INSTITUTE OF COST AND MANAGEMENT ACCOUNTANTS OF PAKISTAN

To be the Preference in Value Optimization for Business.

Vision

To develop strategic leaders through imparting quality education and training in Management Accounting, to continually set and upgrade professional standards and to conduct research, bringing value-addition to the economy.

Mission Statement

Assignment Questions (Fall - 2013 Session)

INVESTMENT ANALYSIS AND PORTFOLIO MANAGEMENT

Semester 6

INSTRUCTIONS: 1. A student who takes admission in Distance Learning Program shall be required to complete all assignments of his/her respective subjects within the same academic session. If he/she fails to complete 60% assignments within that session, he/she shall be required to re-enrol himself/herself in the next session after making payment of 100% Distance Learning Program fee. 2. 3. Each assignment is allocated a total of 100 marks. Assignments of all subjects must be submitted in the session in which the examination is to be taken. The last date for submission of 100% assignments is January 10, 2014 for Fall-2013 Examination. You are required to pay Annual Subscription of Rs.1,500/- during July December each year to avoid payment of Restoration Fee of Rs.2,000/-. Examination Fee is payable from December 1 to 20, 2013 [with normal fee], December 21 to 31, 2013 [with 100% late fee] and January 1 to 15, 2014 [with 200% late fee] for Fall-2013 Examination. Examination forms can be collected from any ICMAP Centre or website: www.icmap.com.pk. Assignments would not be acceptable after due date.

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Examination Eligibility: The students, who are enrolled under the Distance Learning Program, must have submitted 60% assignments of each subject in which they are enrolled to become eligible to appear in the examination.

ASSIGNMENT NO. 1 Q1. (a) Define Investment. Discuss the overall purpose people have for investing. (a) Differentiate between investment and speculation. (b) Explain the concept of direct and indirect investment. Q2. (a) Define the investment environment. Explain the elements of investment environment. (b) Briefly describe the following types of financial assets: a) Repurchase agreements b) Treasury Bond c) Common stock d) Commercial paper e) Preferred Stock f) Certificate of Deposit (05) (12) (07) (18) (08)

Q3.

Describe in detail the following characteristics financial assets and compare these characteristics with physical assets: (25) a) Divisibility b) Liquidity c) Holding period d) Information ability Describe the distinguishing characteristics of a Preferred stock. Explain why preferred stock is called hybrid financial security? (05) Why Treasury bills considered being a risk free investment? Explain why you would change your nominal required rate of return if you expected the rate of inflation to go from 0 to 8%. What would happen if you did not change your required rate of return under these conditions? (05) What is concept of collective investment schemes? Distinguish closed-end funds and open-end mutual funds. Give examples of closed-end funds and open-end mutual funds. (05) ASSIGNMENT NO. 2 (03)

Q4. (a) (b) (C) (d) (e)

Explain the concept of financial intermediaries. Describe how investment funds, pension funds and life insurance companies each act as financial intermediaries. (07)

Q1. (a) (c)

(b) (d) (e)

Define derivative instruments and also give few examples of derivative instruments. Briefly describe the investment and hedging strategy of hedge funds. Explain the differences between Money market and capital market.

Explain how a derivative instrument is an investment vehicle and a hedging instrument.

(05) (05) (05) (05)

Discuss the differences between Primary market and secondary market and also give examples of primary market and secondary markets in Pakistan. (05) Define organized stock exchanges. Explain the importance of the organized stock exchanges in the economies. Give examples of organized stock exchanges in Pakistan. (07) Write sector-wise classifications of the Karachi Stock Exchange for listed equities. Briefly define each of the following term: 1. Market order 2. Limit order 3. Short sale 4. Stop loss Briefly explain a technical and fundamental analysis? Explain the margin transactions in organized stock exchanges. (06) (08)

Q2. (a) (b) (c)

(d) Q3. (a) (b)

(04) (05)

Suppose that you have Rs. 400,000 to invest in Rasheed Chamicals limited, a company listed on Karachi Stock Exchange, a share selling at Rs. 80. The initial margin requirement is 65%. Ignoring broker commission and taxes, show in detail the impact on your rate of return if the share price rises to Rs. 100 and if declines to Rs. 40 assuming: (10) 1. You pay cash for the shares 2. You buy it using maximum leverage

(c)

Q4. (a) (b) (c) (d)

You own 200 shares of Javed Engineering Limited, a company listed on Karachi Stock Exchange, which you bought at Rs.45 a share. The share is now selling for Rs. 65. (10) 1. You put in a stop loss order at 55. Explain the reason(s) for this action. 2. If the share price fallen to Rs. 50, what would be your rate of return with and without the stop loss order. What is the investment policy statement? Why policy statement is important? (05) What information is necessary before a financial planner can assist a person in constructing an investment policy statement? (06) Explain why the issues of selectivity, timing and diversification are important when forming the investment portfolio. (07) ASSIGNMENT NO. 3 Suppose a 45 years old man is 15 years away from retirement and a 35 years old woman 25 years away from retirement. How might their investment policy statements differ? (07)

Q1. (a)

(b)

Briefly explain the three components of an investor s required rate of return.

(C) Q2. (a) (b) (d) (C)

Describe historical returns and expected returns. What is the holding period return?

(05) (07)

Discuss the two major factors that determine the market nominal-risk free rate. Explain which of these factors would be more volatile over the business cycle? (07) Compare arithmetic mean with geometric mean. When should the sample mean of return be used instead of expected rate of return? (08) What are features of normal distribution? What is the variance and standard deviation? (05) (06) (05) (06)

(e) Describe the Beta factor. Q3. (a) (c) Q4. (a) (b)

What does covariance measure? Interpret and comment on if returns on two assets have positive covariance? (07) Define investment risk and what statistic tools are used in measurement of investment risk?

What is the coefficient of determination? How an investor or analysts interpret the coefficient of determination? (07)

What does the characteristic line tells to investor? Why stock characteristic lines are different for the securities traded in the same market? (07) From the following table choose two shares portfolio which will give the highest return: Probability Return (%) Company A Company B Company C 0.30 15 15 10 0.25 20 18 15 0.10 25 30 30 0.35 10 5 8 Company A and B; Company A and C; Company B and C;

You should compare following combinations. Arguments and calculations should be the part of solution: a) b) c) (b)

(09)

From the following observations table for Company A and the market portfolio: Month Rate of Return (%) Company A Market Portfolio 1 28 8 2 22 10 3 (4) (8) 4 12 (2) 5 6 8 6 10 7 a) Calculate the following:

(12)

1. 2. 3. b) d) 4.

Calculate the sample residual variance associated with Company As characteristic line and explain how the investor would interpret the number of this statistic. (05) Is this share recommended for the investor that has low tolerance of risk? ASSIGNMENT NO. 4 (04)

The sample covariance between rate of return for the Company A and the market; The sample Beta factor of Company A; The sample correlation coefficient between the rates of return of the Company A and the market; The sample coefficient of determination associated with the Company A and the market.

Q1. (a)

(b) Explain how an investor identifies his / her optimal portfolio according to the Markowitz portfolio model. What specific information does an investor need to identify optimal portfolio? (10)

Compare the single asset investment with a diversified investment portfolio. Explain why a diversified investment portfolio appeals more than the single asset investment to majority of the investors. (08)

(c) What is an efficient frontier? How many portfolios are on an efficient frontier? How is an investor s risk aversion indicated in an indifference curve? (07) Q2. (a) (b) (c) (d) Q3. (a) Describe CAPM and the key assumptions underlying CAPM. Explain why CAPM is still in use despite of the fact that many of underlying assumptions of the CAPM are violated in some degree in real world. Does that fact invalidate model s calculations? (08) (05)

If the risk-free rate of return is 8% and the return on the market portfolio is 12%, what is the expected return according to the CAPM on an asset having a Beta of 1.1? (07) Under the CAPM, at what common point does the security market lines of individual stocks intersect? (05) Given the following information: Expected return on Company A s share = 18% Expected return on Company B s share = 25% Standard deviation of Company As share = 12% Standard deviation of Company Bs share = 20% Correlation coefficient = 1.0.

Calculate expected return of each of the following portfolio and choose the investment below that represents the minimum risk portfolio: (10) a) 100% invest in Company As share ; b) 100% invest in Company Bs share; c) 50% in Company As share and 50% in Company Bs share; d) 60% invest in Company A s share and 40% in Company B s share; e) 30% invest in Company A s share and 70% in Company Bs share. (b) The following investment portfolios are evaluated by investor: Portfolio Expected rate of return, % Standard deviation A 12 15 B 10 8 C 10 9 (06)

(c)

Investor owns the portfolio composed of three stocks. The Betas of these stocks and their proportions in portfolio are shown in the table. What is the Beta of the investors portfolio? (06) Stock Beta Proportion in portfolio, % A 0.9 40 B 1.1 40 C 0.7 20 Differentiate between CAPM and APT model. Which of them are more /less risky and why? Comment on the risk of the stocks presented below: Stock Beta A 0.92 B 2.20 (05) (11)

Using Markowitz portfolio theory explain the choice for investor between portfolios A, B and C.

Q4. (a)

(b)

(c)

(d) (e) (f)

C 0.97 D -1.12 E 1.18 F 0.51 What is meant by an efficient market? What are the benefits to the economy from an efficient market? (03) If the efficient market hypothesis is true, what are the implications for the investors? What are the conditions for an efficient market? Discuss if are they met in the reality. Strong form of efficiency; Semi-strong form of efficiency; Weak form of efficiency; Not enough information to determine form of efficiency. ASSIGNMENT NO. 5

(02) (03)

If stocks prices are assumed to reflect any information that may be contained in the past history of the stock price itself, this is (04) I. II. III. IV.

Q1. (a)

(c)

(b) How then can ordinary shares of a company that does not pay dividends have any value because the ordinary shares of a company have not any term to maturity? There are so many examples in listed share give a few from them. (06) What is the difference between blue chip and income stocks? Explain the intrinsic/breakup value of a share? (06) (06) (08) (06)

Explain the following statements with reasons: 1. There is a consistent relationship between money supply changes and share prices. 2. Money changes cannot be used to predict share prices movements.

(08)

Q2. (a) (c)

(b) (d)

Define EPS and explain how can investors obtain EPS forecasts? What are the sources? What is meant by normalized price/earnings ratio?

What is price to earnings ratio? What are the variables that affect the price to earnings ratio? Is the effect direct or inverse for each component? (08) If the intrinsic value for a share of company is Rs. 27 and the market price for this share is Rs. 35, than explain with reasons: (08) a) share is over valuated and could be good investment; b) share is over valuated and isnt good investment; c) share is under valuated and could be good investment; d) share is under valuated and isn t good investment. Two friends Tahir and Amir are analyzing am investment in a new unlisted Companys shares. The Company paid dividends last year Rs. 3 per share. Tahir and Amir examined the prices of similar shares in the market and found that they provide 12 % expected return. The forecast of Tahir is as follows: 4 % of growth in dividends indefinitely. The forecast of Amir is as follows: 10% of growth in dividends for the next two years, after which the growth rate is expected to decline to 3 % for the indefinite period. (12) a) What is the intrinsic value of the stock of the firm according to Tahir forecast? b) What is the intrinsic value of the stock of the firm according to Amir forecast? c) If the shares of this company are listed and currently are selling in the market for Rs. 40 per share, what would be the decisions of Tahir and Amir, based on their forecasting: is this stock attractive investment? (06) An investor owns a portfolio of four securities. The characteristics of the securities and their proportions in the portfolio are presented in the table: (13) Security Coefficient beta Proportion (%) Expected Rate of Return (%) A 1.40 30 13 B 0.90 30 18 C 1.00 20 10 D -1.30 20 12 a) b) What is the expected rate of return of this portfolio? What is the risk of the portfolio?

Q3. (a)

(b)

Q4. (a)

c) (b)

Variance of the market returns is 0.06

The following table presents the three-stock portfolio of an investor: Stock Portfolio Weight (%) Coefficient beta Expected Return A 25 0.50 0.40 B 25 0.50 0.25 c 50 1.00 0.21

If the investor wants to reduce risk in his portfolio how he could restructure his portfolio? Standard Deviation 0.07 0.05 0.07

Required: (13) a) What is the Beta coefficient of the portfolio? b) What is the expected rate of return on the portfolio? c) What is an actual variance of the portfolio, if the following actual covariance between the stock s returns is given: Cov (rA, rB) = 0.020 Cov (rA, rC) = 0.035 Cov (rB, rC) = 0.035 ASSIGNMENT NO. 6 Q1. (a) (c) (b) What is an investment security? How could you say that an investment secured? Comment whether investment in mortgage bond or asset backed security is more secure investment than any debenture? (08) What credit rating? What is the purpose of bond ratings? Why investors focus on quality ratings of the companies in making their investment decisions in shares of companies? (10) (07)

Q2. Explain what would be the direction of expected interest rates to respond to the following economic events? (12) a) Increase in investments; b) Increase in savings level; c) Decrease in export; d) Decrease in import; e) Increase in government spending; f) Increase in Taxes. (b) Q3. (a) Explain the key factors in analyzing an investment in bonds?

What is interest swap? Distinguish between an interest rate anticipation swap and a substitution swap. (13) (07) (06) (06)

(b) Define yield-to-maturity. Distinguish between yield-to-maturity and yield-to-call.

(c) What is the difference between the market expectation theory and the liquidity preference theory?

(d) The callable bond has a par value of Rs. 100, 8% coupon rate and five years to maturity. The bond makes annual interest payment. Investor purchased this bond for Rs. 90 when it was issued in May 2008. (06) a) b) c) What is the yield-to-maturity of this bond? What is the duration of this bond if currently its market price is Rs. 95? If this bond would be called in May 2010 for Rs. 98, what would be the yield to- call of this bond?

Q4. (a) What would be your recommendation for an Investor planning for investments for the period of four years for two different bonds with the same face values? (12) Bond a has 4 years time to maturity, 8% coupon rate, and Rs. 960 current market price. Bond B has 8 years time to maturity, 12% coupon rate, and Rs. 1085 current market price.

(b) Amna is considering investing in a bond currently selling in the market for Rs. 875. The bond has four years to maturity, a Rs. 1000 face value and a 7% coupon rate. The next annual interest payment is due one year from today. The appropriate discount rate for the securities of similar risk is 10%. Required: (13) I. Estimate the intrinsic value of the bond. Based on the result of this estimation, should Amna purchase the bond? Explain in your words. II. Estimate the yield-to-maturity of the bond. Based on the result of this estimation, should Amna purchase the bond? Explain in your words.

How should be bonds A and B allocated in the portfolio if the investor is using the immunization strategy?

ASSIGNMENT NO. 7 Q1. (a) What are the main tasks an organized performs in modern economy? (b) Write a detailed note on Karachi Stock Exchange (KSE). (c) Discuss in detail Pakistan Mercantile Exchange (PMeX). (08) (08) (09)

Q2. (a) What would be your annualized discount rate % and your annualized investment on the purchase of a 182day Treasury bill for Rs. 492,500 that pays 500,000 at maturity? (06)

(b) If you want to earn an annualized discount rate of 3.5% what is the most you can pay for a 91-day Treasury bill that pays Rs. 500,000 at maturity? (06) (c) The price of 182-day commercial paper is Rs. 7,840,000. If the annualized investment rate is 4.093%, what will the paper pay at maturity? (06) (d) The annualized yield is 3% for 91-day commercial paper, 3.5% for 182 day commercial paper. What is the expected 91-day commercial paper rate 91-day from now? (07)

Q3. (a) A bond makes an annual Rs. 80,000 interest payment (8% coupon). The bond has five years before it mature, at which time it will pay Rs. 1,000,000. Assuming a discount rate of 10%, what should be the price of the bond? (07) (b) A zero coupon bond has a par value of Rs. 1,000,000 and maturity in 20 years. Investors require a 10% annual return on these bonds. For what price should be the bond sell? (05) (c) Consider the two bonds describe below: Bond A B Maturity (years) 15 20 Coupon rate % 10 6 (paid semiannually) Par value Rs. 100,000 Rs. 100,000 a. If both bonds had a required rate of return of 8%, what would be bonds prices be? (06)

b. Describe what it means if a bond sells at a discount, a premium, and at its face value. Are these two bonds selling at a discount, premium or par? (d) Mehran & Co., has an outstanding convertible bond. The bond can be converted into 20 ordinary shares (currently trading at Rs. 52/share). The bond has five years of remaining maturity, a Rs. 1,000 par value, and a 6% annual coupon. Mehran & Co. straight debt is currently trading to yield 5%. What is the minimum price of the bond? (07) Q4. (a) Suppose ordinary share of Bashir Limited is selling at Rs. 19 and currently pays an annual dividend of Re. 0.65 per share. Analyst project that the share will be priced around Rs. 23 in one year. What is expected return? (b) Hashim Limited paid an annual dividend of Re. 1 per share. Management has promised shareholders to increase dividends at a constant rate of 5%. If the required return is 12%, what is the current price per share? (07) (c) Analyst are projecting that Chaudry Limited will have earning per share of Rs. 3.90. if the average industry PE is about 25, what is the current price of Chaudry Limited? (06) (d) Suppose Majid Limited reports earnings per share of around Re. 0.75. If Majid Limited is in an industry with a PE ratio ranging from 30 to 40, what is a reasonable price range for Majid Limited? (06) ASSIGNMENT NO. 8 Q1. (a) Over the time it has been noted that investors have a number biases that negatively affect their investment performance explain this statement. (10) (b) Explain what Fusion Investing. Is? c. If the required return on the two bonds rose to 10% what would be the bonds prices be?

(06)

(c) Why the portfolios of overconfident investors have a higher risk? What are the characteristic of the overconfident investor? (10)

(05)

Q2. (a) Explain this behavior of investors Why do investors are inclined to sell losing stocks together, on the same trading session, and separate the sale of winning stocks over several trading sessions? (12)

(b) What is mental accounting? Explain how mental accounting is related with the disposition effect. (c) How do you understand the disposition effect? Q3. (a) How snakebite effect influence the investors behavior. Explain with the examples.

(07) (06) (10)

(b) Investors demand much more to sell thing than they would be willing to pay to buy this behavior of the investors is understood as: (15) a) Snakebite effect b) House-money effect c) Endowment effect d) Disposition effect e) Sunk-cost effect.

Q4. (a) Avoidance of cognitive dissonance can affect the investors decision making process. Explain how this happen. (10) (c) Define the market sentiment. How this could affect the investors behavior? ASSIGNMENT NO. 9 Q1. (a) Define Futures and Forwards . Explain the differences between Futures and Forwards ? (c) Give explanations of the following terms used with the Options: a) In the money b) Out of money c) At the money (b) Define the Options. Distinguish between a put and a call. (06) (06) (08) (b) How the emotions influence investors decision making. Explain with the examples. (08) (07)

(d) What is the difference between Option Premium and Option Price? Q2. (a) Explain the relationship between option prices and their intrinsic value?

(05) (06) (06)

(b) Explain the positions of writer and buyer of an option. What is the difference between positions of writer and buyer of an option? (06) (c) How a put option is used to protect the position of a particular investor? (d) If an option is not exercised what is the maximum amount the buyer of an option can lose? (07)

Q3. (a) Abdul Rasheed, an investor of equity stock, has only one day left to decide whether to exercise a call option on the Company X stock, which he purchased six months ago for 300 USD (3 USD Per share). The call option exercise price is 54 USD. (08) a) b) For what range of stock price should Robert exercise the call on the last day of the call life? For what range of stock price would Robert realize a loss (including the premium paid for the call option)?

(b) By using information about several call and put options in the table below, which of these options are in the money, at the money or out of money : (09) Type of option Call Put Call Call Put Call Put Put Call Exercise price 18 30 24 45 60 20 35 20 65 Premium 0.25 0.50 0.25 0.30 1.25 0.25 1.00 0.80 0.50 Current price of underlying stock 19.50 31.20 21.40 46.10 56.25 20.00 37.80 17.60 65.50 Your Evaluation

(c) If the all above options would be exercised what would be the profit and loss under each option exercise. Support with calculation. (08) Q4. (a) Why a change in the time to expiration can have either a positive or negative impact on the value of a European-style put option. Explain (09)

(b) Describe the conditions under which it would be rational to exercise both an American-style put and call stock option before expiration date. (07) (c) Assume you hold a well-diversified portfolio of common stocks. Under what conditions might you want to hedge it using a stock index option? (09) a) Explain how these options can be used for hedging. b) What happens with your hedged portfolio if the stock market will fall? c) What happens with your hedged portfolio if the stock market will grow? ASSIGNMENT NO. 10 Q1. (a) Explain active and passive portfolio management. What are the major differences between active and passive portfolio management? (06) (b) Few investors managing their portfolios passively to make changes their portfolios. State the reasons of this passive portfolio management? (07) (c) Explain how a revision in the process of managing a portfolio plays an important role. (d) Distinguish strategic and tactical asset allocation. (06) (06)

Q2. (a) Describe two major factors that a portfolio manager should consider before designing an investment strategy. What types of decisions can a manager make to achieve these goals? (08)

(b) What is the point of investment portfolio rebalancing? What changes in investors circumstances cause the rebalancing of the investment portfolio? (09)

(c) Explain the cost of portfolio revision? Why benchmark portfolios are important in investment portfolio management? (08)

Q3. During the annual review of ABC pension plan, several trustees questioned Ms. Anum, a pension consultant, about various aspects of performance measurement and risk assessment. In particular, one trustee asked about the appropriateness of using each of the following benchmark: 1. Market Index 2. Benchmark normal index 3. Median of the manager universe

Required: (a) Explain two weaknesses of using each of the three benchmarks to measure the performance of a portfolio. (09) Another trustee asked how to distinguish among the following performance measures: 1. Sharpes ratio; 2. Treynors ratio; 3. Jensens Alpha. (i) Describe how each of the three performance measures are calculated? (06)

(b)

(ii) State whether each measure assumes that the relevant risk is systematic, unsystematic or total. Explain how each measure relates excess return and the relevant risk. (05)

(05)

Q4. (a) Assume that you, as an investor, is planning to construct a portfolio aimed at achieving your stated objectives. The portfolio can be constructed by allocating your money to the following asset classes: 1. 2. 3. Ordinary share; Bond;, and Short-term securities.

(b) An investors portfolio consists of Rs. 5,000,000 in stocks and Rs. 500,000 in cash, the Beta of the portfolio is 1.10. How the investor could reduce Beta of the portfolio to 0.95? Explain with calculation and reasons. (13)

Required: (12) a) Identify state and comment your investment objectives. b) Determine an asset allocation to these three classes of assets considering your stated investment objectives. Explain your decision. c) What reasons could cause you to make changes in your asset allocations?