Financial Risk Management

Module 2 Management of liquidity, debt and equity

Question 1
Free cash flows are computed as the net income plus depreciation and amortisation charges
a. plus changes in net working capital minus new capital expenditure.
b. minus changes in net working capital plus new capital expenditure.
c. plus changes in net working capital plus new capital expenditure.
d. minus changes in net working capital minus new capital expenditure.
Question 2
Which of the following are strategies that a company can employ to help maximise its working capital position?
I. Negotiate trading terms with creditors so that payment for goods purchased can be deferred.
II. Outsource the collection of its accounts receivables.
III. Employ best practices when it comes to inventory ordering, storage and delivery.
a. I and II only.
b. I and III only.
c. II and III only.
d. I, II and III.
Question 3
Which of the following features of a commercial bill also apply to a promissory note?
I. The holder will be paid the face value of the instrument at a certain date.
II. Its yield is determined by the market.
III. It can be traded and hence is transferable.
a. I and II only.
b. I and III only.
c. II and III only.
d. I, II and III.
Question 4
Ten days ago, JJJ Bank purchased five 90-day bank bills with a face value of $100 000 each from WWWLtd for
$490802.50. Assumingthat market rates of interest have not changed and ignoring transaction costs, what is the
price you would expect to pay JJJBank for these bills today?
a. $98 160.50.
b. $490 802.50.
c. $491 695.80.
d. $491 807.70.
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Question 5
The board of Fixit Ltd wishes to increase its proportion of equity funding. Its current share price is $6.00, and the
finance manager has recommended a private placement at $5.00 per share instead of a rights issue at $4.50 per
share. Thefinance manager has given the following reasons for this recommendation. Which reason is
notcorrect?
a. A private placement will provide the funds more quickly.
b. A private placement is more beneficial to shareholders.
c. A private placement could reduce the relative voting power of a particular shareholder who is
thoughttobe hostile to theboard.
d. A private placement has cheaper transaction costs.
Question 6
What are the minimum number of director and shareholder requirements for public companies?
a. Two directors and three members/shareholders.
b. Two directors and five members/shareholders.
c. Three directors and one members/shareholder.
d. Five directors and five members/shareholders.
Question 7
In which one of the following aspects does venture capital differ from other types of equity capital?
a. Equity capital is listed on the sharemarket.
b. Venture capital is a higher risk form of equity capital.
c. Venture capital consists of debt capital, originating from banks.
d. Venture capital is only sourced through pooled development funds.
Question 8
Convertible notes have which of the following characteristics?
I. They are equity securities which are perpetual in nature.
II. They are hybrid securities.
III. They carry a fixed interest rate return, which accumulates if not paid out in any 12-month period.
a. I only.
b. II only.
c. I and II only.
d. I, II and III.
Question 9
What minimum number of shareholders is specified as a condition for companies wishing to list on the ASX?
a. 500.
b. 750.
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c. 1000.
d. 2000.
Question 10
Which of the following correctly describes an entitlement issue?
a. A rights issue.
b. A placement issue.
c. The second instalment of a government privatisation issue.
d. A non-renounceable rights issue.
Question 11
In what circumstances are companies likely to float their shares on the ASX as a means of raising funds?
a. The economy is showing signs of slowing down.
b. Interest rates have started to decline.
c. Overall sharemarket prices are rising.
d. The building sector is slowing down.
Question 12
Eagles Flight Ltd (Eagles) wishes to obtain the use of an additional aircraft to complement its fleet. The company
has had preliminary discussions with an aircraft supplier which has proposed a financing arrangement under
which Eagles will enter into a non-cancellable contract to make a series of payments for four years in exchange
for the right to use the plane. All maintenance will be performed by Eagles and at the conclusion of the contract,
Eagles will legally own the plane. Which of the following best describes the proposed arrangement from the
aircraft supplier?
a. Operating lease.
b. Finance lease.
c. Sale and lease back.
d. Hire purchase.
Question 13
A holder of a convertible note
a. must convert the note to debt.
b. may convert the note to equity.
c. may convert the note to debt.
d. must convert the note to equity.
Question 14
Two Australian banks, Goodo Ltd and BMP Ltd, have lent Australian dollars to OS Ltd, a Mongolian company.
This loan isa
a. eurodollar loan.
b. LIBOR loan.
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c. term loan.
d. foreign loan.
The following case note relates to the next two (2) questions (questions 15 to 16)
Jim Jams Pty Ltd (Jim Jams) is about to raise funds to cover a cash shortfall by issuing a bill. Jim Jams will
receive a significant payment in 40days time but needs cash now to meet its operating costs until the payment
is received. Thebill will have a $100000 face value, 40 days to maturity and yield of 5per cent which is at a
discount to its recent long-term borrowings of 6.5percent.
Question 15
What is the amount that Jim Jams will receive as a result of issuing the bill?
a. $98 782.
b. $99 293.
c. $99 455.
d. $100 000.
Question 16
What is the amount that Jim Jams will have to repay in 40 days time?
a. $98 782.
b. $99 293.
c. $99 455.
d. $100 000.
The following case note relates to the next four (4) questions (questions 17 to 20)
The following is an extract of the annual accounts for Ziplok Ltd.
Ziplok Ltd statement of financial position at 30 June
Assets 20X3 20X2
(000) (000)
Current assets
Cash 30.0 35.0
Accounts receivable 20.0 15.0
Marketable securities 20.0 15.0
Inventory 50.0 45.0
Total current assets 120.0 110.0

Non-current (fixed) assets
Plant and equipment 100.0 90.0
Total non-current assets 100.0 90.0
Total assets 220.0 200.0

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Ziplok Ltd comparative profit and loss statements at 30 June

Question 17
What is the current ratio for Ziplok in 20X3?
a. 0.54.
b. 0.93.
c. 1.42.
d. 2.43.
Question 18
What is the quick ratio for Ziplok in 20X3?
a. 0.54.
b. 0.93.
c. 1.42.
d. 2.43.

Liabilities
Accounts payable 49.4 50.0
Non-current liabilities 80.0 75.0
Total liabilities 129.4 125.0

Shareholders equity
Issued share capital 4500 shares @ $10 45.0 45.0
Retained profits 45.6 30.0
Total shareholders equity 90.6 75.0

Total liabilities and shareholders equity 220.0 200.0
20X3 20X2
(000) (000)
Gross sales 90.0 102.0
Less: Cost of goods sold 50.0 60.0
Gross profit 40.0 42.0
Less: Selling and distribution expenses 11.0 13.0
Less: General and administration expenses 4.0 7.0
Operating profit 25.0 22.0
Non-operating income 3.0 0.0
Non-operating profit before interest expenseandtaxes 28.0 22.0
Less: Interest expenses 2.0 2.0
Net profit before tax 26.0 20.0
Less: Income tax expense 10.4 8.0
Net profit after tax 15.6 12.0
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Question 19
What is the accounts receivable period for Ziplok in 20X3, rounded to the nearest whole number?
a. 61.
b. 66.
c. 73.
d. 81.
Question 20
What is the accounts payable period for Ziplok in 20X3, rounded to the nearest whole number?
a. 300.
b. 361.
c. 365.
d. 380.









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Solutions
Question 1
Correct Answer: d
Free cash flow is a measure of cash remaining, assuming that new investment capital has come from internal
cash flow rather than additional debt or equity.
Free cash flow = Net income + Depreciation and amortisation Changes in net working capital
Capitalexpenditure
You can review this topic area in the study materials under the section entitled Free cash flow.
Question 2
Correct Answer: d
All three strategies are appropriate.
You can review this topic area in the study materials under the section entitled Strategies to manage
workingcapital.
Question 3
Correct Answer: d
All three are features of both promissory notes and commercial bills.
You can review this topic area in the study materials under the section entitled Money market instruments.
Question 4
Correct Answer: d
To calculate the interest rate (7.60%), we use the current price ($490 802.50), the face value ($500 000.00) and the
term to maturity (90 days).
However, the question states that the price ($490 802.50) was obtained ten days ago. So, there is now only
80days until maturity. Thus, using the interest rate of 7.60 per cent (refer to the calculation below), and the new
term to maturity (80-days), we can calculate the new price of the instrument ($491 807.70).
The correct formula to calculate the present value is
Multiplying both sides by the right side denominator, we get

PV = FV/(1 + (r (n/365)))
$490 802.50 = $500 000.00/(1 + (r 90/365))
$490 802.50 (1 + (r 90/365)) = $500 000.00
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Dividing both sides by the PV, we get
Subtracting 1 from both sides, we get
Dividing both sides by (90/365), we get
We can then insert this value of r into the PV equation to calculate the new present value with only 80 days to
maturity. Thatis
You can review this topic area in the study materials under the section entitled Money market instruments
(Pricing discount securities).
Question 5
Correct Answer: b
A private placement is not more beneficial to shareholders.
A comparison of the $5.00 figure with the $4.50 is incorrect. A private placement at below the market price
transfers wealth from the existing to the new shareholders, while a rights issue has no wealth effect provided the
rights areexercised.
Options A and D are accurate statements in the majority of cases.
Option C is a correct statement because a placement reduces the percentage ownership of every shareholder
except the buyer of the additional shares.
You can review this topic area in the study materials under the section entitled Mechanisms for raising
equitycapital.
Question 6
Correct Answer: c
Both public and private companies are required to have at least one member/shareholder. In addition, a public
company must have at least three directors and at least two directors must ordinarily reside inAustralia.
You can review this topic area in the study materials under the section entitled Listed and non-listed
companies.
(1 + (r 90/365)) = $500,000.00/$490,802.50
(r 90/365) = ($500 000.00/$490 802.50) 1
r = (($500 000.00/$490 802.50) 1)/(90/365)
r = 0.0187397/0.2465753
r = 7.60%
PV = $500 000.00/(1 + (7.60% 80/365))
= $500 000.00/(1.01666)
= $491807.70
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Question 7
Correct Answer: b
Venture capital is equity capital provided to start-up ventures. These start-up ventures may be businesses
which may, ormaynot, be listed on the stock exchange (Option A).
As venture capital is equity capital, this would preclude the venture capital consisting of a loan from a
bank(Option C).
Finally, as venture capital can be sourced from a range of providers, describing venture capital as being only
sourced from pooled development funds is incorrect(Option D).
You can review this topic area in the study materials under the section entitled Forms of equity financing.
Question 8
Correct Answer: b
Convertible notes are hybrid securities that provide investors with the opportunity to redeem the funds
subscribed or convert their holdings into ordinary shares. This means that the convertible notes are not
perpetual innature (Item 1).
Incomefrom convertible notes is generally higher than available from dividends, and they are not
cumulativeinstruments (Item III).
You can review this topic area in the study materials under the section entitled Hybrids: Equities and securities
(Convertible notes).
Question 9
Correct Answer: a
The reference to a threshold condition, set out in ASX Listing Rule 1.1, requires that there must be at least
500holders each having a parcel of the main classes of securities with a value of at least $2000.
You can review this topic area in the study materials under the section entitled Requirements for entities
wishing to list on the Australian Securities Exchange (ASX).
Question 10
Correct Answer: d
Rights issues refer to non-renounceable rights issues or entitlement issues which cannot be traded on the
sharemarket. Asone cannot sell a non-renounceable right, it follows that the right being given to shareholders
is one of intrinsic entitlement, hence the term entitlement issue. Non-renounceable rights issues should be
distinguished from renounceable rights issues, where a shareholder has the right to sell those rights on
thesharemarket.
You can review this topic area in the study materials under the section entitled Mechanisms for raising
equitycapital.

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Question 11
Correct Answer: c
Companies are most likely to list their shares on the ASX when share prices are rising, which provides a sign
that the economy is improving. Inthis environment, companies would need to issue fewer shares to raise a
given amount of funds than would be the situation if share prices were lower.
You can review this topic area in the study materials under the section entitled Equity financing.
Question 12
Correct Answer: d
The contract is essentially a hire purchase agreement as the term is relatively short (four years for an aircrafts
life), and the asset will be legally owned by Eagles at the conclusion of thecontract.
Option A is incorrect. Even though the contract is short term (four years is not a significant length of time with
respect to an aircraftslife), an operating lease does not provide for a transfer of ownership at the end of
thecontract.
Option B is incorrect. A financial lease is non-cancellable, but transfer of ownership does not necessarily occur
at the end of the contract. As such, the best description of the arrangement is a hire purchase agreement.
Option C is incorrect as Eagles does not own the aircraft initially.
You can review this topic area in the study materials under the section entitled Other sources of short-term and
intermediate-term financing.
Question 13
Correct Answer: b
The holder of a convertible note may convert the note to equity.
Options A, C and D are incorrect. Conversion is optional, and is to equity not debt. If the note remains
unconverted, it remains as a debtinstrument.
You can review this topic area in the study materials under the section entitled Hybrids: Equities and securities
(Convertible notes).
Question 14
Correct Answer: d
Foreign loans and bonds are the same. They are domestic currency loans made to foreign borrowers. Another
way of saying this is that they are issued by domestic borrowers to foreign investors, in the investors currency.
In this question, the borrower (issuer) is a Mongolian company. The investors (funders) are Australian banks
and the loan is in AUD.
The study guide provides the following examples and definitions.

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I Eurobond: USD bond issued by Australian company (ANZ) in London (England). Note that the currency
is different to the borrowers or investors home country.
G Foreign loan/bond: An Australian company (BHP) issuing JPY bonds in Tokyo (Japan). This is similar to
a Mongolian company issuing an AUD loan to Australian banks.
Paraphrasing the definition of a foreign loan: A loan issued by a domestic borrower (i.e. the Mongolian
company) to investors in a country other than the borrowers home country (i.e. the Australian banks), with the
loan being denominated in the investors currency (i.e. AUD).
A, B and C are therefore incorrect. Eurodollar loans are loans obtained in a foreign currency in foreign countries.
LIBOR loans are loans at the London Inter-Bank Offered Rate. Term loans are fixed-term (domestic)loans.
You can review this topic area in the study materials under the section entitled Offshore long-term fundraising.
Question 15
Correct Answer: c
Price = $100 000/[1 + (0.05 40/365)] = $99 455
Note that the reference in the case information to 6.50 per cent for recent long-term borrowings is a distractor as
it is not required for the purposes of calculating the price of the bill.
You can review this topic area in the study materials under the section entitled Money market instruments.
Question 16
Correct Answer: d
In 40 days time, the company will have to repay the face value of the bill ($100 000), not the amount raised.
You can review this topic area in the study materials under the section entitled Money market instruments.
Question 17
Correct Answer: d
Current ratio = Current assets/Current liabilities.
Current ratio = 120/49.4 = 2.43.
Note that accounts payable is the only current liability.
You can review this topic area in the study materials under the section entitled Cash flow management
(Liquidity management).
Question 18
Correct Answer: c
Quick ratio = (Current assets Inventory)/Current liabilities
Quick ratio = (120 50)/49.4 = 1.42.
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Note that accounts payable is the only current liability.
You can review this topic area in the study materials under the section entitled Cash flow management
(Liquidity management).
Question 19
Correct Answer: d
The accounts receivable period can be calculated as
Accounts receivable period = Accounts receivable/Average days sales.
Average days sales = Total sales/365.
Average days sales = 90/365 = 0.2466.
Accounts receivable period = 20/0.2466 = 81.1 or 81 days.
You can review this topic area in the study materials under the section entitled Measuring working
capitalrequirements.
Question 20
Correct Answer: b
The accounts payable period can be calculated as
Accounts payable period = Accounts payable/Average days costs of goods sold.
Average days cost of goods sold = Annual cost of goods sold/365.
Average days cost of goods sold = 50/365 = 0.137.
Accounts payable period = 49.4/0.137 or 361 days.
You can review this topic area in the study materials under the section entitled Measuring working
capitalrequirements.
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