# Fight Finance

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Your friend claims that by reading 'The Economist' magazine's economic news articles, she can identify shares that will have positive abnormal expected returns over the next 2 years. Assuming that her claim is true, which statement(s) are correct?

(i) Weak form market efficiency is broken.

(ii) Semi-strong form market efficiency is broken.

(iii) Strong form market efficiency is broken.

(iv) The asset pricing model used to measure the abnormal returns (such as the CAPM) is either wrong (mis-specification error) or is measured using the wrong inputs (data errors) so the returns may not be abnormal but rather fair for the level of risk.

Select the most correct response:

A three year corporate bond yields 12% pa with a coupon rate of 10% pa, paid semi-annually.

Find the effective six month yield, effective annual yield and the effective daily yield. Assume that each month has 30 days and that there are 360 days in a year.

All answers are given in the same order:

$r_\text{eff semi-annual}$, $r_\text{eff yearly}$, $r_\text{eff daily}$.

A stock has a beta of 0.5. Its next dividend is expected to be $3, paid one year from now. Dividends are expected to be paid annually and grow by 2% pa forever. Treasury bonds yield 5% pa and the market portfolio's expected return is 10% pa. All returns are effective annual rates. What is the price of the stock now? Over the next year, the management of an unlevered company plans to: • Make$5m in sales, $1.9m in net income and$2m in equity free cash flow (EFCF).
• Pay dividends of $1m. • Complete a$1.3m share buy-back.

Assume that:

• All amounts are received and paid at the end of the year so you can ignore the time value of money.
• The firm has sufficient retained profits to legally pay the dividend and complete the buy back.
• The firm plans to run a very tight ship, with no excess cash above operating requirements currently or over the next year.

How much new equity financing will the company need? In other words, what is the value of new shares that will need to be issued?

If trader A has sold the right that allows counterparty B to buy the underlying asset from him at maturity if counterparty B wants then trader A is:

Below is a graph of 3 peoples’ utility functions, Mr Blue (U=W^(1/2) ), Miss Red (U=W/10) and Mrs Green (U=W^2/1000). Assume that each of them currently have $50 of wealth. Which of the following statements about them is NOT correct? (a) Mr Blue would prefer to invest his wealth in a well diversified portfolio of stocks rather than a single stock, assuming that all stocks had the same total risk and return. A bank buys 1000 European put options on a$10 non-dividend paying stock at a strike of $12. The bank wishes to hedge this exposure. The bank can trade the underlying stocks and European call options with a strike price of 7 on the same stock with the same maturity. Details of the call and put options are given in the table below. Each call and put option is on a single stock.  European Options on a Non-dividend Paying Stock Description Symbol Put Values Call Values Spot price ($) $S_0$ 10 10 Strike price ($) $K_T$ 12 7 Risk free cont. comp. rate (pa) $r$ 0.05 0.05 Standard deviation of the stock's cont. comp. returns (pa) $\sigma$ 0.4 0.4 Option maturity (years) $T$ 1 1 Option price ($) $p_0$ or $c_0$ 2.495350486 3.601466138 $N[d_1]$ $\partial c/\partial S$ 0.888138405 $N[d_2]$ $N[d_2]$ 0.792946442 $-N[-d_1]$ $\partial p/\partial S$ -0.552034778 $N[-d_2]$ $N[-d_2]$ 0.207053558 Gamma $\Gamma = \partial^2 c/\partial S^2$ or $\partial^2 p/\partial S^2$ 0.098885989 0.047577422 Theta $\Theta = \partial c/\partial T$ or $\partial p/\partial T$ 0.348152078 0.672379961

Which of the following statements is NOT correct?

Below are some statements about European-style options on non-dividend paying stocks. Assume that the risk free rate is always positive. Which of these statements is NOT correct?

A fixed coupon bond’s modified duration is 20 years, and yields are currently 10% pa compounded annually. Which of the following statements about the bond is NOT correct?

Question 882  Asian financial crisis, foreign exchange rate, original sin, no explanation

In the Asian currency crisis in 1997, the Asian businesses most vulnerable to bankruptcy were those that: