Assignment for Fin 4320
Problem 1:
Here are data on two companies. The T-Bill rate is 4% and the market risk premium is 6%
CompanyVictoria StoreHouston Store
Forecasted return 12 % 11 %
Standard Deviation of Returns 8 % 10 %
Beta 1.5 1.0
a. Estimate the expected return for each company according to CAPM
b. Characterize each company as underpriced, overpriced, or properly priced according to CAPM
c. Another company, Sugar Land store, has a beta of 2.0. Assuming efficient market hypothesis
(CAPM holds), estimate the expected rate of return for a portfolio consisting of 1/3 Victoria
stock, 1/3 Houston stock, and 1/3 Sugar Land store.
Problem 2:
You are the financial adviser to three individuals, a Young person with high risk tolerance, a Middle
aged person with medium risk tolerance and an old person with low risk tolerance. Here are the current
conditions:
Risk free asset is earning 12 % per year.
Risky asset (or market portfolio) has expected return of 30% per year and standard deviation of 40%.
Using the mutual fund theorem or Separation theorem
a. Construct an appropriate portfolio (Mix of risky asset and risk free asset)for your young client
and estimate the expected return and standard deviation of your young client for the coming year.
b. Construct an appropriate portfolio for your middle aged client and estimate the expected return
and standard deviation of your middle aged client.
c. Construct an appropriate portfolio for your old client and estimate the expected return and
standard deviation of your old client.
d. If your middle aged client requires a portfolio with a standard deviation of 30%, what is its
expected rate of return?
Problem 3:
Sugar Land Co. is a fast growing firm and no dividend will be paid on the stock over the next 9
years. The company then will pay a $12 dividend per share in year 10 and will increase the
dividend by 5 percent forever. If the required rate of return for this stock is 13 %, what should
be the intrinsic value of Sugar Land Co.?
Victoria bond is a premium bond with 8% coupon. Houston bond is a 4 % coupon bond currently
selling at a discount. Both bonds make annual payments and have a yield to maturity (YTM) of
6%, and have 5 years till maturity.
a. Estimate their prices (Bond prices).
b. Estimate their current yields
c. If interest rates remain unchanged by next year, estimate their prices a year from now.
d. Estimate their first year capital gain yields. Hint: CGY = (P1-P0)/P0
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