Financial Risk

Management
3rd Edition (Enhanced)

Study Guide Errata

Errata last updated: 28/02/2022

Module 2
Errata Published: 11/01/2021

Figure 2.1 Cash and operating cycles for a company, page 66

There is a word missing from the text associated with the second to last arrow in the diagram. It
should read ‘Cash conversion cycle’ rather than ‘Cash cycle’.
Errata Published: 26/01/2021

Module 2: Example 2.6 Price of a coupon-paying bond, page 78

In the PDF version of the Study Guide, the example for the market price of a bond with coupons paid
semi-annually incorrectly shows number of periods as 4 (1 + 0.03)4. It should be 8 periods (1 +
0.03)8. The resulting calculations are however, correct.
Errata Published: 10/08/2021
Example 2.6, p78 (online PDF and Print versions only)

Replace
4000 1 100 000
P0 = (
0.03
) (1 − ( 1 + 0.03 ) 4 ) + ( 1 + 0.03 ) 4
With
4000 1 100 000
P0 = (
0.03
) (1 − ( 1 + 0.03 ) 8 ) + ( 1 + 0.03 ) 8

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Module 3
Errata Published: 23/02/2022

Example 3.3, page 124

The result of the calculation with the discount rate at 19 per cent should be + $11 527 rather than - $11
527

Errata Published: 10/08/2021

Example 3.10, page 137

There is an error in the layout of the formulas given in the Study Guide and one formula is missing.
Please replace the example in the Study Guide with the example below.

Example 3.10: Bias when inflation is not consistently treated in the cash flows and
discount rate
A project’s cash flows are shown in Table A. Assume that after-tax cash flows have been estimated in real terms and that the
required nominal discount rate is 12 per cent. Also assume that the inflation rate is expected to be 6 per cent per annum.
Table A; Real after-tax cash flows

Real after-
Project
tax cash
End of year cost
flow
$
$

0 (100 000)

1 20 000

2 27 000

3 30 000

4 34 000

5 20 000

Using the nominal discount rate of 12 per cent, the NPV is calculated as follows:

NPV = –100 000 + 20 000 / (1.12)1 + 27 000 / (1.12)2 + 30 000 / (1.12)3 + 34 000 / (1.12)4 + 20 000 / (1.12)5
NPV = –$6309
Based on this analysis, the project would be rejected. However, this is incorrect because the analysis applies a nominal discount
rate to cash flows, which are measured in real terms.
The correct procedure would be to convert the real after-tax cash flows into nominal terms using the expected inflation rate. In
this example, the expected inflation rate is 6 per cent per annum.
The real after-tax cash flows would be converted to nominal cash flows as shown in Table B. This table shows that the nominal
after tax cash flows are obtained by adjusting the real after-tax cash flows from Table A by the expected inflation rate of 6 per
cent; that is, 21 200 = 20 000(1.06)1, 30 337 = 27 000(1.06)2, and so on.

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Table B: Real and nominal after-tax cash flows

Real after- Nominal

tax cash after-tax
End of year flow cashflow
$ $

1 20 000 21 200

2 27 000 30 337

3 30 000 35 730

4 34 000 42 924

5 20 000 26 765

Using the 12 per cent nominal discount rate, the correct NPV is:

NPV = –100 000 + 21 200 / (1.12)1 + 30 337 / (1.12)2 + 35 730 / (1.12)3 + 42 924 / (1.12)4

+ 26 765 / (1.12)5
NPV = $11 011
The correct NPV is positive and so the project should be accepted. The consistent treatment of the effects of inflation has
resulted in correctly accepting a project that would otherwise have been incorrectly rejected.
Note that rather than making the investment decision using the nominal cash flows, the real cash flows (shown in Table A) could
have been discounted at the real discount rate. The NPV using this method would be the same as the correct NPV previously
calculated.
Based on the expected inflation rate of 6 per cent, the corresponding real discount rate is (1.12 / 1.06) - 1 = 5.66 per cent per
annum.
Discounting the real cash flows at the real discount rate of 5.66 per cent gives the following NPV:
NPV = –100 000 + 20 000 / (1.0566)1 + 27 000 / (1.0566)2 + 30 000 / (1.0566)3
+ 34 000 / (1.0566)4 + 20 000 / (1.0566)5
NPV = $11 011
As expected, this is the same as the NPV obtained using the nominal cash flows with the nominal discount rate. The key
implication of this analysis is that when discounting nominal cash flows, the nominal discount rate should be used, and when
discounting real cash flows the real discount rate should be used.

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Errata Published: 10/08/2021

Effective interest rates, 147

The formula to calculate an effective annual interest rate is incorrect.

Replace

With
re = (1 + r / m) m - 1

Errata Published: 26/08/2021

Question A3.2 (d) (ii), page 397

There is an error in the formula. The amount of $24 000 should be divided by 0.083 which is the
effective interest rate and not 0.08. Note that the answer is however correct.
The correct calculation should be ( 24 000 / 0.083 ) * ( ( 1 + 0.083 )5 – 1) = $141 643

Module 4
Errata Published: 11/01/2021

Figure 4.4 Inter Continental Exchange (ICE) Sugar No. 11 Futures, page 159
The final paragraph on this page asks the reader to note ‘the falling prices of sugar futures’. The note is
referring to Figure 4.4 and should instead read ‘the falling prices of sugar futures in the two months to
May-2018’.

Second paragraph, page 166

In the second paragraph the text states that ‘the pay-off is $5’. This should read ‘the pay-off is -$5’.

Module 5
Errata Published: 11/01/2021

Case Study 5.2, pages Second paragraph, pages 186-187

In the final table in the case study the word ‘impact’ should instead be ‘gap’ as shown below.

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GFC Ltd will benefit from: Under 1 year 1 year and above

(a) Normal yield curve Negative gap Positive gap

(b) Inverse yield curve Positive gap Negative gap

Errata Published: 26/08/2021

Example 5.6: Hedging with interest rate caps, page 201

Replace:
This example ignores the premium that would be charged on a cap. However, the premium would
reduce the pay-off from the long cap and add to the effective borrowing rate. Assuming a CP of
0.10 per cent, the effective borrowing rates would be as follows:
• Where BBSW < Cap, the cap would lapse unexercised, the pay-off from the long cap would be
–0.10 per cent and the effective borrowing rate would be 4.60 per cent (i.e. 4.50% + 0.10%).
• Where BBSW = Cap, the cap may or may not be exercised. Either way, the pay-off from the
long cap would be –0.10 per cent and the effective borrowing rate would be 5.10 per cent (i.e.
5.00% + 0.10%).
• Where BBSW > Cap, the cap would be exercised, the pay-off from the long cap would be 0.40
per cent (i.e. 0.50% – 0.10%) and the effective borrowing rate would be 5.10 per cent (i.e.
5.00% + 0.10%).

With:
This example ignores the premium that would be charged on a cap. However, the premium would
reduce the pay-off from the long cap (to give the resulting profit from the long cap) and add to the
effective borrowing rate. Assuming a CP of 0.10 per cent, the effective borrowing rates would be
as follows:
• Where BBSW < Cap, the cap would lapse unexercised, the profit from the long cap would be –
0.10 per cent and the effective borrowing rate would be 4.60 per cent (i.e. 4.50% + 0.10%).
• Where BBSW = Cap, the cap may or may not be exercised. Either way, the profit from the long
cap would be –0.10 per cent and the effective borrowing rate would be 5.10 per cent (i.e.
5.00% + 0.10%).
• Where BBSW > Cap, the cap would be exercised, the profit from the long cap would be 0.40
per cent (i.e. 0.50% – 0.10%) and the effective borrowing rate would be 5.10 per cent (i.e.
5.00% + 0.10%).

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Errata Published: 28/02/2022

Example 5.10, page 209

The formula for d1 should be:

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