CMA MAY 2022 EXAMINATION

ADVANCED LEVEL I
CORPORATE FINANCIAL STRATEGY & FINANCIAL MARKET

Course Code : EF343 Total Marks : 100

Reading Time : 15 minutes Writing Time : 180 minutes

Instructions to Candidates
 You MUST NOT write anything during the reading time.
 There are 5 (five) questions.
 You should attempt ALL questions.
 Answers should be properly structured and relevant.
 Show all relevant computation.
 Carefully read ALL the requirements and sub-questions before attempting a specific
question.
 ALL answers must be written in the answer book.
 AVOID WRITING/MARKING on the question paper at any time which may cause
disciplinary action.
 Start answering each question from a fresh sheet.
 Answers should be clearly numbered with the sub-question number.

Allowable Materials
 Writing Stationaries
 Non-programmable Calculator

Assessment Structure

Sub- Expected Time

Marks
question Required
Question 1 Essay/Computational/Case 4 20 35 minutes
Question 2 Essay/Computational/Case - 20 35 minutes
Question 3 Essay/Computational/Case 3 20 35 minutes
Question 4 Essay/Computational/Case 4 20 35 minutes
Question 5 Essay/Computational/Case 4 20 35 minutes
Revision 5 minutes
Total 100 180 minutes

RESTRICTED USE
This paper MUST NOT BE REMOVED from the examination venue

Do not turn the page until instructed

QUESTION 1 [4 + 5 + 7 + 4 = 20] MARKS]
(a) Suppose there were call options and forward contracts available on coal, but no put
options. Show how a financial engineer could synthesize a put option using the
available contracts. What does your answer tell you about the general relationship
between puts, calls, and forwards?
(b) The net income of Novis Corporation is $85,000. The company has 25,000 outstanding
shares and a 100 percent payout policy. The expected value of the firm one year from
now is $1,725,000. The appropriate discount rate for the company is 12 percent, and
the dividend tax rate is zero.
(i) What is the current value of the firm assuming the current dividend has not yet
been paid?
(ii) What is the ex-dividend price of the company’s stock if the board follows its
current policy?
(c) You have been asked for advice in selecting a portfolio of assets and have been given
the following data:
Expected return
Year Asset A Asset B Asset C
2018 12% 16% 12%
2019 14% 14% 14%
2020 16% 12% 16%
You have been told that you can create two portfolios – one consisting of assets A and
B and the other consisting of assets A and C – by investing equal proportions (50%) in
each of the two component assets.
Required:
(i) What is the expected return for each asset over the 3-year period?
(ii) What is the standard deviation for each asset’s return?
(iii) What is the expected return for each of the two portfolios?
(iv) How would you characterize the correlations of returns of the two assets making
up each of the two portfolios identified in part (iii)?
(v) What is the standard deviation for each portfolio?
(vi) Which portfolio do you recommend? Why?
(d) The market portfolio has an expected return of 12 percent and a standard deviation of
22 percent. The risk-free rate is 5 percent.
Required:
(i) What is the expected return on a well-diversified portfolio with a standard
deviation of 9%?
(ii) What is the standard deviation of a well-diversified portfolio with an expected
return of 20%

QUESTION 2 [4 + 8 + 8 = 20 MARKS]
GG, a large engineering and project management group, has announced plans to sell its
wholly owned telecommunications subsidiary, BB, so that it can concentrate on its core
business of major infrastructure developments.
HH, an entity with diverse business interests, has expressed an interest in making a bid for BB, but
the directors of HH are aware that there are likely to be several other interested parties.
News of the possible sale has been well received in the financial markets and GG has seen
its share price rise by 15% in the last two months. HH expects to be able to use its good
reputation and strong market presence to enhance the prospects of BB by improving BB’s
annual earnings by 10% from the date of acquisition.

CMA May 2022 Examination, EF343 [Page 2 of 5]

Financial information as at today, 25 May 2022, ignoring any potential synergistic benefits
arising from the possible acquisition of BB by HH:
 Profit after tax for BB for the year ended 30 April 2022 is estimated as $1 million;
 BB’s profit after tax has increased by 7% each year in recent years and this trend is
expected to continue;
 The gearing level of BB can be assumed to be the same as for GG;
 The business tax rate is 30%;
 Estimated post-tax return on the market is 8% and the risk-free rate is 3% and these
rates are not expected to change in the foreseeable future;
 Assume a debt beta of zero;
HH GG Proxy entity for
BB in the same
industry
Number of ordinary shares in issue 8 million 4 million
Current share price 613 cents 800 cents
P/E ratios today 11 14 13
Dividend payout 40% 50% 50%
Equity beta 1.1 1.4 1.4
Gearing (debt: equity at market values) 1:2 1:2.5 1:4
Forecast earnings growth 5% 6%
Required:
(i) Calculate an appropriate cost of equity for BB based on the data provided for the
proxy entity.
(ii) Calculate a range of values for BB both before and after any potential synergistic
benefits to HH of the acquisition.
(iii) Discuss your results in (ii) and advise the directors of HH on a suitable initial cash
offer for BB.
QUESTION 3 [6 + 4 + 10 = 20 MARKS]
(a) Suppose a factor model is appropriate to describe the returns on a stock. The current
expected return on the stock is 10.5 percent. Information about those factors is
presented in the following chart:
Factor β Expected Value Actual Value
Growth in GNP 1.67 2.1% 2.6%
Inflation −1.09 4.3 4.8
(i) What is the systematic risk of the stock return?
(ii) The firm announced that its market share had unexpectedly increased from 11
percent to 15 percent. Investors know from past experience that the stock return
will increase by .58 percent for every 1 percent increase in its market share.
What is the unsystematic risk of the stock?
(iii) What is the total return on this stock?
(b) The net income of Lily Company Ltd. is Tk. 85,000. The company has 25,000
outstanding shares and a 100 percent payout policy. The expected value of the firm
one year from now is Tk. 1,725,000. The appropriate discount rate for Lily is 12 percent
and the dividend tax rate is zero.
(i) What is the current value of the firm assuming the current dividend has not yet
been paid?
(ii) What is the ex-dividend price of Lily’s stock if the board follows its current policy?

CMA May 2022 Examination, EF343 [Page 3 of 5]

(c) Dutch Ltd is a listed company that sells fashion clothes over the Internet. Financial
markets have criticized the company recently because of the high levels of debt that it
has maintained in its balance sheet.
The company’s debt consists of Tk. 150 million of 8% debentures that are due for
repayment by 31March 2025. Financial markets indicate it would not be possible to
issue a new loan under the same conditions. The market value of the debentures is Tk.
90 per Tk. 100 nominal.
Dutch Ltd’s draft balance sheet at 31 March 2021 was as follows:
Equity and Liability Tk. (ml) Assets Tk. (ml)
Ordinary shares of Tk. 1 100 Non-current assets 200
Reserves 20 Net current assets 70
8% debentures (at nominal value) 150
Total 270 Total 270
Fixed assets consist of Tk. 150 million of capitalized development costs and Tk. 50
million of land and buildings. The company’s share price has fallen consistently over
the past two years as follows:
Price per share
31 March 2019 Tk. 20
31 March 2020 Tk. 8
31 March 2021 Tk. 4

The company intends to make 1-for-2 rights issue at an issue price of Tk. 2.50 on 30
June 2021. It is assuming that the cum rights price at the issue date will be Tk. 4.
Immediately thereafter, all the proceeds will be used to redeem the debentures at
nominal value and thereby reduce its gearing.
Required:
(i) Calculate the gearing (that is, debt/equity) of Dutch Ltd at 31 March 2021 using
both book values and market values.
(ii) Calculate the gearing of Dutch Ltd in market value terms, immediately after the
rights issue and redemption of the debentures.
QUESTION 4 [4 x 5 = 20 MARKS]
(a) What is ICRR? What are the qualitative and quantitative indicators of ICRR?
(b) Distinguish between fixed price method and book-building method of issuing new
equity securities? Describe the relative merits and demerits of each method.
(c) What do you mean by pricing efficiency of the stock market? Trust Limited has
changed how it accounts for inventory. Taxes are unaffected, although the resulting
earnings report released this quarter is 20 percent higher than what it would have been
under the old accounting system. There is no other surprise in the earnings report, and
the change in the accounting treatment was publicly announced. If the market is
efficient, will the stock price be higher when the market learns that the reported
earnings are higher?
(d) A company has a large bond issue maturing in one year. When it matures, the
company will float a new issue. Current interest rates are attractive, and the company
is concerned that rates next year will be higher. What are some hedging strategies that
the company might use in this case?

CMA May 2022 Examination, EF343 [Page 4 of 5]

QUESTION 5 [4 + 6 + 5 + 5) = 20 MARKS]
(a) Suppose the market is semistrong form efficient. Can you expect to earn excess
returns if you make trades based on:
(i) Your broker’s information about record earnings for a stock?
(ii) Rumors about a merger of a firm?
(iii) Yesterday’s announcement of a successful new product test?

(b) Aerotech, an aerospace technology research firm, announced this morning that it has
hired the world’s most knowledgeable and prolific space researchers. Before today,
Aerotech’s stock had been selling for $100. Assume that no other information is
received over the next week and the stock market as a whole does not move.
(i) What do you expect will happen to Aerotech’s stock?
(ii) Consider the following scenarios:
(a) The stock price jumps to $118 on the day of the announcement. In
subsequent days it floats up to $123, then falls back to $116.
(b) The stock price jumps to $116 and remains at that level.
(c) The stock price gradually climbs to $116 over the next week.
Which scenario(s) indicate market efficiency? Which do not? Why?

(c) Who are financial intermediaries? Discuss the importance of financial intermediation for
the development of a resilient financial system of a country.
(d) What are the objectives of credit control by the central bank? Describe some
qualitative and quantitative credit control mechanisms used by Bangladesh Bank to
control supply of money in the market.

END OF QUESTION

CMA May 2022 Examination, EF343 [Page 5 of 5]