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FEO810S-FINANCIAL ECONOMICS-1ST OPP-JUNE 2022 |
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nAmlBIA un1VERSITY
OFSCIEnCEAno TECHnOLOGY
FACULTY OF MANAGEMENT SCIENCES
DEPARTMENT OF ACCOUNTING, ECONOMICS AND FINANCE
BACHELOR OF ECONOMICS HONOURS
(0SBECH)
FINANCIAL ECONOMICS (FEO810S)
DATE:
DURATION:
MARKS:
Time:
June 2022
3 Hours
100
08:00- 11:00am
EXAMINER
MODERATOR
FIRST OPPORTUNITY EXAMINATION QUESTION PAPER (2022)
Prof. T. KAULIHOWA
Dr. R. KAMATI
INSTRUCTIONS
1. This paper is made up two sections (A & B)
2. Section A is compulsory, answer any two questions in Section B
3. Show all your workings & round off only final answers to 4 decimal places
4. Financial/Scientific calculators are allowed
REQUIREMENTS: Scientific or Financial calculator
This paper consists of 5 pages excluding this cover page and the formulas sheet
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SECTIONA: Answer all questions
[20 MARKS)
1.Markets in which funds are transferred from those who have excess funds available to those who
have a shortage of available funds are called?
[2]
A) commodity markets.
B) fund-available markets.
C) derivative exchange markets.
D) financial markets.
2. Poorly performing financial markets can be the cause of
[2]
A) wealth.
B) poverty.
C)financial stability.
D) financial expansion
3. Banks and other financial institutions engage in financial intermediation, which
[2]
A) can hurt the performance of the economy.
B) can benefit economic performance.
C) has no effect on economic performance.
D) involves borrowing from investors and lending to savers
4. Stockholders are residual claimants, meaning that they
[2]
A) have the priority claim on all a company's assets.
B) are liable for all a company's debts.
C) will never share in a company's profits.
D) receive the remaining cash flow after all other claims are paid.
5. Information plays an important role in asset pricing because it allows the buyer to more accurately
judge
[2]
A) liquidity.
B) risk.
C) capital.
D) policy.
6. The coronavirus pandemic led to a decline in stock prices because
A) of a lowered expected dividend growth rate.
B) of a lowered required return on investment in equity.
C) higher expected future stock prices.
D) higher current dividends.
[2]
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7. According to the efficient market hypothesis, the current price of a financial security
[2]
A) is the discounted net present value of future interest payments.
B) is determined by the lowest successful bidder.
C) fully reflects all available relevant information.
D) is a result of none of the above.
8. Stock market crashes lead us to believe that
[2]
A) factors other than market fundamentals influence asset prices.
B) unexploited profit opportunities never exist.
C) crashes are always predictable when market participants behave rationally.
D) bubbles are a natural outcome of an efficient market.
9. Suppose you are currently in the long position of a long-term bond. In this case, to hedge against a
capital loss, you would enter a ____
contract to ____
a long-term bond in the future. [2]
A) interest-rate forward; sell
B) interest-rate forward; buy
C) exchange-rate forward; buy
D) exchange-rate forward; sell
10. The seller of an option has the ____
to buy or sell the underlying asset while the purchaser of
an option has the ____
to buy or sell the asset.
[2]
A) obligation; right
B) right; obligation
C) obligation; obligation
D) right; right
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SECTION B: Answer any two questions
QUESTION 1
[40 MARKS]
= 1.1 Assume an investor utility function U 2E(r) - ¼Aa 2 , where E(r) denotes portfolio
expected returns, A is coefficient of risk aversion which is assumed to be greater than zero and a 2
represent the variance. Show that the investor's utility function is increasing in the portfolio
expected returns and decreasing in its risk.
[4]
½2
1.2 Suppose an investor utility function is presented asu =E(r)- Aa • Use the information below to
answer the following questions.
Portfolio
Standard Bank hares
MTC shares
Capricorn Holding shares
Expected
Return
6%
10%
12%
Standard Deviation
4%
6%
8%
a. Assume an investor with risk aversion A=2, which portfolio yields the highest utility.
[4]
b. Assume an investor with risk aversion A=4, which portfolio yields the highest utility.
[4]
c. Use your answers in a) and b) above to comment on what happened to Utility when risk aversion
increases also advise an investor who is contemplating to invest in one of the three portfolios.[6]
1.3 Suppose the return on RMB Shares was quoted as 10% with a risk premium of 8%. Assume that
the Capital Asset Pricing Model (CAPM) is correct. Use the Security Market Line (SML) to
determine if RMB Shares are correctly prices. The current T-bill rate is 4% and RMB Beta is
estimated to be 0.85.
[6]
1.4 Suppose that a European call option price c= 4; spot price So= 40, T = 6 months; r = 10% per
annum; strike price K =35 and dividends D = 0. Use the put-call parity to calculate the
arbitrage possibilities when p = 5 and p = 4.
[6]
= 1.5 Consider a 20-year bond with the following characteristics. The bond was issued at time t 0
= with face value FV 1000, and annual coupon payment of N$ 10, the current price of the bond
is N$ 1200.77.
i) Calculate the yield to maturity
[5]
= ii) Suppose at t 10, the investor has faced liquidity constraints that prompted him/her to sell
the current. Similar bonds are currently offering 8% coupon rate. At what price should the
investor sell his/her bond?
[5]
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QUESTION 2
[40 MARKS]
1. Suppose you observe the following for two securities (X & Y). Answer the following question.
Outcome
Probability
Rate of Return X % Rate of Return Y%
1
0.25
12
14
2
0.2
6
0
3
0.25
0
8
4
0.3
10
4
a) Calculate the expected return of portfolio with 50% in asset X and 50% in asset Y. [4]
b) Calculate the risk of this portfolio.
[8]
c) Show that the risk of the minimum variance portfolio is zero.
[12]
2. Assume that the Development Bank of Namibia has a 10% bond outstanding with 7 years
remaining to maturity. Coupon payments are paid semi-annually, and the par value is N$ 1000-
00. What is the value of the bond if the expected rate of return is?
a. 12%
[2]
b. 10%
[2]
c. 8%
[2]
d. Use answers in a., b. & c. above to explain relationship between bond prices and interest
rate.
[4]
3. Briefly explain the concept of market anomalies in Efficient Market Hypothesis; also provide
reasons why they do not disappear if markets are completely efficient.[6]
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QUESTION 3
[40 MARKS]
1. Suppose you want to buy 1000 MTC shares at a price of N$ 10/share. You broker has indicated
you can use Short Selling under the following conditions: Initial margin is 50%, maintenance
margin is 20% and initial price of the stock in N$ 10 per share. How much can a stock price rise
before you receive a margin call?
[5]
2. TALAMO FOODSPty ltd has a total value of$ 1 million made of 50% common stock and 50% debt
in forms of bonds. The bonds have a face value of$ 1000, pay 10% coupon per annum, matures
in 10 years with yield to maturity (YTM} of 12%. TALAMO FOODSdividends are expected to grow
at the constant rate of 5% and they just paid dividends of$ 10 per share. The ex-dividend price
is$ 40 per share. TALAMO FOODStax rate is 35%.
a. Use Gordon growth model to calculate cost of Equity.
[5]
b. Calculate TALAMO FOODweighted average cost of capital.
[5]
= 3. Consider a 2-year bond with the following characteristics. The bond was issued at time t 0
= with face value FV 100, and annual coupon payment of N$ 5, the current price of the bond
= is N$ 102.77. You are now in period t 2, suppose that all market interest rates increased by
2%. Calculate the return (holding period return) at period between t = 0 & t = 2
[4]
= 4. Suppose that the expected return on the market portfolio E(Rm) 0.08, return on the risk-
= = free rate r1 0.01 and a variance er~ 0.025. Use the Capital Asset Pricing Model (CAPM) to
= calculate the expected return of a risky asset i that has a covariance crim 0.01 with the
market return, also interpret the beta of this security.
[6]
5. Explain the term structure of interest rates and discuss any 2 theories that that determine the
shape of a yield curve.
[10]
6. Consider a call option with a strike price of N$ 50. Compute the intrinsic value of this option if
stock prices were to be N$ 55, N$50 and N$ 45 on the t exercise date.
[5]
***End***
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U
=
1
E(r)--Ao-
2
2
Formula Sheet
E~Jfw;E(r;)
i=l
f II a!=E~-PE~J= w,2+a/ w,w,a=,i,; w;a,i2;i+;w,w,p,,,a,a,
f,.1
J:o.lt"l
i"l
i::I ,,,1
J~I
nti
Re=
D0 (1 + g)
Po
+g
COV(x,y)
= Px,y
O"xO"y
COV(x,y) = E[(X - E(X))(Y - E(Y))]
FV = PV(l +r?
E(R,J=J/1>,,.
1
;•
[E(/1,,,)·l/1}
CT~
Divident payable
RP = Market value(ex - dividend)
R0 = Rd(l-Cr)
D
Re= WACC +E(WACC- R0 )
EBIT
R =WACC=--------
e
Market value of Equity
// =CT,. __ COV(R.-,R,,)
·' a;, VAR(R.,)
p =-(-1P-+M+-Ty-)-+·(·1·P++M-yT-)-+2 ----
PMT
(1 + y) 2
FV + PMT
(1 + Yr
P=--+ C
1 +i
C
(1+i'I
. +--O-++··i)·C'+---+1---
C
(l+i)"
F
(l+i)"
_
[1 - (1 + y)-n]
FV
P - PMT
Y
+ (l +yn)
RET = -C+
P -P
t+l
t
pt
pt
C + FV-PV
YTM = FV + ~V
2
Re
=
W ACC
+
D
E
(W
ACC
-
R0 )
Lower bound European Call Price= S0 - Ke-rT
Lower bound European Put Price= Ke-rT - S0
Put - call - parity: c + Ke-rT = p + S0