SEAT NUMBER: ……….… ROOM:..……………….

FAMILY NAME:………….....………………………….
This question paper must be returned.
OTHER NAMES:……..…….…………………..……..
Candidates are not permitted to remove any part
of it from the examination room.
STUDENT NUMBER:…..…….………..……………..

FORMAL EXAMINATION PERIOD: SESSION 1, JUNE 2018

Unit Code: AFIN250

Unit Name: Investment

Duration of Exam 2.5 hours plus 10 minutes reading time

(including reading time if applicable):

Total No. of Questions: 30

Total No. of Pages 19

(including this cover sheet):

GENERAL INSTRUCTIONS TO STUDENTS:

• Students are required to follow directions given by the Final Examination Supervisor and must refrain from communicating in any way with another student once they have entered
the final examination venue.
• Students may not write or mark the exam materials in any way during reading time.
• Students may only access authorised materials during this examination. A list of authorised material is available on this cover sheet.
• All watches must be removed and placed at the top of the exam desk and must remain there for the duration of the exam. All alarms, notifications and alerts must be switched off.
• Students are not permitted to leave the exam room during the first hour (excluding reading time) and during the last 15 minutes of the examination.
• If it is alleged you have breached these rules at any time during the examination, the matter may be reported to a University Discipline Committee for determination.

EXAMINATION INSTRUCTIONS:

1. This test comprises 30 questions. The first 24 questions comprise equal value and the remaining 6
questions comprise unequal value for a total of 100 marks.
2. Do NOT use a separate exam booklet for your answers. Write your answers neatly in the space
provided on the examination paper (you can do rough working on the back of a page, if needed).
Illegible answers will receive zero marks.
3. The exam paper comprises two parts.
a. Part A: True and False Questions total of 24 marks
b. Part B: Problem Solving Questions total of 76 marks
4. You must return this test paper at the end of the test. You must not leave the examination room with
any part of this paper.

Part A: /24
True False total no. of
questions 24
Part B: /15
Question 1
Question 2 /12
Question 3 /12
Question 4 /10
Question 5 /12
Question 6 /15
Total Marks /100

AIDS AND MATERIALS PERMITTED/NOT PERMITTED:

Dictionaries: No dictionaries permitted
Calculators: Non-programmable calculators with no text storage/retrieval capacity permitted
Other: Closed book with specified materials permitted (1 X A4 sheet of handwritten or typed notes
(double-sided) permitted. Notes to be collected with the exam paper at the end of the exam).
 Final Exam Session 1, 2018
AFIN250_Investment

Part A True False questions (24 marks)

Circle ‘T’ (True) or ‘F’ (False) for each of the following questions to indicate your answer

1. T F
Is large economies of scale required to be profitable, established brand loyalty and rapid
industry growth the three barriers to entry?

2. T F
Items that are Necessities and product purchases for which income is not important tend to
be less cyclical in nature.

3. T F
The only money exchanged by both the long and short at the creation of a futures contract
is called the Futures price

4. T F
During 2004 China increased its use of global oil by 40%. This followed a 100% increase
during the previous 5 years. Economists refer to this kind of economic event as Supply
shock?

5. T F
Everything else equal, an increase in the government budget deficit would, Increase the
government's demand for funds, Shift the demand curve for funds to the left and Increase
the interest rate in the economy.

6. T F
A money market fund is a private investment pool open only to wealthy or institutional
investors that is exempt from SEC regulation and can therefore pursue more speculative
policies than mutual funds.

7. T F
Long call and long put strategies makes a profit when the stock price declines and loses
money when the stock price increases?

8. T F
A bond has a maturity of 12 years and a duration of 9.5 years at a promised yield rate of 8%.
Which means the modified duration is 9.8 years.

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9. T F
Coupon rates represents a bond’s annual interest payment per dollar of par value?

10. T F
You calculate the Black-Scholes value of a call option as $3.50 for a stock that does not pay
dividends, but the actual call price is $3.75. The most likely explanation for the discrepancy
is that either the option is undervalued or the volatility you input into the model is too low.

11. T F
If the risk-free rate is greater than the dividend yield, then we know that the futures price
will be higher as contract maturity increases

12. T F
A high dividend payout will decrease the value of a call option and decrease the value of a
put option.

13. T F
A long hedger will profit from an increase in the basis; a short hedger will be hurt.

14. T F
When discussing bonds, convexity relates to the slope of the yield curve with respect to maturity.

15. T F.
Based on the following statement if you believe this represents a mispricing situation. You
may want to buy the 105 call and write the 100 call

Statement: You find the option prices for three June call options on the same stock. The 95
call has an implied volatility of 25%, the 100 call has an implied volatility of 25%, and the 105
call has an implied volatility of 30%.

16. T F
The tax burden of the firm is .4, the interest burden is .65, the return on sales is .05, the
asset turnover is .90, and the leverage ratio is 1.35. The ROE of the firm is 0.0258?

17. T F
Firm A is high-risk, and Firm B is low-risk. Everything else equal, both would have the same
P/E if they were in the same industry.

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18. T F
According to the expectations hypothesis, a downward sloping yield curve implies that
interest rates are expected to increase in the future.

19. T F
Bond portfolio immunization techniques balance price and credit risk.

20. T F
Firms with higher expected growth rates tend to have P/E ratios that are lower than the P/E
ratios of firms with lower expected growth rates.

21. T F
The convergence property states that the futures and the spot price must converge at the
maturity of futures contract.

22. T F
During the expansion period of a business cycle, defensive industries should be preferred
under the notion of sector rotation.

23. T F
The value of a stock put option is negatively related to the time to expiration and the strike
price.

24. T F
Short time to expiration and volatility is a combination of variables that is likely to lead to
the lowest time value?

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 Part B Short Problem Solving Questions

Question 1 (15 marks)

(a) Assume Ace Frisbee Corporation produces a good that is very mature in their product life
cycles. Ace Frisbee Corporation is expected to pay a dividend in Year 1 of $3.00, a dividend
in Year 2 of $2.00, and a dividend in Year 3 of $1.00. After Year 3, dividends are expected to
decline at the rate of 2% per year. An appropriate required return for the shares is 8%. How
much should the shares be worth today? (6 marks)

(b) The EBIT of a firm is $300, the tax rate is 35%, the depreciation is $20, capital expenditures
are $60, and the increase in net working capital is $30. What is the free cash flow to the firm?
(2 marks)

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(c) Assume the free cash flow to the firm is reported as $205 million. The interest expense to the
firm is $22 million. If the tax rate is 35% and the net debt of the firm increased by $25 million,
what is the approximate market value of the firm if the FCFE grows at 2% and the cost of
equity is 11%? (3 marks)

(d) Assume the free cash flow to the firm is reported as $405 million. The interest expense to the
firm is $76 million. If the tax rate is 35% and the net debt of the firm increased by $50 million,
what is the free cash flow to the equity holders of the firm? (1 mark)

(e) If a firm has a free cash flow equal to $50 million and that cash flow is expected to grow at
3% forever, what is the total firm value given a WACC of 9.5%? (1 mark)

(f) A firm has a stock price of $55 per share and a P/E ratio of 75. If you buy the stock at this P/E
and earnings fail to grow at all, how long should you expect it to take to just recover the cost
of your investment? (2 mark)

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 Question 2 (12 marks)
(a) You would like to hold a protective put position on the stock of Avalon Corporation to lock
in a guaranteed minimum value of $50 at year-end. Avalon currently sells for $50. Over the
next year, the stock price will increase by 10% or decrease by 10%. The T-bill rate is 5%.
Unfortunately, no put options are traded on Avalon Co. What would have been the cost of a
protective put portfolio? (3 marks)

(b) The stock price of Harper Corp. is $33 today. The risk-free rate of return is 6%, and Harper
Corp. pays no dividends. A put option on Harper Corp. stock with an exercise price of $30
and an expiration date 73 days from now is worth $.95 today. A call option on Harper Corp.
stock with an exercise price of $30 and the same expiration date should be worth how much
today? (2 marks)

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(c) Assume that company ABC share is going to increase significantly next year. The current
price of the stock is $100. Assume you hold a call option expiring in one year time selling for
$10, the exercise price is $100. You have $10,000 to invest and you are considering three
alternatives shown below:
1. Invest all $10,000 in stocks, buying 100 shares.
2. Invest all $10,000 in 1,000 options (10 contracts). Hint: Assume all option, 1000 shares.
3. Buy 100 options (one contract for $1,000) and invest the remaining $9,000 in a money market
fund where interest rate is 4% p.a.

Required: Calculate the dollar value for each alternative investment if stock price is $80 and $120
one year from now. Show all your work in detail (7 marks)

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Question 3 (12 marks)

1. Trader Matilda opens an account to short sell XYZ Ltd 1000 shares. The shares are
trading at $40. The initial margin requirement is 50%. Assume at the end of one year
price of XYZ increased to $50.

a. What is the remaining margin in the account (2 marks)

b. If maintenance margin requirement is 30% will she receive a margin call? If so at what
price? (2 marks)

c. Suppose you purchased 200 shares in ABC on margin at $50 per share. Assume the
initial margin is 50% and the maintenance margin is 30%. Assume the share pays no
dividends and ignore interest on the margin loan. At what price will you get a margin
call when the share price increases or decrease? (2 marks)

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2. Luna Ltd is a portfolio manager for trust department within a financial institution. Luna
meets with two clients, Lucy and Lina, to review their investment objectives. Each client
expresses an interest in changing her individual investment objectives. Both clients
currently hold well-diversified portfolios of risky assets.
a. Lucy wants to increase the expected return of her portfolio. State what action Luna
should take to achieve Lucy’s objective. Justify your response in the context of the
capital market line. (2 marks)

b. Lina wants to reduce the risk exposure of her portfolio but does not want to engage in
borrowing or lending activities to do so. State what action Luna should take to achieve
Lina objective. Justify your response in the context of the security market line. (4 marks)

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 Question 4 (10 marks)
(a) What is the price of a European call option on a non-dividend-paying stock when the
stock price is $52, the strike price is $50, the risk-free interest rate is 12% per annum, the
volatility is 30% per annum, and the time to maturity is three months? Show your work in
detail. (8 marks)

b. The common stock of the Avalon Corporation has been trading in a narrow range around $40
per share for months, and you believe it is going to stay in that range for the next 3 months.
The price of a 3-month put option with an exercise price of $40 is $3, and a call with the same
expiration date and exercise price sells for $4. Calculate the total premium income that will
be generated from selling a straddle. (2 marks)

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Question 5 (12 marks)

1.
Consider one year futures price of ASX500 index is 4450. The stock index is currently 4400.
The one year risk free rate is 3% and the index is currently paying dividend of 2%.
a. Is the contract mispriced? If so by how much is the contract mispriced? (2 marks)

b. Draw a table using a zero –net investment arbitrage portfolio and show that you can
lock in riskless profits equal to the futures mispricing. Show your work in detail by clearly
outlining the actions, initial cash flow and cash flow at maturity (T). (7 marks)

2.
a. A farmer sells futures contracts at a price of $2.75 per bushel. The spot price of corn is $2.55
at contract expiration. The farmer harvested 12,500 bushels of corn and sold futures contracts
on 10,000 bushels of corn. What are the farmer's net proceeds from the sale of corn? (2
marks)

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 b. Ignoring the transaction costs, how much did the farmer improve his cash flow by hedging
sales with the futures contracts? (1 mark)

Question 6 (15 marks)

(a) You are considering investing $1000 in a complete portfolio. The complete portfolio is
composed of Treasury notes that pay 5% and a risky portfolio, P, constructed with two risky
securities X and Y. The optimal weights of X and Y in P are 60% and 40% respectively. X has an
expected rate of return of 14% and Y has an expected rate of return of 10%. If you decide to
hold 25% of your complete portfolio in the risky portfolio and 75% in the Treasury notes then
calculate the dollar values of your positions in X and Y respectively? (3 marks)

(b) You purchased a 5-year annual interest coupon bond one year ago. Its coupon interest rate
was 6% and its par value was $1 000. At the time you purchased the bond, the yield to
maturity was 4%. If you sold the bond after receiving the first interest payment and the
bond's yield to maturity had changed to 3%, your annual total rate of return on holding the
bond for that year would have been approximately how much? (6 marks)

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(c) Consider two shares, A and B. Share A has an expected return of 10% and a beta of 1.20.
Share B has an expected return of 14% and a beta of 1.80. The expected market rate of
return is 9% and the risk-free rate is 5%. Which security would be considered a better buy
and why? (3 marks)

(d) You have a $50 000 portfolio consisting of Intel, GE and Con Edison. You put $20 000 in Intel,
$12 000 in GE and the rest in Con Edison. Intel, GE and Con Edison have betas of 1.3, 1.0 and
0.8 respectively. What is your portfolio beta? (3 mark)

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END OF EXAMINATION

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