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TT1_Soln

# TT1_Soln - waribo 5 04 U W U 3 University of Waterloo Term...

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Unformatted text preview: waribo. 5 04/ U W U 3 University of Waterloo Term Test #1 ACTSC 372 — Corporate Finance 2 Instructor: Peter Wood Date: February 14‘“, 2011 Time: 5:30 pm. Duration: 50 minutes Number of Pages: 8 (including the cover page and the blank page) Aids: Calculator Name: ID#: FOR EXAMINERS’ USE ONLY Question _J Mark 1 /9 2 4 Q‘ 3 / 8 4 /5 5 —1 / 3 TOTAL /34 ACTSC 372 Winter 2011 Term Test #1 Answer in the spaces provided. Show your work. [9] 1. Suppose the risk-free rate is 4%. Suppose the following data is available. Assume CAPM holds. Beta... '5 Standai‘deeviaﬁon’ . Exgegtedreturn 1 Royal Bank 1 .1 25% (i) Market portfolio (ii) _]_16% 10% (a) Calculate the Market Risk Premium. mm: M ~77 = 4/2‘ (b) Find the values (i) and (ii). Provide a brief justiﬁcation (L We“ well/('2); /oé/ (1:1)} [Kw/IL; (6)0 [’Z“) KP”) :_ I 07);“, RA) (0) Sketch both the CML and the SML. Show where the market portfolio and Royal appear on each graph. 7 5 H L. CML ((1) Your friend recommends you short-sell Royal Bank stock since it lies well below the CML and thus must be over-priced. Do you agree with this recommendation? Explain. IUD' 714 (9/11“ /5 Sn Wﬁj/ COUCH/1&1 pang/[Uf H‘s-F Mal/WGZW/ 8'M3- [46; [J' on He SML C/W/ ”WE )5 'Pbir/7 fir/teak Page 2 of 8 ACTSC 3 72 Winter 2011 Term Test #1 [9] 2. Suppose there are 2 securities in the marketplace, A and B. Assume 0A = 10%, 03 = 15%, ,uA = 5%, [13 = 7%, and the correlation of the returns is p = 0.5. (a) What is the standard deviation and the expected return on a portfolio equally weighted in assets A and B? (b) Assume now that p is unknown. Show that the standard deviation of the returns on an equally weighted portfolio of A and B is never less than 2.5%, regardless of what the value of p actually is. f i 3 474 NIL/”86751773 ”Lu/'Aﬂw 048 /” /‘ 7%qu {MM/L [S “A” FC’I Page 3 of 8 [8] ACTSC 372 Winter 2011 Term Test #1 a“ 3. You have analyzed the returns on various securities, and you believe that they are best modeled with a two factor APT model. More speciﬁcally, assume Rx = R—x+ 311:1 + 321:2 + EX where X is a typical security in the market. (a) For a given security A, what kind of announcement would make the actual value of EA > 0? Ge give an example of a company and a speciﬁc announcement that would likely result in a positive value for EA.) A (70/1 more Sivr/é” 5735M (b) In practice, how are the beta values determined for a typical security? (J6 [L44 4: Ina/7Q1 I”€&/t5\$i&v 01A J’L [lo/alums- 091 61% S‘Ethrﬂl) 0314,5413}! M fly/7111043 6% #1 Firm/em. Page 4 of 8 AC T SC 3 72 Winter 2011 Term Test #1 (c) There are 3 securities A, B and C with the following data factor L l 0% 1 2% Beta of second 7 Expected Return l l J 14% l (i) Show that there is there an arbitrage portfolio available. K 4 J 6 > ~. , _ Cur Lﬂt l0 ”QC -//A—/6 (it ﬁlmi-lwlé) [In 12?: gawk/92%;; : 4‘2 70 (ii) Assume you invest in the arbitrage portfolio. Do you believe that this portfolio is truly risk-free? Explain. [121i Likfzﬂ ‘ , m 519\$th [1151‘ ( [Z {/0 2 Q55, "57} ~£/3 ) ram/1M ,. Page 5 of 8 [5] ACTSC 372 Winter 2011 Term Test #1 ——————_—______ 4. Assume the following data for ABC is available. 0 The beta of ABC is 0.5 0 The market risk premium is 8% and the risk free rate is 4% 0 ABC debt has a YTM of 5% and a debt-to-equity ratio of 3 0 Corporate taxes are 25%. (a) Calculate the rwacc. L/j; go’Y/S'Z) : 32 Q: \~ L/ 824 317(52X 1'15?) ‘i 8/: :7) 0 (9/: :3 3 77:? E, 4’44 (b) When calculating the NPV of capital budgeting projects for ABC, for what type of projects would it be inappropriate to discount the cash ﬂows at the WACC (above)? ( A“? m‘cul Jen ML rug/L a é/fﬂmmé 4/ij iL/L \$3:th / (JV Lj‘ﬁﬂ ‘lL/va gimme/14‘? {(2 COIIFIW J’ilvucA/e) 6% HI Pmﬁdi [5 JFMIM \W/wX Ht i'lW’ Page 6 of 8 AC TSC 3 72 Winter 2011 Term Test #1 [3] 5. State and brieﬂy describe the three forms of the EMH. Uﬁet/C ’ [0/1ij rtﬁ’f‘} QM ’06'8'72' F014 4'- [at/um th/U W!" SVIVOMO I Pﬂté’) [91347071 Qﬂ ﬂue/2b /“hfz) 5W - ftp/Cf} f‘éJ/an‘f,’ ﬂ N’Lﬂb //46//L /%’/74’%14/ Page 7 of 8 AC T SC 3 72 Winter 201 1 Term Test #1 “h“ BLANK PAGE Page 8 of 8 ...
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TT1_Soln - waribo 5 04 U W U 3 University of Waterloo Term...

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