Exam 4: Security Analysis and Portfolio Theory

A common stock is expected to generate an end-of-period dividend of $5 and an end-of-period price of $62.If this security has a beta coefficient of 1.3,the risk-free interest rate is 10%,and the expected return on the market portfolio is 19%,then what is the value of this security today?

Tests of market efficiency are often referred to as joint tests of two hypotheses: that the market is efficient and that an expected returns model holds.Explain.Is it ever possible to test market efficiency alone (i.e.,without also testing some type of asset-pricing model)?

Which of the following statements is (or are)true of the efficient markets hypothesis?

You are testing the effect of merger announcements on stock prices.(This type of testing is called an "event study.") Your procedure is as follows: Step 1: You select the twenty biggest mergers of the year. Step 2: You isolate the date the merger becomes effective as the key date around which you will examine the data. Step 3: You look at the returns for the five days after the effective merger date. After looking at the returns in step 3 (you found an average of 0.13%),you conclude that you could not have made money on merger announcements.Are there any flaws that you can detect in this test? How could you correct for them? Can you devise a stronger test?

You are trying to value a stable firm that has the following characteristics: current EPS = $5.00; dividend payout ratio = 60%; ROA = 16%; debt/equity ratio = 0.8; interest rate on debt = 11%; required rate of return = 15%; number of shares outstanding = 100,000.What is your best estimate of the firm's value?

You have the opportunity to invest at the following rates.Rank them from best to worst. a. 10% compounded continuously b. 10.3% compounded monthly c. 10.7% simple interest (compounded annually)

Tribbles are soft,furry creatures that reproduce themselves by dividing (like amoebas do)into two tribbles every 60 days.If a tribble now costs $1,what should be the price of a forward contract that expires in 60 days (immediately after the reproduction takes place)for one tribble?

Studies of firms classified on the basis of P/E ratios come to the conclusion that low-P/E-ratio stocks earn much higher returns,after adjusting for risk,than high-P/E-ratio stocks.This is because

An investment bank has come up with a new product on the S&P 500 index.It offers an appreciation share,the owner of which is entitled to all price appreciation over 10% in the first two years and over 20% in the next three years after that.If the current index value is 250,the riskless rate is 8%,the dividend yield on the index is 3%,and the annualized standard deviation of the index is 20%,what is the value of this share? (Hint: There might be more than one option in this share.)

Assume that you have been asked to evaluate the P/E ratios of five prospective acquisition candidates.You have the following information: company P/E ratio beta growth rate payout ratio 10 1.0 5\% 0.9 8 1.25 8\% 0.8 9 1.25 10\% 0.6 6 1.5 11\% 0.4 5 2.0 12\% 0.45 a. If the riskless rate is 7% and the above statistics will hold through infinity, which of the companies are overvalued and which are undervalued? b. Now assume that you are using a regression methodology to estimate the relationship between P/E ratios and these variables. Using a cross-sectional sample, you obtain the following equation: P/E = 2 + 0.3 x growth rate + 5 x payout ratio - 1 x beta. Using this equation, which of the companies are overvalued and which are undervalued?

Discuss whether the following statement is true or false: Buying a call option on a portfolio of common stocks is the same as buying a futures contract on the same portfolio.

You are a portfolio manager who has just discovered the possibilities of stock-index futures.Assume that today is January 12. a. Assume that you have the resources to buy and hold the stocks in the S&P 500. The current level of S&P 500 index is 258.90, the June S&P 500 futures contract is selling for 260.15, the annualized rate on the T-bill expiring on the expiration date of the futures contract is 6%, and the annualized dividend yield on S&P 500 stocks is 3%. Assume that dividends are paid out continuously over the year. Is there a potential for arbitrage, and, if so, how would you go about setting up the arbitrage? b. Assume now that you are known for your stock selection skills. You have 10,000 shares of Texacola (now selling for 38) in your portfolio, and you are worried about the direction of the market until June. You would like to protect yourself against market risk by using the December S&P 500 futures contract (which is currently at 260.15). If Texacola's beta is 0.8, how would you go about creating this protection?

Assume that it is now December 2002.You are given the following information: December 2003 gold futures contract price = 515.60/troy oz.; spot gold price = 481.40/ troy oz.; annualized interest rate = 6%; annualized carrying cost of gold = 2%. a. The above information presents an arbitrage opportunity. Describe what you would have to do now to set up the arbitrage. b. What would you have to do in December to unwind the position in part a? What is the arbitrage profit?

Consider a forecast of the next period's earnings.How much information is in past earnings?

You have been asked to estimate the duration of a ten-year,8% coupon bond with a yield to maturity of 10%.It has a sinking fund provision where 10% of the outstanding bonds will be retired each year.What is the duration of this bond?

You want to invest $1 million in the S&P 500 index for one year.There are two ways to go about it.You could actually buy all the stocks in the index according to their index investment weights,or you could buy an S&P index futures contract (and put the $1 million in a risk-free investment for one year).The S&P index is now at 350,and an S&P index future with a one-year maturity is selling at 355.The riskless rate is 8%,and the dividend yield on the S&P index is 6%.Assume that the S&P contract size is equal to the index,and that all cash flows to the future occur at maturity (i.e.,there is no daily resettlement). a. What should you do and why? b. Under your strategy for part a, how much money will you have at the end of the year if the S&P index closes at 380?

In a strongly efficient market,no mutual fund manager will beat the market in any period.

You are interested in putting together an option position on Flaming Yon,Inc.The current stock price is 58.25,and The Wall Street Journal of December 11,2002,reports the following prices for the various listed options on the stock: a. Assume that you buy a January 50 call and a January 60 put. Draw the payoff diagram for this position at maturity. b. What are the upside and downside breakeven points for this position?

You are the CFO of a small corporation and you anticipate that you will have a significant liability of $10 million coming due in five years.You are considering investing enough money in one or both of the following two bonds to protect yourself against interest rate risk: a five-year bond with a coupon rate of 16%,and a ten-year bond with a coupon rate of 12%.Each bond has a yield to maturity of 12%.Assuming duration is a perfect measure of interest rate risk,what combination of the two bonds would provide you with complete protection against interest rate risk?

Discuss whether the following statement is true or false: If semi-strong efficiency holds,then weak-form efficiency must hold.