Investment Management Exam: Comprehensive Solution to Mock Test 1

This document presents a detailed solution to an Investment Management mock exam, covering various key concepts and calculations. It includes problems related to expected return and standard deviation of securities, return on investment with leverage, bond pricing using the present value formula, and the application of the Capital Asset Pricing Model (CAPM) to determine the required rate of return and fair value of stocks under different dividend growth scenarios. Furthermore, the solution addresses option pricing, including the calculation of intrinsic value and time value for call options, and concludes with an analysis of daily stock price fluctuations. This comprehensive solution aims to aid students in understanding and mastering investment management principles, and similar resources can be found on Desklib.

INVESTMENT
MANAGEMENT
INDIVIDUAL EXAM MOCK
TEST
1

Table of Contents
Question 1....................................................................................................................................2
Question 2....................................................................................................................................3
Question 3....................................................................................................................................3
Question 4....................................................................................................................................4
Question 5....................................................................................................................................4
Question 6....................................................................................................................................5
Question 7....................................................................................................................................6
2

Question 1
Return (%)
(R)
Probability
(P)
Expected
return
(R) * (P)
D = R -
Expected
return on
security
D2 =
D*D P* D2
6 0.05 0.3 -3 9 0.45
7 0.1 0.7 -2 4 0.4
8 0.2 1.6 -1 1 0.2
9 0.3 2.7 0 0 0
10 0.2 2 1 1 0.2
11 0.1 1.1 2 4 0.4
12 0.05 0.6 3 9 0.45
Total 9 2.1
3

Expected return on
security 9
Variance 2.1
Standard deviation 1.449138
Question 2
Purchase
price $20,000
Sale
price $25,000
Holding
period 1 year
Item
number Item Choice B (90% Leverage)
1 Initial equity 2000
2 Loan Principle 18000
3 Sales price 25000
4 Capital gain [(3) - (1) - (2)] 5000
5 Interest cost [0.09*(2)] 1620
6 Net return [(4) - (5)] 3380
Return on investors equity[(6)/(1)] 169%
Question 3
Bond Price Formula = Bond Price = ∑(Cn / (1+YTM)n )+ P / (1+i)n
((70/(1+5%)^1)+(70/(1+5%)^2)+(70/(1+5%)^3)+(70/(1+5%)^4)+(70/(1+5%)^5)+(70/
(1+5%)^6)+(70/(1+5%)^7))
Par value of the bond 1000
Coupon rate (7%) 70
Maturity (number of 4
4

years)
Yield/ Interest rate 5%
Bond Price 405.0461
Question 4
A.
Calculation of Required rate of return using CAPM model:
RRR = Risk free rate of return + Beta * Equity risk premium
= 2.0% + 1.5 * 5.0%
= 9.5%
B.
The fair value for the company’s share price under a Zero growth dividend discount model is as
follows:
Value of Stock = Expected dividend per share / (cost of capital equity – Dividend growth rate)
= $6 / (9.5% - 0%)
= $6 / 9.5% = $63.15789
C.
The fair value per share of company in the case when its dividend growth rate is 4% per year:
= Expected dividend per share / (cost of capital equity – Dividend growth rate)
= $6.24/ (9.5% - 4%)
= $6.24/ 5.5% = 113.4545
Expected dividend = $6 + ($6 * 4%)
= $6 + 0.24
= $6.24
Question 5
5 A)
5

5.8 * 1 – .05 / 1 - .03
= 5.6
5B)
6.1 * 1 - .05 / 1 - .03
= 5.97
Question 6
Intrinsic value: Current price – Strike Price
a) BG Group:
1100 – 1078
= 22
b) BHP Biliton
1950 – 1903
= 47
c)
Time value:
Option premium + Intrinsic value
5.25 + 5
= 10.25
D)
Cost of carrying the stock is more. In case of the call price interest component further
added. The total amount of benefits generated in case of call option are more than the put option
which make this option more strategic and effective. This is required fact that the call option
derive more and better possibilities to generate return which make them more expensive than the
put option. Stock market is highly based on production to generate heavy return. In case of the
call options the predictions are more clear than the put option which make it more expensive by
nature.
E)
BHP Billitons
18.5 -3 (1900 – 1903)
6

= 15.5
Question 7
Day 0: 100
Day 1: 100 – 5%
= 95
Day 2:
95 – 3%
= 92.15
Day 3:
92.15 + 4%
92.16
7