Corporate Finance Academic year 2011-2012 Tutorials Part I

Introduction In this document, you will find the exercises for the course Corporate Finance 2011-2012. They are organised per week. Not all exercises will be treated during the tutorial meetings. Priority will be given to the exercises labelled with an asterisk (*). The last section of the document contains an old exam, consisting of 25 multiple choice questions. Per week, we have indicated which of the old exam questions belong to the theory of that week and which will be treated during the tutorial. Standard solutions to the exercises will be provided separately on WebCT, the Monday following the tutorial. Since all solutions will be provided, the tutorials aim at increasing understanding of the material and practising strategies and methods to solve the exercises, not at listing all correct answers on the spot.

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Week 1 (chapters 3 and 5)

* 1. Market versus Book Values. The founder of Alchemy Products, Inc., discovered a way to turn lead into gold and patented this new technology. He then formed a corporation and invested $400,000 in setting up a production plant. He believes that he could sell his patent for $50 million. a. What are the book value and market value of the firm? b. If there are 2.5 million shares of stock in the new corporation, what would be the price per share and the book value per share? 2. Profits versus Cash Flow. Butterfly Tractors had $ 14 million in sales last year. Cost of goods sold was $ 8 million, depreciation expense was $ 2 million, interest payment on outstanding debt was $ 1 million, and the firms tax rate was 35 percent. a. What was the firms net income and net cash flow? b. What would happen to net income and cash flow if depreciation were increased by $1 million? How do you explain the differing impact of depreciation on income versus cash flow? c. Would you expect the change in income and cash flow to have a positive or negative impact on the firms stock price? d. Now consider the impact on net income and cash flow if the firms interest expense were $1 million higher. Why is this case different from part (b)? * 3. The following table contains data on Fincorp, Inc., that you should use for problems 3-10. The balance sheet items correspond to values at year-end of 2008 and 2009, while the income statement items correspond to revenues or expenses during the year ending either 2008 or 2009. All values are in thousands of dollars. Construct a balance sheet for Fincorp for 2008 and 2009. What is the value of shareholders equity?
Revenue Cost of goods sold Depreciation Inventories Administrative expenses Interest expense Federal and state taxesa Accounts payable Accounts receivable Net fixed assetsb Long-term debt Notes payable Dividends paid Cash and marketable securities 2008 $4,000 1,600 470 300 500 150 400 300 370 5,000 2,000 1,000 410 800 2009 $4,100 1,700 500 350 550 150 420 350 400 5,800 2,400 600 410 340

a. Taxes are paid in their entirety in the year that the fax obligation is incurred. b. Net fixed assets are fixed assets net of accumulated depreciation since the asset was installed.

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* 4. Working Capital. What happened to net working capital during the year? * 5. Income statement. Construct an income statement for Fincorp for 2008 and 2009. What were reinvested earnings for 2009? How does that compare with the increase in shareholders equity between the two years? * 6. Earnings per Share. Suppose that Fincorp has 500,000 shares outstanding. What were earnings per share in 2009? * 7. Taxes. What was the firms average tax bracket for each year? Do you have enough information to determine the marginal tax bracket? * 8. Balance Sheet. Examine the values for depreciation in 2009 and net fixed assets in 2008 and 2009. What was Fincorps gross investment in plant and equipment during 2009? * 9. Cash Flows. Construct a statement of cash flows for Fincorp for 2009. * 10. Book versus Market Value. Now suppose that the market value (in thousands of dollars) of Fincorps fixed assets in 2009 is $6,000. In addition, the consensus among investors that Fincorps past investments in developing the skills of its employees are worth $3,100. This investment of course does not show up on the balance sheet. What will be the price per share of Fincorp stock? * 11. Annuities and Interest Rates. Professors Annuity Corp. offers a lifetime annuity to retiring professors. For a payment of $100,000 at age 65, the firm will pay the retiring professor $750 a month until death. a. If the professors remaining life expectancy is 20 years, what is the monthly rate on this annuity? What is the effective annual rate? b. If the monthly interest rate would be 0.5 percent, what monthly annuity payment could the firm offer to the retiring professor? 12. Annuity Value. You just borrowed $200,000 to buy a condo. You will repay the loan in equal monthly payments of $804.62 over the next 30 years. What monthly interest rate are you paying on the loan? What is the effective annual rate on that loan? What rate is the lender more likely to quote on the loan? * 13. Continuous Compounding. How much will $100 grow to if invested at a continuously compounded interest rate of 11 percent for 7 years? What if it is invested for 11 years at 7 percent? * 14. Perpetuities. A local bank advertises the following deal: Pay us $100 a year for 10 years and then we will pay you (or your beneficiaries) $100 a year forever. Is this a good deal if the interest rate available on other deposits is 6 percent? 15. Perpetuities. A property will provide $8,000 a year forever. If its value is $125,000, what must be the discount rate?

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* 16. Applying Time Value. You can buy property today for #3.5 million and sell it in 5 years for $4 million. (You earn no rental income on the property.) a. If the interest rate is 7.5 percent, what is the present value of the sales price? b. Is the property investment attractive to you? Why or why not? c. Would your answer to (b) change if you also could earn $150,000 per year rent on the property? Old exam questions: Questions E1-E5 and E21 correspond to the material in chapters 1-5 of BMM. In the first week tutorial, we will pay attention to E1-E3 (*).

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Week 2 (chapters 6 and 7)

17. Bond Pricing. A 30-year maturity bond with face value of $1,000 makes annual coupon payments and has a coupon rate of 8 percent. What is the bonds yield to maturity if the bond is selling for. a. $870 b. $1,000 c. $1,130 * 18. Bond Pricing. A 30-year maturity bond with face value of $1,000 makes semi-annual coupon payments and has an annual coupon rate of 8 percent. What is the bonds yield to maturity if the bond is selling for: a. $870 b. $1,000 c. $1,130 19. Bond Pricing. Complete the table below for the following zero-coupon bonds. The face value of each bond is $1,000. Price Maturity (Years) Yield to Maturity $400 30 ? $400 ? 8% ? 10 9% 20. Bond Pricing. Large Industries bonds sell for $1,130,30. The bond life is 9 years, and the yield to maturity is 7 percent. What must be the coupon rate on the bonds? * 21. Consider three bonds with 8 percent coupon rates, all selling at face value. The shortterm bond has a maturity of 4 years, the intermediate-term bond has maturity 8 years, and the long-term bond has maturity 30 years. a. What will happen to the price of each bond if their yields increase to 10 percent? b. What will happen to the price of each bond if their yields decrease to 6 percent? c. What do you conclude about the relationship between time to maturity and the sensitivity of bond prices to interest rates? * 22. A bonds credit rating provides a guide to its risk. Long-term bonds rated Aa currently offer yields to maturity of 7.5 percent. A-rated bonds sell at yields of 7.8 percent. If a 10-year bond with a coupon rate of 7 percent is downgraded by Moodys from Aa to A rating, what is the likely effect on the bond price? * 23. Suppose interest rates increase from 7 percent to 8 percent. Which bond will suffer the greater percentage decline in price: a 30-year bond paying annual coupons of 7 percent, or a 30-year zero coupon bond? Can you explain intuitively why the zero exhibits greater interest rate risk even tough it has the same maturity as the coupon bond?

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* 24. The below table depicts the cash flows of zero-coupon bonds for the next five years. Using this table, calculate the spot rates of the zero-coupon bonds and depict the spot rate curve.
Market price 0 -934.58 -841.68 -731.19 -658.73 -620.92 1 1000 Cash flows per period (EUR) 2 3 4 1000 1000 1000 5 1000

* 25. Using the information from the table in problem 24 and its solution (the spot rates on one to five year zero-coupon bonds) it is possible to compute all forward rates of different zero-coupon bonds with annual maturities within the next five years. Compute the following forward rates: i12, i13, i24, i45. The notation must be interpreted as follows: i24 is the interest rate on a zero-coupon bond that will be issued two years from now and has a maturity of two years so that it matures in year 4. The forward price then follows. Compute the four corresponding forward prices of the bonds too. * 26. Eastern Electric currently pays a dividend of about $1.75 per share and sells for $27 a share. a. If investors believe the growth rate of dividends is 3.5 percent per year, what rate of return do they expect to earn on the stock? b. If investors required rate of return is 11 percent, what must be the growth rate they expect of the firm? c. If the sustainable growth rate is 5 percent, and the plowback ratio is .4, what must be the rate of return earned by the firm on its new investments? 27. You believe that the Non-stick Gum Factory will pay a dividend of $3 on its common stock next year. Thereafter, you expect dividends to grow at a rate of 6 percent a year in perpetuity. If you require a return of 12 percent on your investment, how much should you be prepared to pay for the stock? * 28. No-Growth Industries pays out all of its earnings as dividends. It will pay its next $6 per share dividend in a year. The discount rate is 12 percent. a. What is the price-earnings ratio of the company? b. What would the P/E ratio be if the discount rate were 10 percent? * 29. Start-up Industries is a new firm that has raised $240 million by selling shares of stock. Management plans to earn 22% of ROE which is more than the 15 percent rate of return available on comparable-risk investments. Half of all earnings will be reinvested in the firm. a. What will be Start-ups ratio of market value to book value? b. How would that ratio change if the firm can earn only a 10 percent rate of return on its investments? 30. Tattletale News Corp. has been growing at a rate of 25 percent per year, and you expect this growth rate in earnings and dividends to continue for another 3 years. a. If the last dividend paid was $3, what will the next dividend be? b. If the discount rate is 15 percent and the steady growth rate after 3 years is 5 percent, what should the stock price be today?

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* 31. A company will pay a $2.5 per share dividend in 1 year. The dividend in 2 years will be $5 per share, and it is expected that dividends will grow at 4 percent per year thereafter. The expected rate of return on the stock is 12 percent. a. What is the current price of the stock? b. What is the expected price of the stock in a year? c. Show that the expected return, 12 percent, equals dividend yield plus capital appreciation. * 32. Better Mousetraps has come out with an improved product, and the world is beating a path to its door. As a result, the firm projects growth of 20 percent per year for 4 years. By then, other firms will have copycat technology, competition will drive down profit margins, and the sustainable growth rate will fall to 5 percent. The most recent annual dividend was DIV0 = $1.50 per share. a. What are the expected values of DIV1, DIV2, DIV3, and DIV4? b. What is the expected stock price 4 years from now? The discount rate is 10 percent. c. What is the stock price today? d. Find the dividend yield, DIV1/P0. e. What will next years stock price, P1, be? f. What is the expected rate of return to an investor who buys the stock now and sells it in 1 year?

Old exam questions: Questions E6-E11 and E22-23 correspond to the material in chapters 6 and 7 of BMM. In the second week tutorial, we will pay attention to E6-E7(*).

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Week 3 (chapter 23)

* 33. Turn back to table 23.2 which lists prices of various Google options. Use the data in the table to calculate the payoff and the investment profits in each of the following March maturity options, assuming that the stock price on the expiration date is $720. a. Call option with exercise $620 b. Put option with exercise $620 c. Call option with exercise $720 d. Put option with exercise $720 e. Call option with exercise $820 f. Put option with exercise $820 * 34. Discuss which options would be profitable if the stock price on the expiration date was a) $780, b) $680. * 35 Option Contracts. Fill in the blanks by choosing the appropriate terms from the following list: call, exercise, put. A (n)_________ option gives its owner the opportunity to buy a stock at a specific price which is generally called the ________ price. A (n)_________ option gives its owner the opportunity to sell stock at a specified _______ price. * 36 Puts versus Calls. The buyer of a call and the seller of a put both hope that the stock price will rise. Therefore the two positions are identical. Is the speaker correct? Illustrate with a simple example or diagram. * 37 Option Portfolios. Mixing options and securities can often create interesting playoffs. For each of the following combinations show what the payoff would be when the option expires if (i) the stock price is below the exercise, and (ii) the stock price is above the exercise price. Assume that each option has the same exercise price and expiration date. a. Buy a call and invest the present value of the exercise price in a bank deposit. b. Buy a share and a put option on the share. c. Buy a share, buy a put option on the share, and sell a call option on the share. d. Buy a call option and a put option on the share. * 38 Option Valuation. Table 23.2 shows call options on Google stock with the same exercise date in March and with exercise prices $620, $720, and $ 820. Notice that the price of the middle call option (with exercise price $720) is less than halfway between the prices of the other two calls (with exercise prices $620 and $820). Suppose that this were not the case. For example, suppose that the price of the middle call were the average of the prices of the other two calls. Show that if you sell two of the middle calls and use the proceeds to buy one each of the other calls, your proceeds in March may be positive but cannot be negative despite the fact that your net outlay today is zero. What can you deduce from this example about option pricing?

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* 39 How does the price of a put option respond to the following changes, other things equal? Does the put price go up or down? a. stock price increases. b. exercise price is increased. c. risk-free interest rate increases. d. expiration date of the option is extended. e. volatility of the stock price falls. f. time passes, so the options expiration date comes closer. * 40 a. Circular File stock is selling for $25 a share. You see that call options on the stock with exercise price of $20 are selling at $3. What should you do? What will happen to the option price as investors identify this opportunity? b. Now you observe that put options on Circular File with exercise price $30 are selling for $4. What should you do?

Old exam questions: Questions E15-E18 and E24-E25 correspond to the material in chapter 23 of BMM. In the third week tutorial, we will pay attention to questions E15, E17, E24 and E25 (*).

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Week 4 (chapters 11 and 12)

* 41. Risk Premiums. Here are stock markets and Treasury bill returns between 2003 and 2007: Year 2003 2004 2005 2006 2007 Stock Market Return 31.64 12.62 6.38 15.77 5.62 T-Bill Return 1.02 1.20 2.98 4.80 4.66

a.What was the risk premium on common stock in each year? b.What was the average risk premium? c.What was the standard deviation on the risk premium? 42. Maturity premiums. Investments in long-term government bonds produced a negative average return during the period 1977-1981. How should we interpret this? Did bond investors in 1977 expect to earn a negative maturity premium? What do these 5 years bond returns tell us about the normal future maturity premium? * 43. Scenario Analysis. The common stock of Leaning Tower of Pita, Inc., a restaurant chain, will generate the following payoffs to investors next year:
Boom Normal Economy Recession Dividend $5 2 0 Stock price $165 100 0

The company goes out of business if a recession hits. Calculate the expected return and standard deviation of return to Leaning Tower of Pita shareholders. Assume for simplicity that the three possible states of the economy are equally likely. The stock is selling today for $80. * 44. Scenario Analysis. Consider the following scenario analysis:
Scenario Recession Normal Economy Boom Probability .15 .70 .15 Rate of Return Stocks Bonds -5% +14% +15% +8 +25% +4

a. Is it reasonable to assume that Treasury bonds will provide higher returns in recessions than in booms? b. Calculate the expected rate of returns and standard deviation for each investment. c. Which investments would you prefer? * 45. Portfolio analysis. Use the data in the previous problem and consider a portfolio with weights of 0.60 in stocks and 0.40 in bonds. a. What is the rate of return of the portfolio in each scenario? b. What is the expected rate of return and standard deviation of the portfolio? c. Would you prefer to invest in stocks, in bonds or in the portfolio?

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46. In which of the following situations would you get the largest reduction in risk by spreading your portfolio across two stocks? a. The stock returns vary with each other. b. The stock returns are independent. c. The stock returns vary against each other. 47. Which firms of each pair would you expect to have greater market risk: a. General Steel or General Food Supplies b. Club Med or General Cinemas 48. A stock will provide a rate of return of either 20 percent or + 28% percent. a. If both possibilities are equally likely, calculate the expected return and standard deviation. b. If Treasury bills yield 4 percent, and investors believe that the stock offers a satisfactory expected return, what must the market risk of the stock be? * 49. Sassafras Oil is staking all its remaining capital on wildcat exploration off the Cte dHuile. There is a 10% chance of discovering a field with reserves of 50 million barrels. If it finds oil, it will immediately sell the reserves to Big Oil, at a price depending on the state of the economy. Thus the possible payoffs are as follows:
Value of reserves (per barrel) $4 5 6 Value of reserves (50 mln barrels) $200,000,000 250,000,000 300,000,000 Value of dryholes 0 0 0

Boom Normal economy Recession

Is Sassafras Oil a risky investment for a diversified investor in the stock market, compared to, say the stock of Leaning Tower of Pita (see above)? Explain. 50. The following provides several months rates of return for Tumblehome Canoe Company. Prepare a plot like Figure 11-1. What is Tumblehomes beta?
Month 1 2 3 4 5 6 7 8 9 10 Market Return, % 0 0 -1 -1 +1 +1 +2 +2 -2 -2 Tumblehome Return, % +1 -1 -2.5 -0.5 +2 +1 +4 +2 -2 -4

* 51. Consider the following two scenarios for the economy, and the returns in each scenario for the market portfolio, an aggressive stock A, and a defensive stock D.
Scenario Bust Boom Market -8% 32 Aggressive Stock A -10% 42% Rate of Return Defensive Stock D -6% 26

a. Find the beta of each stock. In What way is stock D defensive?

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b. If each scenario is equally likely, find the expected rate of return on the market portfolio and on each stock. c. If the T-bill rate is 4 percent, what does the CAPM say about the fair expected rate of return on the two stocks? d. Which stock seems to be a better buy based on your answers to (a) through (c)? 52. You are a consultant to a firm evaluating an expansion of its current business. The cashflow forecasts (in million of dollars) for the project are:
Years 0 1-10 Cash Flow -100 + 15

Based on the behavior of the firms stock, you believe that the beta of the firm is 1.3. Assuming that the rate of return available on risk-free investments is 4 percent and that the expected rate of return on the market portfolio is 12 percent, what is the net present value of the project? 53. A share of stock with a beta of .80 now sells for $40. Investors expect the stock to pay a year-end dividend of $2. The T-bill rate is 4 percent, and the market risk premium is 8 percent. If the stock is perceived to be fairly priced today, what must be investors expectation of the price of the stock at the end of the year? * 54. True of false? Explain or qualify as necessary. a. The expected rate of return on an investment with a beta of 2 is twice as high as the expected rate of return on the market portfolio. b. The contribution of a stock to the risk of a diversified portfolio depends on the market risk of the stock. c. If a stocks expected rate of return plots below the security market line, it is under-priced. d. A diversified portfolio with a beta of 2 is twice as volatile as the market portfolio. e. An under-diversified portfolio with a beta of 2 is twice as volatile as the market portfolio. * 55. We Do Bankruptcies specializes in providing advice to firms in financial distress. It prospers in recessions when other firms are struggling. Consequently, its beta is negative -0.3. a. If the interest rate on Treasury bills is 5 percent and the expected return on the market portfolio is 15 percent, what is the expected return on the shares of the law firm according to the CAPM? b. Suppose you invested 90 percent of your wealth in the market portfolio and the remainder of your wealth in the shares of the law firm. What would be the beta of the portfolio? * 56. Footnote 4 in the chapter asks you to consider a borrow-and-invest strategy in which you use $1 million of your own money and borrow another $1 million to invest $2 million in a market index fund. If the risk-free interest rate is 4 percent and the expected rate of return on the market index fund is 12 percent, what is the risk premium and expected rate of return on the borrow-and-invest strategy? Why is the risk of this strategy twice that of simply investing your $1 million in the market index fund?

Old exam questions: Questions E12-E14 and E20 correspond to the material in chapter 11+12 of BMM. In the fourth week tutorial, we will pay attention to questions E12, E14 and E20 (*).

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Exam Questions
* E.1. Royal Bank offers a savings account with an semi-annual interest rate of 3%. How much will 1,000 EUR grow to if they are invested for 12.5 years? The interest is continuously compounded throughout this period (round the answer to the integer). a. 2,117 EUR b. 2,000 EUR c. 2,054 EUR d. 2,425 EUR e. 2,094 EUR * E.2. The effective annual interest rate on a loan given by RemiBank is 8.7311%. What is the APR (annual percentage rate) that RemiBank will quote for this loan, if it compounds interest monthly (round the answer to two digits after the integer)? a. 10.00% b. 9.09% c. 8.40% d. 8.92% e. 7.98% * E.3. A local bank advertises the following deal: Pay us $200 a year for 20 years and then we will pay you (or your beneficiaries) $200 a year forever. Is this a good deal if the interest rate available on other deposits is 12%? a. Yes b. No c. Requires more information E.4. With the information given in Tables 1 and 2, what happened to net working capital during the year 2004 (round the answer to two digits after the integer)? a. Increased by 23,000. b. Increased by 252,000. c. Decreased by 23,000. d. Decreased by 252,000. e. None of the above. E.5. With the information given in Tables 1 and 2, Palento, Inc. sells in 2003 for $34 a share, and in 2004 for $41 a share. Calculate the percentage change in the market to book ratio. Assume that Palento, Inc. had the same number of shares outstanding in 2003 as in 2004 (round the answer to two digits after the integer). a. -7.86% b. +7.86% c. +8.53% d. +9.94% e. None of the above.

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Table 1

CONSOLIDATED BALANCE SHEET PALENTO, INC. AS OF DECEMBER 31, 2004 (thousands of dollars) 2004 140 294 269 58 761 2003 107 270 280 50 707 Liabilities and shareholders Equity Current liabilities: Accounts payable Notes payable Debt due for repayment 2004 213 50 223 2003 197 53 205

Assets Current Assets: Cash and equivalents Accounts receivable Inventories Other Total current assets

Total current liabilities Long-term liabilities: Deferred taxes Long-term debt Total long-term liabilities Stockholders equity: Common stock and other paid-in capital Retained earnings Total shareholders equity

486

455

Fixed assets: Plant & equipment 1,423 Accumulated depreciation (550) Net fixed assets 873 Intangible assets 245

1,274 (460) 814 221 1,035

117 471 588

104 458 562

Total fixed assets 1,118

415 390 805 1,879

378 347 725 1,742

Total assets

1,879

1,742

Total liabilities and shareholders equity

Table 2

INCOME STATEMENT PALENTO, INC., 2004 (thousands of dollars) $ 2,262 (1,655) (327) (90) 190 29 219 (49) 170 (84)

Total operating revenues Cost of goods sold Selling, general, and administrative expenses Depreciation Operating income Other income EBIT (Earnings before interest and tax) Interest expense Pretax income Taxes Current: $71 Deferred: $13 Net income Retained earnings: Dividends:

86 $ 43 43

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* E.6. The price of a bond with a 10-year maturity was 1,010 EUR. A year later the interest rates have dropped and the bonds price has increased to 1,040 EUR. What are the nominal and real rates of return if this bond pays an annual coupon of 70 EUR and the inflation (deflation) rate was 3 % during this year (round the answer to two digits after the integer)? a. nominal 6.93% and real 10.24% b. nominal 6.93% and real 3.82% c. nominal 9.90% and real 13.30% d. nominal 6.70% and real 9.90% e. nominal and real 6.93% * E.7. Random Fortune just paid a dividend of 2 EUR per share, and its dividend is expected to grow 20% per year for the next two years. Afterwards, the dividends will grow at a constant rate of 3% per year indefinitely. What is the stock price of Random Fortune today if investors expect a rate of return of 12% (round the answer to two digits after the integer)? a. 25.59 EUR b. 25.00 EUR c. 30.01 EUR d. 36.86 EUR e. 30.71 EUR E.8. Suppose the New York Stock Exchange (NYSE) is a market characterized by semistrong form efficiency, prices reflect not just the information contained in past prices but also all publicly available information. Tony Soprano is a New York fund manager who is active on this market. He advertises in the New York Times stating that his Vici Fund has consistently beaten the market return on the NYSE for the last 10 years. Which of the following statements cannot be true? a. Tony has a cousin Vinnie who works for the Securities and Exchange Commission and slips him some investment advice at a reasonable price. b. Tonys Vici Fund will outperform the market again next year. c. Tonys fortune can be attributed to the fact that he is much better at estimating and interpreting the CAPM model than other market participants. d. Tony fails to mention in his ads that Vici Fund is a high risk fund. e. Tony may have many bad character traits, but he is one incredibly lucky guy. E.9. A company has been growing at a rate of 10 percent per year, and you expect this growth rate in earnings and dividends to continue for another 3 years. The last dividend paid was $2. If the steady growth rate after 3 years is 5 percent, and the stock price in 3 years is $27.95, what is the expected rate of return (round the answer the answer to the integer)? a. 5% b. 10% c. 15% d. 20% e. None of the above E.10. With the information given in Tables 1 and 2, what is the expected growth rate of Palento, Inc. in 2004 according to the constant dividend growth model (round the answer to two digits after the integer)? a. g = 2.23 % b. g = 2.81 % c. g = 3.94 %

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d. g = 5.62 % e. None of the above. E.11. With the information given in Tables 1 and 2, suppose that Palento, Inc. has 27,500 shares outstanding. What were net earnings per share in 2004 (round the answer to two digits after the integer)? a. EPS = $ 3.13 b. EPS = $ 6.91 c. EPS = $ 1.56 d. EPS = $ 7.96 e. None of the above. * E.12. A share of stock has a beta of 0.5 and now sells for 100 EUR. The investors expect to get a dividend of 3 EUR at the end of the year. Moreover, the risk-free interest rate these investors can get is 3% and the market risk premium is 9%. If the stock is priced fairly today, what is the investors expectation for the price per share of this stock at the end of the year (round the answer to one digit after the integer)? a. 96.5 b. 101.5 c. 104.5 d. 107.5 e. 110.5 E.13. Edward Insecure does not like risk much. He wants to diversify as much as possible. Peter Parrot decides to give him investment advice, and presents him with four well-known statements. Which statement is true? a. The variance of the market portfolio is always lower than the variance of individual stocks. b. Arbitrage eliminates unique risk. c. Diversification lowers market risk. d. The market portfolio always has the highest expected return. e. None of the above. * E.14. You are a consultant to a firm evaluating an expansion of its current business. The cash-flow forecasts (in millions of dollars) for the project are: Years Cash Flow 0 - 50 1-5 10 6-10 20 Based on the behavior of the firms stock, you believe that the beta for the firm is 0.75. Assuming that the rate of return available on risk-free investments is 3 percent and that the market risk premium is 8%, what is the net present value of the project (round the answer to two digits after the integer)? a. $39.45 b. $66.69 c. $89.45 d. $116.69 e. None of the above

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* E.15. When the volatility of the underlying asset decreases, a. the value of the put option increases, but the value of the call option decreases. b. the value of the put option decreases, but the value of the call option increases. c. both the value of the put option and the call option increase. d. both the value of the put option and the call option decrease. e. the value of the put option and the call option remain the same. E.16. The higher the exercise or strike price, a. the higher the value of the call option on the underlying stock. b. the lower the value of the call option on the underlying stock. c. has no effect on the value of the call option on the underlying stock. d. the higher the stock price. e. the lower the stock price. * E.17. Suppose a stock with a current market price of 25 euro, on which a call option is written with an exercise or strike price of 16 euro. What is the minimal value of the call option? a. 0 b. 9 c. 16 d. 25 e. cannot be determined without additional information E.18. An in-the-money American call option on a stock, is an option with a. with an exercise or strike price lower than the current stock price. b. with a positive value upon exercise. c. with an exercise or strike price above the current stock price. d. both a and b are correct. e. both b and c are correct. E.19. A(n) is a trading platform for stocks that does not contribute to the price discovery process, but that reduces the market impact of block trades since it executes such orders at the market price taken from another market. (fill in the omitted term) a. Electronic Communications Network (ECN) b. Alternative Trading System (ATS) c. Crossing Network (CN) d. Systematic Internaliser (SI) e. Multilateral Trading Facility (MTF) * E.20. The expected rates of return of stocks and bonds in different market conditions and the probabilities of those market conditions are: Condition Boom Normal Recession Probability 0.3 0.5 0.2 Stocks 23% 10% -18% Bonds -6% 8% 14% How do the risk and return of a bonds-only portfolio compare to a portfolio in which 60% of your wealth is invested in stocks and 40% in bonds?

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a. b. c. d.

Return of bonds-only portfolio is higher, risk of bonds-only portfolio is also higher. Return of bonds-only portfolio is higher, while risk of bonds-only portfolio is lower. Return of bonds-only portfolio is lower, while risk of bonds-only portfolio is higher. Return of bonds-only portfolio is lower, risk of bonds-only portfolio is also lower.

E.21. Suppose you open a savings account and you deposit 1,000 in this account each year at the beginning of the year. Using an Excel spreadsheet you want to calculate how much you will have in the account at the start of year 10, if the account earns 10% per year. In Excel you open the dialog box as depicted below. In order to calculate the Future Value (FV) in year 10, which information do you need to plug into the cell Nper of the dialog box? a. If the payments are due at the end of the period, you put zero; if the payments are due at the beginning of the period, you put one b. The cash balance you start with. Since you open a new savings account, you put zero c. The payment made each period and which cannot change over the life time of the investment d. The total number of payments e. None of the above

E.22. Below you find a candle stick chart for the share of Boeing for some trading days during the year 2003. Take a look at the third candle from the left. Which of the following statements is true? a. The lowest intraday price is higher than the opening price of that day b. The closing price is lower than the opening price of that day c. The opening price was higher than the highest intraday price of that day d. The opening price is lower than the closing price of that day e. None of the above statements is true

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E.23. Suppose you want a zero-coupon bond with a maturity of two years. Such a bond is currently not offered at the bond market. However, the investment bank Morgan Stanley offers you to strip a 1,000 euro fixed-rate bond with a coupon rate of 8% and a four year maturity. The market value of the created two-year zero-coupon bond will be ... of the market value of the original straight bond, assuming a market interest rate of 7% and efficient bond markets? (fill in the omitted term and round to two digits after the integer) a. 8.00% b. 7.41% c. 6.99% d. 6.76% e. 6.32% * E.24. The share price of DELL is currently $ 29. Suppose you want to buy a call-option on this share with an exercise price of $ 29 and a time to expiration of 1 year. The annual US interest rate amounts 3.5%. Furthermore suppose you want to calculate the market value of this call-option using the binomial option pricing model with one tree step. The future stock price at expiration date will either be $ 43 or $ 14. How many shares do you have to combine with 100 call-options to create a replicating portfolio? (round to zero digits after the integer) a. you dont have to combine any shares with the call-options b. you have to combine 14 shares with 100 call-options c. you have to combine 29 shares with 100 call-options d. you have to combine 45 shares with 100 call-options e. you have to combine 48 shares with 100 call-options. * E.25. The share price of Arnold on Euronext is currently EUR 32. A European call-option with a time to expiration of one year and an exercise price of EUR 29 costs EUR 4.20. The continuously compounded risk-free interest rate amounts 3%. What will be the market value of an otherwise identical European put-option using the put-call parity? (round to two digits after the integer) a. 4.20 EUR b. 0.34 EUR c. 1.20 EUR d. 8.06 EUR e. 29.00 EUR

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