COMM 221 Financial Markets Final Exam Sample Fall 2024 Dec Concordia University

COMM 221 Financial Markets Final Exam Sample Fall 2024 Dec Concordia University

Examination Cover Sheet COURSE:

NUMBER:

SECTION(S):

Financial Markets

Comm 221

A, B, C, DD, FF

EXAMINATION:

DATE:

TIME: 14:00-17:00

PAGES:

_X_ FINAL

December 4, 2024

Exam Length:

Including cover

3 Hours

14

ALTERNATE DEFERRED

VERSION: INSTRUCTOR(S):

DIVISION:

Moein Karami

John Molson School of Business

MATERIALS ALLOWED:

INSTRUCTIONS:

Booklets X_ IBM (Scantron)

Return all Blue

Green

X_ Printed Translation Dictionary Other X_ Calculator X_ Other: standard 8.5x11 inch double-sided formula sheet

_X_ Answer on Exam Open book X_ Crib sheet

Please print your name, I.D. number and section in the appropriate spaces below.

STUDENT NAME: I.D. NO.

SECTION:

SPECIAL INSTRUCTIONS: NONE

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[20 Multiple choice questions, 1.5 points each, 30 points in total] Q1. The price offered by consumers for a good is given as PD = 30 – 1.5Q while the price required by suppliers is given as PS = 5 + 2Q where Q is the quantity consumed/produced. What is the equilibrium quantity and price for this market?

A) B) C) D) E)

0 units & $30/unit 6 units & $21/unit 7.1428 units & $19.29/unit 9.3 units & $16.05/unit Unable to determine with the information provided

Q2. Use the information in Question 1 to answer this question. What would be the consumer surplus for the identified equilibrium price and quantity?

A) B) C) D) E)

0 38.25 64.87 76.49 129.74

Q3. Use the information in Question 1 to answer this question. What would be the new equilibrium price if the government imposed a quota of 5 units?

A) B) C) D) E)

$15.00 $16.05 $18.75 $22.50 Some unknown value between $15.00 and $22.50 inclusive

Q4. The reason that economists are so concerned and strongly avoid dead weight losses is because: A) B) C) D) E)

It is caused by taxes and taxes are bad It will result in their execution, hence the title “Dead Weight Loss” It is operationally efficient It is a loss to the entire economy, with no person gaining potential but unrealized benefits It is a loss to consumers and producers but to the advantage of governments which are, typically, wasteful

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Q5. Which of the following distortions/government meddling in equilibriums would have no impact on consumer or producer surplus?

A) B) C) D) E)

Imposing a flat tax of $X per unit sold Imposing a percent tax on the price of each unit sold Providing a subsidy or $X per unit sold Imposing a price cap/ceiling higher than the market equilibrium price Imposing a price minimum/floor higher than the market equilibrium price

Q6. Which loan has the highest effective annual rate?

Loan A Loan B Loan C Loan D A) B) C) D) E)

19.99% APR with daily compounding 21% APR with quarterly compounding 5% EQR 0.052% EDR

Loan A Loan B Loan C Loan D Both A and C

Q7. Marie has a utility function 𝑈(𝑊) = 𝑊0.3 and a current net worth of $20,000. She holds a lottery ticket that offers a 1% chance of winning $1,000 and a 99% chance of winning nothing. What is the minimum price Marie would be willing to accept to sell her lottery ticket?

A) B) C) D) E)

$9.83 $9.65 $8.45 $4.85 $3

Q8. John saves $1,000 at the end of each month for 25 years until his retirement. What will be the value of his savings at the time of retirement, assuming an Annual Percentage Rate (APR) of 6% with monthly compounding?

A) $ 631,475 B) $ 666,854 C) $ 692,994 D) $ 701,022 E) $712,035 Q9. A bond has a current price of $970 and pays semi-annual coupons, each payment equal to 3% of the $1000 face value. If the bond has 18 months to maturity, what is the effective annual yield on this bond?

A) 8.33% B) 8.16% 3

C) 7.42% D) 6.19% E) 6.04%

Q10. A stock has just paid a quarterly dividend of $2. If you expect that the dividend amount will grow indefinitely over time by 1% per quarter and the effective annual required rate (EAR) of return for this stock is 15%, what is the current price of this stock?

A) B) C) D) E)

$79.04 $78.25 $73.45 $72.72 $70.54

Q11. Which of the following laws seeks to punish perpetrators of human rights violations by freezing their assets, either domestic or international, in hopes of creating a more socially just global rule of law?

A) B) C) D) E)

The Volcker rule The Magnitsky Act The Sarbanes-Oxley Act The Securities Exchange Commission Act None of the above laws have the described aim

Q12. ABC stock has historically earned 12% per year while the stock market has been earning 11% per year. Given that the US treasury bill has been yielding 5% per year over the same period and that you believe the CAPM, what is your best estimate of the Beta of ABC stock?

A) B) C) D) E)

Cannot be computed with the information provided 0 0.8571 1 1.1666

Q13. You’re building a new house in a hurricane prone region and thinking of installing storm shutters (protective barrier put over the window during a storm) on your windows. You manage to find data on various products as detailed below: Storm shutter Wind test failures

Plywood 5/8”

Aluminum 0.04”

Aluminum 0.05”

Aluminum 0.063”

18%

19%

13%

6%

If you wanted a product that would only fail 10% of the time or less, which choices would you consider?

A) None, all of these products fail at too high a rate 4

B) C) D) E)

Plywood 5/8” Either Aluminum 0.05” or Aluminum 0.063” Aluminum 0.063” Any, all of these products meet the desired specifications

Q14. Tarik deposited $10,000 two years ago into his TFSA. Over that time the value of his assets grew to $17,536. Tarik just withdrew all the funds from his TFSA to help pay for a renovation to his house.

Given that Tarik is in the 30% income tax bracket and assuming he stays in that bracket after this withdrawal, what are his taxes owing on his asset gains?

A) B) C) D) E)

Nothing, his assets grew within a TFSA $1,130.40 $2,260.80 $2,630.40 $5,260.80

Q15. Which of the following investments would typically finance shopping malls, condominium developments and commercial office space?

A) B) C) D) E)

ETFs REITs RRSPs 401Ks IRAs

Q16. A payday loan has advertised that its rate is “JUST 1% EFFECTIVE DAILY”. What is the effective annual rate of this loan?

A) B) C) D) E)

Cannot be determined with the information provided 37.78% 52% 365% 3,678%

Q17. NBM stock and MKL stock have 0 correlation between their returns, but each have a standard deviation of returns equal to 10%. If you were to make a portfolio that consisted of 30% of NBM and 70% MKL, what would be the expected standard deviation of returns for this portfolio?

A) B) C) D) E)

Cannot be computed with the information provided 5% 7.071% 7.615% 10% 5

Q18. Consider the information in Question 17 when answering this question. Which assumptions do you need to make in order for your answer to be correct?

A) I must assume that the average returns of the two stocks are unknown B) I must assume that the historical measures of correlation and standard deviation are good forecasts of the future C) I must assume that the two stock returns are normally distributed D) I must assume that the risk-free rate is lower than the average return of either of the stocks E) C and D Q19. A lottery ticket has a 1 in 13 million chance of paying $65 million dollars. What is the most that a risk-neutral corporation would be willing to pay to buy such a ticket?

A) B) C) D) E)

Insufficient information, we need to know the value of the firm Insufficient information, we need to know the utility function of the firm $0, as companies don’t gamble $5, but not a penny more $65 million dollars as companies are not concerned about risk or losses

Q20. The SOX sulfur pollution trading market established to reduce acid rain had terrific success in its stated objectives. A reason or reasons for this success was/were: A) B) C) D) E)

The plan did not tell companies which technology to use but only which objectives to meet The scheme granted heavier polluters time to phase in a solution The costs to pollution started low but scaled over time Political resistance was reduced as lower polluters stood to profit from the scheme All the above are reasons for the market’s success in limiting acid rain

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Problem 1 [10 points total] The equations for the demand and supply functions of a product are represented by the following equations.

30𝑃𝑑 = 210 − 𝑄 20𝑃𝑠 = 40 + 𝑄 A) What is the equilibrium price of the product in this market? (2 marks) 𝑄𝐷 = 𝑄𝑠, 210 − 30𝑃 = 20𝑃 − 40 ; Equilibrium Price=$5

B) If the government imposes a $2 tax on this product, find: the price that consumers will pay (Pd), the price sellers will receive (Ps) and the total government revenues collected by the tax. (3 marks) 𝑃𝑑 − 𝑃𝑠 = 2, 210 − 30𝑃𝑑 = 20𝑃𝑠 − 40 ➔ 𝑷𝒅 = 𝟓. 𝟖, 𝑷𝒔 = 𝟑. 𝟖 Government revenues would be equal to $2* units sold. The new level of demand is: 30(5.8) = 210-Qd → Qd = 36 units OR 20(3.8) = 40+Qs → Qs = 36 units The government revenue is therefore 2*36 or $72 from this tax C) Calculate the deadweight loss to the economy resulting from the imposition of the $2 tax on this product. Then in a sentence or two, describe what a deadweight loss is. (3 marks) 𝑄𝑜𝑙𝑑 = 210 − 30 ∗ (5) = 60, 𝑄𝑛𝑒𝑤 = 210 − 30 ∗ (5.8) = 36 Deadweight loss=[(60 − 36) ∗ 2]/2 = 24 Deadweight loss is a loss to the economy in the form of trades that never happen. By raising the price that consumers pay, or the amount producers earn, the incentive to trade for marginal consumers/producers is reduced. In response, some of those (who had total benefits less than $2) will elect to exit the market entirely and some portion of value additive trades are lost. The government cannot collect taxes on trades that never occur, thus consumers/producers nor the government get these benefits – they are lost to all stakeholders of the economy.

D) Using the equilibrium result you found in part A, Estimate own-price elasticity of this good at the original equilibrium for both the consumer and the producer. [Hint: You may find it useful to estimate the change in demand/supply for some small % change of price change]. Using those 7

elasticities, in a sentence or two argue which party (producer/consumer) would see a greater reduction in their surplus because of the taxes imposed in part B. We estimate the quantity change for a small price change. We’ll try a price change of 1% as an arbitrary value (grader, allow for other values if computed correctly).

Original equilibrium price was Pd=Ps = 5, increasing by 1% would be 5.05 Original quantity was 30*5=210-Q → Q = 60 units 30*Pd = 210-Qd →30(5.05) = 210 -Qd, Qd = 58.5 units (60-58.5)/60 or 58.5.60-1 = -0.025 or -2.5% demand in quantity for a 1% increase in price For the produder: 20*5.05 = 40+Qs → Qs = 61 61/60 – 1 = 1.66% increase in supply for a 1% increase in price Thus, the own price elasticities are -2.5 and +1.66 respectively.

Consumer demand is more elastic than producers. As consumers are more elastic, they are less willing to carry the cost of taxes and would sooner leave the market. Producers will therefore carry a disproportionate loss of the tax in order to entice/encourage some consumers to stay in the market.

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Problem 2 [10 points in total] Eclipse Soda Corporation (ESC) is considering a new advertising campaign on Spofity. Before they make their decision, they first establish that they expect to earn $200,000 at the end of this month in profit but that this is declining at a rate of 0.1% per month.

To estimate their cost of capital, the accounting department has gathered the information that the stock has a beta of 1.3, that the historical return on the broad market index has been 11% EAR and that treasury bills are yielding 5% EAR presently.

ESC is all equity financed and disregard corporate taxes or other frictions/costs for this question.

A) What is the present value of their business? If they have exactly 10 million shares outstanding, what would be a fair price for the stock (equity)? [4 points] [Hint: find the value of the business and divide equally into the number of shares] To determine their present value we need to estimate the cost of capital. We’re given information for the CAPM but annual data, we’ll use that formula but then convert to effective monthly rate (EMR) in order to estimate the value of the business: E(R) = rf + B(E(Rm)-rf) = 5% + 1.3(11%-5%) = 12.8% EAR 1.128^1 = (1+EMR)^12 → 1.128^1/12 -1 = EMR = 0.0100877 or ~ 1% EMR With this information we can use the growing perpetuity equation to find the value of the current business, that is: PV = D1/(r-g) = 200K/(0.0100877 – (-0.001)) = 18,037,972.13 The current business is worth approximately 18 million at present If you divide this evenly over 10 million shares that givens a share price of about $1.80/share B) Suppose the Spofity advertising campaign could stop the decline in Soda sales but would not increase it above the expected value of $200,000/month. What is the maximum price ESC should be willing to pay for the advertising? Explain your rationale in a sentence or two. [4 points] If the decline in sales can be averted then the value of the business would be a perpetuity, growth = 0, so: PV = 200K/0.0100877… = 19,826,083.88 The business will have a value of 19 million with the ad or 18 million without, the benefit of the advertising is thus 19,826,038.88 – 18,037,972.12 = 1,788,111.75 9

So long as the advertising cost is less than 1.788 million the ad will contribute more value to the firm than it will cost, it will be NPV positive. They should pursue it. If the ad costs more than this amount then the benefits are outweighed by the cost and the ad should not be contracted.

Therefore the maximum price they’d pay for the ad is $1,788,111.75

C) Suppose Spofity offered an ‘ultra-deluxe’ advertisement that, they claim, would increase sales by 3% per month every month, forever. What is the estimated value of the ultra-deluxe advertisement? Does something unusual happen to your equation and what does that suggest about the sustainability or realism of Spotify’s claim? [2 points] If the ultra-deluxe ad performed as promised the new business value would be: D1/(r-g) = 200K/(0.0100877 – 0.03) = -10,044,043.13 The implied value of the business, when it’s growing faster than the cost of capital, is seemingly negative.

This is nonsense. The equation is only applicable if the growth rate is LESS THAN the cost of capital. At any value above, the cash-flows are always growing each period more than they are discounted. The total value of all those discounted cash-flows does not converge (explodes) towards an infinite value.

This is not realistic or sustainable. The pitch of Spofity is that revenues would eventually grow to trillions of dollars a second, and just keep on growing even from those absurd levels. No business can grow infinitely large and thus no advertising campaign can promise that and deliver.

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Problem 3 [10 points in total] Use the following tax bracket information to answer the question below. You may assume that these brackets do not change for the entire duration of the question.

-

Grace earns $55,867 a year and lives in the province of Ontario.

Last year, she invested into each of her RRSP and TFSA account $5000 (total $10K) Both accounts had their assets increase in value by 20% over the last year Grace has a pet cat named Dog

A) What are Grace’s average and marginal total tax brackets at her present income level (Note: do not worry about the basic personal exemption or other deductions, treat the full income as taxable). [3 points] The first 51,446 of Graces income is at 5.05% provincial and 15% Federal for a total rate of 20.05% on the first 51,446 The next 4,421 (55867-51446) is at 9.15% provincial but remains at 15% Federal for a total rate of 24.15% Thus, her average tax rate is: 51446/55867 * 20.05% + 4421/55867 * 24.15% = 20.374% Her next incremental/marginal dollar would be crossing into the next federal bracket of 20.5% (above 55,867) and so her marginal tax would be 9.15% provincial + 20.5% federal or 29.2% B) What is the value in each of Grace’s savings accounts (both the TFSA and the RRSP)? If she had to withdraw about $1000 to pay for her pet’s medical bill, which account would you recommend that she use and why? [2 points] The value in each account is 5000*1.2 or 6000 for a total savings of 12K If she urgently needed a little money, she’d be better off to withdraw from her TFSA as the gains on that account will not be taxed. If she withdraws from her RRSP she’ll trigger additional taxes as it will increase her taxable income.

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C) Suppose Grace withdrew $5000 from her RRSP. How much tax would she owe on that withdrawal? [Do not worry about capital gains deduction as it does not apply to RRSP withdrawals] [2 points] If she withdrew from her RRSP, since there is no capital gains deduction, this would be treated strictly as income. As such, she would have her income increase by 5000 which would be at the same 29.2% rate we computed in part A. This would imply a total tax owing of 0.292*5000 or $1460 on this withdrawal D) One of the proposed rules of personal finance is to invest 100 minus your age in percent into stocks and put the remainder of savings into bonds. Explain the intuition behind this investing advice and state if it is always good advice. [3 points]

The idea for this investing advice is that when you are young you have time on your side and can adjust consumption, income and take other strategies to recover from losses. Thus you can afford to take some risk and historically the stock market has yielded better returns than the bond market. Thus, with a long horizon investing in the stock market is both manageable and rewarded.

As you age however your ability to adjust your income and/or consumption becomes challenging and you risk suffering an uncomfortable retirement if you bet on stocks that lose a lot of value. Thus bonds, typically safer than stocks, are seen as a good investment vehicle for the security they provide to aged investors.

This is not strictly good advice as some stocks are quite reliable, such as utility stocks, while other bonds may be very risky (such as high yield debt). Furthermore, certain investors have other sources of income (pension) or assets (real estate) that may modify their ability to carry risk at different stages of life. While it’s sound advice to keep some savings in safe investments and possibly increase this as you age, it isn’t universally good advice and needs to consider the characteristics of the assets in question.

[Note to grader: This is a detailed explanation but if the student gets the essence of this argument in a shorter version, please award full marks]

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