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BACHELOR OF BUSINESS ADMINISTRATION (HONS) FINANCE
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2020

INTRODUCTION TO CORPARATE FINANCE (FIN430)

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GROUP ASSIGNMENT 1 (10%)

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PREPARED BY:
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Bil. NAME STUDENT ID

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1 IMAN FIRDAUS BIN MOHD KHAIROL ANUAR 2019218296

2 NURUL ANIS ASYIQIN BINTI MOHD MUSTAFA 2019295068

PREPARED FOR:
PROFESOR MADYA NOOR IZAH ISMAIL

CLASS: JBA2422A
DUE DATE: 21 MAY 2020

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 Table of Contents
QUESTION 1 ............................................................................................................................................ 3
QUESTION 2 ............................................................................................................................................ 5
QUESTION 3………………………………………………………………………………………………………………………………………6

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 QUESTION 1

a) Calculate the expected return for each stock

By using the formula:

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E (Rv) = 6 + (1.8) (18-6) = 27.6

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E (Rw) = 6 + (1.5) (18-6) = 24.0

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E (Rx) = 6 + (0.7) (18-6) = 14.4
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E (Ry) = 6 + (1.2) (18-6) = 20.4

E (Rz) = 6 + (0.9) (18-6) = 16.8

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b) Plot your answer in (i) on a graph and show the equilibrium return of the stocks
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y y
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Expected Return

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0
0 0.2 0.4 0.6 0.8 1 1.2 1.4 1.6 1.8 2
Beta

Required Return Estimated Return

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 c) Decide your investment decision to buy or sell by identify which stock is overpriced or
under-price.

Stock (%) Estimated Return (%) Required Return Valuation Decision

V 25.0 27.6 Overprice Sell
W 22.0 24.0 Overprice Sell
X 17.0 14.4 Under-price Buy
Y 20.0 20.4 Overprice Sell
Z 19.0 16.8 Under-price Buy

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 QUESTION 2

a) What do you understand about CAPM?

In finance, the capital asset pricing model (CAPM) is a model used to determine a theoretically
appropriate required rate of return of an asset, to make decisions about adding assets to a well-
diversified portfolio. The Capital Asset Pricing Model (CAPM) is a model that describe the
relationship between the expected return and risk of investing in security is equal to the risk-
free return plus a risk premium which is based on the beta of that security. The goal of the
CAPM formula is to evaluate whether a stock is fairly valued when its risk and the time value
of money are compared to its expected return.

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b) Is it possible that a risky asset could have a beta of zero? Explain. Based on CAPM,

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what is the expected return on such an asset?

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Yes. It is possible, in theory, A zero-beta portfolio is a portfolio constructed to have zero

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systematic risk, or in other words, a beta of zero. A zero-beta portfolio would have the same
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expected return as the risk-free rate. Such a portfolio would have zero correlation with market
movements, given that its expected return equals the risk-free rate or a relatively low rate of
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return compared to higher-beta portfolios.

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c) It is possible that risky asset could have a negative beta? What does the CAPM predict
about the expected return on such an asset. Can you give an explanation for your answer?
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Yes. It is possible, in theory, the return would be less than the risk-free rate. A negative beta
asset would carry a negative risk premium because of its value as a diversification instrument.
A stock whose price moves contrarily to a stock market can have a negative beta. In this case,
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the CAPM based expected return is lower than a normal positive beta stock as beta is negative.
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 QUESTION 3

a) What is Hedging?

Maturity matching or hedging approach is a strategy of working capital financing wherein

short term requirements are met with short-term debts and long-term requirements with long-
term debts. The underlying principal is that each asset should be compensated with a debt
instrument having almost the same maturity.

b) What do you understand about temporary and permanent financing?

Temporary financing is defined as a closed-end mortgage loan or an open-end line of credit

which is designed to be replaced by permanent financing. Permanent Financing refers to a

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longer-term loan or debt instrument. It can also be thought of as longer term equity financing

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or debt. Permanent financing to finance permanent asset while temporary financing to finance

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current asset.

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c) With a graph and explanation, differentiate between conservative and aggressive
hedging.
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Aggressive Approach
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S Short- term Financing

Temporary Working Capital

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Permanent Working
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Capital
Long- term Financing
Fixed Assets
Time

Long-term Financing = Noncurrent Assets + Portion of Permanent Working Capital

Short-term Financing = Portion of Permanent Working Capital + Temporary Working Capital
FORMULA AGGRESSIVE APPROACH

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 An aggressive approach is most risky among working capital financing strategies. It doesn’t
assume to hold any reserves to cover spontaneous needs in working capital. It means that only
some portion of permanent working capital is financed by long-term financing. The rest and
the temporary working capital, including seasonal fluctuations, are met by short-term
borrowing. Adopting this approach makes it possible to reduce interest expense and increase
profitability of a business, but it also carries the greatest risk.

The main drawback of an aggressive approach is that businesses need to access short-term
borrowing frequently to recover both the portion of permanent working capital and temporary
working capital. As a result, the exposure to refinancing risk increases sharply, and businesses
become vulnerable to any interruption in accessing short-term borrowing.

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The advantage of this working capital financing strategy is that short-term financing is mostly

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cheaper compared with long-term financing, which allows a reduction in interest expense. Such

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an approach, however, violates the matching principle, which states that noncurrent assets and
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permanent working capital should be financed by long-term financing.
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Conservative Approach
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Ringgits
Marketable Securities
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Short-term Financing
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Temporary Working Capital

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Long- term Financing

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Fixed Assets

Time

Long-term financing = Noncurrent Assets + Permanent Working Capital + Part of Temporary

Working Capital
Short-term financing = Part of Temporary Working Capital
FORMULA CONSERVATIVE APPROACH

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 A conservative approach has the lowest risk and lowest profitability among other working
capital financing strategies. Businesses use long-term financing to fund not only noncurrent
assets and permanent working capital but also some portion of temporary working capital. This
approach is also inherent in low liquidity risk because of excessive cash.

Under a conservative approach, even a portion of temporary working capital is covered by

long-term financing, and only an emerging need for funds is met by short-term financing. It
also happens that businesses have an excessive cash balance, which should be invested in
marketable securities. Such investments are able to be sold at any time to cover the emerging
need for working capital.

The advantages of a conservative approach are the lowest reinvestment and interest rate risk

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among the other working capital financing strategies. Moreover, it results in a higher level of

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liquidity and solvency, so such businesses can easily access short-term borrowing to cover

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emerging needs in working capital.
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Lowest risk, however, also results in lowest profitability because long-term financing usually
has a higher cost than short-term financing. Funding temporary working capital by long-term
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financing also leads to the fact that businesses have interest expenses even when they do not
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have any need for temporary working capital.

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