1. (8 marks) Time Value of Money a. How much is a cash flow of $1,000 to be paid in two years and $2,000 to be paid in four years worth today if interest rate is 6%? (4 marks) b. What is the nominal interest rate of a $1,000 pure discount loan that the borrower is required to pay back $1,200 in six months? (4 marks)

2. (8 marks) Your company is looking for a 40-channel recording and mixing console. You can either buy one at an upfront cost of $158,400, or lease one for 5 year at $3,544 a month. The machine is expected to obsolete in 5 years with no resale value. Should you buy one or lease one if the companys opportunity cost of capital is 12%? Explain your answer.

3. (8 marks) Suppose you take out a $10,000 loan at 5% APR that requires five equal annual payments, with the first payment starting two years from today. What is the annual payment?

4. (8 marks) Consider two $1,000 par coupon bonds with the same coupon rate and credit rating. Bond A has a maturity of ten years and bond B has five years until maturity. a. Use a numerical example to prove that Bond A has higher interest risk than bond B. (5 marks) b. Explain why bonds with longer maturities carry higher interest rate risk than bonds with shorter maturities. (3 marks)

5. (8 marks) The table below is the YTM of U.S. Treasuries with different maturities on March 22, 2021. 3 mo 6 mo 1 yr. 2 yr. 3 yr. 5 yr. 7 yr. 0.03 0.05 0.06 0.15 0.32 0.87 1.34 a. What is the expected two-year rate in three years according to the Pure Expectations Theory? (4 marks) b. Find the risk premium of a 5-year bond and explain what that number means.

6. (12 marks) Dividend Discount Model (DDM)

a. Welch Corporation just paid its annual dividend of $2.00 per share. The firm is expected to grow at a rate of 15 percent for the next three years and then at 6 percent per year thereafter. The required return of Welch Corp. is 12%. What is the expected price of the stock in one year? (6 marks)

b. A main assumption of the DDM is that dividends grow at a constant rate indefinitely, which is clearly not true in the real world. Does it make it a not-so-useful model? Explain why or why not. (6 marks)

7. (8 marks) Capital Asset Pricing Model (CAPM)

a. What is the beta coefficient of a stock and what does it tell us about the risk premium of that stock? (5 marks)

b. Mario has a portfolio that consists of $100,000 invested in stock A which has a beta of 0.8, $150,000 invested in stock B which has a beta of 1.2, and $50,000 invested in stock C which has a beta of 1.8.What is the portfolio beta according to CAPM ? (3 marks)

8. (12 marks) Mega Movies Inc. is considering investing in a movie project. The expected cash flows of the project are given in the table below. Year 0 1 2 3 4 Cash Flow -$120,000 $65,000 $45,000 $25,000 $15,000 The required return of the project is 12 percent.

a. What is the NPV of this project? (4 marks)

b. What is the discounted payback period of this project? (4 marks)

c. Should the firm accept this project? Explain why or why not (4 marks).

9. (12 marks) Diversification and Portfolio Choice

a. Define the following concepts: covariance of returns and non-systematic risk. (4 marks)

b. Explain the relationship between these two concepts in terms of portfolio choice and diversification. (8 marks)

10. (8 marks) Efficient Market Hypothesis

a. Explain in your own words what it means when we say the capital market is informationally efficient. (3 marks)

b. If the capital market is efficient as defined in part a above, what is the value of money managers to investors? Explain. (5 marks)

11. (8 marks) Two guidelines in the Code of Conduct of a major business news agency that deals with information reporting and personal investments by members of its editorial staff states that

Before you report on a company in which you or your family has any kind of shareholding or other financial interest you must notify the interest to your manager or bureau chief.

You must not deal in securities of any company, or in any other investment, about which you have reported in the previous month.

Critically comment on the rationale of each of the two guidelines above in terms of conflicts of interest and market manipulation. Justify your arguments.