Cheat Sheet Midterm.docx - (PSG has a market...

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(PSG) has a market capitalizaton (market value of equity) of INR 90 billion, INR 30 billion in debts debt beta is 0.2. PSG's equity beta is 1.2. You are planning to start a sportng risk free interest to be 7% and market risk premium to be 9%. 100% equity fnanced . estimated cost of capital Soluton: First calculate asset beta for PSG. That would be asset beta for your business. Equity beta would be same as no debt fnancing, use this Asses Beta into CAPM. BA = (D/D+E)*BD +(E/E+D)*BE => BA= 0.95. COC = 7+0.95*9=15.55%. Beta difers from volatility: True. B) The risk premium investors can earn by holding the market portolio is the diference between the market portolio's expected return and the risk free interest rate: True. C) Stocks in cyclical industries, in which revenues tend to vary greatly over the business cycle, are likely to be more sensitive to systematic risk and have higher betas than stocks in less sensitive industries: true. D) Returns to the market portolio represent unsystematic shocks to the economy: False – Systematic shocks. Variance of Portolio: Consider a portolio that consists of an equal investment in 10 firms. Variance of return each of the firm is 0.01 and covariance for each pair is 0.005. What is the variance of this portolio? Portfolio Variance = (1/N)*Var avg + (1- 1/N)*Cov avg = 1/10*0.01 + (1 1/10)*0.005 =0.0055. Expected Return and Std Dev of Portolio For the stock Onion, the expected return is 8% and the standard deviation is 12%. For the stock Pyaaj, the expected return is 11% and the standard deviation is 15%. Covariance between Onion and Pyaaj is 0.0108. What is the expected return and standard deviation of a portolio that invests 30% in Onion and balance in Pyaaj. Expected Return = WaRa+ (1-Wa)Rb = = 0.30*8% + 0.70*11% = 10.1%: Var = W^2Var(Ra)+(1- Wa)^2Var(Rb)+2Wa*(1-Wa)Cov(Ra,Rb) = (0.3^2)*(0.12^2)+(0.7^2)*(0.15^2) + 2*0.3*07*0.0108 = 0.0169; Std Dev = Sqrt(0.0169) = 12.98%. A company has an asset beta of 1.0. It's debt beta is zero, the ratio of the book value of its equity to the book value of its assets is 0.50, and the ratio of the market value of its equity to the market value of its assets is 0.80. The company's equity beta is Solution: Market value of debt and equity are relevant. ? D=0; E/(D+E)=0.8; D/E=0.2/0.8=1.25; ?e=? a(1+D/E) = (1)(1.25)=1.25 Which of the following are systematic risks and which are idiosyncratic? A) The risk that oil prices rise (S) B) The risk of a product liability lawsuit(I) C) The risk that the CEO is killed in a plane crash(I) D) The risk the Reserve Bank of India will increase the interest rates(S) Suppose that the market portolio is equally likely to increase by 26% or decrease by 4%. Risk free rate is 6%. What is the expected return, according to CAPM, on an asset with a beta of 0.8? ? [ ? i]=Rf+ ? i( ? [ ?m]-? f) ; ? [ ?m] = 0.5(26%) + 0.5( 4%) = 11%; ? f=6% ; ? [ ? i]=6% + (0.8)(11% 6%) = 10% As per CAPM equaton, the expected return on the stock with beta of 0.8 is 10% There is a 60% chance that the market return will 15% next year and a 40% chance that it will be 5% next year. Risk free rate is 6%. If Quantum Solace has beta is 1.18, what is its expected return next year? E[Rm]= (60% × 15%) + (40% × 5%) = 11%; E[Ri]= 6% + 1.18 × (11% − 6%) investment is equally likely to have a 20% return or a 5% return. The expected return, and Var of this investment? E
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