# Financial Management Principles (FINA 3311)

**Financial Management Principles (FINA 3311)**

**Exam II, Spring 2019-20**

**Total Points: 30 (8×3+1×2+1×4)**

**Today: April 8, 2020; Due Date:**

It is an individual work. No copying. Must be hand-written, scanned and submitted by email attachment.

- Define systematic (market) and unsystematic (unique) risk. Give two examples for each of them. Which one is more important and why?

- Systematic risk is a type of risk that cannot be diversified away in which it is associated with the entire market. Examples: inflation, changes in interest rates.
- Unsystematic risk is a type of risk that can be reduced through diversification in which it is associated with a specific industry. Examples: management risk and location risk.
- Systematic risk is more important because it may affect the entire market moreover, the risk is spread from unhealthy institutions to the healthy ones.

- Suppose for a project, initial investment is $13,000. The cash flows for next 4 years are $2,000, $4,000, $6,000 and $9,000. Calculate the net present value (NPV) and IRR of this project. Should you accept the project?

Suppose the interest rate is 8%.

CF_{0}= -13000

CF_{1}=2000

CF_{2}=4000

CF_{3}=6000

CF_{4}=9000

I=8

NPV= 3,659.46

IRR=17.56%

Yes, we should accept the project.

- Suppose the Treasury bond rate is 5%, the average return on the S&P 500 index is 12%, and XYZ, Inc. has a beta of 1.5. According to the CAPM, what should be the required rate of return on XYZ stock?

Equation slide 58, chapter 7&8.

K_{j}= 0.05 + 1.5 (.12 – 0.05) = 0.155 = 15.5%

- Use the following information to find
*volatility* (standard deviation) and *expected return* of ABC Company. Also find *coefficient of variation*. How do you explain? Which stock is riskier considering both risk and return? **4 Points**

States Probability Return

Economy (P) Orl. Utility Orl. Tech

Recession 0.20 4% -10%

Bad 0.10 6% 4%

Normal 0.40 10% 14%

Boom 0.30 14% 30%

Expected return:

K(ou)= 0.20(4%)+0.10(6%)+0.40(10%)+0.30(14%) = 9.6%

K(OI)= 0.20(-10%)+0.10(4%)+0.40(14%)+0.30(30%) = 13%

Standard deviation:

6.272

1.296

6.4

5.808

19.776 = 4.45%

0.01058

8.1

4

8.67

20.78058 = 4.56%

Coefficient of variation

46.35%

35.07%

- You bought a bond for $1,100. It has a face value of $1,000 and will mature in 8 years. It gives
*semi-annual coupon* of 10%. Calculate the YTM of this company.

PMT = 10% / 2 = 5

FV= 1000

N= 8×2 = 16

PV=1100

- QQ Corp. gives dividend of $6 just few days ago. You believe that the dividend amount will grow at 4%. This firm’s stock is now selling for $80. What is the cost of capital (discount rate) of QQ Corp’s stock?

- A firm’s preferred stock is selling for $1,100. Preferred dividend is fixed at $8.5. What is the cost of preferred capital?
**2 points**

- Write down the CAPM equation. Correctly explain the notations used in the equation.

- Why are we NOT able to diversify market risk?

- Explain the difference between required return and expected return. Give an example for both of them.