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BM 410 Investments
Bryan Sudweeks Final Exam
December 13, 2000 11-2 p.m.
Each problem is worth 5 points. Please make sure you answer each part of each question.
Remember that if you show your work and don’t get the problem correct, there is a greater
likelihood that I can give you partial credit. If you only put down the answer, I cannot determine
whether you understood the problem or not and hence cannot give even partial credit.
Course Objectives:
1. What were the objectives that I wanted you to get out of this class and why are they important?
Forecasting
2. In this class I had you analyze a company and forecast 5 years of financial statements. What is
the purpose of forecasting? Why is it important for someone who is not planning to be a financial
analyst to know how to do forecasting for a business? What are the key tools that you had to use?
3. Fill in the following statements regarding non-sales based forecasting:
Account
Common Assumptions
Net plant and
Forecast = Current + ____________
- Depreciation
Equipment (P&E)
P&E
P&E
Long-term
Forecast = Current - Debt
+
______________
Debt (LTD)
(LTD
LTD
repayments
Common stock (CS)
Forecast = Current + Proceeds from - ______________
CS
CS
Sale of new stock
Total Points
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Final Paper Recommendations
4. A. Using only the information below from Bloomberg and a current S&P 500 price of 1,387.5,
calculate the forward or prospective PE for the years 2000-2005 using the mean EPS estimate for
2000, the low EPS estimate for 2001, and the mean EPS estimate for the remaining three years
using the 5-year growth rates.
B. Using the same information as above, calculate the relative PE for Costco versus the S&P500
for 2001 and 2002. Costco has a June year-end and a prospective PE for 2001 and 2002 of 14x and
12x.
Bond Prices and Yields
5. (10-CC7) A 30-year bond is issued with a 4% coupon and a yield to maturity of 8%. Suppose
that the yield to maturity falls to 7% by the end of the first year, and that the investor sells the bond
after the first year. If the investor’s tax rate on interest income is 36% and the tax rate on capital
gains is 28%, what is the investor’s after-tax return?
Total Points
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6. Interest rates are a critical component of the return from fixed income securities. In class, we
discussed three different theories regarding the term structure of interest rates, the relationship
between yields to maturity and maturity across bonds. Those theories were the expectations
hypothesis theory, the liquidity preference theory, and market segmentation theory. Give a
one-sentence explanation of each theory.
Managing Fixed-Income Investments
7. (11-CC1) A. Fill in the price and duration of a 2-year maturity, 9% coupon bonds when the
market interest rate is 10.00%.
Bond
Time until
Payment discounted
Time times
Payment
Payment
at YTM
Weight
weight
1.
2.
__________
______
_________
B. Now suppose the interest rate increases to 10.05%. Calculate the new value of the bond
and the percentage change in the bond’s price.
C. Calculate the percentage change in the bond’s price predicted by the duration formula:
Change in Price = - D * (change in (1+y))/(1 + y)
Total Points
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Macroeconomic and Industry Analysis
8. (12-6) Here are four industries and four forecasts for the macro-economy. Choose (check) the
industry that you would expect to perform the best in each scenario:
Deep Recession:
Superheated Econ.: Healthy Expansion: Stagflation
Falling inflation,
Rapidly rising GDP, Rising GDP, mild
Falling GDP,
Interest rates, and
Inflation, and interest inflation, low
high inflation
GDP
rates
unemployment.
Industries:
Housing
Construction_________________ __________________ _________________ ____________
Health
Care _______________________ __________________ _________________ ____________
Gold
Mining _____________________ __________________ _________________ ____________
Steel
Production __________________ __________________ _________________ ____________
9. (12-5) Consider two firms producing videocassette recorders. One uses a highly automated
robotics process, while the other uses human workers on an assembly line and pays overtime when
there is heavy production demand.
A. Which firm will have the higher profits in a recession?
B. Which firm’s stock will have a higher beta?
10. You are the CFO ACE Manufacturing Company, a family-owned manufacturing firm in Utah.
It has been around for a while, with 6 million shares outstanding and a book value per share of $40.
It has expected earnings per share next year of $2. You know that similar companies trade in the
US at a prospective PE range of 14-16 times earnings. You also have estimated the assets in the
company, less the liabilities, are worth about $225 million, and that it would cost about $250
million to replicate the same company. You have been asked by your boss to value your company,
which is likely to go public soon. Since he owns 72% of the company, he would like to get the
highest valuation possible. List three different ways you would value the company, and your
approximate values of the company’s worth using each method (there is enough information to
value it using four methods).
Total Points
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11. (13-5) The constant growth Dividend Discount Model can be used both for the valuation of
companies and the estimation of the long-term total return of a stock. Assume a $20 price of the
stock today, an 8% expected growth rate of dividends, and a $.60 expected annual dividend oneyear forward.
A. Using only the above data, compute the expected long-term total return on the stock using
the constant growth dividend discount model. Show calculations.
B. Briefly discuss two disadvantages of the constant growth dividend discount mode in its
application to investment analysis.
C. Identify two alternative methods to the dividend discount model for the valuation of
companies.
Technical Analysis
12. (15-10) Given only the information below is the confidence index rising or falling? Why or
why not?
This Year
Last Year
Yield on top-rated corporate bonds
8%
9%
Yield on intermediate-grade corporate bonds
9%
10%
Intrinsic Value
13. Thai Steel in Thailand is currently trading at a PE of 15x earnings, at a price of 45 Baht (B),
and is expected to pay a B1.5 dividend each year for the next 5 years. Assuming steel companies
in Thailand are expected to trade at a PE of 10x five years from now, what is the intrinsic value of
Thai Steel given a required rate of return of 20% in Thai Baht? (The analysis is valid in Thai Baht
as well as in US Dollars).
Total Points
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Options Markets
14. (16-11) An executive compensations scheme might provide a manager a bonus of $1,000 for
every dollar by which the company’s stock price exceeds some cutoff level. In what way is this
arrangement equivalent to issuing the manager call options on the firm’s stock?
15. (16-CC1) A. What will be the proceeds and net profits to an investor who purchases the
December maturity Motorola calls for $2.75 with exercise price $50 if the stock price at maturity
is $45? What if the stock price at maturity is $55?
B. Now answer A for an investor who purchases December maturity Motorola put options at
$2.125 with exercise price $50.
Option Valuation
16. (17-9) Would you expect a $1 increase in a call option’s exercise price to lead to a decrease in
the option’s value of more or less than $1? The Black Scholes pricing formula for a call option is
C0 = S0N(d1) - Xe-rT N(d2) where C is the current call option value, S is the stock price, N(d) is the
probability distribution, and X is the exercise price.
17. (17-10) All else being equal, is a put option on a high beta stock worth more than one on a low
beta stock? Why? The firms have identical firm-specific risk.
Total Points
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Futures Markets
18. (18-9) Suppose the value of the S&P500 stock index is currently $660. If the one-year T-bill
rate is 5% and the expected dividend yield on the S&P500 is 2%, what would the one-year maturity
futures price be?
Performance Evaluation
19. (19-1) A plan sponsor with a portfolio manager who invests in small-capitalization, high
growth stocks should have the plan sponsor’s performance measured against which one of the
following: A. S&P 500 Index, B. Wilshire 5000 Index, C. Dow Jones Industrial Average, D.
S&P 400 Index. Why?
International Investing
20. (20-5) If the current exchange rate is $1.75/£, the one year forward exchange rate is $1.85/ £,
and the interest rate on British government bills is 8% per year, what risk-free dollar-denominated
return can be locked in by investing in the British bills?
Extra Credit
21. (2 points) I would like your help. If you were the teacher, what would you do differently in
this class to improve the learning experience and to help the students to get more out of this class?
(I promise that the answer to this question will have no negative impact on your final grade, and
that it likely will have a positive impact).
Total Points
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