Question 1 (50 marks)
Peter is interested in investing and usually reviews his portfolio monthly.
Based on the updated information, he will make an adjustment to his
investment from time to time. Currently, his portfolio includes both
stocks and bonds. Additional information on his stock — MKT Company
and Pacific Group — and his bond — Western Company — are listed
below. Please answer the following questions.
a MKT Stock:
MKT Company is expecting a period of intense growth and has
decided to retain more of its earnings to help finance that growth. As
a result, it is going to reduce its annual dividend by 20% a year for
the next two years. After that, it will maintain a constant dividend of
$1.50 per share. Last year, the company paid $2.60 as the annual
dividend per share. Evaluate the market value of the MKT stock if the
required rate of return is 14.5%. (15 marks)
b Pacific Group Stock:
i The expected return on the market portfolio is 10% and the
Treasury Bill rate is 3%. If the beta of the Pacific Group Stock is
1.5, determine its required rate of return. (5 marks)
ii After a significant change in capital structure, the beta of the
Pacific Group Stock rises to 2.0. Thus, Peter plans to increase his
investment because the expected return on this investment is
twice as high as that in the market. Do you agree with Peter?
Explain. (15 marks)
c Western Bond:
The bond of Western Company with a 12% coupon rate and a face
value of $1,000 was issued in 2017. The bond pays the semi-annual
coupon, and has a yield to maturity of 6%. Recently, the interest rate
suddenly increased by 2%. If the bond has 10 years to maturity,
analyse the percentage change in the price of the Western Bond.
(15 marks)
12 FIN B280 Introduction to Financial Management
Question 2 (50 marks)
Four stocks which have the following characteristics are used to construct
a portfolio:
Stocks Number
of shares
Market
prices
Expected
return
Standard
deviation
Beta
HSBC 100 70 5% 4% 1.10
CLP 100 60 5% 4% 0.80
SINOPEC 1000 7 6% 5% 1.30
China Mobile 100 80 6% 5% 1.05
In addition, ten-year Hong Kong Exchange Fund Notes currently yield 1%
annually. The Hang Seng Index generates the market return of 5%
annually.
Required
a Based on the above information, evaluate which of the stocks —
HSBC, CLP, SINOPEC and China Mobile (if any) — is appealing to
investors. (12 marks)
b If the four stocks are included in a portfolio as described in the above
table, determine the beta and expected return for this portfolio.
(12 marks)
c Analyse how much SINOPEC stock one must sell and reinvest in
CLP so that the beta of the portfolio can change to 1.00. (6 marks)
d If the returns of the four stocks are presumed to follow a normal
distribution, discuss the probability that each of them is undervalued
or overvalued. (20 marks)
