Seminar on Investment Trading Strategies

Prof. Urbi Garay

Due: Monday, March 18th, 2019

Notes: The problem set shall be prepared by groups of up to four students.

You should hand in this problem set to me before or at the beginning of Monday´s (March 18th) class.
Alternatively, you could email the problem set to me to: ugaray@gmail.com.

1) A common stock just paid a dividend of $4. The dividend is expected to grow at 15% per year for 6 years, and then it will grow
at 8% per year in perpetuity. If stocks of similar risk earn 10% annual return, calculate the price of the stock.

2) ABC Corp. has a common stock that paid its annual dividend this morning. The stock is expected to pay a $5 dividend one year
from now, and the following dividends are expected to grow at a rate of 8% per year forever. If stocks of similar risk earn 12%
annual return, calculate the price of a share of ABC stock.

3) In the previous exercise, suppose that an analyst would like to estimate the required rate of return to invest in ABC. The beta
of stock ABC is 1.2; the risk free rate is 5% per year, and the market risk premium is estimated to be 8%. Calculate the price
of stock ABC in this case.

4) A common stock just paid a dividend of $2. The dividend is expected to grow at 13% per year for 4 years, then it will grow at
9% per year for the next 4 years, after which dividends will grow at 6% per year in perpetuity. If stocks of similar risk earn
12% annual return, calculate the price of the stock.

5) A company has the mandate to retain 40% of its earnings. The company just reported earnings of -$20 million (a loss of $20
million). The equity value of the company is $500 million. What is the expected growth rate of dividends?

6) Suppose a mutual fund analyst that is undertaking the three-step approach to valuation. The analyst has already conducted the
three steps of the analysis for stock ABC and is recommending adding the stock to the portfolio of the fund. Stock ABC has a
correlation of 0.75 with the fund’s portfolio. Does this correlation level reinforce or mitigate the desire to add stock ABC to
the portfolio? Briefly explain.

7) Which type of economic indicators (leading, coincident or lagging) help the most to predict the future evolution of the
economy? Why?

8) What does a degree of operating leverage of 3% mean?