Question 6:

a. Calculate the NPV for each project.

Year Project A Project B Project C

0 -7,020,000 -10,350,000 -14,875,000
1 3,180,000 1,050,000 3,400,000
2 4,230,000 2,200,000 5,000,000
3 5,125,000 4,530,000 6,125,000
4 5,975,000 5,275,000 6,590,000
5 6,395,000 7,140,000
6 7,500,000

Discount rate (k) 15.00%

Project A Project B Project C

NPV $5,729,701.44 $1,400,551.67 $6,449,679.75

Excel function: NPV = Initial cost + NPV(Discount rate; [Cash flow year 1; Cash flow year N])

b. Which project will you accept? Why?

As all three projects A,B and C have positive NPV during its life, both the three projects could all be accepted

However, if the manager want the best project with the best return, project C will be accepted as the
best choice as this project delivers the highest NPV among the three

Question 9:

a. To 2 decimal places calculate the total assets turnover for XYZ in 2022 (1 mark)

Total Assets Turnover = Net Sales / Average Total Net Assets

FY2022 FY2021
Net Sales $2,525.70
Total Assets $2,358.80 $2,507.10
Average Total Assets $2,432.95
Total Assets Turnover 1.04

b. In percentage terms and to 2 decimal places calculate the interest coverage ratio for XYZ for 2022 (1 mark)

Interest coverage ratio = Earnings Before Tax and Interest / Interest Expense

FY2022
EBIT $761.50
Interest Expense $101.20
Interest coverage ratio 7.52

c. Calculate the EBITDA margin for XYZ in 2022 in percentage terms to 2 decimal places (1 mark)

EBITDA Margin = EBITDA / Net Sales

 FY2022
EBITDA $1,191.40
Net Sales $2,525.70
EBITDA Margin 47.17%

d. Calculate the return on assets for XYZ over 2022 in percentage terms to 2 decimal places (1 marks)

Return on Assets = Net profit after tax from continuoning operation / Average Total Assets

FY2022 FY2021
Total Assets $2,358.80 $2,507.10
Average Total Assets $2,432.95
Net profit after tax $462.20
Return on Assets 19.00%

e. Calculate the return on equity for XYZ over 2022 in percentage terms to 2 decimal places (1 marks)

Return on Equity = Net profit after tax from continuoning operation / Average Total Equity

FY2022 FY2021
Total Equity $1,262.40 $1,266.50
Average Total Equity $1,264.45
Net profit after tax $462.20
Return on Equity 36.55%

f. Calculate the return on invested capital for XYZ over 2022 in percentage terms to 2 decimal places (2 marks)

Return on Invested Capital = (Net profit after tax + Interest Expense) / Average Total Invested Capital

FY2022 FY2021
Net profit after tax $462.20
Interest Expense $101.20
Total Invested Capital $1,213.60 $1,293.50
Average Total Invested Capital $1,253.55
Return on Invested Capital 44.94%

FY2022 FY2021
Short-term borrowings $0.00 $0.00
Long-term borrowings $308.50 $391.90
Interest-bearing Debt = Short-term borrowings + Long-term borrowings $308.50 $391.90
Shareholder's Equity = Issued Capital + Reserve Shares $905.10 $901.60
Total Invested Capital = Interest-bearing Debt + Shareholder's Equity $1,213.60 $1,293.50

Question 8:

a. Specify the swap cashflows

b. Calculate the borrowing costs and the benefit to each party from entering into the swap.

Step 1: Determine the mid-rate for fixed leg

Mid-rate fixed leg 10.55%

Step 2: Determine the mid-rate for floating leg

Mid-rate floating leg BBSW + 1.90%

Step 3: Determine which entity could borrow fixed rate at the most opportune rate

Party Fixed rate offering

Firm A 11.75%
Firm B 9.35%

<=> Comparative advantage: As firm B could borrow fixed rate at 9.35% which is cheaper than the cost of
borrowing at 11.75% of firm A, we could say that B has comparative advantage on borrowing fixed.

<=> As a result, B should enter the swap by borrowing fixed rate while A should enter the swap by borrowing floating
rate and the two parties then will swap with each other under the facilitation of the intermediary party (in this case is
you as the investment bank)

Step 4: Determine half of the intermediary fee on each leg

Half of the intermediary fee 0.075%

Step 5: Specify the swap cash flows for each parties entering the swap and their net results

Swap cash flows

A pays fixed rate at The bank pays fixed
10.625% for the bạnk rate at
10.475% for B
Party Investment Bank Party B
A ⇄ ⇄
↓ ↓
The bank pays B pays floating rate
floating rate at BBSW at BBSW + 1.975%
+ 1.825% for A for the bank

A enters the swap by borrowing B enters the swap by borrowing

floating rate at BBSW + 2.35% fixed rate at 9.35% which it has
which it has greatest greatest
comparative advantage comparative advantage

Net result
Party A
Borrowing floating rate at BBSW + 2.35%
Receiving floating rate at BBSW + 1.825% (for a cost of (BBSW + 2.35%) - (BBSW + 1.825%) = 0.525%)
Paying fixed rate at 10.625%
Resulting in paying fixed rate at 10.625% + 0.525% = 11.15% (for a benefit of 11.75% - 11.15% = 0.60%)

Bank
Receiving fixed rate at 10.625% and paying fixed rate at 10.475%, for a benefit of 10.625% - 10.475% =
0.15%
Receiving floating rate at BBSW + 1.975% and paying floating rate at BBSW + 1.825%, for a benefit of
 (BBSW + 1.975%) - (BBSW + 1.825%) = 0.15%
Resulting in a total benefit of 0.15% + 0.15% = 0.30%

Party B
Borrowing fixed rate at 9.35%
Receiving fixed rate at 10.475% (for a benefit of 10.475% - 9.35% = 1.125%)
Paying floating rate at BBSW + 1.975%
Resulting in paying floating rate at BBSW + 1.975% - 1.125% = BBSW + 0.85% (for a benefit of
(BBSW + 1.45%) - (BBSW + 0.85%) = 0.60%)

Question 7:

a. Calculate the annualised return of the portfolio and the benchmark

Year Portfolio Return (Rp) Benchmark Return (Rb) Portfolio Index Benchmark Index
0 1.0000 1.0000
1 8.75% 10.50% 1.0875 1.1050
2 7.25% 3.75% 1.1663 1.1464
3 17.50% 13.25% 1.3705 1.2983
4 -6.50% -6.75% 1.2814 1.2107
5 11.25% 7.50% 1.4255 1.3015
Annualized Return (CAGR) 7.35% 5.41%

b. Calculate the portfolio alpha

Year Portfolio Return Benchmark Return (Rb) Portfolio Index Benchmark

(Rp) Index
0 1.0000 1.0000
1 8.75% 10.50% 1.0875 1.1050
2 7.25% 3.75% 1.1663 1.1464
3 17.50% 13.25% 1.3705 1.2983
4 -6.50% -6.75% 1.2814 1.2107
5 11.25% 7.50% 1.4255 1.3015
Annualized Return (CAGR) 7.35% 5.41%
Portfolio Alpha (α) 1.94%

c. Calculate the tracking error of the portfolio (2 marks)

Year Portfolio Benchmark Portfolio Benchmark Difference Rp - Rb Square of difference (Rp -

Return (Rp) Return (Rb) Index Index Rb)^2
0 1.0000 1.0000

1 8.75% 10.50% 1.0875 1.1050 -1.7500% 0.000306250

2 7.25% 3.75% 1.1663 1.1464 3.5000% 0.001225000

3 17.50% 13.25% 1.3705 1.2983 4.2500% 0.001806250

4 -6.50% -6.75% 1.2814 1.2107 0.2500% 0.000006250

5 11.25% 7.50% 1.4255 1.3015 3.7500% 0.001406250

Annualized Return (CAGR) 7.35% 5.41% 0.0000% 0.000000000

 Portfolio Alpha (α) 1.94%

Sum 0.004750000

Tracking error (σTE) 0.03082207

d. Calculate the information ratio of the portfolio (1 mark)

Year Portfolio Return Benchmark Return Portfolio Benchmark Difference Rp - Square of difference (Rp -
(Rp) (Rb) Index Index Rb Rb)^2
0 1.0000 1.0000
1 8.75% 10.50% 1.0875 1.1050 -1.7500% 0.000306250
2 7.25% 3.75% 1.1663 1.1464 3.5000% 0.001225000
3 17.50% 13.25% 1.3705 1.2983 4.2500% 0.001806250
4 -6.50% -6.75% 1.2814 1.2107 0.2500% 0.000006250
5 11.25% 7.50% 1.4255 1.3015 3.7500% 0.001406250
Annualized Return 7.35% 5.41% 0.0000% 0.000000000
(CAGR)
Portfolio Alpha (α) 1.94%
Sum 0.004750000
Tracking error (σTE) 0.03082207
Information Ratio 0.62829080
(IRp)

e. If the risk free rate is 1.75%, the return of the market is 9.85%, the value risk premium is 2.15%, the small cap premium is
2.03%, the momentum premium is 43.10% and the portfolio’s exposure to these three factors was -0.41, -0.58, and 0.23,
respectively, as a percentage to 2 decimal places determine the amount of Carhart’s alpha that was produced by the manager of
the portfolio (2 marks)

Actual Return 7.35%

Coefficients Risk premia

β 1.00 ERP 8.10%
h -0.41 HML (Value premium) 2.15%
s -0.58 SMB (Small cap premium) 2.03%
u 0.23 UMD (Momentum factor) 43.10%

Rm 9.85%
RFR 1.75%

Estimated Return 17.70%

Cahart's Alpha -10.36% Cahart's Alpha = Actual Return - Estimated Return

Question 4:

a. What is the expected return on this portfolio, in percentage terms?

Asset Beginning Price Ending Price HPR HPY (E(Ri)) Weight (Wi) Wi x E(Ri)
A $5.52 $6.24 1.1304 13.04% 25.00% 3.26%
B $4.73 $4.91 1.0381 3.81% 25.00% 0.95%
 C $17.05 $18.26 1.0710 7.10% 25.00% 1.77%
D $214.89 $217.82 1.0136 1.36% 25.00% 0.34%
Total 6.33%

E(Rp) 6.33%

b. What is the value of this portfolio after 12 months in dollars and cents?

Initial Investment $3,800,000.00

E(Rp) 6.33%
Investment Horizon (years) 1
Future Value of Investment $4,040,437.76

c. What is the standard deviation of this portfolio?

Variance Table A B C D Portfolio

A 0.00490000 0.00171500 0.000735 -0.0002625 -
B 0.00171500 0.00122500 0.00024500 -0.00013125 -
C 0.000735 0.00024500 0.00030625 -0.000021875 -
D -0.0002625 -0.00013125 -0.000021875 0.00015625 -
Column totals 0.0070875 0.00305375 0.001264375 -0.00025938 -
Portfolio Variance - - - - 0.01114625
Portfolio Standard Deviation - - - - 0.10557580

Question 2:

a. Describe the shape of the yield curve.

Bond 1 has time to maturity is on 13 August, 2029 which provides yield to maturity at 1.82% per annum
While bond 2 has time to maturity is on 14 December, 2029 which provides yield to maturity at 1.95% per annum
We could see that when time to maturity increases, the yield on bond also increases. Therefore, the shape of the yield curve is normal

b. What is the fair market price for?

I. Bank bill 1

Face Value (FV) $3,870,000.00

Yield on Bank Bill (y) 0.98%
Days to maturity (N) 15
Present Value (PV) $3,868,442.02

II. Bank bill 2

Face Value (FV) $10,510,000.00

Yield on Bank Bill (y) 1.73%
Days to maturity (N) 204
Present Value (PV) $10,409,351.55

III. Bond 1 (4 marks)

13/2/2023 21/7/2023 13/8/2023 13/8/2029

Face Value $2,460,000 f 23

Coupon rate 2.15% d 181
Maturity date 13/8/2029 f/d 0.12707182
Yield to maturity (YTM) 1.82% i/2 0.0091
Last Coupon Payment 13/2/2023 v 0.99098206
Valuation date 21/7/2023 n 12 12
Next Coupon Payment 13/8/2023 g 1.075
P 102.824
Price $2,529,470.40

IV. Bond 2 (4 marks)

14/6/2023 21/7/2023 14/12/2023 14/12/2029

Face Value $91,430,000 f 146

Coupon rate 2.47% d 183
Maturity date 14/12/2029 f/d 0.79781421
Yield to maturity (YTM) 1.95% i/2 0.00975
Last Coupon Payment 14/6/2023 v 0.99034414
Valuation date 21/7/2023 n 12 12
Next Coupon Payment 14/12/2023 g 1.235
P 103.363
Price $94,504,790.90

c. If you sold bond 2 at 33 days later at a yield of 1.725% how much profit would you make? What is your return over
this period? What is your annualised return? Compared with long term returns from cash, was this a good return?
Explain why? (6 marks)

Profit from bond trading

Purchase Sales
Face Value $91,430,000.00 $91,430,000.00
Valuation Date 21/7/2023 23/8/2023
Maturity Date 14/12/2029 14/12/2029
Copupon Rate 2.470% 2.470%
YTM 1.950% 1.725%
Next Coupon Payment 14/12/2023 14/12/2023
Last Coupon Payment 14/6/2023 14/6/2023

f 146 113
d 183 183
f/d 0.79781421 0.61748634
i/2 0.0097500 0.0086250
v 0.99034414 0.99144875
n 12 12 12 12
g 1.2350 1.2350
P 103.363 104.906
Price $94,504,790.90 $95,915,555.80
Capital Gain / Loss $1,410,764.90
Coupon Received $0.00
Total Profit / Loss $1,410,764.90
Total Return 1.49% in 33 days
Annualized Return 17.54% in 1 year (360 days)

As the annualized return from selling this bond is 17.54% which is much higher than the long-term return on cash at 1.01%,
this strategy decision could be said as a good investment after all

d. If you sold bank bill 2 at 86 days later at a yield of 1.34%:

Orginal Present Value $10,409,351.55

Face Value (FV) $10,510,000.00

Yield on Bank Bill (y) 1.34%
Days to maturity (N) 118
New Present Value (PV) $10,464,666.49

Total Profit / Loss $55,314.94

Total Return 0.53% in 86 days
Annualized Return 2.24% in 1 year (360 days)

As the annualized return from selling this bank bill is 2.24% which is much higher than the long-term
return on cash at 1.01%, this strategy decision could be said as a good investment after all

Question 3:

a) An investor isn’t sure which model is appropriate to value stocks and uses both CAPM and Fama-French to confirm the
CAPM

i. What is the problem with this approach?

The rationale of CAPM model is that only systematic risk (β and ERP) deserves to be borne, the investors who are willing to take
unsystematic risk in their portfolio will receive no rewards. Therefore, the CAPM model just consider the beta, or the measurement of
how sensitive the movement of price of stock is with the movement of the market.

On the other hand, Fama - French model assumes that value (HML) and size (SMB) are the additional risks and the exposure to two
of them (h and s) besides the systematic risk (β and ERP) in order to explain virtually all the performance of the portfolio, everything
else does not matter. While two models are proved to be true, they may lead to two different results as the assumption of stock
valuation is different. The comparison between results of two models, thus, seems not reasonable.

ii. What is the expected return of the stock using CAPM?

CAPM: E(Ri) = RFR + β x (E(Rm) - RFR) = RFR + β x ERP

RFR 1.75%
β 1.10
ERP 7.30%
E(Ri) CAPM 9.78%

iii. What is the expected return of the stock using Fama-French?

Fama-French: E(Ri) = RFR + β x ERP + s x SMB + h x HML

RFR 1.75%
β 1.00 In Fama models, β =
1 always
ERP 7.30%
s -0.46
SMB 2.15%
h -0.44
HML 7.10%
E(Ri) Fama 4.94%

iv. By how much does the asset’s expected return differ between the two models and does CAPM overvalue or undervalue the
stock?

E(Ri) CAPM 9.78%

E(Ri) Fama 4.94%
Difference 4.84%

As E(Ri) in CAPM is 9.78% higher than compared to in Fama-French is 4.94%, we could say the stock is overvalued under CAPM if
Fama-French is the comparison method

b. Suppose the above asset is observed in the market trading at a price such that its expected return was 6.75%.
What strategy would you suggest profiting from this situation, assuming:

i. The CAPM was the correct pricing model, and explain your reasoning

If CAPM method is correct, then the expected return 6.75% is lower than the estimated return at 9.78%, thus, the investor should take
advantage by short selling the stock because the stock is overvalued and the market pays less for the value the investors deserve to
receive when exposing to the sensitivity of the movement of stock with the movement of the market.

ii. The Fama-French three-factor model was the correct pricing model and explain your reasoning.

If Fama-French method is correct, then the expected return 6.75% is higher than the estimated return at 4.94%, thus, the investor
should take advantage by buying the stock because the stock is undervalued and the market pays more for the value the investors
deserve to receive when exposing to the three risks (systematic risk, value risk and size risks) of the stock.

c. Suppose you are considering the purchase of shares in the XYZ mutual fund. As part of your investment analysis, you
regress XYZ’s monthly returns for the past five years against the three factors specified in the Fama and French models.
This procedure generates the following coefficient estimates: market factor = 1.2, SMB factor = −0.3, HML factor = 1.4.
Explain what each of these coefficient values means. What types of shares is XYZ likely to be holding? (4 marks)

A market factor of 1.2 means the mutual fund is 1.2 times as sensitive as the market portfolio, all other factors held equal. The SMB
(‘small minus big’) factor is the return of a portfolio of small capitalisation shares minus the return to a portfolio of large capitalisation
shares. A value of –0.3 indicates the fund tends to react negatively to small cap factors; thus the fund is primarily invested in large
cap shares. The HML (‘high minus low’) factor is the return to a portfolio of shares with high ratios of book-to-market value less the
return to a portfolio of low book-to-market returns. A value of 1.4 indicates the fund reacts positively to this factor; thus the fund is
weighted toward high value shares.

Question 5:

a. What is the expected outcome with respect to the asset’s value?

Initial investment $3,430,000.00

Investment Horizon (years) 1
 Scenario Value return (FVi) Probability (Pi) FVi x Pi
1 $3,275,000.00 10% $327,500.00
2 $3,380,000.00 25% $845,000.00
3 $3,760,000.00 45% $1,692,000.00
4 $3,025,000.00 20% $605,000.00
Total $3,469,500.00

Expected Value of Investment $3,469,500.00

b. What is the expected return on the asset?

Scenario Value return (FVi) Probability (Pi) Return (E(Ri)) Pi x E(Ri)

1 $3,275,000.00 10% -4.52% -0.45%
2 $3,380,000.00 25% -1.46% -0.36%
3 $3,760,000.00 45% 9.62% 4.33%
4 $3,025,000.00 20% -11.81% -2.36%
Total 1.15%

Expected return 1.15%

c. What is the expected standard deviation of the return of the asset?

Expected return E(Rp) 1.15%

Scenario Value return (FVi) Probability (Pi) Return (E(Ri)) E(Ri) - E(Rp) [E(Ri) - E(Rp)]^2 Pi x [E(Ri) - E(Rp)]^2
1 $3,275,000.00 10% -4.52% -5.67% 0.0032155 0.00032155
2 $3,380,000.00 25% -1.46% -2.61% 0.0006809 0.00017022
3 $3,760,000.00 45% 9.62% 8.47% 0.0071731 0.00322787
4 $3,025,000.00 20% -11.81% -12.96% 0.0167940 0.00335881
Total 0.00707845

Variance 0.00707845
Expected standard 0.08413352
deviation

d. What is the coefficient of variation of the asset?

Expected return 1.15%

Expected standard deviation 0.08413352
Covariance coefficient (CV) 7.3058

e. What is the fair value of a stock that has a dividend just paid of $2.04, which is expected to grow indefinitely at 2.42% pa,
and that stock has a cost of capital of 9.75%? (1 mark)

Dividend just paid (D0) $2.04

Dividend growth rate (g) 2.42%
Dividend year 1 (D1) $2.09
Cost of capital (k) 9.75%
Fair value of stock $28.50 P0 = D1 / (k-g) = D0 x (1+g) / (k-g)
f. If the expected future dividend yield of a stock is 3.17% and the stock’s cost of capital is 10.25%, what is its expected
growth rate? (1 mark)

Cost of capital (k) 10.25% P0 = D1/(k-g) <=> 1 = (D1/P0) / (k-g) <=> 1 = Dividend yield / (k-
g)
Dividend yield 3.17% <=> k - g = Dividend yield <=> k = Dividend yield + g

Capital gain yield (g) 7.08% <=> Required return = Dividend yield + Capital gain yield

Where g = Expected growth rate = Capital gain yield

We have: Expected growth rate = Capital gain yield = 7.08% (See explannation for more clear)

g. If a stock with an expected infinite growth rate of 2.41% pa is trading at $98.45, what must its cost of capital be to justify
the assumption of the next dividend being $6.82? (1 mark)

P0 = D1 / (k-g)
<=> $98.45 = $6.82 / (k - 2.41%)
<=> k = 0.0934 = 9.34%

Therefore, cost of capital = k = 9.34%

h. What is the post-tax dividend per share received by an investor who pays marginal tax at 25% where the
company has earnings of $175 on which it pays tax at 28%, has a 90% payout ratio and the dividend is
franked at 80%? (1 mark)

Company Earnings $175.00

Company Tax Rate 28.00%
Franking Level 80.00%
Less Company Tax $39.20
Amount Available for Dividend $135.80
Dividend Payout Ratio 90.00%
Dividend $122.22
Grossed Up Dividend $157.50
Shareholder Marginal Tax Rate 25.00%
Tax on Grossed Up Dividend $39.38
Franking Credit $35.28
Tax Payable $4.10
Post-tax Dividend $118.13

i. In dollars and cents, what would you pay for a company that generated profits of $1.85 per share on its 120 million shares
from which it paid a dividend of $ 0.87 per share and has equity capital of $2050 million if it’s cost of capital is 11.85%?

Earnings per share (EPS) $1.85

Dividend per share (DPS) $0.87
Dividend payout ratio 47.03% Dividend payout ratio = DPS / EPS
Rentention Ratio (RR) 52.97%
Number of shares 120,000,000
Net Profit $222,000,000
Total Equity $2,050,000,000
Return on Equity (ROE) 10.83% ROE = Net Profit / Total Equity
Dividend growth rate (g) 5.74% g = RR x ROE
Dividend year 1 (D1) $0.92
Cost of capital (k) 11.85%
Present value of stock $15.05 P0 = D1 / (k-g) = D0 x (1+g) / (k-g)

Question 1:

a. Identify the three most important determinants of the price of a bond. Describe the effect of each. (4 marks)

The three factors affecting the price of a bond are coupon, yield and term to maturity. The relationship between price and coupon is
a direct one – the higher the coupon, the higher the price. The relationship between price and yield is an inverse one – the higher
the yield the lower the price, all other factors held constant. The relationship between price and maturity is not so evident. Price
changes resulting from changes in yields will be more pronounced, the longer the term to maturity.

b. Discuss the difference between a foreign bond (e.g., a Samurai) and a Eurobond (e.g., a Euroyen issue). (3 marks)

The difference between a foreign bond and a Eurobond can be broken down as a difference in issuer and the market. For example,
a foreign bond in Japan (e.g., a Samurai) is denominated in the domestic currency (yen) and is sold in the domestic market
(Japan), but it is sold by non-Japanese issuers. On the other hand, a Eurobond is denominated in the domestic currency (yen) but it
is sold outside the domestic country in a number of national markets. These bonds are typically underwritten by international
syndicates. The relative size of these two markets varies by country.

c. Is it better to buy a high coupon bond or a low coupon bond? (3 marks)

Neither is necessarily better, as the market prices each to reflect the size of the coupon. Investors wanting higher current income
may prefer to hold high coupon bonds. Other investors may not wish to have high current income, especially if the income is
taxable.