You recently graduated from college, and your job search led you to S&S Air. Because you felt the companys business was headed skyward, you accepted the job offer. As you are finishing your employment paperwork, Chris Guthrie, who works in the finance department, stops by to inform you about the companys new 401(k) plan. A 401(k) is a type of retirement plan offered by many companies. A 401(k) is tax deferred, which means that any deposits you make into the plan are deducted from your current income, so no current taxes are paid on the money. Assume your salary will be $40,000 per year. If you contribute $3,000 to the 401(k) plan, you will pay taxes only on $37,000 in income. No taxes will be due on any capital gains or plan income while you are invested in the plan, but you will pay taxes when you withdraw the money at retirement. You can contribute up to 15 percent of your salary to the plan. As is common, S&S Air also has a 5 percent match program. This means that the company will match your contribution dollarfor-dollar up to 5 percent of your salary, but you must contribute to get the match. The 401(k) plan has several options for investments, most of which are mutual funds. As you know, a mutual fund is a portfolio of assets. When you purchase shares in a mutual fund, you are actually purchasing partial ownership of the funds assets, similar to purchasing shares of stock in a company. The return of the fund is the weighted average of the return of the assets owned by the fund, minus any expenses. The largest expense is typically the management fee paid to the fund manager, who makes all of the investment decisions for the fund. S&S Air uses Arias Financial Services as its 401(k) plan administrator. Chris Guthrie then explains that the retirement investment options offered for employees are as follows: 1. Company stock. One option is stock in S&S Air. The company is currently privately held. The price you would pay for the stock is based on an annual appraisal, less a 20 percent discount. When you interviewed with the owners, Mark Sexton and Todd

Story, they informed you that the company stock was expected to be publicly sold in three to five years. If you needed to sell the stock before it became publicly traded, the company would buy it back at the then-current appraised value. 2. Arias S&P 500 Index Fund. This mutual fund tracks the S&P 500. Stocks in the fund are weighted exactly the same as they are in the S&P 500. This means that the funds return is approximately the return of the S&P 500, minus expenses. With an index fund, the manager is not required to research stocks and make investment decisions, so fund expenses are usually low. The Arias S&P 500 Index Fund charges expenses of .20 percent of assets per year. 3. Arias Small-Cap Fund. This fund primarily invests in small capitalization stocks. As such, the returns of the fund are more volatile. The fund also can invest 10 percent of its assets in companies based outside the United States. This fund charges 1.70 percent of assets in expenses per year. 4. Arias Large-Company Stock Fund. This fund invests primarily in large capitalization stocks of companies based in the United States. The fund is managed by Melissa Arias and has outperformed the market in six of the last eight years. The fund charges 1.50 percent in expenses. 5. Arias Bond Fund. This fund invests in long-term corporate bonds issued by U.S.-domiciled companies. The fund is restricted to investments in bonds with an investment grade credit rating. This fund charges 1.40 percent in expenses. 6. Arias Money Market Fund. This fund invests in short-term, high-credit-quality debt instruments, which include Treasury bills. As such, the return on money market funds is only slightly higher than the return on Treasury bills. Because of the credit quality and short-term nature of the investments, there is only a very slight risk of negative return. The fund charges .60 percent in expenses.

1. What advantages/disadvantages do the mutual funds offer compared to company stock for your retirement investing? 2. Notice that, for every dollar you invest, S&S Air also invests a dollar. What return on your investment does this represent? What does your answer suggest about matching programs? 3. Assume you decide you should invest at least part of your money in large capitalization stocks of companies based in the United States. What are the advantages and disadvantages of choosing the Arias Large-Company Stock Fund compared to the Arias S&P 500 Index Fund? 4. The returns of the Arias Small-Cap Fund are the most volatile of all the mutual funds offered in the 401(k) plan. Why would you ever want to invest in this fund? When you examine the expenses of the mutual funds, you will notice that this fund also has the highest expenses. Will this affect your decision to invest in this fund? 5. A measure of risk-adjusted performance that often is used in practice is the Sharpe ratio. The Sharpe ratio is calculated as the risk premium of an asset divided by its standard deviation. The standard deviations and returns for the funds over the past 10 years are listed here. Assuming a risk-free rate of 3.1 percent, calculate the Sharpe ratio for each of these. In broad terms, what do you suppose the Sharpe ratio is intended to measure?

CHAPTER CASE A Job at S&S Air 3 Vou recently graduated from college, and your job I search led you to S&S Air. Because you felt the com- pany's business was headed skyward, you accepted the job offer. As you are finishing your employment paper- work, Chris Guthrie, who works in the finance depart- ment, stops by to inform you about the company's new 408) plan. A 401(k) is a type of retirement plan offered by many companies. A 401(k) is tax deferred, which means that any deposits you make into the plan are deducted from your current income, so no current taxes are paid on the money. Assume your salary will be $40,000 per year. If you contribute $3,000 to the 401(k) plan, you will pay taxes only on $37.000 in income. No taxes will be due on any capital gains or plan income while you are in- vested in the plan, but you will pay taxes when you with draw the money at retirement. You can contribute up to 15 percent of your salary to the plan. As is common, S&S Air also has a 5 percent match program. This means that the company will match your contribution dollar- for-dollar up to 5 percent of your salary, but you must contribute to get the match The 401(k) plan has several options for investments most of which are mutual funds. As you know, a mutual fund is a portfolio of assets. When you purchase shares in a mutual fund, you are actually purchasing partial ownership of the fund's assets, similar to purchasing shares of stock in a company. The return of the fund is the weighted average of the return of the assets owned by the fund, minus any expenses. The largest expense is typically the management fee paid to the fund man- ager, who makes all of the investment decisions for the fund. S&S Air uses Arias Financial Services as its 401(k) plan administrator. Chris Guthrie then explains that the retirement in- vestment options offered for employees are as follows: Story, they informed you that the company stock was expected to be publicly sold in three to five years. If you needed to sell the stock before it be came publicly traded, the company would buy it back at the then-current appraised value. 2. Arias S&P 500 Index Fund. This mutual fund tracks the S&P 500. Stocks in the fund are weighted ex- actly the same as they are in the S&P 500. This means that the fund's return is approximately the return of the S&P 500, minus expenses. With an index fund, the manager is not required to research stocks and make investment decisions, so fund ex- penses are usually low. The Arias S&P 500 Index Fund charges expenses of 20 percent of assets per year. Arias Small Cap Fund. This fund primarily invests in small capitalization stocks. As such, the returns of the fund are more volatile. The fund also can invest 10 percent of its assets in companies based outside the United States. This fund charges 170 percent of assets in expenses per year. 4. Arias Large-Company Stock Fund. This fund invests primarily in large capitalization stocks of companies based in the United States. The fund is managed by Melissa Arias and has outperformed the market in six of the last eight years. The fund charges 150 percent in expenses. 5. Arias Bond Fund. This fund invests in long-term corporate bonds issued by U.S.-domiciled compa- nies. The fund is restricted to investments in bonds with an investment grade credit rating. This fund charges 1.40 percent in expenses. 6. Arias Money Market Fund. This fund invests in short-term, high-credit-quality debt instruments which include Treasury bills. As such, the return on money market funds is only slightly higher than the return on Treasury bills. Because of the credit qual- ity and short-term nature of the investments, there is only a very slight risk of negative return. The fund charges 60 percent in expenses. Company stock. One option is stock in S&S Air. The company is currently privately held. The price you would pay for the stock is based on an annual ap- praisal, less a 20 percent discount. When you in- terviewed with the owners, Mark Sexton and Todd 56% Page 348 of 652 Location 8440 of 15229 CHAPTER 10 Some Lessons from Capital Market History 349 QUESTIONS 1. What advantages/disadvantages do the mutual funds offer compared to company stock for your retirement investing? 2. Notice that, for every dollar you invest, S&S Air also invests a dollar. What return on your invest- ment does this represent? What does your answer suggest about matching programs? 3. Assume you decide you should invest at least part of your money in large capitalization stocks of companies based in the United States. What are the advantages and disadvantages of choosing the Arias Large-Company Stock Fund compared to the Arias S&P 500 Index Fund? 4. The returns of the Arias Small Cap Fund are the most volatile of all the mutual funds offered in the 401(k) plan. Why would you ever want to invest in this fund? When you examine the ex- penses of the mutual funds, you will notice that this fund also has the highest expenses. Will this affect your decision to invest in this fund? 5. A measure of risk-adjusted performance that of- ten is used in practice is the Sharpe ratio. The Sharpe ratio is calculated as the risk premium of an asset divided by its standard deviation. The standard deviations and returns for the funds over the past 10 years are listed here. As- suming a risk-free rate of 3.1 percent, calculate the Sharpe ratio for each of these. In broad terms, what do you suppose the Sharpe ratio is intended to measure? 10-Year Annual Return Standard Deviation Arias S&P 500 Index Fund Arias Small-Cap Fund Arias Large-Company Stock Fund Arias Bond Fund 11.80% 15.12 11.15 7.92 19.35% 27.95 21.16 11.45 CHAPTER CASE A Job at S&S Air 3 Vou recently graduated from college, and your job I search led you to S&S Air. Because you felt the com- pany's business was headed skyward, you accepted the job offer. As you are finishing your employment paper- work, Chris Guthrie, who works in the finance depart- ment, stops by to inform you about the company's new 408) plan. A 401(k) is a type of retirement plan offered by many companies. A 401(k) is tax deferred, which means that any deposits you make into the plan are deducted from your current income, so no current taxes are paid on the money. Assume your salary will be $40,000 per year. If you contribute $3,000 to the 401(k) plan, you will pay taxes only on $37.000 in income. No taxes will be due on any capital gains or plan income while you are in- vested in the plan, but you will pay taxes when you with draw the money at retirement. You can contribute up to 15 percent of your salary to the plan. As is common, S&S Air also has a 5 percent match program. This means that the company will match your contribution dollar- for-dollar up to 5 percent of your salary, but you must contribute to get the match The 401(k) plan has several options for investments most of which are mutual funds. As you know, a mutual fund is a portfolio of assets. When you purchase shares in a mutual fund, you are actually purchasing partial ownership of the fund's assets, similar to purchasing shares of stock in a company. The return of the fund is the weighted average of the return of the assets owned by the fund, minus any expenses. The largest expense is typically the management fee paid to the fund man- ager, who makes all of the investment decisions for the fund. S&S Air uses Arias Financial Services as its 401(k) plan administrator. Chris Guthrie then explains that the retirement in- vestment options offered for employees are as follows: Story, they informed you that the company stock was expected to be publicly sold in three to five years. If you needed to sell the stock before it be came publicly traded, the company would buy it back at the then-current appraised value. 2. Arias S&P 500 Index Fund. This mutual fund tracks the S&P 500. Stocks in the fund are weighted ex- actly the same as they are in the S&P 500. This means that the fund's return is approximately the return of the S&P 500, minus expenses. With an index fund, the manager is not required to research stocks and make investment decisions, so fund ex- penses are usually low. The Arias S&P 500 Index Fund charges expenses of 20 percent of assets per year. Arias Small Cap Fund. This fund primarily invests in small capitalization stocks. As such, the returns of the fund are more volatile. The fund also can invest 10 percent of its assets in companies based outside the United States. This fund charges 170 percent of assets in expenses per year. 4. Arias Large-Company Stock Fund. This fund invests primarily in large capitalization stocks of companies based in the United States. The fund is managed by Melissa Arias and has outperformed the market in six of the last eight years. The fund charges 150 percent in expenses. 5. Arias Bond Fund. This fund invests in long-term corporate bonds issued by U.S.-domiciled compa- nies. The fund is restricted to investments in bonds with an investment grade credit rating. This fund charges 1.40 percent in expenses. 6. Arias Money Market Fund. This fund invests in short-term, high-credit-quality debt instruments which include Treasury bills. As such, the return on money market funds is only slightly higher than the return on Treasury bills. Because of the credit qual- ity and short-term nature of the investments, there is only a very slight risk of negative return. The fund charges 60 percent in expenses. Company stock. One option is stock in S&S Air. The company is currently privately held. The price you would pay for the stock is based on an annual ap- praisal, less a 20 percent discount. When you in- terviewed with the owners, Mark Sexton and Todd 56% Page 348 of 652 Location 8440 of 15229 CHAPTER 10 Some Lessons from Capital Market History 349 QUESTIONS 1. What advantages/disadvantages do the mutual funds offer compared to company stock for your retirement investing? 2. Notice that, for every dollar you invest, S&S Air also invests a dollar. What return on your invest- ment does this represent? What does your answer suggest about matching programs? 3. Assume you decide you should invest at least part of your money in large capitalization stocks of companies based in the United States. What are the advantages and disadvantages of choosing the Arias Large-Company Stock Fund compared to the Arias S&P 500 Index Fund? 4. The returns of the Arias Small Cap Fund are the most volatile of all the mutual funds offered in the 401(k) plan. Why would you ever want to invest in this fund? When you examine the ex- penses of the mutual funds, you will notice that this fund also has the highest expenses. Will this affect your decision to invest in this fund? 5. A measure of risk-adjusted performance that of- ten is used in practice is the Sharpe ratio. The Sharpe ratio is calculated as the risk premium of an asset divided by its standard deviation. The standard deviations and returns for the funds over the past 10 years are listed here. As- suming a risk-free rate of 3.1 percent, calculate the Sharpe ratio for each of these. In broad terms, what do you suppose the Sharpe ratio is intended to measure? 10-Year Annual Return Standard Deviation Arias S&P 500 Index Fund Arias Small-Cap Fund Arias Large-Company Stock Fund Arias Bond Fund 11.80% 15.12 11.15 7.92 19.35% 27.95 21.16 11.45