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QUESTION
POINTS
19
QUESTION
10
11
12
POINTS
10
10
10
10
GRADE
GRADE
--------------------------Any communication with other students during the exam (including showing, viewing or sharing any
writing) is strictly prohibited. Any violation will result in a score of 0 points for the exam.
Clearly state all the mathematical expressions that are needed to solve the problems. Partial credit
will be given for correct formulas. Show all answers to all least four significant digits.
No credit will be given to numerical answers without the proper setup, so please show your work.
Please pace yourself carefully to finish as many problems as you can within the allotted 3 hours.
Answer each of the following twelve questions in the space provided beneath the relevant question. If
you need more space to show major computations you performed to obtain your answer for a particular
problem, use the back of the preceding page. If you need additional space, you may submit additional
sheets that are clearly identified as yours, with your name and SID, and on which your work is clearly
marked to indicate the particular problem to which it relates.
You can quote and use any result stated in class or in the main body of the textbook as well as wellknown general mathematical results but no references to other sources (including textbook exercises)
are allowed. In addition, you are allowed ten sheets of notes, which may be double-sided, for a total of
tewemty pages of notes.
If you cannot answer a problem the result of which is used in a subsequent problem, make a reasonable
assumption about the problem's answer for use in the subsequent problem, stating it clearly.
Page 1 of 13
Description
Answers
Points
Corporation.
Corporation
Page 2 of 13
Points
II. If Felicia's managers wanted to increase Felicia's ROE by 3.5% (i.e. add 3.5% to the current
ROE) solely by increasing asset turnover, what would Felicia's asset turnover need to be?
Answers
Points
Using the DuPont Identity, the answer is that Felicia's new asset turnover = 17.5%/7% = 2.5 or
an increase of 0.5; 10.5% = 7%*25*1
Points
2
IV.Comparing Harry's results and data with Felicias results and data, explain the difference
between the two firms ROEs in terms of the formula referred to in I above. Whose stores
are likely busier? Whose food is likely more expensive relative to its cost?
Answers
Points
Harry's asset turnover is lower than Felicia's, so Felicia's stores are likely busier. Harry's net
profit margin is greater, so Harry's food is likely more expensive relative to its cost
Page 3 of 13
Points
2 points
3 Points
Accounting Earnings
Dividend Payments
Total Payouts (All Dividends and Repurchases)
Page 4 of 13
1 Point
Check only one
$20.00
$21.60
$23.33
$25.19
b) Compute the present value of the FCF over the first three years. 2 points
Answer: Student can use the annuity formula, or just compute discount factors @ 6% as follows:
94.34%
89.00%
83.96%
79.21%
Page 5 of 13
False
1 Point
II. Let P be the efficient portfolio and A an asset with expected return rA. Write down the
equation rA must satisfy in terms of rA, rP, their volatility and correlation, and the risk-free
rate. (Hint: it includes A's required return with respect to P, as defined in the textbook.)
Identify the beta term, referred to as PA.
Page 7 of 13
( A ) Cor ( r A , r P ) ( r P r f )
(P)
Points
III. True or False: Under the CAPM assumptions, the equation you found in II above
expresses the Capital Asset Pricing Model. Check one.
1 Point
True X
False
IV.Under the CAPM assumptions, which of the following resembles most closely P in II
above? (Check only one.) 1 Point
Exxon-Mobil, the largest
US industrial company
V. Write the equation you found in II above in a form that relates the Sharpe Ratio of A to the
Sharpe Ratio of P. (Hint: there should be a correlation term.) 2 Points
Answer: Sharpe Ratio(A) = Corr(rA,rP)*Sharpe Ratio P
VI. An application: Optima Fund has an expected return of 22% and a volatility of 10%.
Assume the risk free rate is 2%. 1 Point
a) What is Optima Fund's Sharpe Ratio?
Answer: Sharpe Ratio(Optima) = 20%/10% = 2
b) Now assume Optima Fund has the highest Sharpe Ratio of any portfolio, and that Alpha
Pharmaceuticals has a correlation of 75% with Optima Fund. What is Alpha's Sharpe
Ratio? (Based on your prior answers, this should be all the information you need.)
2 Points
Answer: Sharpe Ratio(Alpha) = 75%*2 = 1.5
Page 8 of 13
ACME
DREAMTECH
YEAR-END
STOCK PRICE
DIVIDEND
STOCK PRICE
DIVIDEND
2010
$1
$0
$10
$0
2011
$4
$1
$20
$0
2012
$7
$1
$100
$0
2013
$12
$2
$500
$0
Increase
False
Page 10 of 13
False
1 Point
False
1 Point
No
1 Point
IV.What is the expected return on GILD stock over the next year? 1 Point
Answer: E[Payoff] = 75, r = 75/72 -1 = 4.167%
V. Under the binomial model we studied in class, what is the value of the one-year call option
on GILD stock? (Hint: recall that we first construct a portfolio in the stock and a riskless
bond that replicates the payoffs from the option at time t=1 year. We then compute the
value of the option at time t=0 as the value of this portfolio, using the Law of One Price.)
2 Points
Answer: = (Cu Cd)/(Su Sd) = 40%, B(future) = - 40%*$70 = $28 => B(present) = $28/1.02 = $27.45, so current option value = C(0) = 40%*$72 - $28/1.02 = $1.349
VI. What is the risk-neutral probability that GILD's stock price will move up to $80? (Hint:
Recall that in class we showed how to express the formula for the value of the call you
computed in V above in the form: Call Value = 1/(1+rf)*(pUp*CallUp + pDown*CallDown), with
CallUp and CallDown the call option payoffs, pUp + pDown = 1 and 1 pU p,pDown 0. This
expression justified treating pUp and pDown as probabilities. The problem asks for pUp.)
2 Points
Answer: pU = (1.02*S(0) Sd)*(Su Sd) = 34.40%
VII. Suppose the annual volatility of GILD stock is 40% (a much higher volatility than implied
from the data above.) Write the Black-Scholes formula, and then apply it to the data above
to compute the value of your call option, using N(x) to denote the cumulative normal
distribution function evaluated at x. Compute as many of the terms in the formula as you
can, excluding the cumulative normal distributions (but do try to compute d1 and d2.)
2 Points
Answer: C(0) = S(0)*N(d1) PV(K)*N(d2); d1 = ln(/S(0)/PV(K))/a-a/2, d2 = d1 -a , where a = T, so
a = 40%, PV(K) = $76/1.02 = $74.51 and d1= ln($72/$74.51)/40% - 20% = 11.43%, d2 = d1 -40% =
-28.57% and we have C(0) = 72*N(0.1143) - $74.51*N(-0.2857)
CONGRATULATIONS! YOU HAVE FINISHED THE FINAL EXAM IN E 120
Page 13 of 13