FALL 2023 EFIN/MFIN 304 INVESTMENT MANAGEMENT Building a portfolio by using a combination of instruments with maximum returns and just the right amount of risk is key to successful investing. In

An investment project will require development costs of $120 million at time zero and $80 million at the end of second year from time zero with incomes of $25million per year at the end of years 1, 2 and 3 and incomes of $60 million per year at the end of years 4through 10 with zero salvage value predicted at the end of year 10. Calculate the rate of return for this project.

1. Select three different corporate bonds from three different companies. The bonds must have years to maturity at least 5 years apart from each other. One of the bonds should be issued by the company evaluated by your group in the first written assignment. a. A good bond data resource is: http://finra-markets.morningstar.com/ 2. Calculate the duration of each bond and the duration of a bond portfolio investing equally in the three bonds. 3. For reference purposes, select an additional two bonds issued by the companies from step 1 that match the longest maturity bond in your portfolio (i.e., you will analyze 5 bonds in total) a. Example: In step 1 you use a 2030 bond for Co. A, a 2040 bond for Co. B and a 2045 bond for Co. C. So, you choose a 2045 bond from Co. A and a 2045 bond from Co. B to be able to compare to the already selected 2045 bond from Co. C. b. Provide the key details for the additional bonds including spread to treasury. These two bonds are not included in your portfolio but will be useful in your overall analysis. 4. Your research indicates: a. Treasury bond rates will increase, and, b. The spread between corporate bonds and Treasury bonds will widen. 5. Forecast a change in yields for the three bonds in your portfolio. Discuss the properties of your three-bond portfolio with respect to returns and risk (interest rate risk and default risk). Including: What assumptions drive your change in treasury bond rates? What assumptions drive your change in spreads for each bond? How would you change the weights of the bonds in the portfolio (from equal) to take advantage of your research? How would you quantify the impact? What happens to the interest rate risk and default risk in your portfolio?

Question 1. Answer all parts of the question. I. The following table shows a market where there are only three assets, and in the next time period, one of three possible outcomes will occur. State Probability E(r) City Lama Wool Excellent 0.3 16% 1.5% 25% James Alp Delta Good 0.5 (b) Calculate and interpret the returns correlation for each pair of assets. 13% 1.5% 18% (a) Calculate and interpret the expected return and standard deviation for each asset. (11 marks) (5 marks) E(r) 16.4% 9.25% 12% 12% II. The table presents the annual expected returns and standard deviations for three portfolios and for the market index: Asset Poor 0.2 6% 1.5% 4% Standard deviation 19.25% 11.30% 13.125% 13.75% Market index The risk-free rate of interest is 1%. This stock market is in equilibrium according to the capital asset pricing model (CAPM). (a) Calculate and interpret the beta value of each of these three portfolios. (5 marks) (b) Do these three portfolios lie on the Capital Market Line and what do you conclude from this? (7 marks) (c) Two new assets, Nick and Roll, are introduced to this market at prices which imply expected returns of 9% and 16%, respectively. The expected beta values are 0.9 and 1.25, respectively. Do Nick and Roll lie on the Security Market Line and what do you conclude from this? (8 Marks) III. Critically analyse the advantages and disadvantages of direct/individual investment in stock and bonds versus investment in Mutual funds. (14 marks) [Total 50 marks] Page 3 of 5/nQuestion 2. Answer all parts of the question. I. Consider the following three bonds: Bond N £1,000 8% Bond S £1,000 5% Bond T £1,000 Par Value Coupon Zero Time to Maturity 7 years Required Yield 5% (a) Calculate and interpret the present values of each bond. (b) Calculate and interpret the Macaulay Duration for each bond. 4 years 5% 5 years 5% (11 marks) (7 marks) (c) If required yield increases from 5% to 6%, discuss the action that a bond portfolio manager should take in this situation. (3 marks) II. You are considering a new project that costs £2000m and you have estimated the following cash flows: Year 1: £300m; Year 2: £400m; Year 3: £1400m. If the discount rate is 9%, do you recommend the project? (4 marks) III. Discuss, providing examples, the similarities and differences between Active versus Passive investment strategies, and then explain the roles or responsibilities of portfolio managers in an efficient market environment. (25 marks) [Total 50 marks] Question 3. Answer all parts of the question. I. Discuss, providing insights from relevant literature, the main characteristics of external credit rating agencies and the key roles of credit ratings in financial markets. (25 marks) II. Discuss, providing examples, the motivation for hedging, speculation and arbitrage in financial markets. (25 marks) [Total 50 marks] Page 4 of 5/nQuestion 3. Answer all parts of the question. L. Discuss, providing insights from relevant literature, the main characteristics of external credit rating agencies and the key roles of credit ratings in financial markets. (25 marks) II. Discuss, providing examples, the motivation for hedging, speculation and arbitrage in financial markets. (25 marks) [Total 50 marks] Page 4 of 5/nQuestion 4. Answer all parts of the question. L. Consider the following information about Kaplan and Morris for one-time period: Expected return Standard Deviation 16% 24% Stock Kaplan Morris 18% 26% You invest 40% of your fund in Kaplan and 60% in Morris. (a) Calculate and interpret the expected return of your portfolio. (3 marks) (b) Calculate the standard deviation of returns on your portfolio, and interpret your results, for the following two different scenarios: (10 marks) i. the correlation coefficient between the returns for Kaplan and Morris is +0.55'. ii. the correlation coefficient between the returns for Kaplan and Morris is *-0.80. II. Suppose you have a portfolio of Koll and Nell with a beta of 1.6 and 0.7, respectively. If you put 60% of your money in Koll, 35% in Nell and 5% in the risk-free asset, calculate and interpret the beta of your portfolio. (4 marks) III. An investor wishes to: (1) have a shareholding in only one company, Jax, with a beta of 1.25, and (ii) have a portfolio with a beta value of one. What is your advice as to how the investor can achieve these twin objectives? (4 marks) IV. The share price of Carl is currently £250 and the last dividend was £5. The analyst is predicting a dividend growth rate of 6% and the required rate of return is 8%. According to the Gordon Growth model, is Carl's stock fairly priced? (4 marks) V. Analyse, providing examples, the steps involved in the process of portfolio investment. (25 Marks) [Total 50 marks] Page 5 of 5

A. What is the balance of liabilities and equity (i.e., the capital structure) for each company, and what is the composition of equity for each (i.e., what items are listed in the equity section of the balance sheet)? B. What is your opinion about management's decision about the composition of equity? C. How is each company's decision-making process affected by its composition of equity? D. What changes has each company made to the composition of equity in the last few years, and for what purpose? E. What is your opinion regarding these changes? F. How are the retailers similar to each other in their decisions about capital structure? G. How are the service providers similar to each other in their decisions about capital structure? H. How are the retailers (as a group) different from the service providers (as a group) in their decisions about capital structure? I. How are the manufacturers similar to each other in their decisions about capital structure? J. How are the manufacturers (as a group) different from the service providers (as a group) in their decisions about capital structure?

For each portfolio • explain the reasoning for your stock selection and weighting relative to the index • attach screenshots of your portfolios created in Workspace • report your results for each portfolio • provide comments on the total return/risk and active return/risk of your portfolios • discuss the sectors and securities' active weights in your portfolio • analyse the active return of your portfolios with reference to the allocation and selection effects What was the overall performance of the active portfolio, your passive portfolio and the benchmark index? describe any major market events that contributed to the return performance of the benchmark or of your portfolios • have you achieved (or not achieved) the goal for your passive/active portfolio Finally, which of the two portfolios will you recommend and why? RMIT Equity Investment and Portfolio Management UNIVERSITY Page 3 of 6

) IPO Underpricing. In 1980, a certain assistant professor of finance bought12 initial public offerings of common stock. He held each of these for approximately one month and then sold. The investment rule he followed-was to submit a purchase order for every firm commitment initial public-offering of oil and gas exploration companies. There were 22 of these-offerings, and he submitted a purchase order for approximately $1,000 in-stock for each of these companies. With 10 of these, no shares were allocated to the assistant professor. With 5 of the 12 offerings that were purchased, fewer than the requested number of shares were allocated. The year 1980 was very good for oil and gas exploration company owners:On average, for the 22 companies that went public, the stocks were selling for 80 percent above the offering price a month after the initial offering date.The assistant professor looked at this performance record and found that the$8,400 invested in the 12 companies has grown to $10,000, representing a return of only about 20 percent (commissions were negligible). Did he have bad luck, or should he have expected to do worse than the average initial public offering investor? Explain

4. Using the following two independent situations, calculate the ROI and ROI bonus for each branch both before and after the investment opportunity. Comment on any noted differences.

Considering discount rate of 8%, calculate NPV,Benefit Cost Ratio, and Present Value Ratio for the following investment and explain if it is a good investment. C: Cost, I:Income, L: Salvage value \text { ó, calculate NPV, } Value Ratio for the n if it is a good

1. Capital budgeting. Calculate initial investment, appropriate cash flows, and use the net present value criteria to evaluate the following investment opportunity: a. Initial investment: b. Intermediate cash flows (or their PV) C. Net present value: d. Accept/reject? Why?

15 The "father" of modern portfolio theory is: (a) Markowitz. (b) Friedman. (c) Samuelson. (d) Sharpe. 16. To describe the random variable of the portfolio rate or return, the investor needs (a) mean and coefficient of correlation. (c) only the expected value. (b) median and standard deviation. (d) expected value and standard deviation. 17. Portfolio Á has an expected return of 16% with a standard deviation of 8%. Portfolio B has an expected return of 12% with a standard deviation of 7%. (a) Portfolio A has a lower risk/return. (b) Portfolio B has a larger expected terminal wealth. (c) The portfolios have the same risk/return. (d) Portfolio B has a more certain return. 18 For an investor's indifference curve (a) each portfolio on the curve has the same standard deviation. (b) all portfolios on the curve are equally desirable. (c) he will choose the portfolio where his set of curves intersect. (d) he will prefer a portfolio that lies to the "southeast" of the curve. 19. The development of an investor's indifference curves is based on (b) correlation theory. (c) economic theory. (a) cognitive psychology. (e) probability theory. (d) utility theory. 20. Modern Portfolio Theory assumes (a) risk averse. (c) not concerned with risk. investors are (c) is risk neutral. (d) is risk-seeking. (b) risk seekers. (d) risk neutral. 21. Assuming investor non-satiation, an investor (a) will choose the portfolio with the lowest risk. (b) will choose the portfolio with the highest return for a given level of risk.