Question
CAPM: Assume that the risk-free rate of interest is 6% and the expected rate of return on the market is 16%. (a) A share of
CAPM:
Assume that the risk-free rate of interest is 6% and the expected rate of return on the market is 16%.
(a) A share of stock sells for $50 today. It will pay a dividend of $6 per share at the end of the year. If beta is 1.2. What (price) do investors expect the stock to sell for at the end of the year if the investor believes the CAPM model holds?
(b)An investor is buying a fully equity financed firm with an expected perpetual cashflow of $1,000 but is unsure of its risk. If the investor thinks the beta of the firm is 0.5, when the true beta is 1, how much more will the investor offer for the firm than its true value?
Futures Contracts:
The current spot price of gold is $1200 per ounce. The risk less interest rate is 1% per month. For simplicity, assume there are no storage/security costs of gold.
a)If you need to buy the gold in 8 months' time, which position (long or short) will you take in the futures market to hedge the price risk of the gold?
b)What is the arbitrage-free futures price for the delivery of gold in 8 months' time?
c)If you see an 8-month futures price of gold quoted at $1240 per ounce, explain how you would capture an arbitrage profit. Show your work in detail by clearly outlining the actions, initial cash flow and cash flow at maturity (T).
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