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Hba2303:Financial Accounting Question Paper
Hba2303:Financial Accounting
Course:Bachelor Of Commerce
Institution: Meru University Of Science And Technology question papers
Exam Year:2011
QUESTION ONE – 30 MARKS
(a) Discuss the limitations of Harry Markowitz model of portfolio analysis. (5Marks)
(b) The following table shows three major classes of risky assets.
Assets Total Risk Correlation with Classes Market (shs) (s.d) A B C A 10,000 20% 1 0.3 0.3 B 6,000 30% 0.3 1 0.3 C 4,000 15% 0.3 0.3 1
Required:
(i) Calculate the risk of the portfolio of A,B and C (8Marks) (ii) If the risk free rate is 8% and return on the market portfolio is 15% what are the capital market line and security line? (7Marks) (iii) What are the limitations of CAMP (5Marks) (iv) Explain the strategies that are adopted by the acquiring firm in case of hostile takeovers. (5Marks)
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QUESTION TWO – 20 MARKS
You would like to invest in the shares of ABC Ltd. You consulted security analyst who supplied the following information
Event Probability Excess returns on the shares (%)
Excess return on the market (%) 1 0.3 25 18 2 0.3 -8 -6 3 0.1 8 11 4 0.2 13 0 5 0.3 18 13
Required:
(i) Calculate the security beta and alpha and interpret your result. (10Marks) (ii) Estimate non market risk for the shares (10Marks)
QUESTION THREE – 20 MARKS
(a) Sick Ltd has been making little profit for the last five years. Healthy Ltd wishes to takeover.
Sick Ltd. The financial data for two companies were as given below:
Healthy Ltd (shs ‘000’) Sick Ltd (shs ‘000’) Equity shares (shs. Per share) 100,000 50,000 Share premium A/C - 2,000 Profit premium A/C 38,000 4,000 Preference shares 20,000 - 10% debentures 15,000 5,000 173,000 61,000 Fixed assets 122,000 35,000 Net current assets 51,000 26,000 173,000 61,000 Market price per equity share 24 27 Price earnings ratio 10 9
Required: What offer do you think healthy company could make to sick company in terms of exchange ratio based on: (i) Net asset value (8Marks) (ii) Earnings per share (6Marks) (iii) Market price per share (3Marks) (iv) Which method is more preferable from healthy companies’ point of view? (3Marks)
3
QUESTION FOUR – 20 MARKS
You are evaluating various investment opportunities currently available and you have calculated expected returns and standard deviation for five well-diversified portfolios of risky assets:
Portfolio Expected Return Standard Deviation S 7.8 10.5% T 10.0 14.0 U 4.6 5.0 V 11.7 18.5 W 6.2 7.5
(a) For each portfolio, calculate the risk premium per unit of risk that you expect to receive. Assume that the risk free rate is 3%. (5Marks)
(b) Using your computations in (a) explain which of these five portfolios is most likely to be the market portfolio. Use your calculations to draw the capital market line (CML). (5Marks)
(c) If you are only willing to make an investment with ? = 7.0% is it possible for you to earn a return of 7%. (5Marks)
(d) What is the minimum level of risk that would be necessary for an investment to earn 7%? What is the composition of the portfolio along the CML that will generate that expected rate of return?
(5Marks)
QUESTION FIVE – 20 MARKS
(a) You are considering the sale of a call option with an exercise price of Kshs. 100 and one year to expiration. The underlying stock pays no dividends; its current price is kshs. 100 and you believe it will either increase to kshs. 120 or decrease to ksh. 80. The risk free rate of interest is 10%.
(i) Describe the specific steps involved in applying the binomial option pricing model to calculate the option’s value. (2Marks) (ii) Compare the binomial option pricing model to the black-scholes option pricing model. (3Marks)
(b) Consider the following data relevant to valuing a European style call option on a non-dividend paying stock: Exercise price = 40, risk free rate = 9%, T = six months and ?= 0.25. For s = 40; (i) Calculate the Black-Scholes value for a European style put option. (4Marks) (ii) How much of this value represents the premium? (3Marks)
(c) Discuss the factors that determine the theoretical value of the option. (8Marks)
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