CONFIDENTIAL AC/NOV 2011/MAF620

UNIVERSITI TEKNOLOGI MARA

PROGRESS TEST 1

COURSE : CORPORATE FINANCE

COURSE CODE : MAF 620

DATE : 24 November 2011

TIME : 2 HOURS

INSTRUCTION TO CANDIDATES

1. This question paper consists of four (4) Questions. Answer all questions.

2. Do not bring any material into the examination room unless permission is given by the
invigilator.

This examination paper consists of printed pages

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QUESTION 1

A. Data pertaining to the performance of the shares of three public listed companies at Bursa Malaysia
was complied by a consultant is presented below:

State of Economy Returns on MSB Bhd Returns on Sime Returns on Protec

Shares Bhd Shares Bhd Shares
Recession 3% -10% 17%
Normal 10% 18% 8%
Boom 15% 25% -6%

The possibility of the occurrence, based on past record indicates a probability of 0.25, 0.40 and 0.35
each of the economic condition to occur. Mr. Roland is interested to invest in the above shares and
due to limited fund, he has asked your help to analyse which possible combination of shares to
choose. In order to assist Mr. Roland to decide on his investment, you are required to furnish him
with the following additional information:

1.
The expected returns of the above shares
2.
The variance of the above shares
3.
The standard deviation of each of the share
4.
The covariance and correlation of the possible pair of the above securities
5.
Mr. Roland is to choose his investment portfolio based on the following proportions:
a. 60% in MASB Bhd and 40% in Sime Bhd
b. 30% in Sime Bhd and 70% in Protec Bhd
c. 45% in Protec Bhd and 55% in Msb Hhd
In order to assist Mr. Roland, you are required to calculate the expected return,
variance and standard deviation of the proposed portfolio based on the above
proportions.
6. Advice Mr. Roland which of the above portfolio is the best for him to invest and why?
(12 marks)
(Total: 12 marks)
QUESTION 2

A. Encik Haneef is evaluating six (6) companies for investment purposes. The Treasury
Bills is 4% and the Market Risk Premium is 7%. As of September 2011, the betas and
expected returns for the six companies are provided below:

Company Beta Expected Return

Selasih 1.20 15%
Melur 1.30 12%
Chempaka 0.75 12%
Lotus 0.60 13%
Rose 1.50 16.5%
Oregano 0.50 6.5%

Assume that the capital-asset pricing model is valid.

Required:
a) Calculate the required rate of return for the ordinary shares of each of the above
companies. Which of these shares are underpriced, overpriced or correctly priced? Advise
Encik Haniff what actions to be taken in the investment. (12 marks)

b) If Encik Haneef bought an equal Ringgit amount of each of these stocks,

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i. Determine the beta of his portfolio. Comment whether his portfolio is more or less risky
compared to market portfolio.
ii. Determine the required return on his portfolio. (4 marks)

B. Azeldeen hassome excess cash and approached you for some advice with the following
information.

Security Average Standard Beta Correlation

Return Deviation Coefficient Coefficient of
return on security
with the market
Belang Berhad 16% (i) 0.9 0.72
Rimba Berhad 20% 16% 1.3 (ii)
Market 15% 12% (iii) (iv)
Treasury Bills 8% 0% (v) (vi)

Required:

Determine the missing values in the table. (4 marks)

(Total: 20 marks)

QUESTION 3

A. Miss Ana is planning to form an equally weighted portfolio of stocks. Assuming that, a two
factor model describes the returns on each of these stocks. She was informed that in the
stock market, there are many stocks that all have the same beta with respect to two factors
that is beta 1.3 for the first factor and beta 0.8 for the second factor.

Required:
If the expected return of all the stocks is 10%,

i. Express the returns on Miss Anas portfolio in an equation form if she plans to place only
5 stocks in it.
ii. Express the returns on Miss Anas portfolio in an equation form if she places in it a
very
large number of stocks. (4 marks)

B. As an investor in Royal Sdn. Bhd, Ryan expected the following events to take place:

i. The interest rates would increase by 3%. The returns of Royal are negatively related to
interest rates.
ii. A new product would be launched soon by Royal Sdn Bhd.

iii. Inflation would rise by 2%. The returns of Royal Sdn Bhd are negatively related to
inflation.
iv. GNP would decrease by 2%. The returns of Royal Sdn Bhd are positively related to
GNP.

The following events actually occurred:

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i. Bank Negara issued a directive requiring all banks to increase interest rates by 2%.
ii. The new product was launched as planned.
iii. Inflation rose by 1.3%.
iv. GNP decrease by 1%.

Required:

i. Discuss how each of the actual events affects the return of Ryan shares in Royal Sdn
Bhd.
ii. For each event, identify whether it represents systematic risk or unsystematic.
(6 marks)
(Total: 10 marks)

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SOLUTIONS

QUESTION 1
A.
1. The expected returns:
= 0.25(0.03) + 0.40(0.10) + 0.35(0.15) = 0.10 @ 10%

= 0.25(-0.10) + 0.40(0.18) + 0.35(0.25) = 0.1345 @ 13.45%

= 0.25(0.17) + 0.40(0.08) + 0.35(-0.06) = 0.0535 @ 5.35%

2. Variance of each share:

= 0.25(0.03 0.10 + 0.40(0.10 0.10 + 0.35(0.15 - 0.10 = 0.0021

= 0.25(- 0.10 0.1345 + 0.40(0.18 - 0.1345 + 0.35(0.25 - 0.1345 = 0.00192445

= 0.25(0.17 0.0535 + 0.40(0. 80 0.0535 + 0.35(- 0.06 - 0.0535 = 0.00818275

3. Standard deviation of each share:

= = 0.04582576 @ 5.5825%

= = 0.1387 @ 13.87%

= = 0.09045 @ 9.045%

4. Covariance for each pair:

= 0.25(0.03 0.10 (- 0.10 0.1345 + 0.40(0.10 0.10 (0.18 - 0.1345 + 0.35(0.15 -

0.10 (0.25 - 0.1345 = 0.006125

= 0.25(0.03 0.10 (0.17 0.0535 + 0.40(0.10 0.10 (0. 80 0.0535 + 0.35(0.15 -

0.10 (- 0.06 - 0.0535 = - 0.004025

= 0.25(- 0.10 0.1345 (0.17 0.0535 + 0.40(0.18 - 0.1345 (0. 80 0.0535 + 0.35

(0.25 - 0.1345 (- 0.06 - 0.0535 = - 0.01093575

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Correlation:

= = 0.963562244

= = - 0.9709736

= = - 0.871688979

5. Investment portfolio:
a. 60% M, 40% S
= 0.60(0.10) + 0.40(0.1345) = 0.1138 @ 11.38%

+ 2 +

= (0.60 (0.1345) + 2(.60)(0.40)(0.006125) + (0.40 (0.0192445) = 0.00677516

= = 0.08231136 @ 8.23%

b. 30% S, 70% P
= 0.30(0.0021) + 0.70(0.0535) = 0.0778 @ 7.78%

+ 2 +

= (0.30 (0.00192445) + 2(.30)(0.70)( - 0.01093575) + (0.70 (0.00818275) =

0.00114856

= = 0.033896 @ 3.39%

c. 45% P, 55% M
= 0.450(0.0535) + 0.55(0.10) = 0.0791 @ 7.91%

+ 2 +

= (0.45 (0.00818275) + 2(.45)(0.55)( - 0.004025) + (0.55 (0.0021) =

0.000299881

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= = 0.017317022 @ 1.73%

Decision: Choose C (45% P, 55%M), moderate returns but the lowest risk (standard
devistion).

B. Tests of semi-strong form of EMH event studies, record of mutual fund

C. i. Possible ii. Not possible iii. Not possible

QUESTION 2:
Expected
A. Return_ Action
a. Selasih = 4% + 1.20(7%) = 12.4% 15% Underpriced Buy
Melor = 4% + 1.30(7%) = 13.1% 12% Overpriced Sell
Chempaka = 4% + 0.75(7%) = 9.25% 12% Underpriced Buy
Lotus = 4% + 0.60(7%) = 8.20% 13% Underpriced Buy
Rose = 4% + 1.50(7%) = 14.5% 16.5% Underpriced Buy
Oregon = 4% + 0.50(7%) = 7.50% 6.5% Overpriced Sell

b. Beta of Portfolio
0.16(1.20) + 0.16(1.30) + 0.16(0.75) + 0.16(0.60) + 0.16(1.50) + 0.16(0.50) = 0.936
Portfolio is less risky compare to market portfolio because beta of portfolio is less than 1.

Required return on the Portfolio:

0.16(12.40%) + 0.16(13.1%) + 0.16(9.25%) + 0.16(8.20%) + 0.16(14.5%) + 0.16(7.50%) = 10.39%

B. The missing values:

i. = =

0.9 x 0.12 = 0.72 x =

0.108 = 0.72

= 0.108/0.72 = 0.15 @ 15%

i. = =

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1.3 x 0.12 = =

0.156 =

= 0.156/0.16 = 0.975

ii. 1
iii. 1
iv. 0
v.0

QUESTION 3

A.

i. = 10% + 1.3 + 0.8 + 1/5( + + + + )

ii. = 10% + 1.3 + 0.8

B. i.

a. Actual interest rate increased by 2% to 5%, since return of Royal is negatively relate to interest,
the return of Royal will decrease
b. A new product of Royal is launch as expected, this will have no impact on the return of Royal
since this event has been anticipated
c. Actual inflation rose by 1.3% which is less than anticipated, and since return of Royal is
negatively relate to inflation, the return of Royal will increase
d. Actual GDP decreased by 1% which is less than anticipated, and since return of Royal is positively
relate to GDP, the return of Royal will decrease slightly

ii. Interest rate Systematic risk

New productUnsystematic risk
Inflation Systematic risk
GDP Systematic risk

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