QUESTION 2 a) Gold Industry plc and Metal Materials plc have the following expected returns in four different states of the economy. All states of the economy have equal probability of occurrence. State of economy Gold Industry plc Metal Materials plc Worst scenario -10% 15% Bad state -5% 6% Good state 12% 8% Best scenario 24% -4% (i) Calculate the expected rate of return and volatility for Gold Industry plc and Metal Materials plc, respectively. [8 marks] (ii) Calculate the covariance and correlation coefficient between Gold Industry plc and Metal Materials plc. [6 marks] (iii) Assume the risk-free rate is 2%. If a portfolio invests 60% of its assets in Gold Industry plc , 25% of its assets in Metal Materials plc and 15% of its assets in risk-free assets, then what is the expected rate of return of the portfolio? What is the volatility of the portfolio? [8 marks] (iv) Assuming the capital asset pricing model holds, the risk-free rate is 2% and Metal Materials plcs beta is greater than Gold Industry plcs beta by 0.3. What are the Metal Materials plcs beta and Gold Industry plcs beta, respectively? What is the expected rate return of market portfolio? [8 marks] b) Lisa Johnson is a security analyst and she is estimating the target (theoretical) price of Lake Industries. Lisa has learned that Lake Industries has just paid a dividend of 10 per share in 2015 (the current year). She forecasts that the company will pay a dividend of 14 per share in 2016, 12 per share in 2017, and the companys dividends will increase at a constant rate of 5% thereafter. Lisa believes in CAPM as a proper method to estimate the discount rate. Suppose the market portfolio has an expected return of 10% and a volatility of 16%. Lake Industries stock has a volatility of 35% and a correlation with the market of 0.4. The risk-free return is 4%. Given the above information, what is the target price of Lake Industries? [8 marks] c) c.1 Explain the three forms of market efficiency and their implications to investors. [6 marks] c.2 Identify an empirical challenge to the Efficient Market Hypothesis and explain the strategy to earn abnormal returns by exploiting the anomaly you identify. [6 marks] TOTAL 50 MARKS
QUESTION 2 [8 marks] c) c.1 Explain the three forms of market efficiency and their implications to investors. a) Gold Industry plc and Metal Materials plc have the following expected returns in four different states of the economy. All states of the economy have equal probability of occurrence. State of economy Gold Industry plce Metal Materials plce [6 marks) Worst scenario e -10% e 15% e c.2 Identify an empirical challenge to the Efficient Market Hypothesis and explain the strategy to earn abnormal returns by exploiting the anomaly you identify. Bad state -5% e 6% [6 marks) Good state 12% 8% Best scenario 24% e le TOTAL 50 MARKS (i) Calculate the expected rate of return and volatility for Gold Industry plc and Metal Materials plc, respectively. [8 marks) (ii) Calculate the covariance and correlation coefficient between Gold Industry plc and Metal Materials plc. [6 marks] (iii) Assume the risk-free rate is 2%. If a portfolio invests 60% of its assets in Gold Industry plc 25% of its assets in Metal Materials plc and 15% of its assets in risk-free assets, then what is the expected rate of return of the portfolio? What is the volatility of the portfolio? [8 marks] (iv) Assuming the capital asset pricing model holds, the risk-free rate is 2% and Metal Materials ple's beta is greater than Gold Industry ple's beta by 0.3. What are the Metal Materials ple's beta and Gold Industry pld's beta, respectively? What is the expected rate return of market portfolio? [8 marks] b) Lisa Johnson is a security analyst and she is estimating the target (theoretical) price of Lake Industries. Lisa has learned that Lake Industries has just paid a dividend of 10 per share in 2015 (the current year). She forecasts that the company will pay a dividend of 14 per share in 2016, 12 per share in 2017, and the company's dividends will increase at a constant rate of 5% thereafter. Lisa believes in CAPM as a proper method to estimate the discount rate. Suppose the market portfolio has an expected return of 10% and a volatility of 16%. Lake Industries' stock has a volatility of 35% and a correlation with the market of 0.4. The risk-free return is 4%. Given the above information, what is the target price of Lake Industries? QUESTION 2 [8 marks] c) c.1 Explain the three forms of market efficiency and their implications to investors. a) Gold Industry plc and Metal Materials plc have the following expected returns in four different states of the economy. All states of the economy have equal probability of occurrence. State of economy Gold Industry plce Metal Materials plce [6 marks) Worst scenario e -10% e 15% e c.2 Identify an empirical challenge to the Efficient Market Hypothesis and explain the strategy to earn abnormal returns by exploiting the anomaly you identify. Bad state -5% e 6% [6 marks) Good state 12% 8% Best scenario 24% e le TOTAL 50 MARKS (i) Calculate the expected rate of return and volatility for Gold Industry plc and Metal Materials plc, respectively. [8 marks) (ii) Calculate the covariance and correlation coefficient between Gold Industry plc and Metal Materials plc. [6 marks] (iii) Assume the risk-free rate is 2%. If a portfolio invests 60% of its assets in Gold Industry plc 25% of its assets in Metal Materials plc and 15% of its assets in risk-free assets, then what is the expected rate of return of the portfolio? What is the volatility of the portfolio? [8 marks] (iv) Assuming the capital asset pricing model holds, the risk-free rate is 2% and Metal Materials ple's beta is greater than Gold Industry ple's beta by 0.3. What are the Metal Materials ple's beta and Gold Industry pld's beta, respectively? What is the expected rate return of market portfolio? [8 marks] b) Lisa Johnson is a security analyst and she is estimating the target (theoretical) price of Lake Industries. Lisa has learned that Lake Industries has just paid a dividend of 10 per share in 2015 (the current year). She forecasts that the company will pay a dividend of 14 per share in 2016, 12 per share in 2017, and the company's dividends will increase at a constant rate of 5% thereafter. Lisa believes in CAPM as a proper method to estimate the discount rate. Suppose the market portfolio has an expected return of 10% and a volatility of 16%. Lake Industries' stock has a volatility of 35% and a correlation with the market of 0.4. The risk-free return is 4%. Given the above information, what is the target price of Lake Industries
