December 6th 2012 BM 12-14 ROLL: NAME:

Financial Management I Quiz 2 Points: 35 Time: 60 min

Closed book/ closed notes examination. Make assumptions, if necessary, for answering the questions. But state all your assumptions clearly.

1. Beta and Leverage a. Assume a firms operating leverage has been reliably computed to be 2. Assume in the next period, the sales of the firm goes up by 20%, but the EBIT comes down by 5%. Is this situation possible? Elaborate b. Can a firm with high operating leverage have low business risk (variability in EBIT)? Elaborate. Points: 5

a. Yes, OL measures the systematic portion of the relationship. Unique risk (accidents, exchange rate fluctuations, etc) can add to the systematic factors and either increase the EBIT beyond 20% x 2 or bring it down below 20% x 2 b. Yes, sigma sales can even be zero

2. Assume that you have regressed the monthly stock returns of Sun Pharma against monthly returns of the Nifty over the period November 2007 to November 2012. Assume that the regression has a R2 of 0.22, a slope (beta) of 0.65, and an intercept of .1%. Assume the one-year risk-free rate in India to be 12% p.a. a. What is the Jensens Alpha for Sun Pharma? What exactly does this indicate? b. Over the same period, a regression estimate of equity beta for another firm in the pharmaceutical industry, Ranbaxy, had a R2 value of 0.26. How will you interpret these R2 values? What does it indicate? c. If, in the next period, the market goes up by 1% how much will Sun Pharmas stock go up by? Can you be dead sure of this? Why, or why not? d. How would a bottom-up beta estimate for the beta of Sun Pharma be better than the regression beta estimate? Points: 10

a. Straight from A Damodarans material b. Portion of total risk explained by the market. c. .65% . No, unsystematic/ unique factors can introduce deviations. R squared is only .22 d. Standard error would be lesser plus..

3. Efficiency of Markets a. In tests for semi-strong market efficiency, how are abnormal stock returns defined? b. Assume that a firm announces very good results for the quarter ending December 31 2012. Assume that markets are semi-strong efficient. Assume that you have computed the weekly abnormal returns for this firm starting eight weeks before the actual announcement of results on December 31 2012. What will the abnormal returns possibly look like? Put hypothetical values for the abnormal returns for the eight weeks c. What will the abnormal returns look like, after the announcement? Points: 10 a. Returns minus returns as per equilibrium pricing model b. Positive values, by and large c. Positive, negative mixed upno pattern

4. Market Design a. Assuming numbers, show diagrammatically (and very clearly) the structure of a 14-day repo with an approximate repo rate of 12%p.a. b. How is a repo different from an ordinary collateralized loan? Points: 5 a. Show it! b. In a repo there is an actual sale and buy back; the title gets transferred

5. New Venture Financing Can the total value of the firm go up in a down round? Elaborate Points: 5 Yes, while the price per share will come down, the total value can go up