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Paul McLaren holds the following portfolio: Stock InvestmentBeta A $150,000 1.40 B 50,000 0.80 C 100,000 1.00 D 75,000 1.20Total $375,000 Paul plans to sell Stock A and replace it with StockE, which has a beta of 0.75. By how much will the portfolio betachange? a. −0.260 b. −0.286 c. −0.190 d. −0.211 e. −0.234

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Lelia Lubowitz
Lelia LubowitzLv2
28 Sep 2019

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Alex Dale is a portfolio manager at ADIA Investment Company inEurope. Alex would like to buy 50,000 shares of alpha stock whichis a new IPO that was previously offered at £30, but unfortunatelyhe couldn’t get any shares of it. Now, he is still interested inthese shares, but not at a price that is greater than £45. JillJones works for The Global Brokerage House, which providesexecution services for ADIA. In his conversation with Alex, Jillhas suggested that a market order is most suitable for the trade.Alex is also interested in using a market order to sell a largeblock of Gamma shares. However, he is worried that if he instructeda selling using a market order the price would decline and he loseson the value of the deal. Jill argued that this should not be aproblem as automated order driven trading systems provide specialarrangements for small trades (which are often market orders) aswell as for block trades. Alex is also interested in reducing thecost of selling of his Christian Dior shares, Jill suggested thathe should use European electronic crossing network to sell some ofhis shares. She told Alex that these networks are cheap, preserveanonymity and allows for 6 crossing opportunities of trades perday. They also allow participants to place some restrictions suchas price and minimum fill. All orders submitted to the network isgood for day which is means that any unfulfilled part of an orderis automatically resubmitted to subsequent crossing sessions duringthe day. Following Jill’s advice, Alex has submitted his 150,000 CDshares to be sold in the European crossing network with a minimumfill of 125,000. The following orders are on the network for theshares of CD at the time of the first crossing session of the day.The most recent trading price of CD at the Paris Bourse is € 37. A order: a market order to buy 100,000 shares  B order: a marketorder to sell 50,000 shares  C: an order to buy 20,000 shares at €36 In the next crossing session new orders are submitted. The mostrecent trading price of CD at the Paris Bourse is € 38.  D order:a market order to buy 150,000 shares  E order: A market order tosell 50,000 In her speech to buy side clients Jill has made thefollowing statements about electronic communication and crossingnetworks (ECNs): Statement 1: Electronic communication networks areorder driven systems, in which the limit order book plays the acentral role Statement 2: Electronic crossing networks anonymouslymatch buy and sell orders by a pool of participants, generallyinstitutional investors and broker dealers Statement 3: In an ECN,a trade takes place only during a crossing session time and only ifthere are offsetting orders entered by other participants.

Task: 1. For buying alpha shares, should Alex place a marketorder or a limit order? What would be the advantage anddisadvantage of each type of order, given his purpose? (2 Marks) 2.In selling a large block of Gamma shares explain Jill’s argumentthat automated order driven trading systems must provide specialarrangements for small and large trades? (1 Mark) 3. In the firstcrossing session discuss what trades would take place on thecrossing network and what orders remain unfilled? (2 Marks) 4. Inthe second crossing session discuss what trades would take place onthe crossing network and what orders remain unfilled? (2 Marks) 5.Which of Jill’s statement about electronic communication andcrossing networks (ECNs) is true? Justify your answers. (1 Mark) 6.Indicate how you would assess the quality of financial markets? (2Marks)

Instructions: Use the formula below to compute the problems: “Please Read the question carefully.”

Kd = Yield (1 – T)

1. Telecom Systems can issue debt yielding 8 percent. The company is in a 35 percent bracket. What is its after-tax cost of debt?

2. After-tax cost of debt: Royal Jewelers Inc., has an aftertax cost of debt of 6 percent. With a tax rate of 40 percent, what can you assume the yield on the debt is?

3.

Cash flow: Assume a corporation has earnings before depreciation and taxes of $100,000, depreciation of $50,000, and that it has a 30 percent tax bracket. Compute its cash flow using the format below.

Earnings before depreciation and taxes _____

Depreciation _____

Earnings before taxes _____

Taxes @ 30% _____

Earnings after taxes _____

Depreciation _____

4.

Cost of preferred stock: Medco Corporation can sell preferred stock for $80 with an estimated flotation cost of $3. It is anticipated the preferred stock will pay $6 per share in dividends.

a. Compute the cost of preferred stock for Medco Corp.

b. Do we need to make a tax adjustment for the issuing firm?

5. Cost of preferred stock: The Meredith Corporation issued $100 par value preferred stock 10 years ago. The stock provided an 8 percent yield at the time of issue. The preferred stock is now selling for $75. What is the current yield or cost of the preferred stock? (Disregard flotation costs.)

6. Costs of retained earnings and new common stock: Barton Electronics wants you to calculate its cost of common stock. During the next 12 months, the company expects to pay dividends (D1) of $1.20 per share, and the current price of its common stock is $30 per share. The expected growth rate is 9 percent.

a. Compute the cost of retained earnings (Ke). Use Formula 11-6.

b. If a $2 flotation cost is involved, compute the cost of new common stock (Kn). Use Formula 11-7.

7. A firm's cost of preferred stock is equal to the preferred dividend divided by market price plus the dividend growth rate (Kp= D/Po+ g).

8. The coefficient of variation, calculated as the standard deviation of expected returns divided by the expected return, is a standardized measure of the risk per unit of expected return.

a. True

b. False

9. The standard deviation is a better measure of risk than the coefficient of variation if the expected returns of the securities being compared differ significantly.

a. True

b. False

10. The CAPM is built on historic conditions, although in most cases we use expected future data in applying it. Because betas used in the CAPM are calculated using expected future data, they are not subject to changes in future volatility. This is one of the strengths of the CAPM.

a. True

b. False

11. You have the following data on three stocks:

Stock

Standard Deviation

Beta

A

20%

0.59

B

10%

0.61

C

12%

1.29

If you are a strict risk minimizer, you would choose Stock if it is to be held in isolation and Stock if it is to be held as part of a well-diversified portfolio.

a. A; A.

b. A; B.

c. B; A.

d. C; A.

e. C; B.

12. A portfolio’s risk is measured by the weighted average of the standard deviations of the securities in the portfolio. It is this aspect of portfolios that allows investors to combine stocks and thus reduce the riskiness of their portfolios.

a. True

b. False

13. You are considering two bonds. Bond A has a 9% annual coupon while Bond B has a 6% annual coupon. Both bonds have a 7% yield to maturity, and the YTM is expected to remain constant. Which of the following statements is CORRECT?

a. The price of Bond B will decrease over time, but the price of Bond A will increase over time.

b. The prices of both bonds will remain unchanged.

c. The price of Bond A will decrease over time, but the price of Bond B will increase over time.

d. The prices of both bonds will increase by 7% per year.

e. The prices of both bonds will increase over time, but the price of Bond A will increase at a faster rate.

14. A 12-year bond has an annual coupon of 9%. The coupon rate will remain fixed until the bond matures. The bond has a yield to maturity of 7%. Which of the following statements is CORRECT?

a. If market interest rates decline, the price of the bond will also decline.

b. The bond is currently selling at a price below its par value.

c. If market interest rates remain unchanged, the bond’s price one year from now will be lower than it is today.

d. The bond should currently be selling at its par value.

e. If market interest rates remain unchanged, the bond’s price one year from now will be higher than it is today.

15. Suppose the real risk-free rate is 3.50% and the future rate of inflation is expected to be constant at 2.20%. What rate of return would you expect on a 1-year Treasury security, assuming the pure expectations theory is valid? Disregard cross-product terms, i.e., if averaging is required, use the arithmetic average.

a. 5.14%

b. 5.42%

c. 5.70%

d. 5.99%

e. 6.28%

16. Suppose 1-year T-bills currently yield 7.00% and the future inflation rate is expected to be constant at 3.20% per year. What is the real risk-free rate of return, r*? Disregard any cross-product terms, i.e., if averaging is required, use the arithmetic average.

a. 3.80%

b. 3.99%

c. 4.19%

d. 4.40%

e. 4.62%

17. Assume that interest rates on 20-year Treasury and corporate bonds are as follows:

T-bond = 7.72% AAA = 8.72% A = 9.64% BBB = 10.18%

The differences in these rates were probably caused primarily by:

a. Tax effects.

b. Default and liquidity risk differences.

c. Maturity risk differences.

d. Inflation differences.

e. Real risk-free rate differences.

18. You plan to analyze the value of a potential investment by calculating the sum of the present values of its expected cash flows. Which of the following would lower the calculated value of the investment?

a. The cash flows are in the form of a deferred annuity, and they total to $100,000. You learn that the annuity lasts for only 5 rather than 10 years, hence that each payment is for $20,000 rather than for $10,000.

b. The discount rate increases.

c. The riskiness of the investment’s cash flows decreases.

d. The total amount of cash flows remains the same, but more of the cash flows are received in the earlier years and less are received in the later years.

e. The discount rate decreases.

19. Assume that inflation is expected to decline steadily in the future, but that the real risk-free rate, r*, will remain constant. Which of the following statements is CORRECT, other things held constant?

a. If the pure expectations theory holds, the Treasury yield curve must be downward sloping.

b. If the pure expectations theory holds, the corporate yield curve must be downward sloping.

c. If there is a positive maturity risk premium, the Treasury yield curve must be upward sloping.

d. If inflation is expected to decline, there can be no maturity risk premium.

e. The expectations theory cannot hold if inflation is decreasing.

20. Disregarding risk, if money has time value, it is impossible for the present value of a given sum to exceed its future value.

a. True

b. False

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