Response to the following:
Define the following terms, using graphs or equations to illustrate your answers where feasible.
Risk in general; stand-alone risk; probability distribution and its relation to risk
Expected rate of return, ˆrr^
Continuous probability distribution
Standard deviation, σ; variance, σ2σ2
Risk aversion; realized rate of return, ¯rr¯
Risk premium for Stock i, RPiRPi;
market risk premium, RPMRPM
Capital Asset Pricing Model (CAPM)
Expected return on a portfolio, ˆrpr^p; market portfolio
Correlation as a concept; correlation coefficient, ρ
Market risk; diversifiable risk; relevant risk
Beta coefficient, b; average stock's beta
Security Market Line (SML); SML equation
Slope of SML and its relationship to risk aversion
Equilibrium; Efficient Markets Hypothesis (EMH); three forms of EMH
Fama-French three-factor model
Behavioral finance; herding; anchoring
(1) The probability distribution of a less risky return is more peaked than that of a riskier return. What shape would the probability distribution have for (a) completely certain returns and (b) completely uncertain returns?
(2) Required Rate of Return Suppose rRF=5%rRF=5%, rM=10%rM=10%, and rA=12%rA=12%. Calculate Stock A's beta. If Stock A's beta were 2.0, then what would be A's new required rate of return?
(3). Portfolio Required Return Suppose you manage a $4 million fund that consists of four stocks with the following investments: If the market's required rate of return is 14% and the risk-free rate is 6%, what is the fund's required rate of return?
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Stock
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Investment
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beta
|
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A
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400000
|
1.50
|
|
B
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600000
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-0.50
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C
|
1000000
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1.25
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D
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2000000
|
0.75
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How can the WACC be both an average cost and a marginal cost?
(4). After-Tax Cost of Debt LL Incorporated's currently outstanding 11% coupon bonds have a yield to maturity of 8%. LL believes it could issue new bonds at par that would provide a similar yield to maturity. If its marginal tax rate is 35%, what is LL's after-tax cost of debt?
(4). Cost of Preferred Stock with Flotation Costs Burnwood Tech plans to issue some $60 par preferred stock with a 6% dividend. A similar stock is selling on the market for $70. Burnwood must pay flotation costs of 5% of the issue price. What is the cost of the preferred stock?
(5). Cost of Equity: Dividend Growth Summerdahl Resort's common stock is currently trading at $36 a share. The stock is expected to pay a dividend of $3.00 a share at the end of the year (D1=$3.00)(D1=$3.00), and the dividend is expected to grow at a constant rate of 5% a year. What is its cost of common equity?
(6). Cost of Equity: CAPM Booher Book Stores has a beta of 0.8. The yield on a 3-month T-bill is 4%, and the yield on a 10-year T-bond is 6%. The market risk premium is 5.5%, and the return on an average stock in the market last year was 15%. What is the estimated cost of common equity using the CAPM?
(7). WACC Shi Import-Export's balance sheet shows $300 million in debt, $50 million in preferred stock, and $250 million in total common equity. Shi's tax rate is 40%, rd=6%rd=6%, rps=5.8%rps=5.8%, and rs=12%rs=12%. If Shi has a target capital structure of 30% debt, 5% preferred stock, and 65% common stock, what is its WACC?