“TOPICAL ISSUES IN FINANCIAL MANAGEMENT – CAPM AND CAPITAL BUDGETING”
Due date: To Lecturer/Tutor:
on Wednesday, 27 January, 2016
This Assignment is in 2 Parts
Part A – A Critique of the Capital Asset Pricing Model
Part B – Home Purchase Loan Problem
Part A is an Essay while Part B involves calculations.
The requirements for each Part are set out below.
PART A - Topic: CAPM
Your topic is:
“A Critical Assessment of The Capital Asset Pricing Model (CAPM)”
You are required to
- Describe the Capital Asset Pricing Model, including the assumptions underlying the theory
- Explain the relationship between the Security Market Line and the Capital Market Line, using diagrams and examples to illustrate your explanation
- Briefly set out arguments in favour of – and against - the theory, outline its uses and make a critique of its underlying assumptions
- Identify any alternatives which have been suggested in place of CAPM
- Conclude with an overall assessment of the theory and state any recommendations you may have from your study.
- Conclusion – a brief overall assessment of the CAPM theory.
Details of the Assignment requirements, suggested points for detailed examination and penalties for late lodgment are in the Subject Outline.
You are required to complete this essay in Groups of 2 or 3 or 4 or 5 people. All members of the Group should come from the same Tutorial class. You may consult and discuss the Assignment topic with others, but you must write up your Essay yourself/ves. Penalties for copying and plagiarism are severe.

You should follow the following typing conventions:
• Times New Roman font (at minimum , 12 pitch)
• 1.5 line spacing and A4 paper
• Top, bottom, left and right margins to be at least 2.5 cm from the edge of the page; and
• WORD LIMIT – 1,000 – 2,000 words.
Research and Referencing
You should begin by studying Chapter 11 of the text-book.
You will need to discover at least 5 references apart from the text-book.
Use Harvard referencing! See http://en.wikipedia.org/wiki/Harvard_referencing
Marking Guide
Part A will be marked out of fifteen (15) and there will be four components.
Component 1 – 5 marks – ANALYSIS. Discussion and understanding of CAPM and the issues associated with the theory, including the advantages and shortcomings of the theory, along with outlining the underlying assumptions and application of the Security Market Line and the Capital Market Line (illustrated by graphs).
Component 2 – 4 marks – RESEARCH – EXTENT AND APPLICATION. Depth of research should be evident in developing a detailed understanding of CAPM, and its role in in financial management. Evaluate the theory, in the light of your discovered references. Source references of text and diagrams should be cited.
Component 3 – 3 marks – RECOMMENDATIONS / CONCLUSIONS. Following the above analysis and application of your research, state any recommendations which emerge for financial managers and investors and/or for government policy. In a separate section, briefly summarise your overall conclusions.
Component 4 – 3 marks – PRESENTATION. Clear and concise expression required, along with professional presentation, correct grammar and spelling, and the use of clearly labelled graphs, charts and tables. Appropriate source referencing of material, charts, tables, etc. is required
The purpose of Part A of this Assignment is to test your initiative as Master’s degree students, and your ability to discover information and apply your findings to key areas in financial management.
PART B –– Home Purchase Loan Case Problem
You are required to work the following problem, using compound interest techniques. You should model your answer on the text approach in Chapter 5.
On 4 January, 2016, John Brown purchased a home for $900,000. He paid a deposit of $200,000 and on the same day borrowed the balance of the purchase price from the ABC Bank at an interest rate of j12 = 6%, that is, at a nominal interest rate of 6% per annum, compounded monthly (12 times a year). He agreed with the bank that the loan was to be repaid over a period of 25 years, by equal monthly instalments of $4,510.11, each instalment consisting of part interest and part principal. Monthly repayments will be made on 4th day of each month over this period, with the first instalment due on 4th February, 2016.
REQUIRED:
You are required to answer the following questions. Show all workings, and show all answers correct to the nearer cent. Accuracy and presentation are important.
(a) Verify the bank’s calculation of the monthly instalment of $4,510.11.
(b) Assume that all monthly loan repayments are made on the due date. On 4 January, 2019, after payment of the monthly instalment due that day, what will be the amount of loan still outstanding, that is, remaining to be repaid to the bank? [Assume that interest rates are unchanged.)
(c) Over the following 12 months (ending 4 January, 2020, and including the instalment due on that date), all monthly repayments are made on time. What would be the amount of interest paid over that 12 months period?
(d) Calculate the amount of loan principal to be repaid over the year ending 4 January, 2020, assuming that all instalments are paid on the due dates?
(e) On 4 January, 2020, after repayment of the instalment due that day, mortgage interest rates rise to j2 = 7.2% per annum, that is 7.2% per annum, compounded half-yearly. The bank decides to increase the monthly home loan repayment instalment, so that at the new interest rate, the loan will be completely repaid at the end of the original term. What will be the new monthly repayment instalment?
(f) On learning the amount of the increased instalment (from part (e)), John Brown advises the bank that he cannot afford to pay any increased instalment. The Bank decides to allow John Brown to continue to repay the loan by the same level of monthly repayments, but advises John Brown that the term of the loan will be increased as kit will take longer to repay the Loan. Calculate the time required to repay the loan, in years and months (at the new interest rate) if the loan instalment remains unaltered ($4,510.11).
(g) In part (f), what will be the amount of the final monthly repayment?
(h) Suppose that on 4 January, 2022, loan interest rates rise further to J4 = 9.6% per annum, that is 9.6% per annum, compounded quarterly. John Brown advises the bank that he cannot afford to pay any higher instalment. If the bank agrees to John brown’s request, calculate how long it will take before the loan is repaid at the new higher interest rate.
(i) Interpret your answer to part (h). What does it mean? Explain carefully.
(j) Drawing on your knowledge of the Sydney housing market in recent years, advise John Brown and the Bank how they should deal with the situation they are faced with in (h) and (i) above.
Research and Marking Guide
Unlike Part A, text-book and other references are not required for Part B. You should consult the text, Chapter 5, and other available references for guidance as to the setting out of the capital budgeting analysis and the basis for decisions.
Marking will follow generally the style used in marking examination questions, that is, 15 marks are allotted to this Part, from which deductions will be made for errors in calculation, incorrect treatment of items and lack of knowledge.
Submission of Assignments
A soft copy is not acceptable. Please submit to Lecturer a hard copy, including Cover Sheet (see Moodle) & Marks and Comments Page (see page 3 attached. If Marks and Comments page is not submitted or in-complete, 1 mark will be deducted from “Presentation”). Keep a soft copy.
Dr Mervyn Fiedler & Ruhina Karim, Lecturers, KOI, FIN700.
4 January, 2016.
***See Lecturer / Tutor Marks and Comments Page overleaf.***
KOI
FIN700 – Assignment – Trimester 0315
LECTURER/TUTOR MARKS AND COMMENTS PAGE. This form must be attached.
Student’s Name and No., Percentage Contribution to Assignment & Signature
(1)………………………………………………………………………………………………
(2) ……………………………………………………………………………………………..
(3) …………………………………………………………………………………………….
(4) ……………………………………………………………………………………………..
(5) ………………………………………………………………………………………………
TOTAL PERCENTAGE CONTRIBUTION – Must add to 100%
TUTORIAL: Tutor’s Name - Strike out one name: Mervyn Fiedler; Ruhina Karim
Circle Your Tutorial Time: Tues (LA-T1) – 3-5pm; Tues (LA-T2) – 3-5pm; Tues (LA-T3); Wed (LB-T1) – 11am-1pm;Wed (LB-T2)– 1-3pm.
TUTOR’S FEEDBACK MARKS
Part A - CAPM
1. Component 1 – ANALYSIS ……/ 5
……………………………………………………………………………
2. Component 2 – RESEARCH – EXTENT AND APPLICATION ……/4
……………………………………………………………………………
3. Component 3 – RECOMMENDATIONS / CONCLUSIONS ……/3
……………………………………………………………………………
4. Component 4.– PRESENTATION ……/ 3
………………………………………………..… MARK - PART A ……/15%
Part B –HOME LOAN PROBLEM……………..… .MARK – PART B ……/15%
For Tutor’s Comments – see Marked Assignment
TOTAL MARKS FOR ASSIGNMENT ______/ 30%.
TUTOR’s INITIALS …………..DATE ……………………………….