Question: What effect would reducing income tax rates

> Management has recently announced that expected dividends for the next three years will be as follows The firm’s assets will then be liquidated and the proceeds invested in the preferred stock of other firms so that the company will be

> Management has recently announced that expected dividends for the next three years will be as follows For the subsequent years, management expects the dividend to grow at 5 percent annually. If the risk-free rate is 4.3 percent, the return on the market

> Why do the supporters of behavioral finance suggest that emotions lead to inferior investment decisions?

> The required return on an investment is 10 percent. You estimate that firm X’s dividends will grow as follows: For the subsequent years you expect the dividend to grow but at the modest rate of 4 percent annually. What is the maximum p

> You are offered two stocks. The beta of A is 1.4 while the beta of B is 0.8. The growth rates of earnings and dividends are 10 percent and 5 percent, respectively. The dividend yields are 5 percent and 7 percent, respectively. a) Since A offers higher po

> You are considering two stocks. Both pay a dividend of $1, but the beta coefficient of A is 1.5 while the beta coefficient of B is 0.7. Your required return is k = 8% + (15% 2 8%) b. a) What is the required return for each stock? b) If A is selling for $

> A firm’s stock earns $2 per share, and the firm distributes 40 percent of its earnings as cash dividends. Its dividends grow annually at 4 percent. a) What is the stock’s price if the required return is 8 percent? b) The firm borrows funds and, as a resu

> An investor requires a return of 12 percent on risky securities. A stock sells for $25, it pays a dividend of $1, and the dividends compound annually at 7 percent. Will this investor find the stock attractive? What is the maximum amount that this investo

> Amanda Monaco has just inherited her father’s company. Prior to his death, Mr. Monaco was the sole stockholder, and he left the entire company to his only daughter. Although Amanda has worked for the firm for many years as a commercial

> Ken Saffaf’s 22-year-old daughter Bozena has just accepted a job with Doctor Medical Systems (DMS), a firm specializing in computer services for doctors. DMS offers employees a 401(k) plan to which employees may contribute 5 percent of

> The following correlation matrix gives the correlation coefficients for several sectors within the S&P 500. What can you conclude concerning investing in the sectors to diversify a portfolio? Health Consumer Staples Financials Care Utilitles Con

> You make an investment and the annual returns are as follows: The average annual return is 3 percent. What is the true annualized return? Year Return 1 25% 2 3 3 -18 4 -10 5 15

> In October 2009, Ares Capital Corporation (ARCC) announced that it was acquiring Allied Capital (ALD). The terms of the acquisition specified that one share of ALD would become 0.325 share of ARCC. Prior to the announcement, the closing daily prices of t

> What are several human traits that tend to affect investment decisions?

> Currently a stock index stands at 100 and the leveraged ETF is selling for $100. The ETF should generate a return that is twice the daily return on the index. Over the next 21 days the value of the index and its daily percentage change are as follows: W

> The portfolio manager of a hedge fund believes that stock A is undervalued and stock B is overvalued. Currently their prices are $30 and $30, respectively. The portfolio manager of the fund buys 100 shares of A and sells 100 shares of B short. a) Why doe

> REITs pay dividends in order to retain their favorable tax status. As the next chapter on stock explains, corporate dividends are made from earnings. REIT dividends often are not made from earnings but the distributions are made from funds from operation

> You purchase a REIT for $50. It distributes $3 consisting of $1 in income, $0.50 in long-term capital gains, $0.30 in short-term capital gains, and $1.20 in return of capital. After a year, you sell the stock for $56. If you are in the 30 percent income

> a) A closed-end investment company is currently selling for $10 and its net asset value is $10.63. You decide to purchase 100 shares. During the year, the company distributes $0.75 in dividends. At end of the year, you sell the shares for $12.03. At the

> You believe that QED stock may be a good investment and decide to buy 100 shares at $40. You subsequently buy an additional $4,000 worth of the stock every time the stock’s price declines by an additional $5. If the stock’s price declines to $28 and rebo

> You read that stock A is trading for $50 and is down 50 percent for the year. Stock B is also trading for $50 but has risen 100 percent for the year. If the investor had purchased one share of each stock at the beginning of the year, what can you conclud

> You sold a stock short for $50 and maintained the position for two years during which the stock paid an annual dividend of $2. At the end of two years, you closed your position when the stock was selling for $35. The margin requirement for short sales wa

> You invest $100 in a mutual fund that grows 10 percent annually for four years. Then the fund experiences an exceptionally bad year and declines by 60 percent. After the bad year, the fund resumes its 10 percent annual return for the next four years. a)

> You purchase shares in an investment company such as a mutual fund for $35 a share. The fund makes the following cash payments (“distributions”): At the end of the fourth year, you sell the shares for $41. What was th

> A call penalty protects whom from what? Why may firms choose to retire debt prior to maturity? Would you expect a callable bond to have a higher or lower coupon rate of interest than a non-callable bond?

> You purchase a stock for $40 and sell it for $50 after holding it for five years. During this period you collected an annual dividend of $2. Did you earn more than 12 percent on your investment? What was the annual dollar-weighted rate of return?

> You purchase a stock for $100 that pays an annual dividend of $5.50. At the beginning of the second year, you purchase an additional share for $130. At the end of the second year, you sell both shares for $140. Determine the dollar-weighted return and th

> A stock costs $80 and pays a $4 dividend each year for three years. a) If an investor buys the stock for $80 and expects to sell it for $100 after three years, what is the anticipated annual rate of return? b) What would be the rate of return if the purc

> Determine the value of the Dow Jones Industrial Average as of your date of birth and as of your most recent birthday. What was the annualized return on the average between the two dates? Since this return does not include dividend income, it understates

> In 2000, the Dow Jones Industrial Average’s range was 11,72329,796. If the historical returns on stock were 10.4 percent, what should have been the range in the Dow Jones Industrial Average for 2009 if that return had continued to be achieved for 2000 th

> You invest $1,000 in a large company stock and $1,000 in a corporate bond. If you earn 10.0 percent on the stock and 6.0 percent on the bond and hold each security for 10 years, what are the terminal values for each investment? If you continue to hold ea

> You sold a security for $980 that you purchased five years before for $795. What was the holding period return? Prove that this return overstates the annualized, compound return.

> An investor buys a stock for $35 and sells it for $56.38 after five years. a) What is the holding period return? b) What is the true annual rate of return?

> You are given the following information concerning four stocks: Using 20X0 as the base year, construct three aggregate measures of the market that simulate the Dow Jones Industrial Average, the S&P 500 stock index, and the Value Line stock index (i

> Given the following information concerning four stocks, a) Construct a simple price-weighted average, a value-weighted average, and a geometric average. b) What is the percentage increase in each average if the stocks’ prices become: i

> How do you purchase a publicly traded bond?

> Bell Corp. issues a bond with the following features The current interest rate on comparable debt is 7 percent, so the bond initially sells for $713. What is the accrued interest on the bond for each of the next five years? Principal $1,000 Coupon 0

> “Foreign exchange rates, like stock prices, should follow a random walk.” Is this statement true, false, or uncertain? Explain your answer.

> A company has just announced a 3-for-1 stock split, effective immediately. Prior to the split, the company had a market value of $5 billion with 100 million shares outstanding. Assuming that the split conveys no new information about the company, what is

> If the public expects a corporation to lose $5 a share this quarter and it actually loses $4, which is still the largest loss in the history of the company, what does the efficient market hypothesis say will happen to the price of the stock when the $4 l

> If yield curves, on average, were flat, what would this say about the liquidity premiums in the term structure? Would you be more or less willing to accept the pure expectations theory?

> “If bonds of different maturities are close substitutes, their interest rates are more likely to move together.” Is this statement true, false, or uncertain? Explain your answer.

> Why do U.S. Treasury bills have lower interest rates than large-denomination negotiable bank CDs?

> Which should have the higher risk premium on its interest rates, a corporate bond with a Moody’s Baa rating or a corporate bond with a C rating? Why?

> If the income tax exemption on municipal bonds were abolished, what would happen to the interest rates on these bonds? What effect would it have on interest rates on U.S. Treasury securities?

> Predict what would happen to the risk premiums on corporate bonds if brokerage commissions were lowered in the corporate bond market.

> Predict what will happen to interest rates on a corporation’s bonds if the federal government guarantees today that it will pay creditors if the corporation goes bankrupt in the future. What will happen to the interest rates on Treasury securities?

> How can changes in foreign exchange rates affect the profitability of financial institutions?

> Risk premiums on corporate bonds are usually anticyclical; that is, they decrease during business cycle expansions and increase during recessions. Why is this so?

> If a yield curve looks like the one below, what is the market predicting about the movement of future short-term interest rates? What might the yield curve indicate about the market’s predictions about the inflation rate in the future?

> If a yield curve looks like the one shown here, what is the market predicting about the movement of future short-term interest rates? What might the yield curve indicate about the market’s predictions about the inflation rate in the fut

> The one-year interest rate over the next 10 years will be 3%, 4.5%, 6%, 7.5%, 9%, 10.5%, 13%, 14.5%, 16%, and 17.5%. Using the expectations theory, what will be the interest rates on a three-year bond, a six-year bond, and a nine-year bond?

> Debt issued by Southeastern Corporation currently yields 12%. A municipal bond of equal risk currently yields 8%. At what marginal tax rate would an investor be indifferent between these two bonds?

> How does the after-tax yield on a $1,000,000 municipal bond with a coupon rate of 8% paying interest annually compare with that of a $1,000,000 corporate bond with a coupon rate of 10% paying interest annually? Assume that you are in the 25% tax bracket.

> Government economists have forecasted one-year T-bill rates for the following five years, as follows: Year………………1-year rate 1…………………………..4.25% 2…………………………..5.15% 3………………………….5.50% 4………………………….6.25% 5………………………….7.10% You have a liquidity premium of 0.25

> If the interest rates on one- to five-year bonds are currently 4%, 5%, 6%, 7%, and 8%, and the term premiums for one- to five-year bonds are 0%, 0.25%, 0.35%, 0.40%, and 0.50%, predict what the one-year interest rate will be two years from now.

> One-year T-bill rates over the next four years are expected to be 3%, 4%, 5%, and 5.5%. If four-year T-bonds are yielding 4.5%, what is the liquidity premium on this bond?

> How does an increase in the value of the pound sterling affect American businesses?

> One-year T-bill rates are 2% currently. If interest rates are expected to go up after three years by 2% every year, what should be the required interest rate on a 10-year bond issued today? Assume that the expectations theory holds.

> Which bond would produce a greater return if the expectations theory were to hold true, a two-year bond with an interest rate of 15% or two one-year bonds with sequential interest payments of 13% and 17%?

> One-year T-bill rates are expected to steadily increase by 150 basis points per year over the next six years. Determine the required interest rate on a three-year T-bond and a six-year T-bond if the current one-year interest rate is 7.5%. Assume that the

> Consider the decision to purchase either a five-year corporate bond or a five-year municipal bond. The corporate bond is a 12% annual coupon bond with a par value of $1,000. It is currently yielding 11.5%. The municipal bond has an 8.5% annual coupon and

> Assuming that the expectations theory is the correct theory of the term structure, calculate the interest rates in the term structure for maturities of one to five years, and plot the resulting yield curves for the following series of one-year interest r

> You observe the following market interest rates, for both borrowing and lending: one-year rate…………………………………………. 5% two-year rate………………………………………… 6% one-year rate one year from now………… 7.25% How can you take advantage of these rates to earn a riskles

> At your favorite bond store, Bonds-R-Us, you see the following prices: a. 1-year $100 zero selling for $90.19 b. 3-year 10% coupon $1000 par bond selling for $1000 c. 2-year 10% coupon $1000 par bond selling for $1000 Assume that the pure expectations th

> Little Monsters, Inc., borrowed $1,000,000 for two years from NorthernBank, Inc., at an 11.5% interest rate. The current risk-free rate is 2%, and Little Monsters’ financial condition warrants a default risk premium of 3% and a liquidity risk premium of

> Using the information from the previous question, assume that investors prefer holding short-term bonds. A liquidity premium of 10 basis points is required for each year of a bond’s maturity. What will be the interest rates on a three-year bond, a six-ye

> Explain why you would be more or less willing to buy a house under the following circumstances: a. You just inherited $100,000. b. Real estate commissions fall from 6% of the sales price to 4% of the sales price. c. You expect Polaroid stock to double in

> How does a decline in the value of the pound sterling affect British consumers?

> Predict what will happen to interest rates if prices in the bond market become more volatile.

> Predict what will happen to interest rates if the public suddenly expects a large increase in stock prices.

> Will there be an effect on interest rates if brokerage commissions on stocks fall? Explain your answer.

> Using a supply-and-demand analysis for bonds, show what the effect is on interest rates when the riskiness of bonds rises.

> What effect will a sudden increase in the volatility of gold prices have on interest rates?

> “No one who is risk-averse will ever buy a security that has a lower expected return, more risk, and less liquidity than another security.” Is this statement true, false, or uncertain? Explain your answer.

> “The more risk-averse people are, the more likely they are to diversify.” Is this statement true, false, or uncertain? Explain your answer.

> How might a sudden increase in people’s expectations of future real estate prices affect interest rates?

> Using the supply-and-demand for bonds framework, show why interest rates are procyclical (rising when the economy is expanding and falling during recessions).

> What effect might a rise in stock prices have on consumers’ decisions to spend?

> An important way in which the Federal Reserve decreases the money supply is by selling bonds to the public. Using a supply-and-demand analysis for bonds, show what effect this action has on interest rates.

> Why does a lower strike price imply that a call option will have a higher premium and a put option a lower premium?

> If the finance company you manage has a gap of +$5 million (rate-sensitive assets greater than rate-sensitive liabilities by $5 million), describe an interest-rate swap that would eliminate the company’s income gap.

> If your company has a payment of 200 million euros due one year from now, how would you hedge the foreign exchange risk in this payment with 125,000 euros futures contracts?

> If the savings and loan you manage has a gap of -$42 million, describe an interest-rate swap that would eliminate the S&L’s income risk from changes in interest rates.

> I own a professional football team, and I plan to diversify by purchasing shares in either a company that owns a pro basketball team or a pharmaceutical company. Which of these two investments is more likely to reduce the overall risk I face? Why?

> Suppose that you buy a call option on a $100,000 Treasury bond futures contract with an exercise price of 110 for a premium of $1,500. If on expiration the futures contract has a price of 111, what is your profit or loss on the contract?

> If you buy a put option on a $100,000 Treasury bond futures contract with an exercise price of 95 and the price of the Treasury bond is 120 at expiration, is the contract in the money, out of the money, or at the money? What is your profit or loss on the

> If you buy a $100,000 February Treasury bond contract for 108 and the price of the deliverable Treasury bond at the expiration date is 102, what is your profit or loss on the contract?

> If the portfolio you manage is holding $25 million of 6s of 2032 Treasury bonds with a price of 110, what forward contract would you enter into to hedge the interest-rate risk on these bonds over the coming year?

> If the pension fund you manage expects to have an inflow of $120 million six months from now, what forward contract would you seek to enter into to lock in current interest rates?

> A swap agreement calls for Durbin Industries to pay interest annually based on a rate of 1.5% over the one-year T-bill rate, currently 6%. In return, Durbin receives interest at a rate of 6% on a fixed-rate basis. The notional principal for the swap is $

> Consider a put contract on a T-bond with an exercise price of 101 12/32. The contract represents $100,000 of bond principal and had a premium of $750. The actual T-bond price falls to 98 16/32 at the expiration. What is the gain or loss on the position?

> A bank customer will be going to London in June to purchase £100,000 in new inventory. The current spot and futures exchange rates are as follows: Exchange Rates Dollars/Pound Period…………………….Rate Spot……………………………1.5342 March………………………..1.6212 June…………………

> Assume the bank in the previous question partially hedges the mortgage by selling three 10-year T-note futures contracts at a price of 100 20/32. Each contract is for $1,000,000. After two months, the futures contract has fallen in price to 98 24/32. Wha

> Futures are available on three-month T-bills with a contract size of $1 million. If you take a long position at 96.22 and later sell the contracts at 96.87, how much would the total net gain or loss be on this transaction?

> A hedger takes a short position in five T-bill futures contracts at the price of 98 5/32. Each contract is for $100,000 principal. When the position is closed, the price is 95 12/32. What is the gain or loss on this transaction?

> Suppose that your company will be receiving 30 million euros six months from now and the euro is currently selling for 1 euro per dollar. If you want to hedge the foreign exchange risk in this payment, what kind of forward contract would you want to ente

> If your company has to make a 10 million euros payment to a German company in June, three months from now, how would you hedge the foreign exchange risk in this payment with a 125,000 euros futures contract?

> A bank issues a $100,000 variable-rate 30-year mortgage with a nominal annual rate of 4.5%. If the required rate drops to 4.0% after the first six months, what is the impact on the interest income for the first 12 months? Assume the bank hedged this risk

> Explain why greater volatility or a longer term to maturity leads to a higher premium on both call and put options.