Professional Documents
Culture Documents
False. The CML can only be used to price efficient portfolios, that is, portfolios
perfectly positively correlated with the market portfolio. The SML can be used to
price individual assets or portfolios based on their level of systematic risk.
A2.
A3.
False. Arbitragers identify mispricing and obtain risk free profits, or speculators take
a position in the market and profit is the market moves in accordance with their
expectations.
A4.
False. The market value of a company is defined as the market value of debt plus the
market value of equity. i.e. V = DMV + EMV
A5.
True. The value of a company is independent of its capital structure. A company can
be viewed as a collection of assets that generate cash flow, and its value does remains
the same regardless of how these cash flows are divided between different classes of
investors.
A6.
True. It is always possible for some investors/traders to beat the market some of the
time. In an efficient market, it should not be possible for them to beat the market
consistently over time after transactions (and other) costs.
A7.
False. Under a pure residual dividend policy, dividends are paid from profits that
cannot be profitably invested.
A8.
True. Method is biased in favour of projects that recover initial cash outlays quickly.
A9.
False. Short refer to short dated of long dated. Else short hedge means selling
and long hedge refers to a buying hedge.
A10.
False. The APT does not say anything about which factors are priced in the market.
Empirical research has found four main factors, and the market portfolio is not one of
them.
e)
(iii)
(i)
(ii)
B3.
a)
Debt
k d = 13%
MVd =
#=
11
111
+
= 9.7345 + 86.9293 = $96.6638
1.13 (1.13)2
3,000,000
= 30,000
100
Preference
Int = $2 7% = 0.14
MV = $1.50
$1.50 =
0.14
kp
0.14
= 0.0933 = 9.33%
1.50
1,000,000
#=
= 500,000
2
kp =
Ordinary shares
MV = $2.10
ke = 8 + 1.2(18 8) = 20%
D
P
E
WACC
$96.6638 x 30,000
$1.50 x 500,000
$2.10 x 4,000,000
(b)
2,899,914
750,000
8,400,000
12,049,914
0.2407
0.0622
0.6971
1.0000
0.130
0.093
0.200
0.0313
0.0058
0.1394
0.1765
Section C
C1.
a)
i)
ii)
C2.
b)
One reason for the relevance of dividends is that certain shareholders may
require their shares to provide current income. A retired person may require
dividend income to support their consumption pattern. But MM argue that an
investor requiring income could simply sell their shares. In other words,
investors can create home made dividends by selling their shares. Yes, MM
are correct, but any investors following this policy would incur stamp duty and
brokerage costs. They may also incur capital gains tax, plus there is a gradual
erosion of voting power as the portfolio is liquidated.
a)
Hedging period
11
14
Borrowing period
Step 1: Enter the futures market at t0 and sell 90 BAB futures contracts (to the
face value of $1,000,000) expiring at t5, t8, and t11. This assumes that these
dates are actual expiry dates. Else select the nearest futures expiry date after
these times.
Step 2: At t5 Physical - draw down bills in spot market, receive discounted
proceeds. Enter futures market and buy BAB90 futures expiring at t5. If this is
an expiry date, then spot and futures should converge, else we are faced with
basis risk
Step 3: At t8 Physical - draw down bills in spot market, use funds to repay
retired bill from t5. Enter futures market and buy BAB90 futures expiring at t8.
4