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scholarvini
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SAPM FINAL EXAM QUESTION PAPER, SEM 2, 2016

(TOTAL MARKS = 100; MAXIMUM TIME 3 HOURS)

SECTION ONE:

EACH QUESTION CARRIES 2 MARKS (12 * 2 = 24 MARKS)

(1) Growth rates of (1) labor force, (2) average number of hours worked, and (3) labor
productivity are the main determinants of a foreign country’s
a. Dividend payout ratio
b. Beta
c. Real risk free rate
d. Nominal risk free rate
e. Risk Premium

(2) Which of the following statements about business cycle is false?


a. Toward the end of a recession, financial stocks typically increase in value as
investment and borrowing activities accelerate.
b. Once the economy hits a trough and begins to recover, consumer durable stocks
become attractive investments
c. Once the economy has recovered and current levels of consumption are sustainable,
business may consider modernizing or expanding, thus stocks of capital goods
industries become attractive investments
d. As the business cycle reaches peak, inflation rate decrease
e. None of the above
(3) Once it becomes clear that the economy is recovering
a. Financial stocks rise on expectations of increase in loan demand, housing
constructions and security offerings
b. Consumer durable stocks rise on expectations of rising consumer confidence and
personal income
c. Capital goods stocks rise on expectation of increase in business capital spending
d. Basic material stocks rise on expectation of rising profit margins
e. Consumer staple stocks rise on expectations that consumers will continue to spend on
necessities
(4) A fundamental tenet of the contrarian investment strategy is the notion that
a. All stock returns are mean reverting
b. Certain stocks outperform others during different stages of the business cycle
c. Value stock investing is superior to growth stock investing
d. Market participants in general are wrong
e. None
(5) If you expect interest rates to rise, you would prefer to own bonds with
a. Short maturities and low coupons
b. Long maturities and high coupons
c. Long maturities and low coupons
d. Short maturities and high coupons
e. None of the above
(6) The active strategies for bond management include all of the following except
a. Interest rate anticipation
b. Credit analysis
c. Bond swaps
d. Immunization
e. Spread analysis
(7) Consider two bonds, both pay annual interest. Bond C has a coupon of 6%, maturity of 5
years, YTM of 6%, and face value of Rs. 1000. Bond D has coupon of 8% per year,
maturity of 15 years, YTM of 6%, and face value of Rs. 1000

Now assume that your investment horizon is 6 years ans your portfolio consists only of Bond C
and Bond D. Indicate the proportions invested in each bond, so that the portfolio is immunized.

a. 50% in Bond C and 50% in Bond D


b. 64% in Bond C and 36% in Bond D
c. 36% in Bond C and 64% in Bond D
d. 100%in Bond D
e. None of the above

(8) The main tradeoff between forward and future contracts is


a. Design flexibility
b. Credit risk
c. Liquidity risk
d. All the above
(9) A risk less stock index arbitrage profit is possible if the following condition holds
a. Fo,T = So (1 + Rf –D)T
b. Fo,T > So (1 + Rf –D)T
c. Fo,T < So (1 + Rf –D)T
d. A and b only
e. B and c only
(10) Assume that you manage a Rs. 50 crore equity portfolio. The portfolio beta is
0.85. You anticipate a cash inflow of Rs. 5 crore into the portfolio. Calculate the number
of contracts you would need to hedge your position and indicate whether you would go
short or long. Assume that the price of the S&P NIFTY futures contract is 1062 and the
multiplier is 250.
a. 25 contracts short
b. 18 contracts short
c. 16 contracts long
d. 19 contracts short
e. None of the above
(11) If you were to purchase an October option with an exercise price of 50 for Rs.8
and simultaneously sell and October Option with an exercise price of Rs. 60 for Rs.12,
you would be
a. Bullish and taking a high risk
b. Bullish and conservative
c. Bearish and taking a high risk
d. Bearish and conservative
e. Neutral

(12) Aggregate Return of Equity (ROE) increases as


a. Profit margin increase
b. Total asset turnover increases
c. Financial leverage increases
d. Equity turnover decreases
e. All of the above

SECTION TWO

ANSWER ALL QUESTIONS

QUESTION ONE

2.1 (10+10 = 20 MARKS)


a. Consider a stock that is worth Rs.50. A put and call on this stock have an exercise price of Rs. 50
and expire in one year. The call costs Rs. 5 and the put costs Rs. 4. A risk-free bond will pay
Rs.50 in one year and costs Rs.45. How will you respond to these prices? State your transactions
exactly. What principle do these prices violate? (10 MARKS)
b. A protective put position is created by combining a long stock position with a long position in a
put option written on the stock (S+P). Construct the equivalent position using call options,
assuming all the options are European. Show your working with an example. (10 MARKS)

QUESTION TWO

2.2 (4+4+6+2 =16 MARKS)

You have been asked to value Hotel Leela using two-stage dividend discount model (DDM) and
the Capital Asset Pricing Model (CAPM). Using DDM and CAPM you value Hotel Leela at
Rs.63 per share. Now you have been asked to value India Hotels.

a. Calculate the required rate of return for India Hotel using the following information

(4 MARKS):

Hotel Leela India hotels

Beta 1.35 1.15

Market Price Rs.45.00 Rs.30.00

Intrinsic value Rs.63.00 ?

Risk Free Rate 4.5%

Expected market return 14.50%

b. You are provided with the following EPS and dividend growth rates for India Hotels:

First three years 12% per year

Years thereafter 9% per year

Estimate the intrinsic value of India Hotels using the table above, and the two-stage DDM.
Dividends per share were Rs. 1.72 (4 MARKS)

c. Recommend which of the two stocks to purchase by comparing each company’s intrinsic
value with the market price. (6 MARKS)
d. Describe one strength of the two-stage DDM in comparison with constant growth DDM.
Describe one weakness inherent in all DDMs. (2 MARKS)
t n
n D0 1  g S  D0 1  g S  1  g L 
V0  t

t 1 1  r  1  r n r  gL 

QUESTION THREE

For each of the following five parts, answer True, False or Uncertain (2 MARKS EACH; 2*5 =
10 MARKS).

Include a brief justification for each of your responses (2 MARKS EACH).

(a) Marking-to-market protects the futures exchange from default risk by investors.

(b) Risk neutral valuation used in derivative pricing implies investors are assumed to be risk-
neutral, hence the flaw in this approach

(c) By definition, a futures contract is an agreement to buy/sell an asset at a predetermined price


at a specified future date. Using futures, investors can fix the buying/selling price, and
therefore are exposed to no risk at all.

(d) A stock is trading at Rs.50. Assuming the continuously compounded risk free rate is 6%pa,
and no dividend expected over the next 3 months. If a 3-month European call written on the
stock with strike price X=Rs.52 is selling for Rs.2.50, the corresponding put must be selling
at 3.52

(e) Whilst financial derivatives are essentially risk management products, trading them can be
very risky.

QUESTION FOUR

Solve this Problem: (10 + 5+5+5+5 = 30 MARKS)

What is the duration of a five-year, $1,000 Treasury bond with a 10 percent semiannual coupon
selling at par? (Selling with a YTM of 12 percent? (10+ 5 MARKS) 14 percent (5 MARKS)?
What can you conclude about the relationship between duration and yield to maturity? (3
MARKS) Plot the relationship. (3 MARKS) Why does this relationship exist? (4 MARKS)

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