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### PS1_2011

Course: FM 212, Spring 2012
School: LSE
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Word Count: 233

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Principles FM212/FM492 of Finance MT Problem Sets FM212 - Class Assignments (Michaelmas Term) Each class assignment in Part 1 consists of 3 questions. Students should attempt written answers to the questions before the respective class. Class 1 1. A parcel of land costs \$500,000. For an additional \$800,000 you can build a motel on the property. The land and motel will be worth \$1,500,000 next year. Assume that...

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Principles FM212/FM492 of Finance MT Problem Sets FM212 - Class Assignments (Michaelmas Term) Each class assignment in Part 1 consists of 3 questions. Students should attempt written answers to the questions before the respective class. Class 1 1. A parcel of land costs \$500,000. For an additional \$800,000 you can build a motel on the property. The land and motel will be worth \$1,500,000 next year. Assume that there is no risk and that the risk free interest rate is 10%. Would you construct the motel? Why or why not? 2. You run a construction firm. You have just won a contract to build a government office building. Building it will require an investment of \$10 million today and \$5 million one in year. The government will pay you \$20 million in one year. Both year one cash flows occur at the same time. Suppose the cash flows and their times of payment are certain, and the riskfree interest rate is 10%. a. What is the NPV of this opportunity? b. How can your firm turn this NPV into cash today? 3. You have an investment opportunity in Japan. It requires an investment of \$1 million today and will produce a cash flow of 114 million in one year with no risk. Suppose the risk-free interest rate in the United States is 4%, the risk-free interest rate in Japan is 2% and the current exchange rate is 110 per \$1. What is the NPV of this investment? Is it a good opportunity? 1
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LSE - FM - 212
FM212/FM492 Principles of Finance MT Problem SetsClass 24. Mike Polanski is 30 years of age and his salary next year will be \$40,000. Mike forecasts that his salary will increase at the steady rate of 5 percent per annum until his retirement at age 60.
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FM212 Michaelmas Term 2011 Class work SolutionsClass 1 1. NPV = -\$1,300,000 + (\$1,500,000/1.10) = +\$63,636 Since the NPV is positive, you would construct the motel. Alternatively, we can compute r as follows: r = (\$1,500,000/\$1,300,000) 1 = 0.1538 = 15.3
LSE - FM - 212
FM212 Michaelmas Term 2011 Class work SolutionsClass 2 4. Annuity with growth: a. Let St = salary in year tPV = t =1 30St = (1.08) tt =13040,000 (1.05) t -1 (1.08) t=t =130(40,000/1.05) = (1.08 / 1.05) tt =13038,095.24 (1.0286) t 1 1 = 38,0
LSE - FM - 212
FM212/FM492 Principles of Finance MT Problem SetsClass 3 7. NoGrowth Corporation currently pays a dividend of \$0.5 per quarter, and it will continue to pay this dividend forever. What is the ex-dividend price per share if its equity cost of capital is 15
LSE - FM - 212
FM212/FM492 Principles of Finance MT Problem SetsClass 4 10. Answer the following questions: a. Briefly explain the difference between beta as a measure of risk and variance as a measure of risk. b. What is the correlation coefficient between two stocks
LSE - FM - 212
FM212 MT 2011 Class 3 Solutions1.Since dividends are paid quarterly, we can value them as a perpetuity using a quarterly1discount rate of (1.15) 4 - 1 = 3.556% then, P=\$0.5/0.03556=\$14.06. 2. a. We know that g, the growth rate of dividends and earning
LSE - FM - 212
FM212 Michaelmas Term 2011 Class work SolutionsClass 4 10. a. Variance measures the total risk of a security and is a measure of stand-alone risk. Total risk has both unique risk and market risk. In a well-diversified portfolio, unique risks tend to canc
LSE - FM - 212
FM212/FM492 Principles of Finance MT Problem SetsClass 5 13. The Treasury bill rate is 4 percent, and the expected return on the market portfolio is 12 percent. Using the capital asset pricing model: a. Draw a security market line. b. What is the risk pr
LSE - FM - 212
FM212 Michaelmas Term 2011 Class work SolutionsClass 5 13. CAPM20 Expected Return 15 10 5 0 0 0.5 1 Beta 1.5 2a. b. Market risk premium = rm rf = 0.12 0.04 = 0.08 = 8.0%. c. Use the security market line: r = rf + (rm rf) r = 0.04 + [1.5 (0.12 0.04)] =
LSE - FM - 212
Hand in Problem Set 1GE Values as of 28/10/11 1a 1b 2a 2b 3 Current Stock Price Market cap. rate Dividend Return of Equity Payout Ratio Growth next 5 yrs 17.25 0.09 0.6 0.1180 0.48 0.1474 Formulae 1 0.69 2 0.79 3 0.91 4 1.04 5 1.19Dividend Discount Meth
LSE - FM - 212
FM212/FM492 Principles of Finance MT Problem SetsHand in Problem Set 1 Please hand a paper copy of your work to your class teacher at the beginning of class 4 (week 5). As a new analyst for a brokerage firm, you are anxious to demonstrate the skills you
LSE - FM - 212
FM212/FM492 Principles of Finance MT Problem SetsClass 6 16. Which of the following observations appear to indicate market inefficiency? Explain whether the observation appears to contradict the weak, semi-strong or strong form of the market efficiency h
LSE - FM - 212
FM212/FM492 Principles of Finance MT Problem SetsClass 7 19. The following table lists prices of options on IBM stock. Stock IBM Time to Exercise (months) 1 Exercise Price 120 Stock Price 126.36 Put Price 1.27 Call Price 8.1a. Using the information abov
LSE - FM - 212
FM212 Michaelmas Term 2011 Class work SolutionsClass 6 16. a. No contradiction with market efficiency: taxpaying investors must be indifferent between both kinds of bond, since they're equally risky. b. Strong form. c. In an efficient market, predictable
LSE - FM - 212
FM212 Michaelmas Term 2011 Class work SolutionsClass 7 19. From the Put-Call Parity we can derive the implied interest rate: a. P+S=C+EX/(1+r) solving for r=0.39% monthly rate b. Using the derived rate we can calculate the future value of call and put pr
LSE - FM - 212
FM212/FM492 Principles of Finance MT Problem SetsClass 8 22. CH4 trading stock price is \$100 and in each 3 month period will either increase by 25 percent or fall by 20 percent. A 6-month call on CH4 stock has an exercise price of \$90. The risk-free 3-mo
LSE - FM - 212
FM212 Michaelmas Term 2011 Class work SolutionsClass 8 22. a. Note: at this point we do not need to specify whether this is an American or European option as they both have the same value (American call without dividends is never exercised early). The po
LSE - FM - 212
FM212/FM492 Principles of Finance MT Problem SetsHand in Problem Set 2 Please hand a paper copy of your work to your class teacher at the beginning of class 8 (week 9). You may send your excel spreadsheet to your class teacher (this is optional). Your bo
LSE - FM - 212
Lecture 1: Present ValuePresent Value Introduction to Present Value Foundations of the Net Present Value RuleBased on Chapter 2 in BMAFM212 Principles of Corporate FinanceValues and DiscountingDiscount Rate Interest rate used to compute present valu
LSE - FM - 212
Lecture 2: How To Calculate Present ValuesHow To Calculate Present Values Valuing Long-Lived Assets PV Shortcuts Perpetuities and Annuities Compound Interest &amp; Present Values Nominal and Real Rates of InterestBased on Chapters 2 and 3.5 in BMAFM212 Pr
LSE - FM - 212
Lecture 3: Value of Bonds and Stocks Value of Bonds and Common Stocks Using PV Formulas to Value Bonds How Common Stocks are Traded How Common Stocks are Valued Estimating the Cost of Equity Capital Stock Prices and EPSBased on Chapters 3.1 and 4 in BMA
LSE - FM - 212
Lecture 4: Risk and ReturnRisk and Return Over a Century of Capital Market History Measuring Portfolio Risk Calculating Portfolio Risk Beta and Unique Risk Diversification &amp; Value AdditivityBased on Chapter 7 in BMAFM212 Principles of Corporate Financ
LSE - FM - 212
Lecture 6: Market EfficiencyThe Six Lessons of Market Efficiency What is an Efficient Market? Random Walk Efficient Market Theory The Evidence on Market Efficiency Puzzles and Anomalies Six Lessons of Market EfficiencyBased on Chapter 13 in BMAFM212
LSE - FM - 212
Lecture 5: Portfolio TheoryPortfolio Theory and Asset Pricing Equilibrium Markowitz Portfolio Theory Mean Variance Optimization Role of the CAPM Evidence regarding CAPM Some Alternative Theories to CAPMBased on Chapter 8 in BMAFM212 Principles of Corp
LSE - FM - 212
Lecture 7: Put and Call OptionsPut and Call Options Calls, Puts and Shares Financial Alchemy with Options What Determines Option ValueBased on Chapter 20 in BMAFM212 Principles of Corporate FinanceTerminologyDerivatives: Any financial instrument who
LSE - FM - 212
Lecture 8: Options Pricing TheoryOptions Pricing Theory Two Option Valuation Methods Binomial and Continuous-time Models The Black-Scholes Model Option Pricing with DividendsBased on Chapter 21 in BMAFM212 Principles of Corporate FinanceRisk Adjusted
LSE - FM - 212
FM212/FM492 Principles of Finance MT Problem SetsClass 9 25. You have estimated spot rates as follows: Year 1 2 3 4 5 Spot Rate 0.25% 0.50% 0.75% 1.00% 1.25% a. What are the forward rates for each period? b. Calculate the PVs of the following government
LSE - FM - 212
Lecture 9: Valuing Government Bonds Valuing Government Bonds Real and Nominal Rates of Interest The Term Structure and Yield to Maturity (YTM) How Interest Rate Changes Affect Bond Prices Explaining the Term StructureBased on Chapter 3 in BMAFM212 Prin
LSE - FM - 212
FM212 Michaelmas Term 2011 Class work SolutionsClass 9 25. Price of a bond and yield curve a. Use the following non-arbitrage relation to calculate the implied forward rates:(1 + rn ) n = (1 + r1 )(1 + f 2 ).(1 + f n )Year 1 2 3 4 5 Spot Rate 0.25% 0.5
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Hand in Problem Set 2 Your first data observations should look like this: Annual Tbill Rate Date S&amp;P 500 GE S&amp;P 500 return GE Return % 07/10/2002 885.76 18.73 01/11/2002 936.31 0.0571 1.6 20.11 0.0737 02/12/2002 879.82 -0.0603 1.24 18.19 -0.0955 -0.0274 1
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Lecture 10: Forwards and FuturesForwards and Futures Hedging with Commodity Forwards Cash Settlement vs. Delivery Marking-to-market Forwards and Futures Financial Futures Pricing Commodity Futures Pricing Differences between Forwards and Futures Based o
LSE - FM - 212
FM212/FM492 Principles of Finance MT Problem SetsClass 10 28. Yesterday you sold six-month futures on the German DAX stock market index at a price of 6,260. Today the DAX closed at 6,250 and DAX futures closed at 6,268. You get a call from your broker, w
LSE - FM - 212
FM212 Michaelmas Term 2011 Class work SolutionsClass 10 28. 6-months future on equity index: a. She is asking you to pay 8 Euros (your sale is showing a loss). Position diagram for a short position on a future contractb.With 1% implied annual dividend
LSE - FM - 212
1/4/2012List of Topics in Lent Capital Budgeting and the NPV Rule Real Options Payout Policy Does Debt Policy Matter? How Much Should A Firm Borrow? The Many Different Types of Debt Mergers, Corporate Governance, and Control Initial Public Offerings Ris
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FM212/FM492 Principles of Finance Problem Set SolutionsClass 10 28. Insurance companies have advantages/disadvantages in bearing risk Advantages in bearing risk Skills in estimating probabilities Skills in identifying risk-reduction techniques Diversifie
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Class 10 28. Large businesses spend millions of dollars annually on insurance. Why? Should they insure against all risks or does insurance make more sense for some risks than others? 29. A gold-mining firm is concerned about short-term volatility in its r
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Solutions to Data Case1. Home Depot bond, Coupon 4.40%, Maturity 4/1/2021, Moody's rating A3, Yield 2.552% (as of 3/3/12). 2. Estimating spreads using Reuter's Corporate spreads for 10 year maturity: a. 10-year U.S.Treasury Bond yield =1.97% (coupon 2.0%
LSE - FM - 212
FM212/FM492 Principles of Finance Problem Set SolutionsClass 9 25. The initial return on Margoles Publishing stock is (\$19.00 \$14.00) / (\$14.00) = 35.7%. Who gains from the price increase? Investors who were able to buy at the IPO price of \$14/share see
LSE - FM - 212
1/4/2012List of Topics in Lent Capital Budgeting and the NPV Rule Real Options Payout Policy Does Debt Policy Matter? How Much Should A Firm Borrow? The Many Different Types of Debt Mergers, Corporate Governance, and Control Initial Public Offerings Ris
LSE - FM - 212
Class 9 25. Margoles Publishing recently completed its IPO. The stock was offered at a price of \$14.00 per share. On the first day of trading, the stock closed at \$19.00 per share. What was the initial return on Margoles? Who benefited from this underpric
LSE - FM - 212
Hand in Problem Set 2 Please hand a paper copy of your work to your class teacher at the beginning of class 8 (week 9). You are still employed at The Home Depot. Recall your previous assignment. The possibility of changing Home Depot's capital structure p
LSE - FM - 212
FM212/FM492 Principles of Finance Problem Set SolutionsClass 822. TargetCo's a. TargetCo's shares are worth \$25 and your shares are worth \$40. You will have to issue 25 / 40 ( = 5/8 ) shares per share of TargetCo to buy it. That means that in aggregate,
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Class 822. Your company has earnings per share of 4. It has 1 million shares outstanding, each of which has a price of 40. You are thinking of buying TargetCo, which has earnings per share of 2, 1 million shares outstanding, and a price per share 25. You
LSE - FM - 212
1/4/2012List of Topics in Lent Capital Budgeting and the NPV Rule Real Options Payout Policy Does Debt Policy Matter? How Much Should A Firm Borrow? The Many Different Types of Debt Mergers, Corporate Governance, and Control Initial Public Offerings Ris
LSE - FM - 212
FM212/FM492 Principles of Finance Problem Set SolutionsClass 719. Maple debenture a. Conversion ratio=1,000/47=21.28 b. Conversion price=1,000/50=20.00 c. Conversion value=21.28*41.50=883.12 or 88.31%.The difference between the conversion value and the
LSE - FM - 212
Class 719. Maple Aircraft has issued a 4 % convertible subordinated debenture due 2014, with \$1,000 face value. The conversion price is \$47.00 and the debenture is callable at 102.75% of face value. The market price of the convertible is 91% of face valu
LSE - FM - 212
1/4/2012List of Topics in Lent Capital Budgeting and the NPV Rule Real Options Payout Policy Does Debt Policy Matter? How Much Should A Firm Borrow? The Many Different Types of Debt Mergers, Corporate Governance, and Control Initial Public Offerings Ris
LSE - FM - 212
FM212/FM492 Principles of Finance Problem Set SolutionsClass 6 16. Bahia Corporation a. For Project X: Expected value of cash flows = (160 0.05) + (0 0.95) = 8 million. NPVX = 20 + (8/1.15) = 13.04 million reals For Project Y: Expected value of cash flow
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Class 6 16. The Bahia Corporation has fallen on hard times. It successfully issued 80 million Reals of zerocoupon bonds four years ago, but since then its business has gone from bad to worse. The debt is due one year from now. Its only remaining asset is
LSE - FM - 212
Solutions to Data Case1. a. The stock price on February 2, 2012 was \$44.46 and the number of shares outstanding was 1,541,568,000. b. No solution, the students are required to download the statements to Excel. c. As of the date of the case, the YTM for t
LSE - FM - 212
FM212/FM492 Principles of Finance Problem Set SolutionsClass 5 13. Markum a. WACC = (1 / 1.4)(11.3%) + (.4 / 1.4)(5%)(1 .35) = 9% VL = 0.75/(9%-4%)=\$15 million NPV = -10 + 15 = \$5 million b. Debt-to-Value ratio is (0.4) / (1.4) = 28.57%. Therefore Debt i
LSE - FM - 212
1/4/2012List of Topics in Lent Capital Budgeting and the NPV Rule Real Options Payout Policy Does Debt Policy Matter? How Much Should A Firm Borrow? The Many Different Types of Debt Mergers, Corporate Governance, and Control Initial Public Offerings Ris
LSE - FM - 212
Class 5 13. You are a consultant who was hired to evaluate a new product line for Markum Enterprises. The upfront investment required to launch the product line is \$10 million. The product will generate free cash flow of \$750,000 the first year, and this
LSE - FM - 212
Hand in Problem Set 1 Please hand a paper copy of your work to your class teacher at the beginning of class 4 (week 5). You work in the corporate finance division of The Home Depot and your boss has asked you to review the firm's capital structure. Specif
LSE - FM - 212
FM212/FM492 Principles of Finance Problem Set SolutionsClass 4 10. Bermuda a. Yes, there is an arbitrage opportunity. An investor who purchased 1% of the equity of Debt Zero (DZ) would pay: 0.01 (3.6 million \$86) = \$3.096 million This investor's dividend
LSE - FM - 212
1/4/2012List of Topics in Part 2 Capital Budgeting and the NPV Rule Real Options Payout Policy Does Debt Policy Matter? How Much Should A Firm Borrow? The Many Different Types of Debt Mergers, Corporate Governance, and Control Initial Public Offerings R
LSE - FM - 212
Class 4 10. In Bermuda there are no corporate income taxes. Consider two Bermuda firms with perfectly correlated earnings. The first is Debt Galore and the second is Debt Zero. Each company is expected to earn \$35 million (before interest) in perpetuity.
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FM212/FM492 Principles of Finance Problem Set SolutionsClass 3 7. Little Oil a. A t = 0 each share is worth \$20. This value is based on the expected stream of dividends: \$1 at t = 1, and increasing by 5% in each subsequent year. Thus, we can find the app
LSE - FM - 212
1/4/2012List of Topics in Part 2 Capital Budgeting and the NPV Rule Real Options Payout Policy Does Debt Policy Matter? How Much Should A Firm Borrow? The Many Different Types of Debt Mergers, Corporate Governance, and Control Initial Public Offerings R
LSE - FM - 212
Class 3 7. Little Oil has outstanding 1 million shares with a total market value of \$20 million. The firm is expected to pay \$1 million of dividends next year, and thereafter the amount paid out is expected to grow by 5 percent a year in perpetuity. Howev
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FM212/FM492 Principles of Finance Problem Set SolutionsClass 2 4. Wankel engine a. Technology B is equivalent to Technology A less a certain payment of \$0.5 million. Since PV(A) = \$11.5 million then, ignoring abandonment value: PV(B) = PV(A) PV(certain \$