Chapter 8
3.
Exp ret on port = 20%; Exp ret on mkt = 15%; risk-free rate = 5
Using the CAPM, the beta = 1.5
4.
Price =40; Exp return = 13%; risk-free rate = 7%; market risk prem = 8%
What is the market price of this security if the beta doubles?
Use the info to estimate the current beta
0.13 = 0.07 + beta(0.08)  beta = 0.75
New beta = 2*0.75 = 1.5
The new required rate of return = 0.07 + 1.5(0.08) = 0.19
Using the old price and expected return, we can estimate the expectations about
dividends
P = D/r  40 = D/0.13  thus D = $5.20
New price = D/new r = 5.20/0.19 = $27.37
5.
The appropriate discount rate = 0.09 + 1.7(0.19-0.09) = 0.26
The net present value of the cash flows is $15.64
The IRR (discount rate at which NPV = 0) is 49.55%
Using this on the left hand side of the CAPM equation, the beta needs to be 4.055
before the appropriate discount rate increases to 49.55%
8.
Not possible since A has a higher beta but lower return
9.
Possible (can solve for the risk-free rate and expected return on the market for
both securities to be in equilibrium)
10.
Cal the reward to variability ratio for both market and A
Market = (0.18-0.1)/0.24 = 0.33
A = (0.16-0.1)/0.12 = 0.5
Not possible since this implies that A provides a better risk-reward ratio than the
market.
15.
P = (D1 + P1)/(1+k)
Using the CAPM, k = 18%
So, 100 = (9+P1)/(1.18)  so P1 = 109
16.
Present value of cash flows if beta = 1 (thus k=18%) is 100/0.18 = 5,555.56
Present value of cash flows if beta = 0 (thus k=0.08) is 100/0.08 = 12,500
17.
Using the CAPM, beta is –0.2
19a.
19b.
19c.
12%
Exp return on zero beta stock = risk free rate = 5%
Return on stock = (D1+P1)/P0 – 1 = (41+3)/40-1 = 10%
The required rate of return using the CAPM = 0.05 + (-0.5)(0.12-0.05) = 0.015
The share is underpriced.
Chapter 9
2.
Zero. If not, one could use returns from one period to predict returns in later
periods and make abnormal profits.
3.
c. this is a predictable pattern in returns which should not occur if the weak-form
EMH is valid.
5.
b. This is the definition of an efficient market.
6.
d.
8.
No. Intel’s continuing high return on assets does not imply that stock market
investors who purchased Intel shares after its success was already evident would
have earned high returns on their investment.
10.
While positive beta stocks will respond well to favourable new information about
the economy’s progress through the business cycle, they should no show
abnormal returns around already anticipated events. If a recovery, for example, is
anticipated, the actual recovery is not news. The stock price should already reflect
the coming recovery.
11.
Expected return will differ because of differential risk premiums.
20.
The market may have anticipated even greater earnings. Compared to prior
expectations, the announcement was a disappointment.
Chapter 10
3.
The bond callable at 105 should sell at a lower price because the call provision is
more valuable to the firm. Therefore, its YTM should be higher.
4.
Lower. As time passes, the bond’s price which now must be above par (since
YTM < coupon rate) will approach par.
9a.
9b.
The bond pays $50 every 6 months and the par value after 3 years
PV of the cash flows = 60(1/r - 1/[r(1+r)t]) + 1000(1/(1+r)t
Current price = 1052.42
Price 6 months from today (assuming interest rate remains at 4% per half year
= $1044.52
Rate of return = [50+ (1044.52-1052.42)]/1052.42
0.04 or 4% per half year
13a.
Current prices: Zero coupon
8% coupon
10% coupon
13b.
Zero Coupon bond:
Price one year later = 500.25
Coupon
$0
Price change $37.06
Return
= 37.06/463.19 = 0.0800 = 8%
8% coupon bond:
Price one year later 1000
Coupon
$80
Price change $0
Return
80/1000 =
10% coupon bond:
20a.
$463.19
$1000
$1134.20
0.08
Price one year later 1124.94
Coupon
$100
Price change -9.26
Return
90.74/1134.20 = 0.08 = 8%
Coupon payments = $40 every six months
n = 60 (six month periods)
YTM = 3.5 per half year
So, the current price of the bond is $1,124.72
Now, using the current price above, coupon payment = 40, par value = 1100, and
n= 10 (10 six month periods till call)
Solve for the yield to call (by trial and error)  YTC = 3.368% semiannually
20b.
Same as above except par value = 1050
Yield to call then is 2.976% semiannually
20c.
n=4 (4 six month periods), coupon payment = 40, par value = 1100,
current price =1124.72
then, YTC is 3.031% semi-annually
21.
Coupon =140; n = 10 years; Current price = 900; Par = 1000
Based on these, the YTM = 16.07%
If coupon = 70 and everything else the same, the YTM = 8.526%
25.
Features that might account for lower coupon on ABC
- ABC has a larger issue = so may have a more liquid secondary market
- ABC allows for maturity to be extended at the discretion of bondholders. If
interest rates go down, bondholders can opt to extend the maturity. If interest rates
go up, bondholders can get the bonds redeemed and reinvest at the higher interest
rate.
-ABC debt is a more senior claim and has real property as collateral
- Callable feature is attractive to management and thus makes XYZ less attractive
to bondholders.
28.
Market conversion price = value if converted into stock
= 20.83*28 = $583.24
Conversion premium = bond price – value if converted into stock
= 775 - 583.24 = 191.76
There is a typo in the question: price of the bond should read $775.
31.
Two year investment rolled over at the end of the first year.
If row two is the forward rates = (1.1)(1.140364) = 1.2544
Alternatively, invest for 2 trs at 12% p.a = 1.12*1.12 = 1.2544