Chapter 7

42.

Calculate the drop in value of Roybus, Inc. equity shares because of the fire in Taiwan. Would you expect
to make a profit in trading Roybus shares based on information about the fire?

a. PV(change in FCF)  180/1.13  60/1.132  206.

Change in V  206, so if debt value does not change, P drops by 206/35  $5.89 per share.
b. If this is public information, in an efficient market share price will drop immediately to reflect
the news, and no trading profit is possible.

After news of the fire becomes known we would expect Roybus shares to drop by $5.89 per share.
We would also expect the capital market to reduce the value of Roybus shares quickly and
efficiently so that profiting from this announcement by trading Roybus shares would not be a
profitable strategy.

Chapter 11

5.

Both calculations of expected return of a portfolio give the same answer.

Example: You invest $50 to buy 3 shares of stock A (price $10/share) and 1 share of stock B (price
$20/share)

A B PF
weights 60% =($10x3)/$50 40%=($20x1)/$50
P0 10 20 $50=$10x3 + $20x1
D1 1 1.5 4.5
P1 13 18 57
Return 40%=(P1+D1-P0)/P0 -2.50% 23.00%
You can use the weights to calculate the return of the PF as the weighted average return:

RPF = WA x RA + WB x RB = 60% x 40% + 40% x (-2.5%) = 23%

6.

If the price of one stock goes up, the other stock price always goes up as well. Similarly, if one goes down,
the other will also be going down.

8. a.

0.1  0.07  0.15  0.05  0.08

E[ RA ]   0.07
5
0.06  0.02  0.05  0.01  0.02
E[ RB ]   0.024
5

1
 b.
(0.1  0.07) 2  (0.07  0.07) 2  (0.15  0.07) 2 
( 0.05  0.07) 2  (0.08  0.07) 2
Var ( RA )   0.00545
5 1
StdDev ( RA )  0.00545  0.0738
(0.06  0.024) 2  (0.02  0.024) 2  (0.05  0.024) 2 
(0.01  0.024) 2  ( 0.02  0.024) 2
Var ( RB )   0.00103
5 1
StdDev ( RB )  0.00103  0.0321

c.
E[ RP ]  0.7(0.07)  0.3(0.024)  0.0562
Var ( RP )  0.7 2 (0.0738) 2  0.32 (0.0321) 2  2(0.7)(0.3)(0.0738)(0.0321)(0.46)  0.00352
StdDev( RP )  .00352  0.0593

Even with most of the portfolio’s weight on the riskier stock, the diversification effect brings the
overall portfolio risk down below a weighted average of the two standard deviations.

19.

We need to compute the excess returns of BlackBerry and Westjet.

a. The best guess to BlackBerry’s excess return today is the product of the market return and
BlackBerry’s beta. BlackBerry’s excess return   2% 1.5   3.0%.
b. Westjet’s excess return  2%  0.5  1%.

22.

Using the SML, the expected return for Loblaw= Rf + Beta x (Rm – Rf)

Expected Return  4%  0.32  (0.10  0.04)  5.92%

The expected return for Loblaw is 5.92%.

28.

Using the SML, the Expected Return  5%  0.6  (5.5%)  8.3%.

The company should produce a return of 8.3% to compensate its equity investors for the riskiness of their
investment.