BSc.

BLC – Corporate Finance

4 Hour Final Exam

Retake Exam, Summer 2020

IMPORTANT, PLEASE READ:

• The exam contains two independent parts. Part I consists of 4 questions with a total
weight of 75%. Part II consists of 5 questions with a total weight of 25%. The weights
only indicate the amount of time that should be used on each part. The final grade will
be based on the overall impression of answers delivered by a student.

• Answers to the exam questions should be carefully explained and supplemented with
relevant calculations and illustrations. Keep your answers brief, concise and to the
point (lengthy, irrelevant statements or calculations weaken the overall impression of
your solutions).

• Even if you are not able to answer a sub-question, you may be able to answer the
following sub-questions for full marks. If one of your results is incorrect because you
use a faulty previous result to calculate it, but otherwise the method is correct, you
might still be able to receive full marks for this sub-question. If you feel you are
missing crucial information to solve an exercise, you can make assumptions that
enable you to proceed (but explain carefully).

• The exam consists of 5 pages in total (including this title page). Make sure you
answer the questions from all 5 pages.

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 PART 1
Question 1

Imagine the interest rate in the United States is 2% and the inflation rate is 1%. In the EU, the
interest rate is 4%. The current exchange rate is 1.20 US dollars per Euro.

a. What is the European inflation rate?

b. What is the expected exchange rate 1 year from now? (Remember to be clear about
quotation)
c. The exchange rate between the Danish Krone and the Euro is 7.46 DKK per Euro.
What is the price of a US Dollar in Danish Kroner?

Question 2

Imagine you need $500,000 by the time you retire 50 years from now. You are considering two
savings options. Both saving options provide you with a 2 percent annual interest rate.

a. You are considering paying a one-time lump-sum contribution to your savings plan
today. In order to achieve your objective of $500,000 at the end of the fifty-year period,
what should this sum be?
b. You can also decide to pay a fixed amount annually. Your first payment will be made
at the end of the first year and the final payment is to be made at the end of the 50th
year. What amount must you plan to pay annually to achieve your objective?

Unfortunately, you are short on cash these days since you have just graduated university.
However, you expect to make a decent salary over the next 10 year at which point you would
like to make a lump sum payment to your pension plan (you still want to end up with $500,000
at retirement). You expect that in 10 years interest rates will grow to 3%, but that they will
remain at 2% until then.

c. How much will you have to set aside each year in order to pay the lump sum 10 years
from now? (assume that you set aside a fixed amount each year and that this amount
earns the given interest rate)
d. You realize that you should probably also account for inflation which you expect to
be 1% a year of the next 50 years. What is the real value of receiving $500,000, 50
years from now? Explain what this number means.

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Question 3

Imagine a firm financed by outstanding debt, common equity and preferred equity, where
preferred equity holders are promised a dividend of $0.50 every year. The debt financing
consists of 100,000 bonds with 1-year maturity paying a 2% coupon with a face value of $1020
and currently selling for $1000.

The expected return on the stock market is 11%, the risk-free rate is 2% and the company’s
beta is 1.4. There are 30 million common shares outstanding trading at $5 a stock. The market
value of preferred equity is $50 million and there are 5 million outstanding. The book value of
common equity is $80 million. The tax rate is 35%.

a. What is the capital structure of the firm?

b. What is the expected return on the firms stock?
c. What is the WACC of the company?
d. Explain what would happen to the value of the firm if the beta of the company´s stock
fell to 1.

Question 4

Imagine you have three possible states of the world 1 year from now: Boom, Normal and
Bust. The normal state occurs with a 40% probability and the Boom and Bust occur with 30%
probability each, as you can see in the table below:

State of the world Probability Return

Boom 30% 12%
Normal 40% 6%
Bust 30% -6%

a. What is the expected return of the stock?

b. What is the standard deviation of the stock’s return?
Imagine the stock’s price today is $100. You can buy a put-option on the stock with a strike
of 105$ which expires 1 year from now.
c. What is the payoff of the option in each of the three states of the economy
d. Assume that the risk-free rate is 0% and that you can buy a call with strike $105 and
same expiration as the put for $1. What is the expected return of the put-option?

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 PART 2
Question 1
a. Assume that $10,000 5 years from now will buy you the same amount of goods as
$9,000 today. Discuss the statement: “$10,000 discounted back to time 0 at the nominal
interest rate will be worth less than $9,000 discounted at the real interest rate because
the nominal amount will also grow with inflation.”

Question 2
a. Imagine you have just bought insurance on your house. Have you effectively bought or
sold a call or a put? And what is the underlying asset?

Question 3
a. The following graph depicts the payoff of an investment strategy which is long a put
and call (both with strike 100) of a stock. Can you loose money on this strategy? Explain
why/why not.

Payoff diagram
250

200
Value of portfolio

150

100

50

0
0 50 100 150 200 250 300
Value of underlying stock

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Question 4
a. A bond with no credit risk and 30 years to maturity is issued with coupon rate twice
its yield-to-maturity. What is the expected price development on the bond?
b. Think about the bond in the previous question a. Can the bond price deviate from its
expected path over a given period? If so, how and what happens to the expected price
path going forward?

Question 5
a. A CEO and a CFO are discussing whether the company they manage should increase
or decrease its debt ratio. The CEO thinks it would be a good idea while the CFO
disagrees. What do the CEO and CFO think about the value of tax shield and the cost
of financial distress respectively?