Question 1

(a) Explain what are ‘financial markets’ and discuss the functions that it serves.

(b) Describe the differences between the Money market and Capital market.

(c) Define “hedging” and explain its purpose.

Question 2

(a) An investor purchased a share of Northern Ltd on 1 Jan 2016 and held the investment until 31 December 2019. Details of Northern Ltd’s share price and dividend payout during the period of investment are as follows:

Compute:

(i)  Arithmetic rate of return for 2016, 2017, 2018, and 2019 separately.

(ii) The geometric average rate of return for the entire period of investment (2016-2019).

(iii) Logarithmic returns for the entire period of investment (2016-2019).

(b)  Explain how dividend income is different from interest income.

Question 3

The following table shows a market where there are only three securities, and in the next time period, one of three possible outcomes will occur.

Required:

(a) Calculate the expected return for each asset.

(b) Calculate the standard deviation for each asset.

(c) Calculate the returns correlation between AC Ltd and BD Corp.

Question 4

(a) Explain how you would characterize the management strategy of a ‘passive’ investor.

(b) An investor obtains the following beta values for a set of stocks:

The risk-free rate of interest is 2.1%.

Compute the beta value for a portfolio that comprises of the following amounts:

(c) Details of the risk and return of two shares are as follows:

The correlation between the two investments is +0.65

Suppose that an investor decides to create an investment portfolio comprising of:

Calculate:

(i) the expected return of the investment portfolio

(ii) portfolio standard deviation.

Question 5

(a) How much would I need to have invest today in order to have $600,000 in twelve years from today if interest is compounded annually at a rate of 5%?

(b) You are looking at a new project that costs $140,000 and you have estimated the following expected cash flows:

Year 1: $40,000

Year 2: $42,900

Year 3: $45,300

Year 4: $52,550

If the discount rate is 14%, would you recommend the project? Provide your reasoning.

(c) A firm needs to choose between two projects:

Project Sunshine: Project involves an initial outlay of $150,000 today and will yield $354,000 in 8 years’ time.

Project Rain: Project involves an initial outlay of $122,000 today and will yield $242,200 in 5 years’ time.

Using the Internal Rate of Return (IRR) method, determine which of these projects would be invested in if the annual market rate of interest is 12%.

Question 6

(a) Explain FOUR characteristics of equity investments.

(b) Current forecasts for Diamond Limited is to pay dividends over the next four years, as follows:

(i)  Compute the current price of the stock given a 15% discount rate?

(ii) Suppose that Diamond Limited shares are currently trading at $11.25 would you buy the stock? Explain.

(c) The share price of Bronze Ltd is currently $9.85 and the last dividend was $1.20. The analyst is predicting an annual dividend growth rate of 5.00% and the required rate of return is 16%.

(i)  Compute the fair value of Bronze Ltd using the Gordon Growth model.

(ii) Would you buy Bronze Ltd’s shares based on the Gordon Growth Model? Provide your reasoning.

Question 7

Consider the following three bonds:

(a) Explain the term “Par Value”.

(b) Calculate the present values of each bond. State whether the bond is above par, at par or below par.

(c) Calculate the Macaulay Duration for each bond.

Question 8

(a) Explain how you would characterize the management strategy of an ‘active’ investor.

(b) Explain the term “Credit rating”.

(c) Explain the difference between an AA-rated bond and a BBB-rated bond.