Question

Question 1

As companies grow in size, it is inevitable for the shareholders to hire management to run the operations of the business. The entire team of management, starting from the CEO and other top-level management, all the way to the middle and bottom level management are expected to perform towards the growth of the business. Since the shareholders of large companies are scattered across geographies, they appoint certain members as representatives who are elected to represent them on the company board. The board of directors of a company, along with the Chairman, are expected to keep the actions of the management in check. Explain the above in context of agency theory and corporate governance. What can companies do to ensure adequate corporate governance?

Question 2

Mr. Morris had $100,000 in his account. Using this fund, he made a portfolio of two NYSE listed stocks – Johnson and Johnson (J&J) and IBM on 01 Jan 2019 in the ratio of 60:40, i.e. 60% funds in J&J & 40% funds in IBM. The daily stock data of both stocks can be found on market websites such as finance.yahoo.com. Download daily data for 1 year from 1 Jan 2019 – 1 st Jan 2020. Using the stock data of the two stocks, you are required to explain the below concepts and then compute for the given stocks:

a. Annual return of both J&J and IBM.

b. Annualized standard deviation of returns of both J&J and IBM.

c. Correlation coefficient of returns of J&J and IBM. What does this correlation coefficient signify about the correlation of the two stocks and corresponding decision from an investor?

d. Portfolio return of the portfolio of two stocks.

e. Portfolio risk (standard deviation) of the portfolio of two stocks.

f. Critically analyze your investment decision in these two companies. Given an option, would you like to invest in any other company? Or would you like to have a different ratio of investment in the two?

Question 3:

Your firm’s geologists have discovered a small oil field in New York’s Westchester County. The field is forecasted to produce a cash flow of C1 $2 million in the first year. You estimate that you could earn an expected return of r 12% from investing in stocks with a similar degree of risk to your oil field. Therefore, 12% is the opportunity cost of capital. What is the present value? The answer, of course, depends on what happens to the cash flows after the first year. Calculate present value for the following cases:

a. The cash flows are forecasted to continue for 20 years only, with no expected growth or decline during that period

b. The cash flows are forecasted to continue for 20 years only, increasing by 3% per year because of inflation

c. Evaluate the cashflows in a and b and explain which one you will choose and why

Answer 1

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