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Describe the relationship between risk and return and apply methods and techniques of risk and return measurement.

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BCO212 BUSINESS FINANCE I Task brief & rubrics

Task: Midterm Assignment

· Individual task

· The student will answer all the questions and problems below.

Formalities:

· You should submit a document in Excel format.

· Font: Arial 11 pts.

· Text alignment: Justified.

Submission: Week (5) – Via Moodle (Turnitin). Sunday 27th June at 23:59 CEST.

Weight: This task is a 40% of your total grade for this subject.

This task assesses the following learning outcomes:

· Understand the basic theories of finance and apply these to practical problems.

· Describe the relationship between risk and return and apply methods and techniques of risk and return measurement.

· Analyze series of future cash flows and recommend choices for investment.

ASSIGNMENT QUESTIONS:

IMPORTANT: SHOW YOUR DETAILED SOLUTIONS FOR EACH QUESTION.

Problems (60 points)

1.-You want to borrow €100,000 from your local bank to buy a new Porsche. You can afford to make monthly payments of €1,800, but no more. Assuming monthly compounding, what is the highest APR you can afford on a 60-month loan?

2.- David Alonso has received a job offer from a large investment bank as a local Manager. His base salary will be €255,000. He will receive his first annual salary payment one year from the day he begins to work. In addition, he will get an immediate €25,500 bonus for joining the company. His salary will grow at 4% percent each year. David believes he will achieve a yearly bonus of 25% of his annual salary every year.

David is today 40 years old, and he expects to work in the company for ten years, how much is the present value of this job offering if the applicable discount rate is 11%?

3.- You want to create a portfolio equally as risky as the market, and you have

€500,000 to invest. Given this information, fill in the rest of the following table:

 

 

 
Total investment
500.000

 

 
Portfolio beta
1

 

 

 

 
Asset
Investment
Beta
 

 
Stock A
75.000
0,90
 

 
Stock B
150.000
1,30
 

 
Stock C

1,50
 

 
Risk-free asset

 

 
 
 
 
 

4.- A stock has an expected return of 15 percent, a beta of 1.2, and the expected return on the market is 12 percent. What must the risk-free rate be?

5.- Consider the following information:

 

 
 
 

 
State
Probability
Stock A
Stock B
Stock C
 

 
Boom
0,25
0,20
0,30
0,40
 

 
Good
0,35
0,10
0,12
0,02
 

 
Poor
0,35
0,05
0,00
(0,05)
 

 
Bust
0,05
(0,05)
0,02
0,03
 

 

 

 
weights

0,34
0,36
0,30
 

 
 
 
 
 
 
 

What is the expected return of the portfolio?

What is the variance of the portfolio?

What is the standard deviation?

Questions (40 points)

a) What happens to the future value of an annuity if you increase the rate r? What happens to the present value?

b) Who owns a Corporation? Describe the process whereby the owners control the firm’s management. What is the main reason that an agency relationship exists in the corporate form of organization? In this context, what kinds of problems can arise?

c) Is the following statement true or false? A risky security cannot have an expected return that is less than the risk-free rate because no risk-averse investor would be willing to hold this asset in equilibrium. Explain.

d) Is it possible that a risky asset could have a beta of zero? Explain. Based on the CAPM, what is the expected return on such an asset? Is it possible that a risky asset could have a negative beta? What does the CAPM predict about the expected return on such an asset? Can you give an explanation for your answer?

e) In broad terms, why is some risk diversifiable? Why are some risks nondiversifiable? Does it follow that an investor can control the level of unsystematic risk in a portfolio, but not the level of systematic risk?

Rubrics

Descriptor

9-10
The student demonstrates an excellent understanding of the concepts.

8-8.9
The student demonstrates a good understanding of the concepts.

7-7.9
The student demonstrates a fair understanding of the concepts.

6-6.9
The student demonstrates some, but insufficient understanding of the concepts.

3-5.9
The student demonstrates insufficient understanding of the concepts. They may mention some relevant ideas or concepts, although it is clear that the relationship between them is not understood by the student.

1-2.9
The student demonstrates insufficient understanding of the concepts and does not mention any relevant ideas or concepts.

0
The student leaves the question blank or cheats.

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