INSTITUTE OF ACTUARIES OF INDIA
EXAMINATIONS
14th May 2015
Subject ST5 - Finance and Investment A
Time allowed: Three hours (14.45* – 18.00 Hrs.)
Total Marks: 100
INSTRUCTIONS TO THE CANDIDATES
1. Please read the instructions on the front page of answer booklet and
instructions to examinees sent along with hall ticket carefully and follow
without exception.
2. * You have 15 minutes at the start of the examination in which you are
required to read the questions. You are strongly encouraged to use this
time for reading only, but notes may be made. You then have three hours
to complete the paper.
3. You must not start writing your answers in the answer sheet until
instructed to do so by the supervisor.
4. The answers are not expected to be any country or jurisdiction specific.
However, if Examples/illustrations are required for any answer, the
country or jurisdiction from which they are drawn should be mentioned.
5. Attempt all questions, beginning your answer to each question on a
separate sheet.
6. Mark allocations are shown in brackets.
7. Please check if you have received complete Question Paper and no page
is missing. If so, kindly get new set of Question Paper from the
Invigilator.
AT THE END OF THE EXAMINATION
Please return your answer book and this question paper to the supervisor separately.
IAI ST5 - 0515
Q. 1) There are three swaptions available in the market with identical characteristics except
that first is an American swaption, the second is a European swaption while the third is
a Bermudan swaption. Their latest quotes (Last Traded Price) as seen on Bloomberg
are as follows
American swaption Rs 40,
European swaption Rs 30
Bermudan swaption Rs 50.
i) What is a Bermudan Swaption? (1)
ii) Comment whether the prices of the options look sensible or not. (2)
iii) Define Arbitrage. (1)
iv) Assuming that the American swaption is priced correctly, discuss whether there
is any arbitrage opportunity available here. (3)
[7]
Q. 2) The NSE NIFTY has seen a lot of upswing and downswing for the past few months.
You have joined as the Chief Investment Officer of a large life insurance company
managing a portfolio comprising 75% Equities, 15% bonds and remaining cash. The
equity portfolio has a beta of 0.98. The CEO of the Company expects the equity market
to continue with the large movements but is uncertain of the direction.
i) Assuming no regulatory restrictions on investment asset types, suggest a couple
of investment strategies that the Company can adopt to make profit from the
expected market movements. Support your answer with a diagram wherever (6)
applicable.
ii) The Appointed Actuary of the Company has advised the Board that the asset mix
of the company’s fund is inappropriately biased towards equities and the bond
exposure is required to be increased. Suggest some reasons why the Appointed
Actuary might have given such advice? (3)
iii) You are inclined towards using swaps to achieve this objective instead of cash
market transactions. Discuss the advantages and disadvantages of using swaps
instead of cash market transactions to change the asset mix of a fund portfolio. (5)
[14]
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IAI ST5 - 0515
Q. 3) You are the CEO of ABC Bank and have received the following proposal from a non-
life insurance Company’s CEO.
“We understand that ABC Bank wishes to become a distribution partner of our
insurance company’s home insurance policies and would also like to become a
shareholder in our Company. In this respect, we would like to offer you a 5%
shareholding (2 Cr shares) in our Company at Rs 10 per share. After five years, you can
continue being a shareholder or you can divest your stake back to us at Rs 25 per share
or the market value of the shares at that time. I expect my Company’s valuation to grow
at 15% pa in the future which is double than what you are earning by keeping your
surplus money in government securities.”
The market value of the insurance company currently is Rs 500 Cr. Recent data
suggests that the volatility of its share price has been 30%.
i) Evaluate the expected value of offering this deal for the insurance company. Why
do you think the Company set the buy-back price at Rs 25? (8)
ii) If you wanted to negotiate with the Company, what are the possible avenues that
you would consider? (2)
[10]
Q. 4) i) What is put-call parity? Derive the put-call parity relationship explaining each
step and clearly stating all the assumptions that you are making. (8)
ii) TTC Limited is the 5th largest constituent of the main stock index in Indiana
which has a reasonably deep derivative market. The quotes for options of TTC
Limited as on 2nd March 2015 for a call and put option with strike 340 is as
follows:
Bid Ask
Call 12.00 12.10
Put 7.50 7.60
The current market price of TTC is 346 per share and interest rate may be taken
at 10%. The contract expires on 26th of March 2015. Comment on the above
scenario based on your understanding of Put-Call Parity (7)
[15]
Q. 5) Consider the information below regarding a fund and index returns. The benchmark for
the fund is an investment that has equal exposure towards equities and debt.
March 2014 March 2015 Cash flow Investment Income
Rs Cr Rs Cr Rs Cr Rs Cr
Equities 650 750 -10 10
Debt 300 440 70 20
Cash 50 50 -1 1
An analyst has performed some performance attribution and has come up with the
following results:
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IAI ST5 - 0515
Actual Benchmark
Fund Return 17.58% 10.3%
Equity Return 17.05% 15%
Debt Return 20.9% 5.6%
Cash Return 2.0% 4%
Sector selection outperformance 1.02%
Stock selection profit for equity 1.29%
Benchmark equity yield 3.5%
Benchmark debt yield 4%
Assuming that the figures provided by the analyst are correct, provide a qualitative
commentary on the results of the analysis performed by the analyst. [8]
Q. 6) A life insurance company is launching a unit-linked product where it wishes to provide
a minimum guarantee on maturity to the policyholder that maturity value will be higher
of the unit-fund value at maturity or 110% of the premiums paid. The Appointed
Actuary of the Company is contemplating whether any extra reserve required for this
feature.
State clearly the various steps pertaining to ALM that the Appointed Actuary must
undertake to arrive at a reasonable level of such a reserve. [5]
Q. 7) In a country ABC, online retailing is growing at a rapid pace. Blipkart is a 3 year old
online retail company which works on a market place model i.e. it provides an online
platform for customers to place orders with vendors and charges a commission from the
vendors which is a % of the invoice value. The company is growing at a rapid pace and
has hit the Gross Merchandise Value sold of 1000 Cr ABC rupees in this short period.
You are a newly recruited investment actuary of the ABC operations of a global asset
management company. The Chief Investment Officer of your company has received
some information from market sources that Blipkart is probably going to do a fund
raising for the first time. He believes that Blipkart could be one of the major players in
this space a few years from now. He has asked you to discretely prepare a preliminary
investment thesis including suggested valuation for the company from available
information.
What factors will you consider (and problems you might face) when making this
report? [15]
Q. 8) Veda Inc. is the holding company of Mesa Limited which is a miner of iron ore. Mesa
Limited also owns a large Copper smelting operation and an Aluminium smelter.
Recently Veda Inc. acquired 60% stake XYZ Energy – an oil producer. Out of the 60%,
18% is held through Mesa Limited. The remaining stake lies with the public. Veda
recently announced that it is considering the merger of Mesa with XYZ through share
swap deal wherein XYZ shareholders will get shares of combined entity.
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IAI ST5 - 0515
i) Based on the following information (as of year ended March 2014) comment on
the rationale for this move. (7)
FY14 BALANCE SHEET - in Cr
NY/FINANCE/BALANCE Sterlite¤CmbDetail»0¤CmbCommonsize»0
MESA XYZ
SOURCES OF FUNDS :
Share Capital 297 1,908
Reserves Total 33,382 55,530
Total Shareholders Funds 33,679 57,438
Total Debt 38,943 -
Other Liabilities 396 3,113
Total Liabilities 73,018 60,551
APPLICATION OF FUNDS :
Net Fixed Assets 22,584 21,211
Capital Work in Progress 17,327 5,697
Producing Properties - 3,864
Investments 22,767 16,364
Total Current Assets 20,811 18,554
Total Current Liabilities 10,472 4,404
Net Deferred Tax - (736)
Total Assets 73,018 60,551
FY14 PROFIT AND LOSS -in Rs. Cr
MESA XYZ
INCOME :
Net Sales 28,537 18,762
Other Income 1,817 1,503
Raw Materials 18,765 -
Other Expenses 8147 5,090
Interest 3,565 41
Depreciation 1,505 2,297
Profit Before Tax (1,072) 12,850
ii) The minority shareholders of XYZ have opposed this move. What could be the
possible reasons? (9)
[16]
Q. 9) Define the following terms:
a. Deflators
b. Eurobond
c. Non-recourse loan for a project
d. Par yield curve
e. Tracking error [10]
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