Thursday, December 08, 2011

Post mortem on the Finance exam

I've been quiet for the past few weeks mainly because I've been revising for the MBA Finance exam, which was held today. Other than this, there hasn't been much to write about (not that this will stop me...).

The exam was in two halves; 50% of the marks come from multiple choice questions (MCQ) and 50% come from open questions. The agreed tactic was to start with the MCQs, do those which could done without too much thought or effort, then do the open questions, and in the remaining time one does the MCQs which were previously skipped over.

The examiners don't care how one arrives at the answers of the MCQs; they could come from calculation, from intuition or from guessing (I prefer to calculate). The class had passed around a collection of MCQs collected over the years, and I don't think that there was one question today which appeared in the collection (so much for those students who memorised the questions and answers!). Of course, there were questions of the kind "If someone receives a loan of X pounds and repays so much for four years, what is the rate of interest?" and "How much do I have to save every year if I want to receive a pension of 1 million pounds in 25 years, with an interest rate of 6%", but apart from that, almost everything was new. I skipped maybe four questions the first time around; three became obvious when doing them at the end, and the fourth question I guessed (even though there are four options, two were algebraicly the same, presented in slightly different forms, so the possibility of getting the question right is 50%). There were a few questions which I am slightly doubtful about in retrospect, but I imagine that I got about 40 out of 50 marks here.

The first open question started off with a calculation comparing leasing buses or taking a loan in order to buy them, For ten marks, one had to lay out the cash flow, calculate the the company's weighted average cost of capital (WACC) and say which option was better. We've done similar exercises in the past, so this wasn't problematic. Even so, talking with someone after the exam, I discovered that I might well have made a mistake here regarding one of the sums of money. Even so, I'll probably only lose one mark, because I used the correct methods throughout.

A further five marks were to be made by listing the advantages of leasing (easy), four or five with a strange question about a company selling its shop and then leasing it back straight away, and then a few more marks about 'agency problems'. I would like to think that I did very well on this question.

The final question (20 marks) started off with calculating spot and forward interest rates before demanding the calculation of a bond's current price and a question about the bond's duration. As it happens, I had ignored spot and forward interest rates until the subject came up at a revision meeting about two weeks ago when I relearnt the material, which is not too complicated. The data, however, were presented in an unfamiliar manner and I made a false start before I hit on the correct method (or at least, I hope that it's the correct method) of making the calculations. The subquestions about the bond were easy although on reflection, I made a small mistake regarding the duration (lose one mark).

Unless I have made a gross miscalculation, I should have done very well on this exam. Results in about six weeks.

As it happens, I've been reading (when not revising) a very interesting book on the Kindle, called "The ascent of money" by Niall Ferguson. This should be required background material for both the Economics and Finance courses. Apart from the interesting historical background, it is also written after the 2007 crash, which changed the rules of finance. At times, I found the course amusing with remarkably high interest rates (10% is not to be sneered at, when the interest rate in Britain or USA is about 1% these days); even more amusing were the statements that "real (inflation less) interest rates are the same in every country" and that "exchange rates can be calculated on the basis of inflation rates". Will someone please explain to me why the exchange rate for shekels to sterling has remained around six for some time? The interest rate in Britain is maybe 1% and the inflation rate 5%, whereas the interest rate in Israel is 2.75% (just lowered from 3%) and inflation is also about 2.75%. The exchange rate should be completely different. 

Despite being told that there are no arbitrage opportunities for long, the above shows possibilities: if I were to take a loan in Britain for (say) 1000 pounds at 2% per annum (I don't know whether that's accurate), I would have to pay 1020 pounds back after a year - but as there is 5% inflation, that would only be 971 'real' pounds. I could invest that money here in Israel, get a higher rate of nominal interest and then repay the loan, making a profit. But I won't do this.

Next Thursday, I start my penultimate course, "Negotiation". Unfortunately we have one lecture on Thursday evening and one lecture on Friday morning for six weeks but no lectures in February (the exam is in March). I wish I could sleep in the college on Thursday night instead of returning home and then returning the next morning.

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