Download FINANCIAL MARKE TS SOLUTIONS MA Y 2010

FINANCIAL MARKETS I MAY 2010
SUGGESTED SOLUTIONS
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a. Inflation is measured by grouping all goods and services into a single
price index
b. Demand Pull inflation: it occurs when the economy is buoyant
and there is a high aggregate demand which is in excess of the
economy’s ability to supply.
Because: i. aggregate demand exceeds supply, price will rise
ii. since supply needs to be raised to meet the high demand
there will be an increase in demand for factors of production
and so factor rewards (wages, interest rates) will also rise.
c. CPI is based on the chosen basket of items which consumers purchase.
A weighting is decided for each according to the average spending on
the item by the consumers.
RPI is intended to measure the change from month to month in the cost
of goods and services of the sort bought by a typical household. The
relative importance attached to each various goods and services is
revised each year using latest available results of the family expenditure.
d. i. Expected return from equity Investment = 11.00%
Dividend paid
= k0.15
Market value per share = Dividend paid
Expected return
= 0.15/11.00%
= K1.46
ii. Require return = 9.00%
Dividend paid = K0.15
Therefore Market value = K0.15/9.00%
= K1.67
2. A. i. Debenture: is a fixed interest bearing security issued by a company. It
represents a promise by the issuer to pay interest as specified and repay the
nominal value at the maturity. (2 marks)
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ii. Convertible bond is a bond which can be converted into shares of
common stock. This feature permits bondholders to share in the firm’s good
fortunes if the stock price rises. (2 marks)
iii. Over-the-counter is a non regulated market in which listed companies
can sell its shares. This market is not organized in the sense of having a
building where trading takes place. (2 marks)
iv. Rights issue: when a listed company wants to raise capital it might wish
to offer additional shares to its existing shareholders at a discount (2 marks)
v. Bankers acceptance is an order to pay a specified amount of money to
the bearer on a given date. They are used to finance goods that have not yet
been transferred from the seller to the buyer. (2 marks)
b. the investor will do the following:
I. Fill the Reserve bank of Malawi bid form with the necessary
information
II. Face value and the bid price, i.e. MK1, 050,000.00 as face value with
its bid price of say 97.0254. Face value is the maturity value that
RBM will credit back into the account from which it collected the
funds.
III. Send the bid form to RBM through fax.
(1, 000,000.00 x 25/100x91/365) = interest for 91 days
Face Value = principal + Interest earned from the stated period
= K1, 000,000.00+ (1, 000,000.00 x 25/100x91/365)
= K1, 062,328.77
(5 marks)
3 a.Households are the net saver and thus the net provider of loanable or
investment fund to the other sectors. Households deposit their savings to a
financial institution. In the case whereby an individual needs some funds
s/he can obtain a loan facility from a financial institution of which inturn he
will pay interest on top of the loan principal.
Since businesses need vast capital they borrow from financial institution in
order to raise the required capital. Also, they offer their shares to the public
so that they raise capital (Initial Public Offering). If shares are bought by
investors i.e. households inturn they receive dividends.
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Government borrows from a financial sector. They also impose tax on
businesses thus collecting more revenue. Individual investors also pay tax
inform of Withholding Tax, Pay As You Earn (PAYE) and many more
forms of taxation. Businesses earn profits and hence pay provisional tax to
government, pay dividends to investors, bond interest etc.
(8 marks)
b.Risk transformer: instead of an individual lending directly to a business a
bank creates a deposit or current account with relatively low risk for the
investor’s savings. Lending directly to the firm the saver would demand
compensation for the probability of default on the loan and therefore the
business would have to pay a very high interest which would inhibit
investment.
Volume transformer: many institutions gather small amounts of money
from numerous savers and repackage these sums into larger units/ bundles
for investment in the business sector. It is uneconomical for an investor with
K100.00 per month who wants to invest in shares to buy small quantities
periodically. Unit trusts gather together hundreds of individuals’ monthly
savings and invest in a broad range of shares, thereby exploiting economies
of transactional costs.
(4 marks)
c. Broker: an intermediary (go between), someone who marches up a
provider of finance with a user of funds. It is useful for reducing the search
costs for both parties. Examples of brokers are; stockbrokers Malawi Ltd,
CDH stockbrokers, FDH stockbrokers, African Alliance Ltd.
A broker makes it easy for investors wanting to buy shares in a newly
floated company. They also have skills in collecting information on a firm
and monitoring its activities, saving the investor time. They also act as
middle men when the investor wishes to sell shares. (3 marks)
4 a. Value of share = Dividend per share paid
(Rate of return – div growth)
=
0.97
.
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(0.175 – 0.10)
= K12.93
b.
i. DPS 1 = DPS o (1 + g)
= 0.97 x (1.0.10)
ii. Value of share = DPS o (1 + g)
(r – g)
= 97 x (1 + 0.10)
(0.175 – 0.10)
= K14.23
(1 Mark)
(2 Marks)
(1 mark)
b. Types of preference shares
Cumulative: dividend is cumulative if the company does not earn sufficient
profit to pay the dividend i.e. if a dividend is not paid in one year it will be
carried forward to successive years.
Non Cumulative: it the company is unable to pay the dividend on preference
shares because of insufficient profits, the dividend is not accumulated.
Preference shares are cumulative unless expressly stated otherwise.
Participating: participating preference shares, in addition to their fixed
dividend, share in the profits of a company at a certain rate.
Convertible: apart from earning a fixed dividend, convertible preference shares
can be converted into ordinary shares on specified terms.
Redeemable: redeemable preference shares can be redeemed at the option of the
company eiher at a fixed rate on a specified date or over a certain period of
time.
5 a. spot rateis a rate quoted immediately while a forward rate is a spot price
ruling
on the day a forward exchange contract is made (2 marks)
b. for i,ii,and iii a customer buys while the bank sells
I.
US $ 1 month
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Spot rate
Less: Premium (1 month)
1.5200
(0.0032)
1.5168 .
Currency required by customer = $14, 000.00
Cost in Sterling = 14,000 / 1.5168
= ₤9, 229.96
II. Spot rate = 1.8630
Currency required by customer = Can $25, 000.00
Cost in Sterling = 25,000 / 1.8630
= ₤13, 419.22
III. Spot rate
= 72.20
Add:discount = 0.45
72.65
Currency required by customer = Belg Fr 75, 000.00
Cost in Sterling = 75, 000 / 72.65
= ₤1, 032.32
IV, V and VI the customer sells and the bank buys
IV.
Guilder 1 month
Spot rate
Less: Premium
4.06 ¼
0.01 7/8
4.04 3/8
Currency for sell by customer = Guilders 28, 000
Value in Sterling
= 28,000 / 4.04 3/8
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= ₤6,924.27
V.
Kroner 3 months forward
Spot rate
= 13.02
Add: discount bank’s buying rate = 0.19 ¾ .
13.21 ¾
Currency for sell by customer
= Kroner 20,000
Value in sterling
= 20,000 / 13.21 ¾
= ₤1,513.15
VI.
DM 1 month forward
Spot rate
Less: premium
= 3.07 ½
= 0.01 ½
3.06 .
Currency for sell by customer
= DM 6, 000.00
Value of sterling
= 6, 000 / 3.06
= ₤1,960.78
6 a. capital market also known as Equity capital Market (ECM) is a market that
exists between companies and financial institutions that is used to raise equity
capital for companies. (2 marks)
MSE is important to both listed and unlisted companies in Malawi.
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it regulates the equity market
it conducts trading sessions on the dealing table daily at
11.00am
it provides a fair dealing groundto all brokers registered
with it
it helps in disseminating trading results into the market
it helps not-listed companies to get listed through an IPO
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it gives public awareness in share investments
(8 marks)
b. Criteria to be satisfied
I.
II.
III.
IV.
a subscribed capital of atleast K100million
not less than 30,000,000 equity shares in issue
a satisfactory profit history for the proceding three financial years
25% of each class of equity shares be held by the public unless
otherwise agreed with the committee
V. The number of public shareholders of listed securities shall be atleast
300 for the equity shares, 25 preference shares and 10 for debentures
VI. The minimum initial price of securities shall not be less than 100
tambala per security unless agreed with the committee.
(10 marks)
7 a. In April 2009 the share price was at K6.00. By the end of the year,
December 2009 the share price moved upwards i.e. to K7.00. This represents an
increase in the share price of K1.00 per share. The difference between the two
prices with the date ranges referred to is called Capital gain.
Contrary to the above, where in December 2009 the share price was K7.00 and
as of April 2010 the price moved downwards to K5.00 per share it is called
Capital Loss. The share price has lost K2.00 per share. As of April 2009 the
share price was K6.00 while April 2010 the price fell to K5.00 , representing
K1.00 below, which symbolizes that more difficult times have been experienced
by the company. This can be due to many factors such as global crisis (global
melt down), interest rate fluctuation, inflation, exchange rate fluctuations etc.
Observation: marks shall also be awarded accordingly to any student who gives
an answer which best describes what the market forces of demand and supply
for shares comes into effect since availability and no availability of shares have
an influence on the share price. For instance if shares are readily available and in
large quantities but few takers/buyers then prices fall and the opposite is true.
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b. i. To shareholders
Shareholders will always love to see their portfolio increase in value with help
of capital gains, i.e. from K6.00 to K7.00.Investors will always smile and hence
keep the shares / hold on to their shares.
On the contrary if the share price has fallen investors will tend to get rid of their
holding ASAP, i.e. sell off their shareholding in order to reduce the likely
anticipated loss in future.
In addition, any arguments to do with supply and demand can be considered as
solutions,marks can be awarded.
ii. to the company’s performance
Any share price movement will have no any direct effect on the performance of
the company because company’s performance is independent of its share
performance at the stock market (3 marks)
d.
Profit for the company = MK8million
Dividend policy = 50% = 50% x MK8m
= MK4M
No. of ordinary shares = 4, 000,000 shares
Dividend per share
= MK4M / 4 million
= MK1.00 per share
8 a. Currency depreciation is the decrease in the value of the local currency
against other nation’s currencies.
Currency appreciation is the increase in value of the local currency against the
other nation’s currency
If the exchange rate for the $1.00 against the Malawi Kwacha (MK) is
MK142.00 (as of January 28th 2010) and come May 28th 2010 the exchange rate
for the US $ 1.00 against the Mw Kwacha is MK145.00 then in this case the
Mw currency has depreciated. It takes one to cough K145.00 to purchase a
single dollar than the MK142.00.
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If the exchange rate for the US$1.00 against the MW Kwacha is MK145.00 (as
of 28th January 2010) and on May 28th 2010 the exchange rate for the US$1.00
against MW kwacha is MK142.00 then in this case the Mw currency has
appreciated in value. You only pay MK142.00 for a single dollar.
b. cross rate is a bilateral exchange rate calculated from two bilateral exchange
rates
Pound-dollar cross
= Mk x 230 x GBP
Mk x 140 x US$
= 1.6197
Dollar-pound cross
= 1 / 1.6197
= US$0.6174 / GBP
C.
Investors:- if an investor wants to invest in machinery which Mw is not able to
produce,i.e. Ice plant, s/he will be forced to buy it from abroad (import) and
hence need for forex.
Traders:- a lot of goods are not produced locally and hence imports drain foreign
currency hence demand for currency
Students:- foreign examining bodies such as ACCA, CIMA, SAIFM, ABMA are
paid in US$ & Pounds hence students acquiring knowledge from these bodies
seek forex in order to pay for examination fees, subscription fees and many
more expenses as may be required from time to time.
ii. The interaction between the demand for the currency and the supply of the
currency determines the currency’s market value if the exchange rate is free to
change then the currency’s value adjusts to its equilibrium through the market
clearing process.
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