Use this information to answer the following three questions. AES Corporation an

Question

Use this information to answer the following three questions. AES Corporation and WEC are both public utility companies. A hedge fund manager believes that AES stock is cheap relative to is expected performance and WEC is over-priced relative to its expected performance. She has no view about what the stock market will do in general so she decides to take a hedged position in the amount of $10,000,000. Question 15 (1 point) D In order to invest in her view that AES is likely to increase in price relative to WEC she should. A) Buy $10,000,000 worth if AES and $10.000.000 of WEC. B) Borrow and sell AES and buy WEC.

Explanation / Answer

Answer is D

WES is over priced so he should sell those shares and AES is under priced, so he should by those shares

16

9% return is coming from AES since he has bought those shares

but 7% loss is coming from WES since he has borrowed those shares and sold. He has to buy at higher price to return those

So effectively, he is earning 2% on the portfolio (ignoring all other costs)

So Profit = 10,000,000 * 0.02 = 200,000

17

9% loss is coming from AES since he has bought those shares and price have dropped

but 12% profit is coming from WES since he has borrowed those shares and sold. He can buy those shares at cheap rate now and deliver back

So effectively, he is earning 3% on the portfolio (ignoring all other costs)

So Profit = 10,000,000 * 0.03 = 300,000

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