CONFIDENTIAL MAF653/OCTOBER2019

UNIVERSITI TEKNOLOGI MARA

TEST 1

COURSE : FINANCIAL MARKETS

COURSE CODE : MAF653
EXAMINATION : OCTOBER 2019
TIME : 1 HOUR 30 MINUTES

INSTRUCTIONS TO CANDIDATES

1. This question paper consists of THREE (3) questions.

2. Answer ALL questions. Start each answer on a new page.

3. Do not bring any material into the examination room unless permission is given by
the invigilator.

4. Answer ALL questions in English

CONFIDENTIAL MAF653/OCTOBER2019

Answer all questions.

QUESTION 1

A. Explain three (3) characteristics of financial markets.

(5 marks)

B. Explain briefly the differences between government securities, corporate debt

securities and corporate equity securities.
(5 marks)
(Total: 10 marks)

QUESTION 2

A. Briefly explain similarities and differences between Treynor Index, Sharpe Index and
Jensen Index.
(5 marks)

B. Sentiasa Padu Berhad is experiencing a period of gradual growth. The company is

expected to pay a dividend of RM1.20 in year 1. Dividend per share is expected to
grow at a rate of 3% during the next three years, 5% in the following year and at a
constant rate of 6% thereafter. The risk-free rate of return and the market return are
6% and 10% respectively. If the beta of the company’s stock is 2 times that of the
market, determine its intrinsic value.
(5 marks)

C. Cantik Berseri Berhad recently paid a dividend of RM2.10 per share. Yesterday’s
news reported that the Health Ministry has cautioned the public against buying and
using 10 cosmetics products which have been found to contain schedules poison.
One of the affected products is the product of Cantik Berseri Berhad. Due to that, it is
expected that their sales will significantly be reduced and therefore will give impact to
the dividend amount. The dividend is expected to decline by 10% next year and this
trend is expected to continue in the foreseeable future.

Required:

Suppose Cantik Berseri Berhad’s share is currently traded at RM10,

determine whether you should buy the stock if the required rate of return is
12%.
(5 marks)

D. Miss Aaira wishes to invest in shares and she is currently observing the performance
of Senyum Manis Berhad. The company’s recent annual report showed that the total
earnings after tax of Senyum Manis Berhad is RM5,500,000 and the company also
paid preference dividends of RM1,300,000. The value of ordinary shares issued and
subscribed for is RM2,500,000 in which the nominal value is RM2 each. The average
price earnings for the companies in the same industry are quoted at a ratio of 12 at
the time of valuation.

Required:

Advise Miss Aaira whether investing in Senyum Manis Berhad’s share is a

good decision if the share price is currently traded at RM36 per share.
(5 marks)
CONFIDENTIAL MAF653/OCTOBER2019

(Total: 20 marks)

QUESTION 3

A. In a repurchase agreement (repo), one party sells an asset (usually fixed-income

securities) to another party at one price and commits to repurchase the same or
another part of the same asset from the second party at a different price at a future
date or (in the case of an open repo) on demand. If the seller defaults during the life
of the repo, the buyer (as the new owner) can sell the asset to a third party to offset
his loss.

Required:

a) Discuss two (2) major reasons why companies with surplus cash prefer repo
to marketable securities.
(3 marks)

b) Briefly explain one (1) major difference between money market and bond
markets.
(2 marks)

B. A treasury bond has a coupon rate of 9%, a face value of RM1,000 and matures 10
years from today. For a treasury bond, the interest on the bond is paid in semi-annual
instalments. The current riskless interest rate is 12%.

Suppose an institutional investor from one investment bank purchase the treasury
bond described above and immediately thereafter the riskless interest rate falls 8%
and compounded semi-annually. Analyze whether it is worth to invest in treasury
bond if the bond currently sell at RM1,500 in the market.
(5 marks)

C. Kenanga Co is a listed company based in Kuala Lumpur. The company was formed
around 25 years ago and was initially involved in cybernetics, robotics and artificial
intelligence within the information technology industry.

Last 5 years, due to the risky ventures Kenanga Co undertook, its cash flows and
profits were varied and unstable. Hence, the BOD decided to consider the financial
reconstruction plan for company in financing a few new projects. The financial
reconstruction plan would involve raising RM1.32 billion new debt finance consisting
of bonds issued at their face value of RM2,000.

Following are issued bonds in the financial reconstruction that took place 5 years
ago:
Terms of
Kenanga CCC Kenanga X1 Kenanga BA3
issue
CONFIDENTIAL MAF653/OCTOBER2019

Rating (RAM) AA AAA AA

Coupon rate 10% 10% 0%

Maturity 10 years 10 years 20 years

Call features Freely callable Freely callable Non-callable

Conversion Non-convertible Non-convertible Non-convertible

Provision

Required:

a) In June last year, bond Kenanga BA3 facing a credit rating migration from AA
to BBB. As a finance director of Kenanga Co, discuss the possible reasons of
the credit rating changes for the bond Kenanga BA3 from rating AA to BBB.
(3 marks)

b) Encik Derahman is one of the bondholders for bond Kenanga X1. He plans to
sell the bond end of next year and he expected the market price for the bond
will be RM1,950 with the required rate of return,12%. Advice Encik Derahman
whether he should sell the bond or not.
(3 marks)

c) As a broker, you need to assist Puan Najihah in considering a long-term

investment in bond market and she is currently considering bond Kenanga
CCC. Advice Puan Najihah on the investment decision based on the yield or
amount of return that an investor realizes on a bond Kenanga CCC if the
selling price is RM2,200.
(4 marks)
(Total: 20 marks)

End of Questions
CONFIDENTIAL MAF653/OCTOBER2019

Suggested solution for test 1 MAF653 (Oct 2019)

QUESTION 1

A. Characteristic of financial markets

 Meeting different investors’ needs - Short-term, medium, and long-term

securities
 Providing source of finance - Governments, municipals, and private firms
 Allocation of financial resources - Higher production and economic growth
(3 points with explanation = 5 marks)

B. Differences between government securities, corporate debt securities and corporate

equity securities:

 Government securities: risk free securities, issuer is government.

 Corporate debt securities: high risk securities, issuer is a corporate entity,
bondholders have a priority over the claims of equity holders in the case of
bankruptcy.
 Corporate equity securities: high risk securities, issuer is a corporate entity,
(Explanation on differences = 5 marks)
(Total: 10 marks)

QUESTION 2

A. Similarities: all the three measures combine risk and return performance into a single
value. This makes it easier to compare the performance of competing portfolio. √

Differences:
Treynor = the focus of risk is on systematic risk instead of total risk. Use Beta to
represent the risk. √
Sharpe = the focus of risk is on systematic risk but use Standard Deviation to
represent the risk. √
Jensen = this measure is also known as alpha, whereby there is a need for
calculation of portfolio’s expected return. √
(4 √ x 1.25 marks = 5 marks)

B.

Required return = Rf + β (Rm – Rf) = 6% √+ 2 √ (10% √ - 6%) = 14 %

Year Dividend (RM) PVIF14%, n PV of Dividend

CONFIDENTIAL MAF653/OCTOBER2019

(RM)
1 1.20 √ 0.8772 √ 1.053
2 1.20(1+3%) = 1.236 √ 0.7695 0.951
3 1.236(1+3%) =1.273 0.6750 0.859
4 1.273(1+3%) =1.311 0.5921 0.776
5 1.311(1+5% √) =1.377 0.5194 0.715
P1=4.354
6 1.377√ (1+6%) √ / (14% - 6%) √ = 0.5194 P2=9.476
18.245
INTRINSIC VALUE RM 13.83
(10 √ x ½ mark = 5 marks)
C.
Do (1+g) / ke – g = 2.10 √ (1 – 0.10 √) / 0.12 √ + 0.10 √

= 1.89/ 0.22
= RM 8.59
(4 √ x ½ mark = 2 marks)

No, do not buy √ because the market price is overpriced √ (IV RM8.59 vs MV
RM10 √).
(3 √ x 1 mark = 3 marks)

D.
EPS = 5,500,000 √ – 1,300,000 √ = RM 3.36
1,250,000 √√

IV = PE x EPS
= 12 √ x RM 3.36 √
= RM 40.32 √

Yes, it is a good decision √ because the market price is underpriced √ (IV RM 40.32
vs MP 36 √).
(10 √ x ½ mark = 5 marks)
(Total: 20 marks)
QUESTION 3
A.
i. There are two major reasons why companies with surplus cash prefer repos to
marketable securities:

 The adjustable maturity provision embedded in repos. The original repos’

maturity period can be adjusted to suit the needs of investing companies.
Therefore, funds can be productively employed for a very short period of time.
 Repos are protected against price fluctuations throughout the contract period and
therefore any risk involved in the liquidation process is removed. Thus,
companies can invest any surplus cash for a few days. E.g. Mutual funds will buy
repos as a way to “park” excess cash flows for only very short periods.

(2 points x 1.5 marks = 3 marks)

ii. One major difference between money market and bond markets is maturity term of
their financial instruments. In money market, the financial instruments has less than
one year to mature, while in bond market the maturity period is more than one year.
√√
(2 √ x 1 mark = 2 marks)
CONFIDENTIAL MAF653/OCTOBER2019

(Other relevant answer can be accepted)

B. Maximum bond price, Bp = I (PVIFA I,n) + P (PVIF i,n)

= 90/2 (PVIFA 8%/2, 10X2) + 1,000 (PVIF8%/2, 10X2)
= 45 (PVIFA 4%,20) + 1,000 (PVIF4%,20)
= 45√√ (13.59) √ + 1,000√√ (0.4564) √
= RM1,067.95
(6√ x ½ mark = 3 marks)

It is not worth to invest√ in treasury bond now as the market overvalued√ RM1,500 vs
RM1,067.95.
(2√ x 1 mark = 2 marks)
C.
i. Possible reasons for the changes in the credit ratings:

Credit ratings assigned to companies and to borrowings made by companies by

credit rating companies depend on the probability of default and recovery rate.

A credit migration from A to BBB means that Kenanga Co has become riskier in
that it is more likely to default and bondholders will find it more difficult to recover
their entire loan if default does happen. √√

A credit rating company will consider a number of criteria when assigning a credit
rating, as these would give a more appropriate assessment of the probability of
default and the recovery rate. These criteria include, for example, the industry
within which the company operates, the company’s position within that industry,
the company’s ability to generate profits in proportion to the capital invested, the
amount of gearing, the quality of management and the amount of financial
flexibility the company possesses. √
(3√ x 1 mark = 3 marks)

ii. BPc = I (PVIFA12%, 4) + P (PVIF12%, 4 )

= 200 (3.0373) √√ + 2000 (0.6355) √√
= 607.46 + 1,271
= RM1,878.46

Yes √, the Encik Derahman should sell the bond next year because the market is
overvalued √ (RM1,950 vs RM1.878.46).
(6√ x ½ mark = 3 marks)
iii. Current Yeild = 200√/2200√ = 9.09%

Yield to maturity

YTM: TRY i at 8%

= 200 (PVIFA 8%, 5) + 2000 (PVIF 8%, 5) - RM2,200

= 200 (3.9927√) + 2000 (0.6806√) - RM2,200
= RM798.54 + RM1,361.20 – RM2,200
= RM - 40.26

YTM: TRY i at 7%

= 200 (PVIFA 7%, 5) + 2000 (PVIF 7%, 5) - RM2,200

= 200 (4.1002√) + 2000 (0.7130√) - RM2,200
= RM820.04 + RM1,426 – RM2,200
CONFIDENTIAL MAF653/OCTOBER2019

= RM 46.04

YTM = 7% + [(46.04 / 46.04 – (-40.26)] (8% - 7%)

= 7.53%√ OF

CY and YTM is lower than coupon rate, lower than coupon rate. Do not invest. √
(8√ x ½ mark = 4 marks)
(Total: 20 marks)