Question 1

The table below provides forecast data for a UK based FTSE 100 company

The consensus view of the analysts in Bloomberg is that the growth for the shares is 10.0% while the long term growth for the UK economy is considered to be 4.0%.

1. a) If the beta of the company is 1.2, the risk free rate is 2% and the market risk premium is 8% calculate the intrinsic value of a share using the multistage growth version of the DDM model.   (10 marks)

1. b) Explain why the growth rate estimate from Bloomberg is unrealistic and inappropriate for the DDM model and use the date in the table above to produce an alternative estimate.         (9 marks)

1. c) Another company will pay a dividend of £1.00 per share next year and it is known to provide an expected return of 8%. If the share has a current price of £20 what is the expected growth rate in the dividend? (6 marks)

                                                                                                Total: 25 marks

Question 2

The following table provides the expected return and standard deviation of returns for two portfolios. Your client currently holds Portfolio A and she is considering whether she should invest half her investment in Portfolio B.

1. a) Calculate the combined portfolio expected returns and standard deviation, and discuss how you would advise your client.

1. i) if the correlation coefficient between Portfolios A and B was 0.5.

(6 marks)

1. ii) if the correlation coefficient between Portfolios A and B was minus 0.6.

(7 marks)

1. b) The risk free rate is currently 2%. You manage a fund with an expected return of 12% and a standard deviation of 20%. A client chooses to invest 50% of their money in your fund and 50% in the risk free Treasury bills.

What is the expected return and standard deviation of the client’s portfolio?

(3 marks)

What is the risk to reward (Sharpe) ratio of the client’s portfolio?

(3 marks)

Draw the Capital Asset Line (CAL) of the fund on an expected return and standard deviation diagram and show the position of the client’s portfolio

(6 marks)

Total: 25 marks

Question 3

You are comparing the performance of two investment advisers. One produced a return of 12% and the other a 10% return. However the beta of the first adviser was 1.4 while that of the second was 0.8.

1. a) Can you tell which adviser was a better selector of individual shares?

(5 marks)

1. b) If the risk free rate were 3% and the market return during the period were 10%, which adviser would be the superior share selector? (10 marks)

1. c) Discuss why in a CAPM world all investors would hold the market portfolio? (10 marks)

Total: 25 marks

Question 4

1. a) ABC has just recently paid dividends of £1.20 per share out of £2.40 earnings per share. You have obtained information that ABC’s beta is 1.2 and its return on equity would remain the same from now onwards at a rate of 12%. If the risk free rate is 2% and market risk premium is 6%, calculate the PE ratio based on reported earnings as well as next year’s earnings, using the constant dividend growth and price/earnings (PE) ratio model.

(9 marks)

1. b) Discuss the relative advantages and disadvantages of the two valuation methods: the DDM model and the Price Earnings ratio.

(8 marks)

1. c) Explain how the earnings multiplier approach can be used to forecast the aggregate stock market.

(8 marks)

Total: 25 marks

Question 5

100. a) An investor considers investing in a corporate bond which pays a coupon rate of 6% per year semi-annually. The bond has 2 years until maturity and its par value is £100. The current price for the bond is £98. For the bond, calculate

1. i) Its yield to maturity.         (10 marks)

1. ii) The realised compound return if the coupon payments can be reinvested at a semi-annual rate of 2%. (8 marks)

1. b) Discuss the reason why the yield to maturity may not be realised in practice. Given the recent financial crisis and economic climate what are the possible risks faced by bond investors? (7 marks)

Total: 25 marks

Question 6

1. The share price and dividends in pence for Cola Coker are as follows. Dividends are paid on 31 December each year.

Year         1 January Price        Dividend

2012              480                           10

2013               520                           10

2014               480                           12

2015               560                           15

2016               590                           20

What are the arithmetic and geometric average time–weighted rates of return for the shareholder?                                                                                               (8 marks)

1. The table below shows the expected return and risk (standard deviation) for eight shares.

Use the concept of an Efficient Frontier to identify four shares that would be selected for the optimal portfolio. Explain why you have chosen each one and why the remaining shares were not selected. Draw the efficient frontier portfolio on a suitable diagram.                     (12 marks)

1. You are offered an unusual investment. In exactly one year you will either receive £10 with a probability of 0.20, £20 with a probability of 0.70 or £100 with a probability of 0.10.

If the risk free rate is 1% and you require a risk premium of 4% how much should you pay for this investment?                                             (5 marks)

Total: 25 marks

Question 7

1. a) Use the Black-Scholes formula to find the exercise value and time value of a call option on the following share:

Time to expiration                = 9 months

Standard deviation             = 35% per year

Exercise price                       = $90

Share price                           = $100

Interest rate per annum      = 3%

(9 marks)

1. b) Please provide a brief explanation for your answers to the following questions.

1. All else being equal, is a call option on a share with a lot of firm-specific risk worth more than one on a stock with little firm-specific risk? The betas of the shares are equal.

(3 marks)

1. Would you expect a $1 increase in a call option’s exercise price to lead to a decrease in the option’s value of more or less than $1?

(3 marks)

1. c) Describe how the following financial activity may be viewed as transacting an option.

1. i) buying shares in a company with assets of £A and debt £D.

(5 marks)

1. ii) making a loan to the company of £B.

(5 marks)