Questions and Answers of Essentials of Investments

Use the high- and low-volatility scenarios that we used for the call option to show that put options also are worth more when stock price volatility is higher.
Should a put option increase in value with the volatility of the stock?
Suppose the S&P 500 Index portfolio pays a dividend yield of 2% annually. The index currently is 3,000. The T-bill rate is 3%, and the S&P futures price for delivery in one year is $3,045. Construct
Carl Karl, a portfolio manager for the Alpine Trust Company, has been responsible since 2024 for the City of Alpine’s Employee Retirement Plan, a municipal pension fund. Alpine is a growing
A household savings-account spreadsheet shows the following entries for the first day of each month:Use the Excel function XIRR to calculate the monthly dollar-weighted average return for this
The S&P 500 Index is currently at 3,000. You manage a $15 million indexed equity portfolio. The S&P 500 futures contract has a multiplier of $50.a. If you are temporarily bearish on the stock market,
When will the dollar-weighted return on a risky investment exceed the geometric return? When will it be lower?
Suppose the value of your portfolio will either double or fall by half with equal probability in any particular year.a. What is the expected value of the portfolio after one year? b. What is the
Do you agree with the following claim? “U.S. companies with global operations can give you international diversification.” Think about both business risk and foreign exchange risk.
You are a U.S. investor who purchased British securities for £2,000 one year ago when the British pound cost U.S.$1.50. What is your total return (denomiated in U.S. dollars) if the value of the
What are the arbitrage strategy and associated profits if the initial future price is F0 = $1.35/pound?
Use the financial statements for Chicago Refrigerator Inc. (see Tables 14.15 and 14.16) to compute ratios a through h for 2022.Tables 14.15Tables 14.16 a. Quick ratio. b. Return on assets. c.
On May 30, 2021, Janice Kerr is considering the newly issued 10-year AAA corporate bonds shown in the following exhibit:a. Suppose that market interest rates decline by 100 basis points (i.e., 1%).
A portfolio of non dividend-paying stocks earned a geometric mean return of 5% between January 1, 2014, and December 31, 2020. The arithmetic mean return for the same period was 6%. If the market
The information in the following table comes from the 2020 financial statements of QuickBrush Company and SmileWhite Corporation:Determine which company has the higher quality of earnings by
Calculating implied volatility can be difficult if you don’t have a spreadsheet handy. Fortunately, many tools are available on the web to perform the calculation; for example, www.optionprice.com
Suppose that you want to create a spread position using S&P 500 futures contracts. Go to www.cmegroup.com and listed under Equity Index Products, select the E-Mini S&P 500 contract. Click on Contract
On January 1, you sold one February maturity S&P 500 Index futures contract at a futures price of 3,000. If the futures price is 3,050 at contract maturity, what is your profit? The contract
You can click the chart icon to find a plot of futures prices for several maturity dates. What would have been your profit if you had bought a (roughly) two-month maturity contract one month ago and
The current level of the S&P 500 is 3,000. The dividend yield on the S&P 500 is 2%. The risk-free interest rate is 1%. What should be the price of a one-year maturity futures contract?
A one-year gold futures contract is selling for $1,558. Spot gold prices are $1,500 and the one-year risk-free rate is 2%.a. According to spot-futures parity, what should be the futures price? b.
XYZ’s stock price and dividend history are as follows: An investor buys three shares of XYZ at the beginning of 2019, buys another two shares at the beginning of 2020, sells one share at the
A portfolio of stocks generates a −9% return in 2020, a 23% return in 2021, and a 17% return in 2022. What is the annualized return (geometric mean) for the entire period?
What would be the dollar value and rate of return on the market neutral position if the value of the residual turns out to be −4%? If the market return in that month is 5%, where would the plot of
If the current exchange rate is $1.35/£, the one-year forward exchange rate is $1.45/£, and the interest rate on British government bills is 3% per year, what risk-free dollar-denominated return
Classify each of the following strategies as directional or nondirectional.a. The fund buys shares in the India Investment Fund, a closedend fund that is selling at a discount to net asset value, and
Analyze the betas of the convertible arbitrage fund index in Table 20.2. Based on these results, are these funds typically market neutral? If not, do their factor exposures make sense in terms of the
A fund manages a $4.5 billion equity portfolio with a beta of 0.6. If the S&P contract multiplier is $50 and the index is currently at 3,000, how many contracts should the fund sell to make its
Calculate the net advantage of the stock versus bond investment, but now assume that the horizon is 30 years instead of 5 years.
The same ship owner advertises a tariff whereby the freight charged per pound for all cargo will be the same. What kind of cargo can the ship owner expect to attract?
A ship owner is attempting to insure an old vessel for twice its current market value. Is this an adverse selection or moral hazard issue?
Log on to finance.yahoo.com and enter the ticker symbol “RRD” in the Quote Lookup box t/o find information about R.R. Donnelley & Sons.a. Click on company Profile. What is Donnelly’s main line
Visit the website of the Securities and Exchange Commission, www.sec.gov. What is the mission of the SEC? What information and advice does the SEC offer to beginning investors?
When Freddie Mac and Fannie Mae pooled conforming mortgages into securities, they guaranteed the underlying mortgage loans against homeowner defaults. In contrast, there were no guarantees on the
Now visit the website of FINRA (the Financial Industry Regulatory Authority) at www.finra.org. What is its mission? What information and advice does it offer to beginners?
Now visit the website of the IOSCO, www.iosco.org. What is its mission? What information and advice does it offer to beginners?
What were the bid price, asked price, and yield to maturity of the 3.5% February 2039 Treasury bond displayed in Figure 2.3? What was its asked price the previous day?Figure 2.3
What are agency problems? What are some approaches to solving them?
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?
Go to the website for The Walt Disney Co. (DIS) and download its most recent annual report (its 10-K). Locate the company’s Consolidated Balance Sheets and answer these questions:a. How much
Suppose your combined federal plus state tax bracket is 30%. Would you prefer to earn a 6% taxable return or a 4% tax-free yield? What is the equivalent taxable yield of the 4% tax-free yield?
What features of money market securities distinguish them from other fixed-income securities?
What are the major components of the money market?
What is the profit or loss per share of stock to an investor who buys the September expiration Microsoft call option with exercise price $130, if the stock price at the expiration of the option is
Why are corporations more apt to hold preferred stock than other potential investors?
Turn back to Figure 2.10 and look at the Microsoft options. Suppose you buy a November expiration call option with exercise price $140. Figure 2.10a. If the stock price at option expiration is $144,
A municipal bond carries a coupon rate of 2.25% and is trading at par. What would be the equivalent taxable yield of this bond to a taxpayer in a 35% combined tax bracket?
What options position is associated with:a. The right to buy an asset at a specified price? b. The right to sell an asset at a specified price? c. The obligation to buy an asset at a specified
Find the after-tax return to a corporation that buys a share of preferred stock at $40, sells it at yearend at $40, and receives a $4 year-end dividend. The firm is in the 21% tax bracket.
What type of trading order might you give to your broker in each of the following circumstances? a. You want to buy shares of Intel to diversify your portfolio. You believe the share price is
Are the following statements true or false? If false, correct them.a. Market orders entail greater price uncertainty than limit orders.b. Market orders entail greater time-of-execution uncertainty
Here is some price information on Marabel, Inc.:a. You have placed a limit order to sell at $68. What are you telling your broker? b. Given market prices, will your order be executed?
Consider these data from the 2019 annual report of Fidelity’s Focused Stock Fund. (All values are in millions.) What was the net asset value of the portfolio?
Are the following statements true or false? If false, correct them. a. An investor who wishes to sell shares immediately should ask his or her broker to enter a limit order. b. The ask price is
You’ve borrowed $20,000 on margin to buy shares in Ixnay, which is now selling at $40 per share. Your account starts at the initial margin requirement of 50%. The maintenance margin is 35%. Two
The current value of a stock portfolio is $23 million. A financial analyst summarizes the uncertainty about next year’s holding period return using the scenario analysis in the following spread
An investor’s portfolio currently is worth $1 million. During the year, the investor sells 400 shares of FedEx at a price of $175 per share and 1,600 shares of Cisco Systems at a price of $50 per
a. Return to Concept Check 5.3. What is the 5% VaR of the portfolio? b. What is the VaR of a portfolio with normally distributed returns with the same mean and standard deviation as this
Suppose the rates of return of the bond portfolio in the four scenarios of Spreadsheet 6.1 are −10% in a severe recession, 10% in a mild recession, 7% in a normal period, and 2% in a boom. The
You’ve just decided upon your capital allocation for the next year, when you realize that you’ve underestimated both the expected return and the standard deviation of your risky portfolio by a
When adding a risky asset to a portfolio of many risky assets, which property of the asset has a greater influence on risk: its standard deviation or its covariance with the other assets? Explain.
Neighborhood Insurance sells fire insurance policies to local homeowners. The premium is $110, the probability of a fire is .001, and in the event of a fire, the insured damages (the payout on the
Here are some characteristics of two portfolios, the market index, and the risk-free asset.a. If you currently hold a market-index portfolio, would you choose to add either portfolio A or B to your
In the previous question, you used 60 months of data to calculate the SCL for Alcoa. Now compute it for two consecutive periods. Estimate the index-model regression using the first 30 months of data,
In an efficient market, professional portfolio management can offer all of the following benefits except which of the following?a. Low-cost diversification. b. A targeted risk level. c. Low-cost
Which version of the efficient market hypothesis (weak, semistrong, or strong-form) focuses on the most inclusive set of information?
Constantly fluctuating stock prices suggest that the market does not know how to price stocks.” Respond.
Yahoo! Finance provides considerable data that can be used for technical analysis. Short interest ratios are found in the Statistics table for each stock. You can also prepare charts of moving
Use the data in Table 9.3 to compute a five-day moving average for Computers, Inc. Can you identify any buy or sell signals?Table 9.3. Trading
After reading about three successful investors in The Wall Street Journal you decide that active investing will also provide you with superior trading results. What sort of behavioral tendency are
Collect data on the S&P 500 for a period covering a few months. (You can download a historical sample from finance.yahoo.com.) Try to identify primary trends. Can you tell whether the market
What is the option embedded in a callable bond? A puttable bond?
Return to Table 10.1, showing the cash flows for TIPS bonds.Table 10.1a. What is the nominal rate of return on the bond in year 2? b. What is the real rate of return in year 2? c. What is the
What would be the likely effect on a bond’s yield to maturity of:a. An increase in the issuing firm’s times-interest earned ratio? b. An increase in the issuing firm’s debt-equity ratio? c.
Consider a bond with a settlement date of February 22, 2022, and a maturity date of March 15, 2030. The coupon rate is 5.5%.a. If the yield to maturity of the bond is 5.34% (bond equivalent yield,
Suppose that today’s date is April 15. A bond with a 10% coupon paid semiannually every January 15 and July 15 is quoted as selling at an ask price of 101.25. If you buy the bond from a dealer
A 30-year maturity, 6% coupon bond paying coupons semiannually is callable in five years at a call price of $1,100. The bond currently sells at a yield to maturity of 5% (2.5% per half-year).a. What
Fincorp issues two bonds with 20-year maturities. Both bonds are callable at $1,050. The first bond is issued at a deep discount with a coupon rate of 4% and a price of $580 to yield 8.4%. The second
The yield to maturity on one-year zero-coupon bonds is 8%. The yield to maturity on two-year zero-coupon bonds is 9%.a. What is the forward rate of interest for the second year? b. If you believe in
Go to www.tipsinc.com/ficalc/calc.tips. Choose the link for the general-purpose bond calculator. The calculator provides yield to maturity, modified duration, and bond convexity as the bonds’ price
The historical yield spread between AAA bonds and Treasury bonds widened dramatically during the financial crisis.a. If you believed the spread would soon return to more typical historical levels,
Show that the duration of a perpetuity increases as the interest rate decreases, in agreement with Rule 4.
Macaulay’s duration is less than modified duration except for:a. Zero-coupon bonds. b. Premium bonds. c. Bonds selling at par value. d. None of the above.
Is the decrease in a bond’s price corresponding to an increase in its yield to maturity more or less than the price increase resulting from a decrease in yield of equal magnitude?
Find the duration of a bond with settlement date May 27, 2018, and maturity date November 15, 2027. The coupon rate of the bond is 7%, and the bond pays coupons semiannually. The bond is selling at a
Short-term interest rates are more volatile than long-term rates. Despite this, the rates of return of long-term bonds are more volatile than returns on short-term securities. How can these two
This exercise will give you a chance to examine data on some of the leading economic indicators.a. Download the data for new privately owned housing units authorized by building permits from
Why does it make intuitive sense that the slope of the yield curve is considered a leading economic indicator?
Large tax cuts in 2018 were followed by relatively rapid growth in GDP. How would demand-side and supply-side economists differ in their interpretations of this phenomenon?
Why do you think the index of consumer expectations for business conditions is a useful leading indicator of the macroeconomy? (See Table 12.2.) Table 12.2 Indexes of economic indicators A. Leading
Which one of the following firms would be described as having below average sensitivity to the state of the economy?a. An asset play firm. b. A cyclical firm. c. A defensive firm. d. A stalwart
The price of oil fell dramatically in 2020. What sort of macroeconomic shock would this be considered?
What is typically true of corporate dividend payout rates in the early stages of an industry life cycle? Why does this make sense?
Now calculate the intrinsic value of three of the firms you selected in the previous question. Make reasonable judgments about the market risk premium and the risk-free rate.Previous questionChoose
Now choose one of your firms and look up other firms in the same industry. Perform a “Valuation by Comparables” analysis by looking at the price/earnings, price/book value, price/sales, and
Consider the following options portfolio: You write a November 2019 expiration call option on Microsoft with exercise price $140. You also write a November expiration Microsoft put option with
You have the following information for IBX Corporation for the years 2021 and 2024 (all figures are in $ millions):What is the trend in IBX’s ROE, and how can you account for it in terms of tax
Confirm that the intrinsic value of Chevron using the same data as in our example, but assuming that beta is .85, is in fact $135.05. First calculate the discount rate and stock price in 2023. Then
What were GI’s ROE, P/E, and P/B ratios in 2020? How do they compare to these industry average ratios: ROE = 8.64%, P/E = 12, and P/B = 1.10? How does GI’s earnings yield in 2020 compare to the
a. What will be the proceeds and net profits to an investor who purchases the December 20, 2019, expiration Microsoft calls with exercise price $140 if the stock price at option expiration is $134?

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