FOUNDATIONS OF FINANCIAL MANAGEMENT
ACTUAL TEST PAPER SOLVED QUESTIONS
◉ Agency costs.
Answer: Costs incurred by shareholders to minimise agency
problems, including monitoring costs and bonding costs.
◉ Methods for reducing agency problems.
Answer: Corporate governance, managerial compensation linked to
firm value, and the threat of takeovers.
◉ Net Present Value concept.
Answer: NPV = PV(benefits) − PV(costs); NPV represents the change
in shareholder wealth from a decision.
◉ Financial system purpose.
Answer: Transfers funds through the savings-investment cycle
toward the most efficient users of funds, with competitive markets
determining rates of return.
◉ Market efficiency.
,Answer: Security prices fully and rapidly reflect economically
relevant information about expected returns and risk; under no-
arbitrage, price is an unbiased estimate of intrinsic value.
◉ Weak-form efficiency.
Answer: Prices reflect historical price and return information.
◉ Semi-strong-form efficiency.
Answer: Prices reflect all publicly available information.
◉ Strong-form efficiency.
Answer: Prices reflect all public and private information.
◉ Holding Period Return (HPR).
Answer: HPR = [(P1 − P0 + D1) / P0] × 100%, where P1 is ending
price, P0 beginning price, and D1 distributions received.
◉ Time value of money principle.
Answer: Cash flows can only be directly compared when valued at
the same point in time using an appropriate opportunity cost of
capital.
◉ Interest.
, Answer: Compensation for forgoing current consumption or
alternative investment opportunities; effectively the rent paid for
borrowing money.
◉ Nominal vs real interest rate.
Answer: The difference is inflation; the real interest rate is the
inflation-adjusted return.
◉ Fisher equation.
Answer: (1 + nominal rate) = (1 + real rate)(1 + inflation rate).
◉ Approximate real interest rate.
Answer: Real rate ≈ nominal rate − inflation rate.
◉ Simple interest.
Answer: Interest is calculated only on the original principal amount.
◉ Compound interest.
Answer: Interest is calculated on the current balance, including prior
interest; this creates interest-on-interest.
◉ Future value of a single sum.
Answer: FVn = PV0(1 + i)^n.
ACTUAL TEST PAPER SOLVED QUESTIONS
◉ Agency costs.
Answer: Costs incurred by shareholders to minimise agency
problems, including monitoring costs and bonding costs.
◉ Methods for reducing agency problems.
Answer: Corporate governance, managerial compensation linked to
firm value, and the threat of takeovers.
◉ Net Present Value concept.
Answer: NPV = PV(benefits) − PV(costs); NPV represents the change
in shareholder wealth from a decision.
◉ Financial system purpose.
Answer: Transfers funds through the savings-investment cycle
toward the most efficient users of funds, with competitive markets
determining rates of return.
◉ Market efficiency.
,Answer: Security prices fully and rapidly reflect economically
relevant information about expected returns and risk; under no-
arbitrage, price is an unbiased estimate of intrinsic value.
◉ Weak-form efficiency.
Answer: Prices reflect historical price and return information.
◉ Semi-strong-form efficiency.
Answer: Prices reflect all publicly available information.
◉ Strong-form efficiency.
Answer: Prices reflect all public and private information.
◉ Holding Period Return (HPR).
Answer: HPR = [(P1 − P0 + D1) / P0] × 100%, where P1 is ending
price, P0 beginning price, and D1 distributions received.
◉ Time value of money principle.
Answer: Cash flows can only be directly compared when valued at
the same point in time using an appropriate opportunity cost of
capital.
◉ Interest.
, Answer: Compensation for forgoing current consumption or
alternative investment opportunities; effectively the rent paid for
borrowing money.
◉ Nominal vs real interest rate.
Answer: The difference is inflation; the real interest rate is the
inflation-adjusted return.
◉ Fisher equation.
Answer: (1 + nominal rate) = (1 + real rate)(1 + inflation rate).
◉ Approximate real interest rate.
Answer: Real rate ≈ nominal rate − inflation rate.
◉ Simple interest.
Answer: Interest is calculated only on the original principal amount.
◉ Compound interest.
Answer: Interest is calculated on the current balance, including prior
interest; this creates interest-on-interest.
◉ Future value of a single sum.
Answer: FVn = PV0(1 + i)^n.
