All work submitted must be in your own words and you must show all calculations and/or provide explanations. Any calculations should be done in Excel and pasted into the Word document using the ?Paste Special-Excel Worksheet Object? feature. This will allow the instructor to double click on your work to see the formulas and calculations used to answer the selected problems.

Unit 2 [GF540: Investment and Securities Analysis ] Unit 2 Assignment: Problem Set Directions: All work submitted must be in your own words and you must show all calculations and/or provide explanations. Any calculations should be done in Excel and pasted into the Word document using the \"Paste Special-Excel Worksheet Object\" feature. This will allow the instructor to double click on your work to see the formulas and calculations used to answer the selected problems. 1. You have just come across a set of data containing historical prices and dividends that will allow you to calculate stock returns all the way back to 1880. Give at least one advantage and one disadvantage of using this data set to estimate U.S. stock returns for the coming year? 2. During a period of significant inflation, a bond earned an annual nominal return of 80%. The rate of inflation over the year was 70%. a. Calculate the real holding period return for the year. b. Compare this real holding period return to the approximation formula rr rn - i (real return = Nominal return - inflation). 3. 4. Calculate the mean and standard deviation of a random variable with the following probability distribution: Value Associated Probability 0 0.25 1 0.25 2 0.50 You are considering two investments, a conventional, FDIC insured 1-year bank CD with an interest rate of 5% and a 1-year \"Inflation Plus\" CD offering 1.5% plus the rate of inflation, which is also FDIC insured. a. Which investment is safer? b. If you expect inflation to be 3% over the coming year, which investment would be better? Explain. c. If we observe a nominal risk free rate of 5% and a real rate of 1.5% on inflation-indexed bonds, can we infer that the markets expected rate of inflation is approximately 3.5%? 5. The end-of-year cash flow from an asset will be either $70,000 or $200,000 with equal probabilities. T-Bills pay 6%. a. If you require a risk premium of 8%, how much would you be willing to pay for the cash flow? Unit 2 [GF540: Investment and Securities Analysis ] b. If you require a risk premium of 12%, what would you be willing to pay? c. From your answers to parts a and b, describe the relationship between risk premiums and prices. 6. A portfolio offers an expected return and standard deviation of 12% and 18%, respectively. What is the level of risk aversion, A, that would make an investor indifferent between the portfolio and T-bills with a risk-free return of 7%? 7. You manage a portfolio with an expected return of 18% and expected standard deviation of 28%. The T-bill rate is 8%. Calculate the portfolio's reward to volatility (Sharpe) ratio. 8. You have two portfolios for your clients to choose from or combine. One is an actively managed portfolio with an expected return of 18% and standard deviation of 28%. The other is a passive, index portfolio with an expected return of 13% and standard deviation of 25%. If your client has an aversion value of 3.5, determine the optimal proportions in which she should combine the two. The risk free rate is 8%. Rubric: Criteria for Assignment Grades Maximum Percent Maximum Points Provides correct and complete answers for questions and problems. 40% 32 Clearly shows the reasoning and/or calculations used to arrive at the answer or conclusion. 50% 40 Uses the Excel special paste feature where appropriate. 10% 8 100% 80 TOTAL