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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
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TOTAL /34 ACTSC 372 Winter 2011 Term Test #1 Answer in the spaces provided. Show your work. [9] 1. Suppose the riskfree 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 shortsell Royal Bank stock since it lies well below the CML and thus must be overpriced. Do you agree with this recommendation?
Explain. IUD' 714 (9/11“ /5 Sn Wﬁj/ COUCH/1&1 pang/[Uf
H‘sF 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$i&v 01A J’L [lo/alums 091 61% S‘Ethrﬂl) 0314,5413}!
M fly/7111043 6% #1 Firm/em. Page 4 of 8 AC T SC 3 72 Winter 2011 Term Test #1 (c) There are 3 securities A, B and C with the following data factor L
l 0%
1 2% Beta of second 7 Expected Return l
l
J 14% l (i) Show that there is there an arbitrage portfolio available. K 4 J 6 >
~. , _ Cur
Lﬂt l0 ”QC //A—/6 (it ﬁlmilwlé) [In 12?: gawk/92%;; : 4‘2 70 (ii) Assume you invest in the arbitrage portfolio. Do you believe that this
portfolio is truly riskfree? Explain. [121i Likfzﬂ ‘ ,
m 519$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 debttoequity 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
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