Do not provide irrelevant information, but show all steps that are necessary to solve a problem.

Transcription

1 UNIVERSITY OF EAST ANGLIA Norwich Business School Main Series UG Examination INVESTMENT MANAGEMENT Time allowed: 2 hours Answer FOUR questions Each question you answer is worth 25/100 points. This examination accounts for 50% of your module mark. Do not provide irrelevant information, but show all steps that are necessary to solve a problem. Use four decimal places in all your calculations, except when you are calculating percentages, where you should use two decimal places. You may use a UEA approved calculator Notes are not permitted in this examination. Do not turn over until you are told to do so by the Invigilator. Module Contact: Dr Andrei Stancu, NBS Copyright of the University of East Anglia

2 Page 2 Question 1. A friend told you that he has purchased shares of Vertex Solutions, a technology company, in 2014 and is happy with his investment. You wish to invest in this stock for one year. You do some research and find the following historical prices: Year Vertex Solutions Price 2014 $ $ $ $100 a) Compute the historical yearly average return, variance and standard deviation of Vertex Solutions stock given that the company has payed dividends of $3 yearly starting in Does this represent a good investment? How would your answer change considering that the 1 year Treasury bill rate is 1.7%? Discuss. b) Consider your friend s investment in Vertex Solutions over the 2014 to 2017 period. What total return, capital gain yield and dividend yield did he make over the full period? Why is your friend happy with his investment? Discuss. (10 marks) Question 2. a) Briefly discuss the five main features which differentiate debt securities from equity securities with respect to: claim type, tax, priority in financial trouble, maturity, and management control. b) Assume that you manage a risky fund with an expected rate of return of 15% and a standard deviation of 20%. The T-bill rate is 5%. You present to a client a portfolio which invests 60% in your fund and 40% in a T-bill money market fund. Your client, however, wants to invest only 30% in your fund and 70% in the T-bill fund. Estimate the portfolio s expected return and standard deviation in both cases and discuss the differences you observe. What could be the reason behind the client s decision to invest less in your fund? (10 marks)

3 Page 3 Question 3. a) Describe the difference between technical analysis and fundamental analysis. How do these two types of analysis relate to the efficient market hypothesis? b) Suppose that this year you were able to make superior returns by buying stocks after a 5% rise in price and selling stocks after a 5% fall in price. Can this be considered evidence against the EMH? c) Suppose that you are able to consistently beat the market by purchasing stocks with a price-to-earnings ratio below 30. Can this be considered evidence against the EMH? Question 4. You are provided with the following information: Bond Maturity Coupon rate Face value Bond price A 2 years 10% B 3 years 30% Assume the discount rate is constant at 5%. You can use the following discount factors: Year, t 1 (1 + 5%) t a) Considering only the bond characteristics above (i.e. without performing any estimation), which bond is more sensitive to interest rate risk and why? b) Now answer the previous question by estimating the Macaulay s duration for each bond. c) Assume you run a pension fund and wish to immunize the duration of your liabilities, which currently stands at 2.5 years, by purchasing bonds. What strategy should you follow? TURN OVER

4 Page 4 Question 5. a) What is a call option? Explain the differences between the intrinsic value and time value of an option. b) An investor considers the following strategy: sell a call option with a strike price of $30 for $3.5 and sell a put option with a strike price of $30 for $1.5. Both the call and the put options have a 1 year maturity and are written on the same stock which currently trades at $30. What strategy does the investor follow? What does the investor believe will happen to the stock price in 1 year time to choose this strategy? In what cases is this strategy profitable? (10 marks) Question 6. a) How are hedge funds different to exchange-traded funds in terms of transparency, possible number of investors, strategies, liquidity, and fees? b) A hedge fund with $4 billion of assets charges an annual management fee of 3% and an annual incentives fee of 25% of returns over the T-bill rate. Assuming the T-bill rate is currently 5%, estimate the total fees (in dollars) that the fund will charge to its customers this year if the fund s annual return is 9%. What are the total fees in case the fund achieves only a 4% annual return? (10 marks) END OF PAPER

5 May/June UG Examination Investment Management Exam General Feedback & Common Mistakes Question 1: The most common mistake made for this question was using the wrong formulas or reaching the wrong results for the historical yearly average return and variance/standard deviation. Question 2: Most of you did not explain properly the difference between debt securities and equity securities with respect to claim type and management control. Also, in part (b) some of you assigned a 70% weight to the risky fund rather than the T-bill fund. Question 3: The most common mistake in part (a) was that many of you did not clearly specify how the technical and fundamental analysis relate to the efficient market hypothesis. In part (b), many of you failed to recognise that the strategy did not make superior returns consistently, and therefore, it could not be considered as evidence against the EMH. Question 4: In part (a), very few of you recognised that it is difficult to determine which bond is more sensitive to interest rate risk. Many of you used the wrong formula to calculate the duration in part (b), whereas some of you failed to specify which bond has more interest rate risk since given its duration. Question 5: Many of you did not properly explain in part (a) the difference between the intrinsic value and the time value of an option. In part (b), many of you failed to recognise that the strategy is a reverse straddle. Also, many did not specify what the investor is betting on given that he follows this type of strategy. Question 6: The most common mistake was in part (b), where many of you did not perform the calculations correctly.