BBS Fundamentals of Investment

State four money market vehicles.

Describe the investment processes for financial assets in Nepal.

Describe present investment environment in Nepal. Discuss the different types of security markets in Nepal.

Distinguish between investment and speculation.

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

What is investment? Explain different types of investments.

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

What do you mean by investment plan?

Describe the status of investment environment in Nepal.

What are the systematic steps involved in investing? How do the considerations about taxes, life cycle of investors and different economic environment affect investment?

List out any four investment vehicles available in Nepal.

What do you mean by an investment banker? Describe the roles of investment bankers in securities offering process.

What are the different phases of economic cycle? How do they impact on the stock and bond investment? Also discuss the different components of investment environment in Nepal?

List out the differences between individual investors and institutional investors.

Describe major types of investment vehicles? Which of these investment vehicles are most common in Nepalese financial market? Explain.

Gautam short sells 2,000 stocks at Rs. 100 per share. The initial margin requirement is 60 percent and maintenance margin is 30 percent

a. What would be Gautam's amount of margin equity and margin loan if stock price rises to Rs. 115 per share?

b. What is the margin call price of stock? Would Gautam receive margin call if the market stock price rises to Rs. 115 per share?

c. What is Gautam's rate of return from short sells of stock if stock price falls to Rs. 80 per share assuming no interest on margin?

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

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.

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?

List out the uses of market index.

Differentiate between market order and limit order.

What do you mean by fixed income securities? Describe major types of fixed income securities.

Assume that you sell short 500 shares of BOK stock for Rs. 200 per share. Your short margin account requires you to maintain 60 percent initial margin and 30 percent maintenance margin.

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

b. If stock price increase to Rs. 250 per share, what will be the value of equity, debt and actual margin in your short margin account?

c. Do you receive a margin call if stock price increases to Rs. 250? Explain.

Define primary market.

Why do we compute market index?

A stock sells for Rs. 150 per share. You purchased 100 shares for Rs. 150 a share, and after a year the price rises to Rs. 175. Initial margin requirement was 60 percent.

a. What will be the percentage return on your investment if you bought the stock on margin? Ignore commissions, dividends, and interest expenses.

b. Determine the percentage return on your investment but in this case suppose the company pays dividend Rs. 15 per share and interest on loan is 10 percent per annum.

c. In calculating the return on investment you ignored commissions expenses. Describe how does commissions affect the return on your investment?

Is short selling more or less risky than long purchase? Why?

Assume that you sold short 250 shares for Rs. 200 per share. The initial margin and maintenance margin requirements were 55 percent and 25 percent, respectively. At what stock price will there be a margin call?

Subham Hamal purchased 500 shares of BOK stock at Rs. 400 per share using initial margin requirement of 50 percent. He held the stock for exactly four months and sold it at the end of that period. During the four-month holding period, the stock paid Rs. 11 per share in cash dividends. He was charged an 8% annual interest on the margin loan. The minimum maintenance margin was 25%.

a. Calculate the initial value of the transaction, the debit balance, and equity position on Subham's transaction. b. Calculate the actual margin percentage, and indicate whether Subham's margin account would have excess equity, would be restricted, or would be subject to margin call, if the stock price rises to Rs. 700 per share. c. Calculate the rupee amount of dividend received and interest paid on the margin loan during the four-month holding period.

What are the major sources of investment information?

Consider the following three stocks given in the following Table. Q represents number of shares and P represents price of stock.

Stock Beta splits two-for-one on day 2.

a. Calculate price weighted indexes (PWI) for Day 0, Day 1 and Day 2.

b. What would be return for the day 1 based on PWI?

c. Calculate value weighted indexes (VWI) for Day 1 and Day 2, assume base index is 100.

d. What would be rate of returns for day 2 based on value weighted index?

What is long purchase? Illustrate with an example.

Consider the following stock price and no. of shares information:

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.

Consider the following price information on three stocks on two dates with corresponding number of shares outstanding:

a. Construct a price-weighted index for these three stocks, and also compute the percentage change in the index the period from 2018 to 219.

b. Construct a market value weighted index for these three stocks and also compute the percentage change in the index for the period from 2018 to 2019.

c. Construct an equally-weighted index. What is the percentage change in wealth for this equally-weighted portfolio?

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

What do you mean by short sale?

Consider the following stock price and shares outstanding information:

Stock B splits two for one at the end of 2018.

a. Compute the price-weighted index for two periods and the rate of return on price weighted index in 2019.

b. Compute value weighted index for two periods and the rate of return on value weighted index in 2019.

c. Why are they different?

How does a market order differ from a limit order?

Assume that the following quote for the Mega stock was obtained from Tuesday, February 6, issue of a financial newspaper.

Given this information, answer the following questions:

a. On what day did the trading activity occur?

 b. What is the firm's price-earnings ratio? What does that indicate?

c. What is the last price at which the stock traded on the date quoted?

d. How large a dividend is expected in the current year?

e. What are the highest and lowest prices at which the stock traded during the latest 52 week period?

f. How many shares of stock were traded on the day quoted?

g. At what price did the stock close on the immediately preceding day?

Assume that the risk-free rate is 6 percent and the market risk premium is 5 percent. What is the required rate of return on stock X with its beta of 1.30? Would you like to sell the stock X if its expected rate of return is 10 percent?

State major sources of risk.

Consider the following probability distribution and returns of stock M and stock N:

a. Calculate expected returns of stock M and stock N.

b. Estimate standard deviations of stock M and stock N.

c. Calculate coefficient of variations of stock M and stock N. Which stock would you prefer to invest?

 d. Compute the correlation coefficient between returns of stock M and stock N.

 e. If you form a portfolio with your investment of 45 percent funds in stock M and 55 percent funds in stock N, calculate the expected portfolio return and risk.

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?

Consider the following subjective probability distribution of returns on Stock X and Stock Y for a potential investment.

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?

You have been provided the following returns data of three assets for your advice in selecting a portfolio of assets:

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?

Calculate the yield on a investment with Rs. 10,000 today that promises to payback Rs. 15,000 at the end of 5 years? Is this investment a good if your required rate of return is 9 percent?

A stock paid Rs. 40 dividend last year. The dividend is expected to grow at 6 percent rate for foreseeable future. If stock's current selling price is Rs. 500, what is the expected return on this stock?

A stock has a beta of 1.8 the expected return on the market is 15 percent, and the risk-free rate is 5 percent. What must the expected return on this stock be? If return on stock is 20 percent would you purchase the stock?

The probability distribution and expected return on Stock A and B are provided below:

Assume that an investor has Rs. 500,000 to invest, which he/she invests dividing equally in stock A and B.

a. What are the expected returns and standard deviations of each stock?

b. What are the covariance and correlation coefficient between returns from Stock A and B?

c. What are the portfolio return and standard deviation of the portfolio?

d. Do you prefer to hold Stock A or B or the Portfolio? Explain.

e. Suppose risk-free rate is a 4 percent, market return is 10 percent, and Stock A and B have beta coefficients of 0.5 and 1.1, respectively. Are these stocks fairly priced? Overvalued? Undervalued? Explain.

What is systematic risk?

New National Company had sales of Rs. 55 million in 2019, and is expected to have sales of Rs. 83,650,000 for 2020. The company's net profit margin was 5 percent in 2019, and is expected to increase to 8 percent by 2020. Estimate the company's net profit for 2020.

A stock has a beta of 1.5, the expected return on the market is 12 percent, and the risk-free rate is 6 percent. What must the expected return on this stock be? If stock's return in 16 percent would you purchase the stock ? 

You are given the following probability distribution of alternative rate of return associated with three investment alternatives along with their beta coefficient.

a. Which alternative provides highest expected return?

b. Which alternative is the least risky in terms of standard deviation? Which alternative is the most risky in terms of beta?

c. Suppose you created two portfolios—portfolio X and portfolio Y. Portfolio X consists of 75 percent investment in Equity Fund A and 25 percent investment in Stock B. Portfolio Y consists of equal investment in Stock B and Certificate of Deposit C. Which portfolio is least risky in terms of (i) standard deviation, and (ii) beta?

Assume that you have invested Rs. 6,000 today in an investment alternative that promises to pay you Rs. 10,500 exactly in 9 years. What is the yield on this investment? If a minimum return of 7 percent is required, would you recommend this investment?

What do you mean by reinvestment risk?

The probability distribution and expected return on Stock X and Y are provided below:

Assume that an investor has Rs. 1 million to invest, which he invests dividing equally in Stock X and Y.

a. What are the expected returns, variances and standard deviations of each stock?

b. What is the correlation coefficient between returns from Stock X and Y?

c. Can you diversify the risk forming portfolio of these two stocks? Explain.

d. What are the portfolio return, variance and standard deviation of the portfolio? 

e. Do you prefer to hold Stock X or Y or both the Portfolio? Explain.

Distinguish between cash dividend and stock dividend.

What is the technical analysis of financial securities?

The current dividend on common stock of Alpha Company (AC) is Rs. 12 per share. The required rate of return on common stock of the company is 16 percent.

a. What is the present value of the Alpha's stock if the constant growth rate of earnings is 9 percent per year forever?

b. Suppose growth rates of earnings of the company are not constant. Growth rate of earnings of Alpha stock is 10 percent for the first three years and 6 percent thereafter. What would be the present value of the stock?

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?

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? 

The Pokhara Foods Private Limited has net income of Rs. 7.5 million, sales of Rs. 60 million, and 1,000,000 shares of common stock outstanding. The company has total assets of Rs. 150 million and total stockholders' equity of Rs. 110 million. It pays Rs. 4.5 per share in common dividends and the stock trades at Rs. 300 per share.

a. What is the company's EPS?

b. What is its book value per share and price-to-book-value-ratio?

c. What is the company's P/E ratio and What is its net profit margin?

d. What are its dividend payout ratio and dividend yield?

e. What is the stock's PEG ratio, given that the company's earnings have been growing, at an average annual rate of 5 percent?

This year, Mero Nepal Company paid its stockholders as annual dividend of Rs. 30 a share. A major brokerage firm recently put out a report stating that in its opinion, the company's annual dividends should grow at the rate of 10 percent per year for each of the next 3 years and then level off and grows at the rate of 6 percent a year thereafter. According to consensus estimate provided by analysts the stock beta is 1.4 percent, risk-free rate is 5 percent and market return is 14 percent.

a. What is the required rate of return on this stock?

b. What is the maximum price you should be willing to pay for this stock?

c. Define dividend yield and capital gain yield. What is the dividend yield and capital gain yield in year 4?

d. Now assume that after year 3, dividends stop growing altogether. What is the stock's intrinsic value?

Assume you have generated the following information about the stock of JBL Company: The company's latest dividends of Rs. 40 a share are expected to grow to Rs. 43.2 next year, to Rs. 46.7 the year after that, and to Rs. 50.4 in year 3. In addition, the price of the stock is expected to rise from Rs. 565 (its current price) to Rs. 777.50 in 3 years.

a. Using dividend discount model and a required return of 15 percent, what is the intrinsic value per share of the company's stock?

b. What is the stock's expected return using IRR procedure?

c. Given that dividends are expected to grow indefinitely at 8 percent and a 15 percent required rate of return, what is the intrinsic value per share of the stock?

d. Why do you think that a constant growth stock does not have \( g > k_s \)? Explain.

e. Assume that dividends in year 3 actually amount to Rs. 50.4, the dividend growth rate stays at 8 percent, and the required rate of return stays at 15 percent}. Using dividend valuation model to find the price of the stock at the end of year 3, do you note any similarity between your answer here and the forecasted price of the stock Rs. 777.5 given in the problem? Explain.

Write the meaning of fixed income securities.

Assume current market price of stock Y is Rs. 175, and constant growth rate is 10 percent. One convertible bond of Company Y can be converted into its 5 common stocks, what is the conversion value of the convertible present?

Write the role of primary market.

What is term structure of interest rates?

An 11 percent coupon bond of Rs. 1,000 par has 5 years maturity. The bond is currently selling in the market at Rs. 950 per bond. Assume coupon is paid annually.

a. What is the current yield of the bond?

b. What is the yield to maturity of the bond?

c. What is the capital gain of the bond?

d. Would you prefer to buy the bond at current prevailing price of Rs. 950 if your required rate of return is 12 percent?

e. Differentiate between yield to maturity and yield to call of the bond.

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?

 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?

Consider the following bonds outstanding.

Bond A: It has a coupon rate of 8 percent paid semi-annually and matures after 10 years. What will the price of this bond be if the market interest rate is 10 percent?

Bond B: It has a coupon rate of 10 percent (paid annually) and matures after 8 years. What will the price be if investors expect that the bond will be called with no call penalty after two years? Assume interest rates are currently 7 percent.

Bond C : It has a 9 percent coupon (paid annually), a maturity date of 10 years and is selling for Rs. 939. What is its current yield? What is the YTM?

Bond D: 10 percent coupon bond with 4 years maturity, yield to maturity is 12 percent. Calculate duration of Bond D.

Bond E & F: Bond E matures after five years and has a coupon rate of 8.25 percent. Bond F matures after 10 years and has a coupon rate of 8.25 percent. Market interest rates are currently 10 percent (i) Given the same coupon rate for both bonds and the same market interest rate, does the price of each bond differ? (ii) If so, why are these prices different?

A convertible bond has a conversion ratio of 20. The current market price of the underlying common stock in Rs. 49. What is the bond's conversion value?

Consider a bond selling at its par value of Rs. 1,000 with three years to maturity and a 7 percent coupon rate with annual interest payments.

a. What is the yield to maturity on this bond?

b. Calculate the bond's duration.

c. Calculate the bond's modified duration.

d. If market interest rate increases to 7.5 percent, what is the percentage price change on this bond?

Bond A has a coupon rate of 8 percent paid annually and matures after 10 years. What will the price of this bond be if the market interest rate is 10 percent?

New National Corporation's (NNC) bond has 9 years until maturity, a coupon rate of 9 percent, and sells for Rs. 950.

a. What is the current yield on the bond?

b. What is its yield to maturity?
c. If the NNC bond's YTM declines to 7 percent 1 year from now, at what price it will be selling

Differentiate between open-end and closed-end funds.

The composition and information of shares and prices of Artificial Fund Portfolio are given below:

The fund has accrued management fee obligation of Rs. 100,000. There are 50,000 shares outstanding.

a. What is the net assets value of the Artificial fund?

b. What is the percentage of premium or discount if the fund is currently selling in the market at Rs. 32 per share?

(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?

(a) A closed -end fund with portfolio of assets worth Rs. 2,250 million has liabilities of Rs. 50 million and 100 million shares outstanding. If the fund trades at 8 percent discount from its NAV, what is the market price of the fund's shares?(b) Describe the advantages and disadvantages of mutual fund.

ABC Equity Fund's net asset value per share is Rs. 15. If the fund's front-end load fee is 5 percent, what should the offer price be?

One year ago, Sahara Closed-End Fund had a NAV of Rs. 10.50 and was selling at an 10% discount. Today, its NAV is Rs. 12 and it is priced at a 5% premium. During the year Sahara distributed dividends and capital gains of Rs. 1.5. One the basis of the given information, calculate each of the following.

a. Sahara's NAV-based holding period return for the year.

b. Sahara's market-based holding period return for the year. Did the market premium/discount hurt or add value to the investor's return?

The ABC fund, a closed-end investment company, has a portfolio of assets worth Rs. 1,000 million. It has liabilities of Rs. 5 million. It also has 50 million shares outstanding. If the fund trades at 5 percent discount from its NAV, what is the market price of the fund's shares?

Suppose that an open-end mutual fund has NAV of Rs. 15 and the offering price of the shares is Rs. 16. The investor purchased 100 shares of this mutual fund. At the end of year one, the investor receives Rs. 2 per share in cash dividends and capital gain distributions and sells the shares at a NAV of Rs. 18. 

a. What is the HPR on this investment?

 b. Assuming that there is no load fee, what is the HPR on this fund?

c. Calculate holding period return, assuming all the dividends and capital gains distributions are reinvested into additional shares of the fund at an average price of Rs. 16 per share

Consider the following information of portfolios A, B and C:

Assume risk free rate is 5 percent.

a. Estimate Sharpe's indexes.

b. Estimate Treynor's indexes.

 c. Interpret your results.

 d. Would you prefer Treynor's measures rather than Sharpe's measures for portfolio performance evaluation?

How do you interpret a portfolio with Jensen's Alpha of 1.2 percent?

What is the value of a put option written on a share if its strike price is Rs 160 and market price of a share is Rs. 140?

As an analyst, you want to evaluate Equity Fund Portfolio consisting entirely of common stocks of banking sector in Nepal. You have collected the following information the portfolio and the market during the past ten years.

a. Evaluate the Equity Fund by using Sharpe's, Treynor's and Jenson's portfolio performance measures.

b. Which of the performance measures did show that Equity Fund outperformed the market?

A portfolio P has Jensen's Alpha of 0.90 percent. How do you interpret this figure?

Following summary statistics about four investment portfolios are provided to you.

Suppose you have a call option of Rs. 25 premium to buy share of Delta Company (DC) at Rs. 350 per share. Calculate value of call option (pay-off) and profits if the market price of Delta stock rises to Rs. 400 per share.

Write the meaning of derivative securities.

If you hold a call option, in what situation do you exercise it?

What is the value of a put option written on a share if its strike price is Rs. 145 and market price of a share is Rs. 135?

You have a call option to buy 100 shares of MIDBL stock at Rs. 200 before or on December 31. You paid Rs. 5 per share to option writer. Currently shares of MIDBL stock are selling at Rs. 212 a share. What is the intrinsic value of your options on the shares of MIDBL stock?

What are the advantages and disadvantages of options? Explain the basic features of call and put options.