Chapter 3

Question 1

Risk free rate

Answer 1

The rate of return which would satisfy investors if they were guaranteed the return.
OR
The rate required to compensate the individual for not be able to spend the money now - the rate of inflation.

Question 2

What is signalling

Answer 2

Dividend announcements convey information to the market affecting share prices. Management will tend to choose projects which promise positive announcements.

Question 3

ROCE =

Answer 3

Return on capital employed

Question 4

How to calculate proportion of business owned by the shareholder

Answer 4

Number of shares owned / total number of shares issued x 100%

Question 5

Types of shares

Answer 5

Ordinary shares (have voting rights)
Preference shares (no voting rights)

Question 6

How to calculate ROCE:

Answer 6

Profit before interest and tax / total assets less current liabilities x 100%

Question 7

Current liabilities

Answer 7

Any items owed by the company which are expected to be paid back within a year.

Question 8

EPS =

Answer 8

Earnings per share

Question 9

Calculate EPS:

Answer 9

Profit after tax and preference dividends / number of outstanding ordinary shares

Question 10

3 Factors affecting the share price

Answer 10

1. Internal factors
2. External factors
3. Financial factors

Question 11

2 types of risk

Answer 11

1. Systematic risk = uncertainty inherent in a particular market
2. Unsystematic risk = uncertainty inherent in a particular company

Question 12

Risk free rate =

Answer 12

The rate of return which would satisfy investors if they were guaranteed the return. Based on:
1. The rate required to compensate the individual for not being able to spend the money now
2. The rate of inflation

Question 13

3 factors affecting risk and return

Answer 13

1. Company’s strategy
2. Economic conditions
3. Expectations about the industry