GHANA INSTITUTE OF MANAGEMENT AND PUBLIC ADMINISTRATION

(GIMPA)

SCHOOL OF LIBERAL ARTS AND SOCIAL SCIENCES

DEPARTMENT OF ECONOMICS

2021/2022 END OF SECOND TRIMESTER EXAMINATION

TITLE OF PAPER: ECO743B INVESTMENT THEORY AND PRACTICE

ECO721B FINANCIAL ECONOMICS II

LEVEL: MSC / MPHIL

DATE: 18TH JUNE, 2022

EXAMINER(S): PROF. S. AGYEI-AMPOMAH

TIME ALLOWED: THREE HOURS

INSTRUCTIONS

Answer any THREE questions.

Each full question carries equal marks

INDEX NUMBER: …..……………………………………….

VENUE: ……………………………………………………….

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QUESTION ONE

The shares of MTN Ghana Ltd (MTN) are currently trading at ₵0.90 per share
on the Ghana Stock Exchange (GSE). Dela is bullish on MTN shares and is
considering buying 50,000 shares of MTN.

Dela has a share dealing account with a broker, and is eligible to trade on
margin. Her broker charges brokerage commissions of 1.2% for purchases and
sales; initial margin deposit of 60% and a maintenance margin of 25%. The
interest rate on margin debt is 4% per annum.

Other costs for trading securities (purchases and sales) on the Ghana Stock
Exchange include: 35 basis points as GSE fees; 15 basis points as Securities
Exchange Commission fees; 15 basis points as Securities Depository fees; and 5
basis points as Market Development fees;

a. Assuming that Dela paid the full cost of the purchase and the MTN paid
dividends of ₵0.15 per share during the year, what is her rate of return if at
the end of the year she sells the shares for:
i. ₵1.20 per share?

ii. ₵0.60 per share?

(20 marks)

b. Now, assume that Dela bought the 50,000 shares on a margin account and
the company paid dividends of ₵0.15 per share during the year. What is her
rate of return if at the end of the year she sells the shares for:
i. ₵1.20 per share?

ii. ₵0.60 per share?

(20 marks)

c. If Dela purchases the 50,000 shares on a margin account, making the initial
margin deposit of 60%, at what share price would she receive a margin call
from the broker?
(10 marks)

d. Ephraim, on the other hand, believes MTN shares are overvalued and short
sells 50,000 shares of MTN shares. Brokerage commissions, other trading

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 costs, and margin requirements on short-sales are the same as above but the
interest on margin debt for short-sales is 6% per annum. While Ephraim is
short, MTN paid dividends of ₵0.15 per share.

What is Ephraim’s rate of return if at the end of one year he buys MTN
shares to cover his short sale at:

i. ₵1.20 per share?

ii. ₵0.60 per share?

(25 marks)

e. Differentiate between “buying a security on a margin” and “selling a security

short”, and briefly discuss the benefits and risks of selling a security short?
(30 marks)

Total: [100 marks]

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Question 2

Part A

Alhaji Tanko, having reached the statutory retirement age, has retired and has
been paid been paid his lump sum benefit of ₵500,000. Alhaji has no immediate
need for the amount received and he is considering investing the amount in
Sarpco ImpEx Ltd, one of the top-performing stocks on the Ghana Stock
Exchange.

The stock under consideration has an expected return of 22% and a volatility of
16%. Suppose the risk-free rate is 10%, and the market portfolio has an expected
return of 16% and a volatility of 10%.

As an expert in finance and investments, Alhaji has come to you for some
advice.

a. Briefly discuss the benefits and challenges of Alhaji’s intention to invest all
the ₵500,000 in the stocks of Sarpco ImpEx Ltd.
(30 marks)

b. Design a portfolio consisting of the risk free rate and the market portfolio
that will yield the same expected return as the investment in the stock of
Sarpco IMPEX Ltd, and show that the risk of the portfolio is lower than
16%.
(20 marks)

c. Design a portfolio consisting of the risk free rate and the market portfolio
that has the same risk as the investment in the stock of Sarpco IMPEX Ltd,
and show that the expected return of the portfolio is higher than the expected
return on investment in the stock of Sarpco IMPEX Ltd.
(20 marks)

[70 marks]

Part B

The new NPRA Investment Guidelines (2021) has expanded the range of
permissible assets that pension funds can be invested to include investment in
external securities, among others.

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As a Fund Manager why would you recommend that the GIMPA Occupational
Pension Scheme adds foreign securities to its portfolio, given that foreign
securities are generally considered to be more risky than domestic securities?
[30 marks]

Total: [100 marks]

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Question 3

Part A

You are the Chief Investment Officer of a major Investment Company with a
large bond portfolio. You are being offered the following CBC Plc callable
bonds that have various issue dates but all three bonds mature in 2025:

Coupon Maturity Price (₵) Call Price Yield to

Bond
Rate (₵) Maturity
Bond A
24.0% 2025 104.2 110.00 22.0%
Bond B
18.0% 2025 91.50 105.00 22.0%
Bond C
15.0% 2025 87.10 105.00 21.0%

You expect interest rates to fall in the next three years. Given your interest rate
outlook, which of these three bonds would you recommend for purchase?
Provide appropriate justification for your selection. No calculations required.

[25 marks]

Part B

The following table provides information relating to two recently issued

corporate bonds by Modern Properties plc and ELK Finance Ltd. Both bonds
were issued at par.

Characteristic Modern Properties ELK Finance

Maturity 2030 2040
Issue size ₵500 million ₵300 million
Coupon 18.0% 20.0%
Callable after 5 years
Call provisions Noncallable
Optional early retirement by
Put provisions None bondholder

Collateral Mortgaged on Assets None

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 Bonds will be listed Bonds will not be listed for
Trading
for trading trading
S&P Bond rating A B

Using the information in the table above, identify and discuss features of these
bonds that might explain the lower coupon on the bond issued by Modern
Properties.

[35 marks]

Part B

Your client is considering one of the two corporate bonds given below. Both
bonds pay semi-annual coupons and are currently trading at the same price of
₵105.

Characteristic Bond XYZ Bond KKM

Market price ₵103.70 ₵96.20
Maturity 2030 2030
Coupon 22% 20%
Yield to maturity 21% 21%
Macaulay Duration 5.2 years 5.4 years
Convexity 125 90

i. Using the information in the table above, estimate the percentage price
change based on the modified duration, and the new price for both bonds
if the yield increases by 50 basis points.

Hint: % Change in Bond Price = - modified duration x change in yield

(15 marks)

ii. Briefly discuss why the actual price changes in the two bonds might
differ from your estimates in (i) above if the yields actually increases by
50 basis points. In each case indicate whether the actual price will be
higher or lower than the estimated price and why and indicate which of

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the two bonds will have the largest deviation from its actual price.
(Credit will be given for graphical illustration of concepts)

(25 marks)

Total: [100 marks]

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Question 4

Part A
John is considering an investment in these two stocks, Stock A and Stock B, and
has come to you for advice whether to buy and/or avoid any of the stocks. Stock
A has a beta of 1.15 and an expected return of 18%. Stock B has a beta of 0.7
and an expected return of 9%. If the risk free rate is 12% and the market return
is 16.5%, what will be your best recommendation to John?
[30 Marks]

Part B

You have recommended a portfolio comprising of 65 percent in a bond index

and 35 percent in a stock index to one of your clients. The bond index has a
return of 15% and a standard deviation of 12% per year and the stock index has
a return of 20% and standard deviation of 16% per year. The correlation
between the bond index and the stock index is 0.37.

What is the expected return and standard deviation of this portfolio?

[30 Marks]

Part C
Most mutual funds charge fees, however research on mutual fund performance
suggests that funds generally do not outperform their benchmarks net of costs.
Briefly discuss why an investor would still want to buy shares of a mutual fund,
given the evidence of no superior performance.
[40 Marks]

Total: [100 marks]