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Unformatted text preview: MONASHiiJil-IVERSITY LIBRAth- Ul lll Ii Nil 004095331 \JlllUI-r Unu VIIAJ D33 Monash University Semester 2 Examination 2004
Faculty of Business and Economics EXAM CODE: AF W3046 TITLE OF PAPER: INVESTMENT AND PORTFOLIO ANLAYSIS
EXAM DURATION: 180 minutes writing time READING TIME 10 minutes THIS PAPER IS FOR STUDENTS STUDYING AT: (office use only - tick where applicable) Berwick C] Clayton El Malaysia [I Off-Campus Learning El Open Learning CI
Caulfield CI Gippsland Peninsula [:1 Enhancement Studies El South Africa D Pharmacy CI Other (specify) Singapore [fl During an exam, you must not have in your possession, a book, notes, paper, calculator, pencil case, 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 in an exam is a discipline offence under
Monash Statute 4.1. 1. Total number of questions: Seventeen (17) 2. This examination paper is divided into two sections: Section A — 7 questions; and Section B — 10 Multiple Choice questions. 3. Section A must be answered in the script book(s) provided.
Section B must be answered on the sheet provided — include this in your script book(s).
4. Students must answer ALL questions and ALL parts. AUTH RISED ATERIALS CALCULATORS YES El NO I]
OPEN BOOK YES D NO IZi
SPECIFICALLY PERMITTED ITEMS YES [3 NO [21 if yes, items permitted are: Candidates must complete this section if required to answer in this paper DESK NUMBER
SIGNATURE ............................................ ..
OTHER NAMES (in full) ......................................................................................................................... .. STUDENT ID .............................................................. .. Page 1 of 10 '1. SECTION A The portfolios below are being considered for investment: (b)
(6) Portfolio Fund Name Return Beta O'i ACA Investment 0.15 1.0 0.05
Monash Investment 0.20 1.5 0.10
Gippsland Trustees 0.10 0.6 0.03
Market (A0 Index) 0.13 1.0 0.04 Compute the Sharpe measure for each portfolio‘ and the market portfolio.
Compute the Treynor measure for each portfolio and the market portfolio. Rank the portfolios using each measure, explaining the cause for any differences you find
in the rankings. Additional information: The RFR = 7% (a) (b) (2+2+2=6marks) Find the value of a stock that just paid a $1.25 dividend and whose required return is 15%
if the dividend is expected to grow at each of the following rates for the indefinite future: (i) 0%
(ii) —5% Suppose the market DIE is 65%, the required return It is 12%, and the expected growth
rate for market earnings is 6%. (i) What is the current PIE for the market? If the DIE rose to 70%, all else the same,
what would the market PIE be? (ii) Briefly explain the PIE, and its importance. (4+2+4=10marks) Page 2 of 10 After much research on the developing economy and capital markets of the country of Otunia,
four firm, SAG, has decided to include an investment in the Otunia stock market in its
Emerging Markets Comrningled Fund. However, GAC has not yet decided whether to invest
activer or by indexing. Your Opinion on the active versus indexing decision has been solicited.
The following is a summary of the research findings: Otunia’s economy is fairly well diversified across agricultural and natural resources,
manufacturing (both consumer and durable goods), and a growing finance sector. Transaction
costs in securities markets are relatively large in Otunia because of high commissions and
government “stamp taxes” on securities trades. Accounting standards and disclosure regulations
are quite detailed, resulting in wide public availability of reliable information about companies’
financial performance. Capital flows into and out of Otunia, and foreign ownership of Otunia securities is strictly
regulated by an agency of the national government. The settlement procedures under these
ownership rules often cause lon delays in settling trades made by nonresidents. Senior finance
officials in the government are working to deregulate capital flows and foreign ownership, but
GAC’s political consultant believes that isolationiSI sentiment may prevent much real progress in
the short run. (a) Briefly discuss three aspects of the Otunia environment that favour investing actively,
and three aSpects that favour indexing. (b) Recommend whether GAC should invest in Otunia actively or by indexing. Justify your
recommendation based on the factors identified in part (a). (c) Explain two active bond investment strategies. (6+4+6=16marks) Page 3 of 10 Universal Auto is a large multinational corporation headquartered in the United States. For
segment reporting purposes, the cempany is engaged in two businesses: production of motor
vehicles and information processing services. The motor vehicle business is by far the larger of Universal’s two segments. It consists mainly
of domestic US passenger car production, but it also includes small truck manufacturing
operations in the United States and passenger car production in other countries. This segment of Universal has had weak operating results for the past several years, including a large loss in
1996. Although the company does not reveal the operating results of its domestic passenger car
segments, that part of Universal‘s business is generally believed to be primarily responsible for
the weak performance of its motor vehicle segment. Idata, the information processing services segment of Universal, was started by Universal about
15 years ago. This business has shown strong, steady growth that has been entirely internal; no acquisitions have been made. An excerpt from a research report on Universal prepared by Paul Adams, a CPA candidate,
states: “Based on our assumption that Universal will be able to increase prices significantly on
US passenger cars in 1997, we project a multibillion dollar profit improvement”. (a) Discuss the concept of an industrial life cycle by describing each of its five phases, as
described by Rielly and Norton (2003). (b) Identify where each of Universal’s two primary businesscs ~— passenger cars and
information processing - is in such a cycle. (0) Explain and discuss the rational for the ‘top down’ approach to investing. (5+2+6=13marks) (a) The Digital Electronic Quotation System (DEQS) Corporation pays no cash dividends
currently and is not expected to for the next five years. Its latest EPS was $10, all of
which was reinvested in the company. The firm’s expected ROE for the next five years is
20% per year, and during this time it is expected to continue to reinvest all of its earnings.
Starting six years from now the firm’s ROE on new investments is expected to fall to
15%, and the company is expected to start paying out 40% of its earnings in cash
dividends, which it will continue to do forever after. DEQS’s market capitalisation rate is 15% per year.
What is your estimate of DEQS’s intrinsic value per share? Show your working. (b) JOnes (2000, p.447) wrote ..."Puts and calls expand the opportunity set available to
investors.” Explain using examples how a “Put” can benefit a seller. (5 +4 = 9 marks) Page 4 of 10 The stock of Nikro Corporation is currently selling for $10 per share. Earnings per share in the
coming year are expected to be $2. The company has a policy of paying out 50% of its earnings
each year in dividends. The rest is retained and invested in projects that earn a 20% rate of
return per year. This situation is expected to continue indefinitely. (a) Assuming the current market price of the stock reflects its intrinsic value as computed
using the constant-growth DDM, what rate of return do Nikro’s investors require? (b) By how much does its value exceed what it would be if all earnings were paid as
dividends and nothing was reinVested? (4 + 2 : 6 marks) Growth and value can be defined in several ways. “Growth” usually conveys the idea of a
portfolio emphasising or including only issues believed to possess above-average future rates of
per-share earnings growth. Low current yield, high price-to-book ratios and high price-to-
eamings ratios are typical characteristics of such portfolios. “Value” usually conveys the idea of
portfolios emphasising or including only issues currently showing low price-to-book ratios, low
price-to-eamings ratios, above-average levels of dividend yield, and market prices believed to
be below the issues‘ intrinsic values. (3) Identify and provide reasons why, over an extended period of time, value-stock investing
might outperform growth-stock investing. (b) Explain why the outcome suggested in (a) should not be possible in a market widely
regarded as being highly efficient. (c) Briefly discuss the implications of the efficient market hypothesis for investment policy
as it applies to: (i) technical analysis in the form of charting; and
(ii) fundamental analysis. (d) Briefly explain the roles or responsibilities of portfolio managers in an efficient market
environment. (4+6+5+5+5=25marks) Page 5 of 10 FORMULAE D
- Price/Eamings ratio = “*1- - Varlance - Covariance 62 z 21% [Rf _ E(Ri)]2 Covij = E {[R, — E(R,—)] [R]- — E(Rj)]} . _ Covl-j
' Standard Deviation ° Correlation Coefficrent [3
i0}
” 2
0 = [Rf _ E (Rifl 0 Coefficient of Variation Oi
i=1 E (R)
0 CAPM Expected Return 0 Dividend Discount Model
E(R,.)=RFR+|3,- (Rm FRFR) D1 02 D3 Doc, Vj=l k+ 2+ 3+---+ w
(+) (l+k) (1+k) ([+k) - Expected Return of Security
- AM = XHPY/n E(Ri)=i(a)(R,-) i=1 - GM = (nHPR)% —1 - Expected Return of Portfolio
n
E(Rport): ZWiRi
i=1
0 Company Growth Rate = (retention rate) x return on equity
- Treynor_Performance Measure _ R,- —RFR T
Bi ° Sharp Performance Measure S. _ R,- — RFR
‘ SD,- - Holding Period Yield 2 Holding Period Return — 1 Endng investment value Beginning investment value Page 6 of 10 PLEASE COMPLETE THIS PAGE AND USE THIS PAGE TO INDICATE YOUR MULTIPLE-CHOICE RESPONSES BY CIRCLING YOUR SELECTION. Student Name:
1 (a)
2 (a)
3 (a)
4 (a)
5 (a)
6 (a) (b) (b) (b) (b) (b) (b) (C) (C) (C) (C) (d) (d) (d) (d) (d) (d) Multiple-Choice Answer Sheet (6) (e) (e) (6) Student ID: (b) (b) (b) (b) (C) (C) (d) (d) (d) (d) (e) (6) Page 7 of 10 SECTION B Please indicate your multiple choice response by encircling the appropriate answer
on the Answer Sheet provided in this exam paper. Consider two Securities, A and B. Security A and B have a correlation coefficient of 0.65. Security A has standard deviation of 12, and Security B has standard deviation of 25. Calculate
the covariance between these two securities. (a) 300
(b) 461.54
(c) 26154
(d) 195
(e) 200 Datacorp stock currently trades at $50. August call options on the stock with a strike price of
$55 are priced at $5.75. October call options with a strike price of $55 are priced at $6.25.
Calculate the value of the time premium between the August and October options. (a) —$0.50
(b) $0 (c) $0.50
(d) $5 (6) —$5 Assume that you have purchased a call option with a strike price of $60 for $5. At the same time
you purchase a put option on the same stock with a strike price of $60 for $4. If the stock is
currently selling for $75 per share, calculate the dollar return on this option strategy. (a) $10
(b) —$4
(6) $5
((1) $6
(o) $ 15 The standard deviation for GM is 13.00 and for Coca Cola, it is 8.50. The covariance between
returns for these stocks is 21.50. The correlation coefficient (rGM'CC) between these two stocks is: (a) 0.125
(b) 0.195
(c) 0.285
(d) 0.365
(e) 0.405 Page 8 of 10 USE THE FOLLOWNG INFORMATION TO ANSWER QUESTIONS 5, 6, AND 7. An analyst gives you the following data regarding the performance of three stock recommendations
. and a matched set of stocks (matched in terms of beta).
Stock Beginning Price Ending Price Dividend
W 41 44 1.00
W-match 12 13 0.60
Y 72 68 4.00
Y-match 32 31 0.15
Z 38 44 1.50
Z—match 52 57 2.00 5. What is the rate of return for each stock and its match ed stock? (W, W-match, Y, Y-match,
Z, Z—match) (a) 9.76%, 13.33%, 0.00%, —2.66%, 19.74%, 13.46%
(b) 13.33%, 9.76%, —2.66%, 0.00%, 13.46%, 19.74%
(c) 4.88%, -3.33%, 11.11%, 3.59%, —11.84%, —5.77%
(d) —-3.33%, 4.88%, 3.59%, 11.11%, -S.77%, —11.84%
(c) 9.09%, 12.31%, 0.00%, 3.71%, 17.05%, 12.28% 6. If the analyst constructed two portfolio consisting of either the three stocks of the three matched
securities, what would be their average rates of return (portfolio, match portfolio) respectively? (a) 8.04%, 9.83%
(b) 9.83%, 8.04%
(c) —1.87%, 4.84%
(d) 4.84%, 4.87%
(e) 8.71%, 9.43% 7. How would judge this individual as an analyst? (a) Superior, since the analyst’s choices consistently outperformed the matched stocks (b) Poor, since the analyst’s choices consistently underperformed the matched stocks (0) Slightly above-average, since the analyst’s portfolio outperformed the matched stock
portfolio (d) Slightly below-average, since the analyst’s portfolio underperformed the matched stock
portfolio (e) Average, since the analyst’s portfolio had the same return as the matched stock portfolio Page 9 0f10 10. Consider a risky asset that has a standard deviation of returns of 15. Calculate the correlation between the risky asset and a risk free asset. (a) 1.0
(b) 0.0
(c) —1 .0
(d) 0.5
(e) —0.5 An investor wishes to construct a portfolio by borrowing 35% of his original wealth and
investing all the money in a stock index. The return on the risk-free asset is 4.0% and the expected return on the stock index is 15%. Calculate the expected return on the portfolio. (a) 18.25%
(b) 18.85%
(c) 9.50%
(d) 15.00%
(c) 11.15% Calculate the expected return for Express Inc. which has a beta of 0.69 when the risk free rate is 0.09 and you expect the market return to be 0.14. (a) 0.05%
(b) 13.91%
(c) 10.92%
(d) 12.45%
(e) 14.25% (10 x 1.5 =15 marks) Page 10 of 10 ...
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