Questions and Answers of Accounting For Investments

After much research on the developing economy and capital markets of the country of Otunia, your firm, GAC, has decided to include an investment in the Otunia stock market in its Emerging Markets
The Windsor Foundation, a U.S.-based, not-for-profit charitable organization, has a diversified investment portfolio of $100 million. Windsor’s board of directors is considering an initial
A global manager plans to invest $1 million in U.S. government cash equivalents for the next 90 days. However, she is also authorized to use non–U.S. government cash equivalents, as long as the
You are a U.S. investor considering purchase of one of the following securities. Assume that the currency risk of the Canadian government bond will be hedged and the 6-month discount on Canadian
John Irish, CFA, is an independent investment adviser who is assisting Alfred Darwin, the head of the Investment Committee of General Technology Corporation, to establish a new pension fund.Darwin
An investor in the common stock of companies in a foreign country may wish to hedge against the _____ of the investor’s home currency and can do so by _____ the foreign currency in the forward
The correlation coefficient between the returns on a broad index of U.S. stocks and the returns on indexes of the stocks of other industrialized countries is mostly _____, while the correlation
You are a U.S. investor who purchased British securities for £2,000 one year ago when the British pound cost U.S.$1.50. What is your total return (based on U.S. dollars) if the value of the
Much of this chapter was written from the perspective of a U.S. investor. But suppose you are advising an investor living in a small country (choose one to be concrete). How might the lessons of this
If you were to invest $10,000 in the British bills of Problem 7, how would you lock in the dollardenominated return?? L042
If the current exchange rate is $1.35/£, the 1-year forward exchange rate is $1.45/£, and the interest rate on British government bills is 3% per year, what risk-free dollar-denominated return can
Calculate the contribution to total performance from currency, country, and stock selection for the manager in the example below. All exchange rates are expressed as units of foreign currency that
Now suppose the investor in Problem 3 also sells forward £5,000 at a forward exchange rate of$2.10/£.a. Recalculate the dollar-denominated returns for each scenario.b. What happens to the standard
If each of the nine outcomes in Problem 3 is equally likely, find the standard deviation of both the pound- and dollar-denominated rates of return.? L042
Suppose a U.S. investor wishes to invest in a British firm currently selling for £40 per share. The investor has $10,000 to invest, and the current exchange rate is $2/£.a. How many shares can the
In Figure 25.2, we provide stock market returns in both local and dollar-denominated terms.Which of these is more relevant? What does this have to do with whether the foreign exchange risk of an
Do you agree with the following claim? “U.S. companies with global operations can give you international diversification.” Think about both business risk and foreign exchange risk.? L042
Several world market indexes can form a basis for passive international investing. Active international management can be partitioned into currency selection, country selection, stock selection, and
International investing entails an added dimension of political risk, including uncertainty about government and social stability, democratic accountability, macroeconomic conditions, international
Returns in different countries are far from perfectly correlated. Therefore, there is a benefit from international diversification. The minimum variance global portfolio has considerably lower
Exchange rate risk imparts an extra source of uncertainty to investments denominated in foreign currencies. Much of that risk can be hedged in foreign exchange futures or forward markets, but a
U.S. assets account for less than half of the world portfolio. International capital markets offer important opportunities for portfolio diversification with enhanced risk–return characteristics.?
Using the data in Table 25.14, compute the manager’s country and currency selections if portfolio weights had been 40% in Europe, 20% in Australasia, and 40% in the Far East.? L042
How many pounds would the investor in Example 25.2 need to sell forward to hedge exchange rate risk if (a) r (UK) = 20%; (b) r (UK) = 30%?? L042
If the forward exchange rate in Example 25.1 had been F0 = $1.35/£ when the investment was made, the U.S. investor could have assured a riskless dollar-denominated return by arranging to deliver the
Using the data in Example 25.1, calculate the rate of return in dollars to a U.S. investor holding the British bill if the year-end exchange rate is (a) E1 = $1.40/£; (b) E1 = $1.50/£? L042
The spot rates of interest for five U.S. Treasury securities are shown in the following table.Assume all securities pay interest annually. P-639 Spot Rates of Interest Term to Maturity Spot Rate of
U.S. Treasuries represent a significant holding in many pension portfolios. You decide to analyze the yield curve for U.S. Treasury notes.a. Using the data in the table below, calculate the 5-year
The shape of the U.S. Treasury yield curve appears to reflect two expected Federal Reserve reductions in the federal funds rate. The current short-term interest rate is 5%. The first reduction of
A portfolio manager at Superior Trust Company is structuring a fixed-income portfolio to meet the objectives of a client. The portfolio manager compares coupon U.S. Treasuries with zero-coupon
Sandra Kapple is a fixed-income portfolio manager who works with large institutional clients.Kapple is meeting with Maria VanHusen, consultant to the Star Hospital Pension Plan, to discuss management
The tables below show, respectively, the characteristics of two annual-coupon bonds from the same issuer with the same priority in the event of default, as well as spot interest rates on zerocoupon
The 6-month Treasury bill spot rate is 4%, and the 1-year Treasury bill spot rate is 5%. What is the implied 6-month forward rate for six months from now? P-639
The following table shows yields to maturity of zero-coupon Treasury securities. P-639 Term to Maturity (years) Yield to Maturity (%)1 3.50%2 4.50 3 5.00 4 5.50 5 6.00 10 6.60a. Calculate the forward
Which one of the following statements about the term structure of interest rates is true?a. The expectations hypothesis predicts a flat yield curve if anticipated future short-term rates exceed
Briefly explain why bonds of different maturities might have different yields according to the expectations and liquidity preference hypotheses. Briefly describe the implications of each hypothesis
You therefore can interpret the 2-year loan rate as a 2-year forward rate for the last two years.e. Alternatively, show that the effective 2-year forward rate equals? P-639
Suppose that you want to construct a 2-year maturity forward loan commencing in 3 years.a. Suppose that you buy today one 3-year maturity zero-coupon bond with face value $1,000.How many 5-year
Use the data from Problem
Suppose that the prices of zero-coupon bonds with various maturities are given in the following table. The face value of each bond is $1,000.Maturity (years) Price 1 $925.93 2 853.39 3 782.92 4
The current yield curve for default-free zero-coupon bonds is as follows:Maturity (years) YTM (%)1 10%2 11 3 12a. What are the implied 1-year forward rates?b. Assume that the pure expectations
Suppose that a 1-year zero-coupon bond with face value $100 currently sells at $94.34, while a 2-year zero sells at $84.99. You are considering the purchase of a 2-year-maturity bond making annual
The yield to maturity (YTM) on 1-year zero-coupon bonds is 5%, and the YTM on 2-year zeros is 6%. The YTM on 2-year-maturity coupon bonds with coupon rates of 12% (paid annually) is 5.8%.a. What
You observe the following term structure:Effective Annual YTM 1-year zero-coupon bond 6.1%2-year zero-coupon bond 6.2 3-year zero-coupon bond 6.3 4-year zero-coupon bond 6.4a. If you believe that the
Prices of zero-coupon bonds reveal the following pattern of forward rates:Year Forward Rate 1 5%2 7 3 8 In addition to the zero-coupon bond, investors also may purchase a 3-year bond making annual
Below is a list of prices for zero-coupon bonds of various maturities. P-639 Maturity (years)Price of $1,000 Par Bond(zero-coupon)1 $943.40 2 873.52 3 816.37a. An 8.5% coupon $1,000 par bond pays an
The yield to maturity on 1-year zero-coupon bonds is currently 7%; the YTM on 2-year zeros is 8%. The Treasury plans to issue a 2-year maturity coupon bond, paying coupons once per year with a coupon
The term structure for zero-coupon bonds is currently: P-639 Maturity (years) YTM (%)1 4%2 5 3 6 Next year at this time, you expect it to be:Maturity (years) YTM (%)1 5%2 6 3 7a. What do you expect
Consider the following $1,000 par value zero-coupon bonds: P-639 Bond Years to Maturity YTM (%)A 1 5%B 2 6 C 3 6.5 D 4 7 According to the expectations hypothesis, what is the market’s expectation
a. Assuming that the expectations hypothesis is valid, compute the expected price of the 4-year bond in Problem 7 at the end of (i) the first year; (ii) the second year; (iii) the third year;
The following is a list of prices for zero-coupon bonds of various maturities.Maturity (years) Price of Bond: P-639 1 $943.40 2 898.47 3 847.62 4 792.16a. Calculate the yield to maturity for a bond
Assuming the pure expectations theory is correct, an upward-sloping yield curve implies: P-639a. Interest rates are expected to increase in the future.b. Longer-term bonds are riskier than short-term
Which of the following is true according to the pure expectations theory? Forward rates: P-639a. Exclusively represent expected future short rates.b. Are biased estimates of market expectations.c.
If the liquidity preference hypothesis is true, what shape should the term structure curve have in a period where interest rates are expected to be constant? P-639a. Upward-slopingb.
Under the liquidity preference theory, if inflation is expected to be falling over the next few years, long-term interest rates will be higher than short-term rates. True/false/uncertain?Why? P-639
Under the expectations hypothesis, if the yield curve is upward-sloping, the market must expect an increase in short-term interest rates. True/false/uncertain? Why? P-639
What is the relationship between forward rates and the market’s expectation of future short rates?Explain in the context of both the expectations hypothesis and the liquidity preference theory of
Forward rates are market interest rates in the important sense that commitments to forward(i.e., deferred) borrowing or lending arrangements can be made at these rates. P-639
The existence of liquidity premiums complicates attempts to infer expected future interest rates from the yield curve. Such an inference would be made easier if we could assume the liquidity premium
A common version of the expectations hypothesis holds that forward interest rates are unbiased estimates of expected future interest rates. However, there are good reasons to believe that forward
The forward rate of interest is the break-even future interest rate that would equate the total return from a rollover strategy to that of a longer-term zero-coupon bond. It is defined by the
In a world of certainty, all investments must provide equal total returns for any investment period.Short-term holding-period returns on all bonds would be equal in a risk-free economy; all returns
The term structure of interest rates refers to the interest rates for various terms to maturity embodied in the prices of default-free zero-coupon bonds. P-639
Look back at Table 15.1. Show that y4 will exceed y3 if and only if the forward interest rate for period 4 is greater than 7%, which is the yield to maturity on the 3-year bond, y3. P-639
The liquidity premium hypothesis also holds that issuers of bonds prefer to issue long-term bonds to lock in borrowing costs. How would this preference contribute to a positive liquidity premium?
If the expectations hypothesis is valid, what can we conclude about the premiums necessary to induce investors to hold bonds of different maturities from their investment horizons? P-639
Suppose that the required liquidity premium for the short-term investor is 1%. What must E(r2) be if f2 is 7%? P-639
You’ve been exposed to many “rates” in the last few pages. Explain the differences among spot rates, short rates, and forward rates. P-639
Show that the rate of return on the 3-year zero in Table 15.1 also will be 5%. (Hint: Next year, the bond will have a maturity of two years.) Use the short rates derived in Figure 15.3 to compute the
Use Table 15.1 to find the short rate in the fourth year. Confirm that the discount factor on the 4-year zero is a geometric average of 1 + the short rates in the next four years. P-639
Using the data in Table 15.1, calculate the price and yield to maturity of a 3-year bond with a coupon rate of 4%making annual coupon payments. Does its yield match that of either the 3-year zero or
In the application of the momentum equation, explain why we can usually disregard the atmospheric pressure and work with gage pressures only.
What is the importance of the momentum-flux correction factor in the momentum analysis of flow systems?For which type(s) of flow is it significant and must it be considered in analysis: laminar flow,
Explain the importance of the Reynolds transport theorem in fluid mechanics, and describe how the linear momentum equation is obtained from it.
Express Newton’s second law of motion for rotating bodies. What can you say about the angular velocity and angular momentum of a rotating nonrigid body of constant mass if the net torque acting on
Express Pascal’s law, and give a real-world example of it.
The specific weight of a system is defined as the weight per unit volume (note that this definition violates the normal specific property-naming convention). Is the specific weight an extensive or
Louise and Christopher Maclin (see Problem 8) have purchased their house and made the donation to the local charity. Now that an investment policy statement has been prepared for the Maclins, Grant
Christopher Maclin, aged 40, is a supervisor at Barnett Co. and earns an annual salary of £80,000 before taxes. Louise Maclin, aged 38, stays home to care for their newborn twins. She recently
John Franklin is a recent widower with some experience in investing for his own account. Following his wife’s recent death and settlement of the estate, Mr. Franklin owns a controlling interest in
Susan Fairfax is president of Reston Industries, a U.S.-based company whose sales are entirely domestic and whose shares are listed on the New York Stock Exchange. The following are additional facts
Jarvis University (JU) is a private, multiprogram U.S. university with a $2 billion endowment fund as of fiscal year-end May 31, 2030. With little government support, JU is heavily dependent on its
Sam Short, CFA, has recently joined the investment management firm of Green, Spence, and Smith (GSS). For several years, GSS has worked for a broad array of clients, including employee benefit plans,
The aspect least likely to be included in the portfolio management process isa. Identifying an investor’s objectives, constraints, and preferences.b. Organizing the management process itself.c.
Your client says, “With the unrealized gains in my portfolio, I have almost saved enough money for my daughter to go to college in eight years, but educational costs keep going up.” On the basis
Angus Walker, CFA, is reviewing the defined benefit pension plan of Acme Industries. Based in London, Acme has operations in North America, Japan, and several European countries. Next month, the
George More is a participant in a defined contribution pension plan that offers a fixed-income fund and a common stock fund as investment choices. He is 40 years old and has an accumulation of
What is the least-risky asset for each of the following investors?a. A person investing for her 3-year-old child’s college tuition.b. A defined benefit pension fund with benefit obligations that
Your neighbor has heard that you successfully completed a course in investments and has come to seek your advice. She and her husband are both 50 years old. They just finished making their last
Pension plans are either defined contribution plans or defined benefit plans. Defined contribution plans are in effect retirement funds held in trust for the employee by the employer. The employees
When allocating investment funds between tax-protected and other accounts, investors will minimize their overall tax burden by holding the least tax-advantaged asset (e.g., bonds) in their
There are three ways to shelter investment income from federal income taxes besides investing in tax-exempt bonds: The first is by investing in assets whose returns take the form of appreciation in
The life-cycle approach to the management of an individual’s investment portfolio views the individual as passing through a series of stages, becoming more risk averse in later years. The rationale
For investors who must pay taxes on their investment income, the process of asset allocation is complicated by the fact that they pay income taxes only on certain kinds of investment income.Interest
The process of asset allocation includes the following steps:a. Specifying the asset classes to be included.b. Defining capital market expectations.c. Specifying the investor’s objectives and
To some extent, most institutional investors seek to match the risk-and-return characteristics of their investment portfolios to the characteristics of their liabilities. L02
When the principles of portfolio management are discussed, it is useful to distinguish among eight classes of investors:a. Individual investors.b. Personal trusts.c. Mutual funds.d. Pension funds.e.
An employee currently earning $60,000 a year is 40 years old and has been working for the firm for 15 years.The pension plan promises benefits in retirement of 2% of final salary times years of
An employee is 45 years old. Her salary is $60,000 per year, and she has $100,000 accumulated in her selfdirected defined contribution pension plan. Each year she contributes 5% of her salary to the
Suppose our investor earns a 10% per year rate of interest on bonds and a 15% per year return on stocks, with all earnings reinvested. In five years, she will withdraw all her funds and spend them.

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