Question No. 1) Explain market risk protection?

Market risk has been compared to a bank run which has a cascading effect on other banks which are owed money by the first bank in trouble, causing a cascading failure. As depositors sense the ripple effects of default, and liquidity concerns cascade through money markets, a panic can spread through a market, with a sudden flight to quality, creating many sellers but few buyers for illiquid assets. These inter linkages and the potential "clustering" of bank runs are the issues which policy makers consider when addressing the issue of protecting a system against systemic risk. Governments and market monitoring institutions (such as the U.S. Securities and Exchange Commission (SEC), and central banks) often try to put policies and rules in place with the ostensible justification of safeguarding the interests of the market as a whole, claiming that the trading participants in financial markets are entangled in a web of dependencies arising from their inter linkage. In simple English, this means that some companies are viewed as too big and too interconnected to fail. Policy makers frequently claim that they are concerned about protecting the resiliency of the system, rather than any one individual in that system. Systemic risk should not be confused with market or price risk as the latter is specific to the item being bought or sold and the effects of market risk are isolated to the entities dealing in that specific item. This kind of risk can be mitigated by hedging an investment by entering into a mirror trade. Insurance is often easy to obtain against "systemic risks" because a party issuing that insurance can pocket the premiums, issue dividends to shareholders, enter insolvency proceedings if a catastrophic event ever takes place, and hide behind limited liability. Such insurance, however, is not effective for the insured entity. One argument that was used by financial institutions to obtain special advantages in bankruptcy for derivative contracts was a claim that the market is both critical and fragile. However, evidence overwhelmingly suggests that such special treatment, justified by arguments about systemic risk, actually exacerbated systemic risk during the financial crisis and forced the government to bail out derivatives traders. Systemic risk can also be defined as the likelihood and degree of negative consequences to the larger body. With respect to federal financial regulation, the systemic risk of a financial institution is the likelihood and the degree that the institution's activities will negatively affect the larger economy such that unusual and extreme federal intervention would be required to ameliorate the effects.

Question No. 2) Describe the Dow theory? The Dow Theory is a major corner stone of technical analysis. It is one of the oldest and best known methods used to determine the major trend of stock prices. It was derived from the writings of Charles H. Dow from 1900 to 1902 published in the daily newspaper he founded, The Wall Street Journal. Dow's Theory was further refined by analysts and writers S. A. Nelson, William P. Hamilton, and Robert Rhea in the first few decades of the 20th century. Seven Basic Principles of Dow's Theory: 1. Everything is discounted by the price Averages, specifically, the Dow-Jones Industrial Average and the Dow-Jones Transportation Average. Since the Averages reflect all information, experience, knowledge, opinions, and activities of all stock market investors, everything that could possibly affect the demand for or supply of stocks is discounted by the Averages. 2. There are three trends in stock prices. 1) The Primary Tide is the major long-term trend. But no trend moves in a straight line for long, and 2) Secondary Reactions are the intermediate-term corrections that interrupt and move in an opposite direction against the Primary Tide. 3) Ripplesare the very minor dayto-day fluctuations that are of concern only to short-term traders and not at all to Dow Theorists. 3. Primary Tides going up, also known as Bull Markets, typically unfold in three up moves in stock prices. The first move up is the result of far-sighted investors accumulating stocks at a time when business is slow but anticipated to improve. The second move up is a result of investors buying stocks in reaction to improved fundamental business conditions and increasing corporate earnings. The third and final up move occurs when the general public finally notices that all the financial news is good. During the final up move, speculation runs rampant. 4. Primary Tides going down, also known as Bear Markets, typically unfold in three down moves in stock prices. The first move down occurs when far-sighted investors sell based on their experienced judgment that high valuations and booming corporate earnings are unsustainable. The second move down reflects panic as a now fearful public dumps at any price the same stock they just recently bought at much higher prices. The final move down results from distress selling and the need to raise cash. 5. The two averages must confirm each other. To signal a Primary Tide Bull Market major trend, both averages must rise above their respective highs of previous upward Secondary Reactions. To signal a Primary Tide Bear Market major trend, both the Dow-Jones Industrial Average and the Dow-Jones Transportation Average must drop below their respective lows of previous Secondary Reactions. A move to a new high or low by just one average alone is not meaningful. Also, it is not uncommon for one average to signal a change in trend before the other. The Dow Theory does not stipulate any time limit on trend confirmation by both averages. 6. Only end-of-day, closing prices on the averages are considered. Price movements during the day are ignored. 7. The Primary Tide remains in effect until a Dow Theory reversal has been signaled by bothaverages.

Question No.3. Which are the main statements used in financial analysis? State the limitations of financial analysis? Financial analysis is the process of understanding the risk and profitability of a firm (business, subbusiness or project) through analysis of reported financial information, by using different accounting tools and techniques. Financial statement analysis consists of 1) reformulating reported financial statements, 2) analysis and adjustments of measurement errors, and 3) financial ratio analysis on the basis of reformulated and adjusted financial statements. The two first steps are often dropped in practice, meaning that financial ratios are just calculated on the basis of the reported numbers, perhaps with some adjustments. Financial statement analysis is the foundation for evaluating and pricing credit risk and for doing fundamental company valuation. 1) Financial statement analysis typically starts with reformulating the reported financial information. In relation to the income statement, one common reformulation is to divide reported items into recurring or normal items and non-recurring or special items. In this way, earnings could be separated in to normal or core earnings and transitory earnings. The idea is that normal earnings are more permanent and hence more relevant for prediction and valuation. Normal earnings are also separated into net operational profit after taxes (NOPAT) and net financial costs. The balance sheet is grouped, for example, in net operating assets (NOA), net financial debt and equity. 2) Analysis and adjustment of measurement errors question the quality of the reported accounting numbers. The reported numbers can for example be a bad or noisy representation of invested capital, for example in terms of NOA, which means that the return on net operating assets (RNOA) will be a noisy measure of the underlying profitability (the internal rate of return, IRR). Expensing of R&D is an example when such investment expenditures are expected to yield future economic benefits, suggesting that R&D creates assets which should have been capitalized in the balance sheet. An example of an adjustment for measurement errors is when the analyst removes the R&D expenses from the income statement and put them in the balance sheet. The R&D expenditures are then replaced by amortization of the R&D capital in the balance sheet. Another example is to adjust the reported numbers when the analyst suspects earnings management. 3) Financial ratio analysis should be based on regrouped and adjusted financial statements. Two types of ratio analysis are performed: 3.1) Analysis of risk and 3.2) analysis of profitability: 3.1) Analysis of risk typically aims at detecting the underlying credit risk of the firm. Risk analysis consists of liquidity and solvency analysis. Liquidity analysis aims at analyzing whether the firm has enough liquidity to meet its obligations when they should be paid. A usual technique to analyze illiquidity risk is to focus on ratios such as the current ratio and interest coverage. Cash flow analysis is also useful. Solvency analysis aims at analyzing whether the firm is financed so that it is able to recover from a loss or a period of losses. A usual technique to analyze insolvency risk is to focus on ratios such as the equity in percentage of total capital and other ratios of capital structure. Based on the risk analysis the analyzed firm could be rated, i.e. given a grade on the riskiness, a process called synthetic rating. 3.2) Analysis of profitability refers to the analysis of return on capital, for example return on equity, ROE, defined as earnings divided by average equity. Return on equity, ROE, could be decomposed: ROE = RNOA + (RNOA - NFIR) * NFD/E, where RNOA is return on net operating assets, NFIR is the net financial interest rate, NFD is net financial debt and E is equity. In this way, the sources of ROE could be clarified.

Question No.4 Explain the strong form of market efficiency with empirical evidences. INTRODUCTION The purpose of this paper is to investigate the empirical validity of the efficient market hypothesis (EMH) for a random sample of 20 stocks. This will be done in two stages. In the first stage, weak-form market efficiency will be examined by making some statistical tests i.e. serial correlation tests, runs tests etc. as well as by examining whether any of the widely known market anomalies is present. During the second stage, semi-strong form market efficiency will be tested by doing an event study regarding the effect of inflation announcements on stock prices. In order to examine this, the impact on mean returns as well as on returns volatility will be analysed. What do we mean by saying that the capital markets are efficient? When someone refers to efficient capital markets, he means that security prices fully reflect all available information. This is an extremely stringent requirement. Thus, the EMH is divided into three categories, each one dealing with a different type of information. These are the weak form, the semi-strong form, and the strong-form of the efficient market hypothesis (EMH). As we have already mentioned, only the first two will be examined in this paper.

WEAK-FORM MARKET EFFICIENCY Under the weak form of the efficient market hypothesis, stock prices are assumed to reflect any information that may be contained in the past history of the stock price itself. This means that any information given by the sequence of the stock price in the past, is reflected in today's price. The information tested is the past sequence of security price movements. If this form of the EMH is not proven to be valid, this would mean that by examining the history of past prices we can predict tomorrow's price and thus technical analysis or charting becomes effective. In order to test this hypothesis, the appropriate theory should be established. The simplest one to use is the theory of random walks. This theory says that, the future path of the price level of a security is no more predictable than the path of a series of cumulated random numbers. In statistical terms, this means that successive price changes are independent, identically distributed random variables. The past cannot be used to predict the future in any meaningful way (Fama 1965). The random walk model is a restrictive version of the weak form of the EMH. That means that if the random walk theory holds, the weak form of the EMH must also hold but the opposite won't hold. Thus, evidence supporting the random walk model is evidence supporting weak form efficiency.

EMPIRICAL TESTS OF WEAK FORM EFFICIENCY The Database The companies In order to test the EMH we use data of 20 companies chosen at random. The data are given on a daily basis. The period tested is from 24/10/86 to 23/03/90 giving us a total of 891 observations. Each company file contains the following columns: C1 - Date C2 - Holiday Dummy (1: holiday, 0 no holiday)

C3 - Day of the week indicator (1: Monday, 5: Friday) C4 - Natural log Returns (adjusted to include dividends) lnRt = ln((Pt+Dt)/Pt-1) C5 - Adjusted Price C6 - Unadjusted Price C7 - Dividend

Question No.5) How would you immunize the bond portfolio using the immunization technique? A bond portfolio is immunized if its investment performance is not sensitive to changes in interest rates. A bond portfolio manager can use the concept of duration and to immunize the portfolio. The immunization techniques fall into two categories: (1) the bank immunization case and the planning period case. The primary focus of this paper is on the planning period case.

The Planning Period Case With this technique the bond portfolio manager is concerned with managing a portfolio toward an horizon period. Many bond portfolios have a definite planning period, with the goal being to achieve a target value for the portfolio at the end of the planning period.

A typical problem occurs in pension fund management, with the bond manager managing the bonds in the pension fund toward a horizon date set when pensions become payable. The problem confronting the bond manager in this case concerns the effect of changing interest rates on the immediate value of the bond portfolio and on the reinvestment rate, the rate at which cash thrown off by the bond portfolio can be reinvested. Overall, a manager investing toward a future horizon period tries to maximize the value of the portfolio on that future date, subject to risk constraints. Equivalent to maximizing the future value of a portfolio, a manger might attempt to maximize the Realized Compound Yield to Maturity (RCYTM).

RCYTM = T
TV= Terminal Value IV= Initial Value T= Horizon date

TV 1 IV

According to this definition, the RCYTM is the compound yield realized on an investment over T periods. For example, assume that a $1,000 bond (bond A) portfolio consists of one 10% annual coupon rate with a face value of $1,000, which matures in five years. If interest rates are currently 10% and remain steady for the five-year period, all of the coupon payments may be invested at 10%. In this case, the RCYTM will be 10% over that five-year period.

Bond A

R=10% Coupon Future Value

Period 0 1 2 3 4 5

Investment $1,000

Payment

(1+R)t $1,000

$100 $100 $100 $100 $100 TV

$146 $133 $121 $110 $100 $1,611

RCYTM = 5

$1,611 1 10% $1,000

However, a change in interest rates during planning period can dramatically affect the RCYTM. If interest rates had suddenly dropped at the beginning of the investment period from 10% to 6%, the RCYTM would have fallen to 9.35%.

Question No. 6) Suppose a preferred stocks annual dividend is ` 4 and the required rate of return is 10 per cent, what is it worth today?