Mike and Sarah are evaluating two funds in which to invest. Fund A had a 17% compound annual return with 17% annual volatility, while fund B had a...

1. Mike and Sarah are evaluating two funds in which to invest. Fund A had a 17% compound annual return with 17% annual volatility, while fund B had a 14% compound annual return with 7% volatility. Why might some investors choose to invest in the lower returning Fund B. Assume the risk free rate was 2% during this period, calculate a financial ratio for both funds and show why fund B on this ratio looks more attractive. What is the name of the ratio you would use to justify your recommendation?

2. Mike and Sarah decide to look at investing in a hedge fund. One fund, called the Hot Shot fund, returned 10% after fees running its portfolio with an average beta delta adjusted net portfolio long position of 90%. The other fund, called Steady Eddy, returned 7% after fees with an average net beta delta adjusted portfolio long position of 50%. The index returned 10%. What financial concept can you use to show that the funds added value that year and which fund fares the best on this metric? Show your calculations.

3. Mike proposes to Sarah to put a small portion of their domestic stock portfolio in a basket of frontier markets stocks. The frontier markets universe has been a poor performer underperforming US/developed markets in recent years. What are two principal/potential benefits of investing in frontier markets equities for their domestic fund? What are two major risks created by adding frontier markets equities? Which risk can they hedge and how? Should they hedge this risk?

4. Mike and Sarah consult with a colleague at their firm. He argues that one of the main benefits of international investing has diminished due to globalization. Explain what this benefit is and why it has diminished with globalization of financial markets? What attribute do certain foreign markets have that might help offset globalization?

5. Mike and Sarahâs colleague says he only invests in the US. What is the academic term for the bias he is guilty of? What are some of the reasons for this bias?

6. Mike and Sarah are concerned about rising rates thinking rates eventually have to go up? Should they choose a long duration or short duration bond? Mike and Sarah are looking at two bonds a 10 year zero coupon bond and a 30 year zero coupon bond? What is the duration of these two bonds? Which one should they buy to mitigate the risk of rising rates?

7. Their colleague believes interest rates are going to fall. He is looking at a 10 year maturity bond paying a 4% coupon annually, a 10 year zero paying a yield to maturity of 4%, and a five year zero paying a yield to maturity of 4%. Which should he buy to play falling future interest rates?

8. What has the correlation of the ten year treasury been with the S&P 500 returns the last two years? What has been the advantage of holding part of the portfolio in 10 year treasury bonds over holding more cash during periods of market turmoil in recent years? Why hold cash at all, even if one is defensive, and instead just hold more treasuries instead?

9. An elderly, middle income couple come to a financial adviser looking to trade options. The old man says he wants to write puts on blue chips stocks and collect fat premiums just like the great one Warren Buffet. What is the risk in this practice? Should the advisor recommend against this? What is this practice akin to? What are two negatives associated with trading options? What is the major advantage of options? Suggest a defensive options strategy that would make sense for an elderly couple looking to boost portfolio income to undertake?

10. Mike loves Valeant stock. He reads the most recent press release and exclaims that it is a buy since â they always beat the bottom line numbers.â He notes that a prestigious hedge fund just announced it bought stock. Sarah argues that Mike overlooks the negatives. He reads the press release and focuses on the positives and ignores the large cash items that are removed from earnings. Mike exclaims that VRX at below $125 is a buy since last year a prominent analyst told him that exact number. What two behavioral biases is Mike making? Explain. Mike doesnât like to sell stocks where he has lost big money and realize a loss. What is the name of this behavioral bias? Sarah on the other hand tends to run with the pack of smart money investors. This tendency is called what in behavioral finance?

11. Calculate the WACC and discounted cash flow valuation of the firm, using a firm that has 100 mm in debt and 100 mm in market cap with a beta of 1.5, risk free rate of 3%, equity market risk premium of 6%, and tax rate of 30%, and cost of debt of 5%. Assume three years of unlevered cash flows of 6, 8, 9 and then a steady state growth of 3%.

12. Calculate the enterprise value of a firm with 100 mm in debt, mcap of 200, and 25 mm in cash?

13. Explain two drawbacks of discounted cash flows valuations?

14. Would you value a bank stock using a traditional DCF? Explain. How would you value a bank stock? Discuss two critical ratios and one other methodology to value a bank or financial stock.

15. Mike says he has developed a strategy, which calls for buying stocks that have just announced huge quarterly earnings surprises and hold them for the next several months. What is the academic name of this trading strategy?

16. Sarah likes to buy stocks that are trading two standard deviations cheap on price earnings relative to five year averages. This strategy is based on what key concept? Is it a GARP, value or momentum based strategy?

17. Mike and Sarah want to compare the profitability of some technology, industrial and other companies from sectors outside of the banking industry? What metric would you use?

18. Mike and Sarah want to reduce the market risk of their portfolio but stay 100% invested in their current long stock positions? What could they do to accomplish this goal?

19. You are brought in as a consultant to a company. You calculate its WACC to be 9%. Its operating profit is 8 million, tax rate is 33%, total assets are 105 mm, cash is 5mm and noninterest bearing liabilities are 0. If you present to the CEO would you say current profitability is satisfactory? Why not? Show with a ratio?

20. What are two metrics to value cyclical stocks that are losing money on the bottom line? What are the pros and cons of these metrics?

21. You are working at a large pension fund. The CIO tells you that there will be a strong deflationary pulse in the US and global economy. The CIO asks you to pick two investments from the following choices: 2 year treasury bonds, 30 year treasury bonds, high yield bonds, gold etf, emerging markets equities ETF, a commodity etf, or a short S&P 500 fund. You also have the choice of etfs for equities from the following S&P 500 sectors energy, financials, staples, industrials, utilities, technology, timber reits, steel stocks, mining stocks and agricultural service stocks. Justify your two picks for allocation.

22. Next the CIO alters the forecast and says to expect a huge surge in global growth. Which two investments from the same list would you recommend and why?

23. The CIO calls for stagflation or high inflation with low growth. Which two investments would you pick and why?

24. You notice that the yield curve has started to flatten. Which investment from the prior list would you pick based on this signal? Justify your response.