lOMoARcPSD|4041866

Exam 2015, questions

Investments and Portfolio Management (Monash University)

StuDocu is not sponsored or endorsed by any college or university

Downloaded by Fatima Mazhar (fatima.mazhar@gscwu.edu.pk)
 lOMoARcPSD|4041866

OFFICE USE ONLY

Semester Two 2015

Examination Period
Faculty of Business and Economics

EXAM CODES: BFB3121
TITLE OF PAPER: INVESTMENTS AND PORTFOLIO MANAGEMENT – PAPER 1
EXAM DURATION: 3 hours writing time
READING TIME: 10 minutes

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, smart watch/device 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 7 of
the Monash University (Council) Regulations.

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

AUTHORISED MATERIALS
OPEN BOOK YES NO
CALCULATORS YES NO
(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 and five (5) pages of Formulae and Tables printed on a total of
thirteen (13) 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: __ __ __ __ __

THIS EXAMINATION PAPER MUST BE INSERTED INTO THE ANSWER BOOK AT THE COMPLETION OF
THE PAPER.

BFB3121 Dr Abey Gunasekarage Page 1 of 13

Downloaded by Fatima Mazhar (fatima.mazhar@gscwu.edu.pk)

 lOMoARcPSD|4041866

OFFICE USE ONLY

BFB3121 INVESTMENTS AND PORTFOLIO MANAGEMENT

Question 1: Financial Instruments & Markets
(a) Compare and contrast features of preferred stock to corporate bonds giving at
least two similarities and two differences.
(3 marks)
(b) You are provided with the price information for the following four stocks:

Stock Price ($) Price ($)
(t=0) (t=1)
A 80 110
B 100 90
C 50 60
D 70 80

Calculate the following:
(i) Price weighted index at t=0 and t=1.

(ii) Return on the price weighted index for the period.

(iii) Return on an equally weighted index.

(5 marks)
(c) Give an example of a broad based index used to track Australian shares.

(2 marks)
(Total 10 Marks)

Question 2: Trading Mechanism; Mutual Funds & Investment Companies

(a) Given below is some price information on Estelle stock at 11am today. Suppose the
stock is traded in a dealer market.
Bid Ask
50.25 50.50
(i) Sam has submitted an order to his broker to buy at market. At what price will
Sam’s trade be executed?
(ii) Clair has submitted an order to her broker to sell at market. At what price will
Clair’s trade be executed?
(iii) John has submitted a limit order to his broker to sell at $50.62. Will John’s trade
be executed? Explain why.
(iv) Jan has submitted a limit order to her broker to buy at $ 50.37. Will Jan’s trade be
executed? Explain why.
(4 marks)
(Cont’d on next page)

BFB3121 Dr Abey Gunasekarage Page 2 of 13

Downloaded by Fatima Mazhar (fatima.mazhar@gscwu.edu.pk)

 lOMoARcPSD|4041866

OFFICE USE ONLY

BFB3121 INVESTMENTS AND PORTFOLIO MANAGEMENT

Question 2 (cont’d)

(b) Ace Trader opens a brokerage account and purchases 500 shares of Internet Plays at
$50 per share. She borrows $10,000 from her broker to finance the purchase. The
interest rate on the loan is 8% p.a. The maintenance margin is 30%.

(i) What is the initial margin of Ace’s account?
(ii) How far does the price of stock have to fall by the end of the year for Ace to receive
a margin call?
(iii) If the share price falls to $35 at the end of the year, what is the remaining margin
in her account?
(iv) What is the rate of return earned by Ace on her investment?
(6 marks)
(Total 10 Marks)

Question 3: Risk & Return; Risk Aversion & Capital Allocation
(a) Assume that you bought a zero‐coupon bond with a face value of $1,000 for $870 five
years ago. The bond matures today.

(i) What is your 5‐year holding period return [r(5)]?
(ii) What is your effective annual rate of return?
(iii) If the average annual rate of inflation has been 2% over the last five years, what
is your exact annual real rate of return?
(3 marks)

(b) Your uncle invested $200,000 in a portfolio of securities 10 years ago. The value of this
portfolio investment today is $350,000. The average treasury bill rate for the same
period is 2.7% per annum.

Calculate the risk premium earned by your uncle’s investment.
(3 marks)

(c) Your client, Jo Bernard, holds a complete portfolio that consists of a portfolio of risky
assets (P) and treasury bills (T‐Bills). The information below refers to these assets.

12% p.a.

7.20% p.a.

T‐Bill rate 3.60% p.a.

Proportion of complete portfolio in P 80%

Proportion of complete portfolio in T‐Bills 20%

BFB3121 Dr Abey Gunasekarage Page 3 of 13

Downloaded by Fatima Mazhar (fatima.mazhar@gscwu.edu.pk)

 lOMoARcPSD|4041866

OFFICE USE ONLY

BFB3121 INVESTMENTS AND PORTFOLIO MANAGEMENT

Question 3 (cont’d)
(i) What is the expected return on Jo Bernard 's complete portfolio?
(ii) What is the standard deviation of Jo Bernard 's complete portfolio?
(iii) What is the equation of Jo Bernard 's Capital Allocation Line?

(4 marks)
(Total 10 Marks)

Question 4: Optimal Risky Portfolios; Index Models
(a) The manager of a superannuation scheme is planning to create a portfolio by investing
in the following equity and bond funds:

Fund type
Equity Fund 18% 26%
Bond Fund 8% 12%

The returns of these two funds have a correlation coefficient of 0.15. The manager
wants to invest in the portfolio with the minimum variance.

(i) Calculate the proportions (i.e. weights) that the manager should invest in each
fund to achieve the minimum variance portfolio.
(ii) What are the expected return and standard deviation of the minimum variance
portfolio?
(iii) Assume that the manager wants an expected return of 11% per annum from his
portfolio. What advice would you give to him?
(6 marks)


(b) The estimation of the index model for share “Neem’ resulted in the following equation:
R N  0.02  0.97 RM  e N

[Note: RN  (rN  r f ) and RM  (rM  r f ) ]

The R2 of the model is 0.45. The standard deviation of the market portfolio (  M ) is 0.30.
(i) What is the standard deviation of share ‘Neem’?
(ii) What is the firm‐specific risk of this share?
(4 marks)
(Total 10 Marks)

BFB3121 Dr Abey Gunasekarage Page 4 of 13

Downloaded by Fatima Mazhar (fatima.mazhar@gscwu.edu.pk)

 lOMoARcPSD|4041866

OFFICE USE ONLY

BFB3121 INVESTMENTS AND PORTFOLIO MANAGEMENT

Question 5: CAPM
(a) Discuss the differences between the capital market line and the security market line.
(3 marks)
(b) You work for an investment company and your supervisor has asked you to
recommend the best securities selector among the following fund managers:

Fund Manager Portfolio Beta Average annual return
1 1.00 15%
2 1.20 20%
3 0.80 16%
4 1.25 22%

Assume that the risk free rate (rf) is 3% per annum and the expected return on the
market portfolio is 15% per annum.

Provide necessary calculations and determine which fund manager was the best
securities selector.
(5 marks)
(c) You have invested in a well‐diversified portfolio of Australian equities. Your portfolio
beta is 1.40. The financial press predicts that the Australian equity market would have
a bearish run over the forthcoming month.

Explain how you would rebalance your equity portfolio in order to overcome any
adverse impacts.
(2 marks)
(Total 10 Marks)

Question 6: Market Efficiency & Behavioural Finance

(a) What is an efficient market? What is the implication of an efficient market?
(2 marks)
(b) Determine whether the following situations are consistent or inconsistent with the
efficient market hypothesis:

(i) You observe that when the current stock prices of companies are above (below)
their long run moving averages, they tend to show upward (downward) trends
for the following few days.
(ii) Stock prices that have risen (fallen) in the past few weeks, tend to rise (fall) in the
forthcoming few weeks.
(2 marks)
(cont’d on next page)

BFB3121 Dr Abey Gunasekarage Page 5 of 13

Downloaded by Fatima Mazhar (fatima.mazhar@gscwu.edu.pk)

 lOMoARcPSD|4041866

OFFICE USE ONLY

BFB3121 INVESTMENTS AND PORTFOLIO MANAGEMENT

Question 6 (cont’d)

(c) If you identify any of the scenarios in (b) above as inconsistent, explain how you use
such scenarios to earn abnormal return.
(2 marks)
(d) ‘Behavioral finance posits that investors possess behavioral biases’.
Discuss the importance of behavioral biases and explain the four behavioral biases
identified in the literature.
(4 marks)
(Total 10 Marks)


Question 7: Bond Prices & Yields; Bond Portfolio Management

(a) Explain the relationships between (i) price and face value and (ii) yield and coupon rate
in each of a par, discount and premium bond.
(3 marks)
(b) A 20‐year maturity bond with a par value of $1,000 makes semi‐annual coupon
payments at an annual coupon rate of 8%. This bond is currently selling at $1,050.

Calculate the bond equivalent and the effective annual yield to maturity for this bond.
(3 marks)

(c) An insurance company must make payments to a customer of $8 million in 1 year and
$5 million in 5 years. The yield curve is flat at 10% per annum.

(i) If the insurance company wants to fully fund and immunize its obligation to this
customer with a single issue of a zero‐coupon bond, what maturity bond should
it purchase?
(ii) What must be the face value and market value of the bond?
(4 marks)

(Total 10 Marks)

BFB3121 Dr Abey Gunasekarage Page 6 of 13

Downloaded by Fatima Mazhar (fatima.mazhar@gscwu.edu.pk)

 lOMoARcPSD|4041866

OFFICE USE ONLY

BFB3121 INVESTMENTS AND PORTFOLIO MANAGEMENT

Question 8: Equity Valuation
Instell Ltd reported an EPS of $24 for the just concluded financial year and paid a dividend
per share of $9.60. The company’s return on equity (ROE) is 15% per annum.

The company’s book value per share is $120 while its current share price is $95.

The analysts believe that Instell’s current growth rate will last for another three years.
However, the growth rate will drop to the industry average of 5% in year four and will remain
at that level forever.

The company’s required rate of return is 16% per annum.
(a) Calculate the intrinsic value of Instell shares.
(6 marks)
(b) If the market‐to‐book value for the market is 1.25, calculate the market‐to‐book value
of Instell relative to the market.
(2 marks)
(c) Would you consider Instell shares as a good buy?
(2 marks)
(Total 10 Marks)

Question 9: Options Markets; Option Valuation

(a) Differentiate between American options and European options.
(2 marks)
(b) You purchased a call option for $3.45 seventeen days ago. The call has a strike price of
$45 and the stock is now trading for $51. If you exercise the call today, what will be
your holding period return?
(2 marks)
(c) Using the Black‐Scholes option pricing model, estimate the value of the following call
option:
S0 = $100; X = $95; r = 0.10; T =0.25 (3 months); σ = 0.50
(6 marks)
(Total 10 Marks)

BFB3121 Dr Abey Gunasekarage Page 7 of 13

Downloaded by Fatima Mazhar (fatima.mazhar@gscwu.edu.pk)

 lOMoARcPSD|4041866

OFFICE USE ONLY

BFB3121 INVESTMENTS AND PORTFOLIO MANAGEMENT

Question 10: Portfolio Performance Evaluation; International Diversification

(a) The following data are available relating to the performance of Sooner Stock and the
market portfolio:

Variable Sooner Stock Market Portfolio
Average return 20% 11%
Standard deviation of return 44% 19%
Beta 1.8 1.0
Residual standard deviation 2.0% 0.0%

The risk‐free return during the sample period is 3% per annum.

(i) What are the Sharpe, Treynor, Jensen and information ratio measures of
performance evaluation for Sooner Stock?
(ii) Which of the above performance measures is relevant to you if Sooner is the only
security you have invested in? Why?
(iii) Which of the above performance measures is relevant to you if Sooner is only one
stock among many stocks in your investment portfolio? Why?
(5 marks)

(b) You are an Australian investor who purchased British securities for £4,000 one year
ago when the British pound cost AU$1.25. You received a dividend income of £200 at
the end of the year. The value of the securities is now £5,400 and the pound is worth
AU$1.40. What is your Australian dollar denominated total return?
(2.5 marks)
(c) Explain why the benefits of international diversification may not be preserved during
a period of global financial crisis.
(2.5 marks)
(Total 10 Marks)




END OF EXAMINATION

BFB3121 Dr Abey Gunasekarage Page 8 of 13

Downloaded by Fatima Mazhar (fatima.mazhar@gscwu.edu.pk)

 lOMoARcPSD|4041866

OFFICE USE ONLY

BFB3121 INVESTMENTS AND PORTFOLIO MANAGEMENT

Formulae

1
R(1  t )  i  (r  i)(1  t )  i  r (1  t )  it
Market Value of Assets  Liabilities
NAV 
Shares Outs tan ding
EAR  1  rf (T ) T  1
1

P1  P0  D1
r
P0

1
 
N

g  P N  1
 
 P 0 

 E (rP )  rf 
E (rC )  rf    C
 P 

E (rC )  rf  y E (rP )  rf  
E (rP )  r f
S
P
Cov ( Ri , R j )   i   j   M2
 C  y  P
 22  Cov (r1 , r2 )
W1 
 12   22  2Cov(r1 , r2 )
[ E (rS )  rf ]   B2  [ E (rB )  rf ]  Cov(rS , rB )
wS 
[ E (rS )  rf ]   B2  [ E (rB )  rf ]   S2  [ E (rS )  rf  E (rB )  rf ]  Cov(rS , rB )

 P2  (W12 )( 12 )  (W22 )( 22 )  2(W1 )(W2 )Cov (r1 , r2 )

Cov(r1, r2 )  1, 2   1   2
E (ri )  rf   i [ E (rm )  rf ]

sn
E (r )  p
s 1
s  rs

sn 2

 2
  ( p s )  r s  E ( r s ) 
s 1

U  E (r )  0.5( A)( 2 )

BFB3121 Dr Abey Gunasekarage Page 9 of 13

Downloaded by Fatima Mazhar (fatima.mazhar@gscwu.edu.pk)

 lOMoARcPSD|4041866

OFFICE USE ONLY

BFB3121 INVESTMENTS AND PORTFOLIO MANAGEMENT

i n
E (rP )  Wi  E (ri )
i 1

 2 (eP )  wA2   2 (eA )  wB2   2 (eB )  w2f   2 (e f )

 2   m2
R2 
 i2
Ri ,t   i   i RM ,t  ei ,t

 i2   2 m2   2 (ei )
 P2   P2 M2   2 (e p )
n

 P  Wi   i
i 1

E
WD 
D E
E(rP )  rf
y* 
A( P2 )

PB   Ct T  ParValue
T
T

t 1 (1 r ) (1 r )
T


Do(1  g )
Po 
kg

g  ROE  b
T
D   t w t

t 1


wt  CF t (1  y ) Price
t


Volume declining
Number declining
Trin =
Volume advancing
Number advancing

 D  D1 2
...  D P
N N
P
(1 k ) (1 k ) (1 k )
0 1 2 N

BFB3121 Dr Abey Gunasekarage Page 10 of 13

Downloaded by Fatima Mazhar (fatima.mazhar@gscwu.edu.pk)

 lOMoARcPSD|4041866

OFFICE USE ONLY

BFB3121 INVESTMENTS AND PORTFOLIO MANAGEMENT

FCFF  EBIT (1  t c )  DEP  CAPEX  Increase in WC

P  (1  y )
 D 
P (1  y )
D
D* 
(1  y )

1  y (1  y )  T (c  y )
D 
y c[(1  y )T  1]  y

E1
P0   PVGO
k
P0 1

E1 k
P
  D *  y
P
D1 E1(1  b)
P0  
k  g k  (b  ROE )
P0 1 b

E1 k  (b  ROE )
P
  D * (y )  1 (Convexity)(y ) 2
P
2
D
Po 
k


Dt
Po  
(1  k ) t
t 1

Cu  Cd
H 
uS 0  dS 0

S   2 
ln  0    r  T
X  2 
d1 
 T

d 2  d1    T

C0  S 0  N (d1 )  Xe  rT  N (d 2 )

X
C  P  S0 
(1  r f ) T

BFB3121 Dr Abey Gunasekarage Page 11 of 13

Downloaded by Fatima Mazhar (fatima.mazhar@gscwu.edu.pk)

 lOMoARcPSD|4041866

OFFICE USE ONLY

BFB3121 INVESTMENTS AND PORTFOLIO MANAGEMENT

(1  rG ) n  (1  r1 )(1  r2 )...(1  rn )
C C C
PV  r p 1 1  r f 2 2  ... n n
?  1  r  1 
r 1  r 

 P

rp rf
?

P

P
?

 (e P )


P  r P  r f  P (r m  r f ) 
n n

r  r  w r  w r i 1
pi pi 

p B
i 1
Bi Bi

ARi ,t  Ri ,t  [ R f ,t  i ( Rm,t  R f ,t )]

?  (WPi  WBi )rBi

?  (rPi  rBi )WPi

ARi ,t  Ri ,t  [ i   i ( Rm,t )]   

BFB3121 Dr Abey Gunasekarage Page 12 of 13

Downloaded by Fatima Mazhar (fatima.mazhar@gscwu.edu.pk)

 lOMoARcPSD|4041866

OFFICE USE ONLY

BFB3121 INVESTMENTS AND PORTFOLIO MANAGEMENT

BFB3121 Dr Abey Gunasekarage Page 13 of 13

Downloaded by Fatima Mazhar (fatima.mazhar@gscwu.edu.pk)