Question

In: Finance

Question 1 Alex is a young investor with high risk tolerance level and hopes to earn...

Question 1

Alex is a young investor with high risk tolerance level and hopes to earn money as fast as he can. Analyse each of the following plans and evaluate which is the most suitable plan for Alex.

(1) Dollar-cost averaging
(2) Constant-dollar plan
(3) Constant-ratio plan
(4) Variable-ratio plan

Question 2

An investor estimates that next year’s net income for Hilary Pullman Hotel would be RM 8 million. The company has 0.5 million shares outstanding and decided to pay RM 0.5 million to the preferred stockholders from its net income. Listed companies similar to Hilary Pullman Hotel have been recently reported to have an average price/earnings ratio of 4 times. Given the information, calculate the expected price of the stock and evaluate the problems in using Price/earnings ratio method of valuing the shares of a company.

Question 3

Two securities – PohKeong Gold and Mama Care are currently being considered by Jason. He is considering either to invest 100% in PohKeong Gold or building a portfolio that consist of both security – 60% in PohKeong Gold and 40% in Mama Care. The probability distribution of expected returns of these assets are shown in the following table.


State of Economy Probability Return on PohKeong Gold Return on Mama Care
Bear 0.30 3% 2%
Bull 0.70 18% 10%

(i) Calculate the expected return for each of the two alternatives.
(ii) Calculate the standard deviation of returns of the two alternatives.
(iii) Evaluate the investors decisions, based on the above calculations

Question 4

Given the following situations, evaluate in each scenario whether the hypothesis of an efficient capital market of semi-strong form is violated.

(i) Through the introduction of an advanced webinar into the analysis of the past share price movements, a brokerage firm is able to predict price movements are able to earn consistent 1% profit more than normal market returns after adjusted for risk.

(ii) On average, investors in the stock market this year are expected to earn a positive return on their investment. Some investors will earn considerably more than others.

(iii) You have discovered that the square root of any given stock price multiplied by the day of the month provides an indication of the direction in price movement of that particular stock with a probability of 20%.

Solutions

Expert Solution

1.  (2) Constant-dollar plan would be most suitable for Alex.
(1) Dollar-cost averaging is an investment strategy in which an investor invests a total sum of money by dividing the total money across periodic purchases of a target asset so as to reduce the impact of volatility on the overall purchase. This is not suitable for high risk tolerant investors.

(2) Constant-dollar plan is an investment strategy for investing in which a constant dollar amount is kept in stocks, with other investments in bonds or short-term securities. In effect, this plan forces the investor to sell stocks in rising markets and purchase them in falling markets. This is suitable for high risk tolerant investors.

(3) A constant ratio plan is an investment strategy, which keeps the aggressive (high risk) and conservative portions (low risk) of a portfolio set at a fixed ratio. These are also not for high risk tolerant investors.

(4) The variable-ratio plan is an investment strategy which uses a variable proportion of risky investments to safer investments, such that when the prices of the risky securities are low, more money is invested in them, but when they are high, they are sold, placing the proceeds in conservative investments. These are also not for high risk tolerant investors.

I can only answer 1 question at a time, so I am solving question 1 only.
Please do rate me and mention doubts, if any, in the comments section.


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