Determine what is the expected return of the fad followers

Assignment Help Financial Econometrics

Reference no: EM13327222

1. Assume that the CAPM is a good description of stock price returns. The market expected return is 7% with 10% volatility and the risk-free rate is 3%. New news arrives that does not change any of these numbers but it does change the expected return of the following stocks:

Expected Return Volatility Beta

Green Leaf 12% 20% 1.5

Nat Sam 10% 40% 1.8

HanBel 9% 30% 0.75

Rebecca Automobile 6% 35% 1.2

a. At current market prices, which stocks represent buying opportunities?

b. On which stocks should you put a sell order in?

2. Consider the price paths of the following two stocks over six time periods

1 2 3 4 5 6

Stock 1 10 12 14 12 13 16

Stock 2 15 11 8 16 15 18

Neither stock pays dividends. Assume you are an investor with the disposition effect and you bought at time 1 and right now it is time 3. Assume throughout this question that you do no trading (other than what is specified) in these stocks.

a. Which stock(s) would you be inclined to sell? Which would you be inclined to hold on to?

b. How would your answer change if right now is time 6?

c. What if you bought at time 3 instead of 1 and today is time 6?

d. What if you bought at time 3 instead of 1 and today is time 5?

3. Assume the economy consisted of three types of people. 50% are fad followers, 45% are passive investors (they have read this book and so hold the market portfolio), and 5% are informed traders. The portfolio consisting of all the informed traders has a beta of 1.5 and an expected return of 15%. The market expected return is 11%. The risk-free rate is 5%.

a. What alpha do the informed traders make?

b. What is the alpha of the passive investors?

c. What is the expected return of the fad followers?

d. What alpha do the fad followers make?

4. Each of the six firms in the table below is expected to pay the listed dividend payment every year in perpetuity.

Firm Dividend ($ million) Cost of Capital (%/Year)

S1 10 8

S2 10 12

S3 10 14

B1 100 8

B2 100 12

B3 100 14

a. Using the cost of capital in the table, calculate the market value of each firm.

b. Rank the three S firms by their market values and look at how their cost of capital is ordered.

What would be the expected return for a self-financing portfolio that went long on the firm with the largest market value and shorted the firm with the lowest market value? (The expected return of a self-financing portfolio is the weighted average return of the constituent securities.) Repeat using the B firms.

c. Rank all six firms by their market values. How does this ranking order the cost of capital?

What would be the expected return for a self-financing portfolio that went long on the firm with the largest market value and shorted the firm with the lowest market value?

d. Repeat part c but rank the firms by the dividend yield instead of the market value. What can you conclude about the dividend yield ranking compared to the market value ranking?

5. Consider the following stocks, all of which will pay a liquidating dividend in a year and nothing in the interim:

Market Capitalization ($ million) Expected Liquidating Dividend ($ million) Beta

Stock A 800 1000 0.77

Stock B 750 1000 1.46

Stock C 950 1000 1.25

Stock D 900 1000 1.07

a. Calculate the expected return of each stock.

b. What is the sign of correlation between the expected return and market capitalization of the stocks?

6. You are currently considering an investment in a project in the energy sector. The investment has the same riskiness as Exxon Mobil stock (ticker: XOM). Using the data in Table 13.1 and the table above, calculate the cost of capital using the FFC factor specification if the current risk-free rate is 3% per year.

Modigliani-Miller II: Leverage, Risk, and the Cost of Capital

In mid-2012, AOL Inc. had $100 million in debt, total equity capitalization of $3.1 billion, and an equity beta of 0.90 (as reported on Yahoo! Finance). Included in AOL's assets was $1.5 billion in cash and risk-free securities. Assume that the risk-free rate of interest is 3% and the market risk premium is 4%.

a. What is AOL's enterprise value?

b. What is the beta of AOL's business assets?

c. What is AOL's WACC?

Reference no: EM13327222

Questions Cloud

What will be the new return on stockholders equity : what will be the new return on stockholders' equity? Assume that the profit margin stays the same as do current and long-term liabilities and what would happen to return on equity if the debt-to-total-assets ratio decreased to 60 percent?

Determine appropriate amount and classification of each item : Unearned revenue of $78,000 is included as a current liability even though only two-thirds will be earned in 2014. Determine the appropriate amount and classification of each of the following items (in order of liquidity).

Determine year-end balance in retained earnings for k and j : The trial balance for K and J Nursery, Inc., listed the following account balances at December 31, 2013, the end of its fiscal year: cash, $19,000; accounts receivable, $14,000; inventories, $28,000; equipment (net), $83,000;

Statement of retained earnings for the year ended december : If the market value of a share of common stock is 3.2 times book value for 2010, what is the firm's P/E ratio for 2010?

Determine what is the expected return of the fad followers : Assume that the CAPM is a good description of stock price returns. The market expected return is 7% with 10% volatility and the risk-free rate is 3%. New news arrives that does not change any of these numbers

Prepare a statement of cash flows for the jeter corporation : Prepare a statement of cash flows for the Jeter Corporation and Statement of Retained Earnings for the year ended December 31, 2010 and Comparative Balance Sheets for 2009 and 2010 of Jeter Corporation

Calculate the net present value for the original transaction : Firm H has the opportunity to engage in a transaction that will generate $100,000 of cash flow (and taxable income) in year 0. How does the net present value of the transaction change if the firm could restructure the transaction

Determine the conditions in which datagrams are dropped : Use the attached client and server programs to make a test kit to determine the conditions in which datagrams are sometimes dropped.

What was the original distance between outfielder and batter : A baseball is hit at 30.0 m/s at an angle of 53.00 above the horizontal. What was the original distance between the outfielder and the batter

User Account

All Pages