1. Discuss the factors that contribute to an efficient market. (10 Marks)

2. As a financial analyst, you have estimated four possible states of nature in the economy, the returns and probability for the security in that economy are as follows:

Probability(Pi) Possible rate of return (Ri)

0.2 -15.00%

0.3 12.00%

0.2 25.00%

0.3 20.00%

Required: Calculate the expected return, variance, standard deviation and coefficient of variation of the security. (10 Marks)

3. A investor has a portfolio of the following two stocks. Firm X has a current dividend of Kshs. 2.00 a share, cost of equity of 12% and current market price of KShs. 36.00. Firm Y has a current dividend of Kshs. 3.50 a share, cost of equity of 13% and current market price of KShs. 80.00.

Year Dividend growth rate of firm x

1-2 2%

3 5%

4-5 6%

6 onwards 7%

Year Dividend growth rate of firm Y

1-3 6%

4-5 10%

6 onwards 8%

Required i. Calculate the current value of each stock today. State whether the stocks are fairly valued, undervalued or overvalued. ii. If the cost of equity will drop to 10% for the two firms on the 6th year, calculate the current value of each stock today. (10 marks)