Chapter 3 Mutual Funds 1. r2 = 1 Initial expense in decimals 1 = 1 0.05 = 15.48% 2. r2 = 1 Initial expense in decimals 1 16.5% = 1 0.06 16.5% = 0.

= 0.1489 + Recurring expense in percentage terms Recurring expense x 14% + in percentage terms 1 Recurring expense r1 + in percentage terms x 13% + 1.8% 1 Recurring expense r1 + in percentage terms

Recurring expense = 0.1650 0.1489 = 0.0161 in percentage terms = 1.61%

Chapter 4 SECURITIES MARKET 1. Share

Price in base year (Rs.) 1 12 18 35 20 15

Price in year t (Rs.) 2 16 15 60 30 6 577

Price Relative 3 133 83 171 150 40 577 = 144

M N O P Q

No. of outstanding shares (in million) 4 10 5 6 40 30

Market Market capitalisation capitalisatio in the base n in year t year (1 x 4) (2 x 4) 5 6 120 160 90 75 210 360 600 1200 90 180 1110 1975

The equal weighted index For year t is : The value weighted index For year t is : 2. Share

4 1975 x 100 = 178 1110 Price in base year (Rs.) 1 80 40 30 Price in year t (Rs.) 2 100 30 Price Relative 3 125 75 No .of outstanding shares 4 15 20 50 Market Market capitalisation capitalisatio in the base n in year t year (1 x 4) (2 x 4) 5 6 1200 1500 800 600 1500 3500 x 100 3500 Market capitalisation in year t 115 = 115 x 3500 = x 100 3500 Market capitalisation in year t x 100

X Y Z

The value weighted index for year t is: Market capitalisation in year t

115 x 3500 Market capitalisation in year t Market capitalisation of z = 100 = 4025 = 4025 (500 + 600) = 1925 1925 Price of share z in year t = 50 = 38.5

Chapter 5 RISK AND RETURN 1. R1 = 0.20, R2 = - 0.10, R3 = 0.18, R4 = 0.12, R5 = 0.16 (a) Arithmetic mean 0.20 0.10 + 0.18 + 0.12 + 0.16 = = 0.112 or 11.2% 5 (b) Cumulative wealth index CWI5 = 1(1.20) (0.90) (1.18) (1.12) (1.16) = 1.656 (c) Geometric Mean = [(1.20) (0.90) (1.18) (1.12) (1.16)]1/5 1 = 0.106 or 10.6% 2. The standard deviation of returns is calculated below Period Return in % Deviation Ri (Ri R) Square of devi atio ns 2 (Ri R) 77.44 449.44 46.24 0.64 23.04 596.8

1 2 3 4 5

20 -10 18 12 16 (Ri R)2 Variance = n1 =

8.8 21.2 6.8 0.8 4.8 Sum = 596.8

= 149.2 51

Standard deviation = (149.2)1/2 = 12.21 3. The expected rate of return on Alpha stock is: 0.4 x 25 + 0.3 x 12 + 0.3 x 6 = 11.8 The standard deviation of return is calculated below: Ri (RI R) pi pi (Ri R)2 25 13.2 0.40 69.696 12 0.2 0.30 0.012 -6 -17.8 0.30 95.052 Sum = 164.76

Standard deviation of return = [ pi (Ri R)2]1/2 = 12.84% Chapter 6 THE TIME VALUE OF MONEY 1. Value five years hence of a deposit of Rs.1,000 at various interest rates is as follows: r r r r 2. = = = = 8% 10% 12% 15% FV5 FV5 FV5 FV5 = = = = = = = = 1000 x FVIF (8%, 5 years) 1000 x 1.469 = Rs.1469 1000 x FVIF (10%, 5 years) 1000 x 1.611 = Rs.1611 1000 x FVIF (12%, 5 years) 1000 x 1.762 = Rs.1762 1000 x FVIF (15%, 5 years) 1000 x 2.011 = Rs.2011

Rs.160,000 / Rs. 5,000 = 32 = 25 According to the Rule of 72 at 12 percent interest rate doubling takes place approximately in 72 / 12 = 6 years So Rs.5000 will grow to Rs.160,000 in approximately 5 x 6 years = 30 years

3.

In 12 years Rs.1000 grows to Rs.8000 or 8 times. This is 23 times the initial deposit. Hence doubling takes place in 12 / 3 = 4 years. According to the Rule of 69, the doubling period is: 0.35 + 69 / Interest rate Equating this to 4 and solving for interest rate, we get Interest rate = 18.9%.

4.

Saving Rs.2000 a year for 5 years and Rs.3000 a year for 10 years thereafter is equivalent to saving Rs.2000 a year for 15 years and Rs.1000 a year for the years 6 through 15. Hence the savings will cumulate to: 2000 x FVIFA (10%, 15 years) + 1000 x FVIFA (10%, 10 years) = 2000 x 31.772 + 1000 x 15.937 = Rs.79481.

5.

Let A be the annual savings. A x FVIFA (12%, 10 years) = A x 17.549 = So A = 1,000,000 / 17.549 = 1,000,000 1,000,000 Rs.56,983. 10,000 10,000 / 1000 = 10

6.

1,000 x FVIFA (r, 6 years) FVIFA (r, 6 years) From the tables we find that FVIFA (20%, 6 years) FVIFA (24%, 6 years)

= =

= =

9.930 10.980

Using linear interpolation in the interval, we get: 20% + (10.000 9.930) r= (10.980 9.930) 7. 1,000 x FVIF (r, 10 years) FVIF (r,10 years) From the tables we find that FVIF (16%, 10 years) = FVIF (18%, 10 years) = 4.411 5.234 = = 5,000 5,000 / 1000 = 5 x 4% = 20.3%

Using linear interpolation in the interval, we get: (5.000 4.411) x 2% r = 16% + (5.234 4.411) 8. The present value of Rs.10,000 receivable after 8 years for various discount rates (r ) are: r = 10% PV = 10,000 x PVIF(r = 10%, 8 years) = 10,000 x 0.467 = Rs.4,670 = 17.4%

r = 12% r = 15% 9.

PV PV

= 10,000 x PVIF (r = 12%, 8 years) = 10,000 x 0.404 = Rs.4,040 = 10,000 x PVIF (r = 15%, 8 years) = 10,000 x 0.327 = Rs.3,270

Assuming that it is an ordinary annuity, the present value is: 2,000 x PVIFA (10%, 5years) = 2,000 x 3.791 = Rs.7,582

10.

The present value of an annual pension of Rs.10,000 for 15 years when r = 15% is: 10,000 x PVIFA (15%, 15 years) = 10,000 x 5.847 = Rs.58,470 The alternative is to receive a lumpsum of Rs.50,000. Obviously, Mr. Jingo will be better off with the annual pension amount of Rs.10,000.

11.

The amount that can be withdrawn annually is: 100,000 100,000 A = ------------------ ------------ = ----------- = Rs.10,608 PVIFA (10%, 30 years) 9.427 The present value of the income stream is: 1,000 x PVIF (12%, 1 year) + 2,500 x PVIF (12%, 2 years) + 5,000 x PVIFA (12%, 8 years) x PVIF(12%, 2 years) = 1,000 x 0.893 + 2,500 x 0.797 + 5,000 x 4.968 x 0.797 = Rs.22,683.

12.

13.

The present value of the income stream is: 2,000 x PVIFA (10%, 5 years) + 3000/0.10 x PVIF (10%, 5 years) = 2,000 x 3.791 + 3000/0.10 x 0.621 = Rs.26,212

14.

To earn an annual income of Rs.5,000 beginning from the end of 15 years from now, if the deposit earns 10% per year a sum of Rs.5,000 / 0.10 = Rs.50,000 is required at the end of 14 years. The amount that must be deposited to get this sum is: Rs.50,000 / PVIF (10%, 14 years) = Rs.50,000 / 3.797 = Rs.13,165

15.

Rs.20,000 =- Rs.4,000 x PVIFA (r, 10 years)

PVIFA (r,10 years) = Rs.20,000 / Rs.4,000 = 5.00 From the tables we find that: PVIFA (15%, 10 years) PVIFA (18%, 10 years) Using linear interpolation we get: r = 15% + = 15.1% 16. PV (Stream A) = Rs.100 x PVIF (12%, 1 year) + Rs.200 x PVIF (12%, 2 years) + Rs.300 x PVIF(12%, 3 years) + Rs.400 x PVIF (12%, 4 years) + Rs.500 x PVIF (12%, 5 years) + Rs.600 x PVIF (12%, 6 years) + Rs.700 x PVIF (12%, 7 years) + Rs.800 x PVIF (12%, 8 years) + Rs.900 x PVIF (12%, 9 years) + Rs.1,000 x PVIF (12%, 10 years) = Rs.100 x 0.893 + Rs.200 x 0.797 + Rs.300 x 0.712 + Rs.400 x 0.636 + Rs.500 x 0.567 + Rs.600 x 0.507 + Rs.700 x 0.452 + Rs.800 x 0.404 + Rs.900 x 0.361 + Rs.1,000 x 0.322 = Rs.2590.9 Similarly, PV (Stream B) = Rs.3,625.2 PV (Stream C) = Rs.2,851.1 17. FV5 = = = = = = = = Rs.10,000 [1 + (0.16 / 4)]5x4 Rs.10,000 (1.04)20 Rs.10,000 x 2.191 Rs.21,910 Rs.5,000 [1+( 0.12/4)] 5x4 Rs.5,000 (1.03)20 Rs.5,000 x 1.806 Rs.9,030 5.019 5.00 ---------------5.019 4.494 x 3% = = 5.019 4.494

18.

FV5

19. Stated rate (%)

A 12

B 24 4 times

C 24 12 times

Frequency of compounding 6 times Effective rate (%)

(1 + 0.12/6)6- 1 (1+0.24/4)4 1 (1 + 0.24/12)12-1 = 12.6 = 26.2 = 26.8

Difference between the effective rate and stated rate (%) 20.

0.6

2.2

2.8

Investment required at the end of 8th year to yield an income of Rs.12,000 per year from the end of 9th year (beginning of 10th year) for ever: Rs.12,000 x PVIFA(12%, ) = Rs.12,000 / 0.12 = Rs.100,000 To have a sum of Rs.100,000 at the end of 8th year , the amount to be deposited now is: Rs.100,000 = PVIF(12%, 8 years) 2.476 Rs.100,000 = Rs.40,388

21.

The interest rate implicit in the offer of Rs.20,000 after 10 years in lieu of Rs.5,000 now is: Rs.5,000 x FVIF (r,10 years) = Rs.20,000 Rs.20,000 FVIF (r,10 years) = Rs.5,000 From the tables we find that FVIF (15%, 10 years) = 4.046 This means that the implied interest rate is nearly 15%. = 4.000

I would choose Rs.20,000 for 10 years from now because I find a return of 15% quite acceptable. 22. FV10 = Rs.10,000 [1 + (0.10 / 2)]10x2 = Rs.10,000 (1.05)20 = Rs.10,000 x 2.653 = Rs.26,530

If the inflation rate is 8% per year, the value of Rs.26,530 10 years from now, in terms of the current rupees is: Rs.26,530 x PVIF (8%,10 years) = Rs.26,530 x 0.463 = Rs.12,283 23. A constant deposit at the beginning of each year represents an annuity due. PVIFA of an annuity due is equal to : PVIFA of an ordinary annuity x (1 + r) To provide a sum of Rs.50,000 at the end of 10 years the annual deposit should be Rs.50,000 A = FVIFA(12%, 10 years) x (1.12) Rs.50,000 = 17.549 x 1.12 24. The discounted value of Rs.20,000 receivable at the beginning of each year from 2005 to 2009, evaluated as at the beginning of 2004 (or end of 2003) is: = Rs.20,000 x PVIFA (12%, 5 years) Rs.20,000 x 3.605 = Rs.72,100. = Rs.2544

The discounted value of Rs.72,100 evaluated at the end of 2000 is = Rs.72,100 x PVIF (12%, 3 years) Rs.72,100 x 0.712 = Rs.51,335

If A is the amount deposited at the end of each year from 1995 to 2000 then A x FVIFA (12%, 6 years) = Rs.51,335 A x 8.115 = Rs.51,335 A = Rs.51,335 / 8.115 = Rs.6326

25.

The discounted value of the annuity of Rs.2000 receivable for 30 years, evaluated as at the end of 9th year is: Rs.2,000 x PVIFA (10%, 30 years) = Rs.2,000 x 9.427 = Rs.18,854 The present value of Rs.18,854 is: Rs.18,854 x PVIF (10%, 9 years) = Rs.18,854 x 0.424 = Rs.7,994

26.

30 per cent of the pension amount is 0.30 x Rs.600 = Rs.180 Assuming that the monthly interest rate corresponding to an annual interest rate of 12% is 1%, the discounted value of an annuity of Rs.180 receivable at the end of each month for 180 months (15 years) is: Rs.180 x PVIFA (1%, 180) (1.01)180 - 1 Rs.180 x ---------------- = Rs.14,998 .01 (1.01)180 If Mr. Ramesh borrows Rs.P today on which the monthly interest rate is 1% P x (1.01)60 = P x 1.817 = P = Rs.14,998 Rs.14,998 Rs.14,998 ------------ = Rs.8254 1.817

27.

Rs.300 x PVIFA(r, 24 months) = Rs.6,000 PVIFA (4%,24) = Rs.6000 / Rs.300 = 20 From the tables we find that: PVIFA(1%,24) = PVIFA (2%, 24) = Using a linear interpolation 21.244 18.914

r = 1% +

21.244 20.000 ---------------------21.244 18,914

x 1%

= 1.53% Thus, the bank charges an interest rate of 1.53% per month. The corresponding effective rate of interest per annum is [ (1.0153)12 1 ] x 100 = 20% 28. The discounted value of the debentures to be redeemed between 8 to 10 years evaluated at the end of the 5th year is: Rs.10 million x PVIF (8%, 3 years) + Rs.10 million x PVIF (8%, 4 years) + Rs.10 million x PVIF (8%, 5 years) = Rs.10 million (0.794 + 0.735 + 0.681) = Rs.2.21 million If A is the annual deposit to be made in the sinking fund for the years 1 to 5, then A A A A 29. x FVIFA (8%, 5 years) = Rs.2.21 million x 5.867 = Rs.2.21 million = 5.867 = Rs.2.21 million = Rs.2.21 million / 5.867 = Rs.0.377 million

Let `n be the number of years for which a sum of Rs.20,000 can be withdrawn annually. Rs.20,000 x PVIFA (10%, n) = Rs.100,000 PVIFA (15%, n) = Rs.100,000 / Rs.20,000 = 5.000 From the tables we find that PVIFA (10%, 7 years) PVIFA (10%, 8 years) = = 4.868 5.335

Thus n is between 7 and 8. Using a linear interpolation we get 5.000 4.868 n = 7 + ----------------- x 1 = 7.3 years 5.335 4.868 30. Equated annual installment = 500000 / PVIFA(14%,4) = 500000 / 2.914 = Rs.171,585

Loan Amortisation Schedule Year Beginning amount Annual installment Interest Principal repaid Remaining balance

-----1 2 3 4

------------500000 398415 282608 150588

--------------171585 171585 171585 171585

----------70000 55778 39565 21082

------------101585 115807 132020 150503

------------398415 282608 150588 85*

(*) rounding off error 31. Define n as the maturity period of the loan. The value of n can be obtained from the equation. 200,000 x PVIFA(13%, n) = 1,500,000 PVIFA (13%, n) = 7.500 From the tables or otherwise it can be verified that PVIFA(13,30) = 7.500 Hence the maturity period of the loan is 30 years. 32. Expected value of iron ore mined during year 1 = Rs.300 million

Expected present value of the iron ore that can be mined over the next 15 years assuming a price escalation of 6% per annum in the price per tonne of iron 1 (1 + g)n / (1 + i)n = Rs.300 million x i-g 1 (1.06)15 / (1.16)15 = Rs.300 million x 0.16 0.06 = Rs.300 million x (0.74135 / 0.10) = Rs.2224 million MINICASE 1. How much money would Ramesh need 15 years from now? 500,000 x PVIFA (10%, 15years) + 1,000,000 x PVIF (10%, 15years) = 500,000 x 7.606 + 1,000,000 x 0.239 = 3,803,000 x 239,000 = Rs.4,042,000

2. How much money should Ramesh save each year for the next 15 years to be able to meet his investment objective? Rameshs current capital of Rs.600,000 will grow to : 600,000 (1.10)15 = 600,000 x 4.177 = Rs 2,506,200 This means that his savings in the next 15 years must grow to : 4,042,000 2,506,200 = Rs 1,535,800 So, the annual savings must be : 1,535,800 = FVIFA (10%, 15 years) 31.772 1,535,800 = Rs.48,338

3. How much money would Ramesh need when he reaches the age of 60 to meet his donation objective? 200,000 x PVIFA (10% , 3yrs) x PVIF (10%, 11yrs) = 200,000 x 2.487 x 0.317 = 157,676 4. What is the present value of Rameshs life time earnings? 400,000 46 1 400,000(1.12) 2 1.12 1 1.08 = 400,000 0.08 0.12 = Rs.7,254,962
15

400,000(1.12)14 15

Chapter 7 Financial Statement Analysis 1.

(a)

Assets -

Fixed assets ( Net ) Cash and bank Marketable securities Receivables Inventories Prepaid expenses

Rs. 150 million 20 10 70 110 10 90 20 50 60 70 40 30 10

Liabilities Equity capital Preference capital Reserves and surplus Debentures (secured) Term loans (secured) Short term bank borrowing (secured) Trade creditors Provisions

Balance Sheet of Mahaveer Limited as on March 31, 2001 Liabilities Share capital Equity Preference Reserve & surplus Secured loans Debentures Term loans Unsecured loans Short term bank borrowing Current liabilities & provisions Trade creditors Provisions 90 20 50 60 70 40 30 10 -----370 -----Assets Fixed assets Net fixed assets Investments Current assets, loans & advances Marketable securities Pre-paid expenses Inventories Receivables Cash & Bank 10 10 110 70 20 ----370 -----150

2. (a) Sources & Uses of Cash Statement for the Period 01.04.2000 to 31.03.2001

(Rs. in million) ---------------------------------------------------------------------------------------------------------Sources Uses Net profit Depreciation Decrease in inventories Increase in short term bank borrowings Increase in trade creditors Total sources Net decline in Cash balance (b) Classified cash flow statement for the Period 01.04.2000 to 31.03.2001 (Rs. in million) ---------------------------------------------------------------------------------------------------------A. Cash flow from operating activities Net profit before tax and extraordinary items 100 Adjustments for Interest paid 30 Depreciation 20 Operating profit before working capital changes 150 Adjustments for Inventories 10 Debtors (10) Short term bank borrowings 10 Trade creditors 10 Provisions (5) Increase in other assets (5) Cash generated from operations 160 Income tax paid (20) Cash flow before extraordinary items 140 Extraordinary item (50) Net cash flow from operating activities 90 B. Cash flow from investing activities Purchase of fixed assets (30) Net cash flow from investing activities (30) 30 20 10 10 10 80 5 Dividend payment Purchase of fixed assets Increase in debtors Increase in other assets Decrease in long term debt Decrease in provisions Total uses 20 30 10 5 15 5 85

C.

Cash flow from financing activities Interest paid Repayment of term loans Dividends paid Net cash flow from financing activities Net increase in cash and cash equivalents Cash and cash equivalents as on 31.03.2000 Cash and cash equivalents as on 31.03.2001

(30) (15) (20) (65) (5) 20 15

D.

Note : It has been assumed that other assets represent other current assets. Net profit 3. Return on equity = Equity = Net profit x Net sales = Debt Note : Total assets Hence Total assets/Equity 4. PBT = Rs.40 million PBIT Times interest covered = Interest So PBIT = 6 x Interest PBIT Interest = PBT = Rs.40 million 6 x Interest = Rs.40 million Hence Interest = Rs. 8 million 5. Sales = Rs. 7,000,000 Net profit margin = 6 percent = 6 = 0.7 So Total assets = 1/0.3 0.05 x Total assets 1 1.5 x 0.3 = 0.25 or 25 per cent Net sales x Equity Total assets

Equity = 1-0.7 = 0.3

Net profit = Rs. 7000000 x 0.06 = 420,000 Tax rate = 60 per cent

420,000 So Profit before tax = Interest charge (1-.6) = Rs.150,000 = Rs. 1,050,000

So Profit before interest and taxes = Rs. 1,200,000 Hence 1,200,000 Times interest covered ratio = = 8 150,000 6. CA = 1500 CL = 600

Let BB stand for bank borrowing CA+BB = CL+BB 1500+BB = 600+BB BB = 1200 7. Accounts receivable ACP = Sales / 365 120,000 = 43.8 days 1,000,000 / 365 So the receivables must be collected in 43.8 days Current assets 8. Current ratio = Current liabilities = 1.5 = 1.5 1.5

Current assets - Inventories Acid-test ratio = Current liabilities Current liabilities = 800,000 Sales Inventory turnover ratio = = 5 Inventories Current assets - Inventories Acid-test ratio = Current liabilities Current assets This means Current liabilities 1.5 Inventories = 0.3 800,000 Inventories = 240,000 Sales =5 So Sales = 1,200,000 2,40,000 9. Debt/equity = 0.60 Equity = 50,000 + 60,000 = 110,000 So Debt = 0.6 x 110,000 = 66,000 Hence Total assets = 110,000+66,000 = 176,000 Total assets turnover ratio = 1.5 So Sales = 1.5 x 176,000 = 264,000 Gross profit margin = 20 per cent So Cost of goods sold = 0.8 x 264,000 = 211,200 Days sales outstanding in accounts receivable = 40 days Sales So Accounts receivable = x 40 360 800,000 Current liabilities Inventories = 1.2 Inventories = 1.2 = 1.2 = 1.2

264,000 = 360 Cost of goods sold Inventory turnover ratio = Inventory So Inventory = 42,240 Assuming that the debt of 66,000 represent current liabilities Cash + Accounts receivable Acid-test ratio = Current liabilities Cash + 29,333 = 66,000 So Cash = 49867 Plant and equipment = Total assets - Inventories - Accounts receivable - Cash = 176,000 - 42240 29333 - 49867 = 54560 Pricing together everything we get Equity capital Retained earnings Debt(Current liabilities) Balance Sheet 50,000 Plant & equipment 60,000 Inventories 66,000 Accounts receivable Cash 176,000 54,560 42,240 29,333 49,867 = 1.2 = Inventory 211,200 = 5 x 40 = 29,333

176,000 Sales Cost of goods sold 10.(i) Current ratio = 264,000 211,200

Cash & bank balances + Receivables + Inventories + Pre-paid expenses Short-term bank borrowings + Trade creditors + Provisions 5,000,000+15,000,000+20,000,000+2,500,000

= 15,000,000+10,000,000+5,000,000 42,500,000 = 30,000,000 (ii) Acid-test ratio = Current liabilities (iii) Debt-equity ratio = Equity capital + Reserves & surplus 12,500,000 + 30,000,000 = 10,000,000 + 22,500,000 Profit before interest and tax (iv) Times interest coverage ratio = Interest 15,100,000 = 5,000,000 Cost of goods sold (v) Inventory turnover period = Inventory 365 (vi) Average collection period = Net sales/Accounts receivable 365 = 95,000,000/15,000,000 Net sales (vii) Total assets turnover ratio = Total assets Profit after tax = 75,000,000 5,100,000 95,000,000 = 1.27 = 57.6 days = 20,000,000 72,000,000 = 3.6 = 3.02 = 1.31 = 1.42 22,500,000 = 30,000,000 Long-term debt + Current liabilities = 0.75

Current assets Inventories

(ix) Net profit margin PBIT (x) Earning power =

= Net sales

= 95,000,000 = 75,000,000 20.1% 15,100,000 =

= 5.4%

Total assets

Equity earning 5,100,000 (xi) Return on equity = = = 15.7% Net worth 32,500,000 The comparison of the Omexs ratios with the standard is given below Omex Current ratio Acid-test ratio Debt-equity ratio Times interest covered ratio Inventory turnover ratio Average collection period Total assets turnover ratio Net profit margin ratio Earning power Return on equity 1.42 0.75 1.31 3.02 3.6 57.6 days 1.27 5.4% 20.1% 15.7% Standard 1.5 0.80 1.5 3.5 4.0 60 days 1.0 6% 18% 15%

MINICASE a. Current ratio = cash and bank + receivables + inventories 12.4 ----------------------------------------------------- = -------- = 0.67 current liabilities+ short- term bank borrowing 18. 4 current assets inventories 12.4 9.3 --------------------------------- = ----------- = 0.17 current liabilities 18.4 cash and bank balance + current investments ------------------------------------------------------ = current liabilities 1.1+0 ------- = 0.06 18.4

Acid-test ratio =

Cash ratio

Debt-equity ratio = debt / equity =( 3.8+ 11.7 ) / 15.8 = 15.5 / 15.8 = 0. 98 Interest coverage ratio = PBIT / Interest = 5.0 / 2.0= 2.5 PBIT + depreciation Fixed charges coverage ratio = --------------------------------------------------- = interest + repayment of loan / ( 1- tax rate) cost of goods sold 45.8 ----------------------- = --------------average inventory ( 8.2 + 9.3)/ 2

Inventory turnover ratio =

= 5.23

Debtors turnover ratio = net credit sales / average debtors = 57.4 / ( 2.9+2.0) / 2 = 23.43 Average collection period = 365 / debtors turnover = 365 / 23.43 = 15.6 days Fixed assets turnover = net sales/average total assets = 57.4/ ( 34 + 38) / 2 = 1.59 Gross profit margin = gross profit / net sales = 11.6 / 57.4 = 20.21 % Net profit margin = net profit / net sales = 3.0 / 57.4 = 5.22 % Return on assets = net profit / average total assets = 3.0/ ( 34+38) /2 = 8.3 % Earning power = PBIT / average total assets = 5.0/ ( 34+38) /2 = 13.89 % Return on equity = Net profit / average equity = 3.0 / ( 13.9 +15.8)/2 = 20.20 %

b.

net profit Dupont equation : -------------------------- = average total assets

net profit ------------- x net sales

net sales -------------average total assets

Dupont chart
Net sales +/Non-op. surplus deficit 57.8 Net profit 3.0

Net profit margin 5.22%

Total costs 54.8

Net sales 57.4 Return on total assets 8.3% Net sales 57.4 Total asset turnover

1.59

Average fixed assets 21.4

+
Average total assets 36 Average other assets 2.55

+
Average current assets 12.05

c.

Common size statements Balance sheet Regular ( Rs. in million) 20x4 20x5 -----------------------------13.9 15.8 5.2 3.8 3.2 6.0 ---------------------------22.3 25.6 -----------------------------19.6 23.2 2.7 2.4 -----------------------------22.3 25.6 -----------------------------Profit and loss account Regular ( Rs. in million) 20x4 20x5 -----------------------------39.0 57.4 30.5 45.8 8.5 11.6 4.1 5.0 1.5 2.0 2.6 3.0 ---------2.6 3.0 Common Size ( %) 20x4 20x5 ------------------------100 100 78 80 22 20 11 9 4 7 5 ----------7 5 Common Size ( %) 20x4 20x5 -------------------------63 62 23 15 14 23 --------------------------100 100 --------------------------88 91 12 9 --------------------------100 100 ---------------------------

Shareholder funds Long term debt Net current liabilities Total Fixed assets Other assets Total

Net sales Cost of goods sold Gross profit PBIT Interest PBT Tax PAT

Common base financial statements

Balance sheet Regular ( Rs. in million) 20x4 20x5 -----------------------------13.9 15.8 5.2 3.8 3.2 6.0 ---------------------------22.3 25.6 -----------------------------19.6 23.2 2.7 2.4 -----------------------------22.3 25.6 -----------------------------Profit and loss account Regular ( Rs. in million) 20x4 20x5 -----------------------------39.0 57.4 30.5 45.8 8.5 11.6 4.1 5.0 1.5 2.0 2.6 3.0 ---------2.6 3.0 Common base year ( %) 20x4 20x5 ------------------------100 147 100 150 100 136 100 122 100 133 100 115 100 115 Common base year( %) 20x4 20x5 -------------------------100 114 100 73 100 187 100 100 100 100 115 118 89 115

Shareholder funds Long term debt Net current liabilities Total Fixed assets Other assets Total

Net sales Cost of goods sold Gross profit PBIT Interest PBT Tax PAT

d. Financial strengths : leverage position is satisfactory. Interest repayment capacity is good. Inventory is efficiently managed. Credit management is efficient. Margin on sales is satisfactory. Financial weaknesses : liquidity position is very bad.

return on assets is low. fixed assets do not seem to be efficiently employedl. e. The problems in analyzing financial statements are generally as follows: lack of underlying theory. conglomerate firms. window dressing. price level changes. variations in accounting policies. interpretation of results. correlation among ratios. f. The qualitative factors relevant for evaluating the performance and prospects of a company are mainly the following: Are the companys revenues tied to one key customer? To what extent are the companys revenues tied to one key product ? To what extent does the company rely on a single supplier ? What percentage of the companys business is generated overseas ? Competition. Future prospects. Legal and regulatory environment.

Chapter 8 PORTFOLIO THEORY 1. (a) E (R1) = = E (R2) = = (R1) = = (R2) = = 0.2(-5%) + 0.3(15%) + 0.4(18%) + .10(22%) 12% 0.2(10%) + 0.3(12%) + 0.4(14%) + .10(18%) 13% [.2(-5 12)2 + 0.3 (15 12)2 + 0.4 (18 12)2 + 0.1 (22 12)2] [57.8 + 2.7 + 14.4 + 10] = 9.21% [.2(10 13)2 + 0.3(12 13)2 + 0.4 (14 13)2 + 0.1 (18 13)2] [1.8 + 0.09 + 0.16 + 2.5] = 2.13%

(b) The covariance between the returns on assets 1 and 2 is calculated below State of Probability Return Deviation Return on Deviation Product of nature on asset of return asset 2 of the deviation 1 on asset 1 return on times from its asset 2 probability mean from its mean (1) (2) (3) (4) (5) (6) (2)x(4)x(6) 1 0.2 -5% -17% 10% -3% 10.2 2 0.3 15% 3% 12% -1% -0.9% 3 0.4 18% 6% 14% 1% 2.4 4 0.1 22% 10% 18% 5% 5 Sum = 16.7 Thus the covariance between the returns of the two assets is 16.7. (c) The coefficient of correlation between the returns on assets 1 and 2 is: Covariance12 16.7 = = 0.85 1 x 2 9.21 x 2.13 2. (a) For Rs.1,000, 20 shares of Alphas stock can be acquired. The probability distribution of the return on 20 shares is Economic Condition Return (Rs) Probability High Growth Low Growth Stagnation Recession Expected return = = = 20 x 55 = 1,100 20 x 50 = 1,000 20 x 60 = 1,200 20 x 70 = 1,400 0.3 0.3 0.2 0.2

(1,100 x 0.3) + (1,000 x 0.3) + (1,200 x 0.2) + (1,400 x 0.2) 330 + 300 + 240 + 280 Rs.1,150

Standard deviation of the return = [(1,100 1,150)2 x 0.3 + (1,000 1,150)2 x 0.3 + (1,200 1,150)2 x 0.2 + (1,400 1,150)2 x 0.2]1/2 = Rs.143.18 (b) For Rs.1,000, 20 shares of Betas stock can be acquired. The probability distribution of the return on 20 shares is: Economic condition Return (Rs) Probability

High growth Low growth Stagnation Recession Expected return =

20 x 75 = 1,500 20 x 65 = 1,300 20 x 50 = 1,000 20 x 40 = 800

0.3 0.3 0.2 0.2

(1,500 x 0.3) + (1,300 x 0.3) + (1,000 x 0.2) + (800 x 0.2) = Rs.1,200

Standard deviation of the return = [(1,500 1,200)2 x .3 + (1,300 1,200)2 x .3 + (1,000 1,200)2 x .2 + (800 1,200)2 x .2]1/2 = Rs.264.58 (c ) For Rs.500, 10 shares of Alphas stock can be acquired; likewise for Rs.500, 10 shares of Betas stock can be acquired. The probability distribution of this option is: Return (Rs) (10 x 55) + (10 x 75) (10 x 50) + (10 x 65) (10 x 60) + (10 x 50) (10 x 70) + (10 x 40) Expected return = = = = 1,300 1,150 1,100 1,100 Probability 0.3 0.3 0.2 0.2

= (1,300 x 0.3) + (1,150 x 0.3) + (1,100 x 0.2) + (1,100 x 0.2) = Rs.1,175 = = [(1,300 1,175)2 x 0.3 + (1,150 1,175)2 x 0.3 + (1,100 1,175)2 x 0.2 + (1,100 1,175)2 x 0.2 ]1/2 Rs.84.41

Standard deviation

d.

For Rs.700, 14 shares of Alphas stock can be acquired; likewise for Rs.300, 6 shares of Betas stock can be acquired. The probability distribution of this option is: Return (Rs) (14 x 55) + (6 x 75) (14 x 50) + (6 x 65) (14 x 60) + (6 x 50) (14 x 70) + (6 x 40) Expected return = = = = 1,220 1,090 1,140 1,220 Probability 0.3 0.3 0.2 0.2

= (1,220 x 0.3) + (1,090 x 0.3) + (1,140 x 0.2) + (1,220 x 0.2) = Rs.1,165

Standard deviation

= [(1,220 1,165)2 x 0.3 + (1,090 1,165)2 x 0.3 + (1,140 1,165)2 x 0.2 + (1,220 1,165)2 x 0.2]1/2 = Rs.57.66

The expected return to standard deviation of various options are as follows : Option a b c d Expected return (Rs) 1,150 1,200 1,175 1,165 Standard deviation (Rs) 143 265 84 58 Expected / Standard return deviation 8.04 4.53 13.99 20.09 ratio.

Option `d is the most preferred option because it has the highest return to risk 3.

Expected rates of returns on equity stock A, B, C and D can be computed as follows: A: B: C: 0.10 + 0.12 + (-0.08) + 0.15 + (-0.02) + 0.20 = 0.0783 6 0.08 + 0.04 + 0.15 +.12 + 0.10 + 0.06 6 0.07 + 0.08 + 0.12 + 0.09 + 0.06 + 0.12 6 0.09 + 0.09 + 0.11 + 0.04 + 0.08 + 0.16 6 Return on portfolio consisting of stock A Return on portfolio consisting of stock A and B in equal proportions = 0.5 (0.0783) + 0.5 (0.0917) = 0.085 = 8.5% Return on portfolio consisting of stocks A, B and C in equal proportions = 1/3(0.0783 ) + 1/3(0.0917) + 1/3 (0.090) = 0.0867 = 8.67% Return on portfolio consisting of stocks A, B, C and D in equal = 0.0917 = 0.0900 = 7.83% = 9.17% = 9.00%

D: (a) (b)

= 0.095

= 9.50% = 7.83%

(c )

(d)

proportions

= =

0.25(0.0783) + 0.25(0.0917) + 0.25(0.0900) + 0.25(0.095) 0.08875 = 8.88%

4. The standard deviation of portfolio return is:

p

= [w12 12 + w22 22 + w32 32 + 42 42 + 2 w1 w2 12 1 2 + 2 w1 w3 13 1 3 + 2 w1 w4 14 1 4 + 2 w2 w3 23 2 3 + 2 w2 w4 24 2 4 + 2 w3 w4 34 3 4 ]1/2 = [0.22 x 42 + 0.32 x 82 + 0.42 x 202 + 0.12 x 102 + 2 x 0.2 x 0.3 x 0.3 x 4 x 8 + 2 x 0.2 x 0.4 x 0.5 x 4 x 20 + 2 x 0.2 x 0.1 x 0.2 x 4 x 10 + 2 x 0.3 x 0.4 x 0.6 x 8 x 20 + 2 x 0.3 x 0.1 x 0.8 x 8 x 10 + 2 x 0.4 x 0.1 x 0.4 x 20 x 10]1/2 = 10.6%

5. (i) Since there are 3 securities, there are 3 variance terms and 3 covariance terms. Note that if there are n securities the number of covariance terms are: 1 + 2 ++ (n 1) = n (n 1)/2. In this problem all the variance terms are the same ( 2A) all the covariance terms are the same ( AB) and all the securities are equally weighted ( wA = ) So, 2p = [3 w2A 2A + 2 x 3 AB] 2p = [3 w2A 2A + 6 wA wB AB] 1 2 1 1 2 =3x x A+ 6 x x x AB 3 3 3 1 2 = 2A + AB 3 3 (ii) Since there are 9 securities, there are 9 variance terms and 36 covariance terms. Note that if the number of securities is n, the number of covariance terms is n(n 1)/2. In this case all the variance terms are the same ( 2A), all the covariance terms are 1 the same ( AB) and all the securities are equally weighted wA = 9 So, n(n-1) 2 2 2 p= 9 w A A t 2 x wA wB AB 2 1 = 9x 9
2

1 x A + 9(8) x 9
2

1 x 9
AB

1 = 9
2 A

72 + 81
AB

6. Let us arrange the portfolio in the order of ascending expected returns. Portfolio 4 3 5 1 7 2 8 6 Expected return(%) 8 9 10 11 12 14 14 16 Standard deviation(%) 14 15 20 21 21 24 28 32

Examining the above we find that (i) portfolio 7 dominates portfolio 1 because it offers a higher expected return for the same standard deviation and (ii) portfolio 2 dominates portfolio 8 as it offers the same expected return for a lower standard deviation. So, the efficient set consists of all the portfolios except portfolio 1 and portfolio 8. 7. The weights that drive the standard deviation of portfolio to zero, when the returns are perfectly correlated, are: B wA = wB = = A + B 1 - wA = 0.386 35 = 0.614 22 + 35

The expected return of the portfolio is : 0.614 x 14% + 0.386 x 20% = 16.316 8. (a) Covariance (P,Q) = PPQ x P x Q = 0.4 x 14 x 20 = 112 (b) Expected return = 0.5 x 14 + 0.5 x 20 = 17% Risk (standard deviation) = [w2P 2P + w2Q 2Q + 2 Cov (P,Q)] = [0.52 x 625 + 0.52 x 1600 + 2 x 112]

= 27.93% Chapter 9 CAPITAL ASSET PRICING MODEL AND ARBITRAGE PRICING THEORY 1. Define RA and RM as the returns on the equity stock of Auto Electricals Limited a and Market portfolio respectively. The calculations relevant for calculating the beta of the stock are shown below: Year 1 2 3 4 5 6 7 8 9 10 11 RA 15 -6 18 30 12 25 2 20 18 24 8. RM 12 1 14 24 16 30 -3 24 15 22 12 RM = 15.18 RA-RA -0.09 -21.09 2.91 14.91 0-3.09 9.91 -13.09 4.91 2.91 8.91 -7.09 RM-RM -3.18 -14.18 -1.18 8.82 0.82 14.82 -18.18 8.82 -0.18 6.82 -3.18 (RA-RA) 0.01 444.79 8.47 222.31 9.55 98.21 171.35 24.11 8.47 79.39 50.27 (RM-RM) 10.11 201.07 1.39 77.79 0.67 219.63 330.51 77.79 0.03 46.51 10.11 RA-RA/RM-RM 0.29 299.06 -3.43 131.51 -2.53 146.87 237.98 43.31 -0.52 60.77 22.55

RA = 15.09

(RA RA)2 = 1116.93 (RM RM) 2 = 975.61 (RA RA) (RM RM) = 935.86 Beta of the equity stock of Auto Electricals (RA RA) (RM RM) (RM RM) 2 = Alpha = = 935.86 975.61 RA A RM 15.09 (0.96 x 15.18)= 0.52 = 0.96

Equation of the characteristic line is RA = 0.52 + 0.96 RM

2. The beta for stock B is calculated below: Period Return of stock B, RB (%) Return on market portfolio, RM (%) Deviation of return on stock B from its mean (RB - RB) Deviation of return on market portfolio from its mean (RM RM) -1 2 -4 -6 6 1 0 2 -1 -2 2 4 -16 -8 -2 -3 -1 0 27 0 Product of the deviation (RB RB) (RM RM) Square of the deviation of return on market portfolio, from its mean (RM RM)2 1 4 16 36 36 1 0 4 1 4 4 16 256 64 4 9 1 0 729 0 (RB RB)2 = 1186

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

15 16 10 -15 -5 14 10 15 12 -4 -2 12 15 12 10 9 12 9 22 13 180 RB = 180 RB = 9%

9 12 6 4 16 11 10 12 9 8 12 14 -6 2 8 7 9 10 37 10 200 RM = 200 RM = 10%

6 7 1 -24 -14 5 1 6 3 -13 -11 3 6 3 1 0 3 0 13 4

-6 14 -4 144 -84 5 0 12 -3 26 -22 12 -96 -24 -2 0 -3 0 351 0 (RB RB) (RM RM) = 320

Beta of stock B is equal to: Cov (RB, RM)

2 M

(RB - RB) (RM RM) = n 1

320 = 16.84 19

Cov (RB, RM) =

 (RM RM)2
2 M

1186 = 62.42

= n 1 19 So the beta for stock B is: 16.84 = 0.270 62.42 3.

a. The slope of the capital market line is: E(RM) Rf 15 8 = = = 0.28 M 25 b. The expected return for various mutual funds is: Omega: 8 + 0.28 x 16 = 12.48% Pioneer: 8 + 0.28 x 20 = 13.60% Monarch: 8 + 0.28 x 24 = 14.72% Zenith: 8 + 0.28 x 30 = 16.40% 4. E(RM) = 14% A,M = 0.7 A = 24% = 20% Rf = 6% B,M = 0.8 B = 32%
M

(a) Beta for stock A: A,M A = = 2M Beta for stock B: B,M B = = 2M

A,M

A
2 M

0.7 x 24 x 20 = 20 x 20 0.8 x 32 x 20 = 20 x 20 = 1.28 = 0.84

B,M

B
2 M

(b) Required return for A = Rf + A [E(RM) - Rf ] = 6 + 0.84 [14 6] = 12.72% Required return for B = Rf + B [E(RM) - Rf ] = 6 + 1.28[14 6] = 16.24% 5. (a) Market portfolio has an expected return of 13% and standard deviation of 20% 5 Riskless asset has an expected return of 7% and standard deviation of 0%

The expected return of a portfolio which has 60% of market portfolio and 40% of riskless asset is : 0.6 x 13 + 0.4 x 7 = 10.6% The standard deviation of a portfolio which has 60% of market portfolio and 40% of riskless asset is : 0.6 x 20 + 0.4 x 0 = 12% (b) The expected return of a portfolio which has 125% of market portfolio and 25% of riskless asset is : 1.25 x 13 0.25 x 7 = 14.5% The standard deviation of a portfolio which has 125% of market portfolio and 125% of riskless portfolio is: 1.25 x 20 0.25 x 0 = 25% 6. (a) The beta of the aggressive stock is: 40% - (-5%) 45% = = 2.25 25% - 5% 20% The beta of the defensive stock is: 18% - 8% 10% = = 0.50 25% - 5% 20% (b) The expected return on the two stocks is: Aggressive stock: 0.5(-5) + 0.5(40) = 17.5% Defensive stock : 0.5(8) + 0.5(18) = 13.0% (c) The expected return on the market portfolio is: 0.5 x 5 + 0.5 x 25 = 15% If the risk-free rate is 8%, the market risk premium is: 15% - 8% = 7% So, the SML is: Required returni = 8% + i x 7% (d) The alphas of the two stocks are calculated below: Aggressive Stock Expected return = 17.5% Beta = 2.25 Required return = 8 + 2.25% x 7 = 23.75% Alpha = 17 23.75 = - 6.75%

Defensive Stock Expected return = 13.0% Beta = 0.50 Required return = 8 + 0.5 x 7 = 11.5% Alpha = 13.0 11.5 = 1.5% MINICASE

a. For stock A : Expected return = ( 0.2x 15) +( 0.5x20) +( 0.3x 40) =3+10 +12 =25 Standard deviation= [ 0.2( 15-25)2 + 0.5( 20-25)2 + 0.3(40-25)2]1/2 = [ 20 + 12.5+67.5] = 10 For stock B: Expected return = ( 0.2x 30) + ( 0.5x 5) + [ 0.3x (-) 15] = 6+2.5- 4.5= 4 Standard deviation= [ 0.2( 30-4)2 + 0.5(5-4)2 + 0.3(-15-4)2]1/2 = ( 135.2 + 0.5 + 108.3) = 15.62 For stock C: Expected return = [ 0.2x(-)5] +( 0.5x15) +( 0.3x 25) =-1+7.5 +7.5 =14 Standard deviation= [ 0.2(-5-14)2 + 0.5(15-14)2 + 0.3(25-14)2]1/2 = [ 72.2 + 0.5+36.3] = 10.44 For market portfolio: Expected return = [ 0.2x(-)10] +( 0.5x16) +( 0.3x 30) =-2+8 +9 =15 Standard deviation= [ 0.2(-10-15)2 + 0.5(16-15)2 + 0.3(30-15)2]1/2 = ( 125+ 0.5 + 67.5)1/2 = 13.89 b. State of the Proba Return on Return on RA-E(RA) RB-E(RB) p Economy -bility(p) A(%) ( RA) B (%) ( RB) x[RA-E(RA)] x[RB-E(RB)] -------------- --------- ----------- ------------- ---------- --------- ------------Recession 0.2 15 30 -10 26 -52.0 Normal 0.5 20 5 -5 1 - 2.5 Boom 0.3 40 -15 15 -19 - 85.5 -----------total = - 140.0 -------------

Covariance between the returns of A and B is (-) 140 State of the Proba Return on Economy -bility(p) A(%) ( RA) Return on RA-E(RA) RC-E(RC) p C (%) ( RC) x[RA-E(RA)] x[RC-E(RC)] -------------- --------- ----------- ------------- ---------- --------- ------------Recession 0.2 15 -5.0 -10 - 19.0 38.0 Normal 0.5 20 15.0 -5 1.0 - 2.5 Boom 0.3 40 25.0 15 11.0 49.5 -----------total = 85.0 ------------Covariance between the returns of A and C is 85

(-) 140 c. Coefficient of correlation between the returns of A and B =------------- = (-)0.90 10x15.62 85 . Coefficient of correlation between the returns of A and C =------------- = 0. 81 10x 10.44 d Portfolio in which stocks A and B are equally weighted: Economic condition -----------------------Recession Normal Boom Probability --------------0.2 0.5 0.3 Overall expected return ---------------0.5x15 +0.5x30 = 22.5 0.5x20 +0.5x5 =12.5 0.5x40 + 0.5x(-)15=12.5

Expected return of the portfolio=( 0.2x22.5)+( 0.5x12.5)+( 0.3x12.5) = 4.5 +6.25 + 3.75 = 14.5 Standard deviation of the portfolio = [ 0.2(22.5-14.5)2 + 0.5(12.5-14.5)2 + 0.3(12.5-14.5)2]1/2 = [ 12.8 + 2 + 1.2] = 4 Portfolio in which weights assigned to stocks A , B and C are 0.4, 0.4 and 0.2 respectively: Expected return of the portfolio = ( 0.4x25) + ( 0.4x4) +( 0.2x14) = 10 +1.6 +2.8= 14.4 For calculating the standard deviation of the portfolio we also need covariance between B and C, which is calculated as under:

State of the Proba Return on Economy -bility(p) B(%) ( RB)

Return on RB-E(RB) RC-E(RC) p C (%) ( RC) x[RB-E(RB)] x[RC-E(RC)] -------------- --------- ----------- ------------- ---------- --------- ------------Recession 0.2 30 -5.0 26 - 19.0 (-)98.8 Normal 0.5 5 15.0 1 1.0 0.5 Boom 0.3 (-)15 25.0 (-)19 11.0 (-)62.7 -----------total = (-)161.0 ------------Covariance between the returns of B and C is (-) 161 We have the following values: wA =0.4 wB = 0.4 wC = 0.2 A=10 B =15.62 C =10.44 AB=(-)140 AC= 85 BC = (-) 161 Standard deviation =[(0.4x10)2+(0.4x15.62)2+(0.2x10.44)2+{2x0.4x0.4x(-)140}+{2x0.4x0.2x85} +{ 2x0.4x0.2x(-)161}]1/2 = ( 16+ 39.04 + 4.36 44.8 + 13.6 25.76)1/2 = 1.56 e. (i) Risk-free rate is 6% and market risk premium is 15-6= 9% The SML relationship is Required return = 6% + x 9% (ii) For stock A: Required return = 6% + 1.2x9% = 16.8 %; Expected return = 25 % Alpha = 25-16.8 = 8.2 % For stock B: Required return =6 %-0.70x9%=(-)0.3% ; Expected return = 4 % Alpha = 4- (-) 0.3 = 4.3 % For stock C: Required return = 6% + 0.9x 9% = 14.1 %; Expected return= 14% Alpha = 14 14.1 = (-) 0.1 % _ _ _ _ _ 2 f. Period RD(%) RM(%) RD-RD RM-RM ( RM-RM) (RD-RD)(RM-RM) --------- --------- --------- ---------- ------------ ------------- --------------------------1 -12 -5 -18.4 -11.2 125.44 206.08 2 6 4 - 0.4 - 2.2 4.84 0.88 3 12 8 5.6 1.8 3.24 10.08 4 20 15 13.6 8.8 77.44 119.68 5 6 9 -0.4 2.8 7.84 - 1.12

----------------------------------------------------------------------------------------_ _ _ 2 RD=32 RM=31 ( RM-RM) =218.80 (RD-RD)(RM-RM)=335.6 _ _ RD =6.4 RM =6.2 2m =218.8/ 4 = 54.7 Cov( D,M)=335.6/4=83.9 = 83.9/54.7 = 1.53 Interpretation: The change in return of D is expected to be 1.53 times the expected change in return on the market portfolio. g. The linear relationship between expected return and standard deviation for efficient portfolios is called the Capital Market Line ( CML) and the same is given by the equation E (Rm-Rf) E ( Rj) = Rf + [ ---------- ] j m where E(Rj) = expected return on portfolio j Rf = risk-free rate E(Rm) = expected return on the market portfolio m =standard deviation of the market portfolio j = standard deviation of the portfolio j Linear relationship between expected return and standard deviation of individual securities and inefficient portfolios is called Security Market Line (SML) and the equation for it is E( Rm)-Rf E(Ri) = Rf + [ ------------- ] Ci,m 2m where E(Ri) and E(Rm) are the expected returns on the security/ portfolio i and market respectively. Rf = risk-free rate m =standard deviation of the market portfolio Ci,m = Covariance of the return on security/ portfolio i with the market portfolio. CML is a special case of SML as seen from the following. As per SML E( Rm)-Rf E(Ri) = Rf + [ ------------- ] Ci,m 2m Since Ci,m = i,m i m ,the above equation can be rewritten as

E( Rm)-Rf E(Ri) = Rf + [ ------------- ] m

i,m

For efficient portfolios , as returns on i and m are perfectly positively correlated, i,m =1 Therefore, E( Rm)-Rf E(Ri) = Rf + [ ------------- ] i , which is nothing but the CML. m h. Systematic risk refers to the risk associated with the responsiveness of the return of the investment arising from economy-wide factors, which have a bearing on the fortunes of all firms. Unsystematic risk refers to the risk associated with the responsiveness of the return of the investment arising from firm-specific factors. Systematic risk is usually represented by beta ( ), which is given by the formula i,m i = ----------- 2m where i = beta of the security/ portfolio i i,m = covariance between the returns on investment i and the market portfolio 2m = variance of the return on the market portfolio. Unsystematic risk: Being firm specific there is no generalised formula for this risk.

i. CAPM assumes that return on a stock/ portfolio is solely influenced by the market factor whereas the APT assumes that the return is influenced by a set of factors called risk factors.

Chapter 12 BOND PRICES AND YIELDS 1. P = 5 t=1 11 + (1.15) (1.15)5 100

= Rs.11 x PVIFA(15%, 5 years) + Rs.100 x PVIF (15%, 5 years) = Rs.11 x 3.352 + Rs.100 x 0.497 = Rs.86.7 2.(i) When the discount rate is 14% 7 12 100 P = + t=1 (1.14) t (1.15)7 = Rs.12 x PVIFA (14%, 7 years) + Rs.100 x PVIF (14%, 7 years) = Rs.12 x 4.288 + Rs.100 x 0.4 = Rs.91.46 (ii) When the discount rate is 12% 7 12 100 P = + = Rs.100 t=1 (1.12) t (1.12)7 equal

Note that when the discount rate and the coupon rate are the same the value is to par value. 3. The yield to maturity is the value of r that satisfies the following equality. 7 120 1,000 Rs.750 = + = Rs.100 t=1 (1+r) t (1+r)7 Try r = 18%. The right hand side (RHS) of the above equation is: Rs.120 x PVIFA (18%, 7 years) + Rs.1,000 x PVIF (18%, 7 years) = Rs.120 x 3.812 + Rs.1,000 x 0.314 = Rs.771.44 Try r = 20%. The right hand side (RHS) of the above equation is: Rs.120 x PVIFA (20%, 7 years) + Rs.1,000 x PVIF (20%, 7 years) = Rs.120 x 3.605 + Rs.1,000 x 0.279 = Rs.711.60

Thus the value of r at which the RHS becomes equal to Rs.750 lies between 18% and 20%. Using linear interpolation in this range, we get 771.44 750.00 Yield to maturity = 18% + 771.44 711.60 = 18.7% 4. 80 = 10 14 100 + t=1 (1+r) t (1+r)10 x 2%

Try r = 18%. The RHS of the above equation is Rs.14 x PVIFA (18%, 10 years) + Rs.100 x PVIF (18%, 10 years) = Rs.14 x 4.494 + Rs.100 x 0.191 = Rs.82 Try r = 20%. The RHS of the above equation is Rs.14 x PVIFA(20%, 10 years) + Rs.100 x PVIF (20%, 10 years) = Rs.14 x 4.193 + Rs.100 x 0.162 = Rs.74.9 Using interpolation in the range 18% and 20% we get: Yield to maturity 82 - 80 = 18% + ----------- x 2% 82 74.9 = 18.56% 100 + (1.08)
t

5. P = 12 t=1 6 (1.08)12

= Rs.6 x PVIFA (8%, 12 years) + Rs.100 x PVIF (8%, 12 years) = Rs.6 x 7.536 + Rs.100 x 0.397 = Rs.84.92

6. The post-tax interest and maturity value are calculated below: Bond A Bond B * * Post-tax interest (C ) 12(1 0.3) =Rs.8.4 10 (1 0.3) =Rs.7 100 [ (100 60)x 0.1] =Rs.96

Post-tax maturity value (M) 100 [ (100-70)x 0.1] =Rs.97

The post-tax YTM, using the approximate YTM formula is calculated below Bond A : Post-tax YTM = = Bond B : Post-tax YTM = = 7. P = 14 t=1 6 + (1.08) t (1.08)14 100 8.4 + (97-70)/10 -------------------0.6 x 70 + 0.4 x 97 13.73% 7 + (96 60)/6 ---------------------0.6x 60 + 0.4 x 96 17. 47%

= Rs.6 x PVIFA(8%, 14) + Rs.100 x PVIF (8%, 14) = Rs.6 x 8.244 + Rs.100 x 0.341 = Rs.83.56 8. . The YTM for bonds of various maturities is Maturity YTM(%) 1 12.36 2 3 4 13.10 13.21 13.48

5 13.72 Graphing these YTMs against the maturities will give the yield curve The one year treasury bill rate , r1, is 1,00,000 - 1 89,000 To get the forward rate for year 2, r2, the following equation may be set up : 12500 99000 = (1.1236) + (1.1236)(1+r2) 112500 = 12.36 %

Solving this for r2 we get r2 = 13.94% To get the forward rate for year 3, r3, the following equation may be set up : 13,000 99,500 = (1.1236) + 13,000 + (1.1236)(1.1394) 113,000 (1.1236)(1.1394)(1+r3)

Solving this for r3 we get r3 = 13.49% To get the forward rate for year 4, r4 , the following equation may be set up : 13,500 100,050 = (1.1236) + (1.1236)(1.1394) 113,500 + (1.1236)(1.1394)(1.1349)(1+r4) Solving this for r4 we get r4 = 14.54% To get the forward rate for year 5, r5 , the following equation may be set up : 13,750 100,100 = (1.1236) + 13,750 + (1.1236)(1.1394) 13,750 (1.1236)(1.1394)(1.1349) 13,500 + (1.1236)(1.1394)(1.1349) 13,500

13,750 + (1.1236)(1.1394)(1.1349)(1.1454) 113,750 + (1.1236)(1.1394)(1.1349)(1.1454)(1+r5) Solving this for r5 we get r5 = 15.08%

9. The pre-tax rate to the debenture holder is the value of the r in the following equation: n It ai Pi n Fj Subscription = + + t i price t=1 (1+r) (1+r) j=m (1+r) j where: It = interest receivable at the end of period t n = life of the debenture a = number of equity shares receivable when part-conversion occurs at the end of period i Pi = expected price per equity share at the end of period i Fj = instalment of principal repayment at the end of period j For the given problem, r is obtained by solving the following equation: 60 600 = (1+r) + (1+r)1 r works out to 15.5% 10. Annual interest receipt will be Rs.100 for 4 years the future value at the end of 4 years. The future value at the end of 4 years, given the re-investment rate of 9 percent will be: 100 (1.09) + 100 (1.09) + 100 (1.09) + 100 + 1,000 = 100 x FVIFA (r = 9%, n = 4) + 1,000 = 100 x 4.641 + 1,000 = Rs.1464.1 + (1+r)2 200 + 2 x 150 40 + (1+r)3 40 + (1+r)4 40 + (1+r)5 40 + (1+r)6 20

200 + (1+r)5 (1+r)6

Since the present market price of the bond is Rs.1020, the realised yield to maturity is the value of r* in the following equation. 1020 (1+r*)4 = 1464.1 1464.1 (1+r*)4 = 1020 r* = 0.946 or 9.46 percent = 1.435

MINICASE Value of a bond is calculated as the present value of all future cash flows associated with it. Value of a bond (V) carrying an annual coupon payment of C ( in rupees) maturing after n years with maturity value of M is given by n C M V = -------- + -------t=1 ( 1+r)t (1+r)n where r is the required periodic rate of return and t is the time period for receipt of periodic payments. a.

b.

V = 100 PVIFA8%,9yrs + 1000 PVIF8%, 9yrs = 100 x 6.247 + 1000 x 0.5 = 624.7 + 500 = Rs. 1124.7

c.

V= 50 PVIFA 4%, 18 yrs + 1000 PVIF 4 %, 18 yrs = 50 x 12. 659 +1000 x 0. 494 = 632. 95 + 494 = Rs. 1126. 95 d. Let the YTM be r % . We have 100 PVIFA r, 6yrs + 1000 PVIFr, 6 yrs = 1050 Trying r = 8%, LHS = 100 x 4. 623 + 1000 x 0. 630 = 1092.3 Trying r= 9%, LHS = 100x 4.486 + 1000 x 0. 596 = 1044.6 By linear interpolation r= 8% + ( 9-8) ( 1092. 3- 1050) / ( 1092.3 1044.6) = 0.8868 i.e. 8.87 %

e.

100+ (1000- 1050)/6 100- 8.33 V = --------------------------- = ------------ = 0.089 i.e. 8.9 % 0.4 x 1000 + 0.6 x 1050 1030

f. Let r be the yield to call. We then have 100 PVIFA r%, 3yrs +1050 PVIF r%, 3yrs =1050 Trying r= 9%, LHS = 100x 2.531 + 1050 x 0. 772 =1063.7 Trying r=10%, LHS = 100x 2.487 + 1050x 0.751 = 1037. 25 By linear interpolation, ( 1063.7- 1050) 13.7 r= 9% + ( 10- 9)----------------------- = 9 + ------- =9.52 % ( 1063.7- 1037.25) 26.45 g. If future cash flows are reinvested at 8% p.a. the terminal value will be 100 PVIFA 8%, 6 yrs + 1000 = 100x 7.336 + 1000 = 1733.6 Let r* be the realized yield to maturity. We have 1050 ( 1+ r *)6 = 1733.6 ( 1+r*) 6 = 1733.6/ 1050 = 1.6510 1+r* = 1.0872 r* = 0.0872 or 8.72 % 100 + ( 1000 1050) / 6 -------------------------------- = 0.089 or 8.9 % 0.4 x 1000 + 0.6 x 1050

h. Stated YTM =

100+ ( 900 1050)/ 6 75 Expected YTM = ---------------------------- = ----- = 0.0758 or 7.58% 0.4 x 900 + 0.6 x 1050 990 Difference between the expected and stated YTM = 8.9 7.58 = 1.32% i. Annual percentage rate of a bond refers to the stated coupon rate per annum. If m is the frequency of coupon payment per year, annual parentage rate Effective annual coupon interest rate = (1+ --------------------------- )m - 1 m Effective annual coupon interest rate x maturity value Effective annual yield= ----------------------------------------------------------------Current market price

j. Interest rate risk: Interest rates tend to vary over time, causing fluctuations in bond prices. A rise in interest rates will depress the market price of outstanding bonds. This is called interest rate risk.

Reinvestment risk: When a bond pays periodic interest, there is a risk that these interest payments may have to be reinvested at a lower interest rate. This is called reinvestment risk. k. Key financial ratios that have a bearing on debt rating are: Interest coverage ratio = EBIT/ Interest EBIT + Depreciation Fixed charges coverage ratio = --------------------------------------Interest + Repayment of loan -----------------------1 tax rate

PAT+ Depreciation+ Other non- cash charges +Interest on term loans + Lease rentals Debt Service Coverage Ratio = ---------------------------------------------------------Interest on term loans +Lease rentals+ Repayment of term loans l. Yield curve shows how yield to maturity is related to term to maturity for bonds that are similar in all respects, excepting maturity. m. Factors that determine interest rates are: a) Short-term risk-free interest rate, which is given by Expected real rate of return+ Expected inflation b) Maturity premium: It is the difference between the YTM on a short-term ( one year) risk-free security and the YTM on a risk-free security of a longer duration and depends on (i) expectation of the market participants, (ii) liquidity preference of the market participants and (iii) supply and demand for funds in different maturity ranges( called habitats) c) Default premium: An additional default premium will have to be paid when there exists a possibility of default on interest / principal payment. d) Special features: Interest rates are affected when a bond has some special features like call or put option, conversion option, floating rate, zero coupon etc.

Chapter 13 BOND PORTFOLIO MANAGEMENT 9+( 100-105)/5 8 1. Yield to maturity =--------------------------------- = --------- = 0.0767 or 7.77 % ( 0.4x100) + ( 0.6x 105) 40+63 Duration is calculated below Year 1 2 3 4 5 Cash flow 9 9 9 9 109 Present Value at 18% 8.35 7.75 7.19 6.67 74.98 Proportion of bonds value 0.080 0.074 0.068 0.064 0.714 Proportion of bonds Value x Time 0.080 0.148 0.204 0.256 3.570 -----------------------4.258 ------------------------

Duration of the bond is 4.258 years. 2. . a. Issue price (1.10)8 = Rs.10,000 Rs.10,000 Issue price = (1.10) 6
8

= Rs.4670

b. The duration of the bond is 8 years. Note that the term to maturity and the duration of a zero coupon bond are the same. c. The modified duration of the bond is: Duration 8 = = 7.273 (1+ yield) (1.10)

d. The percentage change in the price of the bond, if the yield declines by 0.5 percent is:

P/ P = - Modified duration x 0.5 = - 3.637 percent 3. . a. The duration of a coupon bond is: 1+y (1 + y) + T(c y) y c [(1 +y)T 1] + y y = 10%, c = 10%, T = 10 years So, the duration of the bond is: 1.10 (1.10) + 10 (0.10 0.10) 0.10 0.10 [(1.10) 1] + 0.10 1.10 11 = 6.759 0.2594 b. Because the bond carries a coupon c. (i) A decrease in coupon rate from 10% to 8% will increase the duration. (ii) An increase in yield from 10% to 12% reduces the duration because the duration of a coupon bearing bond varies inversely with its yield. (iii) A decrease in maturity period from 10 years to 8 years decreases the duration. 4. The duration of a level annuity is: 1 + yield Number of payments yield (1 + yield) No. of payments 1 Yield = 8.5%; No. of payments = 15 So, the duration is: 1.085 15 .085 (1.085) 15 1 1.085 .085 3.400 1 15 = 12.76 6.25 = 6.51 years

5. The duration is: 1+y y 1.05 .05

(1 + y) + T(c y) c [(1 +y)T 1] + y (1.05) + 10 (.06 .05) .06 [(1.05)10 1] + 0.05 = 7.89 half year periods.

6. The liability has a duration of ten years. The duration of the zero coupon bond is 6 years and the duration of the perpetuities is : 1.07/ 0.07 = 15.29 years. As the portfolio duration is 10 years, if w is the proportion of investment in zero coupon bonds, we have ( wx6) + ( 1-w)x 15.29 = 10 6w + 15.29 15.29= 10 w=0.569 and 1-w= 0. 431 Therefore the amount to be invested in zero coupon bonds is 100,000 x 0.569 =Rs. 56,900 and the amount to be invested in perpetuities is Rs. 43,100 7. Current price = 9000 PVIFA( 8 %, 8 years) + 100,000 PVIF ( 8%, 8 years) = 9000 x 5.747 + 100,000 x 0. 540 = 51,723 + 54,000 = 105,723 Forecast price = 9000 PVIFA( 7 %, 5 years) + 100,000 PVIF ( 7%, 5 years) = 9000 x 4.100 + 100,000x 0.713 = 36,900 + 71,300 = 108,200 Future value of reinvested coupon = 9000 ( 1.065)2 + 9000 ( 1.065) + 9000 = 10,208 + 9585 + 9000 = 28,793 28,793 + ( 108,200- 105, 723) Three year return = ---------------------------------------- = 0. 2958 105, 723 The expected annualized return over the three year period will be ( 1. 2958 )1/3 1 = 0.0902 or 9.02 %

CHAPTER 14 EQUITY VALUATION 1. Do = Rs.2.00, g = 0.06, r = 0.12 Po = D1 / (r g) = Do (1 + g) / (r g) = = Rs.2.00 (1.06) / (0.12 - 0.06) Rs.35.33

Since the growth rate of 6% applies to dividends as well as market price, the market price at the end of the 2nd year will be: P2 2. 3. Po Po = = = = = Po x (1 + g)2 = Rs.35.33 (1.06)2 Rs.39.70 D1 / (r g) = Do (1 + g) / (r g) Rs.12.00 (1.10) / (0.15 0.10) = D1 / (r g) Rs.2 / 0.12 g 0.0575 or 5.75% D1/ (r g) = Do(1+g) / (r g) Rs.1.50, g = -0.04, Po = Rs.8 Rs.264

Rs.32 = g = 4. Po Do So 8 = =

= 1.50 (1- .04) / (r-(-.04)) = 1.44 / (r + .04)

Hence r = 0.14 or 14 per cent 5. The market price per share of Commonwealth Corporation will be the sum of three components: A: B: C: A= = = Present value of the dividend stream for the first 4 years Present value of the dividend stream for the next 4 years Present value of the market price expected at the end of 8 years. 1.50 (1.12) / (1.14) + 1.50 (1.12)2 / (1.14)2 + 1.50(1.12)3 / (1.14)3 + + 1.50 (1.12)4 / (1.14)4 1.68/(1.14) + 1.88 / (1.14)2 + 2.11 / (1.14)3 + 2.36 / (1.14)4 Rs.5.74

B= = = C= So

2.36(1.08) / (1.14)5 + 2.36 (1.08)2 / (1.14)6 + 2.36 (1.08)3 / (1.14)7 + + 2.36 (1.08)4 / (1.14)8 2.55 / (1.14)5 + 2.75 / (1.14)6 + 2.97 / (1.14)7 + 3.21 / (1.14)8 Rs.4.89 P8 / (1.14)8 P8 = D9 / (r g) = 3.21 (1.05)/ (0.14 0.05) = Rs.37.45

C= Rs.37.45 / (1.14)8 = Rs.13.14 Thus, Po = = A + B + C = 5.74 + 4.89 + 13.14 Rs.23.77

6. The intrinsic value of the equity share will be the sum of three components: A: B: C: A= (1.12) = = B= (1.12)6 4.42 = = C= = (1.12)6 Rs.10.81 D11 x rg Rs.97.20 + (1.12)7 1 = (1 +r)
10

Present value of the dividend stream for the first 5 years when the growth rate expected is 15%. Present value of the dividend stream for the next 5 years when the growth rate is expected to be 10%. Present value of the market price expected at the end of 10 years. 2.00 (1.15) + (1.12)2 2.00 (1.15)2 2.00 (1.15)3 2.00(1.15)4 2.00 (1.15)5 + + + 3 4 (1.1.2) (1.1.2) (1.12)5

2.30 / (1.12) + 2.65 / (1.12)2 + 3.04 / (1.12)3 + 3.50 / (1.12)4 + 4.02/(1.12)5 Rs.10.84 4.02(1.10) + (1.12)7 4.86 + (1.12)8 6.48 (1.05) x 1/(1.12)10 0.12 0.05 4.02 (1.10)2 + (1.12)8 5.35 + (1.1.2)9 4.02(1.10)3 + (1..12)9 5.89 + (1.12)10 4.02(1.10)4 + (1.12)10 6.48 4.02 (1.10)5

The intrinsic value of the share = A + B + C = 10.84 + 10.81 + 97.20 = Rs.118.85 7. Intrinsic value of the equity share (using the 2-stage growth model) 2.36 x = 0.16 0.18 - 0.10801 = = 2.36 x - 0.02 Rs.74.80 + 62.05 (1.18)6 1 - ----------(1.16)6 + (0.16 0.12) x (1.16)6 2.36 x (1.18)5 x (1.12)

8. Intrinsic value of the equity share (using the H model) 4.00 (1.20) = 0.18 0.10 = = 9. Price Po = D1 / (r g) Low growth firm Normal growth firm Supernormal growth firm Po = 2 / (0.16 - .04) = 16.67 Po = 2 / (0.16 - .08) = 25.00 Po = 2 / (0.16 - .12) = 50.00 Dividend yield D1/ Po 12.0% 8.0% 4.0% Capital yield (Po - Po)/ Po 4.0% 8.0% 12.0% Price earnings ratio Po/ E1 4.17 6.25 12.5 60 + 20 Rs.80 + 0.18 0.10 4.00 x 4 x (0.10)

10.

E1/Po = 2.50/30.00 r = 0.16 PVGO E1/Po = r 1 Po 2.50 = 0.16 30.00 PVGO = 0.48 30.00 So, 48 percent of the price is accounted for by PVGO. MINICASE Dr a. The general formula is P0 = -----------------t=1 ( 1+ r)t where Dt = dividend expected t years hence r= expected return D1 b. Value of a constant growth stock P0= -----------r- g where D1 is the dividend expected a year hence, r the expected return and g the growth rate in dividends. c. Required rate of return = 7 % + 1.2 x 6 % = 14.2 % d. (i) Expected value of the stock a year hence = 5 x 1.10 x 1.10 0.142 0.10 = Rs. 144.05 1Po PVGO

( ii) Expected dividend in the first year = 5x 1.10 = Rs.5.50

5x 1.10 Intrinsic price of the stock at present = P0 = ------------ = Rs. 130. 95 0.142- 0.10 5.50

Expected dividend yield = ---------- = 0.042 or 4.2 % 130.95 5x 1.10x 1.10 Expected price of the stock one year hence=P1 = ----------------- = Rs. 144.05 0.142- 1.10 144.05-130.95 Capital gains yield in the first year = ------------------- = 10 % 130.95 e Let r be the expected rate of return on the stock. We then have 5x1.10 5x 1.10 110 = ---------- i.e. r = ----------- + 0.10 = 0.05 + 0.10 = 0.15 or 15% r 0.10 110

f. Let us assume that the required rate of return is 15 percent. Year Expected dividend PV factor @15% PV of dividend 1 5x 1.25 = 6.25 0.870 5.44 2 5x ( 1.25)2= 7.81 0. 756 5.90 3 3 5x ( 1.25) = 9.77 0. 658 6.43 4 5x ( 1.25)4= 12.21 0. 572 6.98 -------------total = Rs. 24.75 (A) -------------Price of the stock at the beginning of the 5th year 12.21x 1.10 = ---------------- = Rs. 268.62 0.15- 0.10 Present value of the above is 268.62x 0.572 = Rs. 153. 65 (B) Present value of the stock = A+B = 24.75 + 153.65 = Rs. 178. 40 The expected dividend in the second year= Rs. 7.81 Expected price of the stock at the beginning of the second year: 7.81 = -----1.15 9.77 + ------( 1.15)2 + 12.21 --------- + ( 1.15 )3 268.62 ---------( 1.15 )3

=6.7913 + 7.3875 + 8.0283 + 176. 6220 = 198. 8291 Dividend yield in the second year = 7.81/ 198. 8291 = 0.0393

Expected price of the stock at the end of the second year, = 9.77 12.21 268.62 ------- + ------- + -------- = 8.4956 + 9. 2325 + 203.1153 = 220.8434 (1.15) (1.15)2 (1.15)2 220.8434 198. 8291 Capital gain in the second year = --------------------------- = 0. 1107 198. 8291

The total return for the second year = 3.93 + 11.07 = 15 % Expected dividend in the fifth year = 12.21x1.10= Rs. 13.43 Expected price of the stock in the beginning of the 5th year = Rs.268.62 Expected dividend yield in the 5th year = 13.43/268.62 =0.05 or 5 % Expected price of the stock at the end of 5th year 13.43x1.10 ------------- =295.46 0.15-0.10 Expected capital gains yield in the 5th year =(295.46-268.62)/268.62 = 0.10 or 10 % . g. . Year Expected dividend 1 5.00 2 5.00 PV factor @15% 0. 870 0. 756 PV of dividend 4. 35 3.78 -----------total = Rs. 8.13 (A) -------------

Expected price of the stock at the beginning of the 3rd year 5x 1.10 = ---------- = Rs. 110 0.15-0.10 Present value of which is 110x 0.756 = Rs. 83. 16 ( B) Present value of the stock = A+B = 8.13 + 83.16 = Rs. 91.29 h. i. 5 [ ( 1+ 0.10) + 2 ( 0.30- 0.10 ) ] Present value of the stock = ---------------------------------------- = Rs. 150 0. 15-0.10 5x (1- 0.05) 5x0.95 Present value of the stock= --------------- = --------- = Rs. 23.75

0.15- (-) 0.05 0.20 Dividend expected after one year = 5x0.95 = Rs. 4.75 Dividend yield per year = 4.75/23.75 = 0.2 or 20 %. Expected price of the stock at the end of the first year 4.75x0.95 = ---------------- = Rs.22.56 0.15-(-)0.05 Capital gains yield per year =( 22.56-23.75) / 23.75 = (-) 0.05 or (-)5%

j. The question is incomplete. Let us assume that the decline in growth rate to 10 percent will occur linearly over 4 years. Year Expected dividend PV factor @15% PV of dividend 1 5x1.30 = 6.50 0. 870 5.66 2 2 5x( 1.30) =8.45 0. 756 6.39 3 5x( 1.30)3= 10.98 0.658 7.22 ----------total Rs.19.27 ( A) ----------Expected price of the stock at the beginning of the 4th year 10.98[ ( 1+ 0.10) + 2 ( 0.30- 0.10) ] = ------------------------------------------- = Rs. 329.40 0. 15 0. 10 Present value of this is 329.40 x 0.658 = Rs. 216.75 ( B) Present value of the stock = A+ B = 19.27 + 216.75 = Rs 236. 02

Chapter 16

COMPANY ANALYSIS 1. Return on equity = Profit after tax / Shareholders funds Book value per share = Shareholders funds / Number of shares EPS = Profit after tax / Number of shares Capital after bonus issue Bonus adjustment factor = Capital before bonus issue Price per share at the beginning of the year PE ratio (prospective) = Earnings per share for the year Price per share at the end of the year PB ratio (retrospective) = Book value per share at the end of the year Sales for 20X5 CAGR in sales = Sales for 20X1 EPS for 20X5 CAGR in EPS = EPS for 20X1 Range of ROE over the period of 20X1 20X5 Volatility of ROE = Average ROE over the period 20X1 20X5 Sustainable growth rate = Retention ratio x ROE Return on equity = Profit after tax / Shareholders funds Book value per share = Shareholders funds / Number of shares EPS = Profit after tax / Number of shares Capital after bonus issue Bonus adjustment factor = Capital before bonus issue Price per share at the beginning of the year PE ratio (prospective) = Earnings per share for the year
1/4 1/4

-1

-1

Price per share at the end of the year PB ratio (retrospective) = Book value per share at the end of the year Sales for 20X5 CAGR in Sales = Sales for 20X1 EPS for 20X5 CAGR in EPS = EPS for 20X1 Range of ROE over the period of 20X1 20X5 Volatility of ROE = Average ROE over the period 20X1 20X5 Sustainable growth rate = Retention ratio x ROE (a) Return on equity Book value per share EPS 20X1 26 / 120 = 21.7% 120/ 16 = Rs.7.5 26/ 16 = Rs.1.63 1 Rs.1.63 20X2 29 / 137 = 21.2% 137/ 16 = Rs.8.6 29/ 16 = Rs.1.81 1 Rs.1.81 17.50/ 1.81 = 9.7 21/ 8.6 = 2.4 17/ 29 20X3 32 / 157 = 20.4% 157/ 16 = Rs.9.8 32/ 16 = Rs.2 1 Rs.2 21/ 2 = 10.5 24.5/ 9.8 = 2.5 20/ 32 20X4 42 / 183 = 23% 183/ 24 = Rs.7.6 42/ 24 = Rs.1.75 1.5 Rs.2.63 24.5/ 1.75 = 14 21.6/ 7.6 = 2.8 26/ 42 20X5 49 / 216 = 22.7% 216/ 24 = Rs.9 49/ 24 = Rs.2.04 1.5 Rs.3.06 21.6/ 2.04 = 10.6 24.2/ 9 = 2.7 33/ 49
1/4 1/4

-1

-1

Bonus adjustment factor Adjusted EPS PE ratio (prospective) PB ratio (retrospective) Retention ratio

17.50/ 7.5 = 2.3 16/ 26

= 0.62 (b) CAGR of Sales = 250 520

= 0.59
1/4

= 0.63

= 0.62

= 0.67

-1 = 0.201 = 20.1%

CAGR of EPS = 1.63

3.06 1/4 -1 = 0.171 = 17.1% 23 20.4

Volatility of ROE = 21.8 (c) Sustainable growth rate =

= 0.12

0.63 + 0.62 + 0.67 3 = 0.64 X 22.03 = 14.09%

20.4 + 23 + 22.7 3

(d) ROE =

PBIT x Sales

Sales x Assets

Profit before tax x PBIT

Profit after tax x Profit before tax

Assets Net worth

The decomposition of ROE for the last two years, viz., 20X4 and 20X5 is shown below: PBIT x Sales 20X4 20X5 0.167 0.181 Assets x 1.758 x 1.646 x x Sales x PBIT 0.70 0.702 x x Profit before tax x Profit before tax 0.75 0.742 x x Profit after tax x Net worth 1.492 1.463 Assets

MINICASE Return on equity = Profit after tax / Shareholders funds Book value per share = Shareholders funds / Number of shares EPS = Profit after tax / Number of shares Capital after bonus issue Bonus adjustment factor = Capital before bonus issue Price per share at the beginning of the year PE ratio (prospective) = Earnings per share for the year Price per share at the end of the year PB ratio (retrospective) = Book value per share at the end of the year Sales for 20X5 CAGR in sales = Sales for 20X1 EPS for 20X5 CAGR in EPS = EPS for 20X1 Range of ROE over the period of 20X1 20X5 Volatility of ROE = Average ROE over the period 20X1 20X5 Sustainable growth rate = Retention ratio x ROE Return on equity = Profit after tax / Shareholders funds Book value per share = Shareholders funds / Number of shares EPS = Profit after tax / Number of shares Capital after bonus issue Bonus adjustment factor = Capital before bonus issue Price per share at the beginning of the year
1/4 1/4

-1

-1

PE ratio (prospective)

= Earnings per share for the year Price per share at the end of the year

PB ratio (retrospective)

= Book value per share at the end of the year Sales for 20X5
1/4

CAGR in Sales

= Sales for 20X1 EPS for 20X5

-1

1/4

CAGR in EPS

= EPS for 20X1

-1 Range of ROE over the period of 20X1 20X5

Volatility of ROE

= Average ROE over the period 20X1 20X5

Sustainable growth rate = Retention ratio x ROE (a) Return on equity Book value per share EPS 20X1 60/ 500 = 12% 500/ 30 = Rs.16.7 60/ 30 = Rs.2 20X2 60/ 540 = 11.1% 540/ 30 = Rs.18 60/ 30 = Rs.2 20/ 2 = 10 20/ 16.7 = 1.2 22/ 18 = 1.2 20X3 110/ 620 = 17.7% 620/ 30 = Rs.20.7 110/ 30 = Rs.3.7 22/ 3.7 = 5.9 45/ 20.7 = 2.2 20X4 150/ 730 = 20.5% 730/ 30 = Rs.24.3 150/ 30 = Rs.5 45/ 5 =9 56/ 24.3 = 2.3 20X5 240/ 920 = 26.1% 920/ 30 = Rs.30.7 240/ 30 = Rs.8 56/ 8 =7 78/ 30.7 = 2.5

PE ratio (prospective) PB ratio (retrospective)

Retention ratio (b)

40/ 60 = 0.67 1780

40/ 60 = 0.67
1/4

80/ 110 = 0.73

110/ 150 = 0.73

190/ 240 = 0.79

CAGR of sales = 780 8 CAGR of EPS = 2

1/4

-1 = 0.229 = 22.9%

-1 = 0.414 = 41.4% 26.1 11.1

Volatility of ROE = 17.5 (c) Sustainable growth rate =

= 0.86 0.73 + 0.73 + 0.79 3 = 0.75 x 21.4 = 16.05% 17.7 + 20.5 + 26.1 3

(d)

The decomposition of ROE for the last two years, viz., 20X4 and 20X5 is shown below: PBIT x Sales Assets x 0.979 x 0.937 x x Sales x PBIT 0.704 0.707 x x Profit before tax x Profit before tax 0.789 0.828 x x Profit after tax x Net worth 1.959 2.065 Assets

20X4 20X5

0.193 0.230

(e) EPS estimate for 20X6 is Net sales Cost of goods sold Operating expenses Non-operating surplus/deficit 20X5 1780 1210 170 10 20X6 2047 1403.60 204 10 Remarks Increase by 15% Increase by 16% Increase by 20% Remains same

PBIT Interest Profit before tax Tax Profit after tax EPS

410 120 290 50 240

449.4 132 317.4 70.59 246.81 8.23

Increase by 10% Effective tax increases by 5% rate

(f) Average retention ratio for the period 20X3 20X5 was 0.75. So the average payout ratio was 1 0.75 = 0.25 Required rate of return = 10% + 1.1 x 8% = 18.8% Expected growth rate in dividends Average retention ratio Average return on equity = in the last three years x in the last three years Average return on equity in 17.7 + 20.5 + 26.1 the last three years = = 21.4% 3 So, the expected growth rate in dividends is: 0.75 x 21.4 = 16.05%

The PE ratio as per the constant growth model is: 0.25 = 9.09 0.188 0.1605 (g) The value anchor is: Expected EPS x PE ratio = Rs.8.23 x 9.09 = Rs.74.8

Chapter 18 OPTIONS 1. S = 100 , uS = 150, dS = 90 u = 1.5 , d = 0.9, r = 1.15 R = 1.15 E = 100 Cu = Max (uS E, 0) = Max (150 100,0) = 50 Cd = Max (dS E, 0) = Max (90 100,0) = 0 Cu Cd = (u-d)S u Cd d Cu B = (u-d)R C = 2. = 0.6 x 1.15 = 0.6 x 100 0 0.9 x 50 = - 65.22 50 = 0.833

S + B = 0.833 x 100 65.22 = 18.08

S = 60 , dS = 45, d = 0.75, C = 5 r = 0.16, R = 1.16, E = 60 Cu = Max (uS E, 0) = Max (60u E, 0) Cd = Max (dS E, 0) = Max (45 60, 0) = 0 Cu Cd = (u-d)S u Cd d Cu B = (u-d)R C = 5 = u 0.75 S+B (u 1) 60 + 1.16 (u 0.75) 45 (1 u) = (u 0.75) 1.16 = (u 0.75)60 0.75 (60u 60) = 1.16 (u 0.75) 60u 60 = u 0.75 45 (1 u) u1

Multiplying both the sides by u 0.75 we get

45 5(u 0.75) = (u 1) 60 + 1.16 Solving this equation for u we get u = 1.077 So Betas equity can rise to 60 x 1.077 = Rs.64.62 3. C0 = S0 N(d1) E N (d2) ert S0 = 70, E = 72, r = 0.12, = S0 ln E d1 = 70 ln 72 = 0.30 0.50 - 0.0282 + 0.0825 = 0.2121 d2 = d1 - t = 0.2560 0.30 0.50 = 0.0439 = 0.2560 + (0.12 + 0.5 x .09) x 0.50 t + r+ 2 0.3, t = 0.50 1
2

(1 u)

N (d1) = 0.6010 N (d2) = 0.5175 E = ert

72 = 67.81 e0.12x 0.50

C0 = S0 x 0.6010 67.81 x 0.5175 = 70 x 0.6010 67.81 x 0.5175 = Rs.6.98

4. C0 = S0 N(d1) -

E N (d2)
rt

e E = 50, t = 0.25, S = 40, = S0 ln E d1 = 40 ln 50 d1 = + r+

0.40, r = 0.14 1 2 t
2

+ (0.14 + 0.5 x 0.16) 0.25 0.40 0.25

- 0.2231 + 0.055 = 0.20 d2 = d1 - t = - 0.8405 0.40 0.25 = -1.0405 = - 0.8405

N (d1) = 0.2003 N (d2) = 0.1491 E = ert

50 = 48.28 e0.14 x 0.25

C0 = S0 x 0.2003 48.28 x 0.1491 = 40 x 0.2003 48.28 x 0.1491 = 0.8135 5. S = 100 E = 105 u = 1.5 r = 0.12 d = 0.8 R = 1.12

The values of (hedge ratio) and B (amount borrowed) can be obtained as follows: Cu Cd = (u d) S

Cu Cd

= = =

Max (150 105, 0) Max (80 105, 0) 45 0 = 0.7 x 100 u.Cd d.Cu

= = 45

45 0 9 = = 14 0.6429

70

= (u-d) R = = (1.5 x 0) (0.8 x 45) 0.7 x 1.12 -36 0.784 = -45.92

= = =

S+B 0.6429 x 100 45.92 Rs.18.37

Value of the call option = Rs.18.37 6. S = 40 R = 1.10 u=? E = 45 d = 0.8 C=8

We will assume that the current market price of the call is equal to the fair value of the call as per the Binomial model. Given the above data Cd = B = B = -0.8Cu (-) 0.034375 u Cd d Cu Cu 0 x 40 1.10 = Max (32 45, 0) Cu Cd x S = R 0

 C 8

= = =

- 0.34375 B S+B x 40 + B

(1) (2)

Substituting (1) in (2) we get 8 8 or B = = = = (-0.034365 x 40) B + B -0.375 B - 21.33 - 0.034375 (-21.33) = 0.7332

The portfolio consists of 0.7332 of a share plus a borrowing of Rs.21.33 (entailing a repayment of Rs.21.33 (1.10) = Rs.23.46 after one year). It follows that when u occurs either u x 40 x 0.7332 23.46 = u x 40 45 -10.672 u = -21.54 u = 2.02 or u x 40 x 0.7332 23.46 u = 0.8 = 0

Since u > d, it follows that u = 2.02. Put differently the stock price is expected to rise by 1.02 x 100 = 102%. 7. E C0 = S0 N(d1) N (d2) ert S0 = 120, E = 110, r = 0.14, t = 1.0, = 0.4 S0 ln E d1 = 120 ln 110 d1 = + 0.14 + 2 t 1 x 0.42 1 + r+ 2 1
2

0.4 = 0.4 d2 = d1 -

1 = 0.7675

.0870 + 0.22

t = 0.7675 0.40 = 0.3675 N (d2) = 0.6434 110 = 99.63 1.1503

N (d1) = 0.2003 E = rt e

C0 = 120 x 0.7786 99.63 x 0.6434 = Rs.29.33 8. E C0 = S0 N(d1) N (d2) ert S0 = Rs.80, E = Rs.82, ert = 1.1503, = S0 ln E d1 = 80 ln 82 d1 = 0.20 = 0.20 d2 = d1 - t = 0.6765 0.20 = 0.4765 N (d2) = 0.683 82 = 71.29 + 0.14 + 2 1 = 0.6765 t 1 x 0.4 1 + r+ 2 1
2

0.20, t = 1, r = ln (1.1503) = 0.14 t

- 0.0247 + 0.1600

N (d1) = 0.751 E =

ert

1.1503

C0 = Rs.80 x 0.751 Rs.71.29 x 0.683 = Rs.11.39 9. According to the put-call parity C0 = S0 + P0 E/ ert S0 = Rs.75, P0 = Rs.0.70, E = Rs.80, r = 0.08, t = 0.25 So C0 should be 80 Rs.75 + Rs.0.70 e0.08 x 0.25 C0 is given to be Rs.7. Clearly the put-call parity is not working in this case. 10. S0 = Rs.60, u = 1.30, d = 0.95, r = 8%, E = Rs.50 If investors are risk-neutral, the expected return on the stock is 8%. Since Bharats stock can either rise by 30 percent to Rs.78 or fall by 5 percent to Rs.57, we can calculate the probability of a price rise in the hypothetical riskneutral world. Expected return = [Probability of rise x 30%] + [1 Probability of rise] x 5% = 8% Therefore the probability of rise is 0.3714 If the stock price rises the call option has a value of Rs.28 (Rs.78 50) and if the stock price falls the call option has a value of Rs.7 (Rs.57 50). Hence, if investors are risk-neutral, the call option has an expected future value of: Probability of rise x Rs.28 + (1- Probability of rise) x Rs.7 = 0.3714 x 28 + (1 0.3714) x 7 = 10.40 + 4.40 = Rs.14.80 The current value of the call option is: Expected future value 14.80 = = Rs.13.70 1 + Risk-free rate (1.08) = - 2.716

MINICASE a. Call option : A call option gives the option holder the right to buy an asset at a fixed price during a certain period. Put option : : A put option gives the option holder the right to sell an asset at a fixed price during a certain period. Strike price ( exercise price ) : The fixed price at which the option holder can buy and /or sell the underlying asset is called the strike price or the exercise price .Expiration date : The date when the option expires is called the expiration date. b. Call options with strike prices 280, 300 and 320 and put options with strike prices 340 and 360 are in - the - money . Call options with stike prices 340 and 360 and put options with strike prices 280, 300 and 320 are out of the money. c. (i) If Pradeep Sharma sells Jan/340 call on 1000 shares, he will earn a call premium of Rs.5000 now. However, he will forfeit the gains that he would have enjoyed if the price of Newage Hospitals rises above Rs.340. (ii) If Pradeep Sharma sells Mar/300 call on 1000 shares, he will earn a call premium of Rs.41,000 now. However, he will forfeit the gains he would have enjoyed if the price of Newage Hospital remains above Rs.300.

d. Let s be the stock price, p1 and p2 the call premia for March/ 340 and March/ 360 calls respectively. When s is greater than 360, both the calls will be exercised and the profit will be { s-340-p1} { s-360-p2 } = Rs. 11 The maximum loss will be the initial investment , i.e. p1-p2 =Rs. 9 The break even will occur when the gain on purchased call equals the net premium paid i.e. s-340 = p1 p2 =9 Therefore s= 349 e. If the stock price goes below Rs.300, Mr. Sharma can execute the put option and ensure that his portfolio value does not go below Rs. 300 per share. However , if stock price goes above Rs. 340, the call will be exercised and the stocks in the portfolio will have to be delivered/ sold to meet the obligation, thus limiting the upper value of the portfolio to Rs. 340 per share. So long as the share price hovers between R. 300 and Rs. 340, Mr. Sharma will be gainer by Rs. 8 ( net premium received ). f. Profit Pay off

g.

305 340 375 Stock price Other things remaining constant, value of a call option - increases when the current price of the stock increases. - decreases when the exercise price increases. - increases when option term to maturity increases. - increases when the risk-free interest rate increases. - increases when the variability of the stock price increases.

h. The assumptions underlying the Black-Sholes option pricing model are as follows: 1. The call option is the European options 2. The stock price is continuous and is distributed lognormally. 3. There are no translation costs and taxes. 4. There are no restrictions on or penalties for short selling. 5. The stock pays no dividend. 6. The risk-free interest rate is known and constant. i. The three equations are E C0 = S0 N(d1) - ------ N (d2) ert S0 ln ----E d1 = t 2 + r + --2

d2 = d1 - t j. S0 = 325 E =320 t =0.25 r = 0.06 =0.30 325 ln 320 d1 = 0.30 x 0.25 + 0.06 + 2 (0.30)2 x 0.25

= ( 0.0155 + 0.02625 ) / 0.15 = 0. 2783 d2 = 0.2783 -0.30 0.25 = 0.2783 0.15 = 0.1283 Using normal distribution table N (d1) = 1 [ 0.3821 + ( 0.4013- 0. 3821) ( 0.30 0.2783 ) /( 0.30 0.25) ] =1- [ 0.3821 + 0. 0192 x 0.0217 / 0.05 ] = 0.6096 N ( d2 ) = 1- [ 0. 4404 + ( 0. 4602- 0.4404) ( 0. 15 0. 1283 ) / ( 0. 15- 0.10 ) ] = 1- [ 0.4404 + 0.0198 x 0.0217 / 0.05 ] = 0. 5510 E / ert = 320 / e0.06 x 0. 25 = 320 / 1. 0151 = 315. 24 C0 = 325 x 0.6096 315.24 x 0. 5510 = 198.12 173. 70 = Rs. 24.42

k.

A collar is an option strategy that limits the value of a portfolio within two bounds. For example the strategy adopted in ( e ) above is a collar.

Chapter 19 FUTURES 1. March 2 March 3 March 4 March 5 2. 3. F0 F0 Cash flow to the buyer 1128 1125 = 3 1127 1128 = -1 1126 1127 = -1 1128 1126 = 2

= S0 (1+rf)t = Rs.40 (1.08)0.25 = Rs.40.78 = S0 (1+rf - d)t = 1200 (1 + 0.10 - .03)1 = 1284

4. If the 6-months futures contract for gold is $432.8 and the interest rate is 8 percent; the appropriate value for the one-year gold futures contract is : $432.8 (1.08) 0.5 = $449.8

If the one-year gold futures has a price of $453 it means that it is over-priced relative to the 6-months futures contract. A profitable strategy would be to : Sell a one-year futures contract for $453 Buy a 6-months futures contract for $432.8 Take delivery of the 6-months futures contract after 6-months with the help of borrowed money, hold the gold for 6 months, and give delivery of the one-year futures contract. 5. The appropriate value of the 3-months futures contract is 1,000 (1.01)3 = Rs.1030.3 Since the 3-months futures price of Rs.1035 exceeds Rs.1030.3, it pays to buy the share in the spot market with borrowed money and sell the futures contract. Such an action produces a riskless profit of Rs.4.7 as shown below : Action Initial cash flow Cash flow at time T (3 months) Borrow Rs.1,000 now and + Rs.1,000 - Rs.1,000 (1.01)3 repay with interest at time T = - Rs.1030.3 Buy a share Sell a futures contract (F0 = Rs.1035) - Rs.1,000 0 0 ST Rs.1035 - ST Rs.4.7

Chapter 20 PORTFOLIO MANAGEMENT FRAMEWORK 1. Rp Rf Treynor Measure: p 15 10 Fund P: 0.9 17 10 Fund Q: 1.1 19 10 Fund R: 1.2 = 7.50% = 6.36% = 5.55%

16 10 Market index: 1.0 Rp Rf Sharpe Measure: p 15 10 Fund P: 20 17 10 Fund Q: 24 19 10 Fund R: 27 16 10 Market index: 20 = 0.25 = 0.33 = 0.29 = 0.25 = 6%

Jensen Measure: Rp [Rf + p (RM Rf )] Fund P: Fund Q: Fund R: 15 [10 + 0.9 (6)] = -0.4% 17 [10 + 1.1 (6)] = 0.4% 19 [10 + 1.2 (6)] = 1.8%

Market Index: 0 ( By definition) 2. (a) The arithmetic average return is: (5 + 12 + 16 + 3)/ 4 = 9% (b) The time-weighted (geometric average) return is: [(1.05) (1.12) (1.16) (1.03)]1/4 - 1 = .089 = 8.9% (c) The rupee-weighted average (IRR) return is computed below:

Rate of return earned Beginning value of assets Investment profit during the period (Rate of return x Assets) 10 Net inflow at the end 10 Ending value of assets 220 Time 1 -10

1 5% 200

2 12% 220 26.4 50 296.4

Period 3 16% 296.4 47.42 30 373.82

4 3% 373.82 11.21 385.03

Net cash flow

0 -200

2 -50

3 -30

4 385.03

The IRR of this sequence is 10 50 30 200 + + + = 2 3 (1 + r) (1 + r) (1 + r) r = 8.81%

385.03 (1 + r)4

Appendix 20A SOLUTION Market Level is 100 Portfolio Stocks Bonds 60,000 40,000 60,000 40,000 60,000 40,000

Buy and Hold Policy Constant Mix Policy Constant Proportion Portfolio Insurance Policy

Total 100,000 100,000 100,000

Buy and Hold Policy Constant Mix Policy Constant Proportion Portfolio Insurance Policy

Market Level Falls to 80 Portfolio Portfolio (before rebalancing) (after rebalancing) Stocks Bonds Total Stocks Bonds Total 48,000 40,000 88,000 48,000 40,000 88,000 48,000 40,000 88,000 52,800 35,000 88,000 48,000 40,000 88,000 24,000 64,000 88,000

Buy and Hold Policy Constant Mix Policy Constant Proportion Portfolio Insurance Policy

Market Level Falls to 100 Portfolio Portfolio (before rebalancing) (after rebalancing) Stocks Bonds Total Stocks Bonds Total 60,000 40,000 100,000 60,000 40,000 100,000 66,000 35,200 101,000 60,720 40,480 101,000 28,800 64,000 92,800 38,400 54,400 92,800

APPENDIX 20 B 1. The portfolio return is decomposed into four components as follows 1. Risk- free return, . Rf = 10 % 2. The impact of systematic return, ( Rm Rf ): 1.2 ( 18 10 ) = 9.6 3. The impact of imperfect diversification, ( p/m p ) (Rm Rf ) : ( 14/16- 1.2) ( 18- 10) = - 2.6 4. The net superior return due to selectivity, Rp { Rf + p/m p ) (Rm Rf ) }: 16 { 10 + 14/ 16 ( 8) } = - 1.00