Question 1:
a) Discuss the various types of financing available for quoted and unquoted businesses.
b) What possible motives might companies have for going private?
Question 2:
a) Over the past three years (Year 1 to Year 3) the stocks of two companies, First Plc and Second Plc, generated annual returns as follows:
i. For each of the three years (Year 1, Year 2, Year 3), calculate the annual return generated by a portfolio that is made up of the two stocks with 60 percent of the portfolio invested in First Plc and the rest in Second Plc.
ii. Based on the annual portfolio returns, calculate the expected (average) portfolio return and the standard deviation of portfolio returns.
b) Assuming the Capital Asset Pricing Model (CAPM) holds, calculate the expected returns and the risk premia of the following three portfolios.
i. Portfolio 1 has a beta of 2; the return on the market portfolio Rm is expected to be 10% and the riskfree rate Rf is 2%.
ii. Portfolio 2: the standard deviation of the market portfolio returns σm is 5 percent and the covariance between the market portfolio returns and the returns of Portfolio 2 σP2,m is 0.001; the values of Rm and Rf are as for Portfolio 1.
iii. Portfolio 3: the estimated correlation coefficient between the returns on Portfolio 3 and the market portfolio returns is 0.7, and the standard deviation of the returns of Portfolio 3 is 2%; the values of σm, Rm and Rf are as for Portfolios 1 and 2.
In each of parts (b1) - (b3), clearly show the derivations of your results.
c) What is the security market line, and how has it been used in practice to quantify the equity cost of capital faced by a company?