Finish this question. (Corporate Finance) Â Â Â Â I. Short answer:
1. What are the perfectmarket assumptions?
2. Explain whether the following statements are true or false. In each case,
provide justification for your answer:
â€¢ In a perfect capital market, expected returns on all bonds must be
equal to the risk-free (T-bill) rate.
â€¢ In a perfect capital market with risk-neutral investors, expected returns
on all bondsmust equal the risk-free rate.
3. Write down the CAPM formula. What are the economy-wide inputs and
what are the firm-specific inputs?
II. The table below describes the return rates for a stock X and a market index
fund, call itM. Find the (true, as opposed to estimated) beta of stock X. Assume
the probability of the â€œgoodâ€ state is 1/3 (â€œbadâ€ has probability 2/3).
M 10% 6%
Asset X 4% 10%
III. Suppose Intelâ€™s stock has an expected return of 10%and a volatility (standard
deviation) of 5%, while Coca-Colaâ€™s has an expected return of 5% and volatility
of 2%. Assume these two stocks have correlation coefficient âˆ’1.
1. Calculate the portfolio weights that remove all risk.
2. If there are no arbitrage opportunities, what is the risk-free rate of interest
in this economy?
IV. A biotech company has a drug in development that will allow you to sell your
firm for $10 billion next year. Assume your boss wants you to use the CAPM.
Your firm has a beta of 4, the risk-free rate is 5% per year, and the equity premiumis
2% per year. What do you think the firmis worth today?
V. Your borrowing rate is 15% per year. Your lending rate is 5% per year. The
project costs $1,000 and has a rate of return of 10%.
1. Assume you have $500 of your own money to invest. Should you invest in
2. Find themaximal amount the investor would bewilling to borrow in order
to invest in the project?1
VI. Option pricing:
1. Consider a European call option on a single share of stock in company
X. The strike price is $25 and the maturity date is 1 year. Call this a â€œ25-
callâ€ for simplicity (and, generally, a â€œKâ€-call, where K is the strike price).
Draw the payoff diagram in the two cases where (i) an investor goes long
on a single 25-call, and (ii) an investor shorts both a 25-call and a 20-call.
2. Consider (European) call and put options on a single share of stock in
company X. Each has a strike price of $25 and matures in 1 year. Assume
the (per share) stock price at the time the options are written is $22 and
that the cost of the put is $2. Also assume that the risk-free rate is 10%.
Find the price of the call.
Finish this question. (Corporate Finance) Â Â Â Â
I. Short answer:
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