(ii) Explain with brief reason which investment, bonds or stocks, you would invest. (4 marks)
B) Consider a portfolio with weights of 60% in stock and 40% in bonds.
(i) What is the rate of return on the portfolio in each scenario? (6 marks)
(ii) What are the expected rate of return and standard deviation of the portfolio? (7 marks)
(iii) Explain with reason what investment you would invest, i.e. in the portfolio, in stocks only, or in bonds
only? (5 marks)
Question 2 (Total 40 marks)
A)
(i) A stock has a market price of $46.10 and pays a $2.40 annual dividend. What is the dividend yield?
(3 marks)
(ii) Investors receive a total return of 13.7 percent on the common stock of Dexter International. The stock
is selling for $41.68 a share. What is the capital gain yield if the company plans to pay an annual dividend
of $2.10 a share next year? (3 marks)
(iii) Tiger Company’s stock is valued at $124.20 a share. The company pays a constant annual dividend of
$8.80 per share. What is the total return on this stock? (4 marks)
2
(iv) A bond yielded a real rate of return of 3.87 percent for a time period when the inflation rate was 3.75
percent. What was the nominal rate of return? (4 marks)
B)
(i) To what extent you agree to the following statement “Investment portfolio can eliminate all the risks”.
(8 marks)
(ii) If the covariance between Stock A and Stock B is -0.125, how do you interpret this number?
(2 marks)
(iii) If the correlation between Stock C and Stock D is equal to +0.62; the correlation between Stock C
and Stock E is equal to -0.5, how do you interpret these numbers and which stocks will you invest?
(6 marks)
(iv) Stock H with a beta of 1.46. The market risk premium is 9.3 percent and the risk-free rate is 4.6
percent. What is the expected return on this stock? How do you interpret the beta? (5 marks)
C)
Stock K had just paid a dividend of $3 per share this morning. The plowback ratio (“b”) of the company is
20% while the return on equity (“ROE”) is 15%, investors require a return rate of 14% on common stock
of similar companies, calculate the intrinsic value of Stock K. (5 marks)
Question 3 (Total 30 marks)
Suppose the finance manager of ABC Company suggests either issuing bonds or shares to raise capital for
the development of an environmental-friendly production technique. Assuming there is no fees or costs for
the securities.
A) Compare and contrast the differences between common stock, preferred stock and corporate bonds from
the perspectives of the issuing companies and investors. (12 marks)
B)
(i) Suppose ABC Company plans to issue bonds with $10,000 par value, 7 years of term to maturity,
5.5% coupon to be paid quarterly, investors require 6% of return on the bond with similar risk. Calculate
the price of the bonds. Will the bond sell at par, discount or premium? Explain.
(6 marks)
(ii) If ABC Company wants to issue 20-year zero coupon bonds to raise fund for development, suppose
the par value of a 20-year zero coupon bond is $20,000, what is the intrinsic value of the bonds if required
rate of return is 7.45%? Would it be worth to invest if the price of bond is $4,800? Explain.
(5 marks)
(iii) ABC Company intends to raise fund by issuing shares for development and announces to pay a constant
dividend of $1.5 per share. If the required rate of return is 12%, would it be worth to invest if the price of
stock is $15? Explain. (4 marks)
(iv) Refer to part (i) to (iii), explain why the investor’s required rate of return on bonds and stocks are
different. (3 marks)
