Assignment 11
Instructions:
• Type your answers and upload your word/pdf file to Blackboard before 6 PM on November 18, 2017
• In answering the Short Questions, elaborate your answers covering relevant discussions.
• Show your work/calculation for the Problems.
• Late submission will be penalized by 50 points.
Short Questions:
1. Differentiate among Capital Allocation Line (CAL), Capital Market Line (CML), and Security Market Line (SML).
2. Briefly discuss the three versions of the Efficient Market Hypothesis.
3. Differentiate between Fundamental Analysis and Technical Analysis. Use examples of each.
4. Differentiate between Active Portfolio Management and Passive Portfolio Management. Use examples of each these strategies.
5. Briefly describe the relationship between Market Interest Rate and Bond Price. Use an example elaborating the relationship.
6. Write a short note on ‘Bond Market’.
7. Differentiate between Intrinsic Value and Market Price of financial assets. How these two can assist in choosing our investment strategies?
8. Briefly discuss the features of Put Options and Call Options.
9. Briefly describe different types of Listed Options.
10. What are the prominent risk-adjusted performance measures for a portfolio? Briefly discuss.
Problems:
1. Louis Incorporated expects non-normal dividend growth over the next three years; that is a 10% growth rate in the first year, then 20%, and then 25% followed by growth of 5% thereafter. If the last dividend paid was $0.25 and the appropriate discount rate is 12%; what is the price of the stock today?
2. You have been hired as a consultant by Feludi Inc.’s CFO, who wants you to help her estimate the cost of capital. You have been provided with the following data: rRF = 4.10%; RPM = 5.25%; and b = 1.30. Based on the CAPM approach, what is the cost of common from retained earnings?
3. You have the choice between investing in a corporate bond or a municipal bond with a yield of 8%. If your marginal tax rate is 28%, what should be the yield on the corporate bond in order to be competitive?
4. Louis Bonds have 14 years to maturity, with a coupon rate of 8%, paid ANNUALLY; if the appropriate discount rate is 12% what is the CURRENT yield of Louis Bonds?
5. Frank sold 100 put options contracts to Claire on APPL with exercise price of $150 and premium of $12 per share. When the price of APPL is $170, will Frank exercise his options? If yes, calculate Frank’s profit. If not, calculate Claire’s profit.
Solution Preview
The Capital Market Line is the line on a graph that is primarily used to indicate the rates of returns for a particular portfolio. These rates of returns depend on both the number of risks involved and the risk-free rates of return involved. The Security Market Line (SML) which can also be referred to as the characteristic line is a line which gives a graphic account of the market’s risk and the returns at a particular given period. The primary differentiating factor for these two lines is how the risk factors involved are calculated,
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