INVESTMENT THEORY & PRACTICE

Investment Theory & Practice Final Exams

Investment Theory & Practice Final Exams

Final Exam: Semester Two, 2009

Question No. 1

(i) Indifference curve and utility function

An indifference curve is the set of combinations of two goods, with which an individual gets the same level of utility, that is, given a certain level of consumption, the individual is indifferent to settle at any point. However, a utility function is a real function that measures the “satisfaction” or “utility” obtained by a consumer when enjoying via consumption of certain quantity of goods.

(ii) Private equity and venture capital

Private equity is the process of acquisition of shares in companies listed on a regulated public markets, with the intent to resell these shares in the future at a profit. In the form in which we know the market today, there are already more than 30 years. However, venture capital is one of the varieties of private equity, which is a policy of investing in companies in the early stages of development.

(iii) Strategic and tactical asset allocation

The strategic asset allocation shows the basic distribution of the assets to be invested in various asset classes that match the determined in advance investor profile in terms of investment objectives, investment horizon and risk class. However, tactical asset allocation is used to exploit opportunities in the short term within a selected asset class. Here, for example, will respond to opportunities as they arise within specific markets or sectors by overweighting this plant area (Groppelli and Ehsan, 2006).

Question No. 2

(a)

Equation of the iso-return line

If, Expected returns (R1) on Shares E = 0.15

Expected returns (R2) on Shares F = 0.08

then, the iso-expected return line is:

E [Rp] = W1 E [R1] + W2 E [R2]

Since W2 = 1 - W1, we can rewrite this equation as;

E [Rp] = W1 E [R1] + (1 - W1) E [R2]

E [0.2] = W1 E [0.15] + (1 - W1) E [0.08]

(b)

Gold Mining Industry

As it is known that traditionally gold is viewed as a hedge against inflation; for that reason, expansionary monetary policy may lead to increased inflation, and therefore could enhance the value of gold mining stocks.

Construction Industry

In view of construction industry, if the Reserve Bank of Australia adopt an expansionary monetary policy then it will lead to lower the interest rates which ought to stimulate housing demand. Therefore, the construction industry will get benefit.

(c)

Free cash flow that is cash flow before dividends and after current investments; free cash flow is one of the financial indicators showing how much cash the company is able to generate after deduction of the company to maintain and expand its base of assets. It is an important indicator for shareholders, because it shows the company's investment potential and the ability to pay dividends.

Free cash flow shows how much money is left for the dividends of shareholders and for a possible return of the debt financing. The extent of sustainable free cash flow is an indicator of financial institutions for the repayment ability of loans and is therefore often used as the ...