6. The following are the historic returns for the Chelle
Computer Company:

Based on this information, compute the following:

a.The
correlation coefficient between Chelle Computer and the General Index.

b.The
standard deviation for the company and the index.

c.The
beta for the Chelle Computer Company.

8. As an equity analyst, you have developed the following
return forecasts and risk estimates for two different stock mutual funds (Fund
T and Fund U):

a.If
the risk-free rate is 3.9 percent and the expected market risk premium
(i.e.,

*E*(*R*_{M}) −*RFR*) is 6.1 percent, calculate the expected return for each mutual fund according to the CAPM.
b.Using
the estimated expected returns from Part a along with your own return
forecasts, demonstrate whether Fund T and Fund U are currently priced to fall
directly on the security market line (SML), above the SML, or below the SML.

c.According
to your analysis, are Funds T and U overvalued, undervalued, or properly
valued?

10. Draw the security market line for each of the following
conditions:

a. (1)

*RFR =*0.08;*R*_{M}(proxy) = 0.12
(2)

*R*0.06;_{z}=*R*_{M}(true) = 0.15
b. Rader
Tire has the following results for the last six periods. Calculate and compare
the betas using each index.

c.If
the current period return for the market is 12 percent and for Rader Tire it is
11 percent, are superior results being obtained for either index beta?

3. You have been assigned the task of estimating the expected
returns for three different stocks: QRS, TUV, and WXY. Your preliminary
analysis has established the historical risk premiums associated with three
risk factors that could potentially be included in your calculations: the
excess return on a proxy for the market portfolio (MKT), and two variables
capturing general macroeconomic exposures (MACRO1 and MACRO2). These values
are: Î»

_{MKT}= 7.5%, Î»MACRO1 = −0.3%, and Î»MACRO2 = 0.6%. You have also estimated the following factor betas (i.e., loadings) for all three stocks with respect to each of these potential risk factors:
a.
Calculate expected
returns for the three stocks using just the MKT risk factor. Assume a risk-free
rate of 4.5%.

b. Calculate
the expected returns for the three stocks using all three risk factors and the
same 4.5% risk-free rate.

c. Discuss
the differences between the expected return estimates from the single-factor
model and those from the multifactor model. Which estimates are most likely to
be more useful in practice?

d. What
sort of exposure might MACRO2 represent? Given the estimated factor betas, is
it really reasonable to consider it a common (i.e., systematic) risk factor?

**5.**Suppose that three stocks (A, B, and C) and two common risk factors (1 and 2) have the following relationship:

a. If
Î»

_{1}*=*4% and Î»_{2}= 2%, what are the prices expected next year for each of the stocks? Assume that all three stocks currently sell for $30 and will not pay a dividend in the next year.
b. Suppose
that you know that next year the prices for Stocks A, B, and C will actually be
$31.50, $35.00, and $30.50. Create and demonstrate a riskless, arbitrage
investment to take advantage of these mispriced securities. What is the profit
from your investment? You may assume that you can use the proceeds from any
necessary short sale.

7. a. Using regression analysis, calculate the factor betas of
each stock associated with each of the common risk factors. Which of these
coefficients are statistically significant?

b.
How well does the
factor model explain the variation in portfolio returns? On what basis can you
make an evaluation of this nature?

c.
Suppose you are now
told that the three factors in Exhibit
9.12 represent the risk exposures in the
Fama-French characteristic-based model (i.e., excess market,

*SMB,*and*HML*). Based on your regression results, which one of these factors is the most likely to be the market factor? Explain why.
d. Suppose
it is further revealed that Factor 3 is the

*HML*factor. Which of the two portfolios is most likely to be a growth-oriented fund and which is a value-oriented fund? Explain why.
4. (Question 4 is composed of two parts.) The
DuPont formula defines the net return on shareholders’ equity as a function of
the following components:

·
Operating margin

·
Asset turnover

·
Interest burden

·
Financial leverage

·
Income tax rate

Using

*only*the data in the table shown below:
a. Calculate

*each*of the*five*components listed above for 2010 and 2014, and calculate the return on equity (ROE) for 2010*and*2014, using all of the*five*components. Show calculations.
b. Briefly discuss the
impact of the changes in asset turnover

*and*financial leverage on the change in ROE from 2010 to 2014.**5.**David Wright, CFA, an analyst with Blue River Investments, is considering buying a Montrose Cable Company corporate bond. He has collected the following balance sheet and income statement information for Montrose as shown in Exhibit 10.10. He has also calculated the three ratios shown in Exhibit 10.11, which indicate that the bond is currently rated “A” according to the firm’s internal bond-rating criteria shown in Exhibit 10.13. Wright has decided to consider some off-balance-sheet items in his credit analysis, as shown in Exhibit 10.12. Specifically, Wright wishes to evaluate the impact of each of the off-balance-sheet items on each of the ratios found in Exhibit 10.11.

a.Calculate the combined effect of the

*three*off-balance-sheet items in Exhibit 10.12 on*each*of the following*three*financial ratios shown in Exhibit 10.11.
i.EBITDA/interest expense

ii.Long-term debt/equity

iii.Current assets/current liabilities

The bond is currently trading at a credit
premium of 55 basis points. Using the internal bond-rating criteria in Exhibit 10.13, Wright wants to evaluate whether or not the credit yield premium
incorporates the effect of the off-balance-sheet items.

d. State and justify whether or not the current
credit yield premium compensates Wright for the credit risk of the bond based
on the internal bond-rating criteria found in Exhibit 10.13.

6. Over the long run, you expect
dividends for BBC in Problem 4 to grow at 8 percent and you require 11 percent
on the stock. Using the infinite period DDM, how much would you pay for this
stock?

8. The Shamrock Dogfood Company
(SDC) has consistently paid out 40 percent of its earnings in dividends. The
company’s return on equity is 16 percent. What would you estimate as its
dividend growth rate?

10. What

*P/E*ratio would you apply if you learned that SDC had decided to increase its payout to 50 percent? (Hint: This change in payout has multiple effects.)Buy now

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