428_PS5_S09_soln - AEM 428 Spring 2009 Professor Manny Dong...

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AEM 428 Spring 2009 Professor Manny Dong Problem Set 5 based upon the On-line stock screening system Minicase 1) Please read the description attached at the end of the problem set. Using the on-line stock screening system (beta version), as of June 1995, what are the firms that have highest 6-month momentum, lowest valuation rank by PB and the highest implied cost of capital quintile? a) How many stocks are there? List their tickers and names. b) What is the average return of an equal-weighted portfolio with these stocks in the next six months? In the next 12 months? c) What is the return of the market in the next six months? In the next 12 months? d) If you invest $1000, how much would you earn from the equal weighted portfolio? How much would you earn from the market portfolio? e) What evidence does this present about market efficiency? 2) Conduct historical research on whether the RIM accurately predicts the direction of future returns of Sears. a) Go to: http://www.professorng.com/stockscreen/ b) Search for Sears’ ticker from Yahoo!Finance. Type in the ticker (i.e. permno) of the firm. Download its historical data. c) Open up the data in Excel. d) How would you describe the firm’s style in June 1995? Value or growth? Size? Momentum? e) Calculate the RIM valuation of Sears in June 1995 using all the inputs. Use a 13% discount rate. Compare that to the price. f) Does the implied cost of capital (ICOC) predict future 12-month (retf12m) returns on average? Calculate the correlations of ICOC with retf12m (excluding those observations of zeros for forward returns at the end).
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Three other problems 2. Draw payoff diagrams for each of the following portfolios (X = strike price) a) Buy a call with X = $50, and sell a call with X=$60 b) Buy a bond with a face value of $10, short a put with X=$60, and buy a put with X=$50 c) Buy a share of stock, buy a put option with X=$50, sell a call with X = $60 and short a bond (i.e. borrow) with a face value of $50. d) What principle do these diagrams illustrate? Ans: a) b. Buy bond FV = $10, short put X = $50, buy put X = $60 0 5 10 15 20 0 50 60 Stock price Option payoff Buy call X = $50, sell call X = $60 0 5 10 15 20 0 50 60 Stock price
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c. d. What these diagrams illustrate is the principle known as replication. All three portfolios have the same payoff structure, even though the portfolios contain different types of securities. In other words, given a particular payoff structure, it is always possible to replicate that payoff structure with a different set of securities. 3a) Imagine that a stock sells for $33. A call option with a strike price, X, of $35 and an
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428_PS5_S09_soln - AEM 428 Spring 2009 Professor Manny Dong...

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