Thursday, 3 May 2018

FIN 550 Wk 4 Homework


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(RM) − 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; RM(proxy) = 0.12
(2) Rz = 0.06; RM(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: λMKT = 7.5%, λMACRO1 = −0.3%, and λMACRO2 = 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 λ1 = 4% and λ2 = 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 fivecomponents. 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.)

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