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Investment Analysis Exam Questions

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35 views4 pages

Investment Analysis Exam Questions

Uploaded by

amogne
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Birhan College

Department of Accounting and Finance


Investment Analysis & Portfolio Management Final Exam (50%)
Date: 06/06/2016
Time Allowed: 1:30
Name……………………………………………………….Id No………………………
Part-I: Write True if the statement is correct and False if not (1.5 Point Each)
1. Risk Seeking (Risk Lover) is the attitude towards risk in which a decreased return would
be accepted for an increase in risk.
2. In the active approach of portfolio management the investor continuously assess the risk
and return of the securities within the asset classes and changes them accordingly.
3. Long term fixed income securities offer more risk to income and Short term fixed income
securities offer more risk to principal.
4. The preference shareholders do not have a right to vote in the annual general meeting of
company, but in the event of non-availability of preference dividend for 2 years or more
the preference shareholder can vote.
5. An investor’s ability to achieve higher returns is dependent upon his ability to judge risk
and his ability to take specific risks.
6. While portfolio returns are the weighted returns of all securities constituting the portfolio,
the portfolio risk is the simple weighted average risk of all securities in the portfolio.
7. A good portfolio is simply a collection of individually good investments.
8. Return on any financial asset consists of capital yield and current yield.
9. A risk free security has zero variance.
10. Systematic risk refers to the risk which emerges out of controlled and known variables
that are industry or security specific.
Part-II: Multiple Choices (1.5 Point Each)
1. The attitude in which an increased return would be required for an increase in risk.
A. Risk Indifferent C. Risk Seeking
B. Risk Averse D. None
2. All of the following are Systematic risk except:
A. Market Risk C. Business Risk
B. Interest Rate Risk D. Purchasing Power Risk
3. Assume that Mr. X estimates that the dividend of ABC Company, an established textile
producer, is expected to remain constant at $6 per share indefinitely. If his required return
on its stock is 12%, the stock’s value is:
A. $45 B. $50 C. $60 D. $75
4. Mr X invested in equity shares of ABC Ltd, its anticipated returns and associated
probabilities are given as follows:
Return % -12 -9 5 10 14 20 25
Probability 0.08 0.11 0.15 0.24 0.30 0.12 0.072
What is the expected rate of return?
A. 12.5% B. 11.75% C. 11.5% D. 13.5%

1
5. One of the following is not a task under planning stage in the process of portfolio
management
A. Identifying and specifying the investor’s objectives and constraints
B. Creating the Investment Policy Statement (IPS)
C. Forming capital market expectations
D. Creating the strategic asset allocation
E. Monitoring and rebalancing
6. Assume that a stock just paid an annual dividend of $5/share. The dividend is expected to
grow at 7% indefinitely, and the market capitalization rate (from CAPM) is 12%. What is
the value of the stock?
A. $107 B. $105 C. $102 D. $109
7. Assume that ABC’s equity share is expected to provide a dividend of Birr 4 & fetch of a
price of Birr 20 a year hence. What price would it sell for now if investors’ Required Rate
of Return (RRR) is 14%?
A. Birr 20.05 B. Birr 22.05 C. Birr 21.15 D. Birr 21.05
8. Which of the following is correct formula to determine the equity value?
A. Equity value = Enterprise value – (Market value of debt + Minority interest
+Pension provisions +other claims)
B. Equity value = Enterprise value + Market value of debt + Minority interest
+Pension provisions +other claims
C. Equity value = Enterprise value + Market value of debt + Minority interest –
Pension provisions – other claims
D. Equity value = Enterprise value + (Market value of debt – Minority interest –
Pension provisions – other claims)
9. Which of the following is not a characteristic that sets preferred stock apart from common
stock?
A. Voting Rights C. Transferability
B. Dividend Payments D. Ownership
10. A portfolio having two risky securities can be turned risk less if
A. The securities are completely positively correlated
B. If the correlation ranges between zero and one
C. The securities are completely negatively correlated
D. None of the above.
11. Efficient portfolios can be defined as those portfolios which for a given level of risk
provides
A. Maximum return C. Minimum return
B. Average return D. None of the above
12. A portfolio comprises two securities and the expected return on them is 12% and 16%
respectively. Determine return of portfolio if first security constitutes 40% of total
portfolio.
A. 12.4% B. 13.4% C. 14.4% D. 15.4%
13. One of the following is not among the steps of Portfolio performance evaluation
A. Understanding the client C. Evaluate portfolio performance
B. Portfolio Construction D. None

2
14. Business risk:
A. is affected by market demand
B. one part of systematic risk
C. is influenced by sales price
D. is due to the variability in operating profits or cash flows
15. Individuals or companies that prefer low-risk, low-return investments are:
A. Risk Neutral C. Risk-Averse
B. Risk-Loving D. Risk-Taking
16. As more assets are included in an equally weighted portfolio,
A. The overall risk decreases at an increasing rate
B. The overall risk increases at a decreasing rate
C. The non-systematic risk decreases at a decreasing rate
D. The systematic risk decreases at a decreasing rate
17. Stocks that are relatively unaffected by the market movement.
A. Growth Shares C. Defensive Shares
B. Income Share D. Cyclical Shares
18. As the number of stocks on a portfolio increases:
A. The expected return decreases
B. The expected return increases
C. The non-systematic risk of the portfolio decreases
D. The systematic risk of the portfolio increases
19. In a well-diversified portfolio
A. Market risk is negligible. D. Non diversifiable risk is negligible.
B. Systematic risk is negligible. E. None of the above.
C. Unsystematic risk is negligible.
20. The stocks that belong to company that have comparative stable operations and limited
growth opportunity.
A. Growth Shares C. Defensive Shares
B. Income Share D. Cyclical Shares
Part-III: Workout (5 Points)
1. Two securities P and Q are considered for investment whose correlation coefficient of
returns is –0.75, are combined in the following proportions in the portfolio:
(a) 0: 100, (b) 10: 90, (c) 20: 80, (d) 50: 50, (e) 80: 20, (f) 90: 10, (g) 100: 0.
• The historical risk-return of the two securities is as follows:
Security Risk % (std. dev.) Return %
15 10
20 15
Required: determine:
a) Return and
b) Risk of the portfolio

2. Consider two perfectly negatively correlated risky securities A & B their correlation
coefficient is equal to -1. A has an expected rate of return of 12% and a standard
deviation of 16%. B has an expected rate of return of 10% and a standard deviation of
14%.
Required: determine
a) The weights of securities A and B.
b) The expected portfolio return.
c) The portfolio risk (standard deviation).

3
Answer Sheet
Name………………………………………………………….…..Id No…………………………..
Part I: True/False
1 6
2 7
3 8
4 9
5 10

Part II: Multiple Choices


1 6 11 16
2 7 12 17
3 8 13 18
4 9 14 19
5 10 15 20

Common questions

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Systematic risk, also known as market risk, affects the overall market and cannot be eliminated through diversification, as it encompasses factors like interest rates and economic cycles. Unsystematic risk relates to individual securities and specific events affecting those assets. Diversification reduces unsystematic risk by spreading investments across various assets, which offsets individual securities' specific risks. Therefore, diversification effectively manages unsystematic risk but not systematic risk, which always remains present regardless of diversification .

Equity value and enterprise value are key metrics in assessing a company's financial status. Equity value represents the value of a company attributable to its shareholders, while enterprise value reflects the total value of the company, accounting for market value of debt, minority interest, and other claims. The relationship between the two indicates the extent to which the company is leveraged and can guide investment decisions. Enterprise value is a broader measure, useful for comparing companies with differing capital structures, while equity value is focused on shareholder returns .

As more assets are included in an equally weighted portfolio, the overall non-systematic risk decreases at a decreasing rate, due to the diversification effect. This is because the unique risks of individual investments tend to offset each other, resulting in a more stable portfolio. However, systematic risk, which is market-wide, remains constant and is not mitigated by diversification .

An investor's ability to evaluate risk is crucial for achieving higher returns because investment returns are typically correlated with risk levels. By analyzing and understanding the risk aspects of different investments, investors can identify opportunities where the potential return justifies the risk. Skilled risk assessment allows investors to make informed decisions about risk-taking, enabling them to optimize their portfolio's return potential, balancing between high-risk, high-return investments and safer, lower-return ones .

The correlation between two securities significantly impacts the overall risk of a portfolio. When two securities have a perfect negative correlation (correlation coefficient of -1), combining them can theoretically eliminate unsystematic risk, leading to a risk-free portfolio. Conversely, if they are perfectly positively correlated (correlation coefficient of +1), no risk reduction is achieved, and the portfolio reflects the combined risks of the individual securities. The degree of correlation influences the extent to which diversification can reduce portfolio risk .

Evaluating portfolio performance is crucial to understand the effectiveness of investment strategies and to ensure that the portfolio aligns with investor objectives. The critical steps in portfolio performance evaluation include measuring and analyzing returns against benchmarks, assessing risk-adjusted performance, and reviewing the portfolio against the investment policy statement (IPS). Regular evaluation helps in identifying inconsistencies or inefficiencies in the portfolio, prompting timely improvements or strategy adjustments to meet desired financial goals .

The Capital Asset Pricing Model (CAPM) determines the intrinsic value of a growing stock by allowing investors to estimate the expected return based on risk-adjusted factors. By considering the stock's expected dividend growth rate and the market's required return, CAPM calculates the intrinsic value through the Gordon Growth Model formula: the present value of future dividends growing at a stable rate. The market capitalization rate derived from CAPM serves as the required rate of return, which is pivotal in determining whether the stock is undervalued or overvalued in the current market .

Risk aversion significantly influences investment decisions, as risk-averse investors require a higher return for taking on additional risk. They prefer investments with stable returns and lower volatility, even if the potential upside is limited. This risk-return trade-off shapes their choice of asset classes and individual securities, leading them to favor bonds, stable stocks, or diversified portfolios that align with their lower risk tolerance while still achieving satisfactory returns .

An active approach to portfolio management benefits investors by allowing them to respond and adapt to market changes quickly, potentially capturing above-market returns. This strategy involves continuous assessment and rebalancing of the portfolio based on market trends, economic conditions, and individual asset performance. In contrast, a passive approach involves holding a fixed portfolio, which may lead to missing out on market opportunities. Active management also involves tactical adjustments aimed at mitigating risk, whereas passive management relies on market index equivalents without individual assessment .

Under normal circumstances, preference shareholders do not have voting rights in the company’s annual general meetings. However, if the company fails to pay the preference dividends for two consecutive years or more, preference shareholders can obtain voting rights. This provision allows them to influence decisions that may affect their dividends or investment return potential .

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