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# FIN 605 Investments Preparation Schedule for Final Exam

The exam contributes 20% towards final assessment Section A calculation questions (15%) Section B Theory questions (5%) Section A: Question 1. (CAPM) 5 short practical questions all based on CAPM the formula. Question 2 (Stock Valuations) 4 practical questions which will test your knowledge on the calculation of valuation of shares, required rate of return, market rate of return. Question 3 (Bond valuation and pricing) 4 practical questions which will test your knowledge on current yield, default risk premium, changes to the value of bonds when quotes change.

Section B: There will be 4 short questions from among the following topics: 1. The definition and meaning of Yield to Maturity Duration 2. Assumptions underlying the CAPM; Components of the CAPM; How CAPM may be used in Capital Budgeting decisions 3. Differences between Debt, Preference, and Ordinary Shares 4. The different shapes of Yield curves and their meaning 5. Different types of risks within a portfolio context; Type of risk rewarded by the market; Type of risk not rewarded by the market. 6. Valuation of Bonds and Stocks

Sample Questions SECTION A Question on CAPM: 1. Assume that a security is fairly priced and has an expected rate of return of 0.13. The market expected rate of return is 0.13 and the risk-free rate is 0.04. The beta of the stock is? 2. The risk-free rate and the expected market rate of return are 0.06 and 0.12, respectively. According to the capital asset pricing model (CAPM), the expected rate of return on security X with a beta of 1.2 is equal to. 3. Your personal opinion is that a security has an expected rate of return of 0.11. It has a beta of 1.5. The risk-free rate is 0.05 and the market expected rate of return is 0.09. According to the Capital Asset Pricing Model, is this security overpriced, underpriced, or fairly priced. 4. A security has an expected rate of return of 0.10 and a beta of 1.1. The market expected rate of return is 0.08 and the risk-free rate is 0.05. The alpha of the stock is? 5. As a financial analyst, you are tasked with evaluating a capital budgeting project. You were instructed to use the IRR method and you need to determine an appropriate hurdle rate. The risk-free rate is 4 percent and the expected market rate of return is 11 percent. Your company has a beta of 1.0 and the project that you are evaluating is considered to have risk equal to the average project that the company has accepted in the past. According to CAPM, the appropriate hurdle rate would be ______%. Ans: The hurdle rate should be the required return from CAPM or (R = 4% + 1.0(11%-4%) = 11%. ______________________________________________________________________________

Question on Valuation of Shares: 1. US Motors just paid an annual dividend of \$2.80 a share and is expected to increase that amount by 4 percent per year. If you are planning to buy 1,000 shares of this stock next year, how much should you expect to pay per share if the market rate of return for this type of security is 11.50 percent at the time of your purchase? Ans:

2. Miller Brothers Hardware paid an annual dividend of \$1.15 per share last month. Today, the company announced that future dividends will be increasing by 2.6 percent annually. If you require a 12 percent rate of return, how much are you willing to pay to purchase one share of this stock today?

Ans:

3. How much are you willing to pay for one share of Jumbo Trout stock if the company just paid a \$0.70 annual dividend, the dividends increase by 1.6 percent annually, and you require a 10 percent rate of return? Ans:

4. Denver Shoppes will pay an annual dividend of \$1.46 a share next year with future dividends increasing by 4.2 percent annually. What is the market rate of return if the stock is currently selling for \$38.90 a share? Ans:

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Question on Bonds and Bond Pricing: 1. A corporate bond was quoted yesterday at 102.16 while today's quote is 102.19. What is the change in the value of a bond that has a face value of \$8,000? 2. If a 7% coupon bond is trading for \$975.00, it has a current yield of? 3. A coupon bond pays annual interest, has a par value of \$1,000, matures in 4 years, has a coupon rate of 10%, and has a yield to maturity of 12%. The current yield on this bond is? 4. A Treasury bond due in one year has a yield of 5.7%; a Treasury bond due in 5 years has a yield of 6.2%. A bond issued by Ford Motor Company due in 5 years has a yield of 7.5%; a bond issued by Shell

Oil due in one year has a yield of 6.5%. The default risk premiums on the bonds issued by Shell and Ford, respectively, are ? 5. A Treasury bill with a par value of \$100,000 due one month from now is selling today for \$99,010. The effective annual yield is? Ans: \$990/\$99,010 = 0.01; (1.01)12 - 1.0 = 12.68%.