Q1. Consider a portfolio consisting of the following three stocks.
Stock Portfolio weight Volatility (SD) Correlation with the market portfolio
Stock |
Portfolio weight |
Volatility (SD) |
Correlation with the market portfolio |
A |
0.25 |
0.12 |
0.4 |
B |
0.35 |
0.25 |
0.6 |
C |
0.4 |
0.13 |
0.5 |
Q2. The actual return of the asset is 10% but based on its beta CAPM estimates its required return as 8%. Is the asset overpriced or underpriced? Explain your answer. You may simply draw the graph that explains your answer.
Q3. The bank promises a stated annual interest of 8%. You invest $100. Find the future value after four years from now using the following compounded interest rates:
a. compounded annually
b. compounded semiannually
d. compounded continuously
Q4. What is the present value of a perpetuity that promises to pay $1,000 today and $1,000 at the end of the year forever? The interest rate is 5 percent.
Q5. A company invests in a project that delivers annual payments of $100 forever! The payments start three years (t=3) from today. Use 5% discount rate. What is the present value of this investment today? (Hint: The formula we learned in class cc rr = 100 0.05 will give you the value of the perpetuity at t=2, not t=0)
Q6. Irvine Development Corporation is expected to pay a dividend of $3 in the upcoming year. Dividends are expected to grow at the rate of 8% per year. The risk-free rate of return is 5%, and the expected return on the market portfolio is 17%. The stock of Irvine Development Corporation has a beta of 0.75. Using the constant-growth DDM, find the intrinsic value of the stock.
Q7. The free cash flow to the firm is reported as $205 million. The interest expense to the firm is $22 million. If the tax rate is 35% and the net debt of the firm increases by $25 million, what is the approximate market value of the equity if the FCFE grows at 2% and the cost of equity is 11%?
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