QUESTION ONE

Explain how the Capital Markets Authority can ensure:

(i)Faster growth and development of Stock Exchange

(ii)Development of other stock exchanges in Kenya.

(iii)(i)What is a stock exchange index?

(ii)Outline four drawbacks of the Stock Exchange index.

(iv) In relation to the stock exchange, explain the role of the following members:

Floor brokers

Underwriters

QUESTION TWO

Your managing director has just returned from a business school seminar on market

efficiency. He is puzzled as he was told in the seminar that if markets are efficient all

investments have an expected NPV of zero, yet his finance director has told him that it is

essential for the company to maximise its expected NPV. He also wonders how recent stock market volatility can be explained if the market is efficient.

Required

You have been asked to produce a report for the managing director discussing his concerns

and the importance of market efficiency to capital investment decisions.

QUESTION THREE

XYZ Ltd is considering three possible investment projects for next year. Each project has a 1-year life, and project returns depend on next year's state of the economy. The estimated returns are shown in the table:

State of the Probability Rate of Return (%)

Economy of occurrenceABC

Recession 0.25 10 9 14

Average 0.50 14 13 12

Boom 0.25 1618 10

Required:

a)Find each project's expected rate of return , variance, standard deviation and coefficient of variation

b)Compute the correlation coefficient between

i.A and B

ii.A and C

iii.B and C

c) Compute the expected return on a portfolio if the firm invests equal wealth on each asset

d) Compute the standard deviation of the portfolio