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Advanced Corporate Finance (2009)

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  1. You have two stocks with the following Expected Returns (ER) and Standard Deviations (SD)
    1. Show how you can create a portofolio with these two stocks which would have an ER of 8%. What is the SD of this portfolio?
    2. Now you also have a Risk-Free Asset with a return of 2.5%. Show how you can combine it with Stock A in order to create a portfolio with a SD of 3%. What is the ER of this portfolio?
    3. Now you want to create a portfolio with just the Risk-Free Asset and Stock B. Show how you can create a portfolio with these two securities that has an ER of 13%. What do you need to do to create this portfolio?
    4. Explain the concept of Efficient Markets Hypothesis and what the difference is between the Weak, Semi-Strong, and Strong forms of it. Do you agree with it?
  2. You put ?15000 into a group of French stocks on January 1. On June 30, your portfolio's value was ?16,125. The next day you added another ?3000 to the portfolio
    1. Calculate your annual return on the portfolio, if no other money was added or removed, and the value on December 31 was ?18,360
    2. If inflation for the year was 4%, what was your real return on your portfolio? What does this mean?
    3. During the same year the CAC40 went from 2500 to 2565. Considering this, do you think your stock portfolio did well or did badly? Explain
    4. Explain what the CAC40 is and how its value is calculated. (You may need to do a little outside research to answer this question)
  3. You have purchased a stock for $35/share and it is now worth $50/share. You would like to wait until the stock reaches $60/share before you sell it, but you are worried that its price might fall suddenly
    1. What type of orders should you make to ensure that you sell it when it rises to $60/share or falls to $20/share? (market, limit, stop-loss)
    2. Assume that you have bought the stock on margin, and borrowed 50% of the purchase price. You purchased 100 shares. If the maintenance margin requirement is 30%, and the price of the stock falls to $22/share, will you receive a margin call ? i.e. will you have to add more money to your account? Explain your calculation
    3. If the price falls to $20/share and you sell your shares, which you purchased on margin at an 8% interest rate, calculate your percentage return on this investment?
    4. Explain what short sales are and why they are dangerous for investors. Also explain why governments often restrict their use
  4. You have decided to buy stock options
    1. Your first purchase is a call option on a stock, with an exercise price of $45/share and a premium of $3/share. If the stock rises in price to $57/share on the date of expiration, how much is your net profit/share (after subtracting the premium paid)?
    2. Now you have bought a put option on another stock, with an exercise price of $80/share, and a premium of $5/share. Calculate the breakeven price of this option, i.e. at what price would the stock have to be so that you have not gained or lost any money by buying this option
    3. If the stock of the put option above (with a premium of $5/share) is selling for $82/share, calculate the time value of this option
    4. Explain the five factors discussed in class that affect the premiums of put and call options. (eg. time to maturity)

In this document we will show how you can create a portfolio with two stocks which would have an ER of 8%, and what the SD of such a portfolio is. We also explain the concept of Efficient Markets Hypothesis and the difference between the Weak, Semi-Strong, and Strong forms of it. Finally we try to explain what short sales are and why they are dangerous for investors, which is also why governments often restrict their use. The efficient markets hypothesis is based on the idea that information is reflected in security prices. In fact, if investors had the information that buying a given stock will have a positive NPV, they will be tempted to buy it and it would then drive up the stock price. In a similar way, if investors are aware that selling given stocks will have a positive NPV, the price of the stocks will go down. The fact that competition among investors works to eliminate the positives NPV trading opportunities is known as the basis of the efficient markets hypothesis. This theory implies that securities are fairly priced based on their future cash flows and given all the information available for investors.

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