Reference no: EM133196296

Assignment:

An analyst estimates the following CAPM Model for ECN Inc. [Enter % as whole number, i.e. 10% is 10].

(??_?????? - ??_??) = 2 + 1.55(??_?? - ??_??)

a) Suppose the market premium is expected to be 12% for the next year. If ECN Inc. has a current return of 20% and the risk-free rate is 1%, is this stock over- or under-valued. Assume the estimated model is true.

b) A different analyst believes that macroeconomic factors, particularly monetary policy matters. To capture that she includes the federal funds rate (FFR) in her CAPM-based model. She estimates the following. [Enter % as whole number, i.e. 10% is 10].

(??_?????? - ??_??) = 1.5 + 1.40(??_?? - ??_??) - 0.25(??????)

Using the same information from part a) and the fact that the federal funds rate is expected to be 1%, is ECN Inc. over- or under-valued?

c) Based on the model estimated in part b) would news that the Federal Reserve is conducting open market purchases like be good or bad for shareholders of ECN Inc? Briefly explain.

d) Based on the model estimated b), briefly explain whether you think shares of ECN Inc. would be complements or substitutes for Treasury (US government) bonds.

2) Suppose the following represents daily share price for XYZ Inc.

                       XYZ Inc.

Day         1        2         3          4         5         6

Price ($)  2.00   5.00    1.00     6.00    5.00     8.00

Calculate a 2-day moving average of these prices (the first number you have will be for day 2).

b) Calculate a 3-day moving average of these returns (the first number you have will be for day 3).

c) Suppose you wanted to use the 2-day and 3-day moving average for momentum trading. Is there a buy or sell signal on days 3,4, 5, or 6? Briefly explain.

d) The following are the standard deviations for days 3-6.

                                                   XYZ Inc.

Day                              3            4          5           6

Standard Deviation ($)  3.00       3.79       3.79       1.53

Calculate the Bollinger Bands based on the 3-day moving average for Day 6

e) On Day 6 is the stock closer to a "buy" or "sell" signal based on the Bollinger Bands?

True/False Explain. For each of the following statements, state whether it is "true" or "false" and provide a brief explanation of your reasoning.

a) Knowing yesterday's stock price is helpful for predicting tomorrow's stock price based on the semi-strong form of the efficient market hypothesis.

b) Fundamental analysis is useful for predicting future stock prices based on the semi-strong from of the efficient market hypothesis.

c) If a market is efficient, it may not be perfectly competitive.

4) The following is the Fama-French Three Factor model estimated for ECN Inc. [Notice here for alpha, 1 would be 1%.]

                                       ECN Inc.Three Factor Model

Alpha/Factor               α         Rm-Rf         SMB         HML

Coefficient                  1          1.30          1.10        -0.67

P-Value                      0.12      0.00          0.04         0.09

Using only the variables statistically significant at a 5% level, what is the expected return on ECN Inc. if the risk-free rate is 1%, market premium is 12%, small stocks outperform large by 3% and value stocks outperform growth stocks by 5%.

b) If ECN Inc's current return is 20%, is ECN Inc. over- or under-valued based on the three factor
model.

5) The current price of ABC Inc. is $12 per share; put options and call options on the stock both have a strike price of $12 and are selling for $0.60 per option.

a) Draw a well labelled net payoff diagram for the portfolio that includes 1 share of ABC Inc. and 1 put option

b) Draw a well labelled net payoff diagram for a portfolio that is short 1 call option and includes one share of stock.

c) Suppose on the expiration date the price of ABC Inc. ends up being $10 per share. What is the profit/loss on the portfolios in part a) and b).

d) Suppose someone had bought 50 call options and the price ends up being $10 per share. What would be the profit/loss on that?

6). Suppose ABC Inc. is currently $12 per share and will go either up to $16 or down to $10. Suppose the risk-free interest rate is 3%.

a) We are interested in finding the price of a put option. What is the hedge ratio using the binomial model?

b) What is the price of a put option using the binomial model?

c) Using put-call parity what is the price of a call option?

d) Re-do parts a) and b) except for call options instead of put options. Does your answer match what you found in part c)?

e) If interest rates were to increase, all else the same how would that affect the price of the put options? All else the same, how would an increase in the interest rates affect the price of call options?