Bus329 (Investment Analysis)

Final exam paper

September trimester 2020

Final exam paper instructions:

- This exam paper contains 5 descriptive/conceptual and numerical questions of equal marks. All questions must be answered.
- For numerical/calculation-based questions, you must show all necessary/relevant workings. A single answer will not be accepted without these workings.
- You will need to type on the exam paper. Since it is a Take-Home test, please note that your completed exam paper will undergo Urkund for plagiarism.
- This is an open book exam. You will be given 14 hours time to download the exam paper, complete the exam and upload the exam paper with answers within this 14-hour window.
- The exam paper with answers must be uploaded in word format.
- Total mark is 50.

Name:

Student ID:

[1(a)] Evaluate the informational and consumption timing roles of financial market with reference to the recent COVID19 pandemic. (6 marks)

*Type your answer here:*

[1(b)] “The successes or failures of the financial assets we purchase depend on the performance of the underlying real asset” – explain this statement with example. (4 marks)

*Type your answer here:*

[2] Mr. Tom is a risk averse investor. Before the COVID19 pandemic (i.e., pre-COVID19 period) his risk aversion coefficient was 2 and his optimal investments in a risky portfolio and risk-free asset were AU$60,000 and AU$ 40,000 respectively. Standard deviation of his complete portfolio was 21% and risk-free rate was 5%.

During the COVID19 pandemic Mr. Tom becomes more risk averse and his risk-aversion coefficient increases to 4. Risk-free rate drops to 3% and return on risky portfolio increases by 2% (i.e., if the pre-COVID19 period return on risky portfolio is X%, return on risky portfolio during the COVID19 crisis becomes X% + 2%) and standard deviation of risky portfolio rises to 45%. Based on these data, compute the following for Mr. Tom:

(a) Optimal investment proportion during COVID19 crisis period in risky portfolio

(b) Standard deviation of complete portfolio during COVID19 crisis

(c) Expected return of complete portfolio during COVID19 crisis

(d) Comment on the changes in Mr. Tom’s investment proportions in risky portfolio and risk-free asset between pre-COVID19 and during COVID19 periods.

(You must show all workings)

(10 marks)

* *

*Type your answer here:*

[3(a)] Mr. Anderson invested AU$200,000 in stock market in December 2019. He purchased 5,000 shares of ABC Company at AU$40 per share. Expected rate of return on ABC stock and S&P/ASX300 were 14% and 12% respectively at the time of purchase. The rate on T-bill issued by Reserve Bank of Australia (RBA) was 4% in December 2019.

Mr. Andrew, neighbour of Mr. Anderson, claims that he is smarter than Mr. Anderson in stock market trading. He also invested AUD$200,000 in the shares of XYZ Company, which had an expected rate of return of 16%. Both Mr. Anderson and Mr. Andrew enjoy the same risk-free rate and market return (return on S&P/ASX300). Use CAPM to answer this question (assume both shares are fairly priced).

- Who invested in the riskier share? Without any calculation explain your answer in words. (2 marks)
- Now explain your answer in (a) above with numerical calculation (you must show all relevant workings) (3 marks)

*Type your answer here:*

[3(b)] COVID19 pandemic has significant impact on stock market. Some stocks experience significant decline in prices, while prices of some stocks show upward momentum. Investors are continuously keeping their eyes on stock market to find mis-priced stocks. One of your neighbours is new in stock trading and has insufficient knowledge in financial analysis. He knows that you are studying investment analysis unit. So, he approached you with the following data and seeks your help to make investment decisions.

Stock | Actual return (%) | Beta | Market risk premium and risk-free rates are 6% and 4% respectively.
[i] Which model will you use for your analysis and why? (1 mark) [ii] What will be your recommendations regarding these four stocks? You must show all relevant numerical calculations for each stock you need to make your recommendations (4 marks) |

A | 11 | 1.20 | |

B | 9 | 1.10 | |

C | 13 | 1.25 | |

D | 12 | 0.90 |

*Type your answer here:*

[4(a)] Mr. X invested in a portfolio of risk-free asset and a risky portfolio. Mr. X’s complete portfolio consists of 40% investment in risk-free asset and 60% investment in risky portfolio. Mr. Y invests 100% in the same risky portfolio. Expected return on Mr. Y’s risky portfolio is 15%. Assume both Mr. X and Mr. Y are on the same Capital Allocation Line (CAL). If the risk-free rate is 5%, what is the expected return on Mr. X’s complete portfolio? (4 marks)

*Type your answer here:*

[4(b)] If the standard deviation of the risky portfolio is 20%, numerically prove that both Mr. X and Mr. Y are on the same CAL (3 marks)

*Type your answer here:*

[4(c)] Now assume that investments in risky portfolio as indicated in [4(a)] above are optimal for both Mr. X and Mr. Y. It is apparent that Mr. X is more risk averse than Mr. Y, since Mr. Y invests 100% of his fund in risky portfolio, while Mr. X invests only 60%. Numerically derive a value to prove that Mr. Y is less risk averse than Mr. X. You must show all relevant calculations (3 marks).

*Type your answer here:*

[5(a)] A four-month call option with $60 strike price is currently selling at $5. The underlying stock price is $59. The risk-free rate is 12% p.a. The put with same maturity and strike price is selling at $3.5. Can an arbitrageur make riskless profit? If ‘YES’ what strategies an arbitrageur should take to make this profit? Show your calculation to support your answer (4 marks)

__ __

*Type your answer here:*

[5(b)] If your answer to 5(a) above is ‘YES’, calculate the arbitrage profit by completing the following table showing strategy (i.e., whether buying or selling put/call portfolio); position, immediate cash flows and cash flows at expiry (i.e., in 4 months) (6 marks)

*Complete the following table (you must show necessary workings below the table)*

Strategy | Position | Immediate cash flows | Cash flow in 4 months | |

S_{T} < $60 |
S_{T} ≥ $60 |
|||

Total |

[END OF EXAM PAPER]

FORMULA SHEET (BUS329)

- Effective annual rate:
- Annual percentage rate:
- Optimal capital allocation to risky portfolio:
- Sharpe ratio =
- Portfolio weights when correlation between two risky assets (D & E) is -1: ;
- Sharpe ratio maximising portfolio weights with two risky assets (S & B) and a risk-free asset:
- Portfolio return in (equally weighted) single index model:
- Portfolio variance in single index model:
- Capital Asset Pricing Model (CAPM):
- Portfolio beta:
- Total risk in index model:
- Covariance in index model:
- Correlation in index model:
- R-square in index model:
- Abnormal return =
- Bus329 (Investment Analysis)
Final exam paper

September trimester 2020

Final exam paper instructions:

- This exam paper contains 5 descriptive/conceptual and numerical questions of equal marks. All questions must be answered.
- For numerical/calculation-based questions, you must show all necessary/relevant workings. A single answer will not be accepted without these workings.
- You will need to type on the exam paper. Since it is a Take-Home test, please note that your completed exam paper will undergo Urkund for plagiarism.
- This is an open book exam. You will be given 14 hours time to download the exam paper, complete the exam and upload the exam paper with answers within this 14-hour window.
- The exam paper with answers must be uploaded in word format.
- Total mark is 50.

Name:

Student ID:

[1(a)] Evaluate the informational and consumption timing roles of financial market with reference to the recent COVID19 pandemic. (6 marks)

*Type your answer here:*[1(b)] “The successes or failures of the financial assets we purchase depend on the performance of the underlying real asset” – explain this statement with example. (4 marks)

*Type your answer here:*[2] Mr. Tom is a risk averse investor. Before the COVID19 pandemic (i.e., pre-COVID19 period) his risk aversion coefficient was 2 and his optimal investments in a risky portfolio and risk-free asset were AU$60,000 and AU$ 40,000 respectively. Standard deviation of his complete portfolio was 21% and risk-free rate was 5%.

During the COVID19 pandemic Mr. Tom becomes more risk averse and his risk-aversion coefficient increases to 4. Risk-free rate drops to 3% and return on risky portfolio increases by 2% (i.e., if the pre-COVID19 period return on risky portfolio is X%, return on risky portfolio during the COVID19 crisis becomes X% + 2%) and standard deviation of risky portfolio rises to 45%. Based on these data, compute the following for Mr. Tom:

(a) Optimal investment proportion during COVID19 crisis period in risky portfolio

(b) Standard deviation of complete portfolio during COVID19 crisis

(c) Expected return of complete portfolio during COVID19 crisis

(d) Comment on the changes in Mr. Tom’s investment proportions in risky portfolio and risk-free asset between pre-COVID19 and during COVID19 periods.

(You must show all workings)

(10 marks)

*Type your answer here:*[3(a)] Mr. Anderson invested AU$200,000 in stock market in December 2019. He purchased 5,000 shares of ABC Company at AU$40 per share. Expected rate of return on ABC stock and S&P/ASX300 were 14% and 12% respectively at the time of purchase. The rate on T-bill issued by Reserve Bank of Australia (RBA) was 4% in December 2019.

Mr. Andrew, neighbour of Mr. Anderson, claims that he is smarter than Mr. Anderson in stock market trading. He also invested AUD$200,000 in the shares of XYZ Company, which had an expected rate of return of 16%. Both Mr. Anderson and Mr. Andrew enjoy the same risk-free rate and market return (return on S&P/ASX300). Use CAPM to answer this question (assume both shares are fairly priced).

- Who invested in the riskier share? Without any calculation explain your answer in words. (2 marks)
- Now explain your answer in (a) above with numerical calculation (you must show all relevant workings) (3 marks)

*Type your answer here:*[3(b)] COVID19 pandemic has significant impact on stock market. Some stocks experience significant decline in prices, while prices of some stocks show upward momentum. Investors are continuously keeping their eyes on stock market to find mis-priced stocks. One of your neighbours is new in stock trading and has insufficient knowledge in financial analysis. He knows that you are studying investment analysis unit. So, he approached you with the following data and seeks your help to make investment decisions.

Stock Actual return (%) Beta Market risk premium and risk-free rates are 6% and 4% respectively. [i] Which model will you use for your analysis and why? (1 mark)

[ii] What will be your recommendations regarding these four stocks? You must show all relevant numerical calculations for each stock you need to make your recommendations (4 marks)

A 11 1.20 B 9 1.10 C 13 1.25 D 12 0.90 *Type your answer here:*[4(a)] Mr. X invested in a portfolio of risk-free asset and a risky portfolio. Mr. X’s complete portfolio consists of 40% investment in risk-free asset and 60% investment in risky portfolio. Mr. Y invests 100% in the same risky portfolio. Expected return on Mr. Y’s risky portfolio is 15%. Assume both Mr. X and Mr. Y are on the same Capital Allocation Line (CAL). If the risk-free rate is 5%, what is the expected return on Mr. X’s complete portfolio? (4 marks)

*Type your answer here:*[4(b)] If the standard deviation of the risky portfolio is 20%, numerically prove that both Mr. X and Mr. Y are on the same CAL (3 marks)

*Type your answer here:*[4(c)] Now assume that investments in risky portfolio as indicated in [4(a)] above are optimal for both Mr. X and Mr. Y. It is apparent that Mr. X is more risk averse than Mr. Y, since Mr. Y invests 100% of his fund in risky portfolio, while Mr. X invests only 60%. Numerically derive a value to prove that Mr. Y is less risk averse than Mr. X. You must show all relevant calculations (3 marks).

*Type your answer here:*[5(a)] A four-month call option with $60 strike price is currently selling at $5. The underlying stock price is $59. The risk-free rate is 12% p.a. The put with same maturity and strike price is selling at $3.5. Can an arbitrageur make riskless profit? If ‘YES’ what strategies an arbitrageur should take to make this profit? Show your calculation to support your answer (4 marks)

*Type your answer here:*[5(b)] If your answer to 5(a) above is ‘YES’, calculate the arbitrage profit by completing the following table showing strategy (i.e., whether buying or selling put/call portfolio); position, immediate cash flows and cash flows at expiry (i.e., in 4 months) (6 marks)

*Complete the following table (you must show necessary workings below the table)*Strategy Position Immediate cash flows Cash flow in 4 months S _{T}< $60S _{T}≥ $60Total [END OF EXAM PAPER]

FORMULA SHEET (BUS329)

- Effective annual rate:
- Annual percentage rate:
- Optimal capital allocation to risky portfolio:
- Sharpe ratio =
- Portfolio weights when correlation between two risky assets (D & E) is -1: ;
- Sharpe ratio maximising portfolio weights with two risky assets (S & B) and a risk-free asset:
- Portfolio return in (equally weighted) single index model:
- Portfolio variance in single index model:
- Capital Asset Pricing Model (CAPM):
- Portfolio beta:
- Total risk in index model:
- Covariance in index model:
- Correlation in index model:
- R-square in index model:
- Abnormal return =