King’s College London

This paper is part of an examination of the College counting

towards the award of a degree. Examinations are governed by
the College Regulations under the authority of the Academic
Board.

BSC BUSINESS MANAGEMENT/ BSC ECONOMICS AND MANAGEMENT/

BSC INTERNATIONAL MANAGEMENT/BA LANGUAGE AND
MANAGEMENT EXAMINATION

6SSMN313 INVESTMENT MANAGEMENT

EXAMINATION PERIOD 2 (MAY 2019)

TIME ALLOWED: THREE HOURS

INSTRUCTIONS TO CANDIDATES:

1. You must answer ALL questions of FOUR out of FIVE parts.

2. Answer each part on a new page of your answer book and write
its number in the space provided.

ALL PARTS CARRY EQUAL MARKS

CALCULATORS MAY BE USED. ONLY THE FOLLOWING MODELS ARE

PERMITTED: Casio fx83, Casio fx85

DO NOT REMOVE THIS PAPER FROM THE EXAMINATION ROOM

TURN OVER WHEN INSTRUCTED

2019 © King’s College London
 6SSMN313

PART A (25 marks)

1. Using the information below:

Economy state Stock A Stock B

Bear 20% 1%
Normal 5% 4%
Bull -10% 7%

a) Calculate the expected return and standard deviation for

Stock A and Stock B. Assume each state of the economy is
equally likely to happen. (7 marks)

b) Suppose you have £20,000 to invest and your target

expected return is 4.2%. How much should you invest in
Stock A and how much should you invest in Stock B? What is
the standard deviation of the rate of return for this
portfolio? (7 marks)

c) Compare the standard deviation of the portfolio’s returns

obtained in (b) with the standard deviation of Stock A and
Stock B. Based on this, explain the benefits of portfolio
diversification. (4 marks)

2. Suppose that the market portfolio is equally likely to

increase by 24% or decrease by 8%. Security "X" goes up by
29% when the market goes up and goes down by 11% when
the market goes down. Security "Y" goes down by 16% when
the market goes up and goes up by 16% when the market
goes down. Security "Z" goes up by 4% when the market
goes up and goes up by 4% when the market goes down.
What is the expected return on security with a beta of 1.2
in this economy? (7 marks)

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PART B (25 marks)

1. In 1990, the total mortgage-backed securities outstanding

was approximately $1 trillion. This grew to $9.3 trillion in
2017. What is a mortgage-backed security? What explained
its explosive growth over the past three decades? (7 marks)

2. Assume an economy consisting only of the following three

assets: stocks of companies A and B, and a risk-free asset.
The return of the risk-free asset is 4%. We further assume
that there is only one period in the economy. Today (date
0), stocks A and B are trading at P A = £9.125 and PB =
£8.145, respectively. On date 1, the liquidation value of
stocks A and B would be £12 and £10, respectively.

a) What are the expected returns of stocks A and B? (3 marks)

b) In this economy, the risky market portfolio consists only of

companies A and B. If company A’s market capitalization is
12% of the risky market portfolio, what would be betas of
stocks A and B? (6 marks)

c) An investor wants to invest in a portfolio that is on the

capital market line and has an expected return of 15%.
What fraction of his wealth must this investor invest in each
of the three assets? (5 marks)

3. Is the following statement true or false? Explain. (4

marks)
“In January 2019, the yield-to-maturity of a ten-year
Sudanese government bond is 18.00%. Therefore, investors
should use this rate as the risk-free rate to estimate the
expected returns for stocks of Sudanese companies”.

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PART C (25 marks)

1. Niklas is buying Deutsche Telekom stock. The current

market price is €20 and he has €5,000 to invest. He borrows
an additional €5,000 from a broker at an interest rate of 4%
per year and invest €10,000 in the stock.

a) What would be his rate of return if, over the next year,
the share price of Deutsche Telekom goes down from €20
to €19.3, and the stock pays a dividend €1 per share? (5
marks)

b) Assume that a year has passed. Further assume that this

stock pays no dividend. How low can Deutsche
Telekom’s price fall before Niklas gets a margin call if
the maintenance margin is 30%? (5 marks)

2. Ben is deciding whether to invest in a bank’s certificate of

deposit that pays a 6% annual interest or to invest in a
mutual fund with a front-end load of 3% and an annual
operating fee of 0.5%. If Ben plans to invest for 3 years,
what annual rate of return must the fund portfolio earns for
him to be better off investing in the fund than in the
certificate of deposit? (7 marks)

3. You have just obtained a new dataset that enables you to

compute historical rates of return on UK stocks all the way
back to 1920. What are the advantages and disadvantages
in using these data to help estimate the expected rate of
return on UK stocks over the coming year? (5 marks)

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4. Give an example of a financial intermediary and explain

how it acts as a bridge between small investors and large
corporations. (3 marks)

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PART D – Equity Valuation (25 marks)

1. Describe each of the four stages of security analysis. Discuss

why each of them is necessary prior to valuation. (8 marks)

2. Simpkins Corporation is expanding rapidly, and it currently

needs to retain all of its earnings and hence, does not pay any
dividends. However, investors expect Simpkins to pay its first
dividend of $1.00 three years from today. The dividend will grow
rapidly—at a rate of 50% per year—during Years 4 and 5. After
Year 5, the dividend should grow at a constant rate of 8% per
year. If the required return on the stock is 15%, what is the value
of the stock today? (7 marks)

3. Parcel Corporation is expected to pay a dividend of $5 per

share next year, and the dividends payout ratio is 50%. If the
dividends are expected to grow at a constant rate of 8% forever
and the required rate of return on the stock is 13%, calculate the
present value of the growth opportunity. (4 marks)  

4. Much of the real world discussion concentrates on a firm’s

price-earnings multiple. Explain why. (6 marks)

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PART E – Bond Valuation (25 marks)

1. A UK gilt has an annual coupon rate of 5%, a face value of

£1,000 and matures in 15 years. The interest payments are made
semi-annually. Calculate the price of the gilt if the yield to
maturity is 3% (7 marks)

2. You own a 7%-coupon bond maturing in two years and priced

at 103% of face value. What is the bond’s promised yield to
maturity? (assume annual coupon payment) (5 marks)

3. A coupon bond pays annual interest, has a par value of $1000.

The bond matures in four years, has a coupon rate of 10%, and
has a yield to maturity of 12%. What is the current yield on this
bond? (5 marks)

4. Why are many bonds callable? What are the advantages and
disadvantages of a callable bond to investors? How are bond
valuation calculations affected if bonds are callable? (8 marks)  

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