Essay - Finance Test Question 1. a I) Expected Return of Her...

Finance Test

Question 1.

A i) Expected return of her new portfol*****o, including ABC stock = 10.3612% per annum ii) covariance of ABC stock *****s with original portfolio returns=100.8182 i) Expected return ***** the government secur*****ties = 8.024% annually ii) Covariance with original ***** *****s = 32.223 iii) standard deviation of ***** new portfolio ***** ***** government securities = 10.9%

The beta of her new ***** with the government ***** is lower than the ***** of her original portfolio. That is because ***** government securities have zero beta, i.e. they have no variation, and therefore bring the variation down for the entire portfolio.

***** reasoning is correct to the extent that the expected return ***** SD are the same. By holding half ***** her ***** in ABC and ***** ***** XYZ, she may reduce her SD through ***** portfolio effect (net of brokerage expenses).

Question 2.

Stock A's beta ***** 0.*****0736 as compared to the market portfolio

***** 3.

***** would be willing to pay up ***** $91.47, assuming a 10-ye*****r time horizon and a discount rate of 14%. This is calculated as a net present v*****lue of the long-term ***** on equity. Two key assumpti*****s

That the 90% equity retention has continued for some ***** in the past, ***** *****re*****e the $5.00 per share earnings last year retained $4.50.

That this 90% retention will continue for ***** next 10 years

No dividends paid would pay up to $36.03, as both the ***** retention and ROE are lower. As with (a), I am ********** back- and forward rates remaining ***** same. The calculation is as follows:

Retained earnings at end of last year = $3.00

*****ncrease per year in retained earnings: 19%

10th year retained earnings (as example) = $17.08

Discount rate used for NPV calculation: 14%

Question 4.

*****

***** exact percentage gain/loss on each bond is as follows: zero-coupon, 11.0847%, 6%, 10.7183%;

The approximate difference if the bonds were ********** callable ***** the change *****ok place at time 0 would ***** ********** 52%

Convexity/value at yield=7%

The exact percentage gain/loss on ***** bond ***** as *****: zero-coupon, =-12.59204%, 6%, -13.04398%;

The approximate difference if the ***** were not callable and the change took ***** at ***** 0 would be *****ly 52%

***** bonds have a greater convexity than bonds which ***** a coupon during the holding period. This *****llows for a greater variation in capital gains, particularly at the early part of the bond holding period (i.e. shortly after issuance). We saw in the above example th***** ***** yields go down, zero-coupon *****s decline less, while if ***** ***** go up, zero-coupon bonds increase slightly more.

It would not be possible to price both bonds the same unless ***** were at ***** ***** Macaulay duration point. That is ***** the difference in convexity dictates different returns along ***** yield curve, ***** therefore different pricing throughout the lives of ***** bonds

Question 5.

A a) b. The bre*****keven *****s of the position are $57.50 and