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essentials of investments

Questions and Answers of Essentials of Investments

Using the factor portfolios of Example 10.5 , find the equilibrium rate of return on a portfolio with 1 .2 and 2 1.4.Consider the following regression results for stock X.rX 2% 1.2
Continue to use the data in Example 10.4 . Now consider portfolio G, which is well diversified with a beta of 1⁄3 and expected return of 5%. Does an arbitrage opportunity exist? If so, what is the
a. A portfolio is invested in a very large number of shares ( n is large). The standard deviation of the residual return of any of these stocks is not so large as to overwhelm the rest of the
Suppose the factor risk premiums in Example 10.3 were RP GDP 4% and RP IR 2%.What would be the new value for the equilibrium expected rate of return on Northeast Airlines?
Using the IBM option prices in Figure 20.1 , calculate the market price of a riskless zero-coupon bond with face value $125 that matures in January on the same date as the listed options.
You are attempting to formulate an investment strategy. On the one hand, you think there is great upward potential in the stock market and would like to participate in the upward move if it
The options are on the same stock and have the same expiration date. One of the calls sells for $3; the other sells for $9.a. Draw the payoff graph for this strategy at the option expiration date.b.
You write a call option with X 5 50 and buy a call with X 5
The puts are on the same stock and have the same expiration date.a. Draw the payoff graph for this strategy.b. Draw the profit graph for this strategy.c. If the underlying stock has positive beta,
You write a put option with X 5 100 and buy a put with X 5
You write a January IBM put option with exercise price 125.a. Graph the payoff of this portfolio at option expiration as a function of IBM’s stock price at that time.b. What will be the profit/loss
Consider the following options portfolio. You write a January expiration call option on IBM with exercise price
Turn back to Figure 20.1 , which lists prices of various IBM options. Use the data in the figure to calculate the payoff and the profits for investments in each of the following January expiration
Should a convertible bond issued at par value have a higher or lower coupon rate than a nonconvertible bond at par?
Suppose the period of call protection is extended. How will the coupon rate the company needs to offer on its bonds change to enable the issuer to sell the bonds at par value?
Graph the payoff diagram for the collar described in Example 20.5 .
Suppose that IBM’s stock price at the exercise date is $140, and the exercise price of the call is $130. What is the payoff on one option contract? After a 2-for-1 split, the stock price is$70, the
a. What will be the proceeds and net profits to an investor who purchases the January expiration IBM calls with exercise price $125 if the stock price at expiration is $135?What if the stock price at
You have the following information for IBX Corporation for the years 2010 and 2012 (all figures are in $ million):What is the trend in IBX’s ROE; how can you account for it in terms of tax burden,
Recalculate the intrinsic value of Honda shares using the free cash flow model of Spreadsheet 18.2 (available at www.mhhe.com/bkm; link to Chapter 18 material) under each of the following
Recalculate the intrinsic value of Honda in each of the following scenarios by using the threestage growth model of Spreadsheet 18.1 (available at www.mhhe.com/bkm; link to Chapter 18 material).
ABC stock has an expected ROE of 12% per year, expected earnings per share of $2, and expected dividends of $1.50 per share. Its market capitalization rate is 10% per year.a. What are its expected
Confirm that the intrinsic value of Honda using ROE 5 13% is $38.05. ( Hint: First calculate the stock price in 2013. Then calculate the present value of all interim dividends plus the present value
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 1 year from now of $2.15 per share.a. What is the
Here are four industries and four forecasts for the macroeconomy. Match the industry to the scenario in which it is likely to be the best performer. Industry a. Housing construction b. Health care c.
Janet Meer is a fixed-income portfolio manager. Noting that the current shape of the yield curve is flat, she considers the purchase of a newly issued, 7% coupon, 10-year maturity, option-free
Spice asks Meyers (see previous problem) to quantify price changes from changes in interest rates. To illustrate, Meyers computes the value change for the fixed-rate note in the table.Specifically,
What will be the rate of return in Example 16.6 if the manager forecasts that in 2 years the yield on 18-year bonds will be 10%, and that the reinvestment rate for coupons will be 8%?
What are the differences between Macaulay duration, modified duration, and effective duration?
Show that the duration of the perpetuity increases as the interest rate decreases in accordance with rule 4.
a. In Concept Check 1, you calculated the price and duration of a 2-year maturity, 8% coupon bond making semiannual coupon payments when the market interest rate is 9%.Now suppose the interest rate
Consider the following $1,000 par value zero-coupon bonds: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 expected 1-year interest rate 3
You’ve been exposed to many “rates” in the last few pages. Explain the differences between spot rates, short rates, and forward rates.
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 2 years. Use the short rates derived in Figure 15.3 to compute the
Use Table 15.1 to find the short rate that will prevail in the fourth year. Confirm that the discount factor on the 4-year zero is a geometric average of 11 the short rates in the next 4 years.
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 the 10% coupon bond
Hatfield has begun recording all new equipment leases on its books as operating leases, a change from its consistent past use of capital leases, in which the present value of lease payments is
Recently, Galaxy Corporation lowered its allowance for doubtful accounts by reducing bad debt expense from 2% of sales to 1% of sales. Ignoring taxes, what are the immediate effects on( a ),
What were GI’s ROE, P/E, and P/B ratios in the year 2010? How do they compare to the industry average ratios, which were: ROE 5 8.64%; P/E 5 8; P/B 5 .69? How does GI’s earnings yield in 2010
Do a ratio decomposition analysis for the Mordett corporation of Concept Check 1, preparing a table similar to Table 19.6 .
What is the expected yield to maturity in Example 14.11 if the firm is in even worse condition?Investors expect a final payment of only$500, and the bond price has fallen to $650.
Show that if yield to maturity increases, then holding-period return is less than initial yield.For example, suppose in Example 14.8 that by the end of the first year, the bond’s yield to maturity
At what price will the bond in Example 14.7 sell in yet another year, when only 1 year remains until maturity? What is the rate of return to an investor who purchases the bond at $982.17 and sells it
A 20-year maturity 9% coupon bond paying coupons semiannually is callable in 5 years at a call price of $1,050. The bond currently sells at a yield to maturity of 8%. What is the yield to call?
Stock prices are useful as a leading indicator. To explain this phenomenon, which of the following is most accurate? Stock prices:a. Predict future interest rates and reflect the trends in other
The yield to maturity on two 10-year maturity bonds currently is 7%. Each bond has a call price of $1,100. One bond has a coupon rate of 6%, the other 8%. Assume for simplicity that bonds are called
The researchers at IAAI have forecasted positive trends for both job creation and consumer confidence. Which, if either, of these trends should have a positive affect on stock prices?
Why do you think the index of consumer expectations is a useful leading indicator of the macroeconomy?
Industries differ in their sensitivity to the business cycle. More sensitive industries tend to be those producing high-priced durable goods for which the consumer has considerable discretion as to
Calculate the price of the 30-year, 8% coupon bond for a market interest rate of 3% per half-year. Compare the capital gains for the interest rate decline to the losses incurred when the rate
The business cycle is the economy’s recurring pattern of expansions and recessions. Leading economic indicators can be used to anticipate the evolution of the business cycle because their values
In which phase of the business cycle would you expect the following industries to enjoy their best performance?a. Newspapersb. Machine toolsc. Beveragesd. Timber supply via monetary policy.
Suppose that Verizon issues two bonds with identical coupon rates and maturity dates. One bond is callable, however, whereas the other is not. Which bond will sell at a higher price?
What will be profits in the three scenarios for Firm C with fixed costs of $2 million and variable costs of $1.50 per unit? What are your conclusions regarding operating leverage and business risk?
Perform the first-pass regressions as did Chen, Roll, and Ross and tabulate the relevant summary statistics. ( Hint: Use a multiple regression as in a standard spreadsheet package. Estimate the betas
What would you conclude if you performed the Fama and MacBeth tests and found that the coefficients on b 2 and s ( e ) were positive?
According to the CAPM and the data in Table 13.1 , what are the predicted values of g 0 , g 1 , g 2 , and g 3 in the Fama-MacBeth regressions for the period 1946–1955?
a. How many regression estimates of the SCL do we have from the sample?b. How many observations are there in each of the regressions?c. According to the CAPM, what should be the intercept in each of
What is the reward-to-volatility ratio for the equity fund in CFA Problem 8?
Given $100,000 to invest, what is the expected risk premium in dollars of investing in equities versus risk-free T-bills on the basis of the following table?Action Probability Expected Return Invest
The variable ( A ) in the utility formula represents the:a. investor’s return requirement.b. investor’s aversion to risk.c. certainty equivalent rate of the portfolio.d. preference for one unit
On the basis of the utility formula above, which investment would you select if you were risk neutral?
On the basis of the utility formula above, which investment would you select if you were risk averse with A = 4?
What is the largest percentage fee that a client who currently is lending ( y < 1) will be willing to pay to invest in your fund? What about a client who is borrowing ( y > 1)?
Draw a diagram of your client’s CML, accounting for the higher borrowing rate. Superimpose on it two sets of indifference curves, one for a client who will choose to borrow, and one who will invest
Look at the data in Table 6.7 on the average risk premium of the S&P 500 over T-bills, and the standard deviation of that risk premium. Suppose that the S&P 500 is your risky portfolio.a. If your
What is the reward-to-volatility ratio ( S ) of your risky portfolio? Your client’s?
Your client chooses to invest 70% of a portfolio in your fund and 30% in a T-bill money market fund. What is the expected value and standard deviation of the rate of return on his portfolio?
Repeat Problem 11 for an investor with A = 3.What do you conclude?Use these inputs for Problems 13 through 19: You manage a risky portfolio with expected rate of return of 18% and standard deviation
( Hint: Choose several possible standard deviations, ranging from 0 to .25, and find the expected rates of return providing a utility level of .05. Then plot the expected return–standard deviation
Draw the indifference curve in the expected return–standard deviation plane corresponding to a utility level of .05 for an investor with a risk aversion coefficient of
Suppose that expectations about the S&P 500 index and the T-bill rate are the same as they were in 2009, but you find that a greater proportion is invested in T-bills today than in 2009.What can you
a. If an investor’s coefficient of risk aversion is A 3, how does the optimal asset mix change? What are the new values of E ( r C ) and C ?b. Suppose that the borrowing rate, rf B 5 9% is
Can the reward-to-volatility (Sharpe) ratio, S [ E ( r C ) r f ]/ C , of any combination of the risky asset and the risk-free asset be different from the ratio for the risky asset taken alone,[
What will be the dollar value of your position in equities ( E ), and its proportion in your overall portfolio, if you decide to hold 50% of your investment budget in Ready Asset?
a. How will the indifference curve of a less riskaverse investor compare to the indifference curve drawn in Figure 6.2 ?b. Draw both indifference curves passing through point P.
Assume that dollar-denominated T-bills in the United States and pound-denominated bills in the United Kingdom offer equal yields to maturity. Both are short-term assets, and both are free of default
Growth and value can be defined in several ways. “Growth” usually conveys the idea of a portfolio emphasizing or including only issues believed to possess above-average future rates of per-share
a. Briefly explain the concept of the efficient market hypothesis (EMH) and each of its three forms—weak, semistrong, and strong—and briefly discuss the degree to which existing empirical
Your investment client 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
Suppose that as the economy moves through a business cycle, risk premiums also change. For example, in a recession when people are concerned about their jobs, risk tolerance might be lower and risk
Examine the accompanying figure, 56 which presents cumulative abnormal returns both before and after dates on which insiders buy or sell shares in their firms. How do you interpret this figure? What
Should you buy or sell the stock?
The market consensus evaluation is that the management score is only
You know that firm XYZ is very poorly run. On a scale of 1 (worst) to 10 (best), you would give it a score of
We know that the market should respond positively to good news and that good-news events such as the coming end of a recession can be predicted with at least some accuracy. Why, then, can we not
Dollar-cost averaging means that you buy equal dollar amounts of a stock every period, for example,$500 per month. The strategy is based on the idea that when the stock price is low, your fixed
Investors expect the market rate of return in the coming year to be 12%. The T-bill rate is 4%.Changing Fortunes Industries’ stock has a beta of .5. The market value of its outstanding equity is
In a recent closely contested lawsuit, Apex sued Bpex for patent infringement. The jury came back today with its decision. The rate of return on Apex was r A 3.1%. The rate of return on Bpex was
The monthly rate of return on T-bills is 1%. The market went up this month by 1.5%. In addition, AmbChaser, Inc., which has an equity beta of 2, surprisingly just won a lawsuit that awards it $1
An index model regression applied to past monthly returns in Ford’s stock price produces the following estimates, which are believed to be stable over time:rF5.10%11.1rM If the market index
Which of the following phenomena would be either consistent with or a violation of the efficient market hypothesis? Explain briefly.a. Nearly half of all professionally managed mutual funds are able
Which of the following would be a viable way to earn abnormally high trading profits if markets are semistrong-form efficient?a. Buy shares in companies with low P/E ratios.b. Buy shares in companies
Respond to each of the following comments.a. If stock prices follow a random walk, then capital markets are little different from a casino.b. A good part of a company’s future prospects are
Suppose that, after conducting an analysis of past stock prices, you come up with the following observations. Which would appear to contradict the weak form of the efficient market
Which of the following sources of market inefficiency would be most easily exploited?a. A stock price drops suddenly due to a large block sale by an institution.b. A stock is overpriced because
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
According to CAPM, the expected rate of return of a portfolio with a beta of 1.0 and an alpha of 0 is:a. Between r M and r f .b. The risk-free rate, r f .c. ( r M r f ).d. The expected return on
A stock has an expected rate of return of 4%. What is its beta?
I am buying a firm with an expected perpetual cash flow of $1,000 but am unsure of its risk. If I think the beta of the firm is .5, when in fact the beta is really 1, how much more will I offer for

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