1N14M29-E1
The University of Nottingham
Business School
MASTER OF BUSINESS ADMINISTRATION
A LEVEL 4 MODULE, SPRING SEMESTER 2010-2011
PORTFOLIO MANAGEMENT AND INVESTMENT ANALYSIS
Time allowed TWOHours
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Candidates may complete the front cover of their answer book and sign their desk card but must NOT writeanything else until the start of the examination period is announced.
Answer THREE questions
Dictionaries are not allowed with one exception. Those whose first language is not English may use a standard translation dictionary to translate between that language and English provided that neither language is the subject of this examination. Subject specific translation dictionaries are not permitted.
No electronic devices capable of storing and retrieving text, including electronic dictionaries, may be used.
Candidates may use a self-contained silent electronic calculator in this examination, provided that the make and type number are noted on the front page of the script. Programmable calculators must NOT be programmed prior to the examination and no program in any form may be taken into the examination room. Calculators capable of storing text are prohibited.
If more than three questions are answered, marks will be awarded for the first three answers only.
Do NOT turn the examination paper over until instructed to do so
ADDITIONAL MATERIAL:Present value and annuity tables
Cumulative normal distribution tables
Exponential function tables
Natural logarithms tables
Turn Over
1)Some company pension schemes have specified that fund managers refrain from direct investment in equities. Fund managers can circumvent this instruction by investing instead in structured bonds which benefit from upward movements in equities. An example of one such bond repays its face value of £1000 at maturity, one year from now, plus interest at 6% per annum. However if a portfolio which tracks a specified stock market index has increased above its current value at the end of the year the bond holder will receive an additional £0.6 for every £1 increase in the value of the portfolio. The value of one unit of this portfolio currently stands at £4000 and it is anticipated that at the end of the year its value will be either £5000 or £3000. The risk free rate in the economy is 3% per annum.
a)How much is the bond worth? (50%)
b)You manage a pension fund which has liabilities of £16 billion with a Macauley’s duration of 8 years. The fund has £18 billion of assets, mainly bonds, with a Macauley’s duration of 12 years. Is there a problem? (30%)
c)In the Spring of 2011 several banks issued CoCos to protect their capital base in the event of another financial crisis. What is a CoCo and how might it assist the issuing banks? (20%)
2)“The evidence is strongly in favour of the hypothesis that returns on shares are generated by a mixture of normals.” Discuss. (100%)
3)A share in RHB plc is currently trading at £1.50. RHB plc has a policy of not paying dividends. The volatility of the return on RHB’s equity is 40% and the risk free rate in the economy is 2% per annum.
a)Value a European call option, with exercise price £1.20 and time to maturity of one year using a two stage binomial tree (50%)
b) “A fair market price for a derivative, obtained from a derivative valuation model, is simply a no-arbitrage restriction between the tracking portfolio and the derivative.” Explain. (30%)
c)What is the difference between a long straddle and a long strangle and which position is likely to be the cheaper to set up? (20%)
/Cont’d overleaf
- The expected anticipated returns of three securities A, B, and C, are 0.235, 0.14, and 0.2075 respectively. The variances and covariances relating to anticipated returns are given in the variance-covariance table below:
A / B / C
A / 0.6892 / 0.0224 / 0.0364
B / 0.2128 / 0.0208
C / 0.4838
a)There is some debate about the covariance between returns of security A and those of security C. An alternative estimate of 0.6404 has been put forward. Which of the two alternative estimates of the covariance is most likely to be correct? (20%)
b)Portfolio X is formed by investing equal amounts in securities A, and B. Portfolio Y is formed by putting 45% of wealth available for investment in share A, and the remainder in share B. Using the best available estimate of the variance – covariance matrix, based on your answer to part (a), what is the covariance between the returns on portfolios X and Y? (30%)
c)The forecasts of expected returns, variances and covariances are based on parameter estimates from a single index model. If the variance of the returns on the index is 0.02, what are the Betas of securities A, B, and C? Explain and justify your choice of method for calculating the Betas. (50%)
/Cont’d overleaf
- The table contains data on returns from 6 Malaysian Islamic Equity Mutual Funds and the KL Shariah compliant index.
Fund / Average Excess Return (over risk free rate) / Standard Deviation of Return / Beta
A / -.004 / 4.382 / .000
B / -.098 / 3.797 / .016
C / .244 / 3.378 / .032
D / .050 / 3.106 / -.031
E / .018 / 2.378 / .032
I / .162 / 1.291 / .134
Index / .155 / 1.438 / 1
a)The return calculation is based on “net asset value and distributions”. What is net asset value and how is return measured? (10%)
b)Rank the funds using average excess return, the Sharpe ratio, and the Treynor ratio. Explain and comment on the ranking process, and also comment on the rankings produced. (50%)
c)Is there any benefit to employing a fund manager pursuing an active rather than a passive strategy? (40%)
- An investor holds a portfolio of UK shares currently valued at £7 million. The portfolio’s Beta is 1.0. The investor wishes to hedge the value of the portfolio over a three month period, using the futures contract available on the FTSE100 which has four months to maturity. The current value of the index is 6000 and the dividend yield, continuously compounded is 3% per annum. The risk free rate is 1% per annum continuously compounded.
a)Given that one futures contract is for £10 times the index, what position should be taken in the futures market? (20%)
b)If the FTSE100 ends up at 5200 in three months time what do you expect the total value of the investor’s position to be? (40%)
c)Index arbitrage is “an investment strategy that exploits divergences between the actual futures price and its theoretically correct parity value.” (Bodie, Kane & Marcus, p789) Explain how index arbitrage is supposed to work. What are the practical problems likely to be encountered in any attempt to implement this strategy? (40%)
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N14M29-E1