Finnix - Round 1

Zaibatsu corporation
These are hard times, Jippon has been struck by a 9.1 Richter magnitude earthquake.There is chaos all around , all previously made disaster management structures are not able to handle the stress of the quake and the tsunami that followed. Zaibatsu corporation a conglomerate with diverse business interests is caught in this problems.All operations are stalled in the affected areas and there is no sense of direction. The business powerhouse has grinded to a halt , it desperately needs the oil (finance) to flow through its system to get it up and running. Even the government is unsure about the economic impact of the quake. Corporations like Zaibatsu which have complex inter-relationships amongst its subsidiaries and partners is clueless about the financial losses. Its 8 am. Takahiro Mahara, a 28year old MBA with previous experience in risk management has been called by his mentor Tsutomu Itoh for an urgent meeting. Congratulations Takahiro, Tsutomu said. What for?, Takahiro asked ,looking puzzled. You are well aware of the current situation Takahiro. These are challenging times. We must answer the call of duty. Our nation calls us and this is our hour. The Financial mess created by the disaster is mind boggling. To tackle the issue a team of elite financial experts has been formed. You are a part of it Tsutomu said looking at Takahiro gravely. Takahiro nodded and said, I shall do all that is there in my power Tsutomu started describing the team he is going to work with. The team is headed by 52 year old Hisashi Yamada. A veteran in risk management who started life as a commodity trader. Legend has it that he can smell and gauge the risk level in any transaction. 38 year old Koichi Ogata is another notable figure. Ambitious and infinitely patient . His calm in the midst of storms is well known in the organisation The rest of the team consists of people from corporate finance, forex strategists, Quantitative modelers a.k.a Quants, financial accountants and legal experts with underwriting experience.

 And one last thing Takahiro .Proving yourself right in this elite club is only your secondary goal. The primary goal is to make zero errors in tasks assigned to you, no matter how trivial the task might seem. Any error would affect the corporation badly and would lead your career to the wall. Takahiro had a calm yet confident expression. He was ready for the challenge. Just as he sat down at his desk the phone rang and it was Hisashi on the line. The senior members of the team had already met . I have something urgent for you Takahiro Hisashi said briskly. What is it? Takahiro asked. Well I have mailed you the details. I want it done within the next 24 hours. There will be no excuses for any kind of delay or errors Hisashi said. Takahiro replied earnestly It shall be done Thank you Takahiro, lets see if what I heard about your expertise is reall y true Hisashi hung up. When Takahiro opened his mail this is what he saw.

Zaibatsu corporation owns government bonds issued by Tropica. Tropica is a tropical developing country which has shown great fiscal discipline. Given data related to inflation and exchange rates certain key questions regarding the financial direction of those instruments should be answered. The currency of Tropica is the Roufle. The currency of Jippon is the Zen. The current exchange rate is 11 Zen / Roufle, the ratio of the price levels of Jippon goods to Tropica goods is also 11. Inflation in Jippon is expected to be 0.75% and 6% in Tropica. The end-of-year expected spot exchange rate is 14.25 Zen / Roufle. The one-year Jippon (risk free) interest rate is 1%, and in Tropica it is 8%. The world portfolio risk premium is 6%. The security has a world beta of 1.3 and currency exposure of 0.65. Q1] Assuming a period of 1 year what would be the real exchange rate be at the beginning of the period and the end of the period respectively? Options: A) B) C) D) 1;1.37 1;1.68 1;2.1 2.1;1

Q2] Assuming the real exchange rate to be constant. What will the expected exchange rate at the end of period? A)11.25 B)9.75 C)10.45 D)9.65 Q3] Assuming the real exchange rate to be constant. If Zaibatsu wants to buy a bond in Tropica, what would be the approximate expected return of this bond? A)7.25% B)2% C)7% D)2.75% Q4] What is the foreign currency risk premium as estimated from Zaibatsu point of view? A) B) C) D) 29% 36.5% 7% 18%

Q5] Why was there a change in the real exchange rate between the begin and end of period ? A) B) C) D) Because there was change in the purchasing power Because of the interest rate differential Because of inflation rate differential Because of Tropicas currency exposure of 0.65

Zaibatsu also holds some stock in a diversified portfolio in Tropica. For this case all forex translations can be ignored. Given below are some of the details related to the holdings.

The risk-free rate is 8% it has been constant over the previous year and is expected to be so in the coming year. The market risk premium during the previous year was 5.5%. The standard deviation of market returns is 25%. This year, the market risk premium is estimated to be 8%. Stock X has a beta of 1.80 and is expected to generate a 15.5% return. The covariance of Stock Y with the market is 0.11. The standard deviation of Stock Ys returns is 41%.

The stock market is expected to return 12.5% next year. Q6]The beta of Stock Y is: A)1.25 B)1.5 C)1.75 D)2 Q7] Referring to the data provided. What is the best action on stock x in the portfolio ? A) B) C) D) Buy Sell Hold No enough information available to take a decision

Q8] Implied expected market return in the coming year is 16%(i.e 8% risk free rate + expected 8% market risk premium). But the expected market return for the coming year is 12.5%. What is the most likely source of the discrepancy? A) B) C) D) Improper risk premium forecast A constant risk-free rate has boosted expectations The higher standard deviation has boosted expectations from 12.5% to 16% The beta value is not taken care of when calculating expected return using CAPM.

Q9] Suppose the market risk premium decreases by 1% and the risk free rate remains the same , and assuming that all other conditions remaining constant. What will happen to the SML (Security Market Line)?

A) B) C) D)

It is un-affected There is an increase in slope There is a decrease in slope There is a parallel shift upwards

Scoring question points 1 1 2 1 3 2 4 2 5 2 6 1 7 2 8 2 9 2 total = 15

Note : The numerical answers might not exactly match your calculations because of rounding off errors. Please choose the nearest option in such cases.