Distinguish between investment and speculation.

Investment vs. Speculation • Investment: Commitment of funds based on thorough fundamental analysis to achieve steady return and capital preservation over a long horizon. • Speculation: High-risk trading targeting short-term capital windfalls based on market rumors and price volatility.

Who is an issue manager? List any three functions of issue manager.

Issue Manager & Three Key Functions An issue manager (merchant bank) manages securities issuance. Functions: (1) Due diligence and prospectus preparation, (2) Underwriting subscription risks, (3) Coordinating IPO allotments via C-ASBA.

What is long purchase? Illustrate with an example.

Long Purchase Buying a financial asset anticipating price appreciation (e.g., buying 100 shares of Nabil at Rs 500 expecting it to rise to Rs 650).

What is the expected return on a stock with a beta of 1.15, a market risk premium of 6 percent and a risk free return of 5 percent?

CAPM Expected Return: E(R) = R_f + \beta (MRP) = 5\% + 1.15(6\%) = 5\% + 6.9\% = \mathbf{11.90\%}

Distinguish between cash dividend and stock dividend.

Cash Dividend vs. Stock Dividend • Cash Dividend: Direct monetary payout reducing cash and retained earnings. • Stock Dividend (Bonus Shares): Issuing additional shares pro-rata, capitalizing retained earnings into share capital without changing corporate asset base.

Assume a share of stock is selling at Rs. 200 per share. You buy 100 shares of stock on margin today. If the initial margin is 60 percent and maintenance margin is 40 percent, compute the margin call price.

Margin Call Price (Long Purchase): P^* = \frac{P_0 (1 - IM)}{1 - MM} = \frac{200(1 - 0.60)}{1 - 0.40} = \frac{80}{0.60} = \mathbf{\text{Rs. } 133.33}

A well-known company has total assets of Rs. 400 million, total debt of Rs. 160 million, and Rs. 40 million of 10 percent preferred stock outstanding. If the company has 10,00,000 shares of common stock outstanding, what is the book value per share?

Book Value Per Share: \text{Common Equity} = \text{Total Assets} - \text{Debt} - \text{Preferred Stock} = 400\text{M} - 160\text{M} - 40\text{M} = \text{Rs. } 200\text{M} BVPS = \frac{200\text{M}}{1\text{M}} = \mathbf{\text{Rs. } 200.00}

Explain why bank discount yield is lower than bond equivalent yield.

Bank Discount Yield vs. Bond Equivalent Yield Bank discount yield understates true yield because it uses face value in the denominator rather than actual purchase price, and assumes a 360-day year instead of 365 days.

A bond has a Macaulay duration equal to 6 years and a yield to maturity of 9 percent. What is the percentage change in price of a bond if yield to maturity rises to 9.5 percent?

Percentage Change in Bond Price: D^* = \frac{D}{1 + y} = \frac{6}{1.09} = 5.505 \text{ years} \% \Delta P \approx -D^* \times \Delta y = -5.505 \times 0.005 = -0.0275 = \mathbf{-2.75\%}

Write the meaning of derivative securities.

Derivative Securities Financial contracts whose value derives from an underlying asset, benchmark, or index (e.g., options, futures).

What is investment? Explain different types of investments.

Types of Investments: Direct vs indirect, financial vs real assets, fixed vs variable return.

Assume that you sell short 500 shares of Nabil stock for Rs. 400 per share. The initial margin and maintenance margin requirements are 50 percent and 30 percent respectively. a. What is the initial value of debt and equity in your margin account? b. If the stock price increases to Rs. 450 per share, what will be the value of debt and equity in your margin account? c. Do you receive a margin call if the price of stock increases to Rs. 450? d. What will your rate of return be if Nabil stock is trading at Rs. 380?

Short Sale Analysis (500 shares at Rs 400): a. Equity = Rs 100k, Debt = Rs 200k. b. At Rs 450, Equity = Rs 75k, Debt = Rs 225k, Margin = 33.3%. c. No margin call (33.3% > 30%). d. Return at Rs 380 = 20%.

Consider the following stock price and no. of shares information: | Stock | No. of shares outstanding | Stock prices at the end of 2022 (Rs) | Stock prices at the end of 2023 (Rs) | | --- | --- | --- | --- | | A | 2,000 | 400 | 380 | | B | 1,000 | 150 | 165 | | C | 5,000 | 700 | 720 | a. Construct a price-weighted index for 2022 and 2023 and compute the percentage change in series for the period from 2022 to 2023. b. Construct a market value weighted index 2023 and compute the percentage change in the period from 2022 to 2023. c. Construct equally-weighted index for 2023 and compute the percentage change in series for the period from 2022 and 2023. d. Briefly discuss the difference in the results for three stock indexes.

PWI, VWI, and EWI index calculations for 2022 to 2023 with step-by-step arithmetic.

Consider the following subjective probability distribution of returns on Stock X and Stock Y for a potential investment. | State of economy | Probability | Estimated rate of returns | | | --- | --- | --- | --- | | | | Stock X | Stock Y | | Strong growth | 0.1 | -10% | 20% | | Moderate growth | 0.4 | 5% | 15% | | Weak growth | 0.4 | 15% | 10% | | Recession | 0.1 | 30% | -10% | a. Which stock would you select on the basis of expected [return]? b. Calculate standard deviation of the returns of Stock X and S[tock Y]. What purpose does standard deviation service for an investor? c. Calculate coefficient of variation for each stock. What purpose does coefficient of variation serve?

Stock X and Y: Expected returns, standard deviation, and Coefficient of Variation (CV) analysis.

(a) City fund had average daily assets of Rs. 1800 million in the past year. The Fund sold Rs. 600 million and purchased Rs. 500 million worth of stock during the year. i) What was the portfolio turnover rate? ii) If City Fund's expense ratio was 1.2 percent and the management fee was 0.8 percent, what were the total fees paid to the fund's investment managers during the year? What were the other administrative expenses? (b) Assume the average return on portfolio P was 35 percent and that of the market was 28 percent. The beta coefficient of portfolio P was 1.2 and that of the market was 1.0. Standard deviation of portfolio P and the market was 42 percent and 30 percent respectively. The T-bill rate during the period was 6 percent. i) Calculate the Treynor and Sharpe measures for both portfolio P and the market. ii) Briefly explain whether portfolio P underperformed, equated, or outperformed the market. Why these two measures may produce conflicting results?

City Fund Turnover & Portfolio P vs Market Sharpe/Treynor calculations.

Assume that risk free rate is currently 6 percent. The expected return on the average stocks in the market is 12 percent. You are evaluating the prospect of ABC stock which is currently paying Rs 20 per share in dividend. The stock has a beta coefficient of 1.5. Currently, the aggressive marketing campaign launched by the company will enhance its earnings significantly. As a result the growth rate of dividends is expected to be 20 percent for the next two year. After this period, the growth rate is expected to slow down to a normal rate of 5 percent indefinitely. a. Calculate the required rate of return on ABC stock. b. What is the expected dividends per share on ABC stock for next two years? c. At what price the stock is expected to sell at the end of year 2? d. What is the intrinsic value of this stock today? e. If the stock is currently trading in Rs. 260 per share, is the stock underpriced or overpriced? Would you prefer to buy the stock?

Two-stage DDM for ABC Stock: Required return = 15%, D1 = 24, D2 = 28.8, P2 = 302.4, Intrinsic Value V0 = Rs 270.36. At Rs 260, stock is undervalued; buy.

What is fixed income security? Explain different types of fixed income securities.

Fixed income security features and types (T-bills, corporate debentures, municipal bonds, preferred shares).

You have been provided the following returns data of three assets for your advice in selecting a portfolio of assets: | Year | Rate of return: Asset A | Asset B | Asset C | | --- | --- | --- | --- | | 2019 | 10% | 18% | 10% | | 2020 | 12% | 16% | 12% | | 2021 | 14% | 14% | 14% | | 2022 | 16% | 12% | 16% | | 2023 | 18% | 10% | 16% | You have been told that you can create two portfolios - one consisting of assets A and B, and other consisting of assets A and C - by investing equal proportions in each of the two component assets. a. Calculate average return and standard deviation for each of the three assets. b. Calculate the covariance between the returns of assets A and B, and assets A and C. c. Calculate the return and standard deviation of the portfolios consisting of assets A and B, and assets A and C. d. Which portfolio do you recommend? Why?

Asset A, B, and C covariance, portfolio return, and risk comparisons.

Assume that you are an aggressive bond trader and therefore, want to speculate on interest rate swing. Market interest rates are currently 9 percent, but you expect the interest rates to fall to 7 percent within a year. You are thinking of buying either a 25-year, zero coupon bond or a 20-year, 5.5 percent bond. Both bonds have Rs. 1000 par values and carry same agency rating. a. If you want to maximize capital gain income, which of the two bonds should you select? Show your calculation. b. If you want to maximize total return from your investment, which of the two bonds should you select? c. Why did one bond provide better capital gains than the other?

Zero coupon 25-yr bond vs 20-yr 5.5% bond under rate drop from 9% to 7%: Zero coupon provides superior capital gains due to longer duration.

Fundamentals of Investment 2080 Board Question Paper – FIN 253

Tribhuvan University

Faculty of Management

Office of the Dean

2080 BS / Regular Examination

Course: FIN 253 · Fundamentals of Investment

Level: Bachelor of Business Studies (BBS) · Fourth Year

Full Marks: 100

Time: 3 hrs.

Candidates are required to give their answers in their own words as far as practicable. The figures in the margin indicate full marks.

Section A

Brief Answer Questions : Attempt All questions .

[10*2=20]

Distinguish between investment and speculation.

[2]
View model solution
Investment vs. Speculation
- Investment: Commitment of funds based on thorough fundamental analysis to achieve steady return and capital preservation over a long horizon.
- Speculation: High-risk trading targeting short-term capital windfalls based on market rumors and price volatility.
Who is an issue manager? List any three functions of issue manager.

[2]
View model solution
Issue Manager & Three Key Functions

An issue manager (merchant bank) manages securities issuance. Functions: (1) Due diligence and prospectus preparation, (2) Underwriting subscription risks, (3) Coordinating IPO allotments via C-ASBA.
What is long purchase? Illustrate with an example.

[2]
View model solution
Long Purchase

Buying a financial asset anticipating price appreciation (e.g., buying 100 shares of Nabil at Rs 500 expecting it to rise to Rs 650).
What is the expected return on a stock with a beta of 1.15, a market risk premium of 6 percent and a risk free return of 5 percent?

[2]
View model solution
CAPM Expected Return:

$E(R) = R_f + \beta (MRP) = 5\% + 1.15(6\%) = 5\% + 6.9\% = \mathbf{11.90\%}$
Distinguish between cash dividend and stock dividend.

[2]
View model solution
Cash Dividend vs. Stock Dividend
- Cash Dividend: Direct monetary payout reducing cash and retained earnings.
- Stock Dividend (Bonus Shares): Issuing additional shares pro-rata, capitalizing retained earnings into share capital without changing corporate asset base.
Assume a share of stock is selling at Rs. 200 per share. You buy 100 shares of stock on margin today. If the initial margin is 60 percent and maintenance margin is 40 percent, compute the margin call price.

[2]
View model solution
Margin Call Price (Long Purchase):

$P^* = \frac{P_0 (1 - IM)}{1 - MM} = \frac{200(1 - 0.60)}{1 - 0.40} = \frac{80}{0.60} = \mathbf{\text{Rs. } 133.33}$
A well-known company has total assets of Rs. 400 million, total debt of Rs. 160 million, and Rs. 40 million of 10 percent preferred stock outstanding. If the company has 10,00,000 shares of common stock outstanding, what is the book value per share?

[2]
View model solution
Book Value Per Share:

$\text{Common Equity} = \text{Total Assets} - \text{Debt} - \text{Preferred Stock} = 400\text{M} - 160\text{M} - 40\text{M} = \text{Rs. } 200\text{M}$
$BVPS = \frac{200\text{M}}{1\text{M}} = \mathbf{\text{Rs. } 200.00}$
Explain why bank discount yield is lower than bond equivalent yield.

[2]
View model solution
Bank Discount Yield vs. Bond Equivalent Yield

Bank discount yield understates true yield because it uses face value in the denominator rather than actual purchase price, and assumes a 360-day year instead of 365 days.
A bond has a Macaulay duration equal to 6 years and a yield to maturity of 9 percent. What is the percentage change in price of a bond if yield to maturity rises to 9.5 percent?

[2]
View model solution
Percentage Change in Bond Price:

$D^* = \frac{D}{1 + y} = \frac{6}{1.09} = 5.505 \text{ years}$
$\% \Delta P \approx -D^* \times \Delta y = -5.505 \times 0.005 = -0.0275 = \mathbf{-2.75\%}$
Write the meaning of derivative securities.

[2]
View model solution
Derivative Securities

Financial contracts whose value derives from an underlying asset, benchmark, or index (e.g., options, futures).

Section B

Descriptive Answer Questions : Attempt any FIVE questions .

[5*10=50]

What is investment? Explain different types of investments.

[10]
View model solution
Types of Investments: Direct vs indirect, financial vs real assets, fixed vs variable return.
Assume that you sell short 500 shares of Nabil stock for Rs. 400 per share. The initial margin and maintenance margin requirements are 50 percent and 30 percent respectively.

a. What is the initial value of debt and equity in your margin account?

b. If the stock price increases to Rs. 450 per share, what will be the value of debt and equity in your margin account?

c. Do you receive a margin call if the price of stock increases to Rs. 450?

d. What will your rate of return be if Nabil stock is trading at Rs. 380?

[10]
View model solution
Short Sale Analysis (500 shares at Rs 400): a. Equity = Rs 100k, Debt = Rs 200k. b. At Rs 450, Equity = Rs 75k, Debt = Rs 225k, Margin = 33.3%. c. No margin call (33.3% > 30%). d. Return at Rs 380 = 20%.
Consider the following stock price and no. of shares information:

Stock No. of shares outstanding Stock prices at the end of 2022 (Rs) Stock prices at the end of 2023 (Rs)

A 2,000 400 380

B 1,000 150 165

C 5,000 700 720

a. Construct a price-weighted index for 2022 and 2023 and compute the percentage change in series for the period from 2022 to 2023.

b. Construct a market value weighted index 2023 and compute the percentage change in the period from 2022 to 2023.

c. Construct equally-weighted index for 2023 and compute the percentage change in series for the period from 2022 and 2023.

d. Briefly discuss the difference in the results for three stock indexes.

[10]
View model solution
PWI, VWI, and EWI index calculations for 2022 to 2023 with step-by-step arithmetic.
Consider the following subjective probability distribution of returns on Stock X and Stock Y for a potential investment.

State of economy Probability Estimated rate of returns

Stock X Stock Y

Strong growth 0.1 -10% 20%

Moderate growth 0.4 5% 15%

Weak growth 0.4 15% 10%

Recession 0.1 30% -10%

a. Which stock would you select on the basis of expected [return]?

b. Calculate standard deviation of the returns of Stock X and S[tock Y]. What purpose does standard deviation service for an investor?

c. Calculate coefficient of variation for each stock. What purpose does coefficient of variation serve?

[10]
View model solution
Stock X and Y: Expected returns, standard deviation, and Coefficient of Variation (CV) analysis.
** (**a) City fund had average daily assets of Rs. 1800 million in the past year. The Fund sold Rs. 600 million and purchased Rs. 500 million worth of stock during the year.

i) What was the portfolio turnover rate?

ii) If City Fund’s expense ratio was 1.2 percent and the management fee was 0.8 percent, what were the total fees paid to the fund’s investment managers during the year? What were the other administrative expenses?

(b) Assume the average return on portfolio P was 35 percent and that of the market was 28 percent. The beta coefficient of portfolio P was 1.2 and that of the market was 1.0. Standard deviation of portfolio P and the market was 42 percent and 30 percent respectively. The T-bill rate during the period was 6 percent.

i) Calculate the Treynor and Sharpe measures for both portfolio P and the market.

ii) Briefly explain whether portfolio P underperformed, equated, or outperformed the market. Why these two measures may produce conflicting results?

[10]
View model solution
City Fund Turnover & Portfolio P vs Market Sharpe/Treynor calculations.
Assume that risk free rate is currently 6 percent. The expected return on the average stocks in the market is 12 percent. You are evaluating the prospect of ABC stock which is currently paying Rs 20 per share in dividend. The stock has a beta coefficient of 1.5. Currently, the aggressive marketing campaign launched by the company will enhance its earnings significantly. As a result the growth rate of dividends is expected to be 20 percent for the next two year. After this period, the growth rate is expected to slow down to a normal rate of 5 percent indefinitely.

a. Calculate the required rate of return on ABC stock.

b. What is the expected dividends per share on ABC stock for next two years?

c. At what price the stock is expected to sell at the end of year 2?

d. What is the intrinsic value of this stock today?

e. If the stock is currently trading in Rs. 260 per share, is the stock underpriced or overpriced? Would you prefer to buy the stock?

[10]
View model solution
Two-stage DDM for ABC Stock: Required return = 15%, D1 = 24, D2 = 28.8, P2 = 302.4, Intrinsic Value V0 = Rs 270.36. At Rs 260, stock is undervalued; buy.

Stock	No. of shares outstanding	Stock prices at the end of 2022 (Rs)	Stock prices at the end of 2023 (Rs)
A	2,000	400	380
B	1,000	150	165
C	5,000	700	720

State of economy	Probability	Estimated rate of returns
		Stock X	Stock Y
Strong growth	0.1	-10%	20%
Moderate growth	0.4	5%	15%
Weak growth	0.4	15%	10%
Recession	0.1	30%	-10%

Section C

Analytical Answer Questions : Attempt any TWO questions .

[2*15=30]

What is fixed income security? Explain different types of fixed income securities.

[15]
View model solution
Fixed income security features and types (T-bills, corporate debentures, municipal bonds, preferred shares).
You have been provided the following returns data of three assets for your advice in selecting a portfolio of assets:

Year Rate of return: Asset A Asset B Asset C

2019 10% 18% 10%

2020 12% 16% 12%

2021 14% 14% 14%

2022 16% 12% 16%

2023 18% 10% 16%

You have been told that you can create two portfolios - one consisting of assets A and B, and other consisting of assets A and C - by investing equal proportions in each of the two component assets.

a. Calculate average return and standard deviation for each of the three assets.

b. Calculate the covariance between the returns of assets A and B, and assets A and C.

c. Calculate the return and standard deviation of the portfolios consisting of assets A and B, and assets A and C.

d. Which portfolio do you recommend? Why?

[15]
View model solution
Asset A, B, and C covariance, portfolio return, and risk comparisons.
Assume that you are an aggressive bond trader and therefore, want to speculate on interest rate swing. Market interest rates are currently 9 percent, but you expect the interest rates to fall to 7 percent within a year. You are thinking of buying either a 25-year, zero coupon bond or a 20-year, 5.5 percent bond. Both bonds have Rs. 1000 par values and carry same agency rating**.**

a. If you want to maximize capital gain income, which of the two bonds should you select? Show your calculation.

b. If you want to maximize total return from your investment, which of the two bonds should you select?

c. Why did one bond provide better capital gains than the other?

[15]
View model solution
Zero coupon 25-yr bond vs 20-yr 5.5% bond under rate drop from 9% to 7%: Zero coupon provides superior capital gains due to longer duration.

Year	Rate of return: Asset A	Asset B	Asset C
2019	10%	18%	10%
2020	12%	16%	12%
2021	14%	14%	14%
2022	16%	12%	16%
2023	18%	10%	16%