Solution to Homework #5 FIN 3710 “Investment Analysis”
Professor Bin Wei
Problem 1 (BKM, Q3 of Chapter 7) (10 points1) What must be the beta of a portfolio with E( rP ) = 20.0%, if the risk free rate is 5.0% and the expected return of the market is E( rM ) = 15.0%? Answer: We use E( rP ) = β P *(E( rM ) – r f ) + r f . We then have: 0.20 = β P *(0.15-0.05) + 0.05. Solving for the beta we get: β P =1.5.

Problem 2 (BKM, Q4 of Chapter 7) (20 points) The market price of a security is $40. Its expected rate of return is 13%. The risk-free rate is 7%, and the market risk premium is 8%. What will the market price of the security be if its beta doubles (and all other variables remain unchanged)? Assume that the stock is expected to pay a constant dividend in perpetuity. Hint: Use zero-growth Dividend Discount Model to calculate the intrinsic value, which is the market price. Answer: First, we need to calculate the original beta before it doubles from the CAPM. Note that: β = (the security’s risk premium)/(the market’s risk premium) = 6/8 = 0.75. Second, when its beta doubles to 2*0.75 = 1.5, then its expected return becomes: 7% + 1.5*8% = 19%. (Alternatively, we can find the expected return after the beta doubles in the following way. If the beta of the security doubles, then so will its risk premium. The current risk premium for the stock is: (13% - 7%) = 6%, so the new risk premium would be 12%, and the new discount rate for the security would be: 12% + 7% = 19%.) Third, we find out the implied constant dividend payment from its current market price of $40. If the stock pays a constant dividend in perpetuity, then we know from the original data that the dividend (D) must satisfy the equation for a perpetuity: Price = Dividend/Discount rate 40 = D/0.13 ⇒ D = 40 * 0.13 = $5.20 Last, at the new discount rate of 19%, the stock would be worth: $5.20/0.19 = $27.37. The increase in stock risk has lowered the value of the stock by 31.58%. Problem 3 (BKM, Q16 of Chapter 7)...

...HEC Paris
FinancialMarkets Spring 2012 Final Exam “Cheat Sheet”
0. Basic Statistics (a) Consider an n-outcome probability space with probabilities p1 , p2 , . . . , pn . Consider two discrete random variables X and Y with outcomes (X1 , X2 , . . . , Xn ) and (Y1 , Y2 , . . . , Yn ). 2 The we have the following formulas for means (µX , µY ), variance (σX ), standard deviation (σX ), covariance (σX,Y ), and correlation (ρX,Y ) µX = EX = E(X) = p1 X1 + p2 X2 +...

...NBER WORKING PAPER SERIES
FINANCIALMARKETS AND THE REAL ECONOMY
John H. Cochrane
Working Paper 11193
http://www.nber.org/papers/w11193
NATIONAL BUREAU OF ECONOMIC RESEARCH
1050 Massachusetts Avenue
Cambridge, MA 02138
March 2005
This review will introduce a volume by the same title in the Edward Elgar series “The International Library
of Critical Writings in Financial Economics” edited by Richard Roll. I encourage comments. Please write...

...How is risk priced in the financialmarkets? What are the shortcomings of the explanations that finance theory offers for this?
Introduction
The valuation of assets in the financialmarket is no doubt a challenging task as it is closely correlated with risks and uncertainties embodied in the assets which provide the possibility that the investment outcomes would differ from the expected value (Grundy and Malkiel, 1995). In other...

...Assignment #1 – Return on Financial Assets
Money and Banking – Fall 2011
October 30, 2011
Assignment 1: Return on Financial Assets
1. Consider the following four debt securities, which are identical in every characteristic except as noted:
W: A corporate bond rated AAA
X: A corporate bond rate BBB
Y: A corporate bond rated AAA with a shorter time to maturity than bonds W and X
Z: A corporate bond rated AAA with the same...

...margin is very low. Another crucial factor is the high discount rates offered to customers with who stayed longer than 6 days. The high discount rates affected the overall profits. However, these discount rates could be the reason existing customers return due to the cheaper rates. The benefits of having a high discount rate compared to a lower discount rate would have to be compared with existing data from previous years to analyse if discount rates have a significant impact on...

...assets are financed. The international model of banking system gather their funds via domestic market and then allocated to borrowers in a foreign market. By contrast, Global Banking generates funds in a foreign market and finances its claims on borrower in the same foreign market. In this way we can see that international bank concentrates on cross border business while global bank mainly focus on local market businesses....

...A.In finance, the financial system is the system that allows the transfer of money between savers (and investors) and borrowers.[1] A financial system can operate on a global, regional or firm specific level. Gurusamy, writing in Financial Services and Systems has described it as comprising "a set of complex and closely interconnected financial institutions, markets, instruments, services, practices, and transactions....

...sense is duration a measure of market risk?
The market risk calculations are typically based on the trading portion of an FI’s fixed-rate asset portfolio because these assets must reflect changes in value as market interest rates change. As such, duration or modified duration provides an easily measured and usable link between changes in the market interest rates and the market value of fixed-income assets.
12....

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