FINA411 AA Fall2022 Assignment 2 solutions
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John Molson School of Business
FINA 411 AA - Page 1 Usual Copyright Disclaimer applies. ASSIGNMENT 2 FINA 411AA Solution sketch –
Selected Exercises 1. The following data is available on 3 stocks –
A, B, C: •
𝐸(𝑅
?
) = 𝐸(𝑅
?
) = 𝐸(𝑅
?
)
•
𝜎
?
= 𝜎
?
= 𝜎
?
•
𝜌
(?,?)
= +0.9
•
𝜌
(?,?)
= −0.2
•
𝜌
(?,?)
= +0.3
Portfolio of which two stocks will have the lowest standard deviation? Explain and include all steps necessary to arrive at the solution. The portfolio constructed containing stocks B and C would have the lowest standard deviation. Combining assets with equal risk and return but with low positive or negative correlations will reduce the risk level of the portfolio. 2. An analyst in the search for investment opportunities is evaluating the following five portfolios of risky assets, which are well-diversified (assume risk-free rate of 3.75 %): Portfolio Exp. Return St. Dev. A 8.00% 11.00% B 11.00% 14.50% C 5.00% 5.00% D 11.80% 20.00% E 6.40% 8.00%
John Molson School of Business
FINA 411 AA - Page 2 Usual Copyright Disclaimer applies. a.
Estimate the risk premium per unit of risk expected to be received per each portfolio. Estimates of (E(R)-Rf)/std: A 0.386 B 0.500 C 0.250 D 0.403 E 0.331 b.
Which of the five portfolios is most likely to be the market portfolio? Draw the CML (define the numerical values of the intercept and slope next to the graph). The CML slope, [E(R
MKT ) - RFR ]/ σ
MKT , is the ratio of risk premium per unit of risk. Portfolio B has the highest ratio, 0.5000, of these five portfolios, so it is most likely the market portfolio. Thus, the slope of the CML is 0.5 and its intercept is 3.75%, which is the risk-free rate. c.
Suppose the analyst
’s
preference is only for making an investment with 𝜎 = 8%
, and earning a 10% return. Would this be possible? The CML equation, based on the above analysis, is E(R
portfolio ) = 3.75
% + (0.50) σ
portfolio . If the desired standard deviation is 8.0%, then the expected portfolio return is 7.75%: E(R
portfolio ) = 3.75% + (0.50) (8%) = 7.75%
. The answer is no, it is not possible to earn an expected return of 10% with a portfolio with standard deviation of 8%. Risky portfolio
R_f
0%
5%
10%
15%
20%
0%
5%
10%
15%
20%
25%
30%
35%
Expected Return
Standard Deviation
Capital Allocation Line
John Molson School of Business
FINA 411 AA - Page 3 Usual Copyright Disclaimer applies. d.
What is the minimum level of risk necessary for an investment earning 10%? Estimate the portfolio composition (along CML) that can generate an expected return of 10%. Using the CML equation, we set the expected portfolio return equal to 10% and solve for the standard deviation: E(R
portfolio ) = 10% = 3.75
% + (0.50) σ
portfolio ➔
σ = 12.5%. Thus, 12.5% is the standard deviation consistent with an expected return of 10%. To find the portfolio weights which result in a risk of 10% and expected return of 10%, we use the fact that the covariance between the risk-free asset and the market portfolio is zero. Thus, the portfolio standard deviation calculation simplifies to σ
portfolio = w
MKT (σ
MKT ), and the weight of the risk-free asset is 1 - w
MKT
. Doing this, we have σ
portfolio = 12.5% = w
MKT (14.5%
), so w
MKT = 0.8621 and w
risk-free asset = 1 –
0.8621 = 0.1379. As a check, the weighted average expected return should equal 10%: 0.8621 (11%) + 0.1379 (3.75%) = 10%, which it does. e.
Recently Bank of Canada has undertaken monetary policy tightening, which have led to a significant increase in the base interest rate in Canada. Given your answers to d), how would an increase in the risk-
free interest rate affect the portfolio composition (i.e., portfolio weights)? Further increases in the risk-free rate will increase the portfolio weight for the risk-free asset as sensitivity analysis can show. At rf=9%, the weights of the risky and risk-free asset are equal to 0.5%. At rf=10%, it is optimal to invest in the risk-free asset only. 3. As a financial director working for a major financial institution, you are asked to evaluate two portfolio managers A and B hired externally. The following performance data based on the last three years is available for your review: Portfolio Actual return (Average) St. Dev. Beta Manager A 9.50% 11.50% 1.3 Manager B 9.00% 10.00% 0.7
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John Molson School of Business
FINA 411 AA - Page 4 Usual Copyright Disclaimer applies. Based on your analysis, you find that the market portfolio has a risk-premium of 6 percent, and the risk-
free rate is currently 3.75 percent. a)
Define the Security Market Line (SML) - intercept and slope. With a risk premium of 6% and risk-free rate of 3.75%, the security market line is: E(return) = 3.75% + (6
%)β. Information about the level of diversification of the portfolios is not given, nor is information about the market portfolio. But a portfolio’s beta is the weighted average of the betas of the securities held in the portfolio so the SML can be used to evaluate the managers. b)
Using CAPM, estimate the expected returns for manager A and manager B. Expected return (A) = 3.75% + (6
%)β = 3.75% + (6%)(1.3) = 0.1155 Expected return (B) = 3.75% + (6
%)β = 3.75% + (6%)(0.7) = 0.0795 c)
Estimate each manager’s alpha over the last three years. Explain whether alpha will plot above the SML, or below the SML in either case. Alpha is the difference between the actual return and the expected return based on portfolio risk: Alpha of manager A = actual return –
expected return = 9.50% - 11.55% = -2.05% Alpha of manager B = actual return –
expected return = 9.00% - 7.95% = 1.05% A positive alpha means the portfolio outperformed the market on a risk-adjusted basis; it would plot above the SML. A negative alpha means the opposite, which is that the portfolio underperformed the market on a risk-adjusted basis; it would plot below the SML. d)
Given the results in c), can you conclude whether 1) either manager outperformed the other, and 2) any of the managers outperformed market expectations in general. In this case, manager B outperformed the market portfolio on a risk-adjusted basis by 1.05%. Manager A underperformed, returning 2.05 % less than expected based upon the risk of A
’s portfolio.
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Exercise 2-29 (Algo) Calculating and Interpreting the debt ratio LO A2
Company
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16, 00
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DreamWorks
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b. Which company has the most financial leverage?
Largest financial leverage
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Otis Company's income statement information folloWS:
Year 3
Year 2
Net sales
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Net income after taxes
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Stockholders' equity, December 31 (Year l: $200,000)
Common stock, December 31
240,000
The average number of shares outstanding was 9,600 for Year 3 and 8,000 for Year 2.
Required
Compute the following ratios for Otis for Year 3 and Year 2.
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Changes in Current Operating Assets and Liabilities
Paneous Corporation's comparative balance sheet for current assets and liabilities was as follows:
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$39,490
$31,590
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76,340
65,150
Accounts payable
60,750
45,410
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18,000
24,000
Adjust net income of $351,000 for changes in operating assets and liabilities to arrive at net cash flows from operating activities.
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Journalizing Installment Notes
On the first day of the fiscal year, a company issues $52,000, 11%, five-year installment notes that have annual payments of $14,070. The first note
payment consists of $5,720 of interest and $8,350 of principal repayment.
a. Journalize the entry to record the issuance of the installment notes. If an amount box does not require an entry, leave it blank.
38
b. Journalize the first annual note payment. If an amount box does not require an entry, leave it blank.
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Changes in Current Operating Assets and Liabilities-Indirect Method
Victor Corporation's comparative balance sheet for current assets and liabilities was as follows:
Dec. 31, 20Y2
Dec. 31, 20Y1
Accounts receivable
$23,400
$22,600
Inventory
78,800
79,500
Accounts payable
20,700
20,400
Dividends payable
18,000
17,000
Adjust net income of $77,900 for changes in operating assets and liabilities to arrive at net cash flow from operating activities.
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- uni 403 a Cha Pra (Ch Preview File Edit View Go Tools Window Help mgt120h-j17.pdf Page 7 of 10 0 CC Search b. Company B has current assets of $234,000, total assets of $459,000, and equity of $100,000. The company wants to reorganize its liabilities so that is current ratio is 2: 1. If it does, what will its noncurrent liabilities be? S QSun Apr 16 1:23 PMarrow_forwardVoWiFi ← 3 K/s ACC 512 ASSIGN 2024 (1... a 90% 6:27 QUESTION THREE (20 MARKS) The following information was obtained from the accounting records of T Super and B Man, Trading as Superman Traders: Balances as at 28 February 2011: Profit for the year (before depreciation).. Asset replacement reserve (1 March 2010).... Capital: T Super... Capital: B Man Current account: T Super (Dr - 1 March 2010).. Current account: B Man (Cr-1 March 2010).. Drawings: T Super..... Drawings: B Man....... R 574 420 30 000 775 000 775 000 9750 4340 10 000 7630 Long-term loan: US Bank. Inventories. Debtors control.. Creditors control. Land and buildings... Equipment at cost... Accumulated depreciation: Equipment (30 November 2010) Vehicles at cost. Accumulated depreciation: Vehicles(1 March 2010) Bank (Cr). Allowance for credit losses Allowance for settlement discount Depreciation (Equipment as at 30 November 2010) Prepaid expenses (Insurance) Additional information: a. Land and buildings consists of: Land -…arrow_forwardgageNOWv2 | Online teachir X * CengageNOWv2 | Online teachin x om/iln/takeAssignment/takeAssignmentMain.do?invoker=&takeAssignmentSessionLocator=&inprogre.. eBook Show Me How Long-Term Solvency Analysis The following information was taken from Acme Company's balance sheet: Fixed assets (net) $1,092,000 Long-term liabilities 280,000 Total liabilities 196,000 Total stockholders' equity 980,000 Determine the company's (a) ratio of fixed assets to long-term liabilities and (b) ratio of liabilities to stockholders' equity. If required, round your answers to one decimal place. a. Ratio of fixed assets to long-term liabilities b. Ratio of liabilities to stockholders' equity Previous Next Check My Work 11:17 A 67°F Sunny A O E O G 40) 12/3/20 delete ome prt se 84l 144 4+ 6 backscace %Darrow_forward
- 8. Fill in all of the blanksarrow_forward* 00 T 4. File Edit View History Bookmarks Window Help A ezto.mheducation.com Bb Welcome, Aury - Blackb... Close reading assignmen... t Center FEnglish essay - Google D... M MyOpenMath - Gradebook M Question 4 - Chapter 5-.. chapter 5 i Saved Help Save Lopez Company reported the following current-year data for its only product. The company uses a periodic inventory system, and its ending inventory consists of 480 units-160 from each of the last three purchases. 1 Beginning inventory 260 units @ $4.40 = $ 1,144 2,940 5,880 5,616 3,640 $ 19,220 Jan. Mar. 7 Purchase oints 560 units @ $5.25 1,200 units @ $4.90 = 1,080 units @ $5.20 = 560 units @ $6.50 = %3D July 28 Purchase Oct. 3 Purchase Skipped %3D Dec. 19 Purchase %3D Totals 3,660 units eBook Hint Determine the cost assigned to ending inventory and to cost of goods sold for the following. (Do not round intermediate calculations and round your answers to 2 decimal places.) Print References Ending Inventory Cost of Goods Sold (a)…arrow_forwardAssignments: ACCT-2301-10 X O Question 4 - Chapter 11 As X https://ezto.mheducation.com/ext/map/index.html?_con%3Dcon&external_browser%3D0&launchUrl=https%253A%252F%252Flms.mheducat.. ignment i Saved Help Save & Che Creative Sound Systems sold investments, land, and its own common stock for $40 million, $16 million, and $42 million, respectively. Creative Sound Systems also purchased treasury stock, equipment, and a patent for $22 million, $26 million, and $13 million, respectively. What amount should Creative Sound Systems report as net cash flows from financing activities? (List cash outflows and any decrease in cash as negative amounts. Enter your answers in millions (i.e., $10,100,000 should be entered as 10.1).) CREATIVE SOUND SYSTEMS Statement of Cash Flows (partial) Cash flows from financing activities Net cash flows from financing activities Next >arrow_forward
- Not a previously submitted question. Thank youarrow_forwardCould someone please do 3 through 8arrow_forward* CengageNOW2 | Onlin x 2.cengagenow.com/ilrn/takeAssignment/takeAssignmentMain.do?invoker=&takeAssignmentSessionLocator=&inprogress=false 人 еВook Show Me How Vertical Analysis of Balance Sheet Balance sheet data for Kwan Company on December 31, the end of two recent fiscal years, follow: Current Year Previous Year Current assets $288,750 $177,120 Property, plant, and equipment 498,750 452,640 Intangible assets 87,500 26,240 Current liabilities 175,000 85,280 Long-term liabilities 376,250 301,760 Common stock 78,750 72,160 Retained earnings 245,000 196,800 Prepare a comparative balance sheet for both years, stating each asset as a percent of total assets and each liability and stockholders' equity item as a percent of the total liabilities and stockholders' equity. If required, round percentages to one decimal place. Kwan Company Comparative Balance Sheet For the Years Ended December 31 Current Current Previous Previous year year year year Amount Percent Amount Percent Current assets…arrow_forward
- X CengageNOWv2 | Online teachin X + .cengagenow.com/ilrn/takeAssignment/takeAssignmentMain.do?invoker=&takeAssignmentSession Locator=&inprogress Use the information provided for Harding Company to answer the question that follow. Harding Company Accounts payable $32,558 Accounts receivable 60,589 Accrued liabilities 6,279 Cash 21,662 Intangible assets 44,020 Inventory 81,454 Long-term investments 97,693 79,992 Long-term liabilities Notes payable (short-term) 27,484 699,362 Property, plant, and equipment 2,375 Prepaid expenses 37,009 Temporary investments Based on the data for Harding Company, what is the quick ratio (rounded to one decimal place)? Oa. 15.7 Ob. 0.9 Oc. 1.8 Od. 3.1 L $ H % 5 6 a & 7 8arrow_forwardCh. 17 - Financial Statement Anal x Bb 2193516 + i learn-us-east-1-prod-fleet02-xythos.content.blackboardcdn.com/5f7ce11c673e5/2193516?X-Blackboard-Expiration=1648004400000&X-Blackboard-Signature=vwLhZZb3V30b7J84... 2 * O w WordCounter - Co... y! Yahoo A Regions Bank | Che.. Welcome, Justin – B. * eBooks, Textbooks... O Jefferson State Co... Electronics, Cars, Fa... C Home | Chegg.com 2193516 1 / 1 100% + | December 31, 2014 and 2013 Dec. 31, 2014 Dec. 31, 2013 Assets bloe Current assets: Cash. Marketable securities $ 500,000 $ 400,000 1,000,000 1,010,000 Accounts receivable (net)... 740,000 510,000 Inventories 1,190,000 950,000 000. Prepaid expenses. 250,000 229,000 Total current assets. $3,690,000 $3,089,000 Long-term investments... 2,350,000 2,300,000 1 Property, plant, and equipment (net) Total assets 3,740,000 3,366,000 $9,780,000 $8,755,000 Liabilities Current liabilities $ 900,000 $ 880,000 Long-term liabilities: $ 200,000 Mortgage note payable, 8%, due 2019. Bonds payable, 10%,…arrow_forward3 Question W Marshal E OM83600 X (3) Slow Awaken P instructi ezto mheducation.com/ext/map/index.html?_con%3con&external_browser%3D0&launchUrl=https%253A%252F%252Flms.mhedu nwk i Saved Condensed Balance Sheets December 31, 2020, 2019, 2018 (in millions) 2020 2019 2818 Current assets $ 764 $ 981 1, 931 $4 24 $ 843 Other assets 2,424 1,730 $2,573 Total assets $3,188 $2,912 Current liabilities $ 588 $ 841 1,034 2$ $ 734 Long-term liabilities Stockholders' equity 1, 582 1, 018 910 1,037 929 Total liabilities and stockholders' equity $3,188 $2,912 $2,573 ces WIPER INC. Selected Income Statement and Other Data For the year Ended December 31, 2020 and 2019 (in millions) 2020 2019 Income statement data; Sales $3,061 $2,924 Operating income Interest expense Net income Other data: 307 321 95 76 224 219 Average number of common shares outstanding Total dividends paid 42.4 47.8 $ 61.0 $ 53.4 Prev 1 of 2 Next > acerarrow_forward
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