FINM7403 Portfolio Management Semester 1, 2022
Hello, dear friend, you can consult us at any time if you have any questions, add WeChat: daixieit
FINM7403
Portfolio Management
Semester 1, 2022
Problem 1 (20 marks)
Your investment screen helps you identify Gear Stop as a potential stock to add to your portfolio. The firm’s free cash flows to firm (FCFF) are shown below:
|
Year |
0 |
1 |
2 |
3 |
4 |
|
FCFF (in $mil) |
12 |
14 |
15 |
16 |
17 |
After year 4, the FCFF is expected to grow at 4% indefinitely. Further information from recent financial statements are shown below:
|
Earnings before interests and taxes (EBIT) |
$30 mil |
|
Cash |
$10 mil |
|
Interest Expenses1 |
$6 mil |
|
Capital Expenditure |
$10 mil |
|
Total Debt |
$30 mil |
|
Total Equity |
$70 mil |
|
Total Asset |
$100 mil |
|
Tax rate |
30% |
The firm issued $30 mil 20-year fixed-rate annual coupon debt at par three years ago. You rely on Moody’s, a credit rating agency, to update the firm’s debt financing conditions including the current cost of debt. Moody’s recently published the financial metrics associated with their credit ratings:
|
|
Aa |
Baa |
Ba |
B |
C |
|
EBIT/Total Asset (%) |
40 |
30 |
20 |
10 |
5 and below |
|
Interest coverage ratio (EBIT/Interest Expenses) |
8 |
5 |
4 |
2 |
0.5 and below |
|
Book Value of Debt/Market Value of Equity (%) |
20 |
50 |
100 |
200 |
500 and above |
|
Credit risk premium2 (%) |
0 |
1 |
2 |
4 |
10 |
You use the current 10-year Treasury yield of 3% to proxy for the risk-free rate. The current share price is $18. The firm has 10 million shares outstanding. The stock market risk premium is 6%. The firm’s equity beta is 1.5.
A. What is the firm’s current weighed average cost of capital (WACC)? Hint: You need to use current market values of equity and debt. (12 marks)
B. What is the firm’s equity value implied by the discounted Free Cash Flows model? Will you buy the share? (8 marks)
Problem 2 (22 marks)
You are a fixed income manager in a large superannuation fund. Your institution is holding the following Australian Government bonds on 12th May 2022:
|
Maturity Date |
Coupon rate (%) |
Price (mil) |
Face Value (mil) |
Coupon Frequency |
|
12/05/2023 |
3.5 |
$97.62 |
$100.00 |
Annual |
|
12/05/2024 |
5 |
$94.53 |
$100.00 |
Annual |
|
12/05/2025 |
5.5 |
$90.94 |
$100.00 |
Annual |
|
12/05/2026 |
6.5 |
$88.77 |
$100.00 |
Annual |
The bonds have just paid their 2022 coupons.
A. Using Excel Solver to construct the pure yield curve from the risk-free Australian Government bond information in the table above. Hint: You are required to calculate four yield values. (10 marks)
The institution aims to immunise a liability of $100 million with a target duration of 8 years, using two securities: (1) the coupon bond maturing on 12/5/2026; and, (2) a perpetuity with a yield of 6%.
B. How much of the coupon bond and the perpetuity will you hold in your portfolio? (5 marks)
C. Three years later, the yield curve remains unchanged. Is your portfolio still immunised? Explain. Hint: You don’t need to do any calculations here. (3 marks)
The institution recently considers a risky investment which generates $10mil every year, starting from 12/5/2023 for the next 4 years. The investment costs $33mil today. Your credit model assigns the investment cash flows a constant risk premium of 2% on top of the (risk-free rate) pure yield curve across maturities.
D. What is the net present value of the risky investment? Will you invest? (4 marks)
Problem 3 (13 marks)
UQEF is responsible for managing the University endowment fund. The actively managed Fund invests broadly in three asset classes: Australian domestic equities, international equities, and cash. The Fund is benchmarked against the International Balanced Index (IBI).
Use information in the table below about UQEF and IBI’s fund allocations and asset class returns for
the most recent year to answer the two questions followed.
|
|
UQEF |
IBI |
||
|
|
Fund allocation |
Return on each asset class |
Fund allocation |
Return on each asset class |
|
Domestic equities |
30% |
10% |
35% |
12% |
|
International equities |
60% |
15% |
55% |
20% |
|
Cash |
10% |
0.25% |
10% |
0.25% |
|
Total: |
100% |
|
100% |
|
A. How has UQEF performed relative to IBI during the year? (5 marks)
B. Discuss the strengths and weaknesses of UQEF in terms of asset allocation and selection. You discussion should be supported by its recent performance. (8 marks)
security
Problem 4 (15 marks)
You manage an existing large portfolio for high net-worth clients. In the current high inflationary environment you believe that quality and value strategies are desirable investments. Your quantitative screen identifies two potential factor funds: Vanguard ETF (VVV) and Blackrock’s ishares Factor ETF (QQQ). The information about the two funds are provided below. Multi-factor regression model estimates are based on monthly excess returns and shown below:
|
|
VVV |
QQQ |
|
Standard deviation of excess returns |
0.06 |
0.03 |
|
Residual standard deviation |
0.05 |
0.02 |
|
Multi-factor model regression |
0.01 +0.32 × MRP − 0.33 × SMB +0.21 × HML + 0.43 × QMJ |
0.02 0.34 × MRP −0.03 × SMB +0.07 × HML +0.24 × QMJ |
|
R2 |
50% |
30% |
2022-07-15