When answer numerical problems, first write down the appropriate formula or financial calculator operation and then fill in the relevant information, which you use to calculate the answer to the question. For essay questions, use the knowledge (including formula, graph, or terms) learned in this class to explain your answer. Incorrect answers with no steps will receive little or no credit.
True or false? If it is true, please justify why it is a true statement. If it is false, please explain exactly why it is false.
a. If two stocks’ returns have a correlation coefficient that is positive, then there is no diversification effect when you combine them into a portfolio.
b. A student plans to visit home in California during the summer break. She can either take an air flight or travel by car. If she chooses to drive, then the flight ticket price she saves is an opportunity cost.
c. A portfolio comprises two stocks, A and B, with equal amounts of money invested in each initially. If the price of stock A increases and that of stock B decreases, the weight of stock A in the portfolio will increase.d. The growing perpetuity’s present value formula is PV=C1/(R-g). If the growth rate g is higher than the discount rate R, and the cash flow C1 is positive, then this growing perpetuity has a negative present value.
Question 2
Today, you turned 21. Happy birthday! On this glorious day, your parents give you a trust fund with the following characteristics. Starting exactly 5 years from now (so on your 26th birthday), it will pay out a constant cash flow of $35,000 per year, for 30 years (so there will be a total of 30 payments). Calculate the present value (today) of the trust fund. Your required rate of return is 8%. (Hints: Drawing a time line definitely helps!)
Question 3
You are finalizing your capital budgeting analysis on whether to proceed with a new plant and are almost ready to present it to your boss. One of your particularly lazy and dim-witted team members comes sauntering in at the last minute and starts arguing about some of the details. He states that the analysis should not have included the land that the plant will be built-on because it’s already bought and paid-for. He further argues that you’ve neglected to include the cost of the exploratory engineering design completed last year when this project was first conceived. Explain exactly what is wrong with his arguments, using the terms and knowledge you learned from this class.
Question 4
Fiona Trail is a recent retiree who is interested in investing some of her savings in corporate bonds. Her financial planner has suggested she invest in bond A, which has 5% coupon rate, paid semi-annually, mature in 15 years, and has a $1000 face value. Bond A has a current yield to maturity of 7.5%
a) Without calculating the price of the bond, indicate whether the bond is trading at a premium, at a discount, or at par. Explain your reason. In other words, use concepts to justify your conclusion, without actually calculating the bond price here.
b) Calculate the price of the bond.
c) If two years after Fiona purchased the bond, the yield of maturity drops to 6.5%, what will be the price of the bond immediately BEFORE its 4th coupon payment?
d) If two years after Fiona purchased the bond, the yield of maturity drops to 6.5%, what will be the price of the bond immediately AFTER its 4th coupon payment?
e) Which of these four bond has the lowest interest rate risk? Explain. Bond A has 5% coupon rate, paid semi-annually, mature in 15 years, and has a $1000 face value.Bond B has 9% coupon rate, paid semi-annually, mature in 9 years, and has a $1000 face value.Bond C has 7% coupon rate, paid semi-annually, mature in 9 years, and has a $1000 face value.Bond D has 7% coupon rate, paid semi-annually, mature in 15 years, and has a $1000 face value.
Question 5
Emerald City Corporation (ECC) is expanding rapidly and currently needs to retain all of its earnings; hence, it does not pay dividends. However, investors expect ECC to begin paying a dividend of $2.00 three years from today. The dividend should grow rapidly: at a rate of 30% per year during years 4 and 5. After Year 5, growth should be a constant 5% per year forever. If the required return on ECC is 9%, what is the value of the stock today?
Question 6
George Costanza has invested 70% of his money in stock A and the 30% in stock B. He accesses their prospects as follows:Stock AStock BExpected return 8%12%Standard deviations 15%17%Beta1.11.5Correlation between returns0.25
a) What are the expected return of his portfolio?
b) What is the standard deviation of his portfolio?
c) Is Mr. Costanza better or worse off investing in the portfolio than investing entirely in stock A, or is it not possible to say? Explain your answer.
d) What is Mr. Costanza’s portfolio beta?
e) Mr. Costanza’s friend, Elaine, wants to invest in one stock and one stock only. Which stock represent a less risky investment for her, stock A or stock B, and why?
f) George’s other friend, Jerry, wants to add one more stock to his portfolio of 50 stocks. Between stock A and B, which one represents a less risky addition for Jerry and why?
0 comments