Advanced Financial Theory and Practice Final Summer 2026 Question Paper

Points: 40 Time: Two (02) Hours Group A: Q. 1. Describe 'costs of bankruptcy', 'effect of bankruptcy costs', and 'incentive signaling approach' related to capital structure. CL01 0 L02 5 Q.2. Explain the uses of Y = MX + C_in finance. Distinguish between capital allocation line (CAL) and capital market line (CML). CLO1 0 L02 5 Q.3. "Dividend changes may communicate information about future performance" demonstrate the statement by putting the required arguments. CLO1 0 L02 5 Group B: Q. 4. Consider the following information: CLO2 0 L03 5 Asset X: E(R) = 12%, SD = 20% Asset Y: E(R) = 8%, SD = 15% Correlation, xy = 0.30 Compute the percentage investment needed in X and Y for minimum risk. Also, compute the variance for the minimum variance portfolio. Q. 5. A company has 200,000 outstanding shares selling at $50 each. Net CLO3 0 profit is $2,000,000, planned investment is $4,000,000, the cost of equity L05 5 is 10%, and the proposed dividend is $15 per share. Estimate the number of new shares needed to be issued to preserve the investment program when (i) dividend is paid and (ii) when dividend is not paid. Group C: Q. 6. Suppose you are working as a financial consultant for a company. CLO3 1 Information provided in the following tables is available for you. The L05 5 first table reports the subjectively estimated returns on three securities A, B, and C; and the changes in the two factors δ₁, and δ₂, for five equally likely states of nature. On the other hand, the second table includes the expectations of each security and transformed factor. It also includes a few of the factor loadings/sensitivities. After computing the missing information in the second table, evaluate the possible arbitrage opportunity by using the market equilibrium rate of return prescribed by the Arbitrage Pricing Theory (APT) and accordingly advise your client. Assume that the risk-free rate is 10%. | State of Nature | Prob. | Securities' Returns (%) A | Securities' Returns (%) B | Securities' Returns (%) C | Factor Changes δ₁ | Factor Changes δ₂ | | :-------------- | :---- | :------------------------ | :------------------------ | :------------------------ | :---------------- | :---------------- | | Horrid | 0.20 | 53.00 | 623.99 | (55.23) | (10.00) | (5.00) | | Bad | 0.20 | 413.37 | 10.00 | 70.70 | (5.00) | 38.48 | | Average | 0.20 | (1493.12) | 25.00 | (9.00) | 25.00 | 8.00 | | Good | 0.20 | 1058.75 | (3771.42) | (12.47) | 40.00 | (1.44) | | Excellent | 0.20 | 83.00 | 3237.44 | 61.00 | 50.00 | 0.00 | | Securities | R, (in %) | Factor Loadings b₁ᵢ | Factor Loadings b₂ᵢ | Factor Expectations (in %) | | :--------- | :-------- | :------------------ | :------------------ | :------------------------- | | A | 23 | 0.50 | 2.00 | δ₁ = 20.00 | | B | 25 | 1.00 | ? | δ₂=8.00 | | C | 11 | 1.50 | 1.00 | |