The market is perfectly competitive, with variance-averse investors. At the end of the period, the economy...

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The market is perfectly competitive, with variance-averse investors. At the end of the period, the economy may be in one of three equally likely states: High, Normal, Low. The market rate of return is 0.35 in High, 0.20 in Normal, and -0.10 in Low (note the negative sign in Low). The risk-free rate is 0.10. HighFlyers plc and LowFlyers plc are two identical firms. Each has payoffs of 120 in High, 130 in Normal, and 80 in Low. Both are all-equity firms, but High Flyers now decides to issue bonds with a face value (at the end of the period) of 66. The market views these bonds as risk-free. The proceeds of the bond sale are paid out to shareholders as a special dividend. When announcing the bond issue, HighFlyer's CEO declares, "By utilising low-interest funding, we enhance performance for our shareholders. The financial press responds positively and the market values the restructured firm (after the dividend has been paid out) at 41. Lowflyers remains an all-equity firm and is valued at 95.4545. You are an analyst for HawkEyes, a hedge fund. Can your fund make a profit out of this market situation? Give full details of your analysis and recommendation. The market is perfectly competitive, with variance-averse investors. At the end of the period, the economy may be in one of three equally likely states: High, Normal, Low. The market rate of return is 0.35 in High, 0.20 in Normal, and -0.10 in Low (note the negative sign in Low). The risk-free rate is 0.10. HighFlyers plc and LowFlyers plc are two identical firms. Each has payoffs of 120 in High, 130 in Normal, and 80 in Low. Both are all-equity firms, but High Flyers now decides to issue bonds with a face value (at the end of the period) of 66. The market views these bonds as risk-free. The proceeds of the bond sale are paid out to shareholders as a special dividend. When announcing the bond issue, HighFlyer's CEO declares, "By utilising low-interest funding, we enhance performance for our shareholders. The financial press responds positively and the market values the restructured firm (after the dividend has been paid out) at 41. Lowflyers remains an all-equity firm and is valued at 95.4545. You are an analyst for HawkEyes, a hedge fund. Can your fund make a profit out of this market situation? Give full details of your analysis and recommendation. The market is perfectly competitive, with variance-averse investors. At the end of the period, the economy may be in one of three equally likely states: High, Normal, Low. The market rate of return is 0.35 in High, 0.20 in Normal, and -0.10 in Low (note the negative sign in Low). The risk-free rate is 0.10. HighFlyers plc and LowFlyers plc are two identical firms. Each has payoffs of 120 in High, 130 in Normal, and 80 in Low. Both are all-equity firms, but High Flyers now decides to issue bonds with a face value (at the end of the period) of 66. The market views these bonds as risk-free. The proceeds of the bond sale are paid out to shareholders as a special dividend. When announcing the bond issue, HighFlyer's CEO declares, "By utilising low-interest funding, we enhance performance for our shareholders. The financial press responds positively and the market values the restructured firm (after the dividend has been paid out) at 41. Lowflyers remains an all-equity firm and is valued at 95.4545. You are an analyst for HawkEyes, a hedge fund. Can your fund make a profit out of this market situation? Give full details of your analysis and recommendation.

Answer rating: 100% (QA)

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