BBMF 2063 Investment and Financial Analysis

Tutorial 1 (Answer)

True and False

1. T
2. F, Capital gain + Yield
3. F, The less the variability of return, the lesser the risk.
4. T

Essay Question

1. TR = (Dt + (PE - PB)) / PB

RR = (1 + TR)
i. TR = (5 + -8) / 70 = -4.29%
RR = 1 + (-0.0429) = 0.9571

ii. TR = (240* + 90) / 830 = 39.76%

RR = 1 + (0.3976) = 1.3976

*interest received is $120 per year (12% of $1000) for two years.

End Val . of For . Curr .

iii.
[ RR×
Begin Val . of For .Curr .
−1 ]
1.35
[
$ return of Stock= 0.9571×
1.25 ]
−1=0 . 0337∨3. 37 %

1.35
[
$ return of Bond= 1.3976 ×
1.25 ]
−1=0 . 5094∨50 .94 %

X=
∑X
2. Arithmetic mean = n , Geometric mean =
1 /n
[(1+TR1 )(1+TR 2 ). ..(1+TR n )] −1
(−0.1185 ) + (−0.2210 ) +0.2837+ 0.1075
i. Arit h metic mean= =1. 29 %
4
1 /4
Geometric mean=[ 0.8815 ×0.779 ×1.2837 ×1.1075 ] −1=−0. 60 %

ii. There are two ways to get the answer:

a) Initial Value x Cumulative Wealth Index
Cumulative Wealth Index = (1+TR1)(1+TR2)...(1+TRn)
= (1-0.1185)(1-0.221)(1+0.2837)(1+0.1075)
= 0.9762

Value = 100,000 x 0.9762 = $97,620

b) Value = Initial value x (1+ Geometric mean)n

= 100,000 x (1 – 0.006)4
= $97,620
 iii.

Year TR X – Mean (X – Mean)2

2001 -11.85 -13.1425 172.7253
2002 -22.10 -23.3925 547.2091
2003 28.37 27.0775 733.1910
2004 10.75 9.4575 89.4443
Mean = 1.29 Sum = 1542.57
1 /2
∑ ( X−Mean )2 1 /2
Standard Deviation= [ n−1 ] [ =
1542.57
4−1 ] =22.68

*The process will be even simple if we use Excel (Refers to excel file).
Notably students have to learn how to use excel to calculate mean and
standard deviation as well as beta (next tutorial) to answer questions in the
assignment.

Year TR
2001 -11.85
2002 -22.10
2003 28.37
2004 10.75
Mean 1.29
Std 22.68
dev.

3. *Answers refer to Excel file. Students were taught in the lecture on how to calculate
by using excel. Students are allowed to obtain the softcopy of the Excel file after the
discussion.

Stock A
(1) (2) (3) (4) (5) (6)
(1) -
Return P (1) x (2) E(R) (4)^2 (5) x (2)
10 0.3 3 6.7 44.89 13.467
5 0.2 1 1.7 2.89 0.578
2 0.2 0.4 -1.3 1.69 0.338
-3 0.2 -0.6 -6.3 39.69 7.938
-5 0.1 -0.5 -8.3 68.89 6.889
E(R) 3.3 Variance 29.21

Standard Deviation 5.40 or 0.054

 Stock B
(1) (2) (3) (4) (5) (6)
(1) -
Return P (1) x (2) E(R) (4)^2 (5) x (2)
15 0.3 4.5 15.3 234.09 70.227
7 0.1 0.7 7.3 53.29 5.329
3 0.1 0.3 3.3 10.89 1.089
-8 0.2 -1.6 -7.7 59.29 11.858
-14 0.3 -4.2 -13.7 187.69 56.307
E(R) -0.3 Variance 144.81

Standard Deviation 12.03 or 0.1203

BBMF 2063 Investment and Financial Analysis

Tutorial 2 (Answer)
True and False

5. T
6. T
7. F. Diversification is not feasible to get rid of market risk.
8. F. The correlation coefficient is a relative measure of risk ranging from -1 to +1

Essay Questions

1. Markowitz was the first to formally develop the concept of portfolio diversification.
He showed quantitatively why, and how, portfolio diversification works to reduce the
risk of a portfolio to an investor. In effect, he showed that diversification involves
the relationships among securities.
2. In the Markowitz model, three factors determine portfolio risk: individual variances,
the covariances between securities, and the weights (percentage of investable funds)
given to each security.
3. This statement is CORRECT. As the number of securities in a portfolio increases,
the importance of the covariance relationships increases while the importance of each
individual security’s risk decreases.
4. *Answers refer to Excel file. Students were taught in the lecture on how to calculate
by using excel. Students are allowed to obtain the softcopy of the Excel file after the
discussion.

Question 4 (i)
Month KLCI Stock Stock
A B
  Return Return Return
January 15% 10% 15%
February 8% 5% 7%
March 6% 2% 3%
April -2% -3% -8%
May -5% -5% -14%
Expected
Return 0.018 0.006
 Standard Deviation 0.061 0.116

Question 4 (ii)

Correlation 0.991962

(a) (b) (c)

wA 0.7 wA 0.5 wA 0.3
σA 0.061 σA 0.061 σA 0.061
wB 0.3 wB 0.5 wB 0.7
σB 0.116 σB 0.116 σB 0.116
ρ 0.991962 ρ 0.991962 ρ 0.991962
           
0.07734
σp 6 σp 0.088339 σp 0.09938

Stock A
12%
10%
f(x) = 0.75 x − 0.02
8%
6% Stock A
4% Linear (Stock A)
2%
0%
-10% -5% 0% 5% 10% 15% 20%
-2%
-4%
-6%

Beta: 0.751

Stock B
20%

15%
f(x) = 1.45 x − 0.06
10%

5% Stock A
Linear (Stock A)
0%
-10% -5% 0% 5% 10% 15% 20%
-5%

-10%

-15%

-20%
Beta: 0.1445
 5. Answer depends on investor’s risk tolerance. As long as the investor considered
bitcoin’s underlying risk:

a. Investors’ acceptance/confidence level

b. Respective government’s regulation
c. Price volatility
*For more information, refers to the given article

BBMF 2063 Investment and Financial Analysis

Tutorial 3 (Answer)

True and False

1. T
2. F, and relates one security's return to market return
3. F, financing decision will involve indifference curve but investment decision does not
involve investor’s decision.
4. F, in a decline market, should lower the beta to prevent losses.

Essay Question

1. Using some methodology (such as the dividend valuation model, Lecture 7) to estimate the
expected returns for securities, investors can compare these expected returns to the required
returns obtained from the SML. Securities whose expected returns plot above the SML are
undervalued because they offer more expected return than investors require; if they plot
below the SML, they are overvalued because they do not offer enough expected return for
their level of risk.

Covi , M 6
2. a. β= 2
= =0.8571
σ M
7

c. bi [ E(RM) - RF ] = 0.8571(8-6) = 1.71%

b. ki = RF +bi [ E(RM) - RF ]
= 6 + 0.8571(8 – 6)
= 7.71%
3. ki = RF +bi [ E(RM) - RF ]
= 3 + 1.16(7 – 3)
= 7.64%

According to CAPM, required return of PBB is 7.64%. PBB pays a return of 10%
which higher than the required return. Thus it is a good investment and investor
should invest in PBB, holding other factor constant.

4. Discussion
ki = RF +bi [ E(RM) - RF ]
11 = 6 + Risk Premium
Risk Premium = 11 – 6 = 5%
 By applying CAPM expected return, we can obtain the risk premium (maximum) of
5%. There is no fixed answer for this question but there are a few important facts that
investor should take note:

- Risk free rate in this case no longer treasury’s rate. This is because this money
either remains in EPF account to obtain interest payment or invest into the mutual
fund. In addition, EPF as a government entity in Malaysia which had the minimal
default risk as compared to mutual fund. Thus, we should use the return of 6% as
the risk free rate.

Mutual fund agent sometimes will misbehave by hiding some of the information,
provide misleading information or the worst case: Cheat. The most common will be
hiding the potential risk of the funds and only highlight the potential returns (always
use the word “up to”). Not all mutual funds are safe investment. There are different
types of funds range from low risk to high risk. They all have incentives to cheat: you
buy the fund, they get the commission.

Thus, if the student answered “Yes”, they should back their argument by saying if the
fund is low risk, and the risk premium of 5% is comfortable for them. They also can
argue that they are risk taker and they willing to take the risk to look for the maximum
return of 11%.

Thus, if the student answered “No”, they should back their argument by saying if the
fund is high, and the risk premium is not attractive for them. They also can argue that
they are risk averse/conservative and they are not willing to take the risk to look for
the maximum return of 10%. They prefer a certain outcome.

5. Academic discipline that merge finance and psychology and studies investor
behavior. By studying behaviour and identifying mistakes, behavioural finance can
contribute to improving returns or reduce investors’ risk.
6. Overconfidence
Making investment decision requires confidence, but overconfidence leads investors
to overestimate their knowledge and abilities. Overconfidence investors often
believe they know more than other investors in term of securities selection or apply
investment tools. If they make poor decisions, they may attribute the losses to “bad
luck” and not lack of ability. As confidence increases, it often leads investors to take
larger risks: did not sufficiently diversify their portfolio.

The Ostrich Effect

Investors are reluctant to cut their losses. During rising markets, investors readily
watch securities prices and track the value of their portfolios, and the experience is
pleasurable. In declining markets, investors stop watching. They do not want to know
that something bad has happened: avoid the pain. They may lose more than it
suppose to be cause of never cut the losses.

The House Money Effect

It is gamblers’ behaviour. Gamblers may increase their bet after winning some
money since the money is “house money” which wins from the dealer and not
belongs to them. If they lose, they also will increase the bet until they win and “break
even”. Notice that with each additional bet, the gamblers increase their risk
 exposure.

Familiarity
Investors often buy stocks in companies they are familiar with. Local news paper
run stories about them, friends and neighbours, sometimes investors themselves work
for the firms or shop in their stores. This visibility increases individuals’ comfort with
the companies and induce them to buy the firms’ securities. Such investments
certainly increase risk exposure. Instead of diversifying their portfolio, these
investments increase the portfolio’s focus and increase risk. Taken to an extreme,
they may lose their investment as well as their employment if the company failed.

Herding
7. Individuals can act in concert and create a herding effect. A consensus forms and
many investors act in the same way. Speculative bubbles are the result of such
herding. The herd effect magnifies individual investors’ biases. If the individual
follow other investors buy a stock that just seems to continue to rise; “feeling”
replaces analysis and may cause a bias decision.

BBMF 2063 Investment and Financial Analysis

Tutorial 4 (Answer)

True and False

1. F, risk free rate of return should increase

2. T
3. T
4. F, utility stock is a defensive stock
5. F, defensive stock remain stable in any phases of the business cycle

Essay Question

1. The business cycle reflects movements in economy activity as a whole, which is

comprised of many diverse parts.

2.

GDP

Time
Peak Trough
 i. Inverted curve may imply a recession
◦ Investor expect lower interest rate in the future
ii. Flat structure implies a slowing economy
◦ Investor stable interest rate in the future
iii. Upward sloping and steepening curve implies accelerating economic activity
◦ Investor higher interest rate in the future.

3. Stocks should be purchased before a bottoming of the economy occurs because prices
almost always rise before the trough.

4. Consumer spending typically constitutes 70 percent of GDP. Therefore, it clearly has

an important effect on the economy. In addition, real earnings growth of a company
correlated with real GDP closely over the long run and affect stock prices.

5. There are 4 stages:

i. Pioneering Stage
 Rapid growth in demand, sales, earnings
 Opportunities may attract other firms and venture capitalists
 Difficult to identify likely survivors

ii. Expansion Stage

 Survivors from the pioneering stage are identifiable

 Lower risk of firm failure
 Considerable investment funds attracted
 Financial policies firmly established
 Dividends often become payable
 Attractive to a wide group of investors

iii. Stabilization Stage

 Growth begins to moderate

 Marketplace is full of competitors
 Costs are stable rather than decreasing
 Industry growth rate typically matches economy growth rate

iv. Declining Sate

 New products (substitution) are developed and shifts in demand occur.

 Examples: home radio, black-and-white TV industries

Other stages can be innovation, can after stabilization or declining stage, and etc
 (opinion).

6. The industry life cycle is useful in helping investors to assess both the return potential and the
risk of investing in various companies, depending upon the stage of the industry life cycle. If
investors buy companies in the pioneering stage, they may realize large payoffs, but they may
also lose a substantial part or even all of their investment in some companies because the risk
of failure is high.
Conversely, investors may choose to invest in very large, well known companies in the
stabilization phase of the industry life cycle, accepting moderate returns with moderate risks.
For example, Coca-cola has been a good stock to own for most of the last 20 or so years.
Finally, investors may choose to find companies in the expansion stage because the potential
returns will be larger than for those companies in the stabilization stage, while the risks,
although larger, are still acceptable.

7. There are five basic competition factors:

 Threat of new entrants
 Bargaining power of buyers
 Rivalry between existing competitors
 Substitute products or services
 Bargaining power of suppliers

The important point of the Porter analysis is that Industry profitability is a function of
industry structure. The strength of each of these factors is depends on industry structure
(Industry structure  competition factors  Profitability). For instant if an industry has low
competition (telecommunication) with less competition and no substitution other than existing
provider, we can expect high profitability from this industry

BBMF 2063 Investment and Financial Analysis

Tutorial 5 (Answer)

True and False

6. F, auditors do not guarantee the accuracy of earnings but only that statements are fair
financial representation.
7. T
8. T
9. F, companies that have reported bad news may benefit by waiting
10. T

Essay Question

1. In fundamental analysis, the intrinsic value of a stock is its justified price; that is, it is the
price justified by investors' evaluations of a company's fundamental financial variables. It is
also thought of as an estimated value or a formula value.
A stock’s intrinsic value can be estimated by using the dividend discount model or the
earnings multiplier model.

2. - The problem with accounting earnings is that alternative accounting principles can be used
to prepare financial statements. Numerous combinations of these principles are possible.
It is probably impossible to estimate the true performance of a company in one accounting
figure.
- Auditor may not able to resolve these problems due to the auditor’s report signifies only
that generally accepted accounting principles were applied on a consistent basis. It does
not guarantee the accuracy or the quality of the earnings in an absolute sense.
 - In addition, the management of a company hires an auditing firm to prepare the financial
statements. The accounting firm is supposed to conform to accepted accounting standards
and act independently. However, management may be able to influence the accounting
firm, which wishes to keep the business, because some flexibility in how certain items are
treated does exist.

3. The earnings growth rate, g, is defined as:

g = br

where r = ROE and b is the retention rate, defined as (1 - dividend payout ratio). Higher
retention rate means lower dividend payout; this may imply that the firm will use the unpaid
dividend to expand their business, vice versa. This is an important formulation in fundamental
analysis.
Earnings growth rates for individual companies usually do not persist over time. Investors
cannot simply assume that a particular trend will continue. Year-to-year growth rates are
often quite variable.

4. The three variables that affect the P/E ratio are:

a. The dividend payout ratio (direct relation)
b. The required rate of return (inverse relation)
c. The expected growth rate in dividends (direct relation)

5. a. Earnings and dividends are directly related; therefore, an increase in the expected growth
rate of earnings would equate with an increase in g, which is directly related to the P/E
(the typical assumption is that the payout ratio is constant; therefore, g is the expected
growth rate in both dividends and earnings)

b. A decline in the expected payout will lead to a decline in the P/E

c. An increase in the risk-free rate of return will result in a rise in k and, therefore, a decline
in the P/E.

d. An increase in the risk premium will result in a rise in k and, therefore, a decline in the
P/E.

e. A decrease in the required rate of return will increase the P/E.

6. The market must have expected an even larger increase in EPS. Thus, the market was
disappointed in Intel’s performance, and the price declined.

7. a. ROA = Net income margin x Turnover

Net Income Sales
= ×
Sales Total Assets
Net Income
=
Total Assets
= 7200/550
= 13.1
 b. ROE = ROA x leverage
Leverage = Total assets/stockholders equity = 550 / 330 = 1.67
ROE = 13.1 x 1.67 = 21.88

BBMF 2063 Investment and Financial Analysis

Tutorial 6 (Answer)

True and False

1. T
2. F. the stock is undervalued and should be purchase (long).
3. T
4. T
5. T

Essay Question

1. The required rate of return for a stock is the minimum expected rate of return
necessary to induce an investor to purchase a stock. It accounts for opportunity cost
and the risk involved for a particular stock. If an investor can expect to earn the same
return elsewhere at a lesser risk, why buy the stock under consideration? Or, put
another way, if your opportunity cost for a given risk level is 15%, you should not
purchase a stock with that risk level unless you can expect to earn 15% or more from
that stock.

2. The three possibilities for dividend growth are:

(a) no growth--the dollar dividend will remain fixed.

(b) constant growth--the dividend will grow at a steady (constant) rate over time.

(c) multiple (super growth)--at least two different growth rates are involved.
Many multiple-growth-rate companies grow rapidly for some years and then slow
down to a more normal growth rate.

The constant growth model is probably the most applicable to the typical large
common stock, and certainly is more often used. For small and medium company,
multiple growth model is most applicable. The no-growth case is the least likely to
apply.

3. The two investors are likely to derive different prices because:

(a) They will probably use different estimates of g, the expected growth rate in
dividends.

(b)They are likely to use different required rates of return

 4. D1 = $1.80 (1.06) = $1.91

β = 0.90 (since the stock is 10% less risky than the

market)

k = 5% + 0.9 (7%) = 11.3%

$1.91

P0 = ─────────── = $36.04

0.113 - 0.06
5. Value of Stock A = D0/k = 3/0.3 = $10.00

Value of Stock B = D1/(k-g)

D1 = D0(1+g) = 3(1.08) = 3.24
Value of Stock B = 3.24/(0.16 – 0.08) = $40.5

D1 D2 D3 P3
Stock C = + + +
(1+k )1 ( 1+ k )2 (1+k )3 (1+ k )3
P3 D4 D5 D∞ D (1+ g)
3
= 4
+ 5
+ ⋯+ ∞
= 3
(1+k ) (1+k ) (1+k ) (1+ k ) (k −g)

D0 = $1.48
D1 = $1.48(1.18) = $1.75; PV = $1.46
D2 = $1.48(1.18)2 = $2.06; PV = $1.43
D3 = $1.48(1.18)3 = $2.43; PV = $1.41
P3 = 2.43(1.07)/ (0.2 – 0.07) = 20; PV = $11.57

Stock C = 1.46 + 1.43 + 1.41 + 11.57 = $15.87

i. Stock B, since the intrinsic value is higher than the market price.
ii. The different between the intrinsic value and market price stocks is $5 higher
for all three stocks. If based on the percentage of return, Stock A obviously is
better since it has the lower buying price. In addition, with the same amount of
money, investor can purchase more Stock A than Stock C and B and generate
more return (%).
BBMF 2063 Investment and Financial Analysis
Tutorial 7 (Answer)

True and False

6. F. Technical analysis focuses on timing and on the short run

7. T.
8. F. P/E ratio uses by fundamental analysis.

Essay Question

1. Fundamental analysis uses a present value model (or, alternatively, a P/E model) to produce
an estimate of a stock’s intrinsic value, which is then compared to the market price. It is
based on fundamental economic variables such as earnings and dividends.
 Technical analysis involves the use of published market data (price and volume
information) to predict short-term price movements in either individual stocks or the
market. Technicians attempt to forecast trends in price changes.

2. With a moving average, a general sell signal occurs when actual prices decline through the
moving average on high volume. Specifically:
a. Actual price is below the moving average, advance toward it, does not
penetrate the average, and starts to turn down again.
b. Following a rise, the moving average flattens out or declines and the price of
the stock or index penetrate it from the top.
c. The stock price rises above the moving average line while the line is still
falling.

A widely used indicator in technical analysis that helps smooth out price action by filtering
out the “noise” from random price fluctuations. A moving average (MA) is a trend-following
or lagging indicator because it is based on past prices. The two basic and commonly used
MAs are the simple moving average (SMA), which is the simple average of a security over a
defined number of time periods, and the exponential moving average (EMA), which gives
bigger weight to more recent prices. The most common applications of MAs are to identify
the trend direction and to determine support and resistance levels. While MAs are useful
enough on their own, they also form the basis for other indicators such as the Moving
Average Convergence Divergence (MACD).

3. Relative strength is generally used to forecast individual stocks or industries. It is calculated

as the ratio of a stock’s price to a market index, an industry index, or the average price of the
stock itself over some previous period. These ratios are plotted to form a graph of relative
price across time. A rising ratio indicates relative strength, and it is often assumed that the
trend will continue.
4. i.

Monday Tuesday Wednesday Thursday Friday

High $9.00 $8.50 $9.00 $9.00 $9.00
Open 8.50 8.50 8.50 8.25 8.50
Close 8.25 8.25 8.75 8.50 8.50
Low 8.00 8.00 8.50 8.00 8.00

ii. $8.42, $8.50, $8.58

(8.25+8.25+8.75)/3 = 8.42
(8.25+8.75+8.5)/3= 8.5
(8.75+8.5+8.5)/3 = 8.58

5. A bar chart is the simplest chart in technical analysis. Price is on the vertical axis and time
on the horizontal axis. Each day’s price movement is represented by a vertical bar whose top
(bottom) shows the high (low) price for the day. The bottom of a bar chart usually shows the
trading volume for each day. Time intervals can be days, weeks, months, or anything else.

A point-and-figure chart shows only significant price changes, with volume omitted
completely. Although the horizontal axis is time, specific calendar time is unimportant. X’s
are typically used to show upward movements, and O’s to show downward movements. The
X or O is recorded only when the price moves by a specified amount.
 BBMF 2063 Investment and Financial Analysis
Tutorial 8 (Answer)

True and False

1. T
2. F. A basis point is 0.01%
3. T
4. T

Essay Question

1. i. By financial calculator:
FV = 1000
I/Y = 12
PMT = 100
N=3
Compute -PV = $951.96 (BUY)

By Manual calculation:
100
¿¿
ii. By financial calculator:

FV = 1000
PMT = 100
N=3
 PV = -750
Compute I/Y = 22%

iii. Semi annually:

FV = 1000 FV = 1000
I/Y = 6 PMT = 50
PMT = 50 N=6
N=6 PV = -750
Compute -PV = $950.83 (BUY) Compute I/Y = 11%

2. $30,000×(1+.082/2)^10 = $44,836.17
 Not enough. There are three suggestions:
 60,000 = face value x (1 + 0.082/2)^10
 By using financial calculator: FV = 60,000, N = 10, I/Y = 0.041,
PMT = 0. Compute PV = 40,146.
 Buy the same bond with face value 41,000 (since face value in multiple
of $1,000).
 60,000 = 30,000 x (1 + Yield/2)^10
 By using financial calculator: FV = 60,000, N = 10, PV = -30,000,
PMT = 0. Compute I/Y = 7%
 Buy the same amount of bond (total face value = 30,000) but the
annual yield must more than 14% (7% semi annual yield x 2).

 PMT = (yield x PV)/1-(1+yield)^(-n)

 By using financial calculator: FV = 60,000, N = 10, PV = -30,000, I/Y
= 0.041. Compute Pmt = 1,257.16.
 Buy $1,257 worth of bond every six month in addition with the
existing $30,000 bond.

3. In an active strategy, the investment policy permits the manager to create a portfolio
that deviates from the characteristics of the benchmark. The deviations are based on
the manager’s view as to where the performance will be better than that of the
benchmark index. For example, if the manager believes that corporate bonds will
outperform Treasury securities, then the manager will overweight the amount invested
in corporate bonds relative to the benchmark index and underweight Treasury
securities relative to the benchmark index. With a passive strategy, the manager
creates a portfolio that has characteristics identical to (or very similar to) those of the
benchmark. That is, a mini-version of the index is created.

Treasury securities—such as bills, notes and bonds—are debt obligations of the U.S.
government. When you buy a U.S. Treasury security, you are lending money to the federal
government for a specified period of time.

4. Three active strategies for common stocks include:

stock selection--searching for undervalued or overvalued stocks

sector rotation--shifting the sector weights in a portfolio to take advantage of those
sectors expected to do relatively better and avoid those expected to do
relatively worse
 market timing--the attempt to earn excess returns by varying the percentage of portfolio
assets in equity securities.

5. The portfolio duration should be set equal to a specified time horizon. It works
because losses (gains) from price changes are offset by changes in income from
reinvestment.
6. Probably the first thing that Ms. Peters should ask is what the investment objectives
are of HPLU. Addressing directly the two statements Mr. Steven made, consider the
first. Mr. Stevens believes that by buying investment grade bonds the portfolio will
not be exposed to a loss of principal. However, all bonds—investment grade and non-
investment grade—are exposed to the potential loss of principal if the interest rates
rise (i.e., interest rate risk) if an issue must be sold prior to its maturity date. If a
callable bond is purchased, there can be a loss of principal if the call price is less than
the purchase price (i.e. call risk). The issue can also be downgraded (i.e., downgrade
risk) or the market can require a higher spread (i.e. credit spread risk), both resulting
in a decline in the price of an issue. This will result in a loss of principal if the issue
must be sold prior to the maturity date.

The request that the bond portfolio have 40% in issues that mature within three years
will reduce the interest rate risk of the portfolio. However, it will expose the HPLU to
reinvestment risk (assuming the investment horizon for HPLU is greater than three
years) since when the bonds mature there is the risk that the proceeds received may
have to be reinvested at a lower interest rate than the coupon rate of the maturing
issues.
BBMF 2063 Investment and Financial Analysis
Tutorial 9 & 10 (Answer)

True and False

1. F. Buyer still losing premium

2. F. Out of the money
3. T
4. T

Essay Question

1. Require return (k) = RF +bi [ E(RM) - RF ]

= 3 + 2(4 – 3)
= 5%
D1 D2 D3 P3
i. Stock ABC = + + +
(1+k ) ( 1+ k ) (1+k ) (1+ k )3
1 2 3

P3 D4 D5 D∞ D (1+ g)
3
= 4
+ 5
+ ⋯+ ∞
= 3
(1+k ) (1+k ) (1+k ) (1+ k ) (k −g)

D0 = $3
D1 = $3(1.05) = $3.15; PV = $3
D2 = $3(1.05)2 = $3.31; PV = $3
D3 = $3(1.05)3 = $3.47; PV = $3
P3 = $3.47(1.03)/ (0.05 – 0.03) =$178.71; PV = $154.37

Stock ABC = 3+3+3+154.37= $163.37

ii. From Question 1(i), we knew that the intrinsic value is $163.37, where Stock
ABC is undervalue and expected to increase in price.

Traditionally we may earn the profit by short the stock, but the return was
restricted due to limited fund. To amplify the return, we can use an option
contract.

Since the stock price is expected to increase( decrease) , we should buy call
option( put option) to with an exercise price that ( lower) higher than the
intrinsic value. Put option allowed investor to sell at a margin; 75 – 100% of
the option premium, which less than the cost of long a stock.

iii. $280,000 able to long 2,000 unit of Stock ABC. If the price became $163.37
as calculated by DDM, the profit is 2,000 x (163.37 - 140) = $46,740.
280,000/ 140 = 2,000 units

Assume the option price is $9 per share, to engage into a call option, investor
pay much lesser than traditional long position. With $280,000, investor able to
buy put option with 31,111 unit of share. Profit = 31,111 x (163.37 – (140 + 9)
= $447,065.07

280,000/ 9 = 31,111 units

iv. Covered call writing

 Profit ($)
-9
0
9
1
3
1
share
sed
Purcha
149 140
n call
Writte
dStock Price
bine
Com
at Expiration

- Covered call writing limiting the gains if the stock rises in exchange for
cushioning the loss, by the amount of the call premium.
- The premiums that receive from buyer of the call enable shareholder to
absorb losses up to $9. Another words, shareholder’s profit capped at $9
even their share price rise infinitely.
- Useful when there is lack of cash on hand

Protective put buying

 Profit ($)
-9
0
9
share
sed
Purcha
140
put
ased
Purch
149
at
d Expiration
bine
Com
Stock Price

- Put act as insurance guaranteeing a minimum price at which the stock can
be sold.
- Losses capped at $9 while profit maybe infinite (depends on stock price).
- Need certain amount of cash on hand, always used by fund manager to
protect certain level of profit.

2. The Black-Scholes model uses five variables to value both put and call option:

Call Put
(a) the price of the underlying stock + -
(b) the exercise price of the option - +
(c) the time remaining to the expiration of the option + +
(d) the riskless rate of return + -
(e) the volatility of the underlying stock price. + +
 E
C=S [ N (d 1 ) ]− [ N (d 2 )]
e rt
ln(S / E)+(r +.5 σ 2 )t
d 1=
σ √t
3. d 2 =d 1 −σ √ t

d 1=ln ( 5040 )+ ¿¿1.696

N ( d 1 )=¿ 0.9554 ( Table)
d 2=1.696−0.3 ( √ 0.25 )=1.546
N ( d 2 )=¿0.9394 ( Table)

40
C=50 ( 0.9554 ) − 0.08 ( 0.25 )
( 0.9394 ) =10.94
e

i. Price of put = C - S + (E/ert)

= 10.94 – 50 +( 40/2.71828^ (0.08X0.25)
= 0.15
ii. The question request “a contract should be WRITTEN”, so the answer must based
on call writing. Since N ( d 1 )=¿ 0.9554, 96 shares must be purchase to perform
perfect hedge for call option.

* i) in Exam, question may require put option. For put option,

N ( d 1 )−1=¿ 0.0449, (0.9554-1= 0.0449), 4 shares must be purchase to
perform perfect hedge for put option.

ii) Question may also require looking for the share to be written in the
option.

BBMF 2063 Investment and Financial Analysis

Tutorial 11 & 12(Answer)

True and False

5. F. Long and short only.

6. T
7. F. Margin call is triggered when account balance falls below the maintenance margin.
8. F. Most contract are settled by offset.

Essay Question

1. In a zero sum game, one person’s loss is another’s gain. Thus, what a buyer (seller)
gains, the seller (buyer) loses.

2. Stock index futures allow investors to hedge systematic (market) risk. This is
desirable for investors attempting to earn the unique part of a stock's return while
avoiding market risk. The futures contract helps to protect the portfolio against
 market fluctuations.

3. i. $3,465
ii. (0.00989 – 0.01) x 12,500,000 = -$1,375 (Margin call)
iii. (0.00989 – 0.00972) x 12,500,000 = $2,125

4. i. Mr. Lee should perform short hedge to protect his portfolio from declining
market.

ii.

Short Hedge

Current Position after a Change in

Position 10% market drop Position
(Long position) $ value RM 900,000 RM 810,000 RM(90,000)
of portfolio
(Short position) sell RM 900,000 RM 990,000 RM 90,000
TEN FKLI contracts at
1,800
Net position RM0

5. i. The investor will exercise the call option because the price of the futures
contract exceeds the strike price. By exercising, the investor receives a long position
in the Treasury bond futures contract and the call option writer receives the
corresponding short position. The futures price for both parties is the strike price of
$91. The positions are then marked to market using the futures price of $96 and the
option writer must pay the option buyer $5 (the difference between the futures prices
of $96 and the strike price of $91).

iii. If the futures price at the option expiration date is $89, the investor will not
exercise the call option because it is less than the strike price. Thus, the option
will expire worthless.

BBMF 2063 Investment and Financial Analysis

Tutorial 13 (Answer)

True and False

9. F. Not all real estate investment are low liquidity, REITs as liquid as a stock.
10. T
11. F, Mortgage REIT provides financing only.
12. F, Equity REIT own property and obtain profit by rent and property transaction.
Essay Question

1.
 Real property such as residential and commercial property serves two purpose
respectively:
 Residential – Shelter, Financial assets (return = rent)
 Commercial – Business activities, Financial assets (return = rent)
Both assets can purchase by leverage (bank loan) use as collateral to raise debt (up
to80 - 90% of the value), and usually at a cheaper rate.

 Besides, real estate investment also exhibit stable returns

 US housing market – Stable growth from year 1995 – 2007, despite the “dot
com” crisis during year 2000.
 Malaysia Market - Stable growth from year 2001 – 2016, despite sub-prime
crisis on year 2008.
US House Price Index Malaysia Average House Price
200

150

100
(%)

50

0
99
5 98 01 04 07 10
1 19 20 20 20 20
Year

400000 1400000
350000 1200000
300000 1000000
250000
800000
200000
600000
150000
100000 400000
50000 200000
0 0

 Robust demand
 Necessity with no close substitution (residential)
 Population growth
 Income growth

 Inelastic Supply
 Limited land

2. There are two major factors:

 Not attractive for those who insufficient cash:
  High upfront cost – 10% down payment and, Sales and Purchase
Agreement (SPA) and loan agreement legal fees (stamp duty, professional
fees)
 May used up all the cash on hand to buy one property

 Subject to 5Cs of credit:

 Character – Credit history
 Capacity – Income, or loan amount
 Capital – Wealth (Assets: Saving, Fixed Deposit, Shares, etc.)
 Collateral – Provide collateral
 Condition – Economic condition (job security)
Then loan will be rejected or amount being reduced if the investor violate the
“Cs”. Not all investor has good “5Cs”

3. i. Upfront cost = Down Payment + Legal fees

= 70,000 + 30,000
= $100,000

ii. Loan amount = 700,000 x 90% = 630,000

By using financial calculator:

PV = -630,000; FV = 0; I/Y = 0.046/12; N = 30 x12
Compute PMT = $3230

By using amortization table (Note to tutor: please find the excel document
“Tutorial 13 Amortization Table”):
Key in the following info: Loan amount =630,000
Interest rate = 4.6%
Loan period = 30
Num. of payment = 12
Scheduled payment = $3230 (Answer)

iii. Step 1: Calculate all the yearly cash flows

Upfront cost = $100,000 (Outflow, year 0)

Selling value = $800,000 (Inflow, year 5)
Outstanding loan = $575,160 (From amortization table PMT number 60,
Ending balance. Outflow, year 5)
Agent Fees = $16,000 (Outflow, year 5)
Rent = 2,100 x 12 = 25,200 (Inflow, yearly starting from year 1 to year 5)
Loan Repayment = 3230 x 12 = 38,760 (Outflow, yearly starting from year 1
to year 5)

Discount Factor
= 0.05
Year 0 1 2 3 4 5
Upfront Cost -100000          
Selling price   800000
 Outstanding
loan   -575160
Agent Fees   -16000
Rent   25200 25200 25200 25200 25200
Repayment   -38760 -38760 -38760 -38760 -38760
Cash Flow -100000 -13560 -13560 -13560 -13560 195280
PV CF -100000 -12914 -12299 -11714 -11156 153007
   
NPV 4924          

The investment is viable since the NPV is positive.

4. Fundamentals (Regional & National)

 Household income
 Economic activity
 Population
 Depreciation

Hedonic (Utility)/ Business Consideration

 Ownership
o Freehold
o Leasehold
o Bumiputra lot
o Transaction process : 3 months for freehold, 6 months for leasehold
 Type
o Landed
o High Rise
 Structure
o Design – Rooms
o Material
 Location
o Neighbourhood
o Environment
o Commuting
o Facility

5. An equity REIT has several advantages over the direct investment in real estate
properties. The trusts have professional management and can construct a diversified
portfolio of properties. For the individual investor they are passive investments that
involve none of the work associated with the individual's managing a property (hassle
free).
Generally, REITs are affordable for investors due to the securitization process. This
upfront cost is lower and marketable (liquid) if compare with real properties.