BMAN23000A FOUNDATIONS OF FINANCE 2018
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BMAN23000A
FOUNDATIONS OF FINANCE
2018
SECTION A – WITHHELD
SECTION B
Question 11 (answer all parts)
The prices of the zero-coupon government bonds with a face value of £100 and a time-to-maturity of 1, 2, 3, and 4 years are, respectively, £97.09, £95.18, £94.23, and £94.22.
a) Using the prices of the zero-coupon government bonds, calculate the price of a coupon-bearing government bond with a face value of £10,000, a coupon rate of 3% per annum, and 4 years till maturity. Coupon payments are made at the end of each year only. Does this bond trade at a discount, at par, or at a premium?
(10 marks)
b) Using the prices of the zero-coupon government bonds, calculate the yield-to- maturity for each of these four maturities, draw the corresponding yield curve, and comment on its shape.
(5 marks)
c) If the spread between the yield-to-maturity of government bonds and the yield-to- maturity of, otherwise similar, BBB-rated corporate bonds is 3% per annum for all maturities, then calculate the price of a coupon-bearing bond issued by a BBB- rated corporation with a face value of £10,000, a coupon rate of 5% per annum, and 4 years till maturity. Coupon payments are made at the end of each year only.
(5 marks)
d) Assume now that the yield curve computed from the zero-coupon government bond prices becomes flat and the yield-to-maturity is equal to 2.5% per annum for all maturities. Using the new yields-to-maturity, calculate the new price of the coupon-bearing government bond specified in a).
(5 marks)
e) Discuss the role of the credit rating agencies in the financial system.
(10 marks)
(Total 35 marks)
Question 12 (answer all parts)
a) Suppose that all stocks can be grouped into two mutually exclusive portfolios (with each stock appearing in only one portfolio): growth stocks and value stocks. Assume that these two portfolios are equal in size (market value), the correlation of their returns is equal to 0.6, and the portfolios have the following characteristics:
|
Expected Return |
Volatility (standard Deviation) |
Value Stocks |
12% |
14% |
Growth Stocks |
15% |
24% |
The risk free rate is 3.5%. Assume that the market portfolio is a 50-50 combination of the value and growth portfolios above.
i. Calculate the Sharpe ratio for the market portfolio.
(8 marks)
ii. Briefly explain what the Sharpe ratio is.
(2 marks)
b) Suppose that Monsters Inc. has a 24% volatility (standard deviation) and a correlation with the market of .60. Assume that the risk-free rate is the same as in part a) and the market portfolio characteristics are those you calculated in part a). If CAPM assumptions hold:
i. Calculate Monsters' beta with the market
(4 marks)
ii. Calculate Monsters' required return
(4 marks)
iii. Suppose that Monsters' expected return is 15%. Calculate Monsters' alpha. Briefly explain.
(6 marks)
c) Describe the CAPM assumptions.
(6 marks)
d) Describe what each of the following pairs of asset pricing models has in common, and how they differ:
i. CAPM and Fama-French-Carhart (F-F-C) model
ii. F-F-C and APT
(5 marks)
(Total 35 marks)
SECTION C
Question 13 (answer all parts)
GlaxoSmithKline plc is a pharmaceutical company. It is considering the replacement of one of its existing machines with a new model. The existing machine can be sold now for £8,000. The new machine costs £50,000 and will generate free cash flows of £11,416.55 p.a. over the next 6 years. The corporate tax rate is 35%. The new machine has average risk. GlaxoSmithKline’s debt-equity ratio is 0.5 and it plans to maintain a constant debt-equity ratio. GlaxoSmithKline’s cost of debt is 5.85% and its cost of equity is 13.10%.
a) Compute GlaxoSmithKline’s weighted average cost of capital.
(5 marks)
b) What is the NPV of the new machine and should GlaxoSmithKline replace the old machine with the new one?
(10 marks)
c) The average debt-to-value ratio in the pharmaceutical industry is 20%. What would GlaxoSmithKline’s cost of equity be if it took on the average amount of debt of its industry at a cost of debt of 5%? Do this calculation assuming the company does not pay taxes.
(10 marks)
d) Given the capital structure change in question c), Modigliani and Miller would argue that according to their theory, GlaxoSmithKline’s WACC should decline because its cost of equity capital has declined. Discuss.
(10 marks)
(Total 35 marks)
Question 14 (answer all parts)
a) Explain in detail the different sources of equity financing for private firms. Which source of finance is preferable? Why?
(15 marks)
b) Fay Plc is planning to sell 20 million shares of stock in a seasoned equity offering (SEO). The current market price of Fay is £12.5 per share. Of the 20 million shares to be sold, 12 million shares are new (primary) shares being offered by the company, and the remaining 8 million shares are to be sold by venture capitalists. Fay's underwriters charge an underwriting fee of 3.5% of the gross proceeds.
I. How much capital will Fay Plc be able to raise from the above SEO?
(6 marks)
II. How much funds will the venture capitalists receive?
(6 marks)
III. Fay Plc originally had 200 million shares of stock outstanding at a price of £12.5 per share. What if the company executives had announced a rights issue instead of a SEO? Details of the right issue:
“Every existing shareholder will be given one right per share of stock that he or she owns. The company plans to require sixteen (16) rights to purchase one share at a price of £10 per share.”
How much capital would the company be able to raise?
(8 marks)
(Total 35 marks)
2022-01-22