Question

Question 1: Answer the following sums

1. The market price of a security is $50. Its expected rate of return is 10%. The risk free rate is 3.5%, and the market risk premium is 8.2%. What will the market price of the security be if Beta doubles and all other variables remains unchanged? Assume the stock is expected to pay a constant dividend in perpetuity.

2. SABB financial institution composition is as follows:

1. Stock	Shares	Price $	Value held
   A	250,000	40
   B	310,000	45
   C	450,000	15
   D	510,000	20

   The fund has not borrowed any funds, but its accrued management fee with the portfolio manager currently totals $75,000. There are 2.8 million share outstanding.

   What is the NAV of the fund?                                       

Answer 1

Solution:

Question 1 )

Share price = $50

Expected rate of return =10%

Dividend is constant, Hence dividend = Share price * Expected rate of return = 50 * 10% = 5

Using CAPM model for expected rate of return

Expected rate of return = Risk free rate + Beta * Market risk premium

10% = 3.5% + Beta * 8.2%

Beta = 6.5% / 8.2% = 0.79

When Beta is doubled then Beta = 0.79*2 = 1.58

Expected rate of return = 3.5%+ 1.58 * 8.2% = 16.46%

Share price = Dividend / Expected rate of return = 5 / 16.46% = $30.38

Question 2 )

NAV = 14.58

When calculating the NAV we subtract fees from the asset value