1. A Canada-based investor buys shares of T0ronto-Dominion Bank (TO) for C$72.08
ID: 2810239 • Letter: 1
Question
1. A Canada-based investor buys shares of T0ronto-Dominion Bank (TO) for C$72.08 on 15 October 2007 with the intent of holding them for a year. The dividend rate was C$2.11 per year. The investor actually sells the shares on 5 November 2007 for C$69.52.
The investor notes the following additional factors:
• No dividends were paid between 15 October and 5 November.
• The required return on TO equity was 8.7% on an annual basis and 0.161% on a weekly basis.
a. State the lengths of the expected and actual holding-periods.
b. Given that TO was fairly priced, calculate the price appreciation return (capital gains yield) anticipated by the investor given his initial expectations and initial expected holding period.
c. Calculate the investor’s realized return.
d. Calculate the realized alpha.
2. The estimated factor sensitivities of TerraNova Energy to Fama-French factors and the risk premia associated with those factors are given in the table below: Factor sensitivity & Risk premium (%) consequently.
Market factor 1.20 & 4.5
Size factor -0.50 & 2.7
Value factor -0.15 & 4.3
a. Based on the Fama-French model, calculate the required return for TerraNova Energy using these estimates. Assume that the Treasury bill rate is 4.7%.
b. Describe the expected style characteristics of TerraNova based on its factor sensitivities.
Explanation / Answer
1a. Expected holding period= 1 year =365 days
Actual holding period = 5 November 2007 – 15 october 2007 = 21 days
b. Let initial price = Po
Closing price =P1
Dividiends = D
Holding period return =((P1-P0)+D)/Po
P1= Po*1.087
D=2.11
HPR= ((0.087*72.08)+2.11)/72.08 =11.63%
c.D=0 as no dividends paid during that period.
Holding period return =((P1-P0)+D)/Po = (69.52-72.08)/72.08 =-3.55%
d.Realised alpha = Realised return – asset return = -3.55%-0.161*3 = -5.18%
2. a.
Ri = Rf + market beta x (RM-RF )+ size beta x SMB + value beta x HML
= 4.7%+ 1.20(4.5-4.7) %+ (0.5)(2.7) +0.15*4.3 =6.45%
b.Bsml is 0.5. This shows that the stock is predominantly small cap and it will have high returns if small cap firms perform better than large cap.
Bhml =0.15. This shows that high book value compared to market value. It will have high returns if these stocks outperform.
Market beta =1.2 means that the stock is more volatile than the market
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.