A stock has the following probability distribution:

_____________________________________________________________________

Demand for the Probability of this Rate of return if this

Company’s products demand occurring demand occurs

_____________________________________________________________________

Weak 0.10 -50%

Below Average 0.20 -5%

Average 0.40 16%

Above Average 0.20 25%

Strong 0.10 60%

______________________________________________________________________

Calculate the stock’s expected return, variance of returns, and standard deviation of returns.

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Use the following information for the problem.

____________________________________________________

State of Probability of Returns if State Occurs

Economy State of Economy Stock S Stock T

____________________________________________________

Boom 0.10 12% 4%

Normal 0.65 9% 6%

Recession 0.25 2% 9%

____________________________________________________

a) Find the expected return of each stock.

Use at least seven decimal places in computations of (b), (c) and (d) below to avoid significant rounding errors.

b) Calculate the variance and standard deviation of returns of each stock.

c) Compute the covariance and correlation of returns between the two stocks.

d) Assume that you invest $4,500 in Stock S and $3,000 in Stock T. Find the expected return on the portfolio and the standard deviation of the portfolio’s return.

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You will receive $7,600 three years from now. The discount rate is 13 percent. a. What is the value of your investment two years from now? Multiply $7,600 × .885 (one year’s discount rate at 13 percent). (Round your answer to 2 decimal places.) b. What is the value of your investment one year from now? Multiply your rounded answer to part a by .885 (one year’s discount rate at 13 percent). (Round your answer to 2 decimal places.) c. What is the value of your investment today? Multiply your rounded answer to part b by .885 (one year’s discount rate at 13 percent). (Round your answer to 2 decimal places.)

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- Some events rarely happen but when they do insurance company must respond appropriately. They fall in a high severity and low frequency category but there are effective means of risk transfer and financing.

Explain the risk transfer options, how
insurers respond and the effect on the company operations.
**[25 marks]**

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- The insurance product is unique in that its quality can only be judged when something goes wrong. The way in which a claim is handled will have important marketing repercussions for insurers. That is the reason why, the claims operation must be adequately managed. The procedure for handling claims vary whether it is a personal or commercial claim.

Review the typical procedures
considered when handling
claims.** [25
marks]**

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- The product offers life protection, savings and even has investment component. Even though it runs for a specified period, life assurance companies are flexible to extend cover so that they make sure that money became available to the policyholders dependents on their death.

Identify and describe the variations
under this product.
**[25 marks]**

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You wish to construct a short butterfly using the following options. Draw the contingency graph and fully label the graph. (You must label the corresponding dollar values for the max gain, max loss, and the spot rates for break-even point(s), and all kinks)

The following are contract characteristics of various options:

A: Put option with a strike price of $0.75 and a premium of $0.04

B: Put option with a strike price of $0.82 and a premium of $0.08

C: Put option with a strike price of $0.89 and a premium of $0.15

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- There are different methods to establish a benefit fund accessible to an individual when they are not economically active; who is eligible to use them, advantages and disadvantages of each method vary. Sometimes companies help in setting up these funds as a condition of service.

Which ones would you recommend to an
individual or
company?
**[25 marks]**

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- Life assurance companies offer contracts from time to time which guarantee income to the policyholder. The attraction of these products and the rate offered at any time vary too. There are useful vehicles for investment of lump sum.

Review the various options available in the marketplace.

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- A quality service should provide at least meet the quality that the customer expects. An insurance company may aim to respond to a claim advice within a specified timeframe in line, this is known as 'threshold quality' and is fundamental to any quality programme. Without knowledge of these customer expectations, a company may waste resources. To maintain a competitive edge in an increasingly complex environment, insurers must know what customers expect and provide services and products that meet or exceed those expectations.

How do insurance companies achieve
this?
**[25 marks]**

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At an output level of 45,000 units, you calculate that the degree of operating leverage is 2.79. Fixed costs are $175,000.

a. What is the operating cash flow at 43,000 units? (Do not round intermediate calculations and round your answer to the nearest whole number, e.g., 32.)

b. What is the degree of operating leverage? (Do not round intermediate calculations and round your answer to 3 decimal places, e.g., 32.161.)

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Matt needs to borrow money to go to college. He has been granted a student loan of $7000. When is school, he actually only needed $6000. He has two options for paying it back. The great news about student loans is that interest does not calculate until he finishes school. What should be choose and why? • Option A: Pay back $1000 extra before the interest starts. Pay back the $6000 loan over 3 years at 5.2% interest compounded annually by making monthly payments. • Option B: Use the extra $1000 to help buy a car. Pay back the entire student loan over 4 years at 5.2% interest compounded annually by making monthly payments.

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Lou wants to set up his own landscaping business and needs to borrow $2500 to buy equipment. He wants to keep on top of his payments so he would prefer to pay off the loan on a weekly basis. Option A: 2 year term at 3.99% Option B: 1 year term at 3.99% What effect does the term length have on his loan? What should he choose and why? (Answers will vary) Lou wants to set up his own landscaping business and needs to borrow $2500 to buy equipment. He wants to keep on top of his payments so he would prefer to pay off the loan on a weekly basis. Option A: 2 year term at 3.99% Option B: 1 year term at 3.99% What effect does the term length have on his loan? What should he choose and why? (Answers will vary)

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**Internal rate of return and modified internal rate of
return.** Lepton Industries has three potential projects,
all with an initial cost of $1,700,000. Given the discount rate
and the future cash flows of each project, what are the IRRs and
MIRRs of the three projects for Lepton Industries?

Cash Flow |
Project Q |
Project R |
Project S |
||||

Year 1 |
$400,000 |
$600,000 |
$900,000 |
||||

Year 2 |
$400,000 |
$600,000 |
$700,000 |
||||

Year 3 |
$400,000 |
$600,000 |
$500,000 |
||||

Year 4 |
$400,000 |
$600,000 |
$300,000 |
||||

Year 5 |
$400,000 |
$600,000 |
$100,000 |
||||

Discount rate |
9% |
14% |
18% |

What is the IRR for project Q?_________%(Round to two decimal places.)

What is the MIRR for project Q?________%(Round to two decimal places.)

What is the IRR for project R?________%(Round to two decimal places.)

What is the MIRR for project R?________%(Round to two decimal places.)

What is the IRR for project S?_________%(Round to two decimal places.)

What is the MIRR for project S?________% (Round to two decimal places.)

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Baker Industries’ net income is $26000, its interest expense is $4000, and its tax rate is 35%. Its notes payable equals $24000, long-term debt equals $75000, and common equity equals $255000. The firm finances with only debt and common equity, so it has no preferred stock.

What are the firm’s ROE and ROIC? Round your answers to two decimal places. Do not round intermediate calculations.

ROE and ROIC | |

Net income | $26,000 |

Interest expense | $4,000 |

Tax rate | 35.00% |

Notes payable | $24,000 |

Long-term debt | $75,000 |

Common equity | $255,000 |

ROE | |

Partial Income Statement: | |

EBIT | |

Interest | $4,000.00 |

EBT | |

Taxes | |

Net income | $26,000.00 |

Capital Summary: | |

Notes payable | $24,000.00 |

Long-term debt | $75,000.00 |

Common equity | $255,000.00 |

Total invested capital | |

ROIC |

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