FUNDAMENTALS OF FINANCE AND BANKING

SECTION A – COMPULSORY
QUESTION 1
A company is considering the following investment projects:
CASH FLOWS (Rs)
Projects C0 C1 C2 C3
A -10 000 10 000
B -10 000 7 500 7 500
C -10 000 2 000 4 000 12 000
D -10 000 10 000 3 000 3 000

(A) Rank the projects according to each of the following methods:

(1) Payback
(4 Marks)
(2) ARR
(4 Marks)
(3) NPV, assuming discount rates of 10% and 25%
(8 Marks)
(4) Profitability Index
(4 Marks)
(5) IRR
(6 Marks)

(B) Assuming the projects are independent, which one should be accepted?
(2 Marks)
(C) Assuming the projects are mutually exclusive, which one should be accepted?
(2 Marks)

QUESTION 2
(A) Your father has promised to give you Rs 1m in cash on your 25th birthday. Today is your
16th birthday. He wants to know three things:
(1) If he decides to make annual payments into a fund after one year, how much will each
have to be if the fund pays 8%? (3 Marks)
(2) If he decides to invest in a lump sum in the account after one year and let it compound
annually, how much will the lump sum be? (3 Marks)
(3) If in (1) the payments are made in the beginning of the year, how much will be the value
of the annuity? (3 Marks)

(B) You have finally saved Rs 10 000 and are ready to make your first investment. You have
the three following alternatives for investing that money:
(i) ABC bonds, with a par value of Rs 1000, that pays an 8.75% interest on its par
value in interest, sells for Rs 1 314 and matures in 12 years.
(ii) XYZ preferred stock paying a dividend of Rs 2.50 and selling for Rs 25.50.
(iii) RST common stock selling for Rs 36.75, with a par value of Rs 5. The stock
recently paid a Rs 1.32 dividend and the firm’s earnings per share has increased from Rs 1.49 to
Rs 3.06 in the past five years. The firm expects to grow at the same rate in the foreseeable future.
Your required rate of returns for these investments are 6% for the bond; 7% for the preferred
stock, and 15% for the common stock. Using this information, answer the following questions:
(1) Calculate the value of each investment based on your required rate of return.
(5 Marks)
(2) Which investment would you select? Why?
(2 marks)
(3) Assume RST’s managers expect an earnings downturn and a resulting decrease in growth
rate of 3%. How does this affect your answer to part (1) and (2)?

(4 Marks)
QUESTION 3
You are provided with the following information about the return of two major fast food
suppliers:

Probability Security MacDo Security KFC

0.1 40 40
0.2 20 30
0.4 0 15
0.2 -5 0
0.1 -10 -20

Calculate the risk and return of a portfolio consisting of 45% in MacDo and the rest in KFC’s
securities. (10 Marks)
SECTION B – ANSWER ANY 2 QUESTIONS
QUESTION 4
Central banks have flooded the financial system with cash, driving investors to park their
money in higher-yielding securities and largely obfuscating the true state of underlying
markets.
1. Why do all advanced economies have a Central Bank?
(10 Marks)
2. Write short notes on each of the following:
a. Reserve Requirements.
b. Cash Ratio.
c. Discount Rate.
d. Open Market Operation.
e. Prudential Standard of Liquidity.
(5 *2 Marks)

QUESTION 5

1. Compare and Contrast international banking with multinational banking.

(8 Marks)
2. What are the costs and benefits of establishing international banking for a host country?
(12 Marks)

QUESTION 6

1. Suppose that Medicinal Co announces a new allergy drug that could completely prevent
hay-fever. How should the share price of Medicinal Co react to this news?

(5 Marks)
2. Explain of each of the three forms of market efficiency may be tested.
(7 Marks)
3. Comment on the main anomalies that may occur in an efficient market.
(8 Marks)