Question: You are given the following information concerning
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.e., a simple average, a value-weighted average, and a geometric average). a) What is the percentage change in each aggregate market measure from 20X0 to 20X1, and 20X0 to 20X2? Why are the results different even though only one stock’s price changed and in each case the price that changed doubled? b) If you were managing funds and wanted a source to compare your results, which market measure would you prefer to use in 20X2
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Stock A B D Shares outstanding 1,000 300 2,000 400 Price 20x0 $50 30 20 60 20X1 50 30 40 60 20X2 50 60 20 60
> Why may investing in an ETF such as the various iShares be preferable to acquiring shares in a mutual fund that makes foreign investments?
> Why are hedge funds and private equity funds of little interest to most investors?
> How may mutual funds, closed-end investment companies, and ETFs be used to take positions in foreign securities?
> Why does arbitrage virtually assure that an ETF will sell for its net asset value?
> How do exchange-traded funds (ETFs) differ from mutual funds? Why may they be considered alternatives to index mutual funds?
> Using the information on the taxation of REIT distributions, what was the tax status of recent annual distributions made by Plum Creek Timber (PCU), UDR Inc. (UDR), and Washington Real Estate Investment Trust (WRE)?
> What differentiates a real estate investment trust (REIT) from a firm involved in building, developing, and owning properties? What differentiates a mortgage trust from an equity trust? What advantages do REITs offer investors over direct investments in
> What is the purpose of technical analysis, and why are those who use technical analysis referred to as chartists?
> Why can a closed-end investment company sell for a discount from net asset value but a mutual fund cannot sell for a discount?
> What are the differences between a closed-end investment company and a mutual fund? What are the sources of return from an investment in a closed-end investment company?
> Your broker suggests that the stock of QED is a good purchase at $25. You do an analysis of the firm, determining that the $1.40 dividend and earnings should continue to grow indefinitely at 5 percent annually. The firm’s beta coefficient is 1.34, and th
> The annual risk-free rate of return is 2 percent and the investor believes that the market will rise annually at 7 percent. If a stock has a beta coefficient of 1.5 and its current dividend is $1, what should be the value of the stock if its earnings and
> An investor buys shares in a mutual fund for $20 per share. At the end of the year the fund distributes a dividend of $0.58, and after the distribution the net asset value of a share is $23.41. What would be the investor’s percentage return on the invest
> If a mutual fund’s net asset value is $23.40 and the fund sells its shares for $25, what is the load fee as a percentage of the net asset value?
> What is the net asset value of an investment company with $10,000,000 in assets, $790,000 in current liabilities, and 1,200,000 shares outstanding?
> You are given the following data: a) What is the value of the stock? b) If the growth rate increases to 6 percent and the dividend remains $1, what is the value of the stock? c) If the required return declines to 9 percent and the dividend remains $1, wh
> 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?
> 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?
> What effect would reducing income tax rates have on the interest rates of municipal bonds? Would interest rates of Treasury securities be affected and, if so, how?
> 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.
