Questions and Answers of Accounting For Investments

An economy is making a rapid recovery from steep recession, and businesses foresee a need for large amounts of capital investment. Why would this development affect real interest rates? p-963
Suppose that the inflation rate is expected to be 3% in the near future. Using the historical data provided in this chapter, what would be your predictions for: p-963a. The T-bill rate?b. The
During a period of severe inflation, a bond offered a nominal HPR of 80% per year. The inflation rate was 70% per year.a. What was the real HPR on the bond over the year?b. Compare this real HPR to
Visit Professor Kenneth French’s data library Web site, mba.tuck.dartmouth.edu/pages/faculty/ken.french/data_library.html, and download the monthly returns of “6 portfolios formed on size and
Using historical risk premiums from Table 5.5 over the 1927–2021 period as your guide, what would be your estimate of the expected annual HPR on the Big/Value portfolio if the current risk-free
The continuously compounded annual return on a stock is normally distributed with a mean of 20% and standard deviation of 30%. With 95.44% confidence, we should expect its actual return in any
Determine the standard deviation of a random variable q with the following probability distribution: p-963 Value of q Probability 0 0.25 1 0.25 2 0.50
Derive the probability distribution of the 1-year HPR on a 30-year U.S. Treasury bond with an 8% coupon if it is currently selling at par and the probability distribution of its yield to maturity a
Suppose your expectations regarding the stock price are as follows:Use Equations 5.11 and 5.12 to compute the mean and standard deviation of the HPR on stocks. p-963
You are considering the choice between investing $50,000 in a conventional 1-year bank CD offering an interest rate of 5% and a 1-year “Inflation-Plus” CD offering 1.5% per year plus the rate of
Use Figure 5.1 in the text to analyze the effect of the following on the level of real interest rates:a. Businesses become more pessimistic about future demand for their products and decide to reduce
You have $5,000 to invest for the next year and are considering three alternatives:a. A money market fund with an average maturity of 30 days offering a current yield of 3% per year.b. A 1-year
The Narnian stock market had a rate of return of 45% last year, but the inflation rate was 30%.What was the real rate of return to Narnian investors? p-963
You’ve just stumbled on a new dataset that enables you to compute historical rates of return on U.S. stocks all the way back to 1880. What are the advantages and disadvantages in using these data
The Fisher equation tells us that the real interest rate approximately equals the nominal rate minus the inflation rate. Suppose the inflation rate increases from 3% to 5%. Does the Fisher equation
Investments in risky portfolios do not become safer in the long run. On the contrary, the longer a risky investment is held, the greater the risk. The basis of the argument that stocks are safe in
Widely used measures of tail risk are value at risk (VaR) and expected shortfall or, equivalently, conditional tail expectation. VaR measures the loss that will be exceeded with a specified
Historical returns on stocks exhibit somewhat more frequent large deviations from the mean than would be predicted from a normal distribution. However, the discrepancies from the normal distribution
Historical rates of return over the last century in other countries suggest the U.S. history of stock returns may be a positive outlier compared to other countries. This would suggest that its
Investors face a trade-off between risk and expected return. Historical data confirm our intuition that assets with low degrees of risk should provide lower returns on average than do those of higher
The equilibrium expected rate of return on any security is the sum of the equilibrium real rate of interest, the expected rate of inflation, and a security-specific risk premium. p-963
The nominal rate of interest is the equilibrium real rate plus the expected rate of inflation. In general, we can directly observe only nominal interest rates; from them, we must infer expected real
The economy’s equilibrium level of real interest rates depends on the willingness of households to save, as reflected in the supply curve of funds, and on the expected profitability of business
Real assets create wealth. Financial assets represent claims to parts or all of that wealth. Financial assets determine how the ownership of real assets is distributed among investors.
Financial assets can be categorized as fixed income, equity, or derivative instruments. Top-down portfolio construction techniques start with the asset allocation decision—the allocation of funds
Competition in financial markets leads to a risk–return trade-off, in which securities that offer higher expected rates of return also impose greater risks on investors. The presence of risk,
Financial intermediaries pool investor funds and invest them. Their services are in demand because small investors cannot efficiently gather information, diversify, and monitor portfolios.The
Investment banking brings efficiency to corporate fund-raising. Investment bankers develop expertise in pricing new issues and in marketing them to investors. By the end of 2008, all the major
The financial crisis of 2008 demonstrated the importance of systemic risk. Systemic risk can be limited by transparency that allows traders and investors to assess the risk of their counterparties;
Financial engineering has been disparaged as nothing more than paper shuffling. Critics argue that resources used for rearranging wealth (i.e., bundling and unbundling financial assets) might be
Although we stated that real assets constitute the true productive capacity of an economy, it is hard to conceive of a modern economy without well-developed financial markets and security types. How
Examine the balance sheet of commercial banks in Table 1.3.a. What is the ratio of real assets to total assets?b. What is the ratio of real assets to total assets for nonfinancial firms (Table
Consider Figure 1A, which describes an issue of American gold certificates.a. Is this issue a primary or secondary market transaction?b. Are the certificates primitive or derivative assets?
Wall Street firms have traditionally compensated their traders with a share of the trading profits that they generated. How might this practice have affected traders’ willingness to assume
Money market securities are very-short-term debt obligations. They are usually highly marketable and have relatively low credit risk. Their low maturities and low credit risk ensure minimal capital
Much of U.S. government borrowing is in the form of Treasury bonds and notes. These are coupon-paying bonds usually issued at or near par value. Treasury notes and bonds are similar in design to
Municipal bonds are distinguished largely by their tax-exempt status. Interest payments (but not capital gains) on these securities are exempt from federal income taxes. The equivalent taxable yield
Mortgage pass-through securities are pools of mortgages sold in one package. Owners of passthroughs receive the principal and interest payments made by the borrowers. The originator that issued the
Common stock is an ownership share in a corporation. Each share entitles its owner to one vote on matters of corporate governance and to a prorated share of the dividends paid to shareholders. Stock
Preferred stock usually pays fixed dividends for the life of the firm; it is a perpetuity. A firm’s failure to pay the dividend due on preferred stock, however, does not precipitate corporate
Many stock market indexes measure the performance of the overall market. The Dow Jones averages, the oldest and best-known indicators, are price-weighted indexes. Today, many broadbased,
A call option is a right to purchase an asset at a stipulated exercise price on or before an expiration date. A put option is the right to sell an asset at some exercise price. Calls increase in
A futures contract is an obligation to buy or sell an asset at a stipulated futures price on a maturity date. The long position, which commits to purchasing, gains if the asset value increases while
In what ways is preferred stock like long-term debt? In what ways is it like equity? L658
Why are money market securities often called “cash equivalents”? L658
What would you expect to happen to the spread between yields on commercial paper and Treasury bills if the economy were to enter a steep recession? L658
What are the key differences between common stock, preferred stock, and corporate bonds? L658
Why are high-tax-bracket investors more inclined to invest in municipal bonds than low-bracket investors? L658
Turn back to Figure 2.3 and look at the Treasury bond maturing in November 2040.a. How much would you have to pay to purchase one of these bonds?b. What is its coupon rate?c. What is the yield to
Suppose investors can earn a return of 2% per 6 months on a Treasury note with 6 months remaining until maturity. What price would you expect a 6-month-maturity Treasury bill to sell for? L658
Find the after-tax return to a corporation that buys a share of preferred stock at $40, sells it at year-end at $40, and receives a $4 year-end dividend. The firm is in the 21% tax bracket. L658
Turn to Figure 2.8 and look at the listing for Honeywell.a. How many shares can you buy for $5,000?b. What would be your annual dividend income from those shares?c. What must be Honeywell’s
Using the data in the previous problem, calculate the first-period rates of return on the following indexes of the three stocks:a. A market-value-weighted index.b. An equally weighted index. L658
What would happen to the divisor of the Dow Jones Industrial Average if FedEx, with a current price of around $300 per share, replaced Intel, with a current price of about $55 per share? L658
An investor is in a 30% combined federal plus state tax bracket. If corporate bonds offer 6%yields, what yield must municipals offer for the investor to prefer them to corporate bonds? L658
Find the equivalent taxable yield of a short-term municipal bond with a yield of 4% for tax brackets of (a) zero, (b) 10%, (c) 20%, and (d) 30%. L658
What problems would confront a mutual fund trying to create an index fund tied to an equally weighted index of a broad stock market? L658
Look at the futures listings for the corn contract in Table 2.7. Suppose you buy one contract for December 2022 delivery. If the contract closes in December at a level of $5.03, what will your profit
Turn back to Table 2.6 and look at the Microsoft options. Suppose you buy an August expiration call option with exercise price $285.a. Suppose the stock price in August is $288. Will you exercise
Why do call options with exercise prices greater than the price of the underlying stock sell for positive prices? L658
Explain the difference between a put option and a short position in a futures contract. L658
Explain the difference between a call option and a long position in a futures contract. L658
A municipal bond carries a coupon of 6.75% and is trading at par. What is the equivalent taxable yield to a taxpayer in a combined federal plus state 34% tax bracket? L658
Short-term municipal bonds currently offer yields of 4%, while comparable taxable bonds pay 5%. Which gives you the higher after-tax yield if your tax bracket is L658a. Zerob. 10%c. 20%d. 30%
The coupon rate on a tax-exempt bond is 5.6%, and the rate on a taxable bond is 8%. Both bonds sell at par. At what tax bracket (marginal tax rate) would an investor be indifferent between the two
Why does it make sense for shelf registration to be limited in time? P-968
What type of trading order might you give to your broker in each of the following circumstances?a. You want to buy shares of Microsoft to diversify your portfolio. You believe the share price is
Suppose the maintenance margin in Example 3.2 is 40%. How far can the stock price fall before the investor gets a margin call? P-968
Suppose that in the FinCorp example, the investor borrows only $5,000 at the same interest rate of 9% per year.What will the rate of return be if the stock price increases by 30%? If it falls by 30%?
Firms issue securities to raise the capital necessary to finance their investments. Investment bankers market these securities to the public on the primary market. Investment bankers generally act as
Already-issued securities are traded on the secondary market, that is, on organized stock markets;on the over-the-counter market; and occasionally, for very large trades, through direct negotiation.
Trading may take place in dealer markets, via electronic communication networks, or in specialist/designated market maker markets. In dealer markets, security dealers post bid and ask prices at which
NASDAQ was traditionally a dealer market in which a network of dealers negotiated directly over sales of securities. The NYSE was traditionally a specialist market. Today, however, trading in both
Buying on margin means borrowing money from a broker to buy more securities than can be purchased with one’s own money alone. By buying securities on margin, an investor magnifies both the upside
Short-selling is the practice of selling securities that the seller does not own. The short-seller borrows the securities from a broker, sells them, and may be required to cover the short position at
Securities trading is regulated by the Securities and Exchange Commission, by other government agencies, and through self-regulation of the exchanges. Many of the important regulations have to do
What are the differences among a limit buy order, a limit sell order, and a market order? P-968
Why have average trade sizes declined in recent years? P-968
How does buying on margin magnify both the upside potential and the downside risk of an investment position? P-968
Are the following statements true or false? If false, correct them.a. Market orders entail greater price uncertainty than limit orders.b. Market orders entail greater time-of-execution uncertainty
Old Economy Traders opened an account to short-sell 1,000 shares of Internet Dreams from the previous problem. The initial margin requirement was 50%. (The margin account pays no interest.) A year
Consider the following limit-order book for FinTrade stock. The last trade in the stock occurred at a price of $50.a. If a market buy order for 100 shares comes in, at what price will it be filled?b.
Here is some price information on Marabel, Inc.:eXcel Please visit us at www.mhhe.com/Bodie13e Bid Ask Marabel 69.95 70.05a. You have placed a stop-loss order to sell at $70. What are you telling
FBN Inc. has just sold 100,000 shares in an initial public offering. The underwriter’s explicit fees were $70,000. The offering price for the shares was $50, but immediately upon issue, the share
If you place a limit order to sell 100 shares of stock at $55 when the current price is $62, how much will you receive for each share if the price drops to $50?a. $50.b. $55.c. $54.87.d. Cannot tell
Which firms look best for someone wishing to buy stocks on margin? P-968
Which firm looks best for someone planning to pay cash to buy 100 shares? P-968
Which firms are best in terms of integrating your account with your banking activities? P-968
Check out the online education services. Which look best to you? P-968
Unit investment trusts, closed-end management companies, and open-end management companies are all classified and regulated as investment companies. Unit investment trusts are essentially unmanaged
Net asset value equals the market value of assets held by a fund minus the liabilities of the fund divided by the shares outstanding. LOP5
Mutual funds free the individual from many of the administrative burdens of owning individual securities and offer professional management of the portfolio. They also offer advantages that are
Mutual funds are often categorized by investment policy. Major policy groups include money market funds; equity funds, which are further grouped according to emphasis on income versus growth or
Costs of investing in mutual funds include front-end loads, which are sales charges; back-end loads, which are redemption fees or, more formally, contingent-deferred sales charges; operating
Income earned on mutual fund portfolios is not taxed at the level of the fund. Instead, as long as the fund meets certain requirements for pass-through status, the income is treated as being earned
The average rate of return of the average equity mutual fund in the last 50 years has been below that of a passive index fund holding a portfolio to replicate a broad-based index like the S&P 500 or
Would you expect a typical open-end fixed-income mutual fund to have higher or lower operating expenses than a fixed-income unit investment trust? Why? LOP5
What are some comparative advantages of investing in the following?a. Unit investment trusts.b. Open-end mutual funds.c. Individual stocks and bonds that you choose for yourself. LOP5
Open-end equity mutual funds commonly keep a small fraction of total investments in very liquid money market assets. Closed-end funds do not have to maintain such a position in “cashequivalent”
Balanced funds, life-cycle funds, and asset allocation funds all invest in both the stock and bond markets. What are the differences among these types of funds? LOP5

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