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As the manager of a large, broadly diversified portfolio of stocks and bonds, you realize that changes in certain macroeconomic variables may directly affect the performance of your portfolio. You are considering using an arbitrage pricing model (APT) approach to strategic portfolio planning and want to analyze the possible impacts of the following four factors: • Industrial production • Inflation • Risk premium or quality spreads • Yield curve shifts Indicate how each of these four factors influences the cash flows and/or the discount rates in the traditional discounted cash flow model. Explain how unanticipated changes in each of these four factors could affect portfolio returns. B. Jeffrey Bruner uses the capital asset pricing model (CAPM) to help identify mispriced securities. A consultant suggests Brunner use the arbitrage pricing theory (APT) instead. In comparing the CAPM and the APT, the consultant made the following arguments: a. Both the CAPM and APT require a mean-variance efficient market portfolio. b. Neither the CAPM nor APT assumes normally distributed security returns. c. The CAPM assumes that one specific factor explains security returns, but the APT does not. State whether each of the consultant’s argument is correct or incorrect. Indicate, for each incorrect argument, why the argument is incorrect.
Question 2 Portfolio A has an expected return of 10.25 percent and a factor sensitivity of 0.5. Portfolio B has an expected return of 16.2 percent and a factor sensitivity of 1.2. The risk-free rate is 6 percent, and there is one factor. Determine the factor’s price of risk. Question 3 A wealthy investor has no other source of income beyond her investments. Her investment advisor recommends that she tilt her portfolio to cyclical stocks and highyield bonds because the average investor holds a job and is recession sensitive. Explain the advisor’s advice.
it wan to combin K and L t reduce nts ne to its inf flation exposure to 0. The ins to hed its exposure to infla dge ation.11 + 1. . of ng stion 5 Ques i olds io stitution wan to use Po nts ortfolio L Suppose that an institution ho Portfoli K. The re eturns to the two portfol are e lios RK = 0. Then T calcu ulate the infla ation factor s sensitivity o the resultin portfolio. Po ortfolios K a L are well diversified so the man and d.12 + 0.5FINFL + 1.5FGDP RL= 0.0F FGDP 0 INFL + 2.5FI Calcu ulate the wei ights that a m manager sho ould have on K and L to achieve this goal. nager can ignor the risk of individual a re f assets and as ssume that th only sour of uncerta he rce ainty in the po ortfolio is th surprises i the two fa he in actors. Specifi ically. Calculate th weights S the ark os he the manager wou put on Po m uld ortfolios A an B to have zero excess business cy nd e ycle factor sensitivity (relative to t business cycle sensit r the s tivity of the S&P 500).stion 4 Ques rtfolio mana ager uses the multifactor model show in the foll e wn lowing table e: A por The S&P 500 is t benchma portfolio for Portfolio A and B.
714 0. Estimate the price earnings (P/E) ratio for each firm. Firm B is similar to Firm A. C and D. Question 7 Sundanci actual 2007 and 2008 financial statements for fiscal years ending May 31 ($ million.Question 6 Firm A $100 12% $12 33 % 12% Firm B $100 12% $12 100% 12% Firm C $100 15% $15 100% 12% Firm D $100 15% $15 33 % 12% Book Value of Equity Return on Equity (ROE) Earnings per share Payout Ratio Required Rate of Return on Equity The above table shows the book value of equity.286 84. c. a.e.. return on equity.214 84. plant and equipment Total assets Current liabilities Long term debt Total liabilities Shareholders’ equity Total liabilities and equity Capital expenditures 2007 474 20 368 86 26 60 18 0. Estimate the fundamental growth rate of dividends using return on equity and payout ratio for each firm.0 2008 326 489 815 141 0 141 674 815 38 . but Firm B pays out all its earnings every year. payout ratio and the required rate of return for Firm A. d. the dividend payout is maintained at 33 % of earnings) and expects to grow at a steady rate per year far into the future. b.0 2007 201 474 675 57 0 57 618 675 34 2008 598 23 460 115 35 80 24 0. Firm C and Firm D have higher return on equity and have different dividend payout policies. earnings per share. B. Which firm has the higher P/E ratio? Explain why. Firm A maintains a constant dividend payout policy (i.952 0. except per share data) Income Statement Revenue Depreciation Other operating costs Income before taxes Taxes Net Income Dividends Earnings per share Dividend per share Common shares outstanding (millions) Balance Sheet Current assets Net property. Estimate the stock value for each firm using dividend discounted model.
Describe one limitation of the two-stage DDM model that is addressed by using the two-stage FCFE model. i. Naylor believes that Sundanci’s FCFE will grow at 27% for 2 years and 13% thereafter. Are they the same? . Describe one limitation of the two-stage DDM model that is not addressed by using the two-stage FCFE model d. a. Calculate the current value of a share of Sundanci stock based on the twostage FCFE model. Calculate the amount of FCFE for the year 2008. b. Capital expenditures.Required rate of return Growth rate of industry Industry P/E ratio 14% 13% 26 Abbey Naylor has been directed to determine the value of Sundanci’s stock using the Free Cash Flow to Equity (FCFE) model. c. ii. depreciation and working capital are all expected to increase proportionally with FCFE. Discuss how we can estimate the growth rates used in the DDM and the FCFE model. using the above data.