Indian Institute of Management Ahmedabad Financial Markets - Fall 2021 Mid Term Exam

Indian Institute of Management Ahmedabad
Financial Markets | Fall 2021

Mid Term Exam
Notes:
 This is a closed book exam
 Duration: 2 hours 30 minutes
 No clarifications will be entertained during the examination
 Make reasonable assumptions wherever necessary and state them clearly
 Clarity and neatness of presentation would be rewarded
- All Questions Must be Answered –
1. Five years (60 months) ago, FedBank issued your firm a monthly amortizing loan
with a principal of ₹10 mi. The loan was to be paid back in equated monthly
instalments (EMI) over ten years, at a fixed interest rate of 10% per year compounded
monthly. Your firm has been struggling with operating cash flows due to the
pandemic. The bank offers you a moratorium of 12 months wherein failure to make
EMI payments does not render you in default, but the compounding schedule remains
intact. You decide not to make any payments during this period.
a. What was your originally scheduled EMI?
Principal $ 10.00 million
Time 60 months (5 years)

Rate of interest 0.83% p.m
Moratorium 12 months
Duration of loan 120 months (10 years)
Orignal EMI $0.13
b. What is the increase in the outstanding balance during these 12 months?
EMI at
Opening Interest Principal
year end of Balance
balance paid Returned
year
1 10 $1.57 0.97 $0.60 $9.40
2 $9.40 $1.57 0.906 $0.67 $8.73
3 $8.73 $1.57 0.836 $0.74 $7.99
4 $7.99 $1.57 0.759 $0.81 $7.18
5 $7.18 $1.57 0.675 $0.90 $6.28
6 $6.28 0 0.65 -0.65 6.93
Increase in outstanding balance =6.93 – 6.28 = 0.65 million

c. When the moratorium expires, the loan payment will be recalculated keeping
the original interest rate, but with an additional year for the loan repayment
(i.e. the loan will mature at the end of the 11th year). FedBank will sell your
loan to ZedBank at the end of the moratorium period. At that time, the
interest rate on such loans will have increased to 12% per year compounded
monthly. Upon sale, how much Profit/Loss will FedBank record on its books
against your loan contract?
2. The beta of XYZ, Inc. is 1.5. In the next several years, you expect the stock market to
offer a stable return of around 16%. The RBI’s policy is to keep the risk-free rate
stable at around 6%. XYZ’s plowback ratio of 30% will also remain stable. Currently,
the stocks are selling at ₹250 and the projected EPS for the next 12 months is ₹50.
EPS growth has stabilized and is expected to remain so.
a. Your return expectation is based on historical data. What is present value of

growth opportunities (PVGO) offered by the stock?
Beta 1.5
market return 16%
risk free rate 6%
XYZ's plowback ratio 30%
p0 250
EPS 50
Expected stock return rf + beta (rm-rf)
Stock return 21%
PVGO p0 - EPS/r
11.90
b. What is the book value (per share) of the stock?

P/B ratio
p0/BVPS = (1-b)/((r/re)-b)
250/BVPS = 151.5%
BVPS = 164.9659864
c. The stock just generated a 22% return. Is the return above, or below the
expectation (state the difference in percent points)? The market return stayed
at 16%.
Expected return 21%
Actual return 22%
4.76%
The actual returns on the stock are more than the expected returns calculated by
4.76%. This means that the stock was undervalued.
3. Your geeky equity analysts have identified 20 stocks with identical risks (σ =20 %)
and returns (r =15%). Interestingly, except the diagonals, all cells in the variance-
covariance matrix have roughly identical values (1%).
a. What is the correlation between any two different assets?

Number of stocks 20
risk 20%
return 15%
covariance between any 2 stocks 1%
Correlation cov(x1,x2)/ (SDx1 * SDx2)

correlation between 2 assets 0.25
b. What is the standard deviation of an equally weighted portfolio?

Number of Stocks 20
risk 20%
covariance between any 2 stocks 1%
Standard Deviation Sqrt(Variance)
Weight of each stock 5%
Vale of diagonals 0.002
vale of non diagonals 0.0095
Variance 0.012
Standard Deviation 0.107
c. What is the Sharpe ratio that you achieve through this portfolio? The risk-
free rate is 5%.
Return on portfolio R(p) 15.0%

Return on risk free asset R (f) 5.0%
Standard deviation of portfolio SD (p) 10.7%
Sharpe ratio R(p) - R (f) / SD (p)
0.933
d.
4. An analysis of historical stock market data leads to the following conclusions: The
market has a standard deviation of 30%. The risk-Free rate is 6%. Returns in assets A
and B have 75% and -60% correlation with the market. Their standard deviations are
20% and 22% respectively. The mutual correlation between A and B is 30%.
a. Which asset has a higher beta?

SD (m) 30.00%
r (f) 6.00%
cor (am) 75.00%
cor (bm) -60.00%
SD (a) 20.00%
SD (b) 22.00%
corr (ab) 30.00%
beta cov (p,m)/var(m)

Cov (am) 4.50%
cov (bm) -3.96%
var (m) 9.00%
beta (a) 50.00%

beta (b) -44.00%
Asset A has higher beta value
b. Which asset has a more volatile return?

Since the standard deviation of asset B is more than asset A, asset B has more volatile
return.
c. What is the standard deviation of a 50:50 portfolio made of assets A and B?
Wt Sigma correlation
A 50% 20.00% 30%
B 50% 22.00%
Diagonals 0.022
Non diagonals 0.0066
Variance 0.029
standard deviation 0.16941
5. You collect a sample of contiguous annual returns on the Market and Stock A as
shown below (Consider the risk-free rate to be zero):
Marke Stock
t A
2019 20.10% 0.20%
2016 72.70% 4.00%
2017 -
25.70% 6.00%
2018 56.90% 27.90%
2019 6.70% -5.10%
2020 17.90% -
11.30%
a. What is the correlation between Stock A and Market returns, as inferred from this
sample?
b. What is the Beta of Stock A, as inferred from this sample?
c. What is the standard deviation of the returns on Stock A, as inferred from this
sample?
Market Stock A
2019 20.10% 0.20%
2016 72.70% 4.00%
2017 -25.70% 6.00%
2018 56.90% 27.90%
2019 6.70% -5.10%
2020 17.90% -11.30%
correaltion (a,m) 0.4004

covaraince (a,m) 0.0191
variance(m) 0.1254
varinace (a) 0.0181
Beta cov (a,m)/var (m)
Beta (a) 0.1521
Standard Dev (a) 0.1346

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Indian Institute of Management Ahmedabad

Financial Markets | Fall 2021

- All Questions Must be Answered –

a. What was your originally scheduled EMI?

Principal $ 10.00 million

Time 60 months (5 years)

Orignal EMI $0.13

b. What is the increase in the outstanding balance during these 12 months?

Increase in outstanding balance =6.93 – 6.28 = 0.65 million

a. Your return expectation is based on historical data. What is present value of

b. What is the book value (per share) of the stock?

a. What is the correlation between any two different assets?

Correlation cov(x1,x2)/ (SDx1 * SDx2)

b. What is the standard deviation of an equally weighted portfolio?

Return on portfolio R(p) 15.0%

a. Which asset has a higher beta?

beta cov (p,m)/var(m)

beta (a) 50.00%

b. Which asset has a more volatile return?

c. What is the standard deviation of a 50:50 portfolio made of assets A and B?

correaltion (a,m) 0.4004

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