Question: 1. 2. 3. R = a + BiRM + ei where R; is the excess return for security i and RM is the market's excess

1. 1.2.3. R = a + BiRM + ei where R; is the 2. excess return for security i and RM is the market's excess return. 3. The risk-free rate is 2%. Suppose also that there are three securities

R = a + BiRM + ei where R; is the excess return for security i and RM is the market's excess return. The risk-free rate is 2%. Suppose also that there are three securities A, B, and C, characterized by the following data: Security A B C Security A Security B Security C Bi 0.6 0.9 1.2 E(ri) 6% Security A Security B Security C 9 12 a. If OM= 10%, calculate the variance of returns of securities A, B, and C. (Do not round intermediate calculations. Round your answers to the nearest whole number.) Variance 1478 1435 1857 x b. Now assume that there are an infinite number of assets with return characteristics identical to those of A, B, and C, respectively. If one forms a well-diversified portfolio of type A securities, what will be the mean and variance of the portfolio's excess returns? What about portfolios composed only of type B or C stocks? (Enter the variance answers as a percent squared and mean as a percentage. Do not round intermediate calculations. Round your answers to the nearest whole number.) Mean 14 16 18 o(ei) 16% 7 10 % % 3 x Variance 949 1239 1568 c. Is there an arbitrage opportunity in this market? The Generic Genetic (GG) Corporation pays no cash dividends currently and is not expected to for the next four years. Its latest EPS was $6.0, all of which was reinvested in the company. The firm's expected ROE for the next four years is 17% per year, during which time it is expected to continue to reinvest all of its earnings. Starting in year 5, the firm's ROE on new investments is expected to fall to 16% per year. GG's market capitalization rate is 16% per year. a. What is your estimate of GG's intrinsic value per share? (Do not round intermediate calculations. Omit the "$" sign in your response. Round your answer to 2 decimal places.) GG's intrinsic value $ 82.95 X b. Assuming its current market price is equal to its intrinsic value, what do you expect to happen to its price over the next year? (Omit the "%" sign in your response.) Price should increase at a rate of 15 % over the next year. The Digital Electronic Quotation System (DEQS) Corporation pays no cash dividends currently and is not expected to for the next five years. Its latest EPS was $14.5, all of which was reinvested in the company. The firm's expected ROE for the next five years is 18% per year, and during this time it is expected to continue to reinvest all of its earnings. Starting in year 6, the firm's ROE on new investments is expected to fall to 13%, and the company is expected to start paying out 20% of its earnings in cash dividends, which it will continue to do forever after. DEQS's market capitalization rate is 18% per year. a. What is your estimate of DEQS's intrinsic value per share? (Do not round intermediate calculations. Round your answer to 2 decimal places. Omit the "$" sign in your response.) $ 42.13 Intrinsic value b. Assuming its current market price is equal to its intrinsic value, what do you expect to happen to its price over the next year? (Omit the "%" sign in your response.) The price should rise by capital gains c. What do you expect to happen to price in the following year? Price in the six year d. What effect would it have on your estimate of DEQS's intrinsic value if you expected DEQS to pay out only 18% of earnings starting in year 6? (Do not round intermediate calculations. Round your answers to 2 decimal places. Omit the "$ and %" sign in your response.) Time Et Dt b g $ 58.65 $36.71 S 6.61 $ 39.35 10.66 % 18 % per year until year 6: because there is no dividend the entire return must be in

Step by Step Solution

There are 3 Steps involved in it

1 Expert Approved Answer

Step: 1 Unlock blur-text-image

Question Has Been Solved by an Expert!

Get step-by-step solutions from verified subject matter experts

Step: 2 Unlock

Step: 3 Unlock

Students Have Also Explored These Related Finance Questions!

Assume that security returns are generated by the single-index model, R = ai + BiRM + ei where R is the excess return for security i and RM is the market's excess return. The risk-free rate is 3%....

B You are applying for a job with Wellington Asset Management. They have said to assume that security returns are generated by the single-index model: Ri = 0; + BiRM + Ei, where Ri is the excess...

If M = .20, b. Now assume that there is an infinite number of assets with return characteristics identical to those of A and B, respectively. If one forms a well-diversified portfolio of type A...

Assume that security returns are generated by the single-index model, Ri = Qi + BiRM + ei where Ri is the excess return for security i and Rm is the market's excess return. The risk-free rate is 3%....

Assume that security returns are generated by the single-index model, Ri = ai + BiRM + ei where Ri is the excess return for security i and Rm is the market's excess return. The risk-free rate is 4%....

Ri= ai + BiRM + ei where R is the excess return for security i and RM is the market's excess return. The risk-free rate is 2%. Suppose also that there are three securities A, B, and C, characterized...

Assume that security returns are generated by the single- index model, Ri= ai + BiRM + ei where R is the excess return for security i and RM is the market's excess return. The risk-free rate is 3%....

Assume that security retums are generated by the single-index model. Ri - ai + BiRM + ei where R, is the excess return for security i and RM is the market's excess return. The risk-free rate is 29....

Why is "Effort" the last step in HBS professor Laura Huang's EDGE system? Because it doesn't matter who you are, there's going to be perceptions that are going to be made about you. Knowing the...

The owner and manager of Smartwear realized that the company is facing an internal control issue which can be remedied using advanced technology. The IT consultant estimates that the impact...

Can markets still be considered efficient if behavioral anomalies exist, and how should investors incorporate these insights into their strategies?

10) For a bond that pays cash interest (i.e., not a zero coupon bond), YTM is (a) always equal to the coupon rate (b) always equal to the current yield (c) is always less than the coupon rate (d) can...

(Appendices) What is a sales discount? How can sales discounts be recorded? LO9

(Appendices) During the 20072009 recession, debate in the U.S. Senate over an extension of unemployment benefits to workers who had exhausted their benefits was often heated and contentious. A...

(Appendices) Compare the Original Medicare Plan with Medicare Advantage Plans with respect to each of the following: LO5 a. Choice of plan coverage b. Benefits provided by the plan c. Need for a...