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essentials of investments

Questions and Answers of Essentials of Investments

a. Suppose the real interest rate is 3% per year, and the expected inflation rate is 8%. What is the nominal interest rate?b. Suppose the expected inflation rate rises to 10%, but the real rate is
What are the expected return, risk premium, standard deviation, and ratio of risk premium to standard deviation for a complete portfolio with y = 0.75?
A three-asset portfolio has the following characteristics:What is the expected return on this three-asset portfolio? Asset X XXN Y Z Expected Return 15% 10 6 Standard
A universe of securities includes a risky stock (X), a stock index fund (M), and T-bills. 6.4 The data for the universe are:The correlation coefficient between X and M is -0.2.a. Draw the opportunity
Two portfolio managers work for competing investment management houses. Each 6.5 employs security analysts to prepare input data for the construction of the optimal portfolio. When all is completed,
What percent of the variance of stock ABC in Example 6.4 is systematic (market) risk? EXAMPLE Estimating the Index Model Using Historical Data 6.4 The direct way to calculate the slope and intercept
If only some investors perform security analysis while all others hold the market port- folio (M), would the CML still be the efficient CAL for investors who do not engage in security analysis?
Historical data for the S&P 500 Index show an average excess return over Treasury bills of about 8.5% with standard deviation of about 20%. To the extent that these averages approximate investor
Suppose the risk premium on the market portfolio is estimated at 8% with a standard deviation of 22%. What is the risk premium on a portfolio invested 25% in GM with a beta of 1.15 and 75% in Ford
a. Stock XYZ has an expected return of 12% and risk of β = 1.0. Stock ABC is expected to return 13% with a beta of 1.5. The market’s expected return is 11% and rf = 5%. According to the CAPM,
Using the factor portfolios of Example 7.11, find the fair rate of return on a security 7.6 with β1 = 0.2 and β2 = 1.4. Suppose the two-factor portfolios, here called portfolios 1 and 2, have
a. Suppose you observed that high-level managers make superior returns on investments in their company’s stock. Would this be a violation of weak-form market efficiency? Would it be a violation of
If everyone in the market believes in resistance levels, why do these beliefs not become self-fulfilling prophecies?
What would happen to market efficiency if all investors attempted to follow a passive strategy?
Legg Mason’s Value Trust, managed by Bill Miller, outperformed the S&P 500 in each of the 15 years ending in 2005. Is Miller’s performance sufficient to dissuade you from a belief in efficient
We saw in the last chapter that stocks seem to exhibit a pattern of short- to middle term momentum, along with long-term reversals. How might this pattern arise from an interplay between the
How might the P/E effect also be explained as a consequence of regret avoidance?
Fundamental risk may be limited by a “deadline” that forces a convergence between price and intrinsic value. What do you think would happen to a closed-end fund’s discount if the fund announced
A “fallen angel” bond is best defi ned as a bond issued:a. Below investment grade.b. At an original issue discount.c. As investment grade, but declined to speculative grade.d. As a secured bond,
Consider a bond with a settlement date of February 22, 2008, and a maturity date of March 15, 2016. The coupon rate is 5.5%. If the yield to maturity of the bond is 5.34% (bond equivalent yield,
On May 30, 2006, Janice Kerr is considering the newly issued 10-year AAA corporatebonds shown in the following exhibit:a. Suppose that market interest rates decline by 100 basis points (i.e., 1%).
Suppose the interest rate decreases to 9%. What will happen to the price and duration of each bond in Spreadsheet 11.1? SPREADSHEET 11.1 Calculation of the duration of two bonds using Excel
a. In Concept Check 11.1, you calculated the price and duration of a three-year maturity, 8% coupon bond for an interest rate of 9%. Now suppose the interest rate increases to 9.05%. What is the new
Figure 11.2 illustrates a 9% coupon, 8-year maturity bond with annual payments, selling at a yield to maturity of 10%. Confirm using Spreadsheet 11.2 that the bond’s duration is 5.97 years. What
Show that the duration of a perpetuity increases as the interest rate decreases, in accordance with Rule 4.Rule 4: With other factors held constant, the duration and interest rate sensitivity of a
a. Suppose that this pension fund is obligated to pay out $800,000 per year in perpetuity. What should be the maturity and face value of the zero-coupon bond it purchases to immunize its
What will be the rate of return in Example 11.5 if the manager forecasts that in two years the yield to maturity on 18-year maturity bonds will be 10% and that the reinvestment rate for coupons will
How would an increase in trading costs affect the attractiveness of dedication versus immunization?
A fixed-income portfolio manager is unwilling to realize a rate of return of less than 3% annually over a five-year investment period on a portfolio currently valued at $1 million. Three years later,
a. IBX’s stock dividend at the end of this year is expected to be $2.15, and it is expected to grow at 11.2% per year forever. If the required rate of return on IBX stock is 15.2% per year, what is
Consider an economy where the dominant industry is automobile production for domestic consumption as well as export. Now suppose the auto market is hurt by an increase in the length of time people
Suppose the government wants to stimulate the economy without increasing interest rates. What combination of fiscal and monetary policy might accomplish this goal?
Large tax cuts in 2001 were followed by relatively rapid growth in GDP. How would demand-side and supply-side economists differ in their interpretations of this phenomenon?
In which phase of the business cycle would you expect the following industries to enjoy their best performance?(a) Newspapers; (b) Machine tools; (c) Beverages; (d) Timber.
You expect the price of IBX stock to be $59.77 per share a year from now. Its current market price is $50, and you expect it to pay a dividend one year from now of $2.15 per share.a. What is the
Cash flow from operating activities includes:a. Inventory increases resulting from acquisitions.b. Inventory changes due to changing exchange rates.c. Interest paid to bondholders.d. Dividends paid
Classify the following statements according to where each fits in the objectiveconstraints- policies framework.a. Invest 5% in bonds and 95% in stocks.b. Do not invest more than 10% of the budget in
Which of the following best explains a ratio of “net sales to average net fixed assets” that exceeds the industry average?a. The firm added to its plant and equipment in the past few years.b. The
In a period of rapid inflation, companies ABC and XYZ have the same reported earnings. ABC uses LIFO inventory accounting, has relatively fewer depreciable assets, and has more debt than XYZ. XYZ
An analyst applies the DuPont system of financial analysis to the following data for a company:What is the company’s return on equity? Leverage ratio • Total asset turnover Net profit margin •
In an inflationary period, the use of FIFO will make which one of the following more realistic than the use of LIFO?a. Balance sheetb. Income statementc. Cash flow statementd. None of the above
A company acquires a machine with an estimated 10-year service life. If the company uses the Accelerated Cost Recovery System depreciation method instead of the straightline method:a. Income will be
Why might a firm’s ratio of long-term debt to long-term capital be lower than the industry average, but its ratio of income-before-interest-and-taxes to debt-interest charges be lower than the
During a period of falling price levels, the financial statements of a company using FIFO instead of LIFO for inventory accounting would show:a. Lower total assets and lower net income.b. Lower total
Cash flow from investing activities excludes:a. Cash paid for acquisitions.b. Cash received from the sale of fixed assets.c. Inventory increases due to a new (internally developed) product line.d.
a. What will be the proceeds and net profits to an investor who purchases the April 2007 expiration IBM calls with exercise price $90 if the stock price at maturity is $80? What if the stock price at
Consider these four option strategies: (i) Buy a call; (ii) Write a call; (iii) Buy a put; (iv) Write a put.a. For each strategy, plot both the payoff and profit diagrams as a function of the
The following price quotations are for exchange-listed options on Primo Corporation common stock.With transaction costs ignored, how much would a buyer have to pay for one call option contract?
How is a callable bond similar to a covered call strategy on a straight bond?
Suppose the period of call protection is extended. How will this affect the coupon rate the company needs to offer to enable it to sell the bonds at par value?
Should a convertible bond issued at par value have a higher or lower coupon rate than a nonconvertible bond issued at par?
Suppose the call option had been underpriced, selling at $5.50. Formulate the arbitrage strategy to exploit the mispricing, and show that it provides a riskless cash flow in one year of $.6167 per
Show that the initial value of the call option in Example 16.1 is $4.434.a. Confirm that the spread in option values is Cu = Cd = $6.984.b. Confirm that the spread in stock values is uS0 = dS0 =
Would you expect the hedge ratio to be higher or lower when the call option is more in the money?
Calculate the call option value if the standard deviation on the stock is 0.6 instead of 0.5. Confirm that the option is worth more using this higher volatility.
What is the elasticity of a put option currently selling for $4 with exercise price $120, and hedge ratio -0.4 if the stock price is currently $122?
The open interest on a futures contract at any given time is the total number of outstanding:a. Contracts.b. Unhedged positions.c. Clearinghouse positions.d. Long and short positions.
a. Compare the profit diagram in Figure 17.2B to the payoff diagram for a long position in a put option. Assume the exercise price of the option equals the initial futures price.b. Compare the profit
In futures trading, the minimum level to which an equity position may fall before requiring additional margin is most accurately termed the:a. Initial margin.b. Variation margin.c. Cash flow
What must be the net inflow or outlay from marking to market for the clearinghouse?
What are the sources of risk to an investor who uses stock index futures to hedge an actively managed stock portfolio?
Return to the arbitrage strategy just laid out. What would be the three steps of the strategy if F0 were too low, say, $617? Work out the cash flows of the strategy now and at time T in a table like
Suppose the bond portfolio is twice as large, $20 million, but that its modified duration is only 4.5 years. Show that the proper hedge position in T-bond futures is the same as the value just
A pension fund holds a portfolio of money market securities that the manager believes are paying excellent yields compared to other comparable-risk short-term securities. However, the manager
Consider the following data for a particular sample period:Calculate the following performance measures for portfolio P and the market: Sharpe, Jensen (alpha), and Treynor. The T-bill rate during the
A plan sponsor with a portfolio manager who invests in small capitalization, high-growth stocks should have the plan sponsor’s performance measured against which one of the following?a. S&P 500
Assume you purchased a rental property for $50,000 and sold it one year later for $55,000 (there was no mortgage on the property). At the time of the sale, you paid $2,000 in commissions and $600 in
A two-year investment of $2,000 results in a return of $150 at the end of the first year and a return of $150 at the end of the second year, in addition to the return of the original investment. What
Does the rationale of sheltering bonds rather than stocks apply to preferred stocks?
Suppose all taxpayers were like you, and the IRS wished to raise a fixed tax revenue. Would it be wise to offer the Roth IRA option?
With the IRA-style tax shelter, all your taxes are due during retirement. Is the trade-off between exemption and tax rate different from the circumstance where you have no shelter?
Are you indifferent between an increase in the low-income bracket tax rate versus an equal increase in the high bracket tax rates?
If you project a rate of inflation of 4%, what nominal ROR on investments would you need to maintain the same real retirement annuity as in Spreadsheet 20.2? SPREADSHEET 20.2 A real retirement
Using the data in Table 19.15, compute the manager’s country and currency selection if portfolio weights had been 40% in Europe, 20% in Australia, and 40% in the Far East. TABLE 19.15 Example of
Would a 1% increase in the exemption compensate you for a 1% increase in the tax rate?
Suppose you like the plan of tilting savings toward later years, but worry about the increased risk of postponing the bulk of your savings to later years. Is there anything you can do to mitigate the
How many pounds would the investor in Example 19.2 need to sell forward to hedge exchange rate risk if: (a) r(UK) = 20%; and (b) r(UK) = 30%? If the futures exchange rate in Example 19.1 had been
Using the data in Example 19.1, 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 = $2.00/£; (b) E1 = $2.20/£. EXAMPLE
Part of your retirement expenditures will be paid for with your Social Security benefits. Part will come from your retirement savings. Compare the risks surrounding the income stream that will be
Project your Social Security benefits with the parameters of Section 20.6.Social Security benefits Section 20.6Calculation of benefits for individuals retiring in a given year is done in four
What if anything should you do about the risk of rapid increase in college tuition?
Should you have any preference for fixed versus variable rate mortgages?
Insurance companies offer life insurance on your children. Is this a good idea?
In addition to expected longevity, what traits might affect an individual’s demand for a life annuity?
If matrimony is such a good deal, but you haven’t yet found a soul mate, should you rush to surf the Web for a potential spouse?
Describe several distinguishing characteristics of endowment funds that differentiate them from pension funds.
a. Think about the financial circumstances of your closest relative in your parents’ generation (for example, your parents’ household if you are fortunate enough to have them around). Write down
A clearly written investment policy statement is critical fora. Mutual fundsb. Individualsc. Pension fundsd. All investors
The investment policy statement of an institution must be concerned with all of the following except:a. Its obligations to its clients.b. The level of the market.c. Legal regulations.d. Taxation.
Under the provisions of a typical corporate defined-benefit pension plan, the employer is responsible for:a. Paying benefits to retired employees.b. Investing in conservative fixed-income assets.c.
Which of the following statements reflects the importance of the asset allocation decision to the investment process? The asset allocation decision:a. Helps the investor decide on realistic

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