Multiple Choice Questions



ACCA F9

Financial Management

Revision Class 4

Session 4

Patrick Lui

hklui2007@.hk

|Revision 6 |

Revision 6 – Business Valuations

Topic List

|1. |Reasons for Valuations and Information Requirements |Exam Question Reference |

| |a. Reasons for valuation | | |

| |b. Information requirements | | |

|2. |Models for Valuation of Shares | | |

| |a. Assets-based valuations | | |

| |Net book value (balance sheet basis) |Dec 10 |Q4a(ii) |

| | |Dec 11 |Q3a(i) |

| |Net realizable value |Dec 12 |Q4a(ii),b |

| | |Pilot 14 |Q2a |

| |Net replacement cost basis | | |

| |b. Income-based valuations | | |

| |Price/earnings ratio method |Dec 07 |Q1a(i) |

| | |Jun 08 |Q2c |

| | |Dec 08 |Q1b |

| | |Jun 09 |Q1b(i) |

| | |Jun 12 |Q4a |

| | |Dec 12 |Q4a(iii),b |

| | |Pilot 14 |Q2a |

| |Earnings yield method |Dec11 |Q3a(iii) |

| |c. Cash-flow based valuation | | |

| |Dividend valuation model |Dec 07 |Q1a(ii) |

| | |Jun 08 |Q2a |

| | |Dec 08 |Q1d |

| | |Jun 09 |Q1b(ii) |

| | |Jun 10 |Q4b |

| | |Dec 10 |Q4a(i) |

| | |Dec 11 |Q3a(ii) |

| | |Jun 12 |Q4b |

| | |Dec 12 |Q4a(iv),b |

| | |Jun 13 |Q4a |

| | |Jun 14 |Q4b |

| | |Pilot 14 |Q5a |

| |Discounted cash flow basis | | |

| | | | |

|3. |Valuation of Debt and Other Financial Assets | | |

| |a. Irredeemable debt | | |

| |b. Redeemable debt |Dec 12 |Q4c(i) |

| |c. Convertible debt |Dec 07 |Q1b |

| |d. Preference shares | | |

| | | | |

|4. |Efficient Market Hypothesis (EMH) | | |

| |a. Weak-form |Dec 07 |Q1c |

| | |Dec 10 |Q2c |

| |b. Semi-strong form |Dec 07 |Q1c |

| | |Jun 08 |Q2d |

| | |Dec 10 |Q2c |

| |c. Strong form |Dec 07 |Q1c |

| | |Dec 10 |Q2c |

| | | | |

|5. |Implications of EMH for the Financial Manager |Dec 07 |1c |

| | | | |

|6. |Practical Consideration in the Valuation | | |

| | | | |

Chapter 17 Business Valuation

I. Shares Valuation

1. Which of the following best describes the replacement value of a business?

A Value if sold off piece-meal

B Value to replace assets with new

C Cost of setting up an equivalent venture

D Net present value of current operations

2. The following is a summary of ABC Co’s statement of financial position:

| |$m |

|Non-current assets |5 |

|Net current assets |3 |

| |8 |

|Financed by: | |

|$1 Ordinary shares |1 |

|Reserves |5 |

|Loan notes |2 |

| |8 |

Non-current assets include machinery which cost $10 million which was purchased 7 years ago and has a useful life of 10 years. Monkton Co uses straight-line depreciation. These assets were recently professionally valued at $1 million.

What is the value per share using the realisable value basis of valuation?

A $1

B $2

C $4

D $6

3. Coombeshead plc has ordinary shares in issue that pay a constant dividend per share of 25p and have a beta of 1·2. The current market rate of return is 8% and the risk-free rate of return is 2%.

What is the predicted market value of each share of the company (to the nearest pence)?

A 179 cents

B 216 cents

C 272 cents

D 347 cents

4. SKV Co has paid the following dividends per share in recent years:

| |2013 |2012 |2011 |2010 |

|Dividend (cents per share) |36.0 |33.8 |32.8 |31.1 |

The dividend for 2013 has just paid and SKV Co has a cost of equity of 12%.

Using the geometric average historical dividend growth rate and the dividend growth model, what is the market price of SKV Co shares to the nearest cent on an ex dividend basis?

A $4·67

B $5·14

C $5·40

D $6·97

(ACCA F9 Financial Management Pilot Paper 2014)

5. Thomworthy plc, which is financed entirely by equity, earns a constant return of 10% on its investments. The company has a constant dividend payout ratio of 40% and the earnings per share of the company is expected to be 50 cents at the end of the forthcoming year.

What is the predicted market value of each share of the company?

A 200 cents

B 206 cents

C 333 cents

D 500 cents

6. Plessur Co pays a constant dividend of $0·10 per equity share and these shares have a beta of 1·4. The current market rate of return is 9% and the risk-free rate of return is 3%.

What is the predicted market value of each equity share?

A $0·64

B $0·88

C $1·14

D $1·19

7. Bernina Co has recently paid a dividend of $0·30 per equity share. The company has a constant dividend payout ratio of 25% and achieves a 12% return on all new investments.

What is the predicted market value of an equity share?

A $1·30

B $2·73

C $3·43

D $10·90

8. Gannet Ltd is a private company that has ordinary shares in issue with a par value of £0·50 each. The company has recently paid a dividend of £0·15 per share. Tern plc is listed on the London Stock Exchange and operates in the same industry as Gannet Ltd. Tern plc has ordinary shares in issue with a par value of £1·00 and a current market value of £3·00. The company has recently paid a dividend of £0·27 per share. The rate of income tax on dividends is 10%.

Which one of the following is the value of each ordinary share in Gannet Ltd on a dividend yield basis?

A £0·56

B £1·50

C £1·67

D £1·85

9. Quartz plc pays an annual dividend of 30 cents per share to shareholders, which is expected to continue in perpetuity. The average rate of return for the market is 9% and the company has a beta coefficient of 1·5. The risk-free rate of return is 4%.

What is the expected rate of return for the shareholders of the company and the predicted value of the shares in the company?

| |Expected rate of return (%) |Predicted value (cents) |

|A |23.5 |705 |

|B |17.5 |171 |

|C |16.5 |182 |

|D |11.5 |261 |

10. Opal Ltd has 2 million $0·50 ordinary shares in issue. The company achieved the following results for the year that has just ended:

| |$000 |

|Operating profit |440 |

|Interest payable |120 |

| |320 |

|Corporation tax |80 |

| |240 |

|Dividend payable |100 |

| |140 |

Kyanite plc, which operates within the same industry as Opal Ltd, has $1·00 ordinary shares in issue that have a current market price of $9·00. It has recently announced a dividend per share of $0·30. Kyanite plc maintains a constant dividend payout ratio of 40%.

What is the value of each ordinary share of Opal Ltd on the basis of Kyanite plc’s price/earnings ratio?

A $0·84

B $1·44

C $1·92

D $9·00

11. Arcturus plc has agreed to acquire all the ordinary shares in Mira plc and has also agreed a share-for-share exchange as the form of consideration. The following information is available:

| |Arcturus plc |Mira plc |

| |$m |$m |

|Operating profit |100 |20 |

|Net profit before taxation |80 |14 |

|Net profit after taxation |60 |10 |

| | | |

|Share capital – $0.50 ordinary shares |$20m |$5m |

|Price/earnings ratio |10 |12 |

The agreed share price for Mira plc will result in its shareholders receiving a premium of 25% on the current share price.

How many new shares must Arcturus plc issue to purchase the shares in Mira plc?

A 8·0 million

B 10·0 million

C 10·5 million

D 12·0 million

12. Kajan plc has recently issued a dividend of $0·20 per share. The company has a constant dividend payout ratio of 30 per cent and achieves a 10 per cent return on new investments.

What is the predicted market value of a share in the company?

A $1·13

B $2·94

C $6·67

D $7·13

13. Which of the following need to be assumed when using the dividend valuation formula to estimate a share value?

1 The recent dividend, ‘D0’, is typical i.e. doesn’t vary significantly from historical trends

2 Growth will be constant

3 The cost of equity will remain constant

4 A majority shareholding is being purchased

A 1, 2 and 3 only

B 3 and 4 only

C 1 and 2 only

D 1, 2, 3 and 4

14. Which of the following best defines the market capitalisation for a company’s shares?

A When a company is listed ie goes ‘public’

B When a company issues new shares and thus increases its capital

C Current share price

D Share price × number of shares in issue

15. NCW Co is considering acquiring the ordinary share capital of CEW Co. CEW has for years generated an annual cash inflow of $10 million. For a one off investment of $6m in new machinery, earnings can be increased by $2m per annum. NCW has a cost of capital of 10%.

What is the value of CEW Co?

A $114m

B $120m

C $100m

D $94m

16. ABC Co is considering purchasing BBC Co. Both are listed companies. Recent information:

| |ABC Co |BBC Co |

|Earnings |$4m |$2m |

|P/E ratio |21 |16 |

A Co believes that if they were to purchase B Co the combined group would have earnings of $6.5 million (after synergies) and a P/E ratio of 19.

What is the maximum A Co should pay for B Co?

A $32 million

B $39.5 million

C $22.4 million

D $28 million

|Question 1 – Rights issue and share price valuation |

|Dartig Co is a stock-market listed company that manufactures consumer products and it is planning to expand its existing business. The|

|investment cost of $5 million will be met by a 1 for 4 rights issue. The current share price of Dartig Co is $2·50 per share and the |

|rights issue price will be at a 20% discount to this. The finance director of Dartig Co expects that the expansion of existing |

|business will allow the average growth rate of earnings per share over the last four years to be maintained into the foreseeable |

|future. |

| |

|The earnings per share and dividends paid by Dartig over the last four years are as follows: |

| |

| |

|2003 |

|2004 |

|2005 |

|2006 |

|2007 |

| |

|Earnings per share (cents) |

|27.7 |

|29.0 |

|29.0 |

|30.2 |

|32.4 |

| |

|Dividend per share (cents) |

|12.8 |

|13.5 |

|13.5 |

|14.5 |

|15.0 |

| |

| |

|Dartig Co has a cost of equity of 10%. The price/earnings ratio of Dartig Co has been approximately constant in recent years. Ignore |

|issue costs. |

| |

|Required: |

| |

| |

| |

|(a) Calculate the theoretical ex rights price per share prior to investing in the proposed business expansion. (3 marks) |

|(b) Calculate the expected share price following the proposed business expansion using the price/earnings ratio method. (3 marks) |

|(c) Discuss whether the proposed business expansion is an acceptable use of the finance raised by the rights issue, and evaluate the |

|expected effect on the wealth of the shareholders of Dartig Co. (5 marks) |

|(d) Using the information provided, calculate the ex div share price predicted by the dividend growth model and discuss briefly why |

|this share price differs from the current market price of Dartig Co. (6 marks) |

|(Amended ACCA F9 Financial Management December 2008 Q1(a) – (d)) |

|Question 2 – Shares valuation methods, bonds valuation and gearing ratio |

|GWW Co is a listed company which is seen as a potential target for acquisition by financial analysts. The value of the company has |

|therefore been a matter of public debate in recent weeks and the following financial information is available: |

| |

|Year |

|2009 |

|2010 |

|2011 |

|2012 |

| |

|Profit after tax ($m) |

|8.5 |

|8.9 |

|9.7 |

|10.1 |

| |

|Total dividends ($m) |

|5.0 |

|5.2 |

|5.6 |

|6.0 |

| |

| |

|Statement of financial position information for 2012 |

| |

|$m |

|$m |

| |

|Non-current assets |

| |

|91.0 |

| |

|Current assets |

| |

| |

| |

|Inventory |

|3.8 |

| |

| |

|Trade receivables |

|4.5 |

|8.3 |

| |

|Total assets |

| |

|99.3 |

| |

|Equity finance |

| |

| |

| |

|Ordinary shares |

|20.0 |

| |

| |

|Reserves |

|47.2 |

|67.2 |

| |

|Non-current liabilities |

| |

| |

| |

|8% bonds |

| |

|25.0 |

| |

|Current liabilities |

| |

|7.1 |

| |

|Total equity and liabilities |

| |

|99.3 |

| |

| |

| |

| |

|The shares of GWW Co have a nominal (par) value of 50c per share and a market value of $4·00 per share. The cost of equity of the |

|company is 9% per year. The business sector of GWW Co has an average price/earnings ratio of 17 times. The 8% bonds are redeemable at |

|nominal (par) value of $100 per bond in seven years’ time and the before-tax cost of debt of GWW Co is 6% per year. |

| |

|The expected net realisable values of the non-current assets and the inventory are $86·0m and $4·2m, respectively. In the event of |

|liquidation, only 80% of the trade receivables are expected to be collectible. |

| |

|Required: |

| |

|(a) Calculate the value of GWW Co using the following methods: |

|(i) market capitalization (equity market value); |

|(ii) net asset value (liquidation basis); |

|(iii) price/earnings ratio method using the business sector average price/earnings ratio; |

|(iv) dividend growth model using: |

|(1) the average historic dividend growth rate; |

|(2) Gorden’s growth model (the bre model) |

|The total marks will be split equally between each part. (10 marks) |

|(b) Discuss the relative merits of the valuation methods in part (a) above in determining a purchase price for GWW Co. (8 marks) |

|(c) Calculate the following values for GWW Co: |

|(i) the before-tax market value of the bonds of GWW Co; |

|(ii) debt/equity ratio (book value basis); |

|(iii) debt/equity ratio (market value basis). |

|Discuss the usefulness of the debt/equity ratio in assessing the financial risk of GWW Co. |

|The total marks will be split equally between each part. (7 marks) |

|(Total 25 marks) |

|(ACCA F9 Financial Management December 2012 Q4) |

|Question 3 – P/E method, dividend valuation model and WACC |

|Corhig Co is a company that is listed on a major stock exchange. The company has struggled to maintain profitability in the last two |

|years due to poor economic conditions in its home country and as a consequence it has decided not to pay a dividend in the current |

|year. However, there are now clear signs of economic recovery and Corhig Co is optimistic that payment of dividends can be resumed in |

|the future. Forecast financial information relating to the company is as follows: |

| |

|Year |

|1 |

|2 |

|3 |

| |

|Earnings ($000) |

|3,000 |

|3,600 |

|4,300 |

| |

|Dividends ($000) |

|Nil |

|500 |

|1,000 |

| |

| |

|The company is optimistic that earnings and dividends will increase after Year 3 at a constant annual rate of 3% per year. |

| |

| |

| |

|Corhig Co currently has a before-tax cost of debt of 5% per year and an equity beta of 1·6. On a market value basis, the company is |

|currently financed 75% by equity and 25% by debt. |

| |

|During the course of the last two years the company acted to reduce its gearing and was able to redeem a large amount of debt. Since |

|there are now clear signs of economic recovery, Corhig Co plans to raise further debt in order to modernise some of its non-current |

|assets and to support the expected growth in earnings. This additional debt would mean that the capital structure of the company would|

|change and it would be financed 60% by equity and 40% by debt on a market value basis. The before-tax cost of debt of Corhig Co would |

|increase to 6% per year and the equity beta of Corhig Co would increase to 2. |

| |

|The risk-free rate of return is 4% per year and the equity risk premium is 5% per year. In order to stimulate economic activity the |

|government has reduced profit tax rate for all large companies to 20% per year. |

| |

|The current average price/earnings ratio of listed companies similar to Corhig Co is 5 times. |

| |

|Required: |

| |

|(a) Estimate the value of Corhig Co using the price/earnings ratio method and discuss the usefulness of the variables that you have |

|used. (4 marks) |

|(b) Calculate the current cost of equity of Corhig Co and, using this value, calculate the value of the company using the dividend |

|valuation model. (6 marks) |

|(c) Calculate the current weighted average after-tax cost of capital of Corhig Co and the weighted average after-tax cost of capital |

|following the new debt issue, and comment on the difference between the two values. (6 marks) |

|(ACCA F9 Financial Management Jun 2012 Q4(a) – (c)) |

|Question 4 – Business valuation methods and WACC |

|Recent financial information relating to Close Co, a stock market listed company, is as follows. |

| |

| |

|$m |

| |

|Profit after tax (earnings) |

|66.6 |

| |

|Dividends |

|40.0 |

| |

| |

|Statement of financial position information: |

| |

|$m |

|$m |

| |

|Non-current assets |

| |

|595 |

| |

|Current assets |

| |

|125 |

| |

|Total assets |

| |

|720 |

| |

| |

| |

| |

| |

|Current liabilities |

| |

|70 |

| |

|Equity |

| |

| |

| |

|Ordinary shares ($1 nominal) |

|80 |

| |

| |

|Reserve |

|410 |

| |

| |

| |

| |

|490 |

| |

|Non-current liabilities |

| |

| |

| |

|6% bank loan |

|40 |

| |

| |

|8% bonds ($100 nominal) |

|120 |

| |

| |

| |

| |

|160 |

| |

| |

| |

|720 |

| |

| |

| |

| |

| |

| |

|Financial analysts have forecast that the dividends of Close Co will grow in the future at a rate of 4% per year. This is slightly |

|less than the forecast growth rate of the profit after tax (earnings) of the company, which is 5% per year. The finance director of |

|Close Co thinks that, considering the risk associated with expected earnings growth, an earnings yield of 11% per year can be used for|

|valuation purposes. |

| |

|Close Co has a cost of equity of 10% per year and a before-tax cost of debt of 7% per year. The 8% bonds will be redeemed at nominal |

|value in six years’ time. Close Co pays tax at an annual rate of 30% per year and the ex-dividend share price of the company is $8.50 |

|per share. |

| |

|Required: |

| |

|(a) Calculate the value of Close Co using the following methods: |

|(i) net asset value method; |

|(ii) dividend growth model; |

|(iii) earnings yield method. (5 marks) |

|(b) Discuss the weaknesses of the dividend growth model as a way of valuing a company and its shares. (5 marks) |

|(c) Calculate the weighted average after-tax cost of capital of Close Co using market values where appropriate. (8 marks) |

|(d) Discuss the circumstances under which the weighted average cost of capital (WACC) can be used as a discount rate in investment |

|appraisal. Briefly indicate alternative approaches that could be adopted when using the WACC is not appropriate. (7 marks) |

|(25 marks) |

|(ACCA F9 Financial Management December 2011 Q3) |

|Question 5 |

|GWW Co is a listed company which is seen as a potential target for acquisition by financial analysts. The value of the company has |

|therefore been a matter of public debate in recent weeks and the following financial information is available: |

| |

|Year |

|2012 |

|2011 |

|2010 |

|2009 |

| |

|Profit after tax ($m) |

|10.1 |

|9.7 |

|8.9 |

|8.5 |

| |

| |

|Statement of financial position for 2012 |

| |

| |

|$m |

|$m |

| |

|Non-current assets |

| |

|91.0 |

| |

|Current assets |

| |

| |

| |

|Inventory |

|3.8 |

| |

| |

|Trade receivables |

|4.5 |

|8.3 |

| |

|Total assets |

| |

|99.3 |

| |

| |

| |

| |

| |

|Equity finance |

| |

| |

| |

|Ordinary shares |

|20.0 |

| |

| |

|Reserves |

|47.2 |

|67.2 |

| |

| |

| |

| |

| |

|Non-current liabilities |

| |

| |

| |

|8% bonds |

| |

|25.0 |

| |

|Current liabilities |

| |

|7.1 |

| |

|Total equity and liabilities |

| |

|99.3 |

| |

| |

|The shares of GWW Co have a nominal (par) value of 50c per share and a market value of $4·00 per share. The business sector of GWW Co |

|has an average price/earnings ratio of 17 times. |

| |

|The expected net realisable values of the non-current assets and the inventory are $86·0m and $4·2m, respectively. |

| |

|In the event of liquidation, only 80% of the trade receivables are expected to be collectible. |

| |

|Required: |

| |

| |

|(a) Calculate the value GWW Co using the following methods: |

|(i) Market capitalization (equity market value); |

|(ii) net asset value (liquidation); and |

|(iii) price/earnings ratio method using the business sector average price/earnings ratio. |

|Note: The total marks will be split equally between each part. (6 marks) |

|(b) Discuss briefly the advantages and disadvantages of using the dividend growth model to value the shares of GWW Xo. (4 marks) |

|(10 marks) |

|(ACCA F9 Financial Management Pilot Paper 2014 Q2) |

II. Debt valuation

1. Luke Co has 8% convertible loan notes in issue which are redeemable in five years’ time at their nominal value of $100 per loan note. Alternatively, each loan note could be converted after five years into 70 equity shares with a nominal value of $1 each.

The equity shares of Luke Co are currently trading at $1·25 per share and this share price is expected to grow by 4% per year. The before-tax cost of debt of Luke Co is 10% and the after-tax cost of debt of Luke Co is 7%.

What is the current market value of each loan note to the nearest dollar?

A $92

B $96

C $104

D $109

(ACCA F9 Financial Management Pilot Paper 2014)

2. A company issues convertible loan stock at $100 nominal value for $104. The loan stock can be converted in four years time at a rate of 80 $1 ordinary shares for each $100 nominal value of loan stock. The current market value of the shares is $1·20.

What is the conversion premium per share?

A $0·05

B $0·10

C $0·20

D $0·30

3. Oriel plc has issued convertible debentures each with a nominal value of $100. The debentures have one year to maturity and have a coupon rate of interest of 6%. The next interest payment is due to be made by the company in one year’s time. Each $100 of debentures can be converted into 25 ordinary shares in Oriel plc in exactly one year’s time and, at the conversion date, the ordinary shares are expected to be worth $5. Debentures not converted will be redeemed at their nominal value a day later. Debenture holders require a pre-tax rate of return of 10%.

What is the expected market value of each $100 of convertible debenture?

A $96·50

B $113·80

C $119·30

D $125·00

4. Some years ago, Megellan Ltd issued bonds that pay interest on an annual basis at the rate of 8·0%. Interest has just been paid on the bonds, which are due for repayment in exactly two years’ time. The bonds will be redeemed at $110 per $100 nominal value. A yield of 10% per year is required by investors for such bonds.

What is the expected market value for the bonds? (To the nearest $ and ignoring taxation)

A $83·00

B $91·00

C $105·00

D $126·00

|Question 6 – Convertible bonds |

|Phobis Co has in issue 9% bonds which are redeemable at their par value of $100 in five years’ time. Alternatively, each bond may be |

|converted on that date into 20 ordinary shares of the company. The current ordinary share price of Phobis Co is $4·45 and this is |

|expected to grow at a rate of 6·5% per year for the foreseeable future. Phobis Co has a cost of debt of 7% per year. |

| |

|Required: |

|Calculate the following current values for each $100 convertible bond: |

|(i) market value; |

|(ii) floor value; |

|(iii) conversion premium (6 marks) |

|(ACCA F9 Financial Management December 2007 Q1(b)) |

Chapter 18 Market Efficiency

I. Efficient market hypothesis

1. Gurdip plots the historic movements of share prices and uses this analysis to make her investment decisions.

To what extent does Gurdip believe capital markets to be efficient?

A Not efficient at all

B Weak form efficient

C Semi-strong form efficient

D Strong form efficient

(ACCA F9 Financial Management Pilot Paper 2014)

2. A colleague states that when a stock market displays only weak-form efficiency, it has the following features:

1. Share price changes are random.

2. Share prices change in anticipation of new information being announced.

Which one of the following combinations (true/false) concerning the above features is correct?

| |Statement 1 |Statement 2 |

|A |True |True |

|B |True |False |

|C |False |True |

|D |False |False |

3. The chief executive of a listed company has recently announced changes to the accounting policies of the company. By making these changes, reported profits are expected to increase. The chief executive made the changes to create a better impression of company performance among investors.

What is the maximum level of market efficiency that the chief executive can assume that would be consistent with such behaviour?

A Strong-form efficiency

B Semi-strong form efficiency

C Weak-form efficiency

D Efficiency at no level.

4. Which one of the following statements is correct?

A A stock market that is efficient in the semi-strong form cannot be efficient in the weak form

B A stock market that is efficient has share price movements occurring on a random basis

C A stock market that is efficient in the strong form is one in which investors cannot make any profit

D A stock market that is efficient will have regular, recurring patterns of share price movements.

5. Different types of efficiency can be identified in the operation of capital markets.

To which particular type of efficiency does the terms ‘weak form’, ‘semi-strong form’ and ‘strong form’ apply?

A Allocative efficiency

B Operational efficiency

C Information processing efficiency

D Economic efficiency

6. The efficient market hypothesis is based on the following assumptions:

1. A world without taxes

2. No share transactions costs

Which one of the following combinations (true/false) concerning the above assumptions is correct?

| |Statement 1 |Statement 2 |

|A |True |True |

|B |True |False |

|C |False |True |

|D |False |False |

7. Consider the following statements concerning capital market efficiency.

Under the weak form of market efficiency:

(1) share prices anticipate new information becoming available

(2) share price movements reveal a detectable trend over time

Which one of the following combinations (true/false) concerning the above statements is correct?

| |Statement 1 |Statement 2 |

|A |True |True |

|B |True |False |

|C |False |True |

|D |False |False |

8. Consider the following statements concerning capital market efficiency.

The Efficient Markets Hypothesis (EMH) states that an efficient market is one in which:

(1) funds are directed towards companies that make most productive use of them.

(2) transaction costs are kept to a minimum.

Which one of the following combinations (true/false) concerning the above statements is correct?

| |Statement 1 |Statement 2 |

|A |True |True |

|B |True |False |

|C |False |True |

|D |False |False |

9. Consider the following statements concerning stock market efficiency:

When a stock market displays weak-form efficiency, it is impossible to:

1. make regular profits from any trends or patterns detected in share prices.

2. make abnormal gains by identifying undervalued or over-valued shares.

Which one of the following combinations (true/false) relating to the above statements is correct?

| |Statement 1 |Statement 2 |

|A |True |True |

|B |True |False |

|C |False |True |

|D |False |False |

10. Lyra plc, a listed public company, received news on 1 June 2014, in the form of a confidential letter, that it had won a contract from the UK government. The new contract is expected to increase profits significantly from 2016 onwards. The news of the contract was not made publicly available until 5 June 2014.

Which one of the following combinations of possible share price reactions would you expect on 5 June 2014 under the semi-strong and strong forms of market efficiency?

| |Share price reaction |

| |Semi-strong form |Strong form |

|A |Increase |Increase |

|B |Increase |No effect |

|C |No effect |Increase |

|D |No effect |No effect |

11. An investor hopes to make abnormal gains on his stock market investments by analysing published annual reports, relevant newspaper and magazine articles and published share prices.

What is the highest form of market efficiency that the investor is assuming?

A Strong form efficiency

B Semi-strong form efficiency

C Weak form efficiency

D Not efficient at any level

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ACCA Dec 2014 Dec 2014

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