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essentials of investments
Questions and Answers of
Essentials of Investments
A fund begins with $10 million and reports the following three-month results (with negative figures in parentheses):Compute the arithmetic, time-weighted, and dollar-weighted average returns. Net
What will be the dollar value of your position in Vanguard and its proportion in your complete portfolio if you decide to hold 50% of your investment budget in Ready Assets?
Suppose the rates of return of the bond portfolio in the three scenarios of Spreadsheet 6.4 are 10% in a recession, 7% in a normal period, and 2% in a boom. The stock returns in the three scenarios
The following tables present returns on various pairs of stocks in several periods. In part A, we show you a scatter diagram of the returns on the first pair of stocks. Draw (or prepare in Excel)
Suppose that for some reason you are required to invest 50% of your portfolio in bonds and 50% in stocks.a. If the standard deviation of your portfolio is 15%, what must be the correlation
Interpret the eight scatter diagrams of Figure 6.12 in terms of systematic risk, diversifiable risk, and the intercept. R4 R3 R2 R₁ RM X X X X RM RM RM R5 RM R6 RM + R7 RM R8 RM FIGURE 6.12 Various
a. What is the characteristic line of XYZ in Example 6.4?b. Does ABC or XYZ have greater systematic risk?c. What percent of the variance of XYZ is firm-specific risk? EXAMPLE 6.4 Estimating the Index
Suppose the risk premiums in Example 7.8 were E(rM) - rf = 4% and E(rTB) - rf = 2%. What would be the equilibrium expected rate of return on Northeast Airlines? EXAMPLE 7.8 A Two-Factor SML Northeast
Draw a point and figure chart using the history in Table 9.1 with price increments of $3. TABLE 9.1 Stock price history Date January 2 January 3 January 4 January 5 January 8 January 9 January
Yields on lower rated debt will rise after fears of recession have spread through the economy. This will reduce the confidence index. Should the stock market now be expected to fall or will it
Suppose that General Motors issues two bonds with identical coupon rates and maturity dates. One bond is callable, however, while the other is not. Which bond will sell at a higher price?
Calculate the price of the 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 increases to 5%.
What will be the relationship among coupon rate, current yield, and yield to maturity for bonds selling at discounts from par? Illustrate using the 8% (semiannual payment) coupon bond assuming it
What will be the price of the bond in Example 10.7 in yet another year, when only one year remains until maturity? What is the rate of return to an investor who purchases the bond at $982.17 and
A 20-year maturity 9% coupon bond paying coupons semiannually is callable in five years at a call price of $1,050. The bond currently sells at a yield to maturity of 8% (bond equivalent yield). What
Show that if the yield to maturity increases, then holding-period return is less than that initial yield. For example, suppose in Example 10.8 that by the end of the first year, the bond’s yield to
Suppose that the yield to maturity of the 4% coupon, 30-year maturity bond falls to 7% by the end of the first year, and that the investor sells the bond after the first year. If the investor’s
Look again at Example 11.3. What would have been the immunizing weights in the second year if the interest rate had fallen to 8%? EXAMPLE 11.3 Rebalancing Suppose that one year has passed, and the
Suppose that the expected value of the interest rate for year 3 remains at 8% but that the liquidity premium for that year is also 1%. What would be the yield to maturity on three-year zeros? What
What is the trigger point if the manager has a three-year horizon, the interest rate is 8%, and the minimum acceptable terminal value is $10 million?
Calculate the price of a firm with a plowback ratio of .60 if its ROE is 20%. Current earnings, E1, will be $5 per share, and k = 12.5%.What if ROE is 10%, which is less than the market
Confirm that the intrinsic value of Honda using the same data as in our example, but assuming its beta is .9, is $26.16. First calculate the discount rate and stock price in 2010. Then calculate the
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
Mordett is a company with the same assets as Nodett and Somdett but a debt/equity ratio of 1.0 and an interest rate of 9%. What would its net profit and ROE be in a bad year, a normal year, and a
Do a ratio decomposition analysis for the Mordett corporation of Concept Check 1, 14.2 preparing a table similar to Table 14.6.Concept Check 1Mordett is a company with the same assets as Nodett and
What were GI’s ROE, P/E, and P/B ratios in the year 2008? How do they compare to the industry average ratios, which were:How does GI’s earnings yield in 2008 compare to the industry average?
You have the following information for IBX Corporation for the years 2006 and 2009 (all figures are in $millions):What is the trend in IBX’s ROE, and how can you account for it in terms of tax
Graph the payoff diagram for the collar described in Example 15.5. EXAMPLE 15.5 Collars A collar would be appropriate for an investor who has a target wealth goal in mind but is unwilling to risk
Graph the profit and payoff diagrams for strips and straps.
Consider the call option in Example 16.2. If it sells for $15 rather than the value of $13.70 found in the example, is its implied volatility more or less than 0.5? Use Spreadsheet 16.1 (available at
Suppose as in Example 17.5 that oil will be selling in April for $59.79, $61.79, or $63.79 per barrel. Consider a firm that plans to buy 100,000 barrels of oil in April. Show that if the firm buys
a. Suppose the benchmark weights had been set at 70% equity, 25% fixed-income, and 5% cash equivalents. What then would be the contributions of the manager’s asset allocation choices?b. Suppose the
What are the annually compounded rates of return for the X, Y, and perfect-timing strategies over the 78-year period?
What is the market timing score of someone who flips a fair coin to predict the market?
Prepare a table like Table 16.1 for the determinants of put option values. How should put values respond to increases in S, X, T, σ, rf, and dividend payout? TABLE 16.1 Determinants of call option
Are the following assets real or financial?a. Patentsb. Lease obligationsc. Customer goodwilld. A college educatione. A $5 bill
What were the bid price, ask price, and yield to maturity of the 4¾% May 2014 Treas- 2.1 ury note displayed in Figure 2.4? What was its ask price the previous day? U.S. Government Bonds and
Suppose you discover a treasure chest of $10 billion in cash.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 answers to
Computer networks have made it much cheaper and easier for small investors to trade for their own accounts and perform their own security analysis. What will be the likely effect on financial
When mortgages are pooled into securities, the pass-through agencies (Freddie Mac and Fannie Mae) typically guarantee the underlying mortgage loans. If the homeowner defaults on the loan, the
Suppose your tax bracket is 28%. 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?
Straight preferred stock yields often are lower than yields on straight bonds of the same quality because ofa. Marketabilityb. Riskc. Taxationd. Call protection
Turn back to Figure 2.4 and look at the fi rst Treasury bond maturing in November 2014.a. How much would you have to pay to purchase one of these bonds?b. What is its coupon rate?c. What is the
Suppose XYZ’s final price in Table 2.4 increases in price to $110, while ABC falls to $20. Find the percentage change in the price-weighted average of these two stocks. Compare that to the
Reconsider companies XYZ and ABC from Concept Check Question 2.4. Calculate 2. 5 the percentage change in the market value–weighted index. Compare that to the rate of return of a portfolio that
a. If you buy 100 shares of IBM common stock, to what are you entitled?b. What is the most money you can make over the next year?c. If you pay $95 per share, what is the most money you could lose
Turn to Figure 2.9 and look at the listing for General Dynamics.a. What was the fi rm’s closing price yesterday?b. How many shares could you buy for $5,000?c. What would be your annual dividend
What would be the profit or loss per share of stock to an investor who bought the 2.6 January 2007 expiration IBM call option with exercise price $100, if the stock price at the expiration of the
Why does it make sense for shelf registration to be limited in time?
Suppose the maintenance margin in Example 3.2 is 40%. How far can the stock price fall before the investor gets a margin call? Suppose the maintenance margin is 30%. How far could the stock price
Many assets trade in more than one type of market. What types of markets do the following trade in?a. Used carsb. Paintingsc. Rare coins
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
Suppose that in the IBM example above, the investor borrows only $5,000 at the 3.5 same interest rate of 9% per year. What will the rate of return be if the price of IBM goes up by 30%? If it goes
The Equity Fund sells Class A shares with a front-end load of 4% and Class B shares with 12b-1 fees of .5% annually as well as back-end load fees that start at 5% and fall by 1% for each full year
Do you think it is possible to completely replace market-making specialists with a fully automated, computerized trade-matching system?
What are the arbitrage strategy and associated profits if the initial future price is F0 = $1.95/pound?
If you project an ROR of only 5%, what savings rate would you need to provide the same retirement annuity?
a. Construct the balance sheet if Dot Bomb goes up to $110.b. If the short position maintenance margin in Example 3.4 is 40%, how far can the stock price rise before the investor gets a margin call?
Consider these data from the September 2006 balance sheet of the Growth and Income mutual fund sponsored by the Vanguard Group. (All values are in millions.) What was the net asset value of the
An investor’s portfolio currently is worth $1 million. During the year, the investor sells 1,000 shares of Microsoft at a price of $80 per share and 2,000 shares of Ford at a price of $40 per
Suppose you observe the investment performance of 400 portfolio managers and rank them by investment returns during the year. Twenty percent of all managers are truly skilled, and therefore always
A portfolio of nondividend-paying stocks earned a geometric mean return of 5.0% between January 1, 2001, and December 31, 2007. The arithmetic mean return for the same period was 6.0%. If the market
A share of stock of A-Star Inc. is now selling for $23.50. A financial analyst summarizes the uncertainty about next year’s holding-period return on the stock by specifying three possible
Which of the following statements about the standard deviation is/are true? A standard deviation:i. Is the square root of the variance.ii. Is denominated in the same units as the original data.iii.
a. A respected analyst forecasts that the return of the S&P 500 Index portfolio over the coming year will be 10%. The one-year T-bill rate is 5%. Examination of recent returns of the S&P 500 Index
Which of the following statements reflects the importance of the asset allocation decision to the investment process? The asset allocation decision:a. Helps the investor decide on realistic
Compute the average excess return on large company stocks (over the T-bill rate) and the standard deviation for the years 1926–1934. You will need to obtain data from the spreadsheet available at
a. Suppose the real interest rate is 3% per year, and the expected inflation rate is 8%. What is the nominal interest rate?b. Suppose the expected inflation rate rises to 10%, but the real rate is
What are the expected return, risk premium, standard deviation, and ratio of risk premium to standard deviation for a complete portfolio with y = 0.75?
A three-asset portfolio has the following characteristics:What is the expected return on this three-asset portfolio? Asset X XXN Y Z Expected Return 15% 10 6 Standard
A universe of securities includes a risky stock (X), a stock index fund (M), and T-bills. 6.4 The data for the universe are:The correlation coefficient between X and M is -0.2.a. Draw the opportunity
Two portfolio managers work for competing investment management houses. Each 6.5 employs security analysts to prepare input data for the construction of the optimal portfolio. When all is completed,
What percent of the variance of stock ABC in Example 6.4 is systematic (market) risk? EXAMPLE Estimating the Index Model Using Historical Data 6.4 The direct way to calculate the slope and intercept
If only some investors perform security analysis while all others hold the market port- folio (M), would the CML still be the efficient CAL for investors who do not engage in security analysis?
Historical data for the S&P 500 Index show an average excess return over Treasury bills of about 8.5% with standard deviation of about 20%. To the extent that these averages approximate investor
Suppose the risk premium on the market portfolio is estimated at 8% with a standard deviation of 22%. What is the risk premium on a portfolio invested 25% in GM with a beta of 1.15 and 75% in Ford
a. Stock XYZ has an expected return of 12% and risk of β = 1.0. Stock ABC is expected to return 13% with a beta of 1.5. The market’s expected return is 11% and rf = 5%. According to the CAPM,
Using the factor portfolios of Example 7.11, find the fair rate of return on a security 7.6 with β1 = 0.2 and β2 = 1.4. Suppose the two-factor portfolios, here called portfolios 1 and 2, have
a. Suppose you observed that high-level managers make superior returns on investments in their company’s stock. Would this be a violation of weak-form market efficiency? Would it be a violation of
If everyone in the market believes in resistance levels, why do these beliefs not become self-fulfilling prophecies?
What would happen to market efficiency if all investors attempted to follow a passive strategy?
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
We saw in the last chapter that stocks seem to exhibit a pattern of short- to middle term momentum, along with long-term reversals. How might this pattern arise from an interplay between the
How might the P/E effect also be explained as a consequence of regret avoidance?
Fundamental risk may be limited by a “deadline” that forces a convergence between price and intrinsic value. What do you think would happen to a closed-end fund’s discount if the fund announced
A “fallen angel” bond is best defi ned as a bond issued:a. Below investment grade.b. At an original issue discount.c. As investment grade, but declined to speculative grade.d. As a secured bond,
Consider a bond with a settlement date of February 22, 2008, and a maturity date of March 15, 2016. The coupon rate is 5.5%. If the yield to maturity of the bond is 5.34% (bond equivalent yield,
On May 30, 2006, Janice Kerr is considering the newly issued 10-year AAA corporatebonds shown in the following exhibit:a. Suppose that market interest rates decline by 100 basis points (i.e., 1%).
Suppose the interest rate decreases to 9%. What will happen to the price and duration of each bond in Spreadsheet 11.1? SPREADSHEET 11.1 Calculation of the duration of two bonds using Excel
a. In Concept Check 11.1, you calculated the price and duration of a three-year maturity, 8% coupon bond for an interest rate of 9%. Now suppose the interest rate increases to 9.05%. What is the new
Figure 11.2 illustrates a 9% coupon, 8-year maturity bond with annual payments, selling at a yield to maturity of 10%. Confirm using Spreadsheet 11.2 that the bond’s duration is 5.97 years. What
Show that the duration of a perpetuity increases as the interest rate decreases, in accordance with Rule 4.Rule 4: With other factors held constant, the duration and interest rate sensitivity of a
a. Suppose that this pension fund is obligated to pay out $800,000 per year in perpetuity. What should be the maturity and face value of the zero-coupon bond it purchases to immunize its
What will be the rate of return in Example 11.5 if the manager forecasts that in two years the yield to maturity on 18-year maturity bonds will be 10% and that the reinvestment rate for coupons will
How would an increase in trading costs affect the attractiveness of dedication versus immunization?
A fixed-income portfolio manager is unwilling to realize a rate of return of less than 3% annually over a five-year investment period on a portfolio currently valued at $1 million. Three years later,
a. IBX’s stock dividend at the end of this year is expected to be $2.15, and it is expected to grow at 11.2% per year forever. If the required rate of return on IBX stock is 15.2% per year, what is
Consider an economy where the dominant industry is automobile production for domestic consumption as well as export. Now suppose the auto market is hurt by an increase in the length of time people
Suppose the government wants to stimulate the economy without increasing interest rates. What combination of fiscal and monetary policy might accomplish this goal?
Large tax cuts in 2001 were followed by relatively rapid growth in GDP. How would demand-side and supply-side economists differ in their interpretations of this phenomenon?
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