2. Suppose that you're given the following information of rates of return for three mutual funds in the stock market as assessed by your financial analyst in mutual fund. The "beta's" for these mutual funds are 1.32, 0.93, 1.24, for Fund A, Fund B, and Fund C, respectively. The market return on S&P 500 index is 12% on the average. Answer the following questions:

a) Let the risk-free rate be 2%, what are the required rates of return for Fund B, and Fund C? What model did you apply here? Is this model a market equilibrium condition?

b) What is the purpose of Capital Asset Pricing Model (CAPM)?Why does the Security Market Line (SML) represent the capital market equilibrium?

c) If you want to combine Fund B and Fund C to form a portfolio that has the same "beta" as Fund A, what is the appropriate weight assigned to each fund? What is the required rate of return for this new portfolio now? Is this the rate of return that the new portfolio's required rate of return? Why or why not?

3. Suppose that you're given the following information of rates of return for the stock market as assessed by your financial analyst in mutual fund. Answer the following questions: CAPM

a)What are the means, standard deviations for each fund? Why do you need to specify the means and the standard deviations?

b)What are the co-variances for these funds? Are these funds mutually "diversifiable"? Why or why not? (Hint: apply correlation coefficients to tell)

c)Explain the assumption(s) and reason(s) why the expected rate of return of investor can be represented by the expected value of the rate of return.

d)Suppose that Fund A represents the Market Index Portfolio. What are the "beta's" for Fund B and Fund C? What is the difference in concept between standard deviation and beta for Fund B and Fund C?

e)Suppose the risk-free rate is 2% and Fund A represents the Market Index Portfolio. What are the expected rates for Fund B and Fund C now according to CAPM? Are they different from the "means" you calculated in a)? Why?

States of the world

Probability

Fund A

Fund B

Fund C

Boom

12%

28%

8%

Recovery

24%

16%

12%

Recession

-32%

-20%

4%

Practice questions Principle of Finance Instructor: Jau-Lian Jeng, Ph.D. Information: a. Answer all questions. b. Show your works. No point will be given to any answer without elaboration of analyses and explanation. State your assumptions clearly. c. all answers with calculation must provide interpretation. d. You need to explain the reasoning. f. Type your answers with Word and copy and paste your calculation in Excel spreadsheet into the document. 1. Suppose you're given with the following information for some assets; a 10-year 2.0%coupon bond of semi-annual coupon payment with face value as $1,000, a common stock of $3.60 expected dividend with 2.5% growth rate currently. Both bond and common stock are issued by Company M&M. Answer the following questions. a) Suppose the yield to maturity (that is, the discount rate) for the bond is 10%, what is the present value of this coupon bond? 1) $435.67 2) $501.51 3) $738.9 4) $583.20 5) none of the above b) Is it a discount bond? Why? c) What is the bond's fair value if the discount rate is 2.0%? 1) $1000 2) $ 894.30 3) $798.32 4) $1036.09 5) none of the above. d) Suppose the bond is in fact, callable. That is, the firm may repurchase it with the call price as $918 and the bond is callable at the end of year 4, what is the yield to call for this bond if the current bond price is $789? (That is, the discount rate for the bond if you choose to be called. Use IRR function in EXCEL for this question). 1) 11% 2) 9.27% 3) 7.464% 4) 6.20% 5) more than 12% 918 plus coupon 4 years only e) Suppose the stock price is $22.32 per share right now, and assuming the capital market is efficient, what is the required rate of return for the stock? What are the assumptions you have for this present value model? 1) 16.73% 2) 12.64% 3) 9.87% 4) 15.84% 5) about 5% f) Suppose the dividend growth rate for the first 4 years is 2.3% and after 4 th year it changes to g% from the beginning of 5th year and on. If the stock price right now is $20.25 per share, what is possible growth rate of dividends g from the 5th year and on if using the rate of return obtained from e)? Please show your work! g) Suppose the bond is convertible. That is, at the end of the 3rd year after issuance, the holder of the bond has the right to convert the bond with 1 to 5 ratio toward company M&M's common stock. Would you possibly convert the bond at the end of 4th year if based on the above information in a) and c)? h) Why the so-called \"fair value\" of financial asset is represented by the present value of future cash flows of financial asset? 2. Suppose that you're given the following information of rates of return for three mutual funds in the stock market as assessed by your financial analyst in mutual fund. The "beta's" for these mutual funds are 1.32, 0.93, 1.24, for Fund A, Fund B, and Fund C, respectively. The market return on S&P 500 index is 12% on the average. Answer the following questions: a) Let the risk-free rate be 2%, what are the required rates of return for Fund B, and Fund C? What model did you apply here? Is this model a market equilibrium condition? b) What is the purpose of Capital Asset Pricing Model (CAPM)? Why does the Security Market Line (SML) represent the capital market equilibrium? c) If you want to combine Fund B and Fund C to form a portfolio that has the same "beta" as Fund A, what is the appropriate weight assigned to each fund? What is the required rate of return for this new portfolio now? Is this the rate of return that the new portfolio's required rate of return? Why or why not? 3. Suppose that you're given the following information of rates of return for the stock market as assessed by your financial analyst in mutual fund. Answer the following questions: CAPM a) What are the means, standard deviations for each fund? Why do you need to specify the means and the standard deviations? b) What are the co-variances for these funds? Are these funds mutually \"diversifiable\"? Why or why not? (Hint: apply correlation coefficients to tell) c) Explain the assumption(s) and reason(s) why the expected rate of return of investor can be represented by the expected value of the rate of return. d) Suppose that Fund A represents the Market Index Portfolio. What are the \"beta's\" for Fund B and Fund C? What is the difference in concept between standard deviation and beta for Fund B and Fund C? e) Suppose the risk-free rate is 2% and Fund A represents the Market Index Portfolio. What are the expected rates for Fund B and Fund C now according to CAPM? Are they different from the \"means\" you calculated in a)? Why? States of world Boom the Probability 1 4 Fund A 12% Fund B 28% Fund C 8% Recovery Recession 1 2 1 4 24% 16% 12% -32% -20% 4% 4. Answer the following multiple questions and with \"Explanation\". (No credits will be given if no explanation is shown) a) The mutual funds are good for investments because they are: 1) all efficient portfolios 2) safe investments 3) good candidates for risk-return tradeoffs. 4) all government-sponsored 5) none of the above. b) The reason for using discounted cash flows for time value of money is: 1) money earns interests 2) the opportunity costs that include compensations for risk 3) inflation rate 4) the market demand and supply for securities 5) none of the above. c) The bond's yield to maturity is the required rate of return for creditors of the firm regardless of the investors' intent of holding horizons. The reason is that it represents the rate that is: 1) the investor can earn if consider holding the bond until maturity 2) represents the inflation rate prevails in the current economy 3) the money market interest for savings as time deposit 4) the long-term interest rate for debts 5) none of the above. d) The coefficient as \"beta\" is a measure of systematic risk. Therefore, it must encompass the risk except for: 1) the change of administration for certain firms 2) the response toward the investors' overall perspectives for capital market 3) the change of economy 4) the change of current governmental fiscal policy 5) none of the above. 5. You are given with the following information statements of a public firm Benny in the airline industry concurrently. (Notice that all negative numbers are parenthesized). The firm has issued 12 million shares of common stock with current market price as $55/per share, the expected dividend is $6.90/per share with 3.2% growth rate, 300,000 shares of preferred stocks with promised preferred dividend and preferred stock price as $3.20/per share and $14.5/per share, respectively. The firm also has currently, 2 million 4.2%coupon bonds with $1,000 face value that pays the coupons semi-annually. The current bond price is $820/per bond. The bonds are expected to mature at 2025. Answer the following questions: a) If using the market prices for assessment on rates of return, what is the rate of return the common stock of Benny? What is the rate of return for their preferred stocks? b) What is the bond's yield to maturity of the firm's corporate bond? c) Suppose you are also given with the following financial statements of Benny for the past three years. What are the historical returns on equity for this company for the past three years? Is the firm Benny doing well from the perspectives of shareholders? Why or why not? d) Is this firm well-diversified with their arrangement of capital? That is, are they well diversified with different sources of capital? e) Based on the given information, provide your ratios analyses. Apply the Du-Pont model and interpret your results for the firm's performance. f) Provide the common size statements for Balance Sheet and Income Statement. What kind of noticeable pattern you may identify for the firm? Is this usual for the airline industry? Balance Sheet (in millions) 2013 2014 2015 Assets Cash Marketable securities Accounts Receivable Inventory Plant, Building, and Equipment's (net) Investments in affiliates 30 100 920 310 1872 0 10 100 150 178 2002 30 473 0 800 450 1209 329 Total Assets 3232 2470 3261 Liabilities Short-term debts Advances from customers Accounts payable Interest payable Tax payable Other Accrued Expenses Bonds payable 507 111 285 75 127 20 925 9 34 192 98 147 15 686 30 134 771 62 128 35 750 1021 74 87 3232 1055 156 78 2470 1175 47 129 3261 2013 2014 2015 3266 2115 700 160 3338 1979 812 298 3933 2510 759 284 Stockholders' Equity Common stock Additional paid-in capital Retained earning Total liabilities and equities Income Statement(in millions) Net Sales Cost of Goods Sold Selling and General Expenses Depreciation Expense Interest Expense Income Tax Expense Net Income 90 195 6 109 137 3 121 254 5