‘This question papermustbe SEAT NUMBER; returned. Candidates are not ‘permitted to remove any part FAMILY NAME. fit from the examination room, Room: OTHER NAMES. STUDENT NUMBER... » MACQUARIE UNIVERSITY ‘SESSION 2 EXAMINATIONS - NOVEMBER 2013 Unit Code/Name: ACST434/ACSTB71/ACSTE71X Investment and Asset Modeling TimeAllowed: Thee hours plus 10 minutes reading time ‘otal Number of Questions: FIVE(@) Instructions: You should answer ALL quesions, The number of marks avaiable for each question partis shown in parentheses next fo tha relavant queston part Each question MUST be answored in a separate answer booklet ‘You are permitied to bring ONE Ad sheet of paper containing reference material writen on bath sides. The sheet may behanduriten typed or photo-reduced. Students are required to ‘submit this Aé sheet with ther examination anewer booklets Dictionaries No dictionaries permite Calelators Non-programmable calculators that do nat have tex! retrieval eapacty permited,[26] Question 1 Answer this question in booklet [A mid-sized industry superannustion fund is reviewing the steatepic asset allocation of its Balanced (Option. The fund has range of investment options that members can readily select fiom; the Balanced Option isjust one of them. I eeounts for approximately 60% ofthe fund’s assets From time to time the tastes, with advice from its asset cons implement minor tits to its ‘asst allocation fo reflet medium term views of pricing imbalances between asset classes. But once ‘these tls have been determined, the fund employs objective rules that will ensure thatthe fund's asset allocation remains close tothe ited target. “The fund has asked you (a its asset consultant) to comment on its ability to invest gud assets, especialy property and altemtives. Hl (a) List and describe in one sentence each, fur types of alternative asset. 4] (@) Hedge Fund Research Inc (HERI groups hedge fund strategies into four major groups and categories 33 specie types of hedge fund strategy into those groups. st the four groups tnd briefly describe two spcifc strategies (from different groups). Do NOT include fund of hedge finds strategy classifications. 2] (© Why do investors desire genuine alternative investments? 2} (@) _Whatpratcal issues do investors need to deal with when investing in alternative assets and hedge funds? 1 (©) Briefly describe the issues thatthe fund should consider when seting rebalancing rules. Restrict your answer to rebalancing an asset allocation defined in tems ofthe asst classes that are define inthe strategic asset allocation. B] (Name three features of property investment which are similar to those of an investment in ‘equity. (Answer only for rent producing real estate, not development) BI (@) Describe how you would estimate the volatility ofthe property aset clas forthe purpose of ‘sftng strategic asset allocation. Hi (8) Whst approaches can the fund take to invest in property? What are the pros an cans of| each? [3] (What issues does the fund need to consider when formulating its liquidity policy? ‘Question 2 ison the following page[16] Question? Answer this question in booklet 2 oy By ey } Ry ro) © © @ © Explain the diference between “value equi’ Investing’ and ‘growth eauity investing’ Which quantiatve financial metrics and ratios are emphasized by a value investor ‘(Remember to answer in a new booklet) ‘na presentation toa superannuation Trustee Board, an equity investment manager claims to have a “GARD syle. The trustees do not understand what this means, Explain this to them in plain English. How would an ‘absolute return’ investment manager manage investment rik Jfferenily toa “relatve return investment manager? ‘What circumstances would incline an institutional investor 19 engage an investment ‘manager via performance fee arrangement? What aspects of such an arrargemeat would ‘he investor require sous to avoid some ofthe problems associated with perfomance based fees? What is shor selling? What benefits does short selling bring? What adltonal risks does shor selling involve? (rnold and Kaba’s Fundamental Law Active Mangement can be wen FO) texte. Define each term in this nw. Use it to contrast a top-down’ investment approach from a “bottom up investment approach Question 3 is om the fallowing page[1S] Question 3 Answer this question in booklet3 ‘You have been asked 10 explain the notion of option pricing to an actuarial student that has not yet studied any option pricing theory. As part of tha process you produce the following spreadsheet: linput parameters free pce sree ia, x Binomial option pricing lattices = i ae3] 0 if 1 3 iRi a oy ia ry uy m BI @ © © @ © 0 ow 0) 0 ‘Deseribe in words the concepts used when pricing an option using the binomial model. Only ciscuss this for & Futopean option over a stock that pays no dividends. (Remember t0 answer in anew booklet) Briely describe, in words, the mechanics used in the binomial option pricing model. You may refer o values or cell labels from the above spreadsheet in your answer. In this par of the question you are NOT required to calculse any numerical values but instead shoul! give an indication ofthe sequence of calculations, ow isthe value $3,006 in cell E83 ealulted? You only ned to demonstrate this using rurbers that are show inthe above output. Using the above model, demonstrate what portfolio of stock and borrowing would replicate holding an option inthe first sime step. You only need to demonstat this using numbers shown in the above output ‘The resus fr the Black-Scholes model arealso shown in the above output, Why are they lerent from the rest obtained using the nomial model? ‘What would you have fo do to make the biromial model results much closer to the Black= Scholes result What happens to the price ofa Buropean put option if you make a small change to () the term 0 expiry (i) the rake rate and (i the volatility? In each case provide a sentence explaining your reasoning. Assume only one variable atime is changed ‘What isthe most dificult parameter to estimate in option pricing? ‘What assumption in the sandard Black-Scholes option pricing in option is overa 7x0 coupon bond? Desribe bref in words when the Lis five of the main "Greeks used to meanite different risks in option pricing. What do these metres measure? Use words, not mathematica definitions ‘Question 4 ison the following page[21] Question4 Answer this question in booklet 4 ‘A small pacific island (population 900,000) has requested your asistance in sting up a sovereign ‘wealth fund, The island has discovered a material ol reserve, butte nature ofthe reserve is such tha it Will be primarily depleted in 10 years. The Government will receive the net proceeds from seling the oi and will use them to improve existing infastructure on te island But the Government also wishes to ‘pu aside an expected $A8 billion received over the next S years ito a sovereign wealth find s that his ‘his once-only windfall wll benefit all future generations. “The Government has asked you to prepare a scoping report to help it understané what types of decisions it will need to take as t creates the sovereign wealth fund. Inthe words ofthe President: *We dont ‘know what we don’t know. Your report should set out the roadmap. We are not looking for specific recommendations, but we do need 19 get a clear sense of what we need todo, and what issues We are Tike to have to deal with” ‘Create a skeleton structure fr your report. For each section, st cut in bullet points the Key issues you Wl ned to deserbe in your report. (Remember to answer ina new booklet) Question § ion he following page[22] Question $ Answer this question in booklet 5 A listed life insurance company has legacy book of traditional insurance policies (whole of life and endowments) that receive bonuses that have some degree of guarantee. You are the actuiry forthe ‘company and have determined that policy holder expectations and company balance sheet risk is best ‘managed by matching asset ish ‘The current date is 31 December 2013, ‘You have estimated the policy cath flow payments tobe: Date of cash fow Cash flow (nominal) Sm 3isiza0is 2 3ut2R021 Ise S1i2n038 7 (ls seal fife, this schedule would include cash lows every year (probably more often) extending for several decades) ‘Suppose that there are only three avaible bonds with suficint liquidity and credit risk, Moreover, each ofthese three is a zero coupon bond Bond Bond maturity Face value outstanding Gm) A 3r2a014 450 B 31/12a018 350 c 3112205 200 (Once again, this is highly unrealistic; in real life there is a wide range of suitable bonds, and they wl ‘ypically poy a coupon.) ‘Te yield cuve is flat forall maturities at 4% per annum. (Anothes unrealistic assumption.) ‘The company’s investment department does ot have the skill o provide & matching solution, 0 you have decided to select an external investment manager for his purpose. [1] (a) Explnin the concept of modified duration in words. (Remember to answer in = new booklet) Det [2] (b) Use ealedus to demonstrate tht modified duration can be ealeulated using HI P(l+y) Deine the symbols used inthis formula.By io} Ry BI 2 ny u a a ey © © © 0 ® O) 0 Just by inspecting the values from the table above, guestimate the modified duration ofthe ilies with a Brief explanation for your reasoning, Then caculate it, rounding your answer to 2 decimal places. Use your modified duration from par () to estimate the value ofthe lables if he yield were to fal 0 3.9%, What is duration-matching immunization for a porfoio of portfolio of assets ofthe same value? (Le. zero surplus or deficit) ities that is backed by @ ‘What skills would you lok for in anastet manager to manage thisportfolio? Js a bond index based on value outstanding a suitable benchmark to use as an investment ‘jective for the asset manager? If no, explain how you would construct » suitable ‘benchmark. You do not need to perfor any calculations, but you should give an indication ‘of how you think the eastom index would vary ffom an index base on value oustanding What other investment marters would you specify in the mandate (je. the investment ‘management agreement and guidelines) provided othe manager? Explain the concept of convexity in words. You may refer to coneps ftom callus if you wish, ‘The convexity of the libiies is 794 and the convexity of duration matched bond pomtolio is 82.3. For modest changes in interest rates, would you expt profit oF loss to merge? Why? ‘What are the key assumptions that you wil have made when estinating liability cashflows ‘that may make the matching tatepy ineffective? ‘Over the next 12 months bond yields fall fom 496 0 2%. Suggest circumstances that may ‘have caused this change ‘After the fll n bond ies given in part () your CEO says to yeu: “Interest rates are 2ero- bound. The tsk ison that they will go up- Our bond portfolio is very long-dated. We are mad to contin tobe 90 exposed to interes ates and analysts ar+ downgrading our sock.” Do you agre with the CEO? Ifo, write a paragraph that explains wy and how the sategy willbe changed. Ifnot wit a paragraph that canbe used by the CEO to convince analysts, ofthe strategy that sin place END OF EXAM