Directions: Read and understand the Problem/case/scenario ,usethe given information to provide your answer.
Part1.ComputationalAnalysisUsing the providedFinancial Informations, provide what is asked.
1.VisionInvest, a financial advisory firm in Bahrain, is preparing investment recommendations for three clients each with different risk preferences:
A risk-averse investor who prioritizes stability and security.
A risk-taker who seeks high potential returns despite volatility.
A risk-indifferent investor who values only expected return, not risk.
The firm has identified two possible portfolios based on their risk levels (Beta) and market information
|
Portfolio |
Beta () |
Risk-Free Rate (%) |
Market Return (%) |
|
A |
0.8 |
4 |
10 |
|
B |
1.4 |
4 |
10 |
Questions
1. Calculate the required rate of return for both portfolios using the Capital Asset Pricing Model (CAPM)(10 marks)
2. Based on the CAPM results and the beta values, recommend which portfolio each of the following investors would prefer:
(a) Risk-Averse Investor
(b) Risk-Taker Investor
(c)Risk-IndifferentInvestorProvide justification for each choice.(5 marks)
3. Explain how investor risk attitudes influence portfolio decision-making.
Discuss how the relationship between risk, return, and required rate of return helps in forming investment strategies.
(10 marks)
Rubric (Marking Guide)
|
Criteria |
Excellent (Full Marks) |
Satisfactory (Half Marks) |
Needs Improvement (Low Marks) |
|
Q1: CAPM Calculation (10 marks) |
Correct use of CAPM, accurate rates for both portfolios, and clear presentation of workings. |
Minor calculation or rounding errors but correct approach. |
Incorrect formula or unclear working. |
|
Q2: Application to Risk Types (5 marks) |
Logical and well-justified portfolio recommendation for all three investor types. |
Basic or incomplete reasoning for investor preferences. |
Incorrect or unsupported reasoning. |
|
Q3: Essay on Risk Attitude (10 marks) |
Well-structured, analytical essay linking CAPM results and investor behavior. |
General discussion with limited linkage to theory. |
Weak, unrelated, or incomplete explanation. |
2. Case Study: When AAA Became Junk Ethics, Ratings, and the 2008 Financial Crisis
Case Background
Case Study: Trust Ratings or Trust Judgment?
In the aftermath of the 2008 global financial crisis, financial markets across the world have become more cautious, but some of the same patterns are beginning to reappear.
Falcon Capital, a Bahraini investment firm, plans to expand into international markets by investing in U.S. corporate bonds. The firms analysts rely heavily on ratings provided by well-known Credit Rating Agencies (CRAs) like Moodys and S&P.
Recently, Falcon Capitals research team discovered that some bonds rated as A by these CRAs had begun to default due to the issuing companies weak financial positions. Many of these bonds were backed by risky loans and aggressive financial structures similar to the Mortgage-Backed Securities (MBS) and Collateralized Debt Obligations (CDOs) that triggered the 2008 crisis.
Senior management is now divided. Some executives believe that ratings from international agencies are still the best available benchmark for investment decisions. Others argue that depending solely on CRAs without independent analysis could expose Falcon Capital to major financial and ethical risks.
The firm is seeking your advice as a financial consultant to ensure that its investment practices are both financially sound and ethically responsible.
1. Understanding the Risk (2.5 Marks)
Based on the lessons from the 2008 financial crisis, explain how overreliance on Credit Rating Agencies can expose investors like Falcon Capital to financial risk.
2. Ethical Consideration (2.5 Marks)
In your opinion, did Credit Rating Agencies act unethically during the 2008 crisis? Support your answer with relevant ethical reasoning.
3. Strategic Decision-Making (5 Marks)
If you were the financial consultant for Falcon Capital, suggest five key actions the firm should take to reduce the risk of misleading ratings and ensure ethical investment practices.
3. Desert Tech Solutions Project Oasis
Desert Tech Solutions, a mid-sized technology and infrastructure firm based in Bahrain, is evaluating an investment opportunity called Project Oasisa solar-powered water purification system aimed at remote desert communities. The project aligns with the firms sustainability goals and is expected to enhance long-term profitability.
The initial investment cost of the project is BD 60,000. The equipment has a useful life of 6 years
The companys required rate of return (cost of capital) is 10%, and it accepts projects with a payback period of up to 4 years.
The projects forecasted cash inflows (before depreciation) over six years are as follows:
|
Year |
Expected Cash Inflow (BD) |
|
1 |
10,000 |
|
2 |
12,000 |
|
3 |
14,000 |
|
4 |
15,000 |
|
5 |
11,000 |
|
6 |
9,000 |
Required:
1. Calculate the Payback Period for Project Oasis and state its acceptability and conditions.(7Marks)
2. Estimate the Internal Rate of Return (IRR) by using interpolation between two close discount rates.(5 marks)
3. Based on your findings from Payback, NPV, and IRR, provide a recommendation to the companys investment committee. Should Desert Tech Solutions proceed with Project Oasis? Why or why not?(5 marks)
4. Critically evaluate the drawbacks of using only Payback Period as a capital budgeting tool. Discuss how inclusion of time value of moneyand strategic alignment in NPV or IRR improves investment decisions.(5 marks)
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