# Financial Markets Essay

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Financial Markets (N13302) Mock Paper (2010/2011) Question 1 (a) BSC Industries has just paid its annual dividend of \$10 per share. The dividend is expected to grow at a constant rate of 5% indefinitely. The beta of BSC industries stock is 1.3, the risk-free rate is 2%, and the market risk premium is 7%. (1) What is the intrinsic value of the stock? (2) What would be your estimate of intrinsic value if you believed that the stock was riskier, with a beta of 1.7? [40%] (b) CBD stock has an expected ROE of 15% per year, expected earnings per share of \$6, and expected dividend of \$4 per share. The beta of CBD stock is 1.3, the risk-free rate is 2%, and the market risk premium is 7%. What are its expected growth rate, its price, and its P/E ratio? [40%] (c) Discuss why P/E multiples are in general negatively correlated with risk and positively correlated with growth. [20%] Question 2 Mr. Smith wants to invest in two shares: share X and share Y. Share X has an expected return of 12% with a variance of 0.0096, and share Y has an expected return of 9% with a variance of 0.0081. Suppose the covariance between X and Y is -0.0034. Calculate the expected return and standard deviation of his portfolio if he invests: (a) 40% in share X and 60% in share Y. [40%] (b) 70% in share X and 30% in share Y. [40%] (c) Calculate the correlation coefficient between X and Y. [20%] Question 3 a) Suppose your neighbour wants to invest in bonds. One of the choices is a corporate bond with a coupon rate 2%, 2-year maturity with par value of £1000 paying annual coupon payment. Suppose