Financial Assets and Asset Valuation (I)

Question 1

Assets have a _____ and generate _____.

Answer 1

Assets have a lifetime and generate cash flow.

Question 2

There are three types of assets, namely:

Answer 2

Defining Assets
Categorising Assets
Financial Assets

Question 3

What are defining assets?

Answer 3

Resources capable of generating cash flow

Question 4

What are categorising assets?

Answer 4

Can be split into two options:
• Accounting / balance sheet approach (current, fixed and intangible assets)
• Assets as investment options (cash/liquid assets; real/tangible assets, financial assets)

Question 5

What are financial assets?

Answer 5

Those which relate to the government/ public sector such as bond, gilts, treasury bills.
Or those which relate to private sector such as equities, shares, debentures, euro bonds, etc

Question 6

Governments issue a variety of debt obligations with maturity dates to finance their activities. These are called…

Answer 6

Bonds / Gilts / Treasury bills

Question 7

What are Coupons?

Answer 7

The coupon rate is the annual interest paid on the face value of a bond, expressed as a %

Question 8

What are Bonds / Gilts / Gilt-edged Bonds?

Answer 8

5-15 year maturity
Use fixed interest payments (coupon) until loan is fully repaid
Less risk investment, but are less attractive to have when interest or inflation rates increase - they sell at a discount instead!

Question 9

What are Treasury bills (T-bills)

Answer 9

Short term debt obligations with 3mo, 6mo, or 1 yr maturity
Governments with them don’t make regular payments (coupons) instead T-bills are sold below par value (or face value) to create profit at maturity date.

Question 10

What are debentures? Describe Fixed, Floating and Naked Debentures.

Answer 10

Debt obligations issued as fixed interest stocks (like bonds!)
“Fixed” are when loans are secured against specific assets
“Floating” are when loans are secured against general assets
“Naked” are when loans are unsecure

Question 11

What are Eurobonds?

Answer 11

Loans denominated in currencies other that the currency of one’s own country (e.g. US dollar sold to UK)
Isn’t limited to issuing from the EU!

Question 12

Shares entitle their owners to ______ of the company

Answer 12

Shares entitle their owners to part-ownership of the company

Question 13

Ordinary shareholders bare the _______ financial risk since they are paid dividends ____ all financial commitments are met

Answer 13

Ordinary shareholders bare the ultimate financial risk since they are paid dividends AFTER all financial commitments are met

Question 14

What are preference shares?

Answer 14

A hybrid of ordinary shares and loans advanced to companies. They are paid fixed and more secure the ordinary share holders but come after creditors if the company liquidates.

Question 15

Financial Derivatives are ______ of contracts between two parties that give the holder ______ to either buy or sell underlying asset at a ______ price

Answer 15

Financial Derivatives are certificates of contracts between two parties that give the holder right to either buy or sell underlying asset at a predetermined price

Question 16

Derivatives are risky because

Answer 16

Their payoffs are based on the outcome of trends in future market developments
The assets their based on could be “toxic”

Question 17

Refer to table on slide 7 of lecture 3

Answer 17

Refer to table on slide 7 of lecture 3

Question 18

Discounting expected future cash flow to present value is called ______.

Answer 18

Discounting expected future cash flow to present value is called capitalisation of income.

Question 19

To discount cash flow to present value, we require (2 things)

Answer 19

Earnings (cash flows) to be capitalised

Appropriate capitalisation or discount rate

Question 20

What is appropriate capitalisation rate?

Answer 20

The minimum expected rate required to induce investors to accept the investment
It is a function of the assets sensitivity to risks such as inflation, interest rates, etc.

Question 21

Compounding converts _____ cash flow into _____ cash flow

Answer 21

Compounding converts present cash flow into future cash flow

Question 22

Discounting converts _____ cash flow into _____ cash flow.

Answer 22

Discounting converts future cash flow into present cash flow.

Question 23

What is the “like-with-like” additivity principle?

Answer 23

Cash flows at different points in time can’t be compared, they must be brought to the same point in time first.

Question 24

Translate the notations
PV
FV
CF_t
k
g

Answer 24

Present Value
Future Value
Cash flow on date t
Discount rate
Expected growth rate

Question 25

What is PVC

Answer 25

Present value costs from an investment over a project life.

If benefit streams are invariant, projects with the least PVC will be chosen

Question 26

What is levelised cost?

Answer 26

Used to compare cost of energy from renewable and non-renewable sources.
Allows comparison between price of energy/electricity from different types of power plants.
(Example OMP)

Question 27

What is Internal Rate of Return? (IRR)

Answer 27

The discounted cash flow yield. It is the rate of return on investment, and measures project profitability compared to cost of borrowing.
If IRR < capital cost there will be no investment
(Example OMP)

Question 28

The real value of cash flow is subject to _____. Therefore, the _____ is amplified by the _____.

Answer 28

The real value of cash flow is subject to inflation. Therefore, the discount rate, k, is amplified by the inflation rate, f.
(Example OMP)