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1 UNIVERSITY OF ESWATINI DEPARTMENT OF ACCOUNTING AND FINANCE ASSIGNMENT PAPER - ACADEMIC YEAR 2020/2021 ASSIGNMENT TWO (2) PROGRAMME OF STUDY : Master of Business Administration YEAR OF STUDY : Year 1 (Part Time) TITLE OF THE PAPER : Investment Analysis and Portfolio Management COURSE CODE : ACF 624 LECTURER : Dr H.Matsongoni DUE DATE : 19 September 2021 INSTRUCTIONS 1. There are TWO (2) questions, ANSWER ALL. 2. Begin the solution to each question on a new page. 3. The marks awarded for a question are indicated at the end of each question. 4. Show your necessary workings. NOTE: You are reminded that in assessing your work, account will be taken of accuracy of the language and the general quality of expression, together with layout and presentation of your answer. SPECIAL REQUIREMENT: FINANCIAL / SCIENTIFIC CALCULATOR 2 ANSWER ALLTHE QUESTIONS QUESTION ONE (25 Marks) 1.1 Consider the following information in Table 1.1 for stock A and B. Stock Expected return Beta (β) A 12% 1 B 13% 1.5 Table 1.1 The market’s expected return and the risk free rate are 11% and 5% respectively. 1.1.1 According to CAPM, what is the expected return of each stock? (2 Marks) 1.1.2 Calculate the alpha of each stock and comment on the pricing of these two stocks. (4 Marks) 1.1.3 Plot each stock’s risk-return point on the Security Market Line (SML) and show both alphas on the SML graph. (4 Marks) 1.2 Ben Carson’s portfolio has the following data shown in Table 1.2 for a particular sample period. Data for Ben Carson’s portfolio for a particular Sample Period Portfolio Market T-Bill (Risk-Free) Average 35% 28% 6% Beta (β) 1.20 1.00 0 Standard deviation 42% 30% 0 Table 1.2 1.2.1 Calculate Sharpe, Jensen (Alpha) and Treynor measures of Performance for Ben’s portfolio and the market. (5 Marks) 1.2.2 Indicate the measures by which Ben’s portfolio outperformed the market? (2 Marks) 1.3 Using the information below in Table 1.3, calculate Sharpe and Treynor ratios for portfolio A and B. Which portfolio do you prefer under each measure? (8 Marks) 3 Expected Rate of Return (%) Standard Deviation (%) Beta Portfolio A 11 10 0.8 Portfolio B 14 31 1.5 Market Index 12 20 1.0 Risk-free Assets 6 0 0.0 Table 1.3 QUESTION TWO (25 Marks) Several discussion meetings have provided the following information about one of your firm’s new advisory clients, a charitable endowment fund recently created by means of a one-time E10 million gift. Objectives Return requirement: Planning is based on a minimum total return of 8% per year, including an initial current income component of E500,000 (5% on beginning capital). Realizing this current income target is the endowment fund’s primary return goal. Constraints Time horizon. Perpetuity, except for requirement to make an E8,500,000 cash distribution on June 30, 2025. Liquidity needs. None, of a day –to –day nature until 2025. Income is distributed annually after year-end. Tax consideration. None, this endowment fund is exempt from taxes. Legal and regulatory consideration. Minimal, but the prudent investor rule applies to all investment actions. 4 Unique needs, circumstances and preferences. The endowment fund must pay out to another tax- exempt entity the sum of E8,500,000 in cash on June 30, 2025. The assets remaining after this distribution will be retained by the fund in perpetuity. The endowment fund has adopted a ‘spending rule’ requiring a first-year current income payout of E500,000; thereafter, the annual payout is to rise by 3% in real terms. Until 2025, annual income in excess of that required by the spending rule is to reinvestment. After 2025, the spending rate will be reset at 5% of the then- existing capital. With this information and information found in other publications, do the following: 2.1.1 Formulate an appropriate investment policy statement for the endowment fund. (7 Marks) 2.1.2 Identify and briefly explain three major ways in which your firm’s initial asset allocation decisions for the endowment fund will be affected by the circumstances of the account. (8 Marks) 2.2 Desmond Tutukhile, is evaluating his investment alternatives in Ytel Incorporated by analyzing a Ytel convertible bond and Ytel common equity. The characteristics of the two securities are given in the following Table 2.1: Characteristics Convertible Bond Common Equity Par value E1,000 - Coupon (annual payment) 4% - Current market price E980 E35 per share Straight Bond Value E925 - Conversion ratio 25 - Conversion option At any time - Dividend - E0 Expected Market Price in 1 Year E1,125 E45 per share Table 2.1 Required. 2.2.1 Calculate the market conversion price for the Ytel convertible bond. (2 Marks) 2.2.2 Calculate the Expected one-year rate of return for the Ytel convertible bond. (2 Marks) 5 2.2.3 Expected one-year rate of return for the Ytel common equity. (2 Marks) 2.3 One year has passed and Ytel common equity price has increased to E51.00 per share. Also, over the year, the yield to maturity on Ytel’s non-convertible bonds of the same maturity increased, while credit spreads remain unchanged. Name two components of the convertible bond’s value. Indicate whether the value of each component should decrease, stay the same, or increase in response to the: 2.3.1 Increase in Ytel’s common equity price (2 Marks) 2.3.2 Increase in bond yield. (2 Marks) ‘ 6 APPENDIX 1 HPR:= ])([)( FMiFi RRERRE Sharpe measure = Treynor measure = Jensen (Alpha) p =