Practice Exam 1

Name: ID:

• Before you start

There are three big questions. Read carefully each problem and make sure you answer
all the questions. There are 37 points in total. However, there are two bonus questions.
Three pages of scratch paper are attached at the back of the exam. You can tear them
apart from your exam. However, you cannot use your own scratch paper.

• After you start

Write down your answers in the space provided. Justify all answers and show all work.
Label all diagrams clearly. Write legibly. If you need to make additional assumptions,
state them clearly.

• When you finish

You are required to return both the exam and the scratch paper, for a total of 14 pages.

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1. Topre is a keyboard company specialized in electrostatic capacitive keyboard switches.
In its IPO, the firm decided to offer 6M class A shares to potential investors. The
offering price was set between $13 and $19 per share. And the firm received the
following bids:

Investor Bid No. Shrs

Fidelity $13.8 1.0M
Vanguard $14.3 3.0M
BlackRock $15.5 1.5M
Bridgewater $16.0 0.3M
PIMCO $17.4 0.7M
2 Sigma $18.0 4.0M

• What is the IPO offering price based on the bids? [3 points]

• How many shares will be allotted to BlackRock? [2 points]

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2. Consider the following quoted prices on discount bonds

Maturity (year) 1/2 1 2 5

Price 0.981 0.953 0.893 0.792

(a) Calculate the holding-period return for each discount bond. [4 points]

(b) Assume that a bond pays three coupons: $10 at the end of month Six, $10 at the
end of year One, and $20 at the end of year Two. The bond matures in five years.
It’s par value is $1000. What is the price of this coupon bond? [4 points]

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(c) Looking at the spot interest rates implied by these discount bonds, Mr Levi wants
to lock in the rate between year Two and year Five. If he will receive $1,000 two
year from today and want to invest it for three years with the locked-in rate, what
is the total investment return in dollars from this investment?[Hint: consider the
forward rate ft and what does (1 + ft )(1 + ft+1 )(1 + ft+2 ) represent? And how
can you cancluate this using discount bonds?] [5 points]

(d) (Bonus) How can Mr Levi do today to lock in the investment cashflows in
(d)? Assume he can only trade on discount bonds. Numerical results required.
[3 points]

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3. Eliyah is a hedge fund manager, who is investing in the stocks of the company CTG.
CTG’s earnings per share in year One is EPS1 , and its return on equity is ROE forever.
And the discount rate is r.

(a) If ROE = r, and, at t = 0, CTG makes an announcement that they will increase
the dividend payout ratio. How does the stock price P0 change? Algebra analysis
is required. [Hint: write the price as an expression of EPS1 , ROE, r, and payout
ratio p.] [5 points]

(b) Assume that EPS1 = $10 and ROE = r = 10%. Eliyah believes that CTG will
have an investment opportunity in year Three. This new investment opportunity
requires CTG to spend $6.69 per share in year Three, and then generates a cash-
flow $2 each year from year Four. However, such forecast may be wrong, though
Eliyah believes it. In Eliyah’s opinion, what should be the price of CTG’s stock
now? What is the PVGO? [6 points]

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(c) Just like Eliyah, other investors also try to forecast the growth opportunity and
the stock price reflects the average of all investors’ opinions. Suppose that the
current price is $105. In order to maximize the investment profits, CTG decides
to use his margin account to buy CTG’s stocks. The initial margin requirement is
60%, and the maintenance margin requirement is 35%. Assume there is no interest
and service charge. If George wants to buy 1000 shares of CTG’s stock, what is
the amount of money he needs to deposit to the margin account? [2 points]

(d) George has other portfolios to manage and cannot spend his entire time and
energy in monitoring the price of CTG. To prevent the margin from decreasing
below the maintenance margin, he decides to place an order. What type of order
should George place? And at what price point is this order triggered? [6 points]

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(e) (Bonus) After George completes the buying on margin transaction, CTG com-
pany announces that the investment opportunity with $6.69 initial investment in
year Three can only generate cashflow $0.5 per share each year from year Four.
What is the price now? Will George receive a margin call? Why? [4 points]

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