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Question 5
The expected return and risk on shares in companies X and Y are as follows:
Expected return
Standard deviation
X
15%
9%
Y
27%
15%
a) The correlation coefficient of the return on X and Y is +0.8. Calculate the expected return and risk
of an equally weighted portfolio.
b) If the correlation coefficient of the returns on X and Y is zero, Calculate the expected return and
risk of an equally weighted portfolio.
c) Security A is expected to produce a rate of return of 22% and has a beta of 1.2. Security B is
expected to produce a rate of return of 15%, and has a beta of 0.5. What is the expected rate of
return on the market portfolio and the risk free rate of interest?
d) What is beta of a portfolio? Explain.
e) What are the factors that an investor would consider in choosing an optimal portfolio? Explain
what an optimal portfolio is.
(3 + 3 + 3+3+3 = 15 marks)
Question 6
Examine the following balance sheet of University Products Limited.
University Product Limited
Balance Sheet as at 31 December 2013
Assets ($m)
Liabilities and Net Worth ($m)
Cash and Short-term securities
$1
8% Coupon Bond (31/12/2023)
$10
Accounts receivable
3
10% Preferred Stock (Par = $10)
2
Inventories
7
Common stock (Par = $10)
$10
Plant and equipment
21
Retained Earnings
$10
Total
$32
Total
$32
Additional information:
i) The preferred stock currently sells for $15 per share. The common stock has a beta of 1.4 and
is currently trading at $20 per share.
ii) The market expects the yield to maturity of the companys bond to trade at 10 percent per
annum.
iii) The market risk premium is 10 percent and the risk-free rate of return is 6 percent.
The company pays a tax rate of 20%.
Required:
a)
b)
(15 marks)
Question 7
Page 3
FORMULAE
FV = PV(1 +r)t
PV = FV / (1 + r)t
PV = C / r
PV = C1 / (r g)
PVA = C({1 [1/(1 + r)t]} / r )
PVGA = C {[1/(r g)] [1/(r g)] [(1 + g)/(1 + r)]t}
EAR = [1 + (APR / m)]m 1
FV = PVeRt
PVAdue = (1 + r) PVA
FVA = C{[(1 + r)t 1] / r}
FVAdue = (1 + r) FVA
RP = XARA + XBRB
2P = (XA2 x 2A) + (2XA A AB XB B) + (XB2 x 2B)
RA = RF + A(RM RF)
Corr(RA,RB) = AB = AB/ A B
A = AM / 2M
WACC = {[S/(S+B)] x RS} + {[B/(S+B)] x RB x (1 tc)}
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