SEAT NUMBER: ……….… ROOM:..……………….

FAMILY NAME:………….....………………………….
This question paper must be returned.
OTHER NAMES:……..…….…………………..……..
Candidates are not permitted to remove any part
of it from the examination room.
STUDENT NUMBER:…..…….………..……………..

FORMAL EXAMINATION PERIOD: SESSION 2, NOVEMBER 2018

Unit Code: AFIN 250

Unit Name: Investments

Duration of Exam Two and a half hours plus 10 minutes reading time
(including reading time if applicable):

Total No. of Questions: 29 (12 true-false questions, 12 multiple choice questions, and 5 longer questions)

Total No. of Pages 15

(including this cover sheet):

GENERAL INSTRUCTIONS TO STUDENTS:

• Students are required to follow directions given by the Final Examination Supervisor and must refrain from communicating in any way with another student once they have entered
the final examination venue.
• Students may not write or mark the exam materials in any way during reading time.
• Students may only access authorised materials during this examination. A list of authorised material is available on this cover sheet.
• All watches must be removed and placed at the top of the exam desk and must remain there for the duration of the exam. All alarms, notifications and alerts must be switched off.
• Students are not permitted to leave the exam room during the first hour (excluding reading time) and during the last 15 minutes of the examination.
• If it is alleged you have breached these rules at any time during the examination, the matter may be reported to a University Discipline Committee for determination.

EXAMINATION INSTRUCTIONS:
1. There are three parts to this examination:
Part A: Twelve (12) true-false questions, each worth one (1) mark.
Part B: Twelve (12) multiple choice questions, each worth one (1) mark.
Part C: Five (5) longer questions worth a total of thirty-six (36) marks.
2. Attempt all questions. The marks for each question are listed in the table below:

Part Question Marks

A 12 questions /12
B 12 questions /12
C 1 /6
2 /10
3 /10
4 /4
5 /6
Total marks /60

3. Do not use a separate exam booklet for your answers. Write your answers neatly in the space provided on
the examination paper (except Part B - use m/c answer sheet). Illegible answers will receive zero marks.

AIDS AND MATERIALS PERMITTED/NOT PERMITTED:

Dictionaries: No dictionaries permitted

Calculators: Non-programmable calculators that do not have text retrieval capacity permitted
Other: Closed book with specified material permitted: Students are permitted to bring into the
examination room, 1 x A4 page of double-sided, handwritten or typed notes only. Notes
are to be collected with the exam paper at the end of the exam.
 Final Exam Session 2, 2018
AFIN250_Investment (Total Marks: 60)

Part A True or false questions (12 marks)

Circle ‘T’ (True) or ‘F’ (False) for each of the following questions to indicate your answer

1. T F
Consider a three-year bond with a face value of $100 and an annual coupon of $11. If its yield-
to-maturity is 12%, the bond is traded at a discount.

2. T F
Consider a 5-year bond with a 10% coupon that has a present yield to maturity of 8%. If the
interest rates remain constant, one year from now the price of this bond will be the same.

3. T F
Short-selling is equivalent to borrowing money from the bank.

4. T F
A 1% change in yield will have more influence on a 10-year 10% $1,000 government bond
than a 2-year 10% $1,000 government bond.

5T F
The slope of the security market line is beta.

6. T F
A higher dividend payout will decrease the value of a call option and increase the value of a
put option.

7. T F
During the contraction period of a business cycle, defensive industries should be preferred
under the notion of sector rotation.

8. T F
The index fund manager tracking her portfolio with an equally weighted index cannot adopt
a buy-and-hold strategy.

9. T F
Everything else equal, an increase in the government budget deficit would, increase the
government's demand for funds, shift the demand curve for funds to the right and Increase
the interest rate in the economy.

10. T F
To hedge against the risk of uncertain buying price, investors could construct a short hedge
using futures contract.

2.
11. T F
A firm has an ROE of 3%, a debt/equity ratio of 0.5, a tax rate of 35%, and pays an interest
rate of 6% on its debt. Its operating ROA equals to 5%.

12. T F
Under the liquidity preference theory, if the yield curve is downward-sloping, the market might
not expect a decrease in short-term interest rates.

Part B: Multiple Choice Questions (12 marks)

13. An investor invests 30% of her wealth in a risky asset with an expected rate of return of
0.15 and a variance of 0.04 and 70% in a T-bill that pays 6%. Her portfolio's expected return
and standard deviation are __________ and __________, respectively

A. 0.114; 0.12
B. 0.087; 0.06
C. 0.295; 0.06
D. 0.087; 0.12
E. None of the options

14. Which one of the following portfolios definitely cannot lie on the efficient frontier?

Portfolio Expected return Standard deviation

Q 9.0% 21.0%
X 5.0% 7.0%
W 15.0% 36.0%
Z 10.0% 18.0%

A. Only portfolio Q cannot lie on the efficient frontier.

B. Only portfolio X cannot lie on the efficient frontier.
C. Only portfolio W cannot lie on the efficient frontier.
D. Only portfolio Z cannot lie on the efficient frontier.
E. Cannot tell from the information given.

3.
15. Which of the following is true about the Fama-French High-Minus-Low portfolio, HML?

A. The portfolio is that of a strategy that attempts to buy stocks at high prices and
sell them at low prices.
B. The portfolio is that of a strategy that attempts to buy stocks with high market cap
and sell stocks with low market cap.
C. The portfolio is that of a strategy that attempts to buy stocks with high past
returns and sell stocks with low past returns.
D. More than one of the above statements is true.
E. None of the above statements is true.

16. Mature Products Corporation produces goods that are very mature in their product life
cycles. Mature Products Corporation is expected to pay a dividend in year 1 of $2.00, a
dividend of $1.50 in year 2, and a dividend of $1.00 in year 3. After year 3, dividends are
expected to decline at a rate of 1% per year. An appropriate cost of equity for the stock is
10%. The price of the stock should be closest to

A. $9.00.
B. $10.57.
C. $15.00.
D. $22.22.
E. $23.00.

17. Which of the following would best explain a situation where the ratio of net income/total
equity of a firm is higher than the industry average, while the ratio of net income/total
assets is lower than the industry average?

A. The firm's net profit margin is higher than the industry average.
B. The firm's asset turnover is higher than the industry average.
C. The firm's equity multiplier must be lower than the industry average.
D. The firm's debt ratio is higher than the industry average.
E. None of the options

18. Consider the free cash flow approach to stock valuation. Utica Manufacturing Company is
expected to have before-tax cash flow from operations of $500,000 in the coming year.
The firm's corporate tax rate is 30%. It is expected that $200,000 of operating cash flow
will be invested in new fixed assets. Depreciation for the year will be $100,000. After the
coming year, cash flows are expected to grow at 6% per year. The appropriate market
capitalization rate for unleveraged cash flow is 15% per year. The firm has no outstanding
debt. The projected free cash flow of Utica Manufacturing Company for the coming year is

A. $150,000.
B. $180,000.
C. $300,000.
D. $380,000.
E. $420,000.

4.
19. The life cycle stage in which industry leaders are likely to emerge is the

A. start-up stage.
B. maturity stage.
C. consolidation stage.
D. relative decline stage.
E. None of above

20. Which one of the followings will likely to increase the value of a put option?

A. An increase in volatility
B. A decrease in time to maturity
C. An increase in the stock price
D. A decrease in the strike price
E. A decrease in dividend

21．Which of the followings is the most likely answer?

Mr. Hamish paid a premium of $5 to buy a put on a stock that is currently valued at $60. The
put strike price is $55. The maximum profit (including the premium) is _________
A. $0
B. $50
C. $55
D. $60
E. $65

22. Which of the followings is the most likely answer?

On the maturity of the European call option, its value must equal to _______

A. The larger of the strike price minus the stock price or zero
B. The stock price minus the strike price
C. The larger of zero, or the stock price minus the strike price
D. The strike price minus the stock price
E. None of above

23. Ms. Doanne shorts a futures contract today. Which of the following is (the) most
likely to be true?

A. She will get dividends on the underlying asset.

B. She agrees to sell the asset at a fixed price at a future date.
C. She receives a premium today for shorting the futures.
D. She will pay dividends on the underlying asset.
E. None of the above.

5.
24. Music Doctors has a beta of 2.25. The market return yesterday was 12%, and
the risk-free rate is currently 4%. You observe that Music Doctors had a return
yesterday of 15%. Assuming that markets are efficient, this suggests that

A. bad news about Music Doctors was announced yesterday.

B. good news about Music Doctors was announced yesterday.
C. no news about Music Doctors was announced yesterday.
D. interest rates rose yesterday.
E. interest rates fell yesterday.

Part C Longer Questions (36 marks)

1. CAPM (6 marks)

Assume that the risk-free rate of interest is 6% and the expected rate of return on the
market is 16%.

(a) A share of stock sells for $50 today. It will pay a dividend of $6 per share at the
end of the year. If beta is 1.2. What (price) do investors expect the stock to sell for at
the end of the year if the investor believes the CAPM model holds?
(3 marks)

(b) An investor is buying a fully equity financed firm with an expected perpetual cash
flow of $1,000 but is unsure of its risk. If the investor thinks the beta of the firm is 0.5,
when the true beta is 1, how much more will the investor offer for the firm than its true
value? (3 marks)

6.
2. Interest rate risk management (10 marks)

A newly issued bond has a maturity of 4 years and pays a 7% coupon rate p.a. (with
coupon payments coming once annually). The bond sells at par value with a face value
of $1,000.

(a) What is the duration of the bond? (4 marks)

7.
(b) Find the actual price of the bond assuming that its yield to maturity
immediately increases from 7% to 8% (with maturity still 4 years). (2 marks)

(c) What price would be predicted by the modified duration rule? (2 marks)

(d) Pls explain why the price predicted in (c) does not equal to the actual price in (b). (2
marks)

8.
3. Option Pricing and Option Strategy (10 marks)

a) What is the price of a European call option according to the Black-Sholes formula
on a non-dividend-paying stock when the stock price is $45, the strike price is $50,
the risk-free interest rate is 12% per annum, the volatility is 25% per annum, and the
time to maturity is six months? Show your work in details. (4 marks)

9.
b) You are attempting to formulate an investment strategy. On the one hand, you think
there is great upward potential in the stock market and would like to participate in the
upward move if it materialises. However, you are not able to afford substantial stock
market losses. Your investment advisor suggests a protective put position: Buy shares
in a market index stock fund and buy put options on those shares with three months
until expiration and exercise price of $400. (6 marks)

The market prices of the securities are as follows:

Stock fund $450
T-bill (face value $420) $405
Call (exercise price $420) $60
Put (exercise price $400) $4

Pls fill in this table below: (ST stands for the price of Stock Fund at maturity, and the
payoff can be a function of ST)

𝑆𝑆𝑇𝑇 < 400 400 ≤ 𝑆𝑆𝑇𝑇 ≤ 420 𝑆𝑆𝑇𝑇 > 420

Stock Fund
Put
Payoff
Profit

4． Equity Valuation (4 marks)

The MoMi Corporation's cash flow from operations before interest and taxes was $2
million in the year just ended, and it expects that this will grow by 5% per year forever.
To make this happen, the firm will have to invest an amount equal to 20% of pretax
cash flow each year. The tax rate is 35%. Depreciation was $200,000 in the year just
ended and is expected to grow at the same rate as the operating cash flow. The
appropriate market capitalization rate for the unleveraged cash flow is 12% per year,
and the firm currently has debt of $5 million outstanding. Use the free cash flow
approach to value the firm's equity.

10.
5． Futures Contracts (6 marks)
The current spot price of gold is $1200 per ounce. The riskless interest rate is 1%
per month. For simplicity, assume there are no storage/security costs of gold.

a) If you need to buy the gold in 8 months’ time, which position (long or short) will
you take in the futures market to hedge the price risk of the gold? (1 mark)

b) What is the arbitrage-free futures price for the delivery of gold in 8 months’ time?
(2 marks)

11.
c) If you see an 8-month futures price of gold quoted at $1240 per ounce, explain how
you would capture an arbitrage profit. Show your work in detail by clearly outlining the
actions, initial cash flow and cash flow at maturity (T). (3 marks)

12.
13.
Rough work space only
Do not write your answers on this page.

14.
Rough work space only
Do not write your answers on this page.

15.