00128 Nor-Alpha Only UNIVERSITYOF BIRMINGHAM BIRMINGHAM BusINEss SCHOOL M.Sc. Investments FUND MANAGEMENT ‘Banner Cove: 07 02888 00128 SUIMER EXAMINATION 2012 3 HouRS Auswer 3 auesions ATLEAST ONE Question enc sEcTION ALL Quesnions Cay EQUAL MARK (CALCULATORS MAY BE USED IN THIS EXAMINATION PROVIDED THEY ARE NOT CAPABLE OF ‘BEING USED TO STORE ALPHABETICAL INFORMATION OTHER THAN HEXADECIAAL NUMBERS 07 02868 1 Tum overn00128 ‘Non-Alpha Only SECTIONA 1 0%) 1, “An overly doctrinalre belie in ficient markets can paralyze the investor and make it appear that no research effort can be justified, This extreme view is probably unwarranted, There are ‘enough anomalies in empirical research to ust the search for nderprced secures that clearly goes on” (page 401, “investments and Porttolo Management Bodie, Kane and Marcus, &" Global Editon, MeGraw-Hil, 2011) i, What is market efficiency? What are its implications fr (1) individual investors, and (2) institutional investors? (25 mares} li Choose two anomalies and explain how they can be used to ‘earn a return in excess ofa aif return forthe risk taken, [80m », “The notion of informationally efficient markets leads toa powerful esearch methodology. If secury prices reflect currently available information, then prices changes must refiect ‘ew information, Therefor, it seems that one should be able to ‘measure the importance of an event of interest by examining price changes during the period in which the event occurs.” ‘investments and Portfolio Management’ Botie, Kar Marcus, 8 Editon, J Wiley, 2011) and Use an earings per share announcement as ‘an event of interest, and explain in detall how you might employ the ‘powerful research methodology’ referred to above, to examine ‘whether or not such an announcement discloses new information to the stock market vests} 07 02868 2 Tum over00128 Non-Aipha Only 2 3% %) 1. Discuss the approaches that might be taken to evaluating the performance of a potfllo. Comment on their strengths and weaknesses. (85 mans] », Style analysis provides an alternative to performance evaluation based on the security market ine (SML) of the CAPM, Explain syle analysis and its uses in understanding and evaluating fund management. [ss mans) 3 (934%) ‘2, “Mean-vatiance optimization (MVO), although formulated inthe carly 1950's, was not Immediately applied and sill not applied in practice for various reasons.” \Whatis simple mean variance optimisation and why isnot applied in practice? (40 mar ». “Inseallife, however, optimization using a given data sets the least of the managers problems. The realissve that faces any potfolo manager is how to come up with the input dat Black and Litterman propose an approach that overcomes some ofthe problems experienced witha simple mean-variance optimization Discuss the key features ofthe Black and Lerman approach, ag mas) ‘ Compare and contrast active and passive investment ‘management (somans} a Tum overaoot28 Non-Aipha Only ‘SECTION 4 634%) ‘2. Explain, wth calculations, how you would fully hedge, over the next three months, a £5 rillon, diversified portfolio of large UK company stocks using FTSE 100 stock index futures contracts “The FTSE 100 index stands at 5800. The dividend yield on the indexis 3% and the three month’ isk fee rate is 2% (all rates are annualised). (Each index point movernent is worth £10). ‘The beta ofthe portoio is 1.1 ‘Assume at the end of the three months when the hedge expires the FTSE 100 index is 5220. (45 mars] », Discuss the assumptions underlying your analysis, Explain the performance ofthe hedged portolo, [Ho mens} ©. Suppose you manage a $1.5m portfolio which you believe has @ posite alpha (a) and thatthe market is about to fall, Over the ‘next month the return on your portfolio, Rp can be described by the folowing equation: kp=Rr+6(Rm-R)+a+T ‘The residual risks defined by e. Assume B= 1.25, a= 0.025, Rt (03 (annualised one month). “The S&P index is 1260 and for simplicity you may assume no ividends are paid during the month, The index value can be sed to find numberof futures contracts required to fully hedge your portfolio, Calculate the hedged value of your portfolio. [35 mars) <. What leks are there inthe above stratepy, used in partic)? {10 mats) 4 Tum over490128 Non-Aipha Only 5. (294%) ‘8. Set up an immunised bond portfolio using the bond information siven below so as to meet the folowing abilities: £6m, £7m, 26m and £8m at times 2, 3,4 and 5 years from now respectively “The current yield curve can be assumed to be flat at an interest rate of § percent, Bond A matures in one year and pays interest ofS percent annually. Bond B pays interest of 6 percent annually ‘and matures In sb year’s time, The market price of bond B is 405.08 and its duration fs 8.284, Comment on any reservations you might have about the immunisation approach you have used. [45 marks) '. Suppose the market rate of interest rises to 7 percent Immediately afer the fst ably payment has been made. (the duration ofthe original 6 year bond will now have four years to ‘maturity, a market value of £96.6tand a duration of 3.67 years).Does the bond portfolio stil meet Redington’s conctions? [80 maka} «6. Discuss the concepts of duration and convexity and their application to fixed income fund management. [25 macs] 5 Tum over00128 Non-Aipha Only 6 (334%) ‘a, Kate Smith, a UK fund manager, has £5 milion which she plans to invest in US equities. The curent spot market bid ~ ask ‘exchange rates are §1.60/8 and $1.61/£ respectively. Atthe end ofthe year Kate wil sll ihe US stocks for an expected $9.5, milion and retum the money o the UK, Assume that atthe end ofthe year the spot marke bid - ask exchange rates of $1.54 and §1.58/E respectively. \What wll be the total return on her US investment? Also provide ‘a breakdown of her ftal return in terms of a currency return and US stock market return (s0mans) », Suppose during the year Kate i concemed thatthe US dolar right depreciate as a result of market concems thatthe US market may not recover as quicly as a result of the lack of resolution of the euro zone crisis. Her boss suggests she should partially hedge her exposure to US dollars by entering into a forward contract to exchange atthe end ofthe year $8 millon at fan exchange rate of $1.61/2, Any remaining US dollars wil be ‘exchanged in the spot market What now would be the retum on her investment and the breakdown of retums in terms of currency and stock market returns f the spot market bid ~ ask exchange rates atthe end of the year are $1.62 and 1.63/¢ respectively? (25 mars) 6 Turn over00128 Non-Alpha Only ‘6. Suppose, instead of using a forward contract o partially hedge her exposure to the US dollar as in (b) above, she buys an over- the-counter, Eurepean style currency option to exchange the $8 milion dolars at an exercise price of $1.61. The option premiums quoted by the bank she deals with are, fora call option |s 2 percent and for a put option is 3 percent ofthe $8 milion ‘Assume atthe tme she purchased the option, the exchange rate wae $1.81 (ignore bid — ask spreac). Any remaining US dollars willbe exchanged inthe spot market. |Which currency option should she purchase ané whet would be ‘the amount of sterling she expecs to receve atthe end ofthe year f the spot exchange rates are as given in (b) above? What 's the breakdown of her returns in terms of market and currency? ‘You may ignore the time value of money. (25 mars) 4, Suppose Kate manages a potflio of UK equities and European ‘equtes in adsition to her US investment. Discuss the potential dversiiation benefits she might obtain under both normal and crisis market conditions, roma} 7 Tum over00128 NonAipha Only 7 (334%) ‘a. Chiitine, @ hedge fund manager, has undertaken an equity neutral strategy involving two stocks from the same industry, ‘hich wil be unwound atthe end of three months. Stock Ais ‘currently trading at £10 per share which she estimates to have @ {air value of £11, A dividend of 0.075 per share is expected shortly, Stock B is current trading at £15 per share and is ‘estimated to have a fir value of £14. A dividend of £0.15 per share is expected. She sells 5000 shares of stock B and uses the proceeds to buy stock A both at ther current market prices. ‘Asgume the manager has the funds to meet a 40% margin at an Interest rate of 5% thal required on the sale. Assume at the ‘end ofthe three months both stocks are trading atthe fair values ‘he estimate. ‘What isthe return to her strategy if she incurs transaction costs of £1007 Ho mers} , Discuss the rsks associated withthe above strategy. 15 mars] ©. Explain how each ofthe following hedge fund strategies are implemented and how thir risks might be managed 1. Distressed secures IL. Fixed income arbitrage i. Converile arbitrage (esas) 07 14385 8 End of exam