1) You are an investment advisor

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1) You are an investment advisor. You currently own two stocks, A and B, with the following characteristics:

 

                         Expected Return        Beta

X                                10%                      0.8

Y                                16%                      1.5

The current risk-free rate is 2 percent, and the expected return on the market is 12 percent. 

How would you change your holdings of the two stocks (i.e., for each, would you sell or buy more)? Show your calculations (and explain). (4 marks)

2A stock that currently trades at $10 has a beta of 1.1. The risk-free interest rate for the coming year is 3 percent, and the market price of risk is 7 percent. (4 marks)

(a) What should the expected return on the stock be?

(b) If the stock price is not expected to increase this year (i.e., the stock price is expected to remain unchanged), what dividend payments must investors be expecting for the coming year?

(c) Now assume that dividends over the coming year are expected to be $0.25 per share and the stock price at the end of this year is expected to be $12. Would you recommend the purchase of this stock to your investment clients? [Show your calculations and explain fully.]

3 A firm has found itself having cash flow problems. It pays its suppliers on terms of 2/15 net 50. In the past, it has always taken the cash discount. However, it finds itself in a situation where it cannot come up with the cash needed to pay within 15 days for purchases. In 50 days, it will have the necessary cash. If it chooses to borrow money to pay for purchases it would be forced to go to a finance company specializing in high-risk loans. It would be forced to pay a rate of 24 percent compounded monthly on the loan. What should the firm do?