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HWK2

The document provides details for an assignment covering financial engineering fundamentals. It includes 7 questions related to topics like returns, risk, diversification, capital budgeting and cash flow analysis.

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inder3999
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153 views

HWK2

The document provides details for an assignment covering financial engineering fundamentals. It includes 7 questions related to topics like returns, risk, diversification, capital budgeting and cash flow analysis.

Uploaded by

inder3999
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
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SEEM 2520 – Fundamentals in Financial Engineering

First term (2019 – 2020)


Assignment 2
Due date: 6:00 pm, Oct 24 (Thursday), 2019
Important notes:
1. You must drop your assignment into the assignment collection box B12, which is
located on the 5th floor of William M.W.Mong Engineering Building near Room
512.
2. If you submit your homework late, please directly give it to the TA either in person
or by email. Submission on the first day after the deadline incurs a 15% penalty
while submission on the second day after the deadline incurs a 30% penalty.
Submissions that are more than two days late are not accepted.
3. Please include both your name and student ID in your submission.
4. The TA responsible for grading this homework is BU Shang.
5. This assignment covers Lectures 4 to 7. The submitted problems are 1, 3, 4 and
6.

1. A closed-end fund starts the year with a net asset value of $28. By year-end, NAV
equals $29.70. At the beginning of the year, the fund is selling at a 3% premium to
NAV. By the end of the year, the fund is selling at an 8% discount to NAV. The fund
paid year-end distributions of income and capital gains of $3.10.
a. What is the rate of return to an investor in the fund during the year?
b. What would have been the rate of return to an investor who held the same
securities as the fund manager during the year?

2. You mange an equity fund with an expected risk premium of 14% and a standard
deviation of 54%. The rate on Treasury bills is 6.8%. Your client chooses to invest
$120,000 of her portfolio in your equity fund and $30,000 in a T-bill money market
fund.
(1) What is the expected return and standard deviation of return on your client’s
portfolio?
(2) What is the reward-to-volatility ratio for the equity fund?
(3) What is the risk-aversion index of your client?

3. A pension fund manager is considering three mutual funds. The first is a stock fund,
the second is a long-term government and corporate bond fund, and the third is a T-
bill money market fund that yields a sure rate of 4.8%. The probability distribution of
the risky funds are:

Expected Return Standard Deviation


Stock fund (S) 18% 38%
Bond fund (B) 9% 32%

The correlation between the fund returns is 0.13.


(1) Find out the minimum-variance portfolio, its expected return and standard
deviation.
(2) Find out the optimal risky portfolio, its expected return and standard

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deviation.
(3) What is the reward-to-volatility ratio of the best feasible CAL?
(4) Suppose now that your portfolio must yield an expected return of 15% and be
efficient, that is, on the best feasible CAL.
a. What is the standard deviation of your portfolio?
b. What is the proportion invested in the T-bill fund and each of the two risky
funds?
(5) If you were to use only the two risky funds and still require an expected return
of 15%, what would be the investment proportions of your portfolio? Compare its
standard deviation to that of the optimal portfolio. What do you conclude?

4. Suppose the yield on short-term government securities (perceived to be risk-free) is


about 4%. Suppose also that the expected return required by the market for a portfolio
with a beta of 1 is 14%. According to the capital asset pricing model:
a. What is the expected return on the market portfolio?
b. What would be the expected return on a zero-beta stock?
c. Suppose you consider buying a share of stock at a price of $30. The stock is
expected to pay a dividend of $4 next year and to sell then for $31. The stock risk has
been evaluated at β = -0.5. Is the stock overpriced or underpriced?

5. Based on current dividend yields and expected capital gains, the expected rates of
return on portfolios A and B are 11% and 14%, respectively. The beta of A is 0.8
while that of B is 1.5. The T-bill rate is currently 6%, while the expected rate of return
of the S&P 500 Index is 12%. The standard deviation of portfolio A is 10% annually,
while that of B is 31%, and that of the index is 20%.
a. If you currently hold a market-index portfolio, would you choose to add either of
these portfolios to your holdings? Explain.
b. If instead you could invest only in bills and one of these portfolio, which would you
choose?

6. Use the following financial statements of Heifer Sports Inc. in Table 14.14 to find
Heifer’s:
a) Inventory turnover ratio in 2012.
b) Debt/equity ratio in 2012.
c) Cash flow from operating activities in 2012.
d) Average collection period.
e) Fixed-asset turnover ratio.
f) Return on equity.

7. Use the following cash flow data for Rocker Transport to find Rocket’s:
a. Net cash provided by or used in investing activities.
b. Net cash provided by or used in financing activities.
c. Net increase or decrease in cash for the year.
Cash dividend $100,000
Purchase of bus $73,000
Interest paid on debt $45,000
Sales of old equipment $92,000
Repurchase of stock $95,000
Cash payments to suppliers $115,000
Cash collections from customers $500,000

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