives holders a right to share in residual profits D ranks alongside secured loan stock in a winding up [2] 14 Each counter party to a swap A is protected from credit risk B is protected from all risks C is exposed to market risk D is exposed to liquidity risk

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15 One of the employees of a company developed a new product. This has just been patented. The development costs of this product were negligible, but the patent rights are almost certainly worth several million Rupees. Which accounting concept would prevent the company from recognising the value of this patent as a fixed asset in its balance sheet? A Going concern B Materiality C Money measurement D Prudence [2] 16 Which of the following best describes the effects of an increase in the risk characteristics of a project when evaluating its net present value? A the discount rate increases and the net present value increases B the discount rate increases and the net present value decreases C the discount rate remains constant, but the net present value decreases D the discount rate decreases and the net present value decreases [2] 17 When choosing between two mutually exclusive projects, the internal rate of return can give a misleading decision. Which one of the following may be the reason for this? A Internal rate of return may not be unique for a project B Internal rate of return ignores the rates of return available from other projects. C Internal rate of return ignores the cost of capital. D Internal rate of return is the rate at which the NPV is zero [2] 18 Which one of the following statement is true? A Specific risk can not be diversified away on a large, well spread portfolio B Systematic risk arises because of the volatility of the market as a whole C Diversification across a well diversified internationally-based portfolio will remove systematic risk entirely

D Specific risk remains the same across different asset classes

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19 A company in the UK has Rs 10,000,000 of ordinary share capital at a nominal value of Rs 10 for each share, and 100,000 5% preference shares at a nominal value of Rs 50 each. The directors decide to declare a dividend of Rs 5 per ordinary share. The total amount to be paid out by way of dividends is: A Rs 500,000 B Rs 750,000 C Rs 5,250,000 D Rs 5,500,000 [2] 20 Which one of the following statements about index linked stock is true? A The real yield varies with the rate of inflatio n. B The coupon rate will be more than the inflation rate C The net redemption yield is protected in real terms D The real yield is protected from inflation

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21 PQR Ltd bought a freehold property on 1 July 1999 for Rs 4,000,000, of which Rs 2,800,000 represented the value of the land. The buildings estimated useful economic life is 50 years from the date of purchase, and no residual value can be estimated. In PQR Ltds interim accounts for the six months to 31 December 1999, what should the depreciation charge be, using the straight line method? A Rs 12,000 B Rs 24,000 C Rs 20,000 D Rs 40,000 [2] 22 A contract between two parties to trade a specified asset on a set date in the future at a specified price could be A call option B put option C forward contract D any of the above [2] 23 A share has a beta of 1.5 relative to a diversified market portfolio. If the risk free return is 5% and the market return is 3%, what could be the return on the share? A 4.5% B 9.5% C 2% D 0.5% [2] 24 Which of the following may find that the contract is a liability at expiry? A buyer of a put option B writer of a put option C any of the above D none of the above

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25 Par value of an ordinary share A is the minimum price at which the share can be traded in a stock exchange B is the minimum price at which shares can be issued by the company C is the minimum price at which the share will be redeemed D all of the above 26 The Prudence concept requires A increasing the financial strength of the company B optimistic assessment of the financial strength of the company C conservative estimate of the financial strength of the company D avoiding risky ventures by the company 27 Share premium account reflects the difference between A the market price and the issue price of the share B the nominal value and the issue price of the share C the market price and purchase price of the share D the market value and the nominal value of the share 28 Life insurance companies typically A have long term liabilities B are long term investors C are passive traders in stock market D all of the above

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29 The published financial statements of a company show a gross profit for the year of Rs 6.5 million. A major error in the stock valuation has just been discovered and rectified. The figure for opening stock is increased by Rs 1.3 million, and the closing stock is decreased Rs 1.6 million. What would be the revised figure for gross profit for the year? A Rs 3.5m B Rs 6.2m C Rs 6.8m D Rs 9.4m [2] 30 Which of the following holds good for investors of unit trust and investment trust A their holdings can be traded in stock exchange B fund management charges could diminish their returns C NAV is not affected by the value of underlying investments D none of the above [2] 31 Explain the importance of the cash flow statement to the shareholders of a limited company. [6] 32 Why is the yield on a company loan stock normally higher than the yield on a comparable
gilt? [2]

33 Explain how goodwill can arise on consolidation and how it would be treated in the accounts. [6] 34 Describe the main characteristics of Eurobonds. 35 The financial statements for XYZ Ltd for the years ended 31/12/1999 and 31/12/2000 are as follows: Profit and Loss Accounts (Rs 000) 1999 2000 Sales Cost of sales Gross profit Selling expenses Bad debts Depreciation Interest Net profit Reserves brought forward 1,800 (720) 1,080 (300) (36) (116) (24) 604 654 1,258 31/12/1999 5,600 (3,360) 2,240 (540) (280) (416) (384) 620 1,258 1,878 31/12/2000 [6]

Balance Sheets (Rs 000) Fixed assets: Factory Machinery Current assets: Stock Debtors Bank Current liabilities: Creditors Bank Current assets less current liabilities Borrowings Share capital Profit and loss

900 980 1,880 60 166 24 250 (72) (72) 178 2,058 (200) 1,858 600 1,258 1,858

882 3,582 4,464 476 1,166 1,642 (350) (22) (372) 1,270 5,734 (3,200) 2,534 656 1,878 2,534

At the end of 1999, the directors of XYZ Ltd asked a firm of management consultants to advise them on how to improve the companys performance. Although XYZ was making reasonable profits, the directors felt that there was room for improvement. The management consultants were specifically instructed to devise a plan to increase sales and profits. After a detailed investigation of the companys current strategy, the consultants recommended that XYZ should reduce its selling prices and extend its credit terms to customers. In order to do this, the company was required to make heavy investments in new machinery early in 2000 to meet the demand which the change in sales policy had created. Once the 2000 financial statements were available, the management consultants met again with the directors of XYZ and argued that the financial statements for the two years showed that the new policy had been a great success because sales and, more importantly, profits, had increased dramatically. (i) Explain whether you agree with the management consultants that the performance for the year ended 31/12/2000 and the financial position at that date had improved as a result of the new policies adopted by the company. You should support your answer with appropriate ratios. [16] (ii) The management consultants have pointed out that XYZ could improve its cash flow position in 2001 by reversing the previous policy, and reducing the credit period offered to customers. Calculate the amount of cash which would be released if the company could impose a collection period of only 45 days. (All of XYZ Ltds sales are on credit). [4] [Total 20]