Problem Set (1) Chapter 2 1. A stock sells for $10 per share. You purchase 100 shares for $10 a share (i.e., for $1,000), and after a year the price rises to $17.50. What will be the percentage return on your investment if you bought the stock on margin and the margin requirement was (a) 25 percent, (b) 50 percent, and (c) 75 percent? (Ignore commissions, dividends, and interest expense.) 2. You purchase 100 shares of stock at $100 ($10,000); the margin requirement is 40 percent. What are the dollar and percentage returns if a) You sell the stock for S112 and buy the stock for cash? b) You sell the stock for $90 and buy the stock on margin? c) You sell the stock for $60 and buy the stock on margin? 3. Ms. Tejal Gandhi has decided that the stock of SmallCap Inc is overvalued at $4 a share and wants to sell it short. Since the price is relatively low, short sales cannot be executed on margin, so Ms. Gandhi must put up the entire value of the stock when it is sold short. a) What is the percentage loss if the price of the stock rises to $8? b) What is the percentage loss if the price of the stock rises to $107 c) What is the percentage gain if the company goes bankrupt and is dissolved? d) What are the maximum percentage gain the short seller can eam and the largest percentage loss the short seller can sustain? c) From the short seller's perspective, what are the best and worst case scenarios? 4. An investor sells a stock short for 36 a share. A year later, the investor covers the position at S30 a share. If the margin requirement is 60 percent, what is the percentage return cared on the investment? Redo the calculations, assuming the price of the stock is $42 when the investor closes the position Q1. Mohamed Hasan is an analyst with Gulf Investment Bank. Mohamed is reviewing the valuation of three companies (NBB.BBK, and SALAM) using the relative valuation (P/E) and their corresponding current market prices. NBB BBK SALAM Market price 35 4 intrinske price 40338 Based on the above information, which stock is overvalued? (1 Mark) Based on the above information, which stock is undervalued? (1 Mark) Based on the above information, which stock is fairly valued? (1 Mark) Q2. Suppose that the average PE multiple in the oil industry is 20. Dominion Oil is expected to have an EPS of $3.00 in the coming year. What is the intrinsic value of Dominion Oil stock? If Dominion Oil stock is selling for $55 a share, is it a good buy? Explain Q3: Ratios for two firms are given below along with their industry averages. Industry A is a high growth industry while industry B is a slower growth consumer durables industry PEP Price Sales FA2214 Indy A 25 6 10 Indy B 12 8