Securities Analysis Ii 07 2007

Question Paper Security Analysis - II (MB341INV) : July 2007 Section A : Basic Concepts (30 Marks) • • • •

1.

Which of the following is not an assumption underlying in technical analysis? (a) (b) (c) (d) (e)

2.

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Market value is determined solely by the interaction of supply and demand Supply and demand are governed by numerous factors, both rational and irrational Stock prices move in trend but the trend due to minor fluctuations in prices persist for a very short period Changes in trend are caused by shifts in supply and demand Some chart patterns tend to repeat themselves.

Which of the following trend lines, helps to study the share price when they are moving haphazardly and are volatile? (a) (b) (c) (d) (e)

3.

This section consists of questions with serial number 1 - 30. Answer all questions. Each question carries one mark. Maximum time for answering Section A is 30 Minutes.

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Support and resistance level Relative strength analysis Moving Averages Stochastics

Momentum.

The closing prices of Torrent Cables Ltd., on five consecutive trading days are as under: Days 0 1 2 3 4

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Closing Prices (Rs.) 274.90 275.60 272.00 268.00 270.00

The Relative Strength Index For Torrent Cable Ltd. is (a) (b) (c) (d) (e) 4.

47.35 49.75 50.25 50.50 51.00.

Which of the following statement(s) is/are not true regarding Gaps?

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I. Runaway gaps occur halfway through a trend. II. A series of breakaway gaps indicate that an exhaustion gap is round the corner. III. Exhaustion gap is treated as a sign of consolidation. IV. Island is separated by an exhaustion gap and a runaway gap. (a) (b) (c) (d) (e) 5.

Only (I) above Only (II) above Only (IV) above Both (I) and (III) above Both (II) and (IV) above.

Which of the following technique is used to identify the trend reversal before it takes place? (a)

Volume of the market

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(b) (c) (d) (e) 6.

Momentum Simple moving average Breadth of the market Weighted moving average.

Which of the following statements is/are true with respect to support and resistance lines?

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I.

New highs are reached after a resistance line is penetrated and new lows follow penetration of a support line. II. Prices are said to remain in a congestion zone as long as they fluctuate in narrow ranges within a support and resistance level. III. Prices penetrate support level, generally after slowing down from a previous high.

(a) (b) (c) (d) (e) 7.

Only (I) above Only (II) above Only (III) above Both (I) and (II) above Both (II) and (III) above.

Which of the following is/are feature(s) of negative pledge? I. II. III.

Prohibition. Unless clause. List of exceptions.

(a) (b) (c) (d) (e) 8.

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Only (III) above Both (I) and (II) above Both (I) and (III) above Both (II) and (III) above All (I), (II) and (III) above.

Which of the following statements is/are true regarding bond price theorems?

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I.

For a given difference between YTM and coupon rate of the bonds, the longer the term to maturity, the greater will be the change in price with change in YTM. II. The percentage price change increases at a diminishing rate as the bond’s maturity time increases. III. Given the maturity, the change in bond price will be greater with an increase in the bond’s YTM, than the change in bond price with an equal decrease in the bond’s YTM.

(a) (b) (c) (d) (e) 9.

Only (I) above Only (II) above Only (III) above Both (I) and (II) above Both (II) and (III) above.

The following information is available about a stock and the market Stock:

Beta Growth rate Market: Return Risk free rate The duration of stock is

(a) (b) (c) (d) (e) 10.

= 2.0 = 6% = 10% = 7%

9.52 years 12.06 years 14.28 years 19.62 years 34.28 years.

IDBI came out with an issue of deep discount bonds. Each bond having a face value of Rs.125,000 was issued at a deep discounted price of Rs.480.50 with a maturity period of 15 years. The corporate tax rate applicable is 25%. If the indexed cost of acquisition is 25%, then the post-tax yield to maturity of the bond is (a) (b) (c) (d)

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42.47% 35.21% 29.67% 11.58%

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(e) 11.

5.37%.

Which of the following is/are true if a bond is selling at its face value?

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I.

The change in the price of the bond is less when yield decreases by 1% than the change in the price of the bond yield increases by 1%. II. YTM of the bond is equal to its coupon rate. III. YTM of the bond is equal to its reinvestment rate.

(a) (b) (c) (d) (e) 12.

Only (I) above Only (II) above Both (I) and (II) above Both (II) and (III) above All (I), (II) and (III) above.

Which of the following are limitations on restricted payments?

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I. A prohibition on restricted payments. II. A list of restricted payments. III. A financial test to determine the time at which restricted payments are allowed. IV. A list of permitted distribution. (a) (b) (c) (d) (e) 13.

An investor bought a 14% bond at par value of Rs.1,000 maturing in five years. Duration at this point of time is 3.97 years. If YTM remains the same, what will be the decrease in the duration of the bond after one year? (a) (b) (c) (d) (e)

14.

(a) (b) (c) (d) (e)

(b) (c) (d) (e) 16.

Only (I) above Only (II) above Only (III) above Both (I) and (II) above All (I), (II) and (III) above. < Answer >

The realized yield cannot be used to estimate rates of return attainable from various trading strategies A low realized yield reflects an investor’s expectation of substantial capital gains in a fairly short period of time The realized yield depends only on the holding period chosen The realized yield will always lie between the YTM and the reinvestment rate For bonds with shorter term to maturity, realized yield will be closer to reinvestment rate.

The average daily price change in coffee futures contract is Rs.2.50 per kg and the standard deviation of the price changes is Re 0.50. If the size of the contract is 1000 kg, then the initial margin required is (a) (b) (c) (d) (e)

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The coupon of bond and convexity are inversely related. The maturity of a bond and convexity are directly related. The yield of a bond and convexity are directly related.

Which of the following is true with respect to realized yield? (a)

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3.00 3.36 0.90 0.65 4.00.

Which of the following statement(s) is/are true regarding convexity? I. II. III.

15.

Both (I) and (III) above Both (II) and (IV) above (I), (II) and (III) above (II), (III) and (IV) above All (I), (II), (III) and (IV) above.

Rs.1,000 Rs.2,000 Rs.3,000 Rs.4,000 Rs.5,000.

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17.

If stock is purchased at Rs.50 and Rs.55 call is written for a premium of Rs.2, the maximum possible gain per share is (a) (b) (c) (d) (e)

18.

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Rs. 2 Rs. 5 Rs. 7 Rs. 8 Rs.10.

Which of the following statement is/are not correct with respect to Key Rate Duration (KRD)?

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I.

KRD can identify the price sensitivity of an option embedded bond to each segment of the spot yield curve. II. KRD can capture the influence of multiple market factors on the yield curve movement. III. The major drawback of KRD is that it is calculated based on the assumption of parallel shifts in the yield curve. IV. The sum of KRDs will be equal to the effective duration. (a) (b) (c) (d) (e) 19.

In the futures market, due to the margin requirement and ___________, the probability of default is non existent. (a) (b) (c) (d) (e)

20.

Only (I) above Only (III) above Both (I) and (IV) above Both (II) and (III) above Both (III) and (IV) above. < Answer >

Careful credit rating checks Daily realization of gains and losses Allowing a discrete number of price changes per day Keeping a required balance between long and short positions Carefully analyzing investor’s background.

Which of the following statements are true with respect to Option-Adjusted-Spread (OAS)?

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I.

It is a measure of the yield spread, which can be used to convert differences between the values and the prices. II. It is basically used as a tool to reconcile value with market price. III. The higher the expected interest rate volatility, the higher the OAS. IV. The cash flows of the callable bond are adjusted to reflect the embedded option; the resulting spread is called option adjusted spread.

(a) (b) (c) (d) (e) 21.

Which of the following is/are true regarding “In-the-Money” Option? I. II. III. (a) (b) (c) (d) (e)

22.

Both (I) and (IV) above Both (II) and (III) above (I), (II) and (IV) above (I), (III) and (IV) above (II), (III) and (IV) above.

Has an exercise price below the current market price of the underlying security. Has positive value if buyer exercises it. Has an exercise price above the current market price of the underlying security. Only (I) above Only (II) above Only (III) above Both (I) and (II) above Both (II) and (III) above.

Which of the following are true regarding features of Floating Rate Notes (FRN)? I. Reference index. II. Reset frequency. III. Observation date. IV. Maturity date. (a)

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Both (I) and (III) above

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(b) (c) (d) (e) 23.

A convertible bond with a face value of Rs.1,000 has been issued at Rs.1,350 with a coupon rate of 10.5%. The conversion rate is 14 shares per bond. The current market price of the bond is Rs.1, 475 and that of stock is Rs.80. The premium over conversion value is (a) (b) (c) (d) (e)

24.

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24.06% 33.33% 31.70% 37.25% 52.00%.

Which of the following statements is/are true, if Ps is the current market price of the common stock, Pe is the exercise price of the warrant and N is the number of shares per warrant? I. The minimum value of the warrant is (Ps–Pe) × N, if Ps > P e. II. The maximum value of the warrant is Ps × N. III. The minimum value of the warrant is 0 if Ps ≤ P e. (a) (b) (c) (d) (e)

25.

Both (II) and (IV) above (I), (II) and (III) above (I), (II) and (IV) above All (I), (II), (III) and (IV) above.

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Only (II) above Only (III) above Both (I) and (II) above Both (II) and (III) above All (I), (II) and (III) above.

Which of the following are true regarding the limitations of Real estate investment?

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I. Lack of liquidity. II. Real estate market is more efficient than other markets. III. Insufficient historical data available on real estate. IV. Diversification is possible for large investor as well as small investors. (a) (b) (c) (d) (e) 26.

Both (I) and (III) above Both (II) and (III) above Both (III) and (IV) above (I), (II) and (III) above (I), (III) and (IV) above. < Answer >

Considered the following data: Risk-free rate Rate for non-liquidity Recapture premium Risk premium NOI

18.4% 4% 8% 6% Rs.30,000

The market value is (a) (b) (c) (d) (e) 27.

Rs.1,52,626 Rs.1,56,689 Rs.1,61,242 Rs.1,64,835 Rs.1,66,299.

Which of the following statements is/are not true of “market extraction method” to derive the capitalization rate of real assets? I. II.

In this method, net operating income is divided by sales price to get the capitalization rate. In this method, the rates on equity as well as debt financing rates are weighted according to their proportions to calculate the capitalization rate. III. In this method, the capitalization rate is the sum of the return required on an asset for its being non-liquid, and the risk free rate. IV. In this method, comparable property is selected to choose a rate which reflects market sentiments.

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(a) (b) (c) (d) (e) 28.

If the maximum sales charge is 6% on the NAV of Rs.27, the Public Offering Price is (a) (b) (c) (d) (e)

29.

(d) (e)

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Net Asset Value (NAV) represents the fair value of a unit of a mutual fund scheme The units of closed-ended funds are generally not redeemable at their NAV The NAV and the price at which the units of mutual funds are traded in secondary market are not the same Open-ended mutual fund companies buy and sell units at their NAV Closed-ended funds channelize funds in secondary market in acquisition of corporate securities.

The qualitative factors affecting the value of real assets may be classified into macro and micro factors. Which of the following is a micro factor? (a) (b) (c) (d) (e)

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Rs.27.68 Rs.28.72 Rs.29.96 Rs.30.04 Rs.32.64.

Which of the following statements is not true with respect to mutual funds? (a) (b) (c)

30.

Only (I) above Only (III) above Both (I) and (IV) above Both (II) and (III) above Both (II) and (IV) above.

Interest Rates Population Demographics Business cycle Location Legal environment. END OF SECTION A

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Section B : Problems/Caselet (50 Marks) • • • • •

1.

2.

This section consists of questions with serial number 1 – 5. Answer all questions. Marks are indicated against each question. Detailed workings/explanations should form part of your answer. Do not spend more than 110 - 120 minutes on Section B.

Two years ago Indian Photofilms Ltd. had issued bonds which have a book value of Rs.5 crores. These bonds carry an interest rate of 12% per annum payable semi-annually and are redeemable in two equal annual installments, each amounting to 50% of the par value of the bonds, payable at the end of the last two years of the life of the bonds. These bonds have a maturity period of 7 years. The yield to maturity on these bonds prevailing in the market is 10%. You are required to find out the aggregate market value of the bonds at present. (12 marks) A bond issued by Greaves Metal Ltd. is selling presently at a face value of Rs.100 and pays coupon rate at the rate of 13% p.a. in arrears which will be redeemed at Rs.113 after

8.5 +

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n 6 where, n =

five years. The ‘n’ years spot rate of interest, yn is given by yn(%) = 1, 2 3, 4 and 5. The term structure of interest rates is flat and pure expectation theory holds good. You are required to calculate a. The implied one year forward rates applicable at time t = 3 and t = 4 . b. The value of the bond at time 0. c. The duration of the above bond. d. Change in bond price for 50 basis point increase in interest rates.

(3 + 3 + 3 + 3 =12 marks) 3.

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Consider the given data on three similar properties:

Property

Rental Value per month (Rs.)

Electricity Charges per month (Rs.)

Water charges per month (Rs.)

Market Value (Rs. in lakhs)

X

16,000

1,520

600

30

Y

11,500

1,050

400

22

Z

6,350

830

330

13

Assume that electricity and water charges are not expected to vary greatly from above values. You are required to calculate the average capitalization rate. ( 10 marks)

Caselet Read the caselet carefully and answer the following questions: Discuss the support and resistance level with the help of demand and supply theory and 4. also explain how bulls and bears affect the support and resistance level. 5.

(8 marks) There are some principles to be kept in mind while applying support and resistance lines

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for trend analysis. Discuss these principles. (8 marks) A technical analyst sits with a lot of charts to conclude patterns by viewing how a stock is being traded in a certain period of time. By employing complex statistical tools, analysts study the graph of stock price and its quantity traded over a period of time. After all these efforts, an analyst expects the graph to tell about the increase or decrease in the price of the stock. Such type of analysis moreover looks in support of certain price levels in a stock’s performance in the past e.g., 52-week high and the 52-week low. These levels infer about the highest and lowest price of the security for the past one-year. The 52-week low is called the support level as it is generally believed to be the ‘support’ level below which the stock’s price shouldn’t fall except there is something fundamentally wrong in the company. Simply, support is the floor level, below which the stock price cannot fall and resistance is a ceiling price level above which the price should not increase. When the price of the security break through a support or resistance line, the traders will drive the price to the new price level. When a resistance level is penetrated and successfully tested, it becomes a support level and vice-versa. Investors usually buy the stock at support line in anticipation of increase in prices and sell the stocks at resistance level expecting the price to come down. Mostly these support and resistance level are triggered through fundamental changes that varies with expectation and also through psychological factors. The foundation of most technical analysis tools is rooted in the concept of supply and demand. In almost all charts support and resistance levels are the most popular. It is always wise to again take a note of new facts after the support/resistance level is broken. For example, if there is a breakout above the resistance level, one should again analyze the new trend and should consider new fundamental and then may think about selling the stock. This creates an observable fact that is referred to as “traders’ remorse” prices return to a support/resistance level following a price breakout. The trend of price line after this period is important. There is a possibility of two things here. Firstly, if the expectation is defensive then the price will move back to the earlier level and secondly, if the expectation is positive, then the price will continue in the same direction.

END OF SECTION B

Section C : Applied Theory (20 Marks) • • • •

6.

7.

This section consists of questions with serial number 6 - 7. Answer all questions. Marks are indicated against each question. Do not spend more than 25 -30 minutes on section C.

Explain what do you mean by futures contract and discuss how it is different from forward contracts. (10 marks) Valuation of real estate assets is different from that of bonds or stocks. Explain the characteristics of real estate markets.

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(10 marks)

END OF SECTION C END OF QUESTION PAPER

Suggested Answers Security Analysis – II (MB341INV) : July 2007 Section A : Basic Concepts 1.

Answer : (c)

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Reason :

2.

3.

The basic assumptions underlying technical analysis are as follows: •

Market value is determined solely by the interaction of supply and demand.

•

Supply and demand are governed by numerous factors, both rational and irrational.

•

Ignoring minor fluctuations in the market, stock prices tend to move in trends which persist for an appreciable length of time.

•

Changes in trend are caused by shifts in supply and demand.

•

Shifts in supply and demand, no matter why they occur, can be detected sooner or later in charts of market value.

• Some chart patterns tend to repeat themselves. Hence (c) is the correct answer. Answer : (c) Reason : When share price move haphazardly and are very volatile, in such circumstances moving averages are used to study the pattern. Hence (c) is the correct answer. Answer : (c) Reason :

RS =

Answer : Reason :

5.

Answer : Reason:

6.

Answer : Reason :

7.

Answer : Reason :

8.

Answer:

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(275.60 + 270.00) / 2 272.80 = = 1.01 (272.00 + 268.00) / 2 270.00

RSI = 100 −

4.

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100 = 100 − 49.75 = 50.25 1 + 1.01

Hence (c) is the correct answer. (e) Runaway gaps occur when prices are on a rapid uptrend or downtrend. They generally occur almost halfway through a trend. A series of runaway gaps indicate that an exhaustion gap is round the corner Exhaustion gaps represent gaps ocurring before a trend ends, or gaps that precede the last legof a bullish or bearish trend. An exhaustion gap is treated as a sign of consolidation. Islands refer to the formation of an isolated price patten, usually within a narrow range, at the end of a price trend, the island is separated by an exhaustion gap and a breakaway gap. Hense statements (I) and (III) are true and statements (II) and (IV) are not true. Hence (e) is the answer. (b) Momentum is used to identify the trend reversal before it takes place. Hence (b) is the correct answer. (d) New highs are reached after a resistance line is penetrated and new lows follow penetration of a support line. Statement (I) is true. Prices are said to be remain in a congestion zone as long as they fluctuate in narrow ranges within a support and resistance level. Statement (II) is true. Prices penetrate support (resistance) level generally after slowing down from a previous low (high) and hovering around a level for sometime. Statement (III) is not true. Hence (d) is the answer. (e) Negative pledge has the following three distinct features: I. Prohibition. II. Unless clause. III. List of exceptions. Hence (e) is the correct answer. (d)

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Reason :

9.

Statement III is incorrect. Infact the statement should be, Given the maturity, the change in bond price will be greater with an decrease in the bond’s YTM than the change in bond price with an equal increase in the bond’s YTM. Hence (d) is the correct answer. Answer : (c)

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1 Reason :

Duration of stock = k e − g

k e = 7 + 2.0 (10 – 7) = 7 + 6 = 13% 1 Duration = 0.13 − 0.06 1 = 0.07 = 14.28 years. 10.

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Answer : (a) Reason :

Post tax yield to maturity = =

11.

Answer : Reason :

12.

Answer : Reason :

cost of acquisition (1+r)15 = Post tax redemption value

480.50(1+r)15 = 97164.16

= (1+r)15 = 202.21 = 42.47% (d) If a bond is selling at its face value YTM of the bond is equal to its coupon rate and its reinvestment rate. The change in the price of the bond is more when yield decreases by 1% than the change in the price of the bond if yield increases by 1%. Therefore (II) and (III) are correct. Hence (d) is the correct answer. (e) The limitation on restricted payments has four parts: •

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A prohibition on restricted payments.

•

A list of restricted payments.

•

A financial test to determine the time at which restricted payments are allowed.

• 13.

Answer: Reason :

14.

Answer : Reason :

15.

Answer : Reason :

A list of permitted distribution. Hence (e) is the correct answer. (d) Change in duration = 3.97-3.32 = 0.65 years. Year Cash flow PV @ 14% Duration 1 140 122.808 0.12281 2 140 107.73 0.21546 3 140 94.50 0.2835 4 1140 674.994 2.7000 Total 3.32 Hence (d) is the correct answer. (d) I. The coupon of bond and convexity are inversely related. II. The maturity of a bond and convexity are directly related. III. The yield of a bond and convexity are inversely related. Hence (d) is the correct answer. (d) The realized yield canbe used to estimate rates of return attainable from various trading strategies

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16.

A high realized yield reflects an investor’s expectation of substantial capital gains in a fairly short period of time The realized yield depends on the holding period chosen and the reinvestment rate The realized yield will always lie between the YTM and the reinvestment rate For bonds with longer term to maturity, realized yield will be closer to reinvestment rate, and for the bonds with shorter term to maturity, realized yield will be closer to the YTM. Hence statement (d) is true and is the answer. Answer : (d) Reason : The margin depends on the price volatility of the underlying. Exchanges generally set this margin equal to Margin = µ + 3σ

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Where µ is the average daily absolute change in the value of the contract and σ is the standard deviation of these changes measured over a period of time. Substituting the given values, we get

17.

Answer : Reason :

18.

Answer : Reason :

19.

Answer: Reason :

20.

Answer : Reason :

21.

Answer : Reason :

22.

Answer : Reason :

Margin = 2.50 × 1000 + 3 × 0.5 × 1000 = 2500 + 1500 = 4000. Hence the correct answer is (d). (c) The maximum possible gain per share when spot price exceeds strike price of Rs.55 is (55 – 50 + 2) = Rs.7. (b) Statement I, II and IV are correct with respect to KRD. The major drawback of effective duration measure is that it is calculated based on the assumption of parallel shifts in the yield curve. To overcome this an alternative measure used for different types of yield curve shifts is ”Key Rate Duration” popularly referred to as KRD. (b) On the futures market, due to the margin requirement and daily realization of gains and losses the probability of default is lowered. Therefore, Option (b) is the correct answer. (c) All statement are correct except statement III. The higher the expected interest rate volatility, the lower the OAS. Similarly the lower the expected interest rate volatility, the higher the OAS. (d) In an in-the-money call option the exercise price is less than the current market price i.e., the option is having a positive intrinsic value and the buyer would make profit if the option is exercised today (in the case of an American option) on the present value of profit (in case of a European option). (e) In the basic floating rate not, the following are the five important features: •

Reference index.

•

Qouted margin toreference rate.

•

Reset frequency.

•

Observation date.

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•

23.

Maturity date. Hence (e) is the correct answwer. Answer : (c) Reason : Conversion rate is 14 shares per bond Market price per share is Rs.80 Conversion value = Rs.(80 × 14) = Rs.1120 Market price of the bond = Rs.1475

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355 ×100 = 31.70%. ∴ Premium over conversion value = 1120 24.

25.

26.

Therefore, Option (c) is the correct answer. Answer : (e) Reason : All the statements are correct with respect the pricing of the warrant. Therefore, Option (e) is the correct answer. Answer : (a) Reason : Real estate investment has its own limitations too: I. Lack of liquidity. II. Real estate market is less efficient than other markets. III. Insufficient historical data available on real estate. IV. Diversification is possible only for large investor and not for small investors. Hence (a) is the correct answer. Answer : (d) Reason : Capitalization rate = Risk-free rate + Rate for non-liquidity + Recapture premium + Risk premium = 18.4 + 4 + 8 + 6 = 36.4 Market Value

27.

28.

NOI R

=

=

29.

Answer : Reason :

30.

Answer : Reason :

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60, 000 0.364 = Rs. 1,64,835.

Answer : (d) Reason : Statement II relates to Bond of Investment method. Statement III relates to Built-up method Hence (d) is the correct answer. Answer : (b) Reason :

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NAV 27 27 = = Rs.28.72 1 − Sales ch arg e = 1 − 0.06 POP = 0.94 Hence (b) is the correct answer. (d) As the intrinsic value of the security represents the fair value of the security, the Net Asset Value (NAV) represents the fair value of a unit in a mutual fund. Statement (a) is true. Open-ended mutual fund companies sell new shares at NAV plus a loading or management fee and redeem them at their NAV. Statement (d) is not true. The shares of closed-ended funds are not redeemable at their NAV as the open-ended funds. On the other hand, these shares are traded in secondary market on stock exchanges at market prices that may be above or below their NAV. Therefore the NAV and the price at which the units of mutual funds are traded in secondary market need not be always equal. Statement (b) & (c) are true. Close-ended funds channelize funds in secondary market in acquisition of corporate securities. Statement (e) is true. Hence (d) is the answer. (d) Interest Rates, Population Demographics, legal environment and Business cycle are the macro factors affecting the value of real asset whereas location of a land in a elite or downward market is considered to be micro factor.

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Section B : Problems/Caselet 1.

The value of the bond can be found out as follows: 2n

V

=

I/2

∑ (1 + k t =1

d

/ 2)

t

+

F (1 + k d / 2) 2n

Since the redemption value of the bond is payable in two equal installments, the first term as well as the second

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term on the RHS have to be modified. Given, F = book value = Rs.500,00,000 I = 500,00,000 (0.12) = Rs.60,00,000 I/2 = Rs.30,00,000 kd = 10% = 0.10 kd/2 =

5% = 0.05

n = 7–2 = 5 (Since the bonds were issued two years ago, two years have to be deducted from the maturity period of seven years). 2n = 2 × 5 = 10 V = 30,00,000 PVIFA(5% , 8 ) + 2,50,00,000 PVIF(5% , 8) + 15,00,000 PVIF(5% , 9) + 15,00,000 PVIF(5% , 10) + 250,00,000 PVIF(5% , 10) 15,00,000 =

2.

a.

(1.05)

30,00,000 PVIFA(5%, 8) +

9

+

15,00,000 10

+

250,00,000

(1.05)

(1.05)

8

+

250,00,000 (1.05)10

= 30,00,000 (6.463) + 15,00,000 [0.645 + 0.614] + 250,00,000 [0.677 + 0.614] = Rs.53,552,500 We can find the forward rates by f3 and f4 using spot rate y1 , y2, y3, y4, and y5 : (1+ y4)4 = (1+ y3)3 (1+ f3) and (1+ y5)5 = (1+ y4)4 (1+ f4) For, f3 (1.0917)4 = (1.09)3 (1+ f3) f3 = 9.68% For, f4 (1.0933)5 = (1.0917)4 (1+ f4) f4 = 9.97%

b.

The value of the bond at time = 0 13 (PVIF 8.67%, 1 + PVIF 8.83%,2 + PVIF 9..0%,3 + PVIF 9.17%,4 + PVIF 9..33%,5) + 113 × PVIF 9.33%, 5 = 13 (0.920 + 0.844 + 0.77 + 0.704 + 0.640) + 113 × 0.640

c.

= 122.76 100 = 13 PVIFA( r 5) + 113 PVIF( r 5) r = 15% Duration rc rd



× PVIFA( r , n ) × (1 + rd ) +  1 −

0.13 =



d

0.15

 ×n rd  rc

 

× PVIFA(15%,5) × (1.15) +  1 −

=3.34 + 0.67 =4.01 years D 1+ d.

Dmod =

rd

4.01

f = 1.15 = 3.49 years

0.13 

×5

0.15 

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∆Po ∆BP × 100 = − Dmod × 100 Po = - 3.49 years × 50/100 = -1.745% i.e.. 1.745% fall in bond price. Therefore new price = 100 (1 - 0.01745) = Rs. 98.26 3.

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The net operating income (NOI) for a month, for these properties is as under:

Property A B C

Rental Value per month (Rs.) 16,000 11,500 6,350

Electricity Charges per month (Rs.) 1,520 1,050 830

Water Charges per month (Rs.) 600 400 330

Net operating Income (Rs.) Per month

Per annum

18,120 12,950 7,510

2,17,440 1,55,400 90,120

The calculation of capitalization rate is shown below: Property

A B C

NOI per annum

Market Value (Rs.)

(1)

(2)

2,17,440 1,55,400 90,120

Capitalization Rate = NOI per annum ÷ Market Value x 100 (1) x100% (3) = (2)

3,000,000 2,200,000 13,00,000

7.248 7.064 6.932

7.248 + 7.064 + 6.932 Therefore, average capitalization rate = 4.

5.

3

= 7.081.

Support and resistance are the key point where the forces of demand and supply convene. Usually supply drives the price down and demand increases the price. Thus excess supply is related with bear signal and excess demand is a signal of bullishness. When supply and demand are equal, prices will move sideways. The support and resistance level is an example of the supply and demand theory, where the supply explains the number of shares the seller is willing to give and demand explains the number of shares a buyer is willing to purchase. Thus at higher prices more investor are willing to sell and number of seller increases in the expectation of selling at higher prices, on the other hand the number of buyers decreases as only few investors are willing to buy at higher prices. A breakout above a resistance level is evidence of an upward shift in the demand line as more buyers become willing to buy at higher prices. Similarly, the failure of a support level shows that the supply line has shifted downward. Thus bull pushes prices higher and bear lowers the prices and the direction of prices will show who had actually won the battle. Bull will come in the picture at the support level and prevent the price from falling lower. On the opposite, bear will take control at resistance level and stop the price from rising higher. The trade will take place at the price where both bull and bear agree to do business and this shows the harmony in the idea. The following principles are to be applied while using support and resistance lines for trend analysis: i. Support and resistance lines are only approximations of the levels, prices may be expected to ‘obey’. They should, therefore, be drawn using judgement, and clues from the past price behavior. Ii. Penetration of a support and resistance line, also confirmed by an underlying price pattern, is a fairly sure indication of a strong ensuing move in the same direction. New highs are reached after a resistance line is penetrated and new low follow penetration of a support line. iii. Prices are said to remain in a ‘congestion zone’ as long as they fluctuate in narrow ranges within a support and resistance level. The direction of breakout from a congestion zone cannot be predicted in advance. iv. The higher the volume accompanying the confirmation of a support or resistance level, the more its significance. v. The speed and extent of the previous move determines the significance of a support or resistance level. Prices penetrate support (resistance) level generally after slowing down from a previous low (high) and

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hovering around a level for sometime. vi. Support and resistance levels repeat their effectiveness time and again, even if separated by many years.

Section C: Applied Theory 6.

Futures Contracts: A futures contract is an agreement between two parties to exchange a commodity or a financial asset for certain consideration after a specified period. Differences between Futures and Forward Contracts Futures contracts Forward contracts 1. 2. 3. 4. 5.

7.

These are traded in organized location known as exchange. The terms of the contract are highly standardized. Contracts are cleared by a separate clearing house. Clearing house guarantees the performance of the contract.

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It is an over-the-counter product. Terms are structured to suit both the contracting parties. No such facility exists. No organization guarantees the performance of the counterparty. Depends on the worth of the counterparty. No compulsion to make such deposits.

Traders have to deposit initial margin irrespective of their trading position. 6. Traders have to pay daily settlement margin No such provisions are in vogue. depending on the movement in the price of the underlying stock. Quite difficult to do so. 7. Futures contracts can be easily closed. 8. Future markets are monitored and regulated by Regulation is not as tight as in futures markets. special agencies. 9. Marking to market is done at the end of every No such adjustments are carried out. trading day. Characteristics of Real Estate/Property Markets Valuation of real estate portfolio is different from that of bonds or stocks because of the following characteristics: a. Each packet is Unique: No two real estate investments can be the same, at least if they are located in different places. This difference may not be very significant but the price of one of them may not give any clue about the price of another. Thus the principle of pricing of similar products cannot be applied to real estate pricing. b. Relatively Fewer Players in the Markets: While there are a large number of players in the stock market or bond market, there are a very few players in the property market. This is because the amount required for investment in property markets is comparatively higher than that required in the other asset markets. c. The Price of a Property is Influential: In a perfectly competitive market, buyers cannot determine the price. Buyers have no choice. But the situation is different in the case of real estate markets because a buyer who can bid for a much higher price than the second bidder will definitely influence the price of the property. Real estate does not have a market mechanism which allows short selling. d. Real Estate Investment are Large Economic Units: Property investments cannot be divided into smaller units like equity shares. This may be overcome to a certain extent by way of securitization of real estate investments. But still a property investment must be made as a single unit. e. Extensive Government Controls: Property markets are subject to several regulations such as tax laws, building codes, environmental norms to be adhered to, etc. These act as detrimental factors to the development of real estate. Frequent changes in government regulations may cause change in ownership position of a real estate which poses an additional risk. f. Slow Reaction of Supply to Demand: Supply and demand in real estate do not balance. This is because it takes time for conversion of a property from one use to another use. This adds to the complication of the valuation of an investment. g. Unorganized Market: There is no regulated market available for real estate. So the price of the real estate becomes difficult to be estimated. Though the shares in Real Estate Investment Trusts (REITS) are traded, they do assume the properties of a share rather than those of a real estate. h. Insufficient Data about Market Prices: Absence of an organized market and indivisible nature of real estate investment are the reasons for the availability of reliable information about the prices of real estate. Even the buyers and sellers are not willing to disburse the price information. Unless lease agreement is signed, it is not possible to estimate the price of a vacant space in any building. Thus, price information about the property is

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difficult to obtain. i. Illiquid Nature: Very few transactions occur in real estate over a period of time. So a definite trend of the prices over time is difficult to determine. The risk and return characteristics are also difficult to estimate. < TOP OF THE DOCUMENT >