I have done mock exam 2007 and am hoping that the forum members could shed some light on some of my problems. I would really appreciate a reply within the next few days. :0) Q1: Pg 1 of the solutions gives the dividend income from the US equity portfolio as 250x2.2%=£5.5m. Not a big deal but if I didn’t include cash and instead calculated 2.2% of 245m – would that also be ok? Pg 2 of the solutions calculates the value of the loan stock as £55m using 6.5%. Firstly the solution is using a yield (6.5%) meant for secured stock. Surely unsecured stock should enjoy a higher yield, say 7%? Secondly the solution happily assumes that there are 10 years left to expiry, i.e. that it is now 2006. Nowhere can I find this in the question that there is only 10 years left to maturity. Is this a plain thumb suck? I calculated the MV using the equation L=A-E, but I suppose this is more an accounting equation (i.e. using book values) and the equation is not being used in the correct situation here. I however calculated L=250-(400x0.42)= £82. There is however no value of n that will solve the loan stock equation of value using 6.5%, so I guess this method is wrong. Any comments? The question talks about a new £75m preference share issue. From CT1 when referring to a bond one usually refers to its nominal value, so although this isn’t exactly a debt issue I took £75 as the par value and not the market value. The solution takes this £75 as being the market value of the stock. This is not obvious to me - could this not have been a bit more clearly put? At the bottom of pg 2 solutions the accounting NAV is taken as 265 – MV(pref shares). As I understand it investments (and cash) will be recorded at market value so that the assets are recorded at £265 in the balance sheet and their market value is also around £265. But, are preference shares (on the liability side of the balance sheet), especially here when a zero ‘bond’, taken as amortised cost in the balance sheet, i.e. the value increases with interest as expiry approaches, and thus at t=0, taken as £75 and at expiry as £496? I was thinking that perhaps the preference shares should be recorded at £496 in the balance sheet, although I realise that such a large value causes a negative NAV and completely “takes over” the balance sheet. Thanks!
Mock 2007 Hi I think some of your points are valid here, and in some cases the mock looks OK. For example, so long as you included something for the cash on the balance sheet your answer would have received full marks. You would not have to get exactly the same US equity yield as the solution. In respect of the loan stock, the question does say that all corporate bonds and prefs yield about 6.5% in the question, which is meant to lead to this approximation. Given that today in the bond mrkets, everything from a AAA to a BBB seems to yield 0.5% over gilts, it seems a reasonable assumption. I see what you mean about the 2016 stock not being 10 years if you are doing the question in 2007. I will try to reword that a little, but ay sensible DC calculation would have scored the marks. The accounting treatment of prefs is a good point. I have assumed that zero coupon prefs would be recorded at issue value, and that the value of the pref would grow each year in the balance sheet until maturity (probably on an accrual basis rather than a mark-tomarket basis). I am not 100% confident of this - it is probably complex in reality. But it would certainly have to be recorded somewhere around the amount raised rather than the maturity value, so the question does stand up OK in this respect. It is also modelled around a past SA6 exam question which also neatly glossed over some of the more complex issues.
