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Questions and Answers
What is the price of a two-year, $1000 face value risk-free bond with a 20% coupon rate if the YTM for a two-year bond is 5%?
What is the price of a two-year, $1000 face value risk-free bond with a 20% coupon rate if the YTM for a two-year bond is 5%?
- $1,123.61 (correct)
- $1,200.00
- $1,000.00
- $1,050.00
If the risk-free interest rate increases from 2% to 4%, what is the likely impact on Company A's stock price according to the dividend-discount model?
If the risk-free interest rate increases from 2% to 4%, what is the likely impact on Company A's stock price according to the dividend-discount model?
- The stock price will decrease. (correct)
- The stock price will remain the same.
- The stock price will increase.
- The stock price may increase or decrease.
What will be the total amount borrowed to purchase the house if the down payment is $20,000 and the house costs $300,000?
What will be the total amount borrowed to purchase the house if the down payment is $20,000 and the house costs $300,000?
- $300,000
- $280,000 (correct)
- $250,000
- $320,000
What type of mortgage is being offered for the house purchase given the payment structure?
What type of mortgage is being offered for the house purchase given the payment structure?
How many total annual payments will be made on the mortgage if the structure requires $10,000 for the first 5 years and then a constant amount for the remaining 25 years?
How many total annual payments will be made on the mortgage if the structure requires $10,000 for the first 5 years and then a constant amount for the remaining 25 years?
What is the expected dividend growth for Company A in the first two years?
What is the expected dividend growth for Company A in the first two years?
Which of the following aspects is NOT true for the semi-closed book exam?
Which of the following aspects is NOT true for the semi-closed book exam?
What is the face value of the risk-free bond mentioned in the mid-term exam?
What is the face value of the risk-free bond mentioned in the mid-term exam?
What determines whether you want to make the payment on a mortgage when the first payment is due?
What determines whether you want to make the payment on a mortgage when the first payment is due?
If a portfolio has a volatility of 30% and you short sell a stock with a volatility of 40%, what is the meaning of a correlation less than zero between them?
If a portfolio has a volatility of 30% and you short sell a stock with a volatility of 40%, what is the meaning of a correlation less than zero between them?
Why might your finance professor suggest reducing the investment in Hannah Corporation stock?
Why might your finance professor suggest reducing the investment in Hannah Corporation stock?
Given the expected returns and volatilities of value and growth stocks, what can be inferred about the comparison of risk in these two portfolios?
Given the expected returns and volatilities of value and growth stocks, what can be inferred about the comparison of risk in these two portfolios?
What is essential for CAPM to hold true in an economy with both growth and value stocks?
What is essential for CAPM to hold true in an economy with both growth and value stocks?
What happens to the risk of a portfolio when adding a negatively correlated asset?
What happens to the risk of a portfolio when adding a negatively correlated asset?
If the expected return from Hannah Corporation is 20% but volatility is 60%, what might this suggest about its risk profile?
If the expected return from Hannah Corporation is 20% but volatility is 60%, what might this suggest about its risk profile?
What is the significance of a correlation of 0.5 between value and growth stocks in the context of a portfolio?
What is the significance of a correlation of 0.5 between value and growth stocks in the context of a portfolio?
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Study Notes
Question 1
- Calculate the price of a 2-year, $1000 face value risk-free bond with a 20% coupon rate and annual coupons using the information provided from the risk-free bond yield curve.
Question 2
- Analysts are predicting dividends of Company A to grow by $0.15 per year over the next two years.
- After those two years, dividends are expected to grow at a constant rate of 6%.
- Company A's dividend payout rate will remain constant.
- The risk-free interest rate is 2%.
- Calculate the price of Company A's stock according to the dividend-discount model.
- Calculate the price of Company A's stock if the risk-free interest rate rises to 4%. Assume the risk premium investors demand for Company A's stock remains unchanged.
Question 3
- You are looking to purchase a house for $300,000.
- You have a $20,000 cash down payment and need a mortgage for the rest.
- The bank is offering a 30-year mortgage with an interest rate of 5% per year.
- Calculate the annual payment needed for the last 25 years of the mortgage, given that the first 5 years' payments are fixed at $10,000 per year.
- Determine the minimum value of the house at the end of the 6th year (right before the payment with the raised rate) that would justify making the payment.
Question 4
- Your portfolio has a 30% volatility and you are considering short selling a stock with a 40% volatility.
- This short sale would reduce your portfolio's risk.
- Calculate the minimum possible correlation between the shorted stock and your original portfolio.
Question 5
- You have a portfolio with a 14% expected return and 20% volatility invested in the Natasha Fund.
- The risk-free rate of interest is 3.8%.
- Your broker suggests adding Hannah Corporation to your portfolio which has a 20% expected return, 60% volatility, and a correlation of 0 with the Natasha Fund.
- Assess the validity of your broker's suggestion.
- You invest in Hannah stock, allocating 60% of your risky investments to the Natasha Fund and 40% to Hannah stock.
- Your finance professor advises you to reduce your investment in Hannah stock.
- Evaluate if your finance professor's advice is correct.
Question 6
- Stocks are classified into two mutually exclusive portfolios: growth stocks and value stocks.
- The portfolios are equal in size, have a correlation of 0.5 and the following characteristics:
- Value stocks: 13% expected return, 12% volatility
- Growth stocks: 17% expected return, 25% volatility
- The risk-free rate is 2%.
- Determine if the CAPM holds in this economy, based on the given information.
- Explain your reasoning.
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