FIN 341 | Homework #1

This homework assignment is worth a total of 50 points.

1) Using excel and the internet, collect the daily price data for the Nasdaq Composite Index from
Feb 5, 1971 to Jan 12, 2017 (inclusive) and calculate the following:
a. The average return over the period
b. The variance over the period
c. The standard deviation over the period
Please provide your excel with working formulas (10 pts).
Answer:
a.). The average return over the period = 1367.367
b.). The variance over the period = 1921788.720
c.). The standard deviation over the period = 1386.286
An excel workbook with all the workings is attached.

2) Price out a bond with the following characteristics

 12 year maturity
 7.5% coupon bond
 3% risk free rate
 2.4% credit spread
 $100 face value
Please show your work in excel. If the bond is being offered initially for $100, should you buy it
based on your calculation (6 points)?
Answer:
The bonds price = $118.2
Based on my calculation, I should purchase the bond since I will be able to resell the bond at a higher
price of $118.2 than the offered price of $100, making a profit of $18.2 per bond.
Calculations are displayed in the attached excel workbook.
3) You are offered a chance to buy a perpetuity that will pay $65 dollars a year. The prevailing
borrowing rate is 12%. What would you be willing to pay for the perpetuity? Show your work
(3 pts).
Answer:
PMT
PV of perpetuity =
r
Where:
 FIN 341 | Homework #1

PMT = Amount of continuous payments = $65

r = Interest rate of borrowing = 12%, or 0.12
65
PV of perpetuity =
0.12
= $541.6667
You will be willing to pay $541.67 for the perpetuity.

4) Calculate the value of a 30 year annuity that pays you $10 with a prevailing borrow rate of
6.2%. Please show your work (3 pts).
Answer:

Present value of annuity = P ¿

Where:
P = Periodic payments = $10
r = Rate of interest = 6.2% or 0.062
n = Number of periods = 30 years

1−( 1+0.062 )−3 ⁰

Present value of annuity = 10( )
0.062

1−( 1 .062 )−3 ⁰ 1−0.164537 0.835463

PVA = 10( ) = 10( ) = 10( ) = 10(13.4752) = $134.752
0.062 0.062 0.062

The value of annuity = $134.75

5) Using some financial resource, find an option chain for a public equity with a market
capitalization greater than USD 1 billion. Choose one of those options and take a screen shot.
Tell me the following details (5 pts):
a. Expiration date
b. Strike price
c. Type of option
d. Current Bid/Offer
Answer:
The option chain chosen is for Apple Inc. company, with a market capitalization of $2.233
Trillion. The details of the option chain are as follows:
a.). Expiration date – 16/04/2021
b.). Strike price - $55
c.). Type of option – Call option (Contract name: AAPL210416C00055000
 FIN 341 | Homework #1

d.). Current Bid/Offer – Current Bid price = $77.65, current Offer price = $78.30

The screenshot with the details is attached.

6) A portfolio manager makes a decision to buy 5,000 shares of Sumatra Natural Resources at
10:00 a.m, when the price was 22.36. The following are snapshots of the trades made during
that time.
Time Bid Price Ask Price Execution Price Shares Bought
10:30 22.18 22.36 22.33 900
11:15 22.23 22.43 22.43 600
13:45 22.29 22.48 22.47 700
15:00 22.37 22.63 22.65 800
The closing price for the day was the portfolio manager's last trade at 22.65, at which point the
order for the remaining 2,000 shares was cancelled. Calculate the following:

What is the average effective spread (Hint: you know how to calculate all the individual
spreads) (4 pts):

Answer:

Time Bid Price Ask Executio Mid-price Bid-Ask Spread

Price n Price
10:30 22.18 22.36 22.33 (22.18+22.36)/2 = 22.36 – 22.18 = 0.18
22.27
11.15 22.23 22.43 22.43 (22.23+22.43)/2 = 22.43 – 22.23 = 0.20
22.33
13:45 22.29 22.48 22.47 (22.29+22.48)/2 = 22.48 – 22.29 = 0.19
22.385
15:00 22.37 22.63 22.65 (22.37+22.63)/2 = 22.63 – 22.37 = 0.26
22.50

Effective spread = 2* (Execution price – Mid-price)

The average effective spread = ∑ (Execution price – Mid-price)*2 / Number of trades

= ((22.33 – 22.27) + (22.43 – 22.33) + (22.47 – 22.385) + (22.65 – 22.50))*2 / 4

= (0.06 + 0.10 + 0.085 + 0.15)*2 / 4
= (0.395*2) / 4
= 0.79 / 4
= 0.1975
 FIN 341 | Homework #1

The average effective spread = 0.1975

7) Using the same data from question (6) assume that the trades listed are the only ones executed
that day in Sumatra. What is the VWAP? (2 pts)
Answer:
The Volume Weighted Average Price (VWAP) is the weighted average of stock price over a specified
period of time.
VWAP = ∑ (Number of shares purchased x Price of the shares) / Volume of shares purchased
VWAP = ((900*22.33) + (600*22.43) + (700*22.47) + (800*22.65) / 3000
= (20097 + 13458 + 15729 + 18120) / 3000
= 67404 / 3000
= 22.468
VWAP = 22.468

8) In a brief paragraph, describe the process of short selling in your own words (10 points).
Answer:
Short selling refers to a technique of selling borrowed securities or assets such as stocks hoping
that their value will decrease and close the trade for a profit. The aim of individuals in employing this
strategy is to be able to profit from a decline in stock prices rather than their increases. Short selling can
be used for both speculation or hedging. Speculators utilize short selling to take advantage of a possible
decline in prices of a particular security to make profits by closing the trade. In contrast, hedgers use it to
protect their earnings or alleviate losses in a specific security or portfolio.
The process of short selling involves a three-step process, which includes the following steps :
 FIN 341 | Homework #1

1. The first step involves borrowing stocks or shares of a particular security, generally from a
broker. When an individual, let's say, Benson, believes that a specific stock price will fall in the
near future, he looks for a willing broker to lend him some stock for a short sale.
2. The second step involves selling the stocks or shares borrowed from the broker immediately at
the current prevailing market price. Benson then sale the stocks at their current price and receives
a cash inflow from the sales proceeds.
3. The third step involves repurchasing the stocks or shares at the predicted lower price and
refunding them to the broker you borrowed them from. The repurchase will result in profit since
you would have purchased the stocks at a lower price than the higher price you sold at, which you
will pocket. Note that, should the stock price go up, Benson will incur a loss from the stock
repurchase.

9) Besides an IPO, what are potential alternatives for a private company to raise capital?
Describe one method in detail and why would a company choose an IPO over this method (6
points)?
Answer:
Besides employing an IPO for a private company to raise capital is debt financing or debt capital.
This occurs when the private company borrows funds from a bank and agrees to pay them back to the
bank with interest at a future date. Another form of debt capital private companies use is the issue of
corporate bonds. It involves selling the bonds to investors or bondholders, and they tend to mature after a
specific period. Similarly, interest payments on the bond are made by the private company. The company
then uses these loans and bonds as capital injections to finance their expansion plans or new projects
being undertaken.
A company would select an IPO over debt financing because of the numerous benefits it receives.
These include the following:
 An IPO allows the company to make use of an extensive pool of possible investors to get enough
capital for future growth, working capital, and debt repayment, if any.
 An IPO enables cheaper access to capital, including the fact that the acquired capital is not
required to be paid back to its public investors.
 It allows a company to expand and diversify its equity base.
 It permits the company to enhance its reputation through increased prestige and public image.
 FIN 341 | Homework #1

References
COMP | NASDAQ composite index historical prices - WSJ. (2021). The Wall Street Journal - Breaking
News, Business, Financial & Economic News, World News and
Video. https://www.wsj.com/market-data/quotes/index/COMP/historical-prices
11. The mechanics of short selling. (2015). Short Selling, 209-220. https://doi.org/10.7312/kuma17224-
012
Latham, S., & Braun, M. R. (2010). undefined. British Journal of Management, 21(3), 666-
683. https://doi.org/10.1111/j.1467-8551.2010.00707.x
Types of debt financing. (2015). The Complete CFO Handbook, 63-
97. https://doi.org/10.1002/9781119198055.ch3
AAPL210416C00055000 (AAPL210416C00055000) stock price, news, quote & history. (2021). Yahoo
Finance - Stock Market Live, Quotes, Business & Finance
News. https://finance.yahoo.com/quote/AAPL210416C00055000?p=AAPL210416C00055000