Instituto Superior de Economia e Gestão
Gestão Financeira II
Ano letivo 2019/2020
Problem Set 1
Realizado por:
Inês Carreira Paulo (nº50388)
Maria Leonor Borges (nº48928)
Maria Margarida Areia (nº50673)
Maria João Rodrigues (nº50711)
1) True or false (explain up to 6 lines)
a. In efficient markets, the expected return on each stock can be different.
True. Companies stocks have different market risk levels; therefore, they will also have
different levels of return. It is easy to understand this when comparing the risk of a waste
management company and a company in the Real Estate industry, the first one has lower risk
and less volatility of the net income and cash flows, then the second one.
b. Most financial asset managers tend to be pessimist.
False. Most financial asset managers tend to be optimistic because they believe that market
values tend to become better (due to the systematic bias), so they increase dividends when
they believe that the market value will not decrease.
c. The semi strong form of the efficient market hypothesis states that stock prices reflect all
publicly available information.
True. An efficient market in the semi strong form will be a market in which prices adjust
immediately, not only to the information contained in past prices, but also to all other
information in the public domain.
d. Tomorrow, the company XYZ announce its earnings. If the earnings are under market
expectations, the stock price will decrease.
True. If the company results are lower than what the market was expecting, the stock price will
decrease.
e. An example of good governance is when managers of a listed company make transactions
in company’s shares two weeks prior to the announcement of quarterly results.
False. If managers make transactions before the announcement of the company results, they
will be doing so based on information that is not yet public. This creates market inefficiency
(markets will not be in their strong form), since there will be the possibility of manipulation of
the stock price due to privileged private information.
f. A fund manager may hold, buy and sold units of the fund at any time, because this does
not affect good governance.
False. This will oppose a good governance situation, since a manager should not have
investments (hold) and make transactions (buy and sell) in a financial instrument that he
manages.
2) Suppose you were asked to analyze the stock market. You calculated the following
betas and alphas (in percent per month) regarding three stocks based on monthly
returns from January 2015 to December 2019:
Stock Alpha Beta
A 0.25% 1.15
B -0.20% 0.80
C 0.30% 1.30
a. How well did these stocks perform in the period?
Assuming that the market return is the same, and knowing that alpha represents how
much on average the stock price changed when the market index was unchanged, and
that beta measures how much extra the stock price moved for each 1% change on the
market index.
In this period, the stock with the best performance was stock C, due to its positive
return and higher alpha indicator value, comparing with the other 2 stocks. We can
confirm this statement in the next question, because by calculating the Abnormal
Returns of all the stocks, we can see that stock C has the higher value again.
b. Based in the market model, what was the abnormal returns for January 2020,
when the market returned 2%, stock A returned 3%, stock B returned 0,5% and stock
C returned 4%?
Abnormal Return = Actual stock return – expected stock return= Ri - [alpha + beta*Rm]
Market Return --> Rm = 2%
Return A --> Ra = 3%
Return B --> Rb = 0,5%
Return C --> Rc = 4%
Abnormal Return (A) = 3% - [0,25% + 1.15*2%] = 0,45%
Abnormal Return (B) = 0,5% - [-0,20% + 0,80*2%] = -0,9%
Abnormal Return (C) = 4% - [0,30% + 1.30*2%] = 1.1%
As we can verify and confirm a), the stock that had the best performance was C, with
the highest actual stock return and the highest expected stock return which means the
highest abnormal return.
3) The company XPTO has been paying a regular cash dividend of 1 € per share each
year for a long time. The payout is 100% and the management doesn’t expect to
grow. The number of shares outstanding is 1.000.000 and the stock market price is
5€ per share. The company has cash to pay the next annual dividend. However, the
management decides to cut its cash dividend to zero and announces a share’s
buyback program.
a. Suppose that you ignore taxes and assume that the share’s buyback program
conveys no information about operating performance and business risk. What is the
immediate reaction from investors and the stock price?
Since the question states that we are ignoring the taxes and assuming that the share’s
buyback program conveys no information about operating performance and business
risk, we can assume there won’t be any extra risk by changing policies. So, the
company’s announcement has no impact on the investors, and nothing justifies a
change in the stock market price. It will stay the same, 5€ per share.
b. How many shares the company purchase?
To calculate how many shares the company will repurchase, we need to calculate the
amount of many the company is spending on dividends: 1.000.000 shares × 1€ =
1.000.000€.
Since the company changed its policy, now we know that the company will use the
same 1.000.00€ in the new share’s buyback program. So, the number of shares XPTO
will repurchase is: 1.000.000€ ÷ 5€ = 200.000 shares.
c. For the old and the new policies, compare future stock prices for the next 3 years.
For the old policy, the dividend’s policy, we know the company has been paying a
regular cash dividend of 1€ per share. As calculated before, it means that they have
1.000.000€ in cash to use. And the stock market price will remain at 5€ per share for
the next 3 years, due to the fact that the dividends themselves do not affect directly
the stock price.
For the new policy:
Year 0
#Shares outstanding = 1.000.000 shares
Shares purchased = 200.000 shares
Value = 1.000.000 shares * 5€ = 5.000.000€
Stock market price = 5€
Year 1
#Shares outstanding = 1.000.000 - 200.000 = 800.000 shares
Stock market price = 5.000.000 ÷ 800.000 = 6.25€
Shares purchased = 1.000.000 ÷ 6.25€ = 160.000 shares
Value = 800.000 shares * 6.25€ = 5.000.000€
Year 2
#Shares outstanding = 800.000 - 160.000 = 640.000 shares
Stock market price = 5.000.000 ÷ 640.000 = 7.81€
Shares purchased = 1.000.000 ÷ 7.81€ = 128.000 shares
Value = 640.000 shares * 7.81€ = 5.000.000€
Year 3
#Shares outstanding = 640.000 - 128.000 = 512.000 shares
Stock market price = 5.000.000 ÷ 512.000 = 9.77€
Shares purchased = 1.000.000 ÷ 9.77€ = 102.400 shares
Value = 512.000 shares * 9.77€ = 5.000.000€
As we repurchased the shares, there are less shares outstanding. So, having in mind
that every year there are 1.000.000€ available in cash to repurchase the shares, the
stock market price will increase. Although this, the value of the company will remain
the same over the 3 years, 5.000.000€.
