Some people like to play a game that constructs a sequence of chemical elements where each element in the sequence begins with the last letter of its predecessor. For example,….
forecast data for a UK based FTSE 100 company: The consensus view of the analysts in Bloomberg is that the growth for the shares is 10.0% while the long term growth for the UK economy is considered to be 4.0%.
Question 1 The table below provides forecast data for a UK based FTSE 100 company
|December 2016||December 2017||December 2018|
|Earnings per share||30p||35p||40p|
|Dividends per share||14p||17p||20p|
|Return on Equity (ROE)||10.1%||9.9%||10.0%|
- a) If the beta of the company is 1.2, the risk free rate is 2% and the market risk premium is 8% calculate the intrinsic value of a share using the multistage growth version of the DDM model. (10 marks)
- b) Explain why the growth rate estimate from Bloomberg is unrealistic and inappropriate for the DDM model and use the date in the table above to produce an alternative estimate. (9 marks)
- c) Another company will pay a dividend of £1.00 per share next year and it is known to provide an expected return of 8%. If the share has a current price of £20 what is the expected growth rate in the dividend? (6 marks)
|Portfolio A||Portfolio B|
- a) Calculate the combined portfolio expected returns and standard deviation, and discuss how you would advise your client.
- i) if the correlation coefficient between Portfolios A and B was 0.5.
- ii) if the correlation coefficient between Portfolios A and B was minus 0.6.
- b) The risk free rate is currently 2%. You manage a fund with an expected return of 12% and a standard deviation of 20%. A client chooses to invest 50% of their money in your fund and 50% in the risk free Treasury bills.
- a) Can you tell which adviser was a better selector of individual shares?
- b) If the risk free rate were 3% and the market return during the period were 10%, which adviser would be the superior share selector? (10 marks)
- c) Discuss why in a CAPM world all investors would hold the market portfolio? (10 marks)
- a) ABC has just recently paid dividends of £1.20 per share out of £2.40 earnings per share. You have obtained information that ABC’s beta is 1.2 and its return on equity would remain the same from now onwards at a rate of 12%. If the risk free rate is 2% and market risk premium is 6%, calculate the PE ratio based on reported earnings as well as next year’s earnings, using the constant dividend growth and price/earnings (PE) ratio model.
- b) Discuss the relative advantages and disadvantages of the two valuation methods: the DDM model and the Price Earnings ratio.
- c) Explain how the earnings multiplier approach can be used to forecast the aggregate stock market.
- a) An investor considers investing in a corporate bond which pays a coupon rate of 6% per year semi-annually. The bond has 2 years until maturity and its par value is £100. The current price for the bond is £98. For the bond, calculate
- i) Its yield to maturity. (10 marks)
- ii) The realised compound return if the coupon payments can be reinvested at a semi-annual rate of 2%. (8 marks)
- b) Discuss the reason why the yield to maturity may not be realised in practice. Given the recent financial crisis and economic climate what are the possible risks faced by bond investors? (7 marks)
- The share price and dividends in pence for Cola Coker are as follows. Dividends are paid on 31 December each year.
- The table below shows the expected return and risk (standard deviation) for eight shares.
- You are offered an unusual investment. In exactly one year you will either receive £10 with a probability of 0.20, £20 with a probability of 0.70 or £100 with a probability of 0.10.
- a) Use the Black-Scholes formula to find the exercise value and time value of a call option on the following share:
- b) Please provide a brief explanation for your answers to the following questions.
- All else being equal, is a call option on a share with a lot of firm-specific risk worth more than one on a stock with little firm-specific risk? The betas of the shares are equal.
- Would you expect a $1 increase in a call option’s exercise price to lead to a decrease in the option’s value of more or less than $1?
- c) Describe how the following financial activity may be viewed as transacting an option.
- i) buying shares in a company with assets of £A and debt £D.
- ii) making a loan to the company of £B.