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essentials of investments

Questions and Answers of Essentials of Investments

Assume that you went to a casino to play and began betting with your $20. After a while, you won big (say, $100). If you continue playing, why would you do that (ignore playing for pleasure or for
Suppose that you examine the economic performance of a company over the last few years and observe that it has earned large profits. Does this contradict the efficient market hypothesis?
Are continuous stock price movements following an announcement by a firm evidence of market inefficiency?
The following sentences are from an article which appeared in the WSJ issue of November 24, 2008, titled “Fear and Frustration: Some Calling it Quits”. After you have read them, answer the
What can the EMH and behaviorists say about the internet bubble of the late 1990s and the subsequent stock market crash?
Assume that investors search for information about asset prices to determine if they are overor undervalued. While searching for such mispriced stocks, they uncover information and quickly act on it
We discussed in the text that economists documented that the market generates systematic biases (such as overreactions) for winner or loser stocks. If investors were rational, what would competition
Haris is pondering whether to invest in a new project which has a positive net return (net present value). He can borrow and lend from a bank at the risk-free rate (for simplicity also assume no
In 2019, a number of well-known stock-picking portfolio managers threw in the towel after investors abandoned them. What do you think was the reason for this?
What is the EMH proponents’ response to criticisms about market anomalies and other financial events?
Under EMH, what would stock price behavior and the implications for specific investment strategies be?
Answer the following questions.a. What happens to an investor’s (degree of) risk tolerance during good economic times and bad economic times? What do you think happened during the financial crisis
Along with the above question, why do you think that optimal risky portfolios may vary across investors?
We learned that portfolio managers can easily compute the optimal risky portfolio (and efficient frontier) for all investors. Thus, they economize on administrative costs (savings which are passed on
Assume that you use the same weighting scheme as used in Table 8.1. Now you have the following information about your two risky assets, X and Y: E(r x) = 10%, E(r y) = 12%,σ2 x=200, and σ2 y=300.
Interpret the following statements (from the financial news):l If your assets in your portfolio move in tandem, then you will either be all right or all wrong.l Correlation has become more important
Read the following paragraph and answer the questions below:Many investors wish to earn hedge-fund type of returns (that is, absolute or superior returns)but are concerned about the high fees that
Please answer the questions below based on the following statements:l Early in 1998, Apple was in huge trouble and its shares were more volatile than those of a rival, IBM. Yet, Apple’s cost of
You are given the following data below on two stocks, the risk-free rate and the market index.Asset Returns Stand. Dev. Beta N 10% 15% 1.0 H 15% 20% 1.2 Risk-free 3%Market index 11%Please answer the
The security market line (SML)c. If a fund representative states that their fund should have a long-term expected rate of return of 10%, how should you obtain it?d. Another fund representative tells
The capital market line (CML)
The portfolio’s standard deviationb. If the risk-free rate is 3%, and the market risk premium is 5%, give an expression for
The portfolio weights
Assume that you are a financial consultant to a pension fund and are asked to discuss the capital market theory with the fund’s representatives. You also have access to the following data.Answer
Assume that you have the following hypothetical data on assets: the risk-free rate is 3%; the expected return on the investor’s optimal (tangency) portfolio is 10% and the risk of the tangency
Please comment on or qualify the following sentence: A well-devised asset allocation does not ensure you are appropriately diversified.
Can you advance some benefits of diversification?
What is the difference between strategic asset allocation and tactical asset allocation?
Why aren’t you able to reduce risk further even if you add more stocks to your portfolio? Why does diversification eliminate firm-specific risk completely?
What are some of the dangers of asset allocation strategies? You may also want to read again the box titled International Focus.
Give an insightful interpretation of the capital market line (CML) and suggest an appropriate strategy for an investor.
Assume that you have a risky portfolio with an expected return of 10% and variance of 400.The Treasury bill is 5%. What would be that level of risk aversion that make you select the risky asset over
If you were presented with two investment opportunity sets with the following Sharpe ratios, 0.55 and 0.57, which one would you select and why?
What would happen to the expected return on a risky-asset portfolio if investors perceived an increase in the fluctuation (volatility) of risky assets?DIVERSIFICATION AND ASSET ALLOCATION | 245
Again, refer to the information on question 5 and answer the questions below.a. Now assume that you want to earn a specific (expected) return on your overall portfolio equal to 10%. What proportions
Using the information from question 5, find your degree of risk aversion and the optimal percentage of funds allocated to the risky assets and the risk-free asset.
Assume that you have the following information for making an investment decision. You have created a portfolio of risky assets with an expected return of 15% and risk of 20%. The risk-free rate,
Assume that you expect the standard deviation of a stock portfolio to be 0.15 next year and you have a risk aversion of 4 (A=4).a. What would be a guess of the portfolio’s (expected) risk
Collect data on the closing stock prices of Alcoa (AA) and IBM (IBM) for the last three months(a possible source is Yahoo!Finance). Input them in EXCEL and do the following analyses (you might also
After reading the article titled “An Ugly Market’s Lessons for Investors”, by S. Anano, which appeared in the Wall Street Journal of October 5, 2008, answer the following questions.a. Explain
After reading the article titled “Commodities Zig. Stocks Do, Too”, by C. Cui, which appeared in the Wall Street Journal of October 17, 2008, answer the following questions.a. Why do investors
A fund of funds is a mutual fund that invests in other mutual funds. In this way, the investors in the original fund get better diversification and a better asset allocation among investment
Assume that a fund holds the following assets:A: 100,000 shares @ $25 B: 50,000 shares @ $10 C: 25,000 shares @ $20 If the fund’s manager sells all of asset C and replaces it with 10,000 shares of
If you want to effectively accomplish asset allocation which is an easy and cheap way to do that? Explain.
Explain why index funds have lower costs than traditional mutual funds.
A fund started the year with a net asset value of $10.60 and ended up the year with a NAV of$9.50. During the year, the fund distributed $1.10 in the form of income and capital gains. If you were an
Assume the following information on a mutual fund, assets: $3,000,000; liabilities: $500,000;no. of shares outstanding: 1,500,000. Compute the fund’s net asset value.
Please answer the following questions based on the passage below.Some trading advantages of ETF’s include the ability of an investor to trade an ETF immediately at any point in time during the
Search recent issues of the Wall Street Journal and answer the following questions.a What kind of problems do closed-end mutual funds currently face?b What type of investors are drawn to such funds
What are the differences between mutual funds and hedge funds?
What are the advantages and disadvantages of passively managed funds over actively managed funds?
You want to decide between two mutual funds that track a market index, say the S&P 500, and you see that one fund manages $100 million in assets while the other manages $400 million in assets. Which
Who are the main participants in the repo market and what is the purpose of using repos?INVESTMENT BANKERS AND COMPANIES | 205 A real estate investment fund resembles a closed-end fund and invests in
Can you advance an argument or two as to why the Fed might be willing to pay interest on banks’ short-term deposits at the Fed?
You own 100 shares of HP stock, which you purchased at $41.20. What is the potential gain and the maximum loss on the stock?
You are examining the common stocks of two (closely related) companies, company ABC, whose goal is to merge with another company, company XYZ. You have a strong expectation that the deal will go
In October 2010, global investors placed huge orders for 2-year bonds issued by mortgage giant Fannie Mae yielding 0.507%, or offering 13 basis points above 2-year Treasuries. At the same time, the
What is interest-rate risk and what is reinvestment-rate risk? Can these two risks offset each other? Explain.
What would you expect to happen to the spread between the 3-month Treasury bill and the 3-month Certificate of Deposit rate if the economy slipped into a recession? Develop your argument in terms of
Why do spreads narrow during good economic times and widen during bad economic times?
Answer the questions below based on the following statements.“The dollar weakened against all major currencies, breaking out of the range since late October 2008, at that time, when global stock
Please answer the two questions below based on the following statement: “As of October 2008, municipal securities’ yields rose to high levels (as high as 5%) as investors shunned such tax-exempt
Refer to Table 5.2 in the text where the recent T-bill auctions results are shown. Then answer the following questions/problems:a. Verify that the 13-week investment rate is 0.1879 and the discount
Answer the three questions below based on the following statement: “Investors who initially had placed their funds into high-yielding corporate bonds, are now withdrawing their funds and placing
Answer the two questions below based on the following statement: “The Fed sped up its purchases of commercial paper from the money market mutual fund industry in an effort to balance the deposit
Why is commercial paper so important for investors? What kind of services does this market provide?
What does globalization mean for you, the individual investor?
What is the pricing function of the financial markets? Does this function ensure the realization of a “fair price”?
Explain in your own words the circular flow of funds in the global financial market.
This question can be answered by reading the text of this chapter’s International Focus. Why is London having hard financial times even though the city is one of the world’s biggest financial
Find the current euro/dollar exchange rate and calculate the domestic and foreign rates of return of $100 invested in a stock of a European country (of your choice) for a year (to keep the analysis
What is the impact of the globalization of financial markets?The question below pertains to Box 4.3.Define the term margin calls and then explain how such calls might accentuate market declines.
Do you think that the world is ready for a truly global monetary authority? Why or why not?
The following questions are from Boxes 4.1 and 4.3.The next two questions pertain to Box 4.1.
Consider the following facts on the world’s stock exchanges (from the Wall Street Journal):❏ The Dow Jones Industrial Average fell 33% in 2008❏ Germany’s DAX index slumped 42% in 2008❏
What would be the impact on a stock market (index) if any of the following actual situations happened?❏ Investors weighed evidence that the global economic slowdown was deepening❏ Investors were
Use the following statement from the financial news and answer the question below: “ Deutsche Börse AG has become the largest European financial market in two months, following NYSE Euronext, to
Use the following statement from the financial news and answer the questions below: “Iceland’s central bank raised its benchmark interest rate by six percentage points to 18% in an attempt to
Use the following statement from the financial news and answer the question below: “Fannie Mae requires that banks speed up transfers of mortgage payments to investors as a precautionary move
How are indifference curves shaped and what do they imply about an investor’s risk tolerance?
How would low interest rates increase investors’ appetite for risk-taking and what would be the implications of such activity?
What are some of the effects of negative interest rates?
Nick is a risk-averse investor and Haris is a less risk-averse investor than Nick. Given the same return, which one would accept (tolerate) higher risk?
Explain how a fair game relates to a risk-averse investor’s attitude toward speculation and risk and how the utility function reflects this attitude.
What are the differences between a risk-lover, a risk-averse and a risk-neutral investor? Answer in terms of expected returns.
Assume that you had a lottery ticket that would pay you either $10,000 or $0, with a fifty-fifty chance.a. What is the ticket’s expected value?b. If you are a risk-neutral investor, would you sell
Assume that your friend challenges you to a game of coin flipping. If you flip a head you win$10, but if you flip a tail you lose $10. You started playing the game with $10. What would be your
What is the relationship between the effective annual yield and the holding period yield?
Your bank company advertises that it charges you a 16.99% Annual Percentage Rate (APR) on purchases on credit. If your payments are monthly, what is the real APR charged by the bank?
What would happen to the expected rate of return if you thought that the riskiness of stocks became greater?
You are given some hypothetical data on the holding period returns two stocks, the three possible economic scenarios in which they could be realized as well as their corresponding probabilities. The
Suppose that you started with a $1,000 investment budget, earned $200 in the quarter, lost$100 in the second quarter, earned $50 in the third quarter, and lost $150 in the fourth quarter.a. What
Assume that you have the following activity – inflows and outflows – in your investment account month by month for half a year.Account M1 M2 M3 M4 M5 M6 Starting value $10,000 $17,000 $16,750
How does risk affect your speculative and precautionary motives to holding cash balances?
Recall from your microeconomics course the concept of “marginal utility” and the “law of diminishing marginal utility”. As an example for the latter consider your thirst: as you drink more
Contrast an investment in a savings account to one in a stock. What are the differences between the two investments? What would entice you to select the stock investment?
Suppose a friend of yours approaches you and offers to give you $110 in a year’s period if you agree to give him $100 now. Assume that you are absolutely certain that you will be repaid.What is
What is the bid-ask spread and what does it indicate? Explain with an example.
What is the short-interest ratio and what does it indicate?
Say you want to invest $300,000 in a portfolio of securities. Of that amount, you allocate$90,000 to a money-market account and the rest in risky assets. The risky assets are stock H and bond N, and

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