Quiz 1 – SAPM term V

10 marks

Show calculations for part marks. DO write your assumptions if the answer you obtain does not correspond to any of the given choices. 1. If the standard deviations of Stock A and B are 0.20 and 0.30 respectively and the COV(A,B) equals 0.012, what is the correlation coefficient? (1) a. 0.00072 b. 0.20 c. 0.30 d. 2.0 Sol: = 0.012/(.2*.3) = 0.2

2. I have an option of taking a loan from Bank A or Bank B. Bank A offers me a rate of 9%, monthly compounded, whereas Bank B offers me 9.2% half yearly. Which one is better? (SHOW CALCULATIONS converting both to annual rate) (2) a. Bank A – annual rate is …… b. Bank B – annual rate is …. c. ….. is better. Sol: Bank A annual rate * * ( ( )+ )+ = (1.0075)12-1 = 0.0938 = 9.38% = (1.046)2 -1 = 0.094116 = 9.4116%

Bank B rate

3. Security A has a beta of 1.2; security B has a beta of 0.8. If the market variance is 0.30, what is COV (A,B)? (1) a. .255 b. .288 c. .314 d. .355 Use relation :Corr(A,C) = corr(A,B)*corr(B,C) and Cov(A,B) = corr(A,B)*sigma(A) *Sigma(B) Beta(A)*beta(B) = cov(A,m)*cov(B,m) / (sigma m)^4 = corr(A,m)*sigma(A)*corr(B,m)*Sigma(b) / (sigma m)^2 Since cov(a,m) = corr(A,m)*sigma(a)*Sigma(m) Therefore, beta(a)*beta(b)*(sigma m)^2 = corr(A,m)*sigma(A)*corr(B,m)*Sigma(b) = corr(A,B)*sigma(A)*sigma(B) = cov(A,B)

no calc needed here 5. Your portfolio consists of $100. then the rate of return can only increase.8+150000*1.69 EPS = 5 P/E = 57.4= $2.8. However.54 6. its P/E ratio will be __________.33% Easy way to do this is to realize that if the Rm-Rf increases.00. Last year this portfolio had a required rate of return of 13 percent. What is the expected return on a portfolio which is invested 20 percent in stock A. Since it is already 13% the only answer greater than 13% is 15.. Its expected ROE is 12% and its expected EPS is $5. This year nothing has changed except for the fact that the market risk premium has increased by 2 percent (two percentage points). 50. $150. . so it reqd no calc at all. 8. 11. plowback = . div = $5-$2 = $3.12*.2.052 = 57.33. 19. the factor that is multiplied to rm-rf is the weighted avg beta. What is the portfolio's current required rate of return? (2) a.54 c.25 percent c.000 invested in a stock which has a beta = 1.40 percent b.69/5 = 11. 50 percent in stock B.33 percent d.14% c. 9. 7. 8. and 30 percent in stock C? (2) State of Probability of Returns on A Returns on B Returns on B Economy State given state given state given state Boom 20% 18% 9% 6% Normal 70% 11% 7% 9% Recession 10% -10% 4% 13% a. 15.00 EPS = 5.23 d.14% b.4 = 0. 7. The risk-free rate is 7 percent. (2) a.33.8. and $50. g= ROE*reinv rate = . multiply this by the increase in rm-rf which is 2. Which is [100000*.8]/300000. The market capitalization rate on the stock of A Company is 10%..048 Price = D/(r-g) = 3/(.048) = 3/. 5. 8.1-.4 = 5*. 11.4.45% d.45 percent Most people got this right.2+50000*1. If the firm's plough-back ratio is 40%.000 invested in a stock which has a beta = 1. and you have the answer to be 2.33 b.000 invested in a stock which has a beta = 0.

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