Question

17. If an equity portfolio manager wished to increase the systematic risk of the equity portfolio it could be done by

Select one:

a. Selling futures contracts on a stock index.

b. Selling Treasury bond futures contracts.

c. Purchasing futures contracts on a stock index.

d. Purchasing Treasury bond futures contracts.

e. None of the above.

18. Calculate the required rate of return on equity based on the following information.
From year 2013 onward growth in FCFE is expected to remain constant at 5% per year. The stock has a beta of 1.1 and the current market price is $80. Currently the yield on 3-month Treasury bills is 5% and the equity market risk premium is 4%. The firm can raise debt at a pre-tax cost of 9%. The tax rate is 25%. The proportion of equity is 55% and the proportion of debt is 45%.

Select one:

a. 8.2%

b. 9.4%

c. 9.0%

d. 10.3%

e. 7.3%

Answer 1

17. Systematic risk is also known as the market risk. This can be increased by purchasing futures contracts on a stock index. The stocks in the index are exposed to the market risk. Option C is correct

Option a is incorrect because selling futures contracts on a stock index decreases the systematic risk

Options b and d are incorrect because Purchasing or Selling Treasure bond futures contract will not have any effect on the systematic risk of the equity portfolio.

18. We need to find the required return on equity to be used to discount FCFE

CAPM

re = 0.05 + 1.1 * 0.04

re = 0.05 + 0.044

re = 0.094

re = 9.4%

Option b is correct