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essentials of investments

Questions and Answers of Essentials of Investments

22. Distinguish between technical and fundamental security analysis.
21. What factors might an individual investor take into account in determining his or her investment policy?
20. Financial advisers often contend that elderly people should invest their portfolios more conservatively than younger people. Should a conservative investment policy for an elderly person call for
19. Why does it not make sense to establish an investment objective of "making a lot of money"?
18. What are the five steps to the investment process? What is the importance of each step to the entire process?
17. Describe how life insurance companies, mu tual funds, and pension plans each act as financial inte rmediaries.
16. Why might it be reasonable to believe that including securities issued in foreign countries will improve the risk-reward performance of your portfolio?
15. Calculate the average annual return on common stocks, government bonds, and Treasury bills during the six decades from the 1930s through the 1980s. Which period was clearly the "decade of the
14. Again referring to Table 1.1, in terms of total returns, what was the worst single calendar year for common stock investors? What was the worst year in the 1970s? Compare these two years in terms
13. Examining Table 1.1, you can find many years in which Treasury bills produced greater returns than common stocks. How can you reconcile this fact with the statements made in the text citing a
12. Give an example, outside of the financial markets, in which you commonly face a trade-off between risk and return.
11. Does it seem reasonable that higher return securities historically have exhibited higher risk than have securities that yielded lower returns? Why?
9. In 1951 the Treasury Department and the Federal Reserve System (the Fed)came to an agreement known as the "Accord," whereby the Fed was no longer obligated to peg interest rates on Treasury
8. Why are corporate bonds riskier than U.S. government bonds?
7. Why are Treasury bills considered to be a riskfree investment? In what waydo investors bear risk when they own Treasury bills?
6. Explain why the rate of return on an investment represents the investor's relative increase in wealth from that investment.
5. At the beginning of the year, Ray Fisher decided to take $50,000 in savings out of the bank and invest it in a portfolio of stocks and bonds; $20,000 was placed into common stocks and $30,000 into
4. Flit Cramer owns a portfolio of common stocks that was worth $150,000 at the beginning of the year. At the end of the year, Flit's portfolio was worth $162,000.What was the return on the portfolio
3. Colfax Glassworks stock currently sells for $36 per share. One year ago the stock sold for $33. The company recently paid a $3 per share dividend. What was the rate of return for an investor in
2. After the overthrow ofcommunist regimes in Eastern Europe, many of the fledgling democracies placed the development of security markets near the top of their economic agendas. Why do you think
1. Why do secondary security markets not generate capital for the issuers of securities traded in those markets?
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?c. What
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
Lanni Products is a start-up computer software development firm. It currently owns computer equipment worth $30,000 and has cash on hand of $20,000 contributed by Lanni’s owners.For each of the
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
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
Here is another quote on savings and investment from the Securities Industry Association( www.pathtoinvesting.org ). Critique and correct this statement in light of the definitions of saving and
Below is an excerpt from the investor education Web site of the SEC.(Appendix)a. How does the excerpt define the difference between saving and investing?b. In what ways does this differ from the
You see an advertisement for a book that claims to show how you can make $1 million with no risk and with no money down. Will you buy the book?(Appendix)
What are some advantages and disadvantages of topdown versus bottom-up investing styles?(Appendix)
The average rate of return on investments in large stocks has outpaced that on investments in Treasury bills by about 8%since 1926. Why, then, does anyone invest in Treasury bills?(Appendix)
Give an example of three financial intermediaries and explain how they act as a bridge between small investors and large capital markets or corporations.(Appendix)
We noted that oversight by large institutional investors or creditors is one mechanism to reduce agency problems.Why don’t individual investors in the firm have the same incentive to keep an eye on
Discuss the advantages and disadvantages of the following forms of managerial compensation in terms of mitigating agency problems, that is, potential conflicts of interest between managers and
Consider Figure 1.5 , which describes an issue of American gold certificates.(Appendix)a. Is this issue a primary or secondary market transaction?b. Are the certificates primitive or derivative
Examine the balance sheet of commercial banks in Table 1.3 . What is the ratio of real assets to total assets? What is that ratio for nonfinancial firms ( Table 1.4 )? Why should this difference be
Reconsider Lanni Products from Problem 7.(Appendix)a. Prepare its balance sheet just after it gets the bank loan. What is the ratio of real assets to total assets?b. Prepare the balance sheet after
Lanni Products is a start-up computer software development firm. It currently owns computer equipment worth $30,000 and has cash on hand of $20,000 contributed by Lanni’s owners. For each of the
Suppose you discover a treasure chest of $10 billion in cash.(Appendix)a. Is this a real or financial asset?b. Is society any richer for the discovery?c. Are you wealthier?d. Can you reconcile your
Firms raise capital from investors by issuing shares in the primary markets. Does this imply that corporate financial managers can ignore trading of previously issued shares in the secondary
Although we stated that real assets comprise 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
What is the relationship between securitization and the role of financial intermediaries in the economy? What happens to financial intermediaries as securitization progresses?(Appendix)
Why would you expect securitization to take place only in highly developed capital markets?(Appendix)
Financial engineering has been disparaged as nothing more than paper shuffling. Critics argue that resources used for rearranging wealth (that is, bundling and unbundling financial assets)might be
Are the following assets real or financial? (Appendix)a. Patentsb. Lease obligationsc. Customer goodwilld. A college educatione. A $5 bill
24. Devise a portfolio using only call options and shares of stock with the following value (payoff) at the option expiration date. If the stock price is currently 53, what kind of bet is the
6. In each of the following questions, you are asked to compare two options with parameters as given. The risk-free interest rate for all cases should be assumed to be 6%. Assume the stocks on which
37. Salomon Brothers believes that market volatility will be 20% annually for the next 3 years.Three-year at-the-money call and put options on the market index sell at an implied volatility of 22%.
5. Ken Webster manages a $200 million equity portfolio benchmarked to the S&P 500 index. Over the past 2 years, the S&P 500 index has appreciated considerably. Webster believes the market is
9. Suppose that the relationship between the rate of return on IBM stock, the market index, and a computer industry index can be described by the following regression equation: Industry . If a
12. Consider the following information:where the interest rates are annual yields on U.S. or U.K. bills. Given this information:a. Where would you lend?b. Where would you borrow?c. How could you
7. You are provided the information outlined as follows to be used in solving this problem.Situation A A fixed-income manager holding a $20 million market value position of U.S. Treasury 113 4% bonds
6. Suppose you think Wal-Mart stock is going to appreciate substantially in value in the next 6 months. Say the stock’s current price, S 0 , is $100, and the call option expiring in 6 months has an
Suppose that the index model for the excess returns of stocks A and B is estimated with the following results:Find the standard deviation of each stock and the covariance between them. = RA 1.0%.9RM
Which of the following statements about the minimum variance portfolio of all risky securities are valid? (Assume short sales are allowed.) Explain.a. Its variance must be lower than those of all
The following are estimates for two stocks.The market index has a standard deviations of 22% and the risk-free rate is 8%.a. What are the standard deviations of stocks A and B?b. Suppose that we were
Consider the following two regression lines for stocks A and B in the following figure.M − rf rM − rfa. Which stock has higher firm-specific risk?b. Which stock has greater systematic (market)
A portfolio manager summarizes the input from the macro and micro forecasters in the following table:a. Calculate expected excess returns, alpha values, and residual variances for these stocks.b.
The data below describe a three-stock financial market that satisfies the single-index model.The standard deviation of the market index portfolio is 25%.a. What is the mean excess return of the index
9. Evaluate the market timing and security selection abilities of four managers whose performances are plotted in the accompanying diagrams. A p-f D B
4. 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
Suppose you think Apple stock is going to appreciate substantially in value in the next year.Say the stock’s current price, S0, is $100, and a call option expiring in one year has an exercise
A large corporation issued both fixed- and floating-rate notes five years ago, with terms given in the following table:a. Why is the price range greater for the 6% coupon bond than the floating-rate
The following is part of the computer output from a regression of monthly returns on Waterworks stock against the S&P 500 index. A hedge fund manager believes that Waterworks is underpriced, with
b. What is the contribution of security selection to portfolio performance if the macro forecast is adjusted upward, for example, to RM = 12%, and short sales are again allowed?
a. When short positions are prohibited, the manager simply discards stocks with negative alphas. Using the preceding example, what would be the composition of the active portfolio if short sales were
1. The five-year history of annual rates of return in excess of the T-bill rate for two com- peting stock funds is The Bull Fund The Unicorn Fund -21.7% -1.3% 28.7 15.5 17.0 14.4 2.9 28.9 -11.9
b. How would these funds compare by Sharpe's measure?
b. Analyze the utility value of the optimal risky portfolio for the A Compare to that of problem 6. = 2.8 investor.
2. Historical data suggest that the standard deviation of an all-equity strategy is about 5.5% per month. Suppose that the risk-free rate is now 1% per month and that market volatil- ity is at its
3. In scrutinizing the record of two market timers, a fund manager comes up with the fol- lowing table: Number of months that > IT Correctly predicted by timer A Correctly predicted by timer B Number
a. What are the conditional probabilities, P and P2, and the total ability parameters for timers A and B?
b. Using the data of problem 2, what is a fair monthly fee for the two timers?
4. A portfolio manager summarizes the input from the macro and micro forecasters in the following table: Micro Forecasts Asset Expected Return (%) Beta Residual Standard Deviation (%) Stock A 20 1.3
b. Construct the optimal risky portfolio.c. What is Sharpe's measure for the optimal portfolio and how much of it is contributed by the active portfolio? What is the M?d. What should be the exact
5. Recalculate problem 4 for a portfolio manager who is not allowed to short-sell securities.a. What is the cost of the restriction in terms of Sharpe's measure and M?b. What is the utility loss to
7. Construct the optimal active and overall risky portfolio with the data of problem 6 with no restrictions on short sales.a. What is the Sharpe measure of the optimal risky portfolio and what is the
b. By how much is the optimal passive portfolio superior to the single-factor passive portfolio, M, in terms of Sharpe's measure?
c. Analyze the utility improvement to the A === 2.8 investor relative to holding portfolio M as the sole risky asset that arises from the expanded macro model of the portfolio manager.
6. A portfolio management house approximates the return-generating process by a two- factor model and uses two factor portfolios to construct its passive portfolio. The input table that is
9. Suppose that based on the analyst's past record, you estimate that the relationship be- tween forecast and actual alpha is: Actual abnormal return = .3 X Forecast of alpha Use the alphas from
1. Given that the implicit assumption of plan sponsors is true to the extent that there is perfect correlation in percentile rankings from one period to the next, list the numerical values you would
c. If a risk-averse investor (with a coefficient of risk aversion A = 3) had to choose one of these funds to mix with T-bills, which fund should he choose, and how much should be invested in that
8. Recalculate problem 7 with a short-sale restriction. Compare the results to those from problem 7.
4. Some pension plan sponsors have agreed that a good practice is to terminate managers who are in the top quartile and to hire those who are in the bottom quartile. State what those who advocate
3. Upon performing such a regression, you observe an intercept of .51, a slope of -.05, and an R-squared of .01. Based on this regression, state your best estimate of a manager's percentile ranking
2. Given that there is no correlation in percentile rankings from period to period, list the numerical values you would expect to observe for the intercept of the regression, the slope of the
Small firms will have relatively high loadings (high betas) on the SMB (small minus big) factor.a. Explain why.b. Now suppose two unrelated small firms merge. Each will be operated as an independent
Assume a universe of n (large) securities for which the largest residual variance is of an order not larger than nsM 2 . Construct as many different weighting schemes as you can that generate
With respect to the comments of Stiles and McCracken concerning for whom the GDP Fund would be appropriate:a. McCracken was correct and Stiles was wrong.b. Both were correct.c. Stiles was correct and
The GDP Fund composed from the other three funds would have a weight in Utility Fund equal to ( a ) 2.2; ( b ) 3.2; or ( c ) .3.
With respect to McCracken’s APT model estimate of Orb’s Large Cap Fund and the information Kwon provides, is an arbitrage opportunity available?
According to the APT, if the risk-free rate is 4%, what should be McCracken’s estimate of the expected return of Orb’s High Growth Fund?
As a finance intern at Pork Products, Jennifer Wainwright’s assignment is to come up with fresh insights concerning the firm’s cost of capital. She decides that this would be a good opportunity
Suppose that the market can be described by the following three sources of systematic risk with associated risk premiums.Factor Risk Premium Industrial production ( I ) 6%Interest rates ( R ) 2
Consider the following multifactor (APT) model of security returns for a particular stock.Factor Factor Beta Factor Risk Premium Inflation 1.2 6%Industrial production 0.5 8 Oil prices 0.3 3a. If
The SML relationship states that the expected risk premium on a security in a one-factor model must be directly proportional to the security’s beta. Suppose that this were not the case. For
Assume that security returns are generated by the single-index model, Ri 5 ai 1 biRM 1 ei where R i is the excess return for security i and R M is the market’s excess return. The risk-free rate is
Assume that stock market returns have the market index as a common factor, and that all stocks in the economy have a beta of 1 on the market index. Firm-specific returns all have a standard deviation
Suppose that two factors have been identified for the U.S. economy: the growth rate of industrial production, IP, and the inflation rate, IR. IP is expected to be 3%, and IR 5%. A stock with a beta

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