Tutorial 1

True and False

1. A Chinese stock denominated in Chinese yuan will have an increase in its dollar-denominated
return if the Chinese yuan strengthens against the dollar. (T)
True. CNY increases then return will increases.
When yuan strengthens, it can convert to more dollars, hence dollar return will increase.

2. Total return is equal to capital gain deduct loss. (F)

False.
TR = Yield + capital gain
HPR/TR = Yield + (Selling - Buying)
Buying Price.

3. The less the variability of return, the greater the risk. (F)
False. Low risk Low return, High risk High return.

Essay questions

1. Calculate the total returns (TR) and the return relatives (RR) in term of Euro for the following
assets:
i. A preferred stock bought for €70 per share, held one year during which €5 per dividend
are collected and sold for €62.
HPR= Yield + (Selling - Buying)
Buying Price.

= 5+(62-70)
70
= -0.0429 / -4.29%

RR= 1+ HPR
= 1-0.0429
= 0.9571

ii. A 12 percent bond bought for €830, held two years during which interest is
collected, and sold for €920 (assume no reinvestment).
Assume the par value = 1000
Yield = rate * parvalue
= 12%*1000 = 120 * 2 years = 240

HPR= Yield + (Selling - Buying)

Buying Price.
= [240+ (920-830)]/830= 0.3976/ 39.76%
RR= 1+0.3976= 1.3976
 iii. Calculate the international returns (in term of Dollar) for question (i) and (ii) if
Euro appreciate from $1.25/€ to 1.35/€.

IR = [RR * (End value of currency/Beg value of currency)] - 1

(i) IR= [0.9571 x (1.35/1.25)] - 1

= 0.03337 / 3.37%
Is this exrate a favorable change?
This is a favourable exchange rate changes as the Euro appreciates, can convert to
more dollar. Return from negative 4% to 3.37%.

(ii) IR= 1.3976 x (1.35/1.25)-1

= 0.5094/ 50.94%

=
2. Bond A’a return from 2001 – 2004: -11.85%, -22.10%, 28.37%, and 10.75% respectively.
i. Calculate the arithmetic and geometric mean rate of return of bond A

AR = [(-11.85%) + (-22.10%) + 28.37% + 10.75%] / 4

= 1.29%

GM =
4
√{[1 + (- 0.1185)] * [1 + (- 0.2210)] * [1 + 0.2837] * [1 + 0.1075]} - 1
= - 0.0060 or -0.60%

ii. If you had invested $100,000 in Bond A since beginning of year 2001, determine the
value of this bond at the end of 2004.

Value of the bond at the end of year 2004

= Initial value * cumulative wealth index
Cumulative wealth index = (1+R1) (1+R2) …. (1+Rn)
= (1-0.1185)(1-0.221)(1+0.2837)(1+0.1075)
= 0.9762
= 100,000 * 0.9762
= $97,620
OR
= Initial value * (1+GM)^n
= 100,000 * (1 – 0.0060) ^ 4
= $97,620
 iii. Calculate the standard deviation of Bond A

Year TR(%), X X - Mean (X - Mean)^2

2001 -11.85 -13.1425 172.7253

2002 -22.1 -23.3925 547.2091

2003 28.37 27.0775 733.1910

2004 10.75 9.4575 89.4443

1.2925 1542.5697

Variance = 1542.5698
Standard Deviation for Stock A = (√1542.5697/4-1) = 22.6758

3. Use the following information to answer the questions below:

Stock A Stock B
Return Probability Return Probability
10% 0.3 15% 0.3
5% 0.2 7% 0.1
2% 0.2 3% 0.1
-3% 0.2 -8% 0.2
-5% 0.1 -14% 0.3

Calculate expected return and standard deviation for both stocks.

Stock A
Possible Probability Expected R-ER (R-ER)^2 P[(R-ER)^2]
Return (R) (P) Return (ER)

0.1 0.3 0.03 0.067 0.004489 0.0013467

0.05 0.2 0.01 0.017 0.000289 0.0000578

0.02 0.2 0.004 -0.013 0.000169 0.0000338

-0.03 0.2 -0.006 -0.063 0.003969 0.0007938

-0.05 0.1 -0.005 -0.083 0.006889 0.0006889

0.033 variance=
0.002921

Standard deviation = √0.002921

= 0.0540
Stock B
Possible Probability Expected R-ER (R-ER)^2 P[(R-ER)^2]
Return (R) (P) Return (ER)

0.15 0.3 0.045 0.153 0.023409 0.0070227

0.07 0.1 0.007 0.073 0.005329 0.0005329

0.03 0.1 0.003 0.033 0.001089 0.0001089

-0.08 0.2 -0.016 -0.077 0.005929 0.0011858

-0.14 0.3 -0.042 -0.137 0.018769 0.0056307

-0.003 variance=
0.014481

Standard deviation = √0.014481

= 0.1203
Tutorial 2

True and False

1. Portfolio risk can be reduced by reducing portfolio weights for assets with positive
correlations. (True)
Portfolio with perfect positive correlation(+1) assets does not diversify the portfolio risk. By
reducing the weightage of positive correlation assets, it can reduce the portfolio risk.

2. An efficiently diversified portfolio has no market risk. (False)

Market risk is non-diversifiable, no matter how efficient the portfolio, it cannot eliminate the
market risk.
Although the portfolio is completely diversified, it is important to note that the systematic risk is
still there.

3. The correlation coefficient explains the cause in the relative movement in returns between two
securities. (False)
Correlation coefficient measures the strength and direction of a linear relationship between
two securities, but it does not imply causation.
Correlation coefficient (ρ) is a scale from -1 to +1 where:
+ represents positive relationship
- represents opposite relationship
0 represents no relationship

4. Investments in precious metals may provide additional diversification opportunities for

portfolios consisting primarily of stocks and bonds. (True)
Investing in different types of investments (some in metal, some in stock, some in
bond) can further diversify the portfolio.

Essay Questions

1. Many investors have known for years that they should not “put all their eggs in one basket.”
How does the Markowitz analysis shed light on this old principle?
Markowitz is the first to develop the solid theory that support the benefits of diversification.
This theory is supported with quantitative and scientific studies.
- Markowitz analysis is also called Modern Portfolio Theory
- It provides a framework for selection of portfolios based on expected return and risk
- It is used, to varying degrees, by financial managers
- It can also show benefits of diversification
- The risk of a portfolio does NOT equal the sum of the risks of its individual securities.
- Must account for correlations among individual risks.
- It suggests that an investor should evaluate portfolios on the basis of their risk and expected
return

2. Which factors determine portfolio risk?

 🞂 Encompasses three factors
◦ Variance (risk) of each security
◦ Covariance between each pair of securities
◦ Portfolio weights for each security

From the Markowitz model, three factors determine portfolio risk which is variances, covariance
between securities, and the weights of each security.

Covariance is an absolute measure of co-movement between assets' return. Positive covariance

means returns of 2 securities tend to move together and vice versa. Therefore, the lower
covariance, the better the diversification effect. (low risk)

The weighted average of the securities would also determine the portfolio risk. Each portfolio
asset has a weight which has a different level of risk and return thus it will affect the portfolio risk.

3. Evaluate the following statements: “As the number of securities held in a portfolio increases,
the importance of each individual security’s risk decreases.”
The statement is correct because when the number of securities in a portfolio increases,
the importance of the covariance relationship increases while the importance of each
individual security’s risk decreases. For example, in a portfolio of 150 securities, the
contribution of each security’s own risk to the total portfolio risk will be extremely small;
portfolio risk consists almost entirely of covariance risk between securities. A positive
covariance return of 2 security tends to move together and a negative covariance returns of
2 security tends to move inversely. Therefore, a low covariance with each other will
provide very much diversification.

Contribution value = 1000

Case 1 = 10 individual
Case 2 = 100individual

Contribution perperson = case 1 = 1000/10 = 100

case 2 = 1000/100 = 10

4. Use the following information to answer the questions below:

Day KLCI Stock A Stock B
Return Retun Retun
January 15% 10% 15%
February 8% 5% 7%
March 6% 2% 3%
April -2% -3% -8%
May -5% -5% -14%

i. Calculate expected return and standard deviation for both stocks.

Stock A
 Expected return/Mean
= ΣRi / n
= [10 + 5 + 2 + (-3) + (-5)] / 5
= 1.8%

Standard deviation

= √ [(10-1.8)^2+(5-1.8)^2+(2-1.8)^2+(-3-1.8)^2+(-5-1.8)^2 ]
5-1
=√ 146.8/4
= 6.06%

Day Return (%) (X) X - Mean (X – Mean)2

January 10 8.2 67.24
February 5 3.2 10.24
March 2 0.2 0.04
April -3 -4.8 23.04
May -5 -6.8 46.24
Mean = 1.8 146.80
Expected Return = 146.80
Standard Deviation = √146.80 / (5-1)
= 6.0581

Stock B
Mean
= [15 + 7 + 3 + (-8) + (-14)] / 5
= 0.6
Day Return (%) (X) X - Mean (X – Mean)2
January 15 14.4 207.36
February 7 6.4 40.96
March 3 2.4 5.76
April -8 -8.6 73.96
May -14 -14.6 213.16
Mean = 0.6 541.20
Expected Return = 541.20
Standard Deviation = √541.20 / (5-1)
= 11.6319

ii. Find out the correlation between Stock A and Stock B, calculate portfolio risk and return
based on following combination:
Correlation (ρ) = Covariance (A,B) / σAσB

= 1/(5-1) x [(10-1.8)(15-0.6) + (5-1.8)(7-0.6) + (2-1.8)(3-0.6) + (-3-1.8)(-8-0.6) +

(-5-1.8)(-14-0.6)] / [(6.0581)(11.6319)]
= 1/4 x [(118.08+20.48+0.48+41.28+99.28) / 70.4672]
= 1/4 x (279.60/70.4672)
= 0.99195

a. 70% invested in Stock A, 30% in Stock B

Portfolio Return

= ΣWiRi
= (0.70 x 1.8) + (0.30 x 0.6)
= 1.26 + 0.18
= 1.44%

Portfolio Risk
= √ (0.70)2(6.0581)2 + (0.30)2(11.6319)2 +
2(0.70)(0.30)(0.99195)(6.0581)(11.6319)
= √ 17.9833 + 12.1771 + 29.3580
= √ 59.5184
= 7.7148%

b. 50% invested in Stock A, 50% in Stock B

Portfolio Risk
= √ (0.50)2(6.0581)2 + (0.50)2(11.6319)2 + 2(0.50)(0.50)(0.99195)(6.0581)(11.6319)
= √ 9.1751 + 33.8253 + 34.9500
= √ 77.9504
= 8.8290%

Portfolio Return
= (0.50 x 1.8) + (0.50 x 0.6)
 = 0.90 + 0.30
= 1.20%

c. 30% invested in Stock A, 70% in Stock B

Portfolio Risk
= √ (0.30)2(6.0581)2 + (0.70)2(11.6319)2 + 2(0.30)(0.70)(0.99195)(6.0581)(11.6319)
= √ 3.3031 + 66.2975 + 29.3580
= √ 98.9586
= 9.9478%

Portfolio Return
= (0.30 x 1.8) + (0.70 x 0.6)
= 0.54 + 0.42
= 0.96%

5. Shall we include Bitcoin into portfolio?

There is no right or wrong answer.
If yes, support with logical explanation, (for investors with higher risk tolerance, can consider to
add in Bitcoin in the portfolio to gain higher possible return)
support with additional advantages of bitcoin -
bitcoin is not regulated or controlled by the Gov.
It is easy to buy and sell (download the apps eg: LUNO in malaysia)

If no, support with explanation:

- it is extremely high risk (very volatile)
- there are risk in certain countries that banning the bitcoin (bitcoin is not recognised in
certain countries)
- it can used in money laundering and fraud.

It needs to depend on investor’s acceptance against bitcoin. Because the price is more volatile. It
also needs to consider the factor of the investor’s capital adequacy.
Tutorial 3

True and False

1. The capital market line (CML) indicates the required return for each portfolio risk level. (True)
Lec2 Slide 23
The capital market line (CML) is a straight line that shows the relationship between risk and return
of different portfolios. The CML is according to the assumption that all investors are rational and
seek to maximize their returns.

2. Beta is a measure of systematic risk and relates one security's return to another security's return.
(False)
Beta is a measurement of systematic risk, BUT it DOES NOT measure the relationship of one
security's return to another security's return.

3. In a declining market, a portfolio manager should attempt to increase the overall beta of
the portfolio. (False)
When the market is declining, should reduce the risk(beta) not increase it!!!
In a declining market, overall market risk is increasing and stock prices are falling, a
portfolio manager typically aims to reduce the portfolio's overall beta(overall risk).

Essay Question

1. Using data from Tutorial 2 Question 4, generate Beta of both stocks.

* pls refer to the excel

KLCI
Expected return/Mean
= ΣRi / n
= [15+ 8 + 6 + (-2) + (-5)] / 5
= 4.4%

Standard deviation
= √ [(15-4.4)^2+(8-4.4)^2+(6-4.4)^2+(-2-4.4)^2+(-5-4.4)^2 ]
5
=√ 257.2/5
= 7.1722%
Stock A
Mean = 1.8%
Standard deviation = 11.6319

Covariance (Stock A and KLCI)

= 1/(5) x [(10-1.8)(15-4.4) + (5-1.8)(8-4.4) + (2-1.8)(6-4.4) + (-3-1.8)(-2-4.4) +
(-5-1.8)(-5-4.4)]
= 0.003868

β for stock A
= Covariance / Variance
= 0.003868 / (7.1722% ^2)
= 0.7519

KLCI
Expected return/Mean
= ΣRi / n
= [15+ 8 + 6 + (-2) + (-5)] / 5
= 4.4%

Standard deviation
= √ [(15-4.4)^2+(8-4.4)^2+(6-4.4)^2+(-2-4.4)^2+(-5-4.4)^2 ]
5
=√ 257.2/5
= 7.1722%

Stock B
Mean = 0.6%
Standard deviation = 10.4038%

Correlation (ρ)
= 1/(5-1) x [(15-0.6)(15-4.4) + (7-0.6)(8-4.4) + (3-0.6)(6-4.4) + (-8-0.6)(-2-4.4) +
(-14-0.6)(-5-4.4)] / [(11.6319)(8.0187)]
= 1/4 x [(152.64+23.04+3.84+55.04+137.24) / 93.2727]
= 1/4 x (371.8/93.2727)
=0.9965

β for stock B =0.9965 x 10.4038%

7.1722%
= 1.4455
 2. How can security market line (SML) be used to identify over and undervalued securities?

Plotting Securities on the SML

Drawing various securities on the SML graph can help investors assess whether they are overvalued,
undervalued, or fairly valued relative to their risk. If a security's expected return lies above the SML for its
level of systematic risk, it is considered undervalued because it offers a higher expected return than what
would be expected given its risk level. Conversely, if a security's expected return lies below the SML, it is
considered overvalued because it offers a lower expected return relative to its risk.

Comparing Expected and Required Returns

Investors can compare the expected returns of securities with their required returns as indicated by the
SML. Securities with expected returns higher than their required returns (as per the SML) are considered
undervalued, while those with expected returns lower than required returns are considered overvalued.

3. Suppose that the risk free rate of 6 percent, the market portfolio expected return and variance is
8 and 7 percent respectively, and the covariance between Stock A and market return is 6
percent. (Important)

rf = 6%
E(Rm) = 8%
σ^2 = 7%
Cov (Ra,Rm) = 6%
 a. Calculate Stock A’s Beta.

βA = Cov(Ri,Rm)/σ2m
= 6/7
= 0.857
Market beta = 1
Hence stock A is less risky than the market as it is 0.857 < 1.

b. Calculate Stock A’s risk premium

Market Risk premium = (Rm - Rf)
Risk premium for stock A = βA[Rm - Rf]
= 0.857 x (8 - 6)
= 1.71%

c. Calculate Stock A’s required rate of return

Required rate of return = Rf + βA x (Rm - Rf)
= 6 + 0.857 x (8 -6)
= 7.71%
OR = 6% + 1.71%(from part b) = 7.71%

4. Suppose that Public Bank Berhad (PBB) pays 10% of return, Treasury bill pays 3% and market
return is 7%. If beta of PBB is 1.16, is PBB a good investment?

E(R)PBB = Rf + βpbb x (Rm - Rf)

= 3 + 1.16 (7-3)
=0.0764 / 7.64%

Based on the calculated the required rate of return for PBB is 7.64%. However, PBB
offers/pays up to 10% of return which is HIGHER than the required rate of return(7.64%).
Hence, PBB is a good investment.

5. Suppose that a mutual fund agent approaches you and promote a fund which allows you to
withdraw money from your Employment Provident Fund (EPF) to invest. From the analysis of
the agent, the fund expected to pay up to 11% return, and you know that EPF paid an average 6%
return and treasury’s return fixed at 2.75%. Based on the discussion in this chapter and in your
opinion, are you going to take the investment? Justify your answer.

EPF = 6% (for sure)

Mutual Funds = 11% (additional risk = 5%)

E(R)mutual fund = Rf + Risk Premium

11 = 6 + Risk Premium
Risk Premium for this mutual fund = 11 - 6 = 5%.
We can see that the risk premium is 5%. Actually we can use the return of 6% as a risk free rate.
The money still remains in EPF to obtain interest payment or invest into mutual funds based on
the investors. EPF is an government entity in Malaysia which
had the minimal default risk compared to mutual funds.
Not all mutual funds are safe investments.
In my opinion, I would choose to invest, the fund is low risk, and the risk premium 5% is
comfortable for me. I am willing to take the risk to look for a maximum return of 11%.
Moreover, mutual funds have professional guidance and it is diversified, etc….

No, I would rather put the money in EPF and earn the 6% for sure rather than taking the
additional risk.
Moreover, agents of mutual funds have a tendency to sugarcoat the condition for the commission
purpose. Next, mutual funds incur high transaction fees.
Tutorial 4

True and False

1. If interest rates rise, the risk free rate of return declines. (False)
Risk free rate is referring to investment where the risk is insignificant, or almost = to zero such as
Government securities/Tbill.
Thus when interest rates rise, the risk free rate of return should rise too.

2. If the economy is prospering, investors expect corporate earnings to rise. (True)

When the economy is prospering, it typically indicates increased consumer spending, business
investment, and overall economic activity. This tends to result in higher corporate earnings as
businesses sell more products or services and generate higher revenues. Consequently, investors
generally anticipate that corporate earnings will rise during periods of economic prosperity, which
can positively impact stock prices and investment returns.

3. Stock prices have almost always risen as the business cycle is approaching a trough. (TRUE)
Stock is the popular LEADING indicator, where it will move in advance.. Thus, when the business
cycle is approaching a trough, stock prices may have already risen.

4. The utility industry is a good example of a countercyclical industry. (TRUE)

Cyclical industry - industry that goes up and down together with the business cycle.
Defensive/Non-Cyclical/CounterCyclical - industry that remain stable or even better during the recession.
This refers to the necessities such as healthcare, utility, staples.

5. Both counter cyclical and defensive stocks will rise during recession. (False)
May just remain stable, not necessarily rise.
Essay Question

1. What is the business cycle?

The business cycle is the fluctuation of the aggregate economy activity mainly in business
enterprise. It refers to the recurring pattern of expansion, contraction, boom and trough. in
economic activity that occurs over time within an economy. It represents the fluctuations in real
GDP, employment, production, investment, and other economic indicators.

2. Explain the relationship between business cycle and yield curve by using graphs.

Business Cycle and Yield Curve

Business Cycle – The recurring patterns of expansion, boom, contraction and recession in the
economy.
Yield Curves show the relationship between bond yields and time, holding issuer constant. It
reflects bond traders’ views about the future. Its shape is related to the business cycle.
-Upward sloping and steepening curve implies accelerating economic activity.
-Flat structure implies a slowing economy.
-Inverted curve may imply a recession.
3. Assume investor can determine the business cycle, when should stocks be purchase?
Investor should purchase stock before a bottoming of the economic occurs because price almost
always rise before the trough.

Stock is the popular LEADING indicator, where it will move in advance. So can purchase when
the business cycle is approaching the trough, as the stock market may already be at the lowest, so
that investors can buy at the lowest price and make a return when it rises later.

4. Why investors are concern about consumer spending?

Investors are concerned about consumer spending because it serves as a significant indicator of
economic health. High levels of consumer spending typically signal confidence, economic growth,
and stability, which are favorable conditions for businesses and investors. Conversely, a decrease
in consumer spending can indicate economic uncertainty, potential recession, and reduced
corporate profits, prompting investors to reassess their investment strategies and risk exposure.

GDP is the most widely used economic indicator.

GDP = C + I + G + EX
C, Consumer spending is 70% of the whole GDP.
So by checking consumer spending, investors can roughly check the GDP, which is the health of
the economy. This is important in analyzing the investment.
 5. What are the stages in the life cycle for an industry? Can you think of other stages to add?

1）Embryonic
Slow growth - Customers are not familiar with the products.
High prices - Volumes are not sufficient to achieve economies of scale
Significant investment required.
High risk - High failure rate.

2）Growth
Rapidly increasing demand - More customers entering the market.
Improving profitability - Economies of scale are achieved.
Falling prices - Economies of scale are achieved.
Low Competition - Although barriers to entry are low, rapidly increasing demand relax the
competition.
Companies typically reinvest their earnings rather than paying dividends.

3）Shake out
Slowing growth - Less new customers.
Intense competition - Growth becomes dependent on market share gains.
Declining profitability - Prices cutting to boost volumes/sales to fill excess capacity.
Companies focus on reducing cost structure and building brand loyalty.

4）Mature
Little or no growth - Market is completely saturated
industry consolidation - industry may consolidate and become oligopolies (Market is
dominated by a few firms)
High barriers to entry - The surviving companies have brand loyalty and relatively efficient
cost structure
Limited reinvestment opportunity - more likely of paying dividends to shareholders

5）Decline
Negative growth - Development of substitutes or social changes.
Excess capacity - Declining of demand.
High competition - Price wars due to excess capacity.

Can you think of other stages to add?

Exit Stage
Innovation stage
Research and development stage - before the embryonic stage

6. Why industry life cycle is useful to an investor doing analysis?

It is important for investors to assess the potential risks and return.

By identifying the stage of the life cycle, investors can evaluate the risk and return of investment.
EG: when investing in the embryonic stage, the risk is very high as it is new but the potential return can be
very high as well.
When investing in the Mature/stability stage, can expect lower risk and stable dividend. However, I cannot
expect high growth.

A company's future growth prospects may be bright

(or dim) depending on the stage that it is in during an industry life cycle.
The industry life cycle is an important and universally accepted concept to help investors
better understand sales growth and change over time.

7. What is the essential factor of Porter’s analysis?

Power of suppliers
● To analyze suppliers’ ability to raise price or restrict supply
● 1) Number of suppliers
- More suppliers in the industry indicates lower suppliers’ ability to raiser price.
● 2) Scarcity of supplied products
- The more scarce is the supplied products, the greater the suppliers’ pricing power

Power of buyers
● To analyze customers’ ability to bargain lower price or better product quality
● 1) Number of customers
- Great number of customers indicates stable demand and weaker customers’ bargaining
power.

Rivalry among competitors

● Industry experience more intense competition if:
1. Industry comprises of many small firms;
2. High fixed costs
3. Undifferentiated products
4. High exit barriers

Threat of entry
● To analyze difficulty of outsiders to establish new firm in the industry.
● Low barriers indicate highly competitive industry profits by new entrants.
● 1) Initial capital requirement - high required capital indicates higher barriers of entry.
● 2) Customer base requirement - big required customer base indicates greater barrier.

Threat of substitute
● Availability of different products / services that could satisfy same needs.
● Affecting the pricing power in industry
Tutorial 5

True and False

1. The auditor's report guarantees the accuracy of the earnings reported in the financial statements.
(False)
Auditor role is to perform checking and assure company accounting comply with the law and
regulations.
Auditor’s report does not guarantee the accuracy of the earnings reported in the financial
statement. Auditors assess the financial statement based on professional standards and their
judgment, but there can still be errors or misstatements that go undetected.

2. Leverage can magnify returns to the stockholders but also increase potential losses to
the stockholders. (True)
Lec5Slide3

Leverage can magnify returns to the stockholders through increased earnings on the
assets the company financed by debt. However, it also increases the potential losses to
stockholders because they have to bear the burden of debt repayment, regardless of the
performance of the assets.

3. A company may maintain its ROA if the net income margin decreases by increasing its asset
turnover. (True)

ROA = NPM * AT (Hence decrease in NPM may offset the increase in AT, making the
ROA remain the same)
 4. Investors interested in buying stocks that report bad news and suffer a sharp decline should buy
the first day bad news is reported. (False)
Can wait for the market to react first, so that it can be purchased at a LOWER price and sold at higher
price when it recovers from the bad news later.

5. The P/E ratio can be expected to change as the expected dividend payout ratio changes. (True)

P/E ratio is calculated by dividing the market price per share by the earnings per share (EPS). It
reflects the price investors are willing to pay for each dollar of earnings. If the company's expected
dividend payout ratio decreases, it means that more earnings are retained by the company. The
increase in EPS will affect the P/E ratio. P/E ratio = (Net Income - Preferred Dividend) / Number
of Common Stock Outstanding

1. What problems do estimating accounting earnings present? Are these problems can be
resolved by hiring auditor firms?
What problems do estimating accounting earnings present?
- There are problems such as subjectivity. Estimating accounting earnings often involves making
judgments and assumptions. However, different individuals or organizations may arrive at different
estimates based on their interpretations of the data or their assessment of future events. This may lead
to conflict and even wrong decision making due to difference in perception and stance.
- The next problem is complexity. Estimating accounting earnings can be complex, especially for large
or diversified companies with multiple revenue streams, expenses, and accounting treatments.
Managing this complexity requires a deep understanding of accounting principles and financial
reporting standards.
- Also, estimation DOES NOT guarantee results. there may be inaccuracy to estimate accounting
earnings. It is inherently prone to error, especially when forecasting future financial performance.
Factors such as unexpected events, changes in market conditions, or inaccurate assumptions can lead
to inaccuracies in the estimates.

Are these problems can be resolved by hiring auditor firms?

NO, cannot be resolved by hiring an Auditor.
Auditor role is to perform checking and assure company accounting comply with the law and
regulations.
Auditor’s report does not help in estimating the earnings.
I think these problems cannot completely be resolved by hiring auditor firms. It is because auditors
rely on the information provided by management. Sometimes, the information can be wrong and they
may not detect all errors or irregularities.

2. How can the earnings growth rates be determined? Will the growth rates persist across time?

How can the earnings growth rates be determined?

Lec5 Slide 21
Methods to estimate growth rate:
1)Sustainable growth rate: rate at which company can grow from internal sources:
g = (1 – Dividend Payout Ratio) x ROE

2) Use average historical earnings growth rate.

3) Use the median industry earnings growth rate.

Will the growth rates persist across time?

- The growth rates will not persist across time because the market environment and other
variables are unpredictable. Most companies don’t grow much at all.

3. What are the variables that affect the P/E ratio? Is the effect direct or inverse for each
component?

P/E ratio can be affected by 3 factors:

1) expected dividend payout ratio, (Direct/Positive Rship)
2) required rate of return, (Inverse/Negative Rship)
3) expected growth rate in dividends(Direct/Positive Rship)

Higher payout ratio makes the P/E ratio increase.

Higher required rate of return means earning more and using less money to buy, P/E
ratio decreases.
Growth rate increases, people will have more confidence, P/E ratio will increase.
 4. Holding everything else remains constant, what effect would the following have on a
company’s P/E ratio?
a. An increase in the growth rate of earnings
Refer to Asnwer in Q3
expected growth rate in dividends(Direct/Positive Rship with P/E)
As an increase in the growth rate of earnings, the P/E ratio of the company will increase.

b. A decrease in the dividend payout

Refer to Asnwer in Q3
(Direct/Positive Rship with P/E)
As a decrease in the dividend payout, the P/E ratio of the company will decrease.

c. An increase in the risk free rate of return

When Rfr Increase, the required rate of return should increase as well
RFR is referring to investment with insignificant risk. (such as Gov securities)
As an increase in the risk free rate of return > required rate of return increases
Refer to Q3: Required rate of return, (Inverse/Negative Rship with P/E)
the P/E ratio of the company will decrease.

d. An increase in risk premium

When risk premium increases, the required return should increases (High risk High Return)
Refer to Q3: Required rate of return, (Inverse/Negative Rship with P/E)
the P/E ratio of the company will decrease.

e. A decrease in the required rate of return

Refer to Q3: Required rate of return, (Inverse/Negative Rship with P/E)
As a decrease in the required rate of return, the P/E ratio of the company will increase.

5. Assume that Intel announces a 40 percent increase in EPS for its most recent quarter, and the
stock price immediately declines 15 percent while the market as a whole is unchanged. How
would you explain this?

This is common when the news/announcements do NOT meet the public/investors expectations.
Eg: Analysts might have predicted the EPS to double or even tripled, and the lower-than-expected
result could disappoint investors, leading to the sell-off.

6. Shao Electronics has total assets of $550 million, $7.2 billion net income and stock
holder’s equity of $330 million. It has total debt of $225 million.
a. Calculate ROA
ROA= Net Income
Total Assets
= $7.2 billion
$550 million
= 7200,000,000
550,000,000
=13.0909
b. Calculate ROE
ROE= Net Income
Average shareholder’s equity
= $7.2 billion
$330 million
=21.8181
Tutorial 6

True and False

1. Under the zero-growth dividend model, expected dividends are the same as current dividends.
(True)
Zero Growth Model - div has no growth rate, the div is always the SAME
Hence the expected div (D1,D2,D3…) = Current div (D0)

2. If the intrinsic value of stock is greater than the current stock price, the stock is overvalued
and should be sold short. (False)
Intrinsic value > Current Stock Price
Current Stock Price < Intrinsic Value = UNDERvalued (worthy) - should be purchased(Long)

3. A number of companies that formerly experienced rapid growth were unable to sustain high
growth rates. These companies included Dell, Yahoo, and Google. (True)
It is common for the rapid growth to be unsustainable due to market saturation, high
competition etc.
Industry Life Cycle - Growth > Shakeout > Maturity > Decline

4. Declining interest rates in the market should send P/E ratios, on average,higher. (True)
Refer back T5 Q3&4
required rate of return, (Inverse/Negative Rship with P/E)

5. If the growth rate in dividends is greater than the required rate of return,the price found
under the constant growth model will be negative. (True)
Constant Growth Model
Vo = D0 (1+g)
r-g
When g>r, it will create negative result
Eg: g(8%) > r(5%) : r-g = 0.05-0.08 = -0.03

Essay Question

1. What is mean by intrinsic value of a stock and how it can be determined?

The intrinsic value of a stock represents its fundamental worth, derived from factors like future
cash flows, earnings potential, and assets.

How it can be determined?

Investors could use:
1) dividend discount model
2) earnings multiplier model (P/E approach)

2. Why is the required rate of return for a stock used as a discount rate in valuation analysis?
 Required rate of return = rfr + Beta(Rm-Rfr)
Required rate of return measures the minimum rate of return required by the investor in order to
induce an investor to purchase the investment.
It takes into account the opportunity cost and risk involved in the investment.

3. Describe the three possibilities for dividend growth. Which is the most likely to apply to
the typical large company? Small and medium company?

The three possibilities for dividend growth are:

(a) Zero Growth Model- there is NO growth rate, the dollar dividend will remain fixed.
(b) Constant growth Model--the dividend will grow at a steady (constant) rate over time.
(c) Multiple (Variable Growth Model)--at least two different growth rates are involved.

Which is the most likely to apply to the typical large company? Small and medium company?
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. Large companies typically make steady income and profit, hence tend
to pay constant growth dividends to the stockholder.
For small and medium companies, a multiple growth model is most applicable. SME usually is not
very stable, thus the growth rates tend to be different/fluctuate.
The Zero growth Model can be applicable to large common stock as Large companies typically
make steady income and profit but with minimum growth. Hence may pay the consistent same div
with no growth.

4. Assume two investors are valuing Stock A and have agreed to use constant growth model.
Both use $3 a share as the current dividend for the current year. Are these two investors likely
to derive different prices? Why or why not?
Constant Growth Model
Vo = D0 (1+g)
r-g
Yes, the two investors are likely to derive different prices even though they are using the same constant
growth model. This is because the constant growth model involves other factors such as the required
rate of return and the growth rate of dividends, which can vary between investors based on their
individual assessment. Therefore, even with the same dividend and model, differences in these other
inputs can lead to different valuation outcomes.
5. McCalla Food Distributors is currently paying a dividend of $1.80. This dividend is expected
to growth at a rate of 6 percent in the future. McCalla is 10 percent less risky than the market as
a whole. The market risk premium is 7% , and the risk free rate is 5%. What is the estimated
price of this stock?

D0 = 1.80
g= 6% / 0.06
Beta for the market = 1
McCalla is 10 percent less risky than the market (Beta for Mccalla = 0.9)
Rm-Rfr = market risk premium = 7%
Rfr = 5%

Beta = 1 - 0.1 = 0.9

Required rate of return
= Rf + B (Rm - Rf)
= 5% + 0.9(7%)
= 11.3%

Vo = D0 (1+g)/ (r-g)
Vo = $1.80 (1+0.06) / (0.113-0.06)
Vo = $36.04

6. Stock A: Current Dividend = $3. No change in future. Required return = 30%

Stock B: Current Dividend = $3. Constant growth at 8%. Required return = 16%
Stock C: Current Dividend = $1.48. Growth at the rate of 18% for 3 years, 7% thereafter.
Required return = 20%

Stock A = zero growth rate model

V0 = Do/r
V0= $3/0.3 = $10

Stock B = constant growth model

V0 = Do(1+g) / r – g
V0= $3(1.08)
0.16 - 0.08
= $40.5
Stock C = multi-stage growth model

D1= $1.48 (1+18%) = $1.7464 = $1.75

D2=$1.48 (1+18%) ^2 = $2.060752 = $2.06
D3=$1.48(1+18%) ^3 = $2.43
D4=$1.48(1+18%) ^3*(1+0.07) = $2.60

V3= $2.60 / (20% -7%) = $20

V0 = ($ 1.75 / (1+20%)) + ($ 2.06 / (1+20%) ^2) + ($2.43 / (1+20%) ^3)) +( $20 / (1+
20%) ^3) = $15.87

i. If the current price for Stock A, B and C is $11, $30 and $17 respectively, which stock
you will choose to invest?

Stock Current Price Intrinsic Value

A 11(overvalued) 10

B 30 (undervalued) $40.5

C 17(overvalued) 15.87
 I will choose stock B because the stock B is undervalued stock. The market value is
<than the intrinsic value ($30 < $40.5)

ii. If the current price for Stock A, B and C is $5, $45.50 and $10.87 respectively, which
stock you will choose to invest? Why?

Stock Current Price Intrinsic Value

A 5(undervalued) 10

B 45.5 (overvalued) $40.5

C 10.87(undervalued) 15.87

I will choose stock A and stock C because stock A and stock C are undervalued
stock. The market value of stock A is < than the intrinsic value ($5 < $10). The
market value of stock C is < than the intrinsic value ($10.87 < $15.87).
If only one choice is given, I will choose stock A because the price is much cheaper
($5). With the same amount of money, I can buy more of stock A than stock C.
Tutorial 7

True and False

1. Technical analysis utilizes a top-down approach to common stocks. (False)
Top down approach consists of fundamental analysis, industry analysis and economic analysis.
Technical analysis focuses on chart and short term approach.

2. A bar chart is the simplest type of chart used in technical analysis. (FALSE)
A bar chart is not the simplest type of chart used in technical analysis. The simplest type of chart
used in technical analysis is the line chart, which plots the closing prices of a financial instrument
over a specified time period as a line.

3. Technical analysis uses P/E ratio. (FALSE)

P/E ratio is under fundamental analysis.
Technical analysis does not typically use the price-to-earnings (P/E) ratio. Technical analysis
focuses on analyzing historical price and volume data to identify patterns and trends in a stock's
price movement.

Essay Question

1. Differentiate between fundamental analysis and technical analysis.

Fundamental Technical

- financial statement - charts and graph

(SFP, SPL, Cash Flow Statements etc)

long term approach short term approach

suitable for investing suitable for trading

Fundamental analysis
Fundamental analysis evaluates stocks by attempting to measure their intrinsic value. 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
Technical analysis differs from fundamental analysis. It attempts to identify opportunities by
looking at statistical trends, such as movements in a stock’s price and volume to predict short-term
price movements in either individual stocks or the market. Technicians attempt to forecast trends
in price changes.
2. Using a moving average, how is a sell signal generated?

Dead Cross- When short term moving average crosses below long term moving averages, this is a
sell signal generate

3. What is relative strength analysis?

Relative strength is a strategy used in momentum investing and in identifying value stocks. It
focuses on investing in stocks or other investments that have performed well relative to the market
as a whole or to a relevant benchmark.

RSA is used to measure the relative performance of the assets / 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.
4. Ah Beng Berhad one week candlestick chart

I. Fill in the information based on the above chart (note: Shaded candlestick represent
red candlestick and unshaded represent green candlestick):

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. Calculate three-day moving average by using closed price.

 5. Distinguish between a bar chart and a point-and-figure chart.
Bar chart has a four bits of data in each entry for a daily data. Short bar indicates little price
movements during the day. Long bar indicates a wide divergence between the high and low for the
day.
refer to slide 7

Point-and-figure chart is drawn on graph paper, with the vertical axis measuring discrete increment
in price, represented by a “box size”. Starting from the opening price, the analyst will fill in a box
in the first column if the closing price has changed by at least the box size. An X indicates an
increase of one box size; and a o indicates a decrease of one box. If the price continues in the same
direction in the next periods, continue filling in the same column. When the price changes in the
opposite direction by at least the reversal size 3 box or any size decided by the chartist, begin the
next column. It is helpful in identifying changes in the direction of price movements.

6. Briefly explain what behavioural finance is. Why it is important.

Behavioral finance is an interdisciplinary field that combines finance and psychology to study how
human emotions, biases, and cognitive errors influence financial decision-making. It explores the
deviations from rationality exhibited by investors and seeks to understand the underlying
psychological factors driving these deviations.

Why it is important.
By studying behaviour and identifying mistakes, behavioural finance can contribute to improving
returns or reduce investors’ risk.

This field is important because it challenges the traditional assumption of rationality in finance and
provides insights into why individuals often make irrational decisions in the financial markets. By
understanding these behaviors, investors and policymakers can develop more effective strategies to manage
risk, enhance returns, and improve market efficiency. Behavioral finance helps bridge the gap between
theory and practice by offering practical insights into real-world financial decision-making.
 7. Explain the following investor’s behaviour and its possible consequences.
I. Overconfidence
Overconfidence is a byproduct of investors who frequently believe they are better investors than other
investors. They believe they are able to outperform the market. They use their information broadly, which
might lead to inefficient trading. Overconfident investors frequently overestimate their talents while
underestimating uncertainties. They view their past achievement as a reliable indicator of future success.

Possible consequences:
● Overtrading: Overconfident investors may engage in excessive buying and selling of securities,
leading to higher transaction costs and lower returns.
● Failure to Diversify: Overconfident investors may concentrate their investments in a few securities
or sectors, ignoring the benefits of diversification. This lack of diversification increases portfolio
risk.
● Disregard for Risk: Overconfident investors may underestimate the risks associated with their
investments, leading to losses when unexpected events occur.
● Overestimation of Returns: Overconfident investors may set unrealistic return expectations, leading
to disappointment and dissatisfaction with actual investment outcomes.

II. Representativeness
Representativeness refers to the tendency of investors to make investment decisions based on past
experiences, patterns, or stereotypes rather than considering all available information. Investors may
classify new information or assets into familiar categories, leading to biased judgments and decisions.

Possible Consequences:
❖ Mispricing of Assets: Investors may incorrectly classify assets based on past performance or
similarities to familiar investments, leading to mispricing and inefficiencies in the market.
❖ Missed Opportunities: Investors may overlook investment opportunities that do not fit their mental
models or preconceived notions, resulting in missed potential returns.
❖ Increased Volatility: Representativeness can contribute to herding behavior (discussed below),
where investors follow the actions of others based on perceived similarities, leading to increased
market volatility and price bubbles.

III. Herding

Herding refers to the tendency of investors to follow the actions or behavior of others in the market, rather
than making independent decisions based on their own analysis or convictions. Investors may herd in
response to social cues, peer pressure, or fear of missing out (FOMO).

Possible Consequences:
Market Bubbles: Herding behavior can contribute to the formation of market bubbles, where asset
prices become disconnected from their underlying fundamentals due to excessive buying driven by
investor sentiment rather than intrinsic value.
Increased Market Volatility: Herding behavior can amplify market swings, leading to increased
volatility and exaggerated price movements, especially during periods of uncertainty or market
stress.
Inefficient Allocation of Capital: Herding can result in inefficient allocation of capital, as investors
may flock to popular assets or sectors without regard for their long-term prospects or intrinsic value,
leading to misallocation of resources and potential market distortions.
Tutorial 8

True and False

1. Both stocks and bonds are valued by summing the discounted future flows of interest (or
dividends), and the repayment of principal (or sale of the stock). ( )
2. Bond traders use the term “basis point” to mean one percentage point in interest rate. ( )
3. One of the most cost-effective methods of passive bond investing is buying into a bond
mutual fund. ( )
4. One of the major benefits of employing a buy and hold strategy is the savings on trading
costs. ( )

Essay Question

1. Bond A and Bond B pay annual coupon rate of 10 %, with a face value of $1000 and
three years to maturity.
i. Assume annual YTM is 12% and the market price is $900, is Bond A worth to buy?
ii. If Bond B currently selling at $750, what is the YTM?
iii. Repeat question (i) and (ii) if both bond pay semi annually

2. You need $60,000 five years from now to pay the down payment for your house. You buy 30
bonds at face value of $1000 with five years maturities yielding 8.2. Will you have enough to
meet your goal at the end of five years? If no, suggest some solutions.

3. Immunization is intended to protect a portfolio against interest rate risk. What should be done?
How does it work?

4. Sam Stevans is the trustee for the Hole Punchers Labour Union (HPLU). He has approached
the investment management firm of IM Associates (IMA) to manage its $200 million bond
portfolio. IMA assigned Carol Peters as the portfolio manager for the HPLU account. In their
first meeting, Mr. Stevans told Ms. Peters: “We are an extremely conservative pension fund.
We believe in investing only in investment grade bonds so that there will be minimal risk that
the principal invested will be lost. We want at least 40% of the portfolio to be held in bonds
that will mature within next three years. I would like your thoughts on this proposed structure
for the portfolio.”
How should Ms. Peters respond?
Tutorial 9

True and False

1. Investors in futures can take either a long, short, or neutral position. ( )
2. A pension fund holds $10 million in Treasury bonds. In order to protect against a rise in
interest rate, the pension fund should use a short hedge in T-bond futures. ( )
3. In a margin account, if the account balance falls below the initial margin, a margin call is
triggered. ( )
4. Most futures contracts are settled by delivery. ( )

Essay Question

1. What does it mean to say that futures trading is a zero-sum game?

2. Which type of risk does stock index futures allow investor to hedge?

3. Consider the Japanese yen futures contract with following

specifications: Contract size: ¥12,500,000
Exchange rate: $0.00989/¥
Initial margin: $3,465
Maintenance margin: $3,150
Expiration date: Sept 2014

i. How much must the speculator initially pay?

ii. If the futures price of Yen rises to $0.01/¥, what are the profit/ loss on the short position?
iii. If the futures price of Yen declines to $0.00972/¥, what are the profit/ loss on the short
position?

4. Mr. Lee has a portfolio of stock valued at RM900,000. He would like to protect against an
anticipated market decline.
i. Suggest and explain a solution to Mr. Lee
ii. Mr. Lee anticipated that the market will decline 10%. Assume FBM KLCI stock index
future priced at 1,800. Explain how stock index future able to hedge against the
market decline.

5. Suppose an investor purchases a call option on a Treasury bond futures contract with a strike
price of $91 and a premium of $1.
i. If at the expiration date the price of the Treasury bond future contract is $96, will the
investor exercise the call option; if so, what will the investor and the writer of call
option receive?
ii. If at the expiration date the price of the Treasury bond future contract is $89, will the
investor exercise the call option; if so, what will the investor and the writer of call
option receive?
Tutorial 10

True and False

1. If the price of the underlying stock equals the strike price of the call option at maturity, the call
buyer has a breakeven transaction. ( )
2. If the price of the underlying common stock is less than the exercise price of a call, it is in
the money. ( )
3. There is a positive relationship between the price of a put option and the volatility of
the underlying common stock. ( )

Essay Question

1. Stock ABC selling at $140 per share in the market, paying dividend of $3 per share, expect
to growth at 5% for next three years, and a constant growth of 3% thereafter. The beta of
Stock ABC is 2.0, Treasury bill paying 3% and the market portfolio return is 4%.
i. Calculate intrinsic value of Stock ABC by using Dividend Discount Model (DDM).
ii. Assume you have limited fund, is there any way to amplify the outcome? Explain
how it works based on the answer in Question 1(i).
iii. Given the call option premium of Stock ABC is $9 per share and the exercise price is
$140, calculate the profit earned by using traditional long position and buying call
option by investing $280,000 respectively.
iv. Assume you are the shareholder of this company; is there anywhere to reduce the
risk exposure? Explain by using graph.

2. Suppose you are a FTSE Bursa Malaysia KLCI (FBM KLCI) Option trader and the FBM KLCI is
currently at 1,660 points. The following quotes are available to you: -
30 days FBM KLCI Option: -
Call Option Put Option
1,640 Call @ 29 points 1,640 Put @ 3 points
1,660 Call @ 3 points 1,660 Put @ 5 points
1,680 Call @ 2 points 1,680 Put @ 31
points Option Contract size: FBM KLCI multiplied by
RM100

Required:

a) Construct the payoff diagram of buying the In-the-Money Put Option indicating its breakeven
price and maximum profit and loss.

b) Construct the payoff diagram of selling the Out-of-the-Money Call Option indicating its
breakeven price and maximum profit and loss.

c) Compute the intrinsic value and time value of the In-the-Money Call Option

d) Suppose you expect that the local stock market will rise drastically in the near future, what can
you do to take advantage of your expectation given that you have sufficient money to purchase
FIFTY (50) Out-of-the-Money options?

e) Based on your strategy in part d) above, indicate whether you will exercise the option and
compute your payoff if, at maturity of the option: -
i) FBM KLCI drops to 1,670
ii) FBM KLCI rises to 1,700
Tutorial 11

True and False

1. Real estate investment always associated with low liquidity and high transaction cost. ( )
2. House can act as a shelter as well as a financial asset. ( )
3. Mortgage REIT is the owner of the property. ( )
4. An equity trust is a REIT that specializes in mortgage loans. ( )

Essay Question

1. Why is real estate an attractive investment?

2. Real property can be purchase by leverage from bank, but still not attractive for certain investor.
Why?

3. Assume you bought a house by using leverage:

i. Buying Price: $700,000
ii. Legal fees: $30,000
iii. Margin of financing: 90%
iv. Tenure and interest rate: 30 years at 4.6%

Calculate the following questions:

i. Upfront Cost
ii. Monthly instalment
iii. Assume you rent out the house at $2100 per month and sell the house end of 5th year at
$800,000, with agent fees of 2%. Calculate net present value (NPV) if discounting
factor is 5%. Comment on the calculated NPV.

4. What are the factors that need to consider when purchasing a residential property?

5. What advantages do equity REITs offer investors over direct investments in real estate
properties?