CB1 MCQ Questions

[Han]

Hello,
I would like to ask the following questions:

Subject CT2, September 2015, Question 2
With regards to the the answer (c), the CMP does not seem to mention this feature about limited companies shareholders: "relationships will be defined by a combination of contracts and implicit agreements.". May I know where this can be found?

Subject CB1, April 2020, Question 2
Why is maximising market cap the solution to dealing with the the many shareholders' different risk appetites?

Subject CB1, September 2020, Question 1
I understand that social responsibility can constrain the creation of wealth. However, I do not understand why it SHOULD constrain wealth creation. May I please ask for a further explanation on this?

Thanks in advance!

 

[Lynn Birchall]

Hi Han!

Subject CT2, September 2015, Question 2
With regards to the the answer (c), the CMP does not seem to mention this feature about limited companies shareholders: "relationships will be defined by a combination of contracts and implicit agreements.". May I know where this can be found?

Chapter 1, Section 2.3 (Contractual theory) is the best reference for this I think.

Subject CB1, April 2020, Question 2
Why is maximising market cap the solution to dealing with the the many shareholders' different risk appetites?

Hopefully Chapter 1, Section 4.1 helps with this one.

Subject CB1, September 2020, Question 1
I understand that social responsibility can constrain the creation of wealth. However, I do not understand why it SHOULD constrain wealth creation. May I please ask for a further explanation on this?

Good question! The exact extent to which it should be a constraint is a subject for debate and different possible opinions (as described in Section 5 of Chapter 1). However, the need to comply with regulation / legislation around socially responsible behaviour and the ethical / professional conduct required of prefessionals suggest it should to some extent at least. Keep in mind too the wording of the question where we're asked which of the options 'best summarises' the attitudes of the directors - this option looks to be a better description than the other three alternatives offered.

Hope these help
Lynn

 

[Han]

Hi Lynn,

Many thanks for your response, they definitely clear things up for me now. May I also seek clarifications on the below questions please?

Subject CT2, April 2014, Question 5
In the question, the Australian company enters a future contract to buy $1m USD with AUD. If USD strengthens, then more AUD is required to buy 1 USD. Hence, as the Australian company is still looking to buy the same amount of USD ($1m), they would now have to exchange more AUD. Hence, shouldn't it be the case that the Australian company adds to the margin since the counterparty is more at risk of receiving fewer AUD for the same $1m of USD?

Subject CT2, September 2017, Question 3
In section 2.1. the cost of equity is the rate forgone by shareholders investing in the project rather than investing in alternative securities. In this question, they ask for the cost of equity to the issuing companies. I fail to understand, given the definition from section 2.1, how this tells that equities are a relatively expensive source of finance. May I please ask what the cost of equity to the issuing company is and how it relates to cost of finance?

Subject CT2, October 2012, Question 6
How is equity calculated? From the statement of financial position, Total Equity = Share Capital + Other Reserves + Retained Earnings. However, considering that the answer is 32500, it seems to me that the 500 in unpaid bills (which should be a liability?) is added to the calculate total equity.

Subject CT2, April 2015, Question 9
I just want to check if my reasoning for this is correct: Lenders are more interested in the fair value of a company's non-current assets because in the event where the company is wound up, the lenders will be getting their repayment from these non-current assets. By having a fair value of these non-current assets, lenders can ensure that they will not be getting back less than they invested in the event of a wound up.

Thanks in advance!

 

[Lynn Birchall]

Subject CT2, April 2014, Question 5
In the question, the Australian company enters a future contract to buy $1m USD with AUD. If USD strengthens, then more AUD is required to buy 1 USD. Hence, as the Australian company is still looking to buy the same amount of USD ($1m), they would now have to exchange more AUD. Hence, shouldn't it be the case that the Australian company adds to the margin since the counterparty is more at risk of receiving fewer AUD for the same $1m of USD?

If USD strengthens, then more AUD is required to buy 1 USD on the open market. But by entering into the futures contract, the Australian comapny is not affected by this - it has locked in the original exchange rate. So, the futures contract is looking a good deal, the Australian co has made a profit on the future and so would receive a margin payment.

Subject CT2, September 2017, Question 3
In section 2.1. the cost of equity is the rate forgone by shareholders investing in the project rather than investing in alternative securities. In this question, they ask for the cost of equity to the issuing companies. I fail to understand, given the definition from section 2.1, how this tells that equities are a relatively expensive source of finance. May I please ask what the cost of equity to the issuing company is and how it relates to cost of finance?

I'm not sure theat thinking of the cost of equity a rate foregone necessarily helps for this particular question. The key idea is really that the cost of equity is effectively the same thing as the return delivered to investors (in a similar way to the cost of debt effectively being the same thing as the return delivered to debt investors). Equities offer a relatively high rate of return (to investors) so the cost of equity (to companies) is relatively high.

Subject CT2, October 2012, Question 6
How is equity calculated? From the statement of financial position, Total Equity = Share Capital + Other Reserves + Retained Earnings. However, considering that the answer is 32500, it seems to me that the 500 in unpaid bills (which should be a liability?) is added to the calculate total equity.

We haven't got the info in this case to calculate equity as the sum of its compnent parts (ie share capital + other reserves + ....).

So, we have to use the fact that in the statement of financial poisition, Assets = Equity + Liabilitites. So, equity = assets - liabilities.
Here, assets = 100,000 + 7,000 + 8,000. Liabilities = 82,000 + 500 (the unpaid bills are a liability as you say).

Subject CT2, April 2015, Question 9
I just want to check if my reasoning for this is correct: Lenders are more interested in the fair value of a company's non-current assets because in the event where the company is wound up, the lenders will be getting their repayment from these non-current assets. By having a fair value of these non-current assets, lenders can ensure that they will not be getting back less than they invested in the event of a wound up.

Thanks in advance!

Yes, your reasoning looks good to me!
Lynn

 

[Han]

Many thanks Lynn, that really helps!

I am still quite confused about the cost of equity for companies.

Equities offer a relatively high rate of return (to investors) so the cost of equity (to companies) is relatively high.

Could you explain this further please?
From my understanding, the rate of return to investors would depend on dividends and/or the increase/decrease of the market price of shares relative to the price they bought it for. I don't see what costs the company incurs if it issues equity as a source of finance.

Is the question asking: Comparing other financing methods (AKA debt financing) and equity financing, why is equity financing relatively more expensive?

 

[Lynn Birchall]

Hi Han

I am still quite confused about the cost of equity for companies.

Could you explain this further please?
From my understanding, the rate of return to investors would depend on dividends and/or the increase/decrease of the market price of shares relative to the price they bought it for. I don't see what costs the company incurs if it issues equity as a source of finance.

Good question - the cost of equity for companies is not as explicit as the cost of debt (where they have a liability to make the interest payemnts). Does it help to think about it like this perhaps ...

The rate of return to equity investors is made up of a stream of dividend income and the movement in the market price of the shares relative to what they bought it for, as you say. In fact, we could view the market price of the shares as the market's assessment of the value of the future income stream it expecst to get from that company. For example, if the future income stream is seen as more risky, the market would put a relatively lower value on it - the share price would fall (& an investor buying at the lower share price would then make a higher rate of return to reflect the higher risk).

The link to the company is that if a company wants to issue equity capital, the price at which it can sell each new share will be dictated by the market. Being able to issue at a high share price means the company raises more money for a certain number of issued shares. The 'cost' to the company (= return to the sharesholders) could be seen as the value of the future returns as a % of this issue price. So, the higher the issue price, the lower the return investors are requiring, the lower the cost to the company.

Hope this helps a little!
Lynn