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essentials of investments

Questions and Answers of Essentials of Investments

3. Why are the indifference curves of typical investors assumed to slope upward to the right?
1. Why must it be the case that an investor with diminishing marginal utility of wealth is risk-averse?
29. (Appendix Question) What is the intrinsic value of a pure-discount bond with a $1,000 face value maturing one year from today and having an 8% discount rate with continuous compounding?
28. (Appendix Question) Recalculate the answers to Questions 15 and 16 assuming that interest compounds continuously.
27. Assume that you own a bond that you purchased three years ago for $10,300. The bond has made three annual interest payments of$700 to you, the last of which wasjust paid. At the end of year 1 the
26. Pol Perritt purchased 100 shares of Waunakee Inc. and held the stock for four years. Pol 's holding-period returns over these four years were:Year Return 1 +20%2 +30%3 +50%4 -90%a. What was the
25. If an investment returns 7% per year, how long does it take for the investment's value to double?
24. The one-year spot rate is 9%, and the twa-year spot rate is 7%. If the one-year spot rate expected in one year is 4.5%, according to the liquidity preference theory, what must be the one-year
23. Assume that the current spot rates are as follows:Yearslrom T~1 2 3 Spot Rate.B%9%10%If the unbiased expectations theory holds, what should be the yields-to-maturity on one- and two-year pure
22. Four theories explaining the term structure of interest rates are described in the chapter. Which theory do you believe best explains the relationship between spot rates and term-to-maturity?
21. How would your answers to Question 20 change if the forward interest rate structure were downward-sloping?
20. Assume that the current structure of forward interest rates is upward-sloping.Which will have a lower yield-to-maturity:a. A 15-year pure-discount bond or a lO-year pure-discount bond?b. AID-year
19. Is it true that an observed downward-sloping yield curve is inconsistent with the liquidity preference theory of the term structure of interest rates? Explain.
18. Turn to the table in The Wall StreetJournal entitled "Treasury Bonds, Notes &Bills." Find the yield-to-maturity for Treasury securities maturing in one month, three months, one year, five years,
17 A finance company offers you a loan of$8,000 for two years. Interest on the loan of$1,500 is subtracted from the loan proceeds immediately. What is the bank discount rate on the loan? What is the
16. Marty Marion is considering placing $30,000 in a three-year, default-free fixedincome investment that promises to provide interest at the rate of8% during the first year, 10% in the second year,
15. Mercury National Bank offers a passbook savings account that pays interest at a stated annual rate of 6%. Calculate the effective annual interest rate paid by Mercury National if it compounds
14. Assume that the government has issued three bonds. The first, which pays $1,000 one year from today, is now selling for $909.09. The second, which pays $100 one year from today and $1, I00 one
13. Assume that the current one-year spot rate is 6% and the forward rates for one year hence and two years hence are, respectively:/1,2 = 9%h.3 = 10%What should be the market price of an 8% coupon
12. Given the following forward rates, calculate the one-, two-, three-, and four-year spot rates.FoniVardTl.mePerIod frl, I J1:2 h.j. ft,,4 ForwanfRate 10.0%9.5%9.0%8.5%
11. Given the following spot rates for various periods of time from today, calculate forward rates from years 1 to 2, 2 to 3, and 3 to 4.Years from Today 12, 3 4spot Rate 5.0%5.5%6.5%7.0% ..
10. Distinguish between spot rates and forward rates.
9. What are the discount factors associated with three-year, four-year, and five-year$l,OOO-face-value pure-discount bonds that sell for $810.60, $730.96, and $649.93, respectively?
8. Consider three pure-discount bonds with maturities of one, two, and three years and prices of$930.23, $923.79, and $919.54, respectively. Each bond has a $1,000 face value. On the basis of this
7. Patsy Dougherty bought a $1,OOD-face-value bond with a 9% annual coupon and three years to maturity that makes its first interest payment one year from today.Patsy bought the bond for $975.13.
6. The concept of yield- to-maturity is based on two crucial assumptions. What are those assumptions? What will happen to the bondholder's return if those assumptions are violated?
5. Camp Douglas Dirigibles has a bond outstanding with four years to maturity, a face value of$I,OOO, and an annual coupon payment of$100. What is the price of the Camp Douglas bond if its
4. Consider two bonds, each with a $1,000 face value and each with three years remaining to maturity.a. The first bond is a pure-discount bond that currently sells for $816.30. What is its
3. At the end of 1974, Emil Bildilli held a portfolio of long-term U.S. government bonds valued at $14,000. At the end of 1981, Emil's portfolio was worth $16,932.Referring to Table 1.1, calculate
2. Equation (5.3) gives a method to approximately calculate the real rate of interest.Why is that approximation much less accurate in a hyperinflationary economy than in an economy with a relatively
1. If the real return on an investment in a given year was 6.0%, while its nominal return was 11.3%, what must have been the inflation rate during the year?
19. Fairfax asks for information concerning the benefits of active portfolio management.She is particularly interested in the question of whether active managers can be expected to consistently
18. Discuss the role of a portfolio manager in a perfectly efficient market.
17. When investment managers present their historical performance records to potential and existing customers, market regulators require the managers to qualify those records with the comment that
16. In perfectly efficient markets with transaction costs, why should analysts be able to find mispriced securities?
15. The text states that tests for market efficiency involving an asset pricing model are really joint tests. What is meant by that statement?
14. In 1986 and 1987 several high-profile insider trading scandals were exposed.a. Is successful insider trading consistent with the three forms of market efficiency?Explain.b. Play the role of
13. What are the implications of the three forms of market efficiency for technical and fundamental analysis (discussed in Chapter I)?
12. When a corporation announces its earnings for a period, the volume of transactions in its stock may increase, but frequently that increase is not associated with significant moves in the price of
11. Although security markets may not be perfectly efficient, what is the rationale for expecting them to be highly efficient?
10. Is it true that in a perfectly efficient market no investor would consistently be able to earn a profi t?
9. Would you expect that NYSEspecialists should be able to earn an abnormal profit in a semistrong efficient market? Why?
8. Would you expect that fundamental security analysis makes security markets more efficient? Why?
7. Consider the following types of information. If this information is immediately and fully reflected in security prices, what form of market efficiency is implied?a. A company's recent quarterly
6. Does the fact that a market exhibits weak-form efficiency necessarily imply that it is also strong-form efficient? How about the converse statement? Explain.
5. Distinguish between the three forms of market efficiency.
4. We all know that investors have widely diverse opinions about the future course of the economy and earnings forecasts for various industries and companies.How then is it possible for all these
3. Imp Begley is pondering this statement: "The pattern ofsecurity price behavior might appear the same whether markets were efficient or security prices bore no relationship whatsoever to investment
2. Using demand-to-buy or supply-to-sell schedules, explain and illustrate the effect of the following events on the equilibrium price and quantity traded of Fairchild Corporation's stock.a.
1. What is the difference between call security markets and continuous security markets?
24. What functions does a clearinghouse perform?
23. Why does the price impact of a trade seem to be directly related to the size of the trade?
22. Transaction costs can be thought of as being derived from three sources. Identify and describe those sources.
21. After May Day, why did commission rates fall so sharply for large investors but decline so little (or even increase) for small investors?
20. What is the purpose of SIPe insurance? Given the late 1980s experience of the ban king and savings and loan deposit insurance programs, under what conditions might SIPC insurance he expected to
19. Why was May Day such an important event for the NYSE?
18. Distinguish between the third and fourth markets.
17. The NYSE has strongly opposed the creation ofalternative market trading structures such as off-exchange crossing systems. The NYSE claims that these alternative structures undermine its ability
16. What are some of the major steps that have been taken toward the ultimate emergence of a truly nationwide security market?
15. How might a dealer attempt to discern whether a trader is information motivated?
14. Using the model described in the text, calculate the appropriate bid-ask spread for a dealer making a market in a security under the conditions that 15% of all traders are information-motivated
13. Distinguish between two forms of preferencing: payment for order flow and internalization.
12. If the NYSE moved to decimal pricing with prices moving in at $.05 increments, would there be greater opportunities for price improvement over the current pricing system? Explain.
11. Why is Nasdaq so important to the success of the OTC market?
10. Why can't all trade orders on the NYSE, no matter how large, be handled through the SuperDOT system?
9. Because specialists such as Chick Gandil are charged with maintaining a "fair and orderly" market, at times they will be required to sell when others are buying and to buy when others are selling.
7. Pigeon Falls Fertilizer Company is listed on the NYSE. Gabby Hartnett, the specialist handling Pigeon Falls stock, is currently bidding 35~ and asking 35~. What would be the likely outcomes of the
6. Describe the functions of commission brokers, floor brokers, and floor traders.
5. Give several reasons why a corporation might desire to have its stock listed on the NYSE.
4. Differentiate between the role ofa specialist on the NYSE and the role ofa dealer on the OTC market.
3. Discuss the advantages and disadvantages of the NYSE specialist system.
2. Circuitbreakers were first instituted after the market crash ofOctober 1987. Some observers argue that the rapid increase in the stock market's value since 1987 has diminished whatever value the
1. Virtually all secondary trading ofsecurities takes place in continuous markets as opposed to call markets. What aspects of continuous markets causes them to dominate call markets?
26. On May 1, Ivy Olson sold short 100 shares of Minnetonka Minerals stock at $25 per share and bought on margin 200 shares ofSt. Louis Park Company stock for$40 per share. The initial margin
25. Pooch Barnhart purchases 100 shares of Batavia Lumber Company stock on margin at $50 per share. Simultaneously, Pooch short sells 200 shares of Geneva Shelter stock at $20 per share. With an
24. Distinguish between an investor's receiving a margin call and having his or her margin account restricted.
23. What aspects of short selling do brokerage houses typically find to be especially profitable?
22. Calculate Candy Cummings's rate of return in parts (a) and (b) of Problem 17, assuming that the short loan wasflat but the initial margin deposit earned interest at a rate of 8% and that the
21. The stock of DeForest Inc. traded at the beginning of the year for $70 per share.At that time Deerfoot Barclay short sold 1,000 shares of the stock. The initial margin requirement was 50%.
20. Eddie Gaedel is an inveterate short seller. Is it true that Eddie's potential losses are infinite? Why? Conversely, is it true that the maximum return that Eddie can earn on his investment is
19. Willie Keeler short sold 300 shares of Sun Prairie Foods stock for $42 per share. The initial margin requirement is 50% and the maintenance margin requirement is 40%. To what price can the stock
18. Dinty Barbare short sells 500 shares of Naperville Products at $45 per share. The initial margin and maintenance margin requirements are 55% and 35%, respectively.If Naperville stock rises to
17. Through a margin account, Candy Cummings short sells 200 shares of Madison Inc. stock for $50 per share. The initial margin requirement is 45%.a. If Madison stock subsequently rises to $58 per
16. Beauty Bancroft short sells 500 shares of Rockdale Manufacturing at $25 per share. The initial margin requirement is 50%. Prepare Beauty's balance sheet as of the time of the transaction.
15. Individual investors are sometimes contacted by their brokers and told that they have "unused buying power" in their brokerage accounts. What do the brokers mean by this statement?
14. Ed Delahanty purchased 500 shares of Niagara Corporation stock on margin at the beginning of the year for $30 per share. The initial margin requirement was 55%. Ed paid 13% interest on the margin
13. Calculate Buck Ewing's rate of return in parts (b) and (c) of Problem 6 under the assumptions that the margin loan was outstanding for one year and carried an interest rate of 10% and that the
12. Penny Bailey bought on margin 500 shares ofSouth Beloit Inc. at $35 per share.The initial margin requirement was 45% and the annual interest on margin loans was 12%. Over the next year the stock
10. Lizzie Arlington has deposited $15,000 in a margin account with a brokerage firm. If the initial margin requirement is 50%, what is the maximum dollar amount of stock that Lizzie can purchase on
9. Cap Anson originally purchased 100 shares of Avalon Company's stock for $13 per share on margin. The initial margin requirement is 60% and the maintenance margin requirement is 35%. To what price
8. Snooker Arnovich buys on margin 1,000 shares of Rockford Systems stock at $60 per share. The initial margin requirement is 50% and the maintenance margin requirement is 30%. If the Rockford stock
7. Distinguish between the initial margin requirement and the maintenance margin requirement.
6. Buck Ewing opened a margin account at a local brokerage firm . Buck's initial investment was to purchase 200 shares of Woodbury Corporation on margin at$40 per share. Buck borrowed $3,000 from a
5. Lollypop Killefer purchases on margin 200 shares of Landfall Corporation stock at $75 per share. The initial margin requirement is 55%. Prepare Lollypop's balance sheet for this investment at the
4. Why are margin account securities held in street name?
3. Discuss the advantages and disadvantages to the investor of the following:a. Market orderb. Limit orderc. Stop order
2. How many round lots and what odd lot size are in an order for 511 shares?
I. Describe the conflict of interest that typically exists in the investment advisory relationship between a brokerage firm and its clients.
24. Ambrose Green, 63, is a retired engineer and a client of Clayton Asset Management Associates ("Associates"). His accumulated savings are invested in Diversified Global Fund ("the Fund"). an
23. Donovan believes that the Board should emphasize the fundamental long-term considerations related to investment for Bl's plan and deemphasize the shortterm performance aspects. Recognizing that a

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