Question: The Saunders Investment Bank has the following

> If a firm is selling futures contracts on lumber as a hedging strategy, what must be true about the firm’s exposure to lumber prices?

> Gary Levin is the chief executive officer of Mountainbrook Trading Company. The board of directors has just granted Mr. Levin 30,000 at-the-money European call options on the company’s stock, which is currently trading at $50 per share. The stock pays no

> What is a call option? A put option? Under what circumstances might you want to buy each? Which one has greater potential profit? Why?

> In the previous problem, assume that the exercise style on the option is American rather than European. What is the price of the option now? Previous problem The stock price is $73, and the standard deviation of the stock returns is 70 percent. The optio

> Why might a firm choose to engage in a sale and leaseback transaction? Give two reasons.

> Suppose a three-factor model is appropriate to describe the returns of a stock. Information about those three factors is presented in the following chart: a. What is the systematic risk of the stock return? b. Suppose unexpected bad news about the firm

> A stock has had returns of 27 percent, 12 percent, 32 percent, 212 percent, 19 percent, and 231 percent over the last six years. What are the arithmetic and geometric returns for the stock?

> In contrast to the CAPM, the APT does not indicate which factors are expected to determine the risk premium of an asset. How can we determine which factors should be included? For example, one risk factor suggested is the company size. Why might this be

> The Durkin Investing Agency has been the best stock picker in the country for the past two years. Before this rise to fame occurred, the Durkin newsletter had 200 subscribers. Those subscribers beat the market consistently, earning substantially higher r

> Schultz Industries is considering the purchase of Arras Manufacturing. Arras is currently a supplier for Schultz, and the acquisition would allow Schultz to better control its material supply. The current cash flow from assets for Arras is $7.5 million.

> Suppose a stock had an initial price of $75 per share, paid a dividend of $1.20 per share during the year, and had an ending share price of $86. What was the dividend yield? The capital gains yield?

> Suppose a stock had an initial price of $75 per share, paid a dividend of $1.20 per share during the year, and had an ending share price of $86. Compute the percentage total return.

> The following diagram shows the cumulative abnormal returns (CAR) for 386 oil exploration companies announcing oil discoveries between 1950 and 1980. Month 0 in the diagram is the announcement month. Assume that no other information is received and the s

> Based on the following information, calculate the expected return and standard deviation for each of the following stocks. What are the covariance and correlation between the returns of the two stocks? Probability of State of Economy State of Return

> Is the following statement true or false? A risky security cannot have an expected return that is less than the risk-free rate because no risk-averse investor would be willing to hold this asset in equilibrium. Explain.

> Assuming that the returns from holding small company stocks are normally distributed, what is the approximate probability that your money will double in value in a single year? Triple in value?

> Based on the following information, calculate the expected return and standard deviation of each of the following stocks. Assume each state of the economy is equally likely to happen. What are the covariance and correlation between the returns of the two

> Suppose the returns on long-term government bonds are normally distributed. Based on the historical record, what is the approximate probability that your return on these bonds will be less than 23.7 percent in a given year? What range of returns would yo

> Imagine that a particular macroeconomic variable that influences your firm’s net earnings is positively serially correlated. Assume market efficiency. Would you expect price changes in your stock to be serially correlated? Why or why not?

> Suppose you have been hired as a financial consultant to Defense Electronics, Inc. (DEI), a large, publicly traded firm that is the market share leader in radar detection systems (RDSs). The company is looking at setting up a manufacturing plant overseas

> You have $100,000 to invest in a portfolio containing Stock X, Stock Y, and a risk-free asset. You must invest all of your money. Your goal is to create a portfolio that has an expected return of 11.22 percent and that has only 96 percent of the risk of

> You bought one of Bergen Manufacturing Co.’s 7 percent coupon bonds one year ago for $1,080.50. These bonds make annual payments and mature six years from now. Suppose you decide to sell your bonds today when the required return on the bonds is 5.5 perce

> Suppose the market is semistrong form efficient. Can you expect to earn excess returns if you make trades based on: a. Your broker’s information about record earnings for a stock? b. Rumors about a merger of a firm? c. Yesterday’s announcement of a succe

> Define the three forms of market efficiency.

> The following three stocks are available in the market: Assume the market model is valid. a. Write the market model equation for each stock. b. What is the return on a portfolio with weights of 30 percent Stock A, 45 percent Stock B, and 25 percent Sto

> Trower Corp. has a debt–equity ratio of .85. The company is considering a new plant that will cost $145 million to build. When the company issues new equity, it incurs a flotation cost of 8 percent. The flotation cost on new debt is 3.5 percent. What is

> You want to create a portfolio equally as risky as the market, and you have $1,000,000 to invest. Given this information, fill in the rest of the following table: Asset Investment Beta Stock A $180,000 85 Stock B $290,000 1.40 Stock C 1.45 Risk-free

> You’ve observed the following returns on Mary Ann Data Corporation’s stock over the past five years: 27 percent, 13 percent, 18 percent, 214 percent, and 9 percent. Suppose the average inflation rate over this period was 4.2 percent, and the average T-bi

> Refer to T able 10.1 in the text and look at the period from 1973 through 1980. a. Calculate the average return for Treasury bills and the average annual inflation rate (consumer price index) for this period. b. Calculate the standard deviation of Treasu

> Photochronograph Corporation (PC) manufactures time series photographic equipment. It is currently at its target debt–equity ratio of .55. It’s considering building a new $50 million manufacturing facility. This new plant is expected to generate aftertax

> Consider the following information about three stocks: a. If your portfolio is invested 40 percent each in A and B and 20 percent in C, what is the portfolio expected return? The variance? The standard deviation? b. If the expected T-bill rate is 3.80

> A stock has had the following year-end prices and dividends: What are the arithmetic and geometric returns for the stock? Year Price Dividend $61.18 2 64.83 $.72 3 72.18 .78 4 63.12 .86 69.27 .95 76.93 1.08 56

> Happy Times, Inc., wants to expand its party stores into the Southeast. In order to establish an immediate presence in the area, the company is considering the purchase of the privately held Joe’s Party Supply. Happy Times currently has debt outstanding

> Using the CAPM, show that the ratio of the risk premiums on two assets is equal to the ratio of their betas.

> Advance, Inc., is trying to determine its cost of debt. The firm has a debt issue outstanding with 17 years to maturity that is quoted at 95 percent of face value. The issue makes semiannual payments and has a coupon rate of 8 percent annually. What is A

> You own a portfolio that has $2,100 invested in Stock A and $3,200 invested in Stock B. If the expected returns on these stocks are 11 percent and 14 percent, respectively, what is the expected return on the portfolio?

> You find a certain stock that had returns of 12 percent, 221 percent, 9 percent, and 32 percent for four of the last five years. If the average return of the stock over this period was 11 percent, what was the stock’s return for the missing year? What is

> Based on the following information, calculate the expected return and standard deviation: State of Probability of State of Economy Rate of Return Economy if State Occurs Depression 10 -.105 Recession 25 .059 Normal 45 130 Вoom .20 211

> TransTrust Corp. has changed how it accounts for inventory. Taxes are unaffected, although the resulting earnings report released this quarter is 20 percent higher than what it would have been under the old accounting system. There is no other surprise i

> Floyd Industries stock has a beta of 1.3. The company just paid a dividend of $.95, and the dividends are expected to grow at 4.5 percent per year. The expected return on the market is 11 percent, and Treasury bills are yielding 4.3 percent. The most rec

> In the previous problem, what would the risk-free rate have to be for the two stocks to be correctly priced?

> Refer back to Table 10.2. What range of returns would you expect to see 68 percent of the time for large-company stocks? What about 95 percent of the time? Table 10.2 Arithmetic Standard Mean Deviation Series (%) (K) Distribution (%) Smal

> Delta, United, and American Airlines announced purchases of planes on July 18 (7/18), February 12 (2/12), and October 7 (10/7), respectively. Given the following information, calculate the cumulative abnormal return (CAR) for these stocks as a group. Gra

> Newtech Corp. is going to adopt a new chip-testing device that can greatly improve its production efficiency. Do you think the lead engineer can profit from purchasing the firm’s stock before the news release on the device? After reading the announcement

> Goodbye, Inc., recently issued new securities to finance a new TV show. The project cost $19 million, and the company paid $1,150,000 in flotation costs. In addition, the equity issued had a flotation cost of 7 percent of the amount raised, whereas the d

> Stock Y has a beta of 1.35 and an expected return of 14 percent. Stock Z has a beta of .80 and an expected return of 11.5 percent. If the risk-free rate is 4.5 percent and the market risk premium is 7.3 percent, are these stocks correctly priced?

> Refer back to Table 10.2. What range of returns would you expect to see 68 percent of the time for long-term corporate bonds? What about 95 percent of the time? Table 10.2 Arithmetic Standard Deviation Mean Series (*) (*) Distribution (%)

> Today, the following announcement was made: “Early today the Justice Department reached a decision in the Universal Product Care (UPC) case. UPC has been found guilty of discriminatory practices in hiring. For the next five years, UPC must pay $2 million

> Is it possible that a risky asset could have a beta of zero? Explain. Based on the CAPM, what is the expected return on such an asset? Is it possible that a risky asset could have a negative beta? What does the CAPM predict about the expected return on s

> Asset W has an expected return of 12.3 percent and a beta of 1.3. If the risk-free rate is 4 percent, complete the following table for portfolios of Asset W and a risk-free asset. Illustrate the relationship between portfolio expected return and portfoli

> Refer to Table 10.1. What was the average real return for Treasury bills from 1926 through 1932? Table 10.1 Large-Company Stocks Long-Term Government U.S. Treasury Bills Consumer Price Year Bonds Index 7.90% 3.30% -1.12% -2.26 1926 1927 1928 1929 II.1

> When the 56-year-old founder of Gulf & Western, Inc., died of a heart attack, the stock price immediately jumped from $18.00 a share to $20.25, a 12.5 percent increase. This is evidence of market inefficiency because an efficient stock market would have

> Och, Inc., is considering a project that will result in initial aftertax cash savings of $3.5 million at the end of the first year, and these savings will grow at a rate of 4 percent per year indefinitely. The firm has a target debt–equity ratio of .55,

> What rule should a firm follow when making financing decisions? How can firms create valuable financing opportunities?

> A stock has a beta of 1.13 and an expected return of 12.1 percent. A risk-free asset currently earns 5 percent. a. What is the expected return on a portfolio that is equally invested in the two assets? b. If a portfolio of the two assets has a beta of .5

> You bought a stock three months ago for $43.18 per share. The stock paid no dividends. The current share price is $46.21. What is the APR of your investment? The EAR?

> Aerotech, an aerospace technology research firm, announced this morning that it has hired the world’s most knowledgeable and prolific space researchers. Before today Aerotech’s stock had been selling for $100. Assume that no other information is received

> Southern Alliance Company needs to raise $55 million to start a new project and will raise the money by selling new bonds. The company will generate no internal equity for the foreseeable future. The company has a target capital structure of 65 percent c

> What is the historical real return on long-term government bonds? On long-term corporate bonds?

> You bought a share of 4 percent preferred stock for $94.89 last year. The market price for your stock is now $96.12. What was your total return for last year?

> A hundred years ago or so, companies did not compile annual reports. Even if you owned stock in a particular company, you were unlikely to be allowed to see the balance sheet and income statement for the company. Assuming the market is semistrong form ef

> Suppose your company needs $20 million to build a new assembly line. Your target debt–equity ratio is .75. The flotation cost for new equity is 7 percent, but the flotation cost for debt is only 3 percent. Your boss has decided to fund the project by bor

> You purchased a zero coupon bond one year ago for $109.83. The market interest rate is now 9 percent. If the bond had 25 years to maturity when you originally purchased it, what was your total return for the past year?

> In the middle to late 1990s, the performance of the pros was unusually poor—on the order of 90 percent of all equity mutual funds underperformed a passively managed index fund. How does this bear on the issue of market efficiency?

> An all-equity firm is considering the following projects: The T-bill rate is 3.5 percent, and the expected return on the market is 11 percent. a. Which projects have a higher expected return than the firm’s 11 percent cost of capital?

> Describe the difference between systematic risk and unsystematic risk.

> A stock has an expected return of 10.2 percent, the risk-free rate is 4 percent, and the market risk premium is 7 percent. What must the beta of this stock be?

> A stock has had returns of 16.12 percent, 12.11 percent, 5.83 percent, 26.14 percent, and −13.19 percent over the past five years, respectively. What was the holding period return for the stock?

> A technical analysis tool that is sometimes used to predict market movements is an investor sentiment index. AAII, the American Association of Individual Investors, publishes an investor sentiment index based on a survey of its members. In the following

> What was the arithmetic average annual return on large-company stocks from 1926 through 2011? a. In nominal terms? b. In real terms?

> Titan Mining Corporation has 9.3 million shares of common stock outstanding and 260,000 6.8 percent semiannual bonds outstanding, par value $1,000 each. The common stock currently sells for $34 per share and has a beta of 1.20, and the bonds have 20 year

> Suppose the average inflation rate over this period was 4.2 percent, and the average T-bill rate over the period was 5.1 percent, what was the average real risk-free rate over this time period? What was the average real risk premium?

> What would a technical analyst say about market efficiency?

> What is the difference between arithmetic and geometric returns? Suppose you have invested in a stock for the last 10 years. Which number is more important to you, the arithmetic or geometric return?

> Several celebrated investors and stock pickers frequently mentioned in the financial press have recorded huge returns on their investments over the past two decades. Does the success of these particular investors invalidate the EMH? Explain.

> Given the following information for Huntington Power Co., find the WACC. Assume the company’s tax rate is 35 percent. Debt: 5,000 6 percent coupon bonds outstanding, $1,000 par value, 25 years to maturity, selling for 105 percent of par; the bonds make

> Filer Manufacturing has 8.3 million shares of common stock outstanding. The current share price is $53, and the book value per share is $4. Filer Manufacturing also has two bond issues outstanding. The first bond issue has a face value of $70 million and

> Consider a levered firm’s projects that have similar risks to the firm as a whole. Is the discount rate for the projects higher or lower than the rate computed using the security market line? Why?

> Assume that the following market model adequately describes the return generating behavior of risky assets: R it = α i + β i R M t + € it Here: R it = The return on the i th asset at Time t. R M t = The return o

> What is data mining? Why might it overstate the relation between some stock attribute and returns?

> How do you determine the appropriate cost of debt for a company? Does it make a difference if the company’s debt is privately placed as opposed to being publicly traded? How would you estimate the cost of debt for a firm whose only debt issues are privat

> Consider the following information: a. Your portfolio is invested 30 percent each in A and C, and 40 percent in B. What is the expected return of the portfolio? b. What is the variance of this portfolio? The standard deviation? State of Probability

> A broker has advised you not to invest in oil industry stocks because they have high standard deviations. Is the broker’s advice sound for a risk-averse investor like yourself? Why or why not?

> You’ve observed the following returns on Mary Ann Data Corporation’s stock over the past five years: 27 percent, 13 percent, 18 percent, 214 percent, and 9 percent. a. What was the arithmetic average return on Mary Ann’s stock over this five-year period?

> Two years ago, the Lake Minerals and Small Town Furniture stock prices were the same. The average annual return for both stocks over the past two years was 10 percent. Lake Minerals’ stock price increased 10 percent each year. Small Town Furniture’s stoc

> Under what circumstances would it be appropriate for a firm to use different costs of capital for its different operating divisions? If the overall firm WACC was used as the hurdle rate for all divisions, would the riskier divisions or the more conservat

> There are two stock markets, each driven by the same common force, F, with an expected value of zero and standard deviation of 10 percent. There are many securities in each market; thus, you can invest in as many stocks as you wish. Due to restrictions,

> You own a portfolio equally invested in a risk-free asset and two stocks. If one of the stocks has a beta of 1.65 and the total portfolio is equally as risky as the market, what must the beta be for the other stock in your portfolio?

> Consider the following information: a. What is the expected return on an equally weighted portfolio of these three stocks? b. What is the variance of a portfolio invested 20 percent each in A and B, and 60 percent in C? State of Rate of Return if S

> Consider the following quotation from a leading investment manager: “The shares of Southern Co. have traded close to $12 for most of the past three years. Since Southern’s stock has demonstrated very little price movement, the stock has a low beta. Texas

> Refer to Table 10.1 in the text and look at the period from 1973 through 1978. a. Calculate the arithmetic average returns for large-company stocks and T-bills over this period. b. Calculate the standard deviation of the returns for large-company sto

> Suppose stock returns can be explained by a two-factor model. The firm-specific risks for all stocks are independent. The following table shows the information for two diversified portfolios: If the risk-free rate is 4 percent, what are the risk premiu

> Two years ago, General Materials’ and Standard Fixtures’ stock prices were the same. During the first year, General Materials’ stock price increased by 10 percent while Standard Fixtures’ stock price decreased by 10 percent. During the second year, Gener

> Fama’s Llamas has a weighted average cost of capital of 9.8 percent. The company’s cost of equity is 13 percent, and its cost of debt is 6.5 percent. The tax rate is 35 percent. What is Fama’s debt–equity ratio?

> Both Dow Chemical Company, a large natural gas user, and Superior Oil, a major natural gas producer, are thinking of investing in natural gas wells near Houston. Both are all-equity financed companies. Dow and Superior are looking at identical projects.

> You are forming an equally weighted portfolio of stocks. Many stocks have the same beta of .84 for Factor 1 and the same beta of 1.69 for Factor 2. All stocks also have the same expected return of 11 percent. Assume a two-factor model describes the retur

> A portfolio is invested 10 percent in Stock G, 65 percent in Stock J, and 25 percent in Stock K. The expected returns on these stocks are 9 percent, 11 percent, and 14 percent, respectively. What is the portfolio’s expected return? How do you interpret y

> Briefly explain why the covariance of a security with the rest of a well-diversified portfolio is a more appropriate measure of the risk of the security than the security’s variance.

> Based on the following information, calculate the expected return and standard deviation for the two stocks: State of Rate of Return if State Occurs Probability of State of Economy Economy Stock A Stock B Recession 20 .06 - 20 Normal 55 .07 .13 Boom

> Using the following returns, calculate the average returns, the variances, and the standard deviations for X and Y: Year Y 8% 12% 2 21 27 3 -27 -32 4 18 5 18 24