INVESTMENT ANALYSIS AND x ICMA PORTFOLIO MANAGEMENT (BAF-602) gay (iy SOS SEMESTER-6 gs Pakistan FALL 2015 EXAMINATIONS ee Saturday, the 27th February 2016 Te mines To Rat (Attempt all questions, (i) Write your Roll No. in the space provided above. (i) Answers must be neat, relevant and brief. Itis not necessary to maintain the sequence, (iv) Use of non-programmable scientific calculators of any model is allowed, (v) Read the instructions printed inside the top cover of answer script CAREFULLY before attempting the paper. (vi) In- marking the question paper, the examiners take into account clarity of exposition, logic of arguments, effective presentation, language and use of clear diagram chart, where appropriate (vi) DO NOT write your Name, Reg. No. or Roll No., or any imelevant information inside the answer script (vii) Question Paper must be returned to invigilator before leaving the examination hall DURING EXTRA READING TIME, WRITING IS STRICTLY PROHIBITED IN THE ANSWER SCRIPT Marks Question No. 4 Proposed Time : 75 Min. | Total Marks : 40 Noor Asset Management Company (NAMC) provides fund management of mutual funds, pension funds and allied investment services. The Board of Directors of NAMC discussed the following items of agenda along with other items in a recent meeting 1. Confirmation of minutes of preceding meeting Investment in corporate bonds Equity investment in Sargodha Foods Limited (SFL) Performance evaluation of fund managers Hedging against exposure to price fluctuations “The briefing papers accompanying the agenda gave following details: ‘Agenda item # 2: Investment in Corporate Bonds NAMC is considering purchase of corporate bonds with following data ehen Description Non-Callable Bond Callable Bond Price (Rs.) 99.55 98.23 Term to maturity (Years) 5 5 ‘Annual coupon (%) 6.00 6.00 Yield to maturity (%) 611 6.42 ‘The Board is interested to determine how the increase or decrease in the volatility of interest rate would affect the value of straight bond and bond with embedded option. Following staternents were made during the discussion in the Board meeting’ (Decrease in volatility of interest rate will decrease the value of the callable bond, (ii) Non-callable bond will not be affected by the change in level of interest rate. (i) Decrease in interest rate will cause less increase in the value of callable bond than the increase in the value of non-callable bond. (iv) Increase in interest rate will cause less decrease in the value of a putable bond than the decrease in the value of a straight bond. (AP MFal 2095 10f5 PTOAgenda # 3: Equity Investment in Sargodha Foods, d (SFL) SFL has evolved into a mature company, growing at the average rate of growth in the industry ie., 5.50% per annum and it is expected that this rate will continue onward after 2015. An extract of financial information of the company at the end of 2014 and 2015 is given below: Rs. in million 2014 2015 Total current assets 2.576 2,757 Net property, plant and equipment (PPE) 4,060 4,441 Total assets 6636 7,198 Notes payable 642 689 Long-term debt 2,161 2,215 Total liabilities 3.435 3,614 Total equity 3,201 3,584 Revenue - 4577 Depreciation = aid Income before interest and tax = 1,392 Interest expense 300 Additional Financial Information: “After-tax cost of debt (9%) 7.00 Income tax rate for the year 2015 (%) 32 Cost of equity (%) 9.50 Desired debt to equity (D/E) ratio fed There was no sale of long-term assets and there are no long-term liabilities of the company other than those indicated above. Agenda # 4: Performance Evaluation of Fund Managers The performance data regarding portfolios managed by two managers (Mr. Afzal and Mr. Bilal) independently is given below: a = iéééiéé£=ié@éi=— Weight Return "weight Return Weight Return (%) (%) (%) (%) (%) (%) Stock 55 5.00 50 6.00 50 4.90 Bond 35 3.80 353.90 35 3.60 Cash 10 0.30 150.40. 15 0.20 ‘Agenda # 5: Hedging Against Exposure to Price Fluctuations ‘The Board has authorized the Chief Investment Officer (CIO) to start the first phase of using option contracts for the purpose of hedging of exposures. The CIO intends to start the phase with hedging of 50,000 shares of Pioneer Cement Company (PCC), which are currently trading at Rs. 40 per share and are held in various portfolios of the NAMC. The continuously compounded risk-free rate is 7%, The information on exchange traded options on the PCC is as under: Maturity Call Option Put Option Call Option (Days) Price (Rs.) _Price(Rs.)__Delta 30 2.84 262 054 90 5.00 4.33 0.58 270 881 6.95 0.63 Exercise price for all the above maturity period is Rs. 40 per share, During the meeting, a director expressed apprehension that 90-day and 270-day put options are mispriced relative to their respective call options. (APMFal 2095 2065 MarksRequired: (a) Give reasons for correctness or otherwise for each statements (i) through (iv) made during the Board meeting relating to Agenda #2. (b) Calculate the market value of the embedded call option of the corporate bonds. (©) Calculate free cash flow to equity of Sargodna Foods Limited (SFL) for the year 2015. (d) Assuming SFL constant growth rate equal to industry average i.e., 5.50% per annum, calculate the value of firm at the close of 2015, (e) Caloulate benchmark retums and actual returns for Mr. Afzal and Mr. Bilal and comment whether both have under or outperformed the benchmark? (f) Using performance attribution analysis, calculate contribution of ‘asset allocation’ and ‘selection’ to performance of Mr. Afzal and Mr. Bilal (9) Assuming the Chief Investment Officer (CIO) selects call option for hedging but he is stil undecided about maturity period of option, Calculate the number of options for each maturity period required to hedge exposure of 50,000 shares of PCC. (h) Assume @ 360-day year, is the director's concern is correct regarding the price of put options relative to their call options? Justify through calculations using put-call parity. Question No. 2 Proposed Time : 30 Min. | Total Marks : 16 (a) Federal Goverment borrows money through issuance of Treasury Bills and Pakistan Investment Bonds, for which auctions are conducted by the State Bank of Pakistan on regular basis. Banks and other investors are wiling to lend money to the Government and submit their bids to the central bank, indicating, among other things, the amount of lending and their respective bid price. An extract from the bid report of the auction held on November 25, 2015 is reproduced below: Auction of 3-month Government of Pakistan Treasury Bills Auction Date : November 25, 2015 Settlement Date : November 26, 2015 Maturity Date : February 17, 2016 Number of Days till Maturity 84 ee Bid Amount Face Value Bid Price per (Rs. in millions) Rs. 100 ‘Al-Hamd Ltd 150 98.59 Star Ltd 150 98.58 Taaj Ltd, 2,000 98.57 Required: (i) Compute bid yield per annum of Al-Hamd Ltd., Star Ltd., and Taaj Ltd. (ii) Assuming that above three banks were the only bidders in the auction, compute weighted average yield of the auction (b) The Board of Governance of the Institute of Management Education (IME) has received a proposal from one of its members; expressing wilingness to contribute Rs. 1.5 million for the Purpose of funding a prize to the candidate securing highest marks in the subject of “investment Analysis and Portfolio Management’ in each of the two bi-annual sittings of the ‘examination, The conditions precedent to the contribution are as under. * The amount of contribution will be placed in a special fund, the principal amount of which shall be protected ‘Only retum on investment can be used for the payment of aforesaid prize and cost of administering the fund. (AP MFal 2095 30f5 Marks 04 02 09 05 06 07 03 04 04 03 PTOFinance Department of IME has indicated that the amount of contribution can be invested at the rate of 12% per annum for indefinite period, with half-yearly coupon payments coincide with the payment of prize. Cost of administering the special fund has been projected around 20% of the amount of half-yearly prize. Required: Calculate the maximum amount of half-yearly prize that could be instituted with the contribution (c) List any two advantages and disadvantages of investing through Mutual Funds. (d) Based on the asset-mix, list three broad categories of mutual fund schemes, Question No. 3 Proposed Time : 25 Min. | Total Marks : 14 ‘A 5-year, 6% annual coupon bond with a par value of Rs.100 is selling to yield 7%. The appropriate spot rates to discount each cash flow of the bond are tabulated below: Year Spot Rate 1 5.50% 2 5.90% 3 6.40% 4 6.90% 5 7.30% Required: (a) Calculate the value of bond under traditional valuation approach (b) Calculate the value of bond under arbitrage free valuation approach. {c) Assume that sf, 2f1, af: and yr; be one-year forward rates for Year-1, Year-2, Year-3 and Year-4 respectively from now. Using the spot rates table given in the question, compute the values Of sf, 2f, 91 and ty, Question No. 4 Proposed Time : 25 Min. | Total Marks : 15 {a) Describe portfolio diversification strategy. (b) What is an arbitrage opportunity? Explain by quoting an example. (c)_ Following information is available regarding two portfolios: State of Economy Probability Eateioh Retina B Market Growth 30% 17.00% 20.00% 15.00% Stable 60% 10.30% 7.50% 11.00% Recession 10% 5.00% -5.00% Expected return 10.00% 10.60% Standard deviation 7.50% 5.50% Covariance with market 0.003 — Required: Which portfolio has most systematic risk and which has most unsystematic risk? (AP MFal 2095 4o0f5 Marks 04 04 01 04 06 04 05 04 06Question No. 5 Proposed Time : 25 Min. | Total Marks : 15 (a) A fund manager is holding stock of a commercial bank in his portfolio. The stock is currently quoted at Rs. 45 per share. The manager is planning to sell the stock in 60 days. He is worried that the price might take a dip in the intervening period. He, therefore, takes a short position in the 60-day forward contract on the stock. The stock is expected to pay dividend of Rs, 3.50 and Rs. 4.00 per share in 45 and 75 days respectively. Day 50 is financial year close of the fund manager when stock is priced at Rs. 39 per share. Risk-free rate is 7% per annum land year consists of 365 days. Required: Calculate the value of short position in the forward contract at the day 50. (b) Describe the prospect theory of the behavioural finance. (c) Identity and then describe the aspects of prospect theory of behavioural finance in the following independent scenarios: (i) Mr, Furgan has been offered following two choices of return on his investment of Rs, 100,000: (1) Guaranteed retum of Rs. 50,000. (2) Rs. 100,000 or nothing, each with probability of 50%, Mr. Furgan chose the option of guaranteed return of Rs. 50,000. (ii) On January 1, 2015, Mr. Aslam purchased 100 shares in Salwa Ltd., for Rs.50 per share. Mr. Aslam still wants to keep these shares in its portfolio, despite the recent decline of Rs. 15 per share. Mr. Sheraz is a salaried person, who has conservative spending habits when making Payments out of his salary income. He is, however, quite liberal in squandering his bonus, income. THE END Present Valu Interest Factor for an Annuity PUIFAG, interest Pid fa) rola? ][s][*][s[s[7[ele|@ ‘5.5% | 0.048 | 1.696 | 2.608 | 3.505 | 4.270 | 4.906 | 5.689 | 6.505 | 6.062 | 7.598 59% [094 | 1606) 2676] 947s 4226 [aoss | sone 6.24 | ct | 7.905 ee [0940 [1479 2055 9.404 | 4.107 [40ss |ss0e |. | 6 | 7.229 [0555 1811 [2620] 9.305 arr [are |s.ane [5.05 [653 | 7.058 om [0905 [1.206 2624 9.987 | 4.100 [4767 [sm [sori [ests] 7.0% sw [osm [1601 [2610] 9960 | «osr [ares [sx [soz [oa [ser Present Value Interest Factor PIF, Interest Period (a) Fae [2)3]4]s|[6]7]s8|°]o 55% [004 | 0698 | 0452 oa07 | 0765 [0725 [0687 | 0652 | 818 05a 59% | 0944] 0.692 | 842 | 0,795 | 0.761 [0700 | 0689 | 0.632 | 0587 | 0554 6.4% [0940 | 0683 | o@30|0,7a0| 0.733 [ace | 0 64e | 0.609 [0572 | 0538 69% | 0935] 0475 | 0819] 0765) 0.716 [0670 | 0627 | 0.585 | OSH | 0513 70% [0925 | 087s | o@t6 0763/0713 | oee6 | 0623 | 052 [ost | 0508 73% | 0832 [0.669 | 0209 | 0754) 0.703 [0885 [0611 | 0569 | 0590 | 0.404 (AP MFal 2095 S ofS Marks 05 04 02 02 02