SET 1 DEC2019 MAF653

Suggested solution

Question 1

A. Dasuki

i)

Year Dividend PV 8% P. Value

D1 1.50(1.06)=1.59 0.926 1.472

D2 1.59(1.06)=1.685 0.857 1.444
D3 1.80 0.794 1.429
D4 1.85 0.735 1.360
D5 onwards P = D6/K 0.735 16.996
= 1.85/ 0.08
= 23.13
Maximum price is 22.70

ii)Dasuki should not recommend his clients to buy the share, because the market is
overpriced.

iii)Factors that affect selling or buying of stocks:

 Earning announcements
 Industry performance
 Dividend
 Stock splits
 Share buy-back
 Product innovation
 Takeover and merger
 Insider trading
 Analyst upgrade/ downgrade
 New major contracts or major government orders

B. Akram

Umie Best Berhad

D o (1+ g ) 2.30(1.05)
Vo = = = RM48.30
k −g (0.10−0.05)

Abi Best Berhad

D 1.50
Vo = = = RM15
k 0.10

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From the calculation, stock for Umie Best Berhad is undervalued and stock for Abi Best
Berhad is overvalued . Thus Akram should buy stock from Umie Best Berhad.

C. Treynor and Sharpe indexes

i) Ranking

Portfolios Treynor Sharpe

Portfolio A 18.10-8 / 0.9 = 11.22 (1st) 18.10 -8 / 13.4 = 0.75 (2nd)
Portfolio B 18.60-8 / 1.5 = 7.06 (3rd) 18.60-8 / 21.7 = 0.49 (3rd)
nd
Portfolio C 22.20-8 / 1.3 = 10.92 (2 ) 22.20-8 / 17.3 = 0.82 (1st)
ii) Treynor Index used beta of portfolio in order to assess the performance of
portfolio which focus on systematic risk instead of total risk. Portfolio with higher
total risk is less diversified and therefore has a higher unsystematic risk which is
not priced in the market . While, Sharpe Index used standard deviation of the
portfolio instead of considering only the systematic risk .

Question 2

A.
i. Value of straight bond = 50X PVIFA 8%, 7 + 1000 X PVIF 8%, 7
= 50 (5.2064) + 1000(0.5835)
= 260.32 + 583.5
= RM843.82

ii. If bond is called at yr 6

= 50X PVIFA 8%, 4 + [(1000 + (40+40)] X PVIF 8%, 4

= 50 (3.3121) + 1080(0.7350)

= 165.61 + 793.80
= 959.41

iii. Bonds with call provisions carry call risk to bondholders. It means that issuers have
the rights to call the bonds prior to maturity date by paying a call premium over the par
value.

In case of market interest rate fall below the coupon rate, issuers will take advantage of
the situation and often call the bonds once they become callable and often create a new
issue of bond at a lower rate.

B.

Assuming that the price of the bond is equal, Quantum Bhd’s bond has the highest yield to
maturity. This is because it has the lowest credit ratings, which implies a higher default risk.
Higher risks give higher return.

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Assuming that the yield to maturity is equal, Freeland Bhd’s bond has highest expected price.
This is because it has the highest credit ratings and lowest coupon payment. It implies that the
company has strong capacity to meet its financial obligations and deliver a steady stream of
interest income. Thus a bondholder is willing to pay higher price for the bonds.

C.

i) Years left to maturity = 20Y– 12Y = 8 Y

Year CF (RM) AF/DF @ 8% PV

1-16 4 8.8514 35.40
16 100 0.2919 29.19
IV= 64.59
ii) Conversion price 5% x RM100 = RM5
Conversion ratio RM100/RM5 = 20 shares
Market price 80% x RM5 = RM4
Conversion Value = RM4 x 20 = RM 80
Bond holder will incur a loss of RM 2 (82-80) . Do not convert the bond.

Question 3

A.

i. Position in August Position in October Revenues/(Cost)

Cash The current market Buy 650 metric tons

market price of the palm oil is at RM 2,750.
RM2,620
= 650 x RM2,750
The refiner needs 650
metric tons of crude =RM 1,787,500
palm oil in October. =(RM 1,787,500)
Future Buy 26 August crude Close position by Net profit from futures
market palm oil futures selling futures at transaction:
contracts at RM 2,650. RM2,750
=1,787,500 -1,722,500
= 26 x 25 x RM 2,650 = 26 x 25 x RM 2,750
=RM65,000
=RM 1,722,500 =RM 1,787,500
Total cost for the transaction = (-1,787,500) +65,000

= (RM 1,722,500)

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ii. Effective cost per metric ton =(RM1,722,500)

650

=RM2650

iii.
Future Buy 26 October crude Close position by Net profit/(loss) from
market palm oil futures selling futures at
contracts at RM 2,650. RM2,500 futures transaction:

= 26 x 25 x RM 2,650 = 26 x 25 x RM 2,500 =1,625,000 -1,722,500

=RM 1,722,500 =RM 1,625,000 =(RM97,500)

No, he will not benefit from the hedging. He will incur a loss of RM 97,500.

B. i)

F = 2,775(1+ 0.05 + 0.02162) 0.1644

= 2,775 (1.011436703)
= 2,806.74

ii) Sell in Future markets, Buy in Cash markets. Overpriced

RM
Cost of purchase 2,775
Storage cost (RM5 x 2 months) 10
2,785
Sale of futures 2,835
Net gain 50

iii) Reasons:
 Market imbalance; where there are more sellers than buyers and vice
versa.
 High transaction costs deter arbitrageurs from entering the market to
restore equilibrium.
 Inefficiencies in the cash market; futures market tend to be more efficient
than cash markets.

iv) Contango: when future price is higher than spot price. Shortage in supply or an
increase in demand in the futures.

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Backwardation: when future price is lower than spot price. Increase in supply or a
shortage in demand in the futures.

Question 4

A.

i) Profit = RM58 – (RM52+RM5) = RM1

ii) a) No , the change in stock price has a negative relation with put option.
b) Yes, an increase in volatility would also increases both call and put option
value.

iii) Call option: right to buy at whatever amount of the underlying security especially when
the underlying price is increasing.

Put option: right to sell at whatever amount of underlying security especially when the
underlying price is decreasing.

B.
i)

Fixed rate Floating rate

APM Bhd 9% KLIBOR + 0.5%
Bella Bhd 11% KLIBOR + 1%
Spread 2% 0.5%

APM Bhd Bella Bhd

Cost of borrowing directly KLIBOR + 0.5% 11%

Cost of borrowing with IRS KLIBOR + 1% 9%

Gain / (Loss) (0.5%) 2%

Transfer of loss 0.5% (0.5%)

Net 0 1.5%

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Less: Payable to Eximbank (0.25)

Net gain 1.25%

Sharing gain 1.25÷2 = 0.625 0.625

After the swap, each firm will end up with:

APM Bhd (Floating rate) : KLIBOR + 0.5% - 0.625% = KLIBOR - 0.125.

Bella Bhd (Fixed rate) : 11% - 0.625% = 10.375%.

ii) Purposes of swaps:

i. Used as a tool to better manage company’s assets and liabilities.
ii. Reduce exposure to changes in the interest rates on a particular transaction.
iii. Lower the net expected costs of borrowing with respect to bonds.
iv. Achieve more flexibility in meeting the overall financial objectives.
v. Obtain customized cash flows to match the required payment obligations.

Question 5
A. Islamic money market
- Financial instruments were traded based on shariah principle
- Short term investment
- More liquid investment

B. Two qualities of shariah compliance are:

- No unfair transaction should take place and all participants are treated fairly in their
business dealings.
- The transactions must be supported by an underlying business activity, which means
setting higher standards for investment and ensures greater accountability and risk
mitigation.

C. The musharakah contract requires that all parties provide capital required by the
business project . It also allows all parties to be involved in the management based on
mutual consent . Partners may choose to be sleeping partners or not participate at all in
the management. Any profit will be shared according to pre-agreed profit sharing ratio
and losses will be shared in accordance with percentage of capital contribution.

D. Syariah principle described in the situation is Uncertainty (Gharar).Any uncertainty in

Islamic finance is not permissible to be part of an agreement as it will make the whole
agreement invalid. Islamic finance should be free from Gharar because it might lead to
disputes caused by an unjustified term in the contract arising from misrepresentation and
fraud.

END OF SOLUTION

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SET 1 DEC2019 MAF653