MU - S2 2005 - Investment and Portfolio Analysis

MU - S2 2005 - Investment and Portfolio Analysis - MONASH...

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Unformatted text preview: MONASH UNIVERSITY LIBRARY ll ll lll 00409 5 9 5 9 Office Use Only CCU Monash University Semester 2 Examination 2005 Faculty of Business and Economics Department of Accounting and Finance EXAM CODE: AFW3046 TITLE OF PAPER: INVESTMENT AND PORTFOLIO ANALYSIS EXAM DURATION: 180 minutes writing time READING TIME 10 minutes THIS PAPER IS FOR STUDENTS STUDYING AT: (oflice use only - tick where applicable) Berwick El Clayton El Malaysia 1:] Off-Campus Learning South Africa [I Caulfield 1:] Gippsland IZI Peninsula El Pharmacy Cl Enhancement Studies 5:! Open Universities Australia [I Other (specify) [:1 During an exam, you must not have in your possession, a book, notes, paper, 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 in an exam is a discipline offence under Monash Statute 4.1. 1. This examination paper is divided into two sections: Section A — 8 questions; and Section B — 11 Multiple Choice questions. 2. 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). 3. Students must answer ALL questions and ALL parts. 4. This examination paper consists of nineteen (19) questions printed on ten (10) pages. PLEASE CHECK THE PAPER BEFORE COMMENCING. THIS IS A FINAL PAPER. 5. THIS EXAMINATION PAPER MUST BE INSERTED INTO THE SCRIPT BOOK AT THE COMPLETION OF THE PAPER. NO EXAMINATION PAPER SHOULD BE REMOVED FROM THE EXAMINATION ROOM. AUTHORISED MATERIALS CALCULATORS YES El NO [I OPEN BOOK YES El NO SPECIFICALLY PERIVIITTED ITEMS YES El NO if yes, items permitted are: Candidates must complete this section if required to answer in this paper STUDENT ID .............................................................. .. DESK NUMBER Page 1 of 10 SECTION A 1. Your rate of return expectations for the common stock of Brother Ltd during the next year are as follows: Possible Rate of Return Probability - 10% 0.25 0 0.15 10 0.35 25 0.25 (a) Compute the expected return, E(Ri), on this investment, and its standard deviation, 6. Your rate of return expectations for the stock of Sister Company during the next year are as follows: Possible Rate of Return Probability —- 60% 0.15 —- 30 0.10 — 10 0.05 20 0.40 40 0.20 80 0.10 (b) Compute the expected return, (E(Ri), on this stock, and its standard deviation, 0'. (c) On the basis of E(Ri) alone, discuss whether Brother or Sister is preferable. (d) On the basis of 0' alone, discuss whether Brother or Sister is preferable. (e) Compute the coefficients of variation (CV5) for Brother and Sister. (4+4+1+1+3=13marks) 2. (a) Explain the relationship between covariance and the correlation coefficient. (b) Explain the shape of the efficient frontier, by drawing it. (c) Explain why most assets of the same type show positive covariances of returns with each other. (4+2+3=9marks) Page 2 of 10 (a) (b) (a) (b) (c) (a) (b) At a social gathering you meet the portfolio manager for the trust department of a local bank. He confides to you that he has been following the recommendations of the department’s six analysts for an extended period and has found that two are superior, two are average, and two are clearly inferior. Discuss what you would recommend that he do to run his portfolio. Define and discuss the strong—form EMH. Why do some observers contend that the strong—form hypothesis really requires a perfect market in addition to an efficient market? Be specific. (6 + 4 = 10 marks) What changes would you expect in the standard deviation for a portfolio of randomly selected stocks between 4 and 10 stocks, between 10 and 20 stocks, and between 50 and 100 stocks? An analyst expects a risk-free return of 4.5 percent, a market return of 14.5 percent, and the returns for stocks A and B that are shown in the following table. Stock Information Stock Beta Analyst’s Estimated Return A 1.2 16% B 0.8 14% Show on a graph: (i) where stock A and B would plot on the Security Market Line (SML) if they were fairly valued using the capital asset pricing model (CAPM); (ii) - where stock A and B actually plot on the same graph according to the return estimated by the analyst and shown in the table. Note: The graph does not have to be drawn with complete accuracy. State and explain whether stock A and B are undervalued or overvalued if the analyst uses the SML for strategic investment decisions. (3+2+3+4=12marks) Some observers have contended that differences in the performance of various firms within an industry limit the usefulness of industry analysis. Discuss this contention. Identify an industry that is likely to do well and one that is likely to do poorly when interest rates rise. Explain each situation. (4 + 4 = 8 marks) Page 3 of 10 (a) (b) (b) (0) Donna Rielly, CPA, wants to explore potential inefficiencies in the futures market. The Monash stock index has a spot value of 185.00 now. Monash futures contracts are settled in cash and underlying contract values are determined by multiplying $100 times the index value. The current annual risk-free interest rate is 6.0 percent. (i) Calculate the theoretical price of the futures contract expiring six months from now, using the cost-of-carry model. Show your calculations. (ii) If total transaction cost for trading a futures contract is $15.00, calculate the lower bound for the price of the futures contract expiring six months from now. Show your calculations. Jones (2000, p.407), wrote “Puts and Calls expand the opportunity set available to investors”. Explain how a “call” can benefit a seller. (3+3+4=10marks) What are the advantages of a cash-matched dedicated portfolio? Discuss the difficulties of developing such a portfolio and some of the added costs. During a conference with a client, the subject of classical immunization is introduced. The client questions the fee charged for developing and managing an immunized portfolio. The client believes that it is basically a passive investment strategy, so the management fee should be substantially lower. What would you tell the client to show that classical immunization is not a passive policy and that it requires more time and talent than a buy-and-hold policy? A bond analyst is looking at a twenty-year, AA-rated bund. The bond is non-callable and carries a coupon of 7.50 percent. The analyst computes both the standard yield to maturity and horizon return for this bond, which are as follows: 8.00% 8.96% Yield to maturity Horizon return Assuming the bond is held to maturity, explain why these two measures of return differ. (4+5+2=11marks) Page 4 of 10 (a) (b) (c) (d) (e) Technicians contend that stock prices move in trends that persist for long periods of time. What do technicians believe happens in the real world to cause these trends? What is a stock’s intrinsic value, and how do fundamental analysts use this figure? Suppose that stock Z’s expected dividends equal $2.50 and it is expected to grow annually at 12 per cent for an indefinite period. (i) If the required rate of return is 16 percent, what is the stock intrinsic value? (ii) If stock Z’s price today were $75.50, would you invest or not? Explain. Stock X is currently trading at $29.50. Its current dividends per share equal $1.25, and this amount is expected to double in ten years. (i) What is stock X‘s growth rate? (ii) If you have a 12 percent required return on stock X, what is its intrinsic value? (iii) Is stock X overvalued or undervalued? Explain. For what reasons can a company’s PIE ratio be high? (3+4+3+4+2=16marks) Page 5 of 10 SECTION B: MULTIPLE CHOICE QUESTIONS USE THE FOLLOWING INFORMATION FOR THE FIRST THREE (3) PROBLEMS. Consider the following portfolio, assuming Rf is 0.08. Portfolio Return Beta Risk A 0.16 1.0 0.05 B 0.22 1.5 0.10 C 0.11 0.6 0.02 D 0.18 1.1 0.06 1. Using the Sharpe Measure, which portfolio performed best? (a) A (b) B (c) C (d) D (e) Two portfolios tied 2. According to the Treynor Measure, which portfolio performed best? (a) A (b) B (c) C (d) D (e) Two portfolios tied 3. According to the Jensen Measure, which portfolio performed best (assume Rm is 14 percent)? (a) A (b) B (c) C (d) D (e) Two portfolios tied 4. Which of the following is not a useful characteristic of a type of benchmark? (a) Unambiguous (b) Investable (c) Measurable (d) Reflective of historical investment opinions (e) Specified in advance Page 6 of 10 5. Relative return portfolio performance measures: (a) adjust portfolio risk to match benchmark risk (b) compare portfolio returns to expected returns under CAPM (c) evaluate portfolio performance on the basis of return per unit of risk (d) indicate historic average differential return per unit of historic variability of differential retUm (e) none of the above 6. If you are considering investing in German stocks as a means to reduce the risk of your portfolio, the initial factor that you should examine is: (a) the average rate of return of the portfolio when you combine US and German stocks (b) the standard deviation of the German stocks (0) the standard deviation of the German stocks compared to the standard deviation of US stocks ((1) the correlation between the rate of return for German stocks and US stocks (e) the coefficient of variation (CV) of rates of return for German stocks versus the CV of rates of return for US stocks 7. Which of the following would be considered a low liquidity investment? (21) Warrants (b) Call options (c) Zero coupon bonds (d) Diamonds (e) Open-end mutual funds 8. According to Rielly and Norton (2003), the correlation between US equities and US government bonds has been: (a) strongly positive (b) weakly positive (c) strongly negative ((1) weakly negative (e) indeterminate 9. For an Australian based investor, a weaker dollar means that overall dollar based returns on an security investments will be higher because: (a) a weaker dollar means that exports will rise (b) a weaker dollar means that more foreign investors will buy Australian securities (0) a weaker dollar mans that the foreign currency will convert to more dollars (d) a weaker dollar means that more investors will purchase the foreign security (e) none of the above Page 7 of 10' 10. 11. Correlations between stock markets in different countries have been rising over time because: (a) countries are developing closer trade and economic links (b) countries are becoming more segmented (c) there are fewer barriers to travel ((1) US investors are purchasing more foreign securities (e) correlations between bond markets of different countries have been rising Global portfolio managers can diversify more risk by: (a) diversifying across countries (b) diversifying across industries (c) diversifying across industries and countries (d) diversifying across US industries (e) diversifying across US asset classes (11x1=11marks) Page 8 of 10 FORMULAE - Divided Discount Model (infinite period) = D] k-g - Variance skim-Emir - Standard Deviation 0 = ":5 [Rt—EiRi)]2 - CAPM Expected Return E(R,-)= RFR + 13,. (Rm — RFR) - Expected Return of Security ’1 EUH=ZUUWJ i=1 0 Expected Return of Portfolio n E(Rp0,,) = Eva-R,- i=1 ' Company Growth Rate = (retention rate) X return on equity - Treynor Performance Measure _&—mm Bi T - Holding Period Yield 2 Holding Period Return — 1 _ Ending investment value 1 _ Beginning investment value Covariance Covij = E {[Ri — EiRii] [RI _ COVU Bioj Correlation Coefficient 0r Em) Coefficient of Variation Dividend Discount Model 03 DI+D2 a+kf U+k) a+kfi J + AM=§ymwn GM=mmm%—1 Sharp Performance Measure _&—mm Si at Jensen Performance Measure = ER = RFR+ B[E(Rm — RFR)] Cost of Carry = FO‘T/(1+rf)T fij=%fi+7f +... (1+ k)” Page 9 of 10 AFW3046 Sl EXAM 2005 SECTION B Questions 1-11. PLEASE USE THIS PAGE TO INDICATE YOUR MULTIPLE-CHOICE RESPONSES BY CIRCLING YOUR SELECTION. Student ID: 10. 11. (a) (a) (a) (a) (a) (a) (a) (a) (a) (b) (b) (b) (b) (b) (b) (b) (b) (b) (b) (b) (c) (C) (c) (C) (C) (c) (c) (c) (C) (C) (C) (d) (d) (d) (d) (d) (d) (d) (d) (d) (d) (d) MULTIPLE-CHOICE ANSWER SHEET (6) (6) (c) (e) (e) (c) (e) (e) (e) Page 10 of 10 ...
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MU - S2 2005 - Investment and Portfolio Analysis - MONASH...

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