1. A technical analyst has been following the NSE 20 Share Index and has observed the following daily closings:

Day

NSE 20 Share Index

Day

NSE 20 Share Index

1

2,010

7

2,220

2

2,100

8

2,130

3

2,165

9

2,250

4

2,080

10

2,315

5

2,070

11

2,240

6

2,150

12

2,310

Based on a 4-day moving average, if the index closed at 2,300 on day 13 would it signal a buy or sell decision? Explain. (5mks)

1. Zee Limited has a current dividend of Ksh1.75 a share. The following are the expected annual growth rates for dividends.

Dividend Year

Growth Rate

1-3

22

4-6

17

7-9

12

10 onwards

10

The required rate of return for the stock (the company's cost of equity) is 12 percent. What is the value of the company Stock? (5mks)

You believe that the addition of other asset classes to the endowment portfolio would improve the portfolio by reducing risk and enhancing return. You are aware that depressed conditions in Kenyan real estate markets are providing opportunities for property acquisition at levels of expected return that are unusually high by historical standards. You believe that an investment in Kenyan real estate would be both appropriate and timely, and have decided to recommend a 20 percent position be established with funds taken equally from stocks and bonds.

Preliminary discussions revealed that several trustees believe real estate is too risky to include in the portfolio. The board chairman, however, has scheduled a special meeting for further discussion of the matter and has asked you to provide background information that will clarify the risk issue. To assist you, the following projected data have been developed:

Correlation Matrix

Asset Class

Return

Deviation

Stocks

Bonds

Real Estate

T-Bills

Stocks

12.0%

21.0%

1.00

Bonds

8.0

10.5

0.14

1.00

Real Estate

12.0

9.0

-0.04

-0.03

1.00

Treasury Bills

4.0

0.0

-0.05

-0.03

0.25

1.00

Required:

Explain the effect onbothportfolio riskandreturn that would result from the addition of real estate. Include in your answertworeasons for any change you expect in portfolio risk. (Note: It isnotnecessary to compute expected risk and return.) [10mks]

1.Consider the investment information given below:

Investment

E(R_i)(%)

²(%)

1

12

20

2

15

35

3

21

40

4

24

45

Given that the utility of investors is determined using the formulaU = E(R_i) - 0.5A²

Required:

i)Which investment will an investor with a risk aversion coefficient of 4 choose? (2mks)

ii)Which investment will an investor with a risk aversion coefficient of 2 choose? (2mks)

iii)Which investment will a risk- neural investor choose? (2mks)

iv)Which investment will a risk-loving investor choose? (2mks)

2.The risk-free rate is 10% and the expected return om the market portfolio is 15%. The expected returns of 4 stocks and their expected betas are listed below

Investment

E(R_i)(%)

²(%)

A

17

1.3

B

14.5

0.8

C

15.5

1.1

D

18

1.7

Required

i)On the basis of these expectations which securities are overvalued and which are overvalued? (2mks)

ii)If the risk-free rate were to rise to 12% and the expected return on the market rose to 16%, which securities are overvalued and which are overvalued? Assume that the expected returns and betas of the stock remained the same (2mks)

3.Consider the following data for two risk factors (1 and 2) and two securities (J and L):

0 = 0.05b_J1= 0.80

1 = 0.02b_J2= 1.40

2 = 0.04b_L1= 1.60

b_L2= 2.25

Required:

i)Compute the expected returns for both securities [4mks]

ii)Suppose that Security J is currently priced at $22.50 while the price of Security L is $15.00. Further, it is expected that both securities will pay a dividend of $0.75 during the coming year. What is the expected price of each security one year from now? [4mks]Assume your idea for your own MNC to conduct international business is selling cheese in world wild shipping. This idea should be simplified to the degree that you could possibly implement it someday. However, this idea should also be sufficiently creative to be successful if done properly. Your idea should focus on Italy and one foreign currency, since many MNCs are focused in this manner when they are first created. So that you can recognize the issues regarding exchange rate risk that are discussed throughout this text, you should assume that you will receive foreign currency when selling your product. This idea should be for a small MNC instead of a large MNC because even most large MNCs began as small firms. The following questions will help you define this MNC idea:

1. What is the product that you plan to sell?

2. What foreign country do you plan to target?

3. How will you sell the product in that country? (i.e., through a distributor? by mail?)

4. Is there some evidence that consumers in that country would buy this type of product?

5. Do you need to purchase supplies or to hire labor?

Will any expenses you incur from producing the product be in dollars or some other currency?

Assessing Country Factors That Will Affect the Demand for Your Product

1. Identify the factors that can affect the balance of trade between the United States and the country that you targeted for your business. Explain how each of these factors may affect the demand for your product.

2. Which of these factors is likely to be most important in affecting the demand for your product?

Accessing Trade Data

Determine whether the product you plan to sell is already one of the main exports to that country.

Accessing Import Controls

Review the import controls set by that country's government. Determine whether your business would be affected by trade regulations.

Using the Foreign Exchange Market

1. Explain how you will use the spot market for your business.

2. What bank do you plan to use to exchange the foreign currency received for dollars? What is the bid/ask spread on a recent quotation by that bank? (Call the bank to obtain quotations.)

Will you possibly need the forward market? Explain.

Monitoring Movements in the Foreign Currency's Value

What key factors likely affect the value of the foreign currency of concern over time?

Monitoring Central Bank Intervention

1. How can your business be affected if the Fed attempts to strengthen the dollar in the foreign exchange market?

2. If the Fed decides to weaken the dollar, how will your business be affected?

3. How can indirect central bank intervention affect your business even if there is no impact on exchange rates?

Accessing Central Bank Information

Go to www.bis.org/cbanks.htm to access the Web site link for the central bank in your target country. Determine whether this central bank intervenes to control its currency in the foreign exchange market.

Assessing Spot and Forward Rates

1. Obtain a quotation for the spot rate of the foreign currency (that you will receive from your business) from the bank where you intend to conduct your foreign exchange transactions. Then, obtain a quotation for the spot rate of the foreign currency from another bank. Does it appear that the spot rates are aligned across locations at a given point in time?

2. Obtain a quotation for the one-year forward rate of the foreign currency from the bank where you intend to conduct your foreign exchange transactions. Then, use a business periodical to determine the prevailing one-year interest rates in the United States and the foreign country of concern. Does it appear that interest rate parity exists?

3. Review the data on forward rates from The Wall Street Journal or another source to determine whether the foreign currency of concern typically exhibits a discount or a premium. Then review data on interest rates to compare the foreign country of concern and the U.S. interest rates. Does it appear that the forward rate of the foreign currency exhibits a premium (discount) when its interest rate is lower (higher) than the U.S. interest rate, as suggested by interest rate parity?

Determining Whether IFE Holds

Use The Wall Street Journal or another data source to record the interest rate differential between the interest rate of the foreign country in which you plan to do business and the U.S. rate over the last five or so quarters. Then, review the exchange rate percentage change in the foreign currency of concern over each of those corresponding quarters to determine whether the international Fisher effect (IFE) appears to hold over those quarters for that currency.

Monitoring Exchange Rate Trends

Use a business periodical or the Internet to determine how the value of the foreign currency of concern has changed in each of the last five weeks. Does it appear that there is a trend over the last five weeks? What is the mean percent-age change over these weeks? If you believed that the currency's value would continue following the recent trend, would it appreciate or depreciate in the near future?

Establishing a Subsidiary in Foreign Country

1. Assuming that your international business is successful, identify reasons why it may be feasible to establish a small subsidiary in the foreign country rather than continue exporting.

Identify the disadvantages associated with establishing a small subsidiary in the foreign country of concern.

Deriving a Required Rate of Return for an International Project

Consider a possible project that would result in expansion of your international business. Describe how you would derive a required rate of return for this project.

Ensuring Payment for Exports

Explain how your business could ensure payment for the products that you are exporting to a foreign country.

Financing in Foreign Currency

1. Given that your business has receivables in a foreign currency, you may want to consider financing in that same foreign currency to offset the exposure. Compare the recent interest rate off the foreign currency of concern to the U.S. interest rate: Is the foreign interest rate typically higher or lower than the U.S. interest rate? Would you use financing in that currency to offset receivables? Explain.

Explain how you could use foreign financing for your business in a manner that would reduce your exposure to exchange rate risk. Be specific.