QUESTION ONE
(a) What economic advantages are created by the existence of:

(i) Primary markets. (3 marks)
(ii) Secondary markets (3 marks)
(iii) Portfolio management firms. (4 marks)

(b) Explain how the Capital Authority can ensure:
(i) faster growth and development of the Nairobi Stock Exchange or Stock Exchange in your country. (6 marks)
(ii) development of other stock exchanges in Kenya or in your country. (4 marks)
(Total: 20 marks)

QUESTION TWO
(a)You are given the following price quotations on a Treasury Bond for the close of trading on May 31 and June 30, 2000. As on June 30 this Treasury Bond has a 90-day remaining life.
Treasury bond information
On May 31 On June 30
Maturity Bid Asked Bid Asked
September 28 9.10% 9.00% 9.30% 9.25%

(i)On May 31, the Treasury Bond had a 120-day remaining life. On that day what percentage of par value would you pay to purchase the Treasury Bond?
(3 marks)

(ii)Assume you purchased the Treasury Bond on May 31 and later sold it on June 30. What rate of return did you earn during this one-month period? (4 marks)

(b) (i)What is a stock exchange index? (2 marks)
(ii)Outline four drawbacks of the Nairobi Stock Exchange index. (4 marks)

(c) (i)What is a Commercial Paper? (3 marks)
(ii)State and explain the advantages of using commercial paper by businesses to raise funds (4 marks)
(Total: 20 marks)

QUESTION THREE
(a)Describe in brief the greatest difficulties faced in capital budgeting in the real world.
(5 marks)

(b)Mumias Milling Company purchased a grinder 3 years ago at a cost of Sh.3.5 million. The grinder had a life of 8 years at the time of purchase. It is being depreciated at 15% per year on a declining balance. The company is considering replacing it with a new grinder costing Sh.7 million with an expected useful life of 5 years.

Due to increased efficiency, the profit before depreciation is expected to increase by Sh.400,000 a year. The old and new grinders will now be depreciated at 25% per year on a declining balance for tax purposes.

The salvage value of the new grinder is estimated at Sh.210,000. The market value of the old grinder, today, is Sh.4 million. It is estimated to have a zero salvage value after 5 years.

The company’s tax is 30% and the after tax cost of capital is 12%.

Required
Should the new grinder be bought? Explain. (15 marks)
(Total: 20 marks)

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