Question 1 (10 Marks)

The Efficient Markets Hypothesis (EMH) described by Fama (1984) is comprised

of three components: weak form, semi-strong form and strong form efficiency.

Required

a. What are the four conditions required for a market to be efficient? (4 marks)

b. Define and discuss the weak-form EMH. Describe the two sets of tests used to
examine the weak-form EMH. (3 marks)

c. Define and discuss the semi-strong-form EMH. Describe the two sets of tests used to
examine the semi-strong form EMH. (3 marks)

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Question 2 (10 Marks)

The risk free rate is 2.25% and an asset has a sensitivity to the risk factors outlined in
the table below. Using the information provided, answer the following questions.

Factor Market return Size Value

Sensitivity β = 1.20 s = -0.50 h = -0.42
Risk premium ERP = 8.50% SMB = 1.95% HML = 6.40%

Required

a. An investor isn’t sure which model is appropriate to value stocks and uses
both CAPM and Fama-French to confirm the CAPM

i. What is the problem with this approach? (1 mark)

ii. What is the expected return of the stock using CAPM? (1 mark)

iii. What is the expected return of the stock using Fama-French? (1 mark)

iv. By how much does the asset’s expected return differ between the two models
and does CAPM overvalue or undervalue the stock? (1 mark)

b. Suppose the above asset is observed in the market trading at a price such that
its expected return was 9.20%. What strategy would you suggest profiting from
this situation, assuming:

i. The CAPM was the correct pricing model, and explain your reasoning (1 mark)

ii. The Fama-French three-factor model was the correct pricing model and
explain your reasoning (1 mark).

c. It is true that recent evidence finds little support for the traditional CAPM.
Provide and briefly discuss two examples why this is the case? (4 marks)

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Question 3 (21 Marks)

Today’s date is 17 June 2023. Consider the following debt securities.

Official Cash Rate: is 0.92%

Bank Bill 1: A bank bill with a face value of $2.48 million, which has 23 days to maturity
and is trading at a yield of 1.08%

Bank Bill 2: A bank bill with a face value of $4.36 million which has 184 days to
maturity and is trading at a yield of 1.81%

Bond 1: A bond with a face value of $1.26 million with maturity of 24 August 2029,
paying coupons semi-annually at a rate of 2.01% and trading at a yield of 1.73% p.a.

Bond 2: A bond with a face value of $85.43 million, which matures on 19 November
2029, paying coupons semi-annually at a rate of 2.38% trading at a yield to maturity of
1.92% p.a.

Required

a. Describe the shape of the yield curve. (1 mark)

b. What is the fair market price for?

I. Bank bill 1 (1 marks)

II. Bank bill 2 (1 marks)

III. Bond 1 (4 marks)

IV. Bond 2 (4 marks)

c. Three hours after you purchase these four securities, lower than
expected consumer price index is released to the market and the market
reacts by bullish buying (i.e., prices rises and yields falls) in a parallel
movement in yields by 0.21% across the entire yield curve and you

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liquidate your holdings. How much profit or loss did you generate on each
debt security?

i. Bank bill 1 (1 marks)

ii. Bank bill 2 (1 marks)

iii. Bond 1 (4 marks)

iv. Bond 2 (4 marks)

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Question 4 (11 Marks)

An investor buys an asset at an initial cost of $2,356,000. The investor believes that at
the end of one year, the asset could have four possible values. These values are
$2,225,000, $2,310,200, $2,756,900, and $2,030,500 with respective probabilities of
20%, 25%, 40% and 15%.

Required

a. What is the expected outcome with respect to the asset’s value? (1 marks)

b. What is the expected return on the asset? (1 mark)

c. What is the expected standard deviation of the return of the asset? (1 marks)

d. What is the coefficient of variation of the asset? (1 mark)

e. What is the fair value of a stock that has a dividend due to pay of $1.56, which
is expected to grow indefinitely at 2.28% pa, and that stock has a cost of capital
of 10.35%? (1 mark)

f. If the expected future dividend yield of a stock is 3.02% and the stock’s cost of
capital is 8.25%, what is its expected growth rate? (1 mark)

g. If a stock with an expected infinite growth rate of 2.14% pa is trading at

$112.30, what must its cost of capital be to justify the assumption of the next
dividend being $7.97? (1 mark)

h. What is the post-tax dividend per share received by an investor who pays
marginal tax at 20% where the company has earnings of $250 on which it pays
tax at 30%, has a 85% payout ratio and the dividend is franked at 75%? (1 mark)

i. In dollars and cents, what would you pay for a company that generated profits
of $2.15 per share on its 105 million shares from which it paid a dividend of $
0.92 per share and has equity capital of $2155 million if it’s cost of capital is
12.01%? (2 marks)

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Question 5 (11 Marks)

Consider that you have $1,200,000 to invest equally across four assets and that your
analysis of these four assets provides the information in the two tables below. To 2
decimal places answer the following questions

Asset A B C D
Beginning Price $10.52 $1.87 $7.03 $124.98
Expected Price $11.24 $1.98 $8.12 $125.74
Standard deviation 31.00% 18.00% 9.00% 3.00%

Correlation A B C D
A 1.0 0.7 0.6 -0.3
B 0.7 1.0 0.4 -0.3
C 0.6 0.4 1.0 -0.1
D -0.3 -0.3 -0.1 1.0

Required

a. What is the expected return on this portfolio, in percentage terms? (2 marks)

b. What is the value of this portfolio after 12 months in dollars and cents? (1
mark)

c. What is the standard deviation of this portfolio? (14 marks)

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Question 6 (8 Marks)

Consider the following table which provides a comparison of the returns for a portfolio
and its benchmark.

Year Portfolio Benchmark Portfolio Benchmark Difference Square of

Return Return Index Index Rp - Rb difference
(Rp) (Rb) (Rp - Rb)^2
0 1.0000 1.0000
1 9.50% 11.75%
2 6.75% 4.75%
3 18.00% 12.50%
4 -5.75% -6.25%
5 9.25% 7.50%
Annualized
Return (CAGR)
Portfolio Alpha
(α)
Sum
Tracking error
(σTE)
Information
Ratio (IRp)

Required

a. Calculate the annualised return of the portfolio and the benchmark (2 marks)

b. Calculate the portfolio alpha (1 mark)

c. Calculate the tracking error of the portfolio (2 marks)

d. Calculate the information ratio of the portfolio (1 mark)

e. If the risk free rate is 2.50%, the return of the market is 10.35%, the value risk
premium is 2.25%, the small cap premium is 1.83%, the momentum premium is
44.60% and the portfolio’s exposure to these three factors was -0.37, -0.62, and
0.18, respectively, as a percentage to 2 decimal places determine the amount of
Carhart’s alpha that was produced by the manager of the portfolio (2 marks)

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Question 7 (7 Marks)

Consider the following after-tax cash flows for three mutually-exclusive projects.

Year Project A Project B Project C

0 -7,345,000 -5,850,000 -11,530,000
1 2,210,000 750,000 4,500,000
2 4,520,000 1,175,000 5,000,000
3 4,730,000 3,250,000 5,160,000
4 6,128,000 4,140,000 5,495,000
5 4,495,000 6,764,000
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Clearly, the three projects have different scale (i.e., initial investment), as well as
differing lives. Assume a 13.50% p.a. discount rate applies to all projects

Required

a. Calculate the NPV for each project. (6 marks)

b. Which project will you accept? Why? (1 mark)

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Question 8 (9 Marks)

The board of a company (Firm A) has agreed to pursue a new project and the manager
is directed to organise debt funding of $200 million for the life of the project, which is 10
years. The CFO speaks with several banks and determines that it may borrow:

• Floating at BBSW + 2.95%pa

• Fixed rate debt at 10.25%pa

A large corporate (Firm B) has launched a takeover bid for a rival firm, that has fallen on
hard times, and the BOD of the suitor company has been directed to raise funds for the
takeover, which is expected to be successful. The BOD meets with the deal team and
learns that if the takeover is successful at the current offer price that the transaction will
be cash flow positive immediately and that funding is required for 10 years. The BOD
also has the view that interest rates are going to decline over that period and therefore
prefers raising floating rate debt. The BOD speaks with their banker and learns that it
may borrow:

• Floating at BBSW + 1.50%pa

• Fixed at 8.65% pa

Government debt is trading at 1.50% pa

Both firms happen to approach the same investment bank, you, to explore funding their
requirements via a swap.

You are willing to enter into an intermediated swap with both parties, on the condition
that you make 0.20% from each party of the swap transaction.

Required

Determine the swap strategy that maximises the benefit of the swap for each party,
including your investment bank.

a. Specify the swap cashflows (6 marks)

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b. Calculate the borrowing costs and the benefit to each party from entering into
the swap. (3 marks)

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Question 9 (7 Marks)

Consider the information for ABC provided in the two tables below and answer the
following questions.

CONSOLIDATED BALANCE SHEETConsolidated Balance Sheet

2022 2021
ASSETS
Current Assets
Cash and cash equivalents 44.9 87.2
Trade and other receivables 274.7 348.7
Derivative financial instruments 2.7 1.1
Inventories 317.6 345
Current tax assets 3 13.3
Assets held for sales 60.5 0
Other current assets 26.9 37.9
Total Current Assets 730.3 833.2

Non-current assets
PPE 844 911.6
Intangible assets 588.1 589.5
Total non-current assets 1628.5 1673.9
Total assets 2358.8 2507.1

LIABILITIES
Current Liabilities
Trade and other payables 449.2 477.4
Other liabilities 16.5 42.8
Derivatives financial instruments 1.7 2.1
Lease liabilities 21 25.5
Current tax liabilities 10.3 18.4
provisions 107.3 119.8
Total current liabilities 606 686

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Non-current liabilities
Borrowings 308.5 391.9
Lease liabilities 93.3 79.1
other liabilities 0 0.5
provisions 16.9 24.6
deferred tax liabilities 71.7 58.5
Total non-current liabilities 490.4 554.6
Total liabilities 1096.4 1240.6

Net assets 1262.4 1266.5

EQUITY
Share capital 878.2 875.7
Reserves 26.9 25.9
Retained earnings 357.3 364.9
Capital and reserves attributable to 1262.4 1266.5
owners
Total equity 1262.4 1266.5

CONSOLIDATED COMPREHENSIVE INCOME STATEMENT

2022 2021
Revenues 2525.7 2317.8
Other Income 502.1 361.5
Expense -1836.4 -1612.7
EBITDA 1191.4 1066.6
Depreciation and Amortization -429.9 -373.0
EBIT 761.5 693.6
Interest -101.2 -102.3
NPBT 660.3 591.3
Tax 198.1 177.4
Net Profit After Tax 462.2 413.9

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Required

a. To 2 decimal places calculate the cash ratio for ABC in 2022 (1 mark)

b. In percentage terms and to 2 decimal places calculate the debt to equity ratio for ABC
for 2022 (1 mark)

c. Calculate the net profit margin for ABC in 2022 in percentage terms to 2 decimal
places (1 mark)

d. Calculate the return on assets for ABC over 2022 in percentage terms to 2 decimal
places (1 marks)

e. Calculate the return on equity for ABC over 2022 in percentage terms to 2 decimal
places (1 marks)

f. Calculate the return on invested capital for BHP over 2022 in percentage terms to 2
decimal places (2 marks)

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