bm12-14 fmi quiz2 and answers

7/30/2019 BM12-14 FMI Quiz2 and Answers

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Financial Management I

Quiz 2December 6th 2012 Points: 35

BM 12-14 Time: 60 min

ROLL:NAME:

Closed book/ closed notes examination. Make assumptions, if necessary, for

answering the questions. But state all your assumptions clearly.

1. Beta and Leveragea. Assume a firms operating leverage has been reliably computed to be 2.

Assume in the next period, the sales of the firm goes up by 20%, but the EBIT

comes down by 5%. Is this situation possible? Elaborateb. Can a firm with high operating leverage have low business risk (variability in

EBIT)? Elaborate.

Points: 5

a. Yes, OL measures the systematic portion of the relationship. Unique risk(accidents, exchange rate fluctuations, etc) can add to the systematic factors and

either increase the EBIT beyond 20% x 2 or bring it down below 20% x 2b. Yes, sigma sales can even be zero


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2. Assume that you have regressed the monthly stock returns of Sun Pharma againstmonthly returns of the Nifty over the period November 2007 to November 2012.

Assume that the regression has a R2

of 0.22, a slope (beta) of 0.65, and an

intercept of .1%. Assume the one-year risk-free rate in India to be 12% p.a.

a. What is the Jensens Alpha for Sun Pharma? What exactly does this indicate?

b. Over the same period, a regression estimate of equity beta for another firm inthe pharmaceutical industry, Ranbaxy, had a R2 value of 0.26. How will you

interpret these R2

values? What does it indicate?

c. If, in the next period, the market goes up by 1% how much will Sun Pharmasstock go up by? Can you be dead sure of this? Why, or why not?

d. How would a bottom-up beta estimate for the beta of Sun Pharma be better than

the regression beta estimate?

Points: 10

a. Straight from A Damodarans materialb. Portion of total risk explained by the market.c. .65% . No, unsystematic/ unique factors can introduce deviations. R squared is

only .22

d. Standard error would be lesser plus..


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3. Efficiency of Marketsa. In tests for semi-strong market efficiency, how are abnormal stock returnsdefined?

b. Assume that a firm announces very good results for the quarter ending

December 31 2012. Assume that markets are semi-strong efficient. Assume thatyou have computed the weekly abnormal returns for this firm starting eight weeks

before the actual announcement of results on December 31 2012. What will the

abnormal returns possibly look like? Put hypothetical values for the abnormal

returns for the eight weeks

c. What will the abnormal returns look like, after the announcement?Points: 10

a. Returns minus returns as per equilibrium pricing modelb. Positive values, by and largec. Positive, negative mixed upno pattern


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4. Market Designa. Assuming numbers, show diagrammatically (and very clearly) the structure of a14-day repo with an approximate repo rate of 12%p.a.

b. How is a repo different from an ordinary collateralized loan?

Points: 5

a. Show it!b.

In a repo there is an actual sale and buy back; the title gets transferred


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5. New Venture FinancingCan the total value of the firm go up in a down round? Elaborate

Points: 5

Yes, while the price per share will come down, the total value can go up

bm12-14 fmi quiz2 and answers

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