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Questions 1 - 6 carry equal marks of 13each, question7 carries 22 marks. Answer all questions Q1. Answer the following questions. a. What is the Optimal Capital Structure? Explain with a graph. b....

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Questions 1 - 6 ca
y equal marks of 13each, question7 ca
ies 22 marks. Answer all questions
Q1. Answer the following questions.
a. What is the Optimal Capital Structure? Explain with a graph.
. What is diversification in Finance? Explain.
c. Explain the differences between American and European options.
Q2. Provide appropriate answers to the following questions.
a. What are differences between future and forward contracts? Explain.
. Explain 3 forms of market efficiencies.
c. Explain the term structure of interest rates.
Q3. If government bonds are cu
ently paying 7 per cent and the inflation rate is 2.1 per cent, what is the approximate real rate? What is the exact real rate?
Q4. The following information relates to Rio Tinto Mining Corporation. What is Rio Tinto’s weighted average cost of capital?
●    10 years ago,Rio Tinto issued 80,000 bonds with 16 yearsmaturity and a face value of $1000 each, pays an – annualcoupon amount of $100 each. The yield on the bonds is 15% p.a. Rio Tinto’s marginal corporate tax rate is 30%.
●     Rio Tinto has 15 million preference shares on issue, which are cu
ently trading for $3.20 each, giving total market value of $48 million. They pay an annual dividend of 30 cents per share.
●     Rio Tinto has 21.5 million ordinary shares on issue, which are cu
ently trading for $4 each. These shares are expected to pay an annual dividend of $0.75 next year, and this dividend is expected to grow at the constant rate of 3% in perpetuity.
Q5. Use the following option quotes to answer the questions below.
                December, 2019, Alibaba Ltd
                Last sale price $16.00
            Calls – Last            Puts- Last
Strike Price JunJuly AugJun XXXXXXXXXXJuly Aug    
$ XXXXXXXXXXcents48cents 72 cents24 cent 27 cents32 cents
a. Suppose you buy 150July $16.00 call contracts. How much will you pay, ignoring commissions?
. Suppose you buy 50 of August 2019 put contracts. What is your maximumnet gain?
On the expiration date, Alibaba is selling for $14.00 per share. What are your options worth?
c. In part (b), suppose you sold your 50 August put contracts. What is your net gain or loss if Alibaba is selling for $13.00?
                
Q6. You would like to invest in two shares A and B. The return on these shares over the next year depends on the state of economy, which will be described as “Boom”, “Normal”, “Slow” and “Recession”. The table below shows the probability of each of these states of economy, and the expected return on each share given each possible state of the economy. The co
elation coefficient between shares A and B is 0.5.
    State of the economy
    Probability
    A Return
    B Return
    Boom
    0.20
    0.25
    0.21
    Normal
    0.40
    0.16
    0.12
    Slow
    0.25
    0.10
    0.08
    Recession
    0.15
     XXXXXXXXXX0.06
    0.05
a. What is the expected return on A and B shares?
. What is the standard deviation of A and B shares?
c. What is the expected return on portfolio comprised of 55% invested in share A and the balance in share B?
d. What is the standard deviation on portfolio comprised of 55% invested in share A and 45% invested in share B?
Q7.The risky portfolio Q consists of 2,500 shares of Google and 7,500 shares of Yahoo. Assume that Google has a share price of $4, an expected return of 18 per cent, and a standard deviation of 25 per cent. Yahoo has a share price of $2, an expected return of 15 per cent, and a standard deviation of 20 per cent. The co
elation between the two is 0.5, and the risk-free rate of interest is 2 per cent.
What fraction of your portfolio must you invest in risky portfolio ofQ and risk-free to have a portfolio standard deviation of 12 per cent?
T317 Final Examination: ACC700 PG – Principles of Accounting XXXXXXXXXXpage 1 of 36
Answered Same Day Jun 15, 2021 FIN200

Solution

Neenisha answered on Jun 15 2021
142 Votes
Question 1
Part a
Optimal Capital Structure
Optimal capital Structure is the proportion of debt and Equity of the firm such that the market value of equity is maximized and the cost of capital is minimized. To reduce the cost of capital financing through debt is used. However, while employing debt in the capital structure, we need to consider the financial risk of employing more debt.
In the above graph we can see that at the optimal capital structure point we have minimum WACC and maximum value of Equity at that level.
Part
Diversification in Finance
Diversification in Finance means that an investor needs to diversify the risk on the investments. The main aim of the investment is to earn maximum returns by minimizing the risk. To minimize the risk, we need to diversify the investments in such a way that the assets have low co
elation between them or negative co
elation. In this case, if the price of one asset falls then the price of other asset will increase and thus investor will be able to make gains or minimize the losses.
Part c
American Options Vs European Option
American option can be exercised anytime – before the date of maturity or at the date of maturity. However, European option can be exercise only at the time of maturity.
Question 2
Part a
Future vs Forward Contracts
Forward contracts are the customized contacts while the future contracts are the standardized contracts. Forward contracts are traded only on OTC market and they involve counter party risk. However, future contracts are traded on exchange and does not involve counter party risk.
Part
3 forms of Market efficiencies
· Weak form – The stock price reflects all the past or the historical information
· Semi Strong Form – The stock price reflects...
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