ps3

12.5 a. To compute the beta of Travis Manufacturing's stock, you need the product of the deviations of Travis' returns from their mean and the deviations of the market's returns from their mean. You also need the squares of the deviations of the market's returns from their mean.

The mechanics of computing the means and deviations were presented in an earlier chapter.

RT = 0.196 / 12 = 0.016333

RM= 0.236 / 12 = 0.019667

E (RT -RT) (RM-RM) = 0.03871141

E (RM-RM)2 = 0.03394667

= 0.03871141 / 0.03394667

= 1.14036

b. The beta of the average stock is 1. Travis' beta is higher. This indicates that Travis stock is riskier than the average stock.

12.9 E (RS) = 0.1 x 3 + 0.3 x 8 + 0.4 x 20 + 0.2 x 15 = 13.7%

E (RB) = 0.1 x 8 + 0.3 x 8 + 0.4 x 10 + 0.2 x 10 = 9.2%

E (RM) = 0.1 x 5 + 0.3 x 10 + 0.4 x 15 + 0.2 x 20 = 13.5%

State {RS- E (RS)} {RM - E(RM)} Pr {RB - E(RB)} {RM - E(RM)} Pr

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1 (0.03 - 0.137) (0.05 - 0.135)x 0.1 (0.08 - 0.092) (0.05 - 0.135) x 0.1

2 (0.08 - 0.137) (0.10 - 0.135) x 0.3 (0.08 - 0.092) (0.10 - 0.135) x 0.3

3 (0.20 - 0.137) (0.15 - 0.135) x 0.4 (0.10 - 0.092) (0.15 - 0.135) x 0.4

4 (0.15 - 0.137) (0.20 - 0.135) x 0.2 (0.10 - 0.092) (0.20 - 0.135) x 0.2

Sum 0.002056 0.00038

= Cov (RS,RM) = Cov (RB,RM)

M2 = 0.1 (0.05 - 0.135)2 + 0.3 (0.10 - 0.135)2

+ 0.4 (0.15-0.135)2 + 0.2 (0.20 - 0.135)2

= 0.002025

a. Beta of debt = Cov (RB, RM) / M2 = 0.00038/0.002025

= 0.188

b. Beta of stock = Cov (RS, RM)M2 = 0.002055/0.002025

= 1.015

c. B/S = 0.5

Thus, B/ (S&B) = 1/3 = 0.3333

S/ (S&B) = 2/3 = 0.6667

Beta of asset = 0.188 x 0.3333 + 1.015 x 0.6667

= 0.739

12.12 a. Cost of equity for National Napkin

= 7 + 1.29 (13-7)

= 14.74%

b. B/ (S+B) = S / (S+B) = 0.5

WACC = 0.5 x 7 x 0.65 + 0.5 x 14.74

= 9.645%

13.2

Weak Form: Prices reflect all information contained in historical data.

Semi-strong form: In addition to historical data, prices reflect all publicly available

information.

Strong form: Prices reflect all information, public or private.

13.3 a. False: Market efficiency implies prices reflect all available information, but it does not imply certain knowledge. Many pieces of information which are available and reflected in prices are somewhat uncertain. Efficiency of markets does not eliminate that uncertainty and therefore does not imply perfect forecasting ability.

B. True: Market efficiency exists when prices reflect all available information. To be weak form efficient, the market must incorporate all historical data into prices. Under the semi-strong form of the hypothesis, the market incorporates all publicly available information in addition to the historical data. In a strong form efficient market, prices reflect all publicly and privately available information.

c. False: Market efficiency implies that market participants are rational. Rational people will immediately act upon new information and they will bid prices up or down to reflect that information.

d. False: Since in efficient markets prices reflect all available information, prices will fluctuate whenever new information becomes available.

e. True: Without competition among investors, information could not be readily transmitted. Without quick transmissions of information, prices would not reflect the information immediately and markets would not be efficient.

13.6 Investors should not be deterred from buying UPC's stock because of the announcement. If the market is at least semi-strong form efficient, the stock price will have already reflected the present value of the payments which UPC must make. Buying the stock at the post announcement price should provide the same return that the stock was providing before the announcement. (NOTE: UPC's current stockholders bear the burden of loss. At the time of the announcement, returns would have been abnormally low. After the information was incorporated into the price, returns are normal again.)

a: travis.man