Advanced Corporate Finance
Practice Problem 1
1
3-16. An Exchange-Traded Fund (ETF) is a security that represents a portfolio of individual
stocks. Consider an ETF for which each share represents a portfolio of two shares of
Hewlett-Packard (HPQ), one share of Sears (SHLD), and three shares of General Electric
(GE). Suppose the current stock prices of each individual stock are as shown here:
a. What is the price per share of the ETF in a normal market?
b. If the ETF currently trades for $120, what arbitrage opportunity is available? What
trades would you make?
c. If the ETF currently trades for $150, what arbitrage opportunity is available? What
trades would you make?
Advanced Corporate Finance
Practice Problem 1
2
3-17. Consider two securities that pay risk-free cash flows over the next two years and that have
the current market prices shown here:
a. What is the no-arbitrage price of a security that pays cash flows of $100 in one year
and $100 in two years?
b. What is the no-arbitrage price of a security that pays cash flows of $100 in one year
and $500 in two years?
c. Suppose a security with cash flows of $50 in one year and $100 in two years is trading
for a price of $130. What arbitrage opportunity is available?
Advanced Corporate Finance
Practice Problem 1
3
6-2. Assume that a bond will make payments every six months as shown on the following
timeline (using six-month periods):
a. What is the maturity of the bond (in years)?
b. What is the coupon rate (in percent)?
c. What is the face value?
d. What’s the price of the bond if the discount rate (stated as an APR with semiannual
compounding) is 5%? Use Annuity formula.
e. What’s the price of the bond if the discount rate (stated as an APR with semiannual
compounding) is 5%? Use Excel Spreadsheet function “PV.”
f. Now assume the price of the bond is $900, what is the annualized discount rate? Use
Excel Spreadsheet function “Rate.”
Advanced Corporate Finance
Practice Problem 1
4
9-2. Anle Corporation has a current price of $20, is expected to pay a dividend of $1 in one
year, and its expected price right after paying that dividend is $22.
a. What is Anle’s expected dividend yield?
b. What is Anle’s expected capital gain rate?
c. What is Anle’s equity cost of capital?
Advanced Corporate Finance
Practice Problem 1
5
9-3. Suppose Acap Corporation will pay a dividend of $2.80 per share at the end of this year
and $3 per share next year. You expect Acap’s stock price to be $52 in two years. If Acap’s
equity cost of capital is 10%:
a. What price would you be willing to pay for a share of Acap stock today, if you planned
to hold the stock for two years?
b. Suppose instead you plan to hold the stock for one year. What price would you expect
to be able to sell a share of Acap stock for in one year?
c. Given your answer in part (b), what price would you be willing to pay for a share of
Acap stock today, if you planned to hold the stock for one year? How does this compare
to your answer in part (a)?
Advanced Corporate Finance
Practice Problem 1
6
9-4. Krell Industries has a share price of $22 today. If Krell is expected to pay a dividend of
$0.88 this year, and its stock price is expected to grow to $23.54 at the end of the year,
what is Krell’s dividend yield and equity cost of capital?
Advanced Corporate Finance
Practice Problem 1
7
Formula Sheet
Present Value of Cash Flows
Present Value of Annuity
Present Value of Perpetuity
Present Value of Growing Perpetuity
∑= + = ×
T
t
t t r
NPV CF
0 (1 )
1
—–
Problem 1 in Advanced Corporate Finance Practice
1
3-16. An ETF (Exchange-Traded Fund) is an investment that represents a portfolio of individual securities.
stocks. Consider an ETF in which each share represents a portfolio of two shares of a company.
Hewlett-Packard (HPQ), Sears (SHLD), and three General Electric shares
(GE). Assume the current stock prices for each individual stock are as follows:
a. What is the ETF’s share price in a regular market?
b. What arbitrage opportunity exists if the ETF is now trading at $120? What
Which trades would you make?
c. What arbitrage opportunity exists if the ETF is now trading at $150? What
Which trades would you make?
Corporate Finance Advanced
Problem 1: Practice
2
3-17. Take a look at two securities.
