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Solution MAF653 June2019

The document contains sample questions and solutions for a financial exam. Question 1 involves calculations of dividend discount model valuation and definitions related to stocks. Question 2 covers convertible bond concepts like forced conversion and benefits of callable bonds. Question 3 demonstrates hedging techniques using futures contracts to protect a stock portfolio's value. Question 4 explains option concepts such as in the money calls, break even points for puts, and synthetic strategies.

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328 views4 pages

Solution MAF653 June2019

The document contains sample questions and solutions for a financial exam. Question 1 involves calculations of dividend discount model valuation and definitions related to stocks. Question 2 covers convertible bond concepts like forced conversion and benefits of callable bonds. Question 3 demonstrates hedging techniques using futures contracts to protect a stock portfolio's value. Question 4 explains option concepts such as in the money calls, break even points for puts, and synthetic strategies.

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dini ff
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We take content rights seriously. If you suspect this is your content, claim it here.
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JUNE 2019

QUESTION 1
A. EPS = Earning per share
DPS = Dividend per share
DPR = Dividend payout ratio

EPS = RM2.50
DPR = 65%
DPR = DPS/EPS = 0.65
Therefore, DPS = 0.65 X RM2.50 = RM1.625 = D0

k= cost of equity = 18%

Year Calculation DividendDF (18%) PV


D1 =1.625(1.25)= 2.031 0.8475 1.7215
D2 =2.031(1.25)= 2.5388 0.7182 1.8233
D3 =2.5388(1.25)= 3.1735 0.6086 1.9314
D4 =3.1735(1.25)= 3.9669 0.5158 2.0461
D5 =3.9669(1.25)= 4.9586 0.4371 2.1674
PV= 9.6897
P5 =4.9586(1.10)/(0.18-0.10)
=5.4545/0.08 = 68.1813 0.4371 29.80205
IV = 39.4918
IV(2dcp) = 39.49

Tatana's stock is undervalued because IV is higher than the MV.


Mr Muhammad may consider to invest in Tatana's stock.

B.i. EPS = RM20,000,000


5,000,000 units
= RM4.00 per share

Price = P/E ratio X EPS


= 11.48 x RM4
= RM45.92

ii. Yes, because if LLM Bhd achieves good earnings results, the share price will rise and
if LLM Bhd delivers poor earnings results, the share price will decline.

C.i. IV = 1.20(1.08)/(0.1-0.08)
= RM64.80

Adam should invest in Berjaya Tahan Bhd's stock because the current market price of RM60 is undervalued.

C.ii. 1. To fix price for unquoted company.


2. To set offer price for take over bid.

C.iii. Types of order


1. Market order
2. Limit order

QUESTION 2
A. i. Two circumstances that may result in forced conversion:-
1. When the conversion value is higher than the call price. Both the bondholder
and the issuer would benefit from the force conversion.
2. When the market interest rate is lower than the convertible bond rate.
In this case, the issuer will benefit because can avoid paying higher interest
rate compared to other companies.

ii. Benefits of callable bond:-


1. It allows companies to pay off their debt early if the companies have excess cash.
2.It provides flexibility to the issuer to retire the bond when the market interest rate
is higher than the coupon rate. The issuer calls back the bond then issue new bond
with lower coupon rate.

Q2B. In 2018, YTM was 7.8% which was lower than coupon rate, the investor was holding a
premium bond. The bond price will be higher than the face value because of higher
demand to buy the bond.

In 2019, YTM was 10.5% which was higher than coupon rate, the investor was holding a
discount bond. The bond price will be lower than the face value because of lower
demand to buy the bond.

C.i. IV = (90/2)(PVIFA 4%,16 ) + 1,000(PVIF4%,16 )


= (45)(11.6523) + 1,000(0.5339)
= 524.3535 + 533.9
= 1,058.2535
≈ 1,058.25

C.ii. Compounding period CF DF(4%) PV DF(5%) PV


0 (1,100) 1.0000 (1,100.00) 1.0000 (1,100.00)
1-16 45 11.6523 524.35 10.8380 487.71
16 1,135 0.5339 605.98 0.4581 519.94
PV 30.33 PV (92.35)

YTM (Semi-annual) = 4% + 30.33 (5%-4%)


30.33+92.35
= 4% + 30.33 '(1%)
122.68
= 4% + 0.24%
= 4.24%
YTM (annual) = 4.24% X 2 = 8.48%

D. Money market instruments


i. Banker’s acceptance
ii. Treasury bills
iii. Commercial paper
iv. Certificate of deposits
QUESTION 3
A.i. He could use hedging the current market position to protect the value of his portfolio from shrinking.
He needs to short KLCI futures now and closes his position in the future by longing the KLCI futures at
lower price. The gain from futures market can be used to offset any loss from the cash market.

ii Number of contracts = 15,000,000


1,400 X 50
= 214 contracts

Position today Position at maturity Gain/Loss


Futures market Sell KLCI futures Buy KLCI futures
KLCI futures =214 X RM50 X 1,400 =214 X RM50 X 1230
=RM14,980,000 RM13,161,000 1,819,000

Value of portfolio in 6 months time = (1250/1350) X RM15,000,000 = 13,888,888.89 At 1350 -----> RM15,000,000
Drop in value = 15,000,000-13,888,888.89 = 1,111,111.11 At 1250 -----> 1250 X RM15,000,000
Therefore net gain = 1,819,000-1,111,111.11 = 707,888.89 1350
In 6 months time, the total portfolio value will be RM15,707,888.89 (15,000,000 + 707,888.89)

B.i. Day Futures price Working Daily gain/loss


16 November 1,950 1950 x 3 x RM50 -
17 November 1,930 (1950-1930) x 3 x RM50 3,000
18 November 1,940 (1930-1940) x 3 x RM50 (1,500)
19 November 1,960 (1940-1960) x 3 x RM50 (3,000)
20 November 1,920 (1960-1920) x 3 x RM50 6,000
21 November 1,900 (1920-1900) x 3 x RM50 3000
Total profit 7,500

ii. Yes, Rajoo was successful in his speculative trade because he obtained RM7,500 profit.

Ci. F=S (1+r+c)ᵗ


F=2,290 (1+0.08+((150/2,290) x 12)^(90/360)
F = RM2,369.10

Based on the calculation above, there is a possibility of mispricing in the above futures
contracts because the market price of CPO futures (RM2110) is lower than fair price (RM2369.10).

ii. Since the situation in (i) above is underpriced, the investors can make profit by going long (buy)
the CPO futures contract and short (sell) CPO simultaneously. In day 90, the investors short CPO
futures and long CPO.
Position today Position at maturity Gain/Loss
Cash market Sell CPO Buy CPO
(CPO)
=10 x 25 x 2290 =10 x 25 x 2450
=572,500 =612,500 (40,000)

Futures market Buy FCPO Sell FCPO


= 10 X 25 X 2,110 = 10 X 25 X 2,450
= RM527,500 = RM612,500 85,000

Storage cost (RM150 x 10 x25)/(3/12) (9,375)

Net proceed = 35,625

iii. Situations that could result in non-zero basis are:


1. asset mismatch
2. maturity mismatch
3. quantity mismatch
QUESTION 4
A. At RM11, the call option is in the money. Therefore, it IV has value.
IV = Market price of stock - Strike price
= RM11 - RM9
= RM2

Time value = Premium - IV


= RM2.50 - RM2
= RM0.50

B.i For put option, BE = Strike price - premium


BEP = 950-20 = 930

ii. Profit = (950-930+15-20) X RM100


= RM1,500

If the time value is 15 points, this option will give a profit of RM1,500.

C. i. Synthetic strategy suggests that we can make combinations of long and short options that
exactly replicate the pay-off of the underlying cash position.

D. Safari Bhd which prefers fixed interest rate shoud borrow at floating rate and
Mariri Bhd which prefers floating interest rate should borrow at fixed rate.
Then they swap through Swap Bank. After the swap, Safari Bhd will receive
floating rate from Mariri Bhd and Mariri Bhd will receive fixed rate from Safari
Bhd. In short, Safari Bhd is floating rate receiver and Mariri Bhd is fixed rate
receiver. They will end up paying the rate they prefer. The gain made from the
swap will absorb lossess if any.

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