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Exam 2014, questions

Investments and Portfolio Management (Monash University)

Exam 2014, questions

Investments and Portfolio Management (Monash University)

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Semester Two 2014

TITLE OF PAPER: INVESTMENTS AND PORTFOLIO MANAGEMENT – PAPER 1

EXAM DURATION: hours writing time

THIS PAPER IS FOR STUDENTS STUDYING AT: (tick where applicable)

 Berwick  Clayton  Malaysia  Off‐Campus Learning  Open Learning

 Caulfield  Gippsland  Peninsula  Enhancement Studies  Sth Africa

 Parkville  Other specify

During an exam, you must not have in your possession, a book, notes, paper, electronic device/s, calculator, pencil case, mobile phone or other material/item which has not been authorised for the exam

or specifically permitted as noted below Any material or item on your desk, chair or person will be deemed to be in your possession You are reminded that possession of unauthorised materials, or attempting

to cheat or cheating in an exam is a discipline offence under Part of the Monash University Council Regulations

No exam paper or other exam materials are to be removed from the room

AUTHORISED MATERIALS

If YES, only calculators with an 'approved for use' Faculty label are permitted

SPECIFICALLY PERMITTED ITEMS  YES  NO

if yes, items permitted are:

This paper consists of ten (10) questions printed on a total of sixteen (16) pages

Students must attempt to answer ALL questions

Candidates must complete this section if required to write answers within this paper

STUDENT ID: DESK NUMBER:

BFB Dr Abey Gunasekarage Page of

Question 1: Financial Instruments & Markets

a Identify three types of securities traded on the money market

(2 marks)

b You are comparing a corporate bond that pays % per annum and a tax‐exempt municipal bond that pays % per annum If your marginal tax rate is %, which bond would you buy?

(2 marks)

c Give an example of a broad market index that can be used to track the movements of the following markets:

i Japan

ii Australia

iii Hong Kong

(2 marks)

d What is a derivative security?

(2 marks)

e The price P and volume Q information for three stocks are provided in the following table:

X

Y

Z

$

$

$

$

$

$

Stock Z splits two for one at the end of period

Calculate the return on the value‐weighted index of the three stocks for the period

(2 marks)

[TOTAL = 10 MARKS]

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Question 2: Trading Mechanism; Mutual Funds & Investment Companies

a Differentiate between a direct search market and a brokered market

(2 marks)

b What is a stop loss order? What is the purpose of placing a stop loss order?

(2 marks)

c On / / you sold short , shares of Sigma Ltd which were selling at $ per share You gave $ , to your broker to establish your margin account The maintenance margin requirement is %

How high can Sigma s share price rise before you get a margin call?

(2 marks)

d Assume that the price of Sigma s share in c above on / / was $ per share During this three month period, Sigma Ltd paid an interim dividend of $ per share What was the rate of return on your short selling transaction?

(3 marks)

e A mutual fund had a net assets value NAV per share of $ on January ,

On December of the same year, the fund's NAV was $ During the year the fund s income distributions were $ and the capital gain distributions were $ per share Without considering taxes and transactions costs, what rate of return did

an investor receive on the fund last year?

(1 mark) [TOTAL = 10 MARKS]

BFB Dr Abey Gunasekarage Page of

Question 3: Risk & Return; Risk Aversion & Capital Allocation

a Assume that you bought a coupon bond for $ six months ago Today, you received

a coupon payment of $ and sold the bond for $

i What is your holding period return?

ii What is your effective annual return?

(2 marks)

b Your father invested $ , in a portfolio of securities ten years ago The value of this investment today is $ ,

Calculate the geometric rate of return earned by your father

(2 marks)

c You work for an investment management company Your senior manager has asked you to advise a client who wishes to invest in a portfolio consisting of three assets –

an equity fund E , a corporate bond fund B and a money market fund M You are presented with the following information:

The client s coefficient of risk aversion is i.e A= The expected returns and standard deviation of various portfolios that the client considers are as follows:

Portfolio WE WB WM E RP P

Which portfolio would you recommend to this client?

(6 marks)

[TOTAL = 10 MARKS]

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Question 4: Optimal Risky Portfolios; Index Models

a Your uncle wishes to invest his funds in the following three securities:

Security E r i i

Risk free asset Risky security B Risky security S

%

%

%

%

%

The covariance between the returns of B and S is The weights of two risky securities in the optimum risky portfolio are as follows:

4286 0



B

5714 0



s

i Calculate the expected return and the standard deviation of the optimum risky portfolio

(3 marks)

ii You uncle needs an expected return of % from his portfolio

Calculate the weights of risk free asset, security B and security S in his portfolio

What is the standard deviation of your uncle s complete portfolio?

(4 marks)

b The index model has been estimated for security ANY with the following output:

20 0

25 0

74 0 03 0

,











M

ANY e

ANY M ANY R e R



i Calculate the variance of this security

ii What are the proportions of market risk and firm‐specific risk of this security?

(3 marks)

[TOTAL = 10 MARKS]

BFB Dr Abey Gunasekarage Page of

Question 5: CAPM

a During the last year, you had investments in the following three stocks:

Stock Amount Invested Beta Actual Return

A

B

C

$ ,

$ ,

$ ,

%

%

%

During the same year, the risk free rate was % and the return on the market portfolio was %

i What is the actual return earned by your portfolio?

(2 marks)

ii What is the beta of your portfolio?

(2 marks)

iii Using the beta calculated in ii above, calculate the required return on your portfolio

(1 mark)

iv Explain whether you have outperformed the market on a risk‐adjusted basis

(2 marks)

b Lisa has been an active investor for a long time Her current portfolio is well diversified in that she faces only the market risk Lisa is retiring from her current job next year and therefore, she wants to reduce the risk exposure of her portfolio

What actions can she take to achieve her objective? Justify your answer in the context of security market line SML

(3 marks)

[TOTAL = 10 MARKS]

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Question 6: Market Efficiency & Behavioural Finance

a Define semi‐strong‐form market efficiency

(1 mark)

b Using the evidence discussed in class, explain whether the evidence on the return behavior of size based portfolios and book‐to‐market based portfolios are consistent with the semi‐strong form market efficiency

(3 marks)

c Differentiate between conventional finance and behavioural finance

(3 marks)

d The following information is available for a market for September :

Number of shares advancing Number of shares declining Number of shares unchanged

Advancing trading volume Declining trading volume Unchanged trading volume

Calculate the trin statistic and determine whether you predict a bullish or a bearish market

(3 marks)

[TOTAL = 10 MARKS]

BFB Dr Abey Gunasekarage Page of

Question 7: Bond Prices & Yields; Bond Portfolio Management

a Define the following:

i Callable bond

ii Puttable bond

(2 marks)

b A corporate bond with a par value of $ , and a maturity of years is currently selling at $ This bond has a coupon rate of % and the coupons are paid semi‐annually The bond is callable in years at a price of $ ,

What is the effective annual yield to call of this bond?

(3 marks)

c A %, ‐year bond has a yield to maturity of % and duration of years If the market yield changes by basis points, how much change will there be in the bond's price?

(2 marks)

d Briefly explain how some institutional investors use immunisation as a passive strategy in managing their bond portfolios exposure to interest rate risk

(3 marks) [TOTAL = 10 MARKS]

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Question 8: Equity Valuation

a A company retains % of its earnings for reinvesting in profitable projects Its return on equity ROE is % If the required rate of return on company s shares is

%, what is the price‐earnings ratio of this company?

(2 marks)

b Fly Boy Corporation is expected to report an EBIT of $ , for the forthcoming year The company has a corporate tax rate of % It will have an annual depreciation of $ , , will invest $ , in new projects, and will have a $ , increase in net working capital in the same year Fly Boy Corporation expects its cash flow to grow at a constant rate of % per annum

The company s value of debt is $ , , It has , shares outstanding The cost of capital of the company is %

Calculate the intrinsic value per share of Fly Boy Corporation

(5 marks)

c Paper Express Company has a balance sheet which lists $ million in assets, $ million in liabilities, and $ million in common shareholders' equity It has , , common shares outstanding The replacement cost of the assets is $ million The market share price is $

i What is Paper Express's price to book value?

ii If the industry average of price to book value is , would you consider Paper Express as a worthwhile investment

(3 marks)

[TOTAL = 10 MARKS]

BFB Dr Abey Gunasekarage Page of

Question 9: Options Markets; Option Valuation

a You have $ , to invest and you are presented with the following two alternative investments:

i Buy shares of ABC Ltd at a price of $ per share

ii Buy call options of ABC Ltd at a price of $ per option and invest the balance in a money market fund that pays % per annum The call options have a time to expiration of six months and an exercise price of $

Assume that your investment horizon is six months Complete the following table

(4 marks)

Value of investment:

i Invest $ , in ABC stocks

ii Invest $ , in ABC options

and in money market fund

Return on Investment:

i Invest $ , in ABC stocks

ii Invest $ , in ABC options

and in money market fund

b What is a straddle? Why does an investor go long on a straddle?

(2 marks)

c Using the Black‐Scholes option pricing model, calculate the value of a call option with following features:

S O = $ ; X = $ ; T = days; r = annually daily ; σ = No dividends will be paid before the option expires

(4 marks)

[TOTAL = 10 MARKS]

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Question 10: Portfolio Performance Evaluation; International Diversification

a You invested $ , through your broker three years ago Your account balance at the end of each year is shown in the table below

Year Account Balance

i Calculate the annual return generated by your investment for each year

(2 marks)

ii Your broker calls to tell you the good news that your average annual return over the three years has been % Where did he get this number?

(1 mark)

iii Your broker s statement confused you You know that you are not much better off than when you started investing three years ago Calculate an alternate return measure that reflects the compound growth of your investment

(1 marks)

iv Explain to your broker when it would make sense to use the % result that he initially quoted you

(2 marks)

b Comment on the following statements using your understanding on the benefits of international diversification

i Australian equities have performed extremely well in the recent past Therefore, Australian investors should invest % in Australian equities

ii There is too much currency risk involved in international investing

(4 marks)

[TOTAL = 10 MARKS]

BFB Dr Abey Gunasekarage Page of

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