Capital Market Line

Explain the creation of the set of risky portfolios and the Capital Market Line. Explain that if the line slopes upwards there will be no demand for risk free asset since shareholders see no premia in the riskless asset. The price of the riskless asset would have to fall and its rate rise until the Capital Market Line is horizontal before the market equilibria can be restored.

QUESTION 2

Explain reasons for Risk Management: Costs of Management, Information Asymetries, Tax Breaks, Costs of Financial Distress. The main advantage for shareholders are diversification by shareholding which is cheaper in general than M&A.

QUESTION 3

3a. Share Y is 15.364, Share Z 11.908

b. Return on Z needs to rise so its price needs to fall.

c. 7.3

d. Problems with CAPM single source of systematic risk and tends to empirically overestimate risk premia. Strength simple to calculate. APT more theoretically sound but no specified sources of systematic risk and econometrically more difficult to implement.

QUESTION 4

Outline how firms can use Present Value and Economic Rent to generate Shareholder Value.

QUESTION 5

Outline the nature of tax breaks perhaps in a Miller 1977 framework and how in most developed societies these will be positive and suggest the highest levels of gearing possible. Then consider the problems related to funding and financial distress and how these differ between enterprises and put different levels of limitations on gearing. They appear to give a sensible theory of gearing.

QUESTION