Assignment Requirements
Follow instructions on paper
DECLARATION OF FITNESS TO SIT EXAMINATION
FIT TO SIT POLICY – IMPORTANT
Under the above policy, any student who attends the assessment is deemed to be “fit to sit”
that assessment. This is important. It means that you may not (for example) later submit an
application to the Mitigating Circumstances Panel relating to impaired performance in that assessment
because of illness, or any other mitigating factor, which affected you at the start of the assessment. If
you are not “fit to sit”, you should not attempt the assessment.
Students must complete the information below and submit with the completed Assessment.
School (please tick one) Business School √ Law School
Programme BSc Business Studies
Examination Portfolio Management
Date Friday, August 22nd 2014
Name
I am not aware of any medical or
other extenuating circumstances that
would impair my performance in this
examination
Signature
……………………………………..
This sheet should be submitted with your completed work. Page 2 of 7
BSc Business Studies
Portfolio Management
Open Book Assessment
Release Date/Time: Monday 18th August 2014 / 9.00am
Submission Date/Time: Friday 22nd August 2014 / 4.00pm
Lecturer: Dr. Linus Etube
Students’ instructions – PLEASE READ
PART A: Requirement and Instructions
Please read the following instructions carefully.
Key Assessment Requirements
1. Analyse the scenarios presented in each question.
2. Present clear recommendations where required
3. Show all logical analytical steps (calculations) used to arrive at conclusions
4. Present a critical report of your analysis and responses to all questions
5. Where appropriate, present key Finance and Economics theories to support your answers and
present assumptions used in your analysis and any practical implications these may have.
Submission Requirements
6. You need to submit an individually completed report via VLE during the submission period.
7. The fully completed report must not exceed a word count of 5,000.
8. Your work should be uploaded into the VLE via a dedicated submission link to be provided.
9. Do not send your completed work via email. Under no circumstances will the work be accepted when
emailed to any member of the faculty.
10. Note that there are penalties for late submission. Any work submitted after the designated deadline
will not be marked.
Referencing
11. You need to follow a proper referencing system in your paper.
12. You also need to do a full bibliography of your sources.
Number of words
13. There is no target number of words for this assessment as this provides students with the flexibility
to refine their work and present it in the best possible way. Students are however encouraged to
reflect fully when producing answers to questions and to ensure that their work is presently
succinctly. The guiding word limit of 5,000 is indeed a guide and should help to set the expectation
that it would not be necessary to exceed this limit in other to produce and excellent piece of work.Page 3 of 7
Pass mark
This assessment constitutes 100% of the overall mark for the module. The pass mark for this assessment is
50%. If this is not your first attempt at this assessment the maximum mark you can obtain is 50%.
There are 4 questions in total. You are required to answer all the Questions in
full. Marks are allocated to each question as follows;
Question Allocated Marks
1 20
2 20
3 30
4 30
Each question may have more than one section and you are required to complete
all sections for all questions. The marks allocated to each section where
applicable are also shown in the relevant section of the question.
Mode of Assessment and Submission
This Assessment is individual. All the relevant material for the assessment should be contained in an
appropriately typed report to be submitted electronically via VLE.
Each student should submit only one document. Material that is not contained in the single electronic
submission will not be marked. If you feel the need to make changes to your work, you can do so at any time
before the final submission deadline by simply submitting the revised version of the work via the same
dedicated Assessment submission link. You will not be able to make any such changes after the submission
deadline.
Allowed Time and Submission Deadline
You are allowed to work on the assessment from the date it is released to you to the final submission
deadline. You may submit completed work before the final submission deadline (Friday 22nd August 2014,
at 4.00pm). No work will be accepted after this date under any circumstances. Page 4 of 7
Questions
1. The purchase price of a call option one month ago, with an exercise price of 200p was 20p when the
underlying stock price was 180p; a put option on that stock with an exercise price of 200p cost 10p at
that date. Both options had the same expiry date.
You have been approached by a client to offer advise on each of the following 2 scenarios (1.1 & 1.2);
1.1. Your client owns 1,000,000 shares of the underlying stock purchased at 200p per share. The
client is now very concerned about the possibility of a decline in price of the stock but does not
wish to sell the shares. The client wishes to hedge this exposure and has requested that you
produce a detailed report explaining the best way to achieve this using only the available options
detailed above. Prepare a detailed report containing the following information;
1.1.1. The general advantages and disadvantages of using options in the portfolio
for hedging, speculation and arbitrage.
1.1.2. Investment strategy recommendation (proposal on the types and sizes of
option contracts to buy or sell) to meet the client’s objectives.
1.1.3. Explanation of the payoff from the client’s current investment, the proposed
investment and the combined portfolio. Illustrate your answer with relevant
analysis, payoff diagrams and explanation of the sources of investment
return and risk for the combined portfolio for a specified range of prices for
the underling stock (You may use the specified range of 150p to 250p for
the stock price).
10 Marks
1.2. Your client owns 1,000,000 shares of the underlying stock purchased at 200p per share. The
client now strongly believes that the market price of the stock is very unlikely to move. They have
however taken a longer-term strategic view that they should continue to hold the stock in their
portfolio. The client however wishes to boost returns in the mean time and has requested that you
produce a detailed report explaining the best way to achieve this using only the available options
detailed above. Prepare a detailed report containing the following information;
1.2.1. The general advantages and disadvantages of using options to boost
portfolio returns by writing naked and covered options.
1.2.2. Investment strategy recommendation (proposal on the types and sizes
option contracts to buy or sell) to meet the client’s objectives.
1.2.3. Explanation of the payoff from the client’s current investment, the proposed
investment and the combined portfolio. Illustrate your answer with relevant
analysis, payoff diagrams and explanation of the sources of investment
return and risk for the combined portfolio for a specified range of prices for
the underling stock (You may use the specified range of 150p to 250p for
the stock price).
10 Marks
Total Marks for Question 1 (20 Marks)Page 5 of 7
2. A Pension fund has an annual liability stream over the next four years. The liability stream commences in
one year’s time; the first liability is £100 million and this liability grows at a compound rate of 5% pa
thereafter. The yield curve is flat at 6% across its whole structure. The Portfolio Management team at the
pension fund is aware that fixed income investments may be susceptible in interest rate risk. They would like
to minimise this risk by employing a portfolio immunisation strategy using a carefully selected portfolio of
zero coupon bonds in order to duration match their assets with their liabilities. The possible assets they could
hold include two zero coupon bonds – one maturing in two years (2YB), the other in four years (4YB).
You are required to:
2.1 Calculate the amounts of the zero coupon bonds (2YB and 4YB) that the fund should buy to ensure
that the liability stream is duration matched
(i) Today for all payments in the future
(ii) After the elapse of one year (i.e. for all payments immediately after the payment of the first
liability of £100m), assuming interest rates do not change.
(iii) After the elapse of two years (i.e. for all payments immediately after the payment of the first and
second respective liabilities of £100m and £105m), assuming interest rates do not change.
10 Marks
2.2 Explain why the amounts invested in the 2-year bond and the 4-year bond changes at the year-end
and after the elapse of two years, numerically justifying the changes.
6 Marks
2.3 Briefly explain the practical problems and limitations of the above strategy.
4 Marks
Total Marks for Question 2 (20 Marks)Page 6 of 7
3. A hedge fund manager is looking to invest in three stocks, A, B and C, all of which expect to pay an
annual dividend of 20p and have required rates of return 15% per annum. The dividend growth profiles
of each are as follows.
Company A A growth rate of 3% per annum over the indefinite future.
Company B A growth rate of 6% per annum over the next three years, followed by a growth rate of
3% per annum in years four to seven, inclusive. Thereafter, the nominal dividend will
grow at 2% over the indefinite future.
Company C The growth rate will be zero over the indefinite life of the company.
The permanent payout ratio for each stock is 60%.
You are required to
3.1 Compute the current market prices of each of the securities, explaining your results.
12 Marks
3.2 Compute the dividend and earnings yields of the three companies and explain your results.
12 Marks
3.3 Explain the practical limitations of using the dividend discount model in estimating the market prices of
Companies A, B and C.
6 Marks
Total Marks for Question 3 (30 Marks)
4.0 You are provided with the historical monthly return data for two securities A and B and the market
covering a period of 12 months from January to December. The data is shown in table 1 below.
Table 1: Historical Monthly percentage returns for securities A, B and the Market
Returns
Month Security A Security B Market
January 0.95 1.23 1.28
February 1.42 0.55 1.2
March 0.4 0.97 -0.21
April 0.97 0.89 1.05
May 1.25 1.65 1.05
June 2.2 1.04 1.55
July -0.75 0.76 -0.48
August 1.44 1.46 1.54
September 0.82 -0.38 0.75
October 1.55 1.35 1.46
November 0.64 1.12 0.58
December 1.88 1.88 1.88Page 7 of 7
The expected returns for the coming year for the two securities, the market and the risk free rate are
estimated as detailed in Table 2 below. Please note that Table 2 contains forecast expected annual returns
while table 1 above contains historical monthly returns.
Table 2: Estimated returns for the coming year
Returns
Risk Free Rate Security A Security B Market
6.0 14.8 11.3 12.3
You are required to
4.1 Use the data presented in Table 1 above to estimate the beta of each security. Based on the beta of
each security use the Capital Asset Pricing Model (CAPM) to estimate the required return that
investors can expect from securities A and B.
12 Marks
4.2 Use your estimated required return calculated in 4.1 above to appraise the investment for the coming
year and make an investment recommendation for securities A and B. Explain the rationale for your
investment recommendation.
12 Marks
4.3 Explain the practical challenges of the appraisal method you used in 4.2 above to support your
investment recommendation. Comment on how these challenges can be addressed.
6 Marks
Total Marks for Question 4 (30 Marks)
End of Assessment
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