1. Stock A and B have the following probability distributions:
ECONONOMY PROBABILITY K(A) K(B)
Boom 0.5 28% 40%
Average 0.3 10% 20%
Recession 0.2 (15%)* (50%)*
*- Numbers in parenthesis are negative.
Calculate the rates of return, standard deviations, and coefficients of variation for the two stocks. Which of the two offers the better tradeoff between risk and return? Which stock probably has a higher beta? Why? As an investor, how could you use each stock in your portfolio?
2. You have been awarded a large insurance settlement after being poised at a local restaurant. Assuming that there are no tax considerations and that you could get a 10% return on investments, would you take a lump sum of a $2 million today, or 25 annual installments totaling $ 4.6 million beginning today? Use time value of money to justify your answer. Would you make the same decision if you could only get a 4% return on your investment? What other qualitative and quantitative factors should also be considered in deciding between the lump sum and annuity?
3. If you had $160,000 to invest and bought a CD that matured in 25 years and paid 6% annual interest, how long would it take until the value of your investment tripled? In addition to interest rates, what other considerations should be part of your investment decision?
4. If Treasury Bonds yield 5% and the overall market is demanding a 12% return on stocks, use the Security Market Line (SML) to determine what a stock with a beta of 1.3 should yield. Graph the Security Market Line. If your stock analyst predicts that this stock will yield 14%, is a good buy according to the SML? Explain?
5. Megasoff, Inc. stock sells for $65 today. What kind of options strategy could you use if you planned to buy 500 shares of Megasoff, Inc. stock in July with the money you get when your dear Aunt Mabel's estate settles and worry that Megasoff's shares will rise significantly between now and then? Explain. Would you use the same strategy if you were worried about the value of the stock, which you hold in your portfolio, going down? Why/why not?
6. If all of a company's asset management ratios are inferior to the industry standards, is that always an accurate reflection of bad asset management? Use examples of each asset management ratio to explain your answer. If these ratios were misleading, what could the company's CFO say about its management that would decrease your concerns as an investor?
7. Assume today is March 16, 2010. On September 20, 1996, you bought $30,000 face value of 8% semiannual U.S Treasury Bonds due on March 15, 2015 at 106% of par. The bond was originally issued with a 25- year maturity in 1989. How much accrued interest did you pay when you bought the bond in 1996? If the market demands 6% for 5-year Treasuries today, how much should your bond be worth today? If you sold the bond today, how much of a capital gain or loss (if any) would you expect to see on your original investment? A second semiannual bond, issued by General Motion, Inc, matures in 15 years, has a 9% coupon, and sells at 92% of par. What are current yield and yield- to- maturity for this bond? A third bond issued by the city of South Portland, is selling at par, has a 5% coupon and matures in 3 years. You are in 28% federal and 7% state tax brackets. Which of the three bonds offers the best return currently, after taxes are considered? What other factors should go into your consideration in making this investment? Using financial management theory, predict what you believe will happen to term structure and risk structure of interest rates over the coming year.
8. Beverly Hillbillies, Inc. discovers oil when ol' jed is shootin' fer some food. The company paid a dividend of $1.10 for the year ending yesterday. Based on the expected size of the oil deposit, most stock analyst who follow your company believe that the company will grow by 40% for the next three years, then the growth rate will slow to a constant 8% rate. Based on the company's risk, the market currently demands 14% for the stock (your rs). What would you expect the price to be for BHI today? If a second, smaller group of analyst believed that the oil would prove to be a small deposit and that there would be no supernormal growth, only the constant growth rate described above, what would this analyst believe that the stock should be worth? Why might the rs for the stock be higher than it is for the overall stock market?