IB tut

UNIVERSITI TUNKU ABDUL RAHMAN (UTAR)FACULTY OF BUSINESS AND FINANCEUBFF3283 Portfolio management

Tutorial 1

1. General discussion of what students can expect to learn in this unit.(Learning Outcomes)

2. To brief on the assignment.

Tutorial 2 (Topic 1)1 Differentiate among the following types of investments, and cite an example of each: (a) Securities and property investments(b) Direct and indirect investments(c) Debt, equity, and derivative securities(d) Short-term and long-term investments

2. Describe the structure of the overall investment process. Explain the role played by financial institutions and financial markets.

3. Classify the role of (a) government, (b) business, and (c) individuals as net suppliers or net demanders of funds.

4. Differentiate between individual investors and institutional investors.

5. What should an investor first establish before developing and executing an investment program? Briefly describe each of the seven steps involved in investing.

6. What are four common investment goals?

7. What makes an asset liquid? Why hold liquid assets? Would 100 shares of IBM stock be considered a liquid investment? Explain.

Tutorial 3 (Topic 2)

1. Elmo Inc.'s stock is currently selling at $60 per share. For each of the following situations (ignoring brokerage commissions), calculate the gain or loss that Maureen Katz realizes if she makes a l00-share transaction.

a. She sells short and repurchases the borrowed shares at $70 per share.

b. She takes a long position and sells the stock at $75 per share.

c. She sells short and repurchases the borrowed shares at $45 per share.

d. She takes a long position and sells the stock at $60 per share.

2. An investor short sells 100 shares of a stock for $20 per share. The initial margin is 50%. Ignoring transaction costs, how much will be in the investor’s account after this transaction if this is the only transaction the investor has undertaken and the investor has deposited only the required amount?

3. Imagine that you have placed a limit order to buy 100 shares of Sallisaw Tool at a price of $38, though the stock is currently selling for $41. Discuss the consequences, if any, of each of the following.

a. The stock price drops to $39 per share 2 months before cancellation of the limit order.

b. The stock price drops to $38 per share.

c. The minimum stock price achieved before cancellation of the limit order was $38.50. When the limit order was canceled, the stock was selling for $47.50 per share.

4. You have been researching a stock that you like, which is currently trading at $50 per share. You would like to buy the stock if it were a little less expensive-say, $47 per share. You believe that the stock price will go to $70 by year-end, and then level off or decline.

You decide to place a limit order to buy 100 shares of the stock at $47, and a limit order to sell it at $70. It turns out that you were right about the direction of the stock price, and it goes straight to $75. What is your current position?

5. You own 500 shares of Ups&Downs, Inc., stock. It is currently priced at $50. You are going on vacation, and you realize that the company will be reporting earnings while you are away. To protect yourself against a rapid drop in the price, you place a limit order to sell 500 shares at $40. It turns out the earnings report was not so good, and the stock price fell to $30 right after the announcement. It did, however, bounce back, and by the end of the day it was back to $42. What happened in your account?

6. You have $5,000 in a 50% margin account. You have been following a stock that you think you want to buy. The stock is priced at $52. You decide that if the stock falls to $50, you would like to buy it. You place a limit order to buy 300 shares at $50. What happens?


1. Assuming you purchased a share of stock for $50 one year ago, sold it today for $60, and during the year received three dividend payments totaling $2.70, calculate the following.

a. Current income.

b. Capital gain (or loss).

c. Total return

(1) In dollars.

(2) As a percentage of the initial investment.

2. Assume you purchased a bond for $9,500. The bond pays $300 interest every 6 months. You sell the bond after 18 months for $10,000. Calculate the following:

a. Current income.

b. Capital gain or loss.

c. Total return in dollars and as a percentage of the original investment.

3. You are considering two investment alternatives. The first is a stock that pays quarterly dividends of $0.50 per share and is trading at $25 per share; you expect to sell the stock in 6 months for $27. The second is a stock that pays quarterly dividends of $0.60 per share and is trading at $27 per share; you expect to sell the stock in 1 year for $30. Which stock will provide the better annualized holding period return?

4. Your friend asks you to invest $10,000 in a business venture. Based on your estimates, you would receive nothing for 4 years, at the end of years 5 you would receive interest on the investment compounded annually at 8%, and at the end of year 6 you would receive $14,500. If your estimates are correct, what would be the yield on this investment?

5. Elliott Dumack must earn a minimum rate of return of 11% to be adequately compensated for the risk of the following investment.

Initial Investment $14,000

End of Year Income

1 $ 6,000

2 3,000

3 5,000

4 2,000

5 1,000

a. Use present-value techniques to estimate the yield on this investment.

b. On the basis of your finding in part a, should Elliott make the proposed investment? Explain.

6. The historical returns for two investments – A and B – are summarized in the table below for the period 2004 to 2008. Use the data to answer the questions that follow.

Investment_____

Year A B

2004 19% 8%

2005 1 10

2006 10 12

2007 26 14

2008 4 16

Average 12% 12%

a. On the basis of a review of the return data, which investment appears to be more risky? Why?

b. Calculate the standard deviation and the coefficient of variation for each investment’s returns.

c. On the basis of your calculations in part b, which investment is more risky? Compare this conclusion to your observation in part a.

d. Does the coefficient of variation provide better risk comparison than the standard deviation in the case? Why or why not?


1. Assume you are considering a portfolio containing two assets, L and M. Asset L will represent 40% of the dollar value of the portfolio, and asset M will account for the other 60%. The expected returns over the next 6 years, 2009-2014, for each of these assets are summarized in the following table.

Expected Return (%)

Year Asset L Asset M

2009 14 20

2010 14 18

2011 16 16

2012 17 14

2013 17 12

2014 19 10

a. Calculate the expected portfolio return, rp, for each of the 6 years.

b. Calculate the average expected portfolio return, rp, over the 6-year period.

c. Calculate the standard deviation of expected portfolio returns, sp over the 6-year period.

d. How would you characterize the correlation of returns of the two assets L and M?

e. Discuss any benefits of diversification achieved through creation of the portfolio.

f. Assume that asset L represent 60% of the portfolio and asset M 40%. Calculate the average expected return and standard deviation of expected portfolio returns over the 6-year period. Compare your answers to the answers from part b. and c.

2. Imagine you wish to estimate the betas for 2 investments, A and B. You have gathered the following return data for the market and for each of the investments over the past 10 years, 1999-2008.

Historical Returns Investment

Year Market A B

1999 6% 11% 16%

2000 2 8 11

2001 -13 - 4 -10

2002 - 4 3 3

2003 - 8 0 - 3

2004 16 19 30

2005 10 14 22

2006 15 18 29

2007 8 12 19

2008 13 17 26

a. On a set of market return (x-axis)-investment return (y-axis) axes, use the data to draw the characteristic lines for investments A and B on the same set of axes.

b. Use the characteristic lines from part a to estimate the betas for investments A and B.

c. Use the betas found in part b to comment on the relative risks of investments A and B.

3. You are evaluating 2 possible stock investments, Buyme Co. and Getit Corp. Buyme Co. has an expected return of 14%, and a beta of 1. Getit Corp. has an expected return of 14%, and a beta of 1.2.

a. Based only on this data, which stock should you buy and why?

b. If you expected a significant market rally, would your decision be different from part i.? Explain.

4. A security has a beta of 1.20. Is this security more or less risky than the market? Explain. Assess the impact on the required return of this security in each of the following cases.

a. The market return increases by 15%.

b. The market return decreases by 8%.

c. The market return remains unchanged.

5. Assume the betas for securities A, B, and C are as shown here.

Security Beta

A 1.40

B 0.80

C -0.90

a. Calculate the change in return for each security if the market experiences an increase in its rate of return of 13.2 % over the next period.

b. Calculate the change in return for each security if the market experiences a decrease in its rate of return of 10.8% over the next period.

c. Rank and discuss the relative risk of each security on the basis of your findings. Which security might perform best during an economic downturn? Explain.

d. Assume you have a portfolio with $20,000 invested in each investment A, B, and C. What is your portfolio beta?

e. Using the portfolio beta calculated in part d., what would you expect the value of your portfolio to be if the market rallied 20%? Declined 20%?

6. Use the capital asset pricing model (CAPM) to find the required return for each of the following securities in light of the data given.

Risk-Free Market

Security Rate Return Beta

A 5% 8% 1.30

B 8 13 0.90

C 9 12 -0.20

D 10 15 1.00

E 6 10 0.60

7. Stock A has a beta of 0.80, stock B has a beta of 1.40, and stock C has a beta of -0.30.

a. Rank these stocks from the most risky to the least risky.

b. If the return on the market portfolio increases by 12 %, what change in the return for each of the stocks would you expect?

c. If the return on the market portfolio declines by 5%, what change in the return for each of the stocks would you expect?

d. If you felt the stock market was about to experience a significant decline, which stock would you be most likely to add to your portfolio? Why?

e. If you anticipated a major stock market rally, which stock would you be most likely to add to your portfolio? Why?

8. Rose Berry is attempting to evaluate 2 possible portfolios consisting of the same 5 asset but held in different proportions. She is particularly interested in using beta to compare the risk of the portfolios and, in this regard, has gathered the following data:

Portfolio Weights (%)

Asset Asset Beta Portfolio A Portfolio B

1 1.30 10 30

2 0.70 30 10

3 1.25 10 20

4 1.10 10 20

5 0.90 40 20

Total 100 100

a. Calculate the betas for portfolios A and B.

b. Compare the risk of each portfolio to the market as well as to each other. Which portfolio is more risky?

c. If the risk-free rate is 2% and the market return is 12%, calculate the required return for each portfolio using the CAPM.

d. Referring to part c. above, assume you now have the following annual returns for each investment.

Annual

Security Return

1 16.5%

2 12.0%

3 15.0%

4 13.0%

5 7.0%

Using your finding from part c., and the additional return data, determine which portfolio would choose and explain why.


1. Refer to the table below:

Fund A Fund B

Beta 1.8 1.1

Investor A 20% 80%

Investor B 80% 20%

As between Investor A and Investor B, which is more likely to represent a retired couple? Why?

2. Portfolio A and Portfolio B had the same holding period return last year. Most of the returns from Portfolio A came from dividends, while most of the returns from Portfolio B came from capital gains. Which portfolio is owned by a single working person making a high salary, and which is owned by a retired couple? Why?

3. Mark Smith purchased 100 shares of Tomco Corporation in December 2007, at a total cost of $1,762. He held the shares for 15 months and then sold them, netting $2,500. During the period he held the stock, the company paid him $200 in cash dividends. How much, if any, was the capital gain realized upon the sale of stock? Calculate Mark's pretax HPR.

4. Niki Malone's portfolio earned a return of 11.8% during the year just ended. The portfolio's standard deviation of return was 14.1 %. The risk-free rate is currently 6.2%. During the year, the return on the market portfolio was 9.0% and its standard deviation was 9.4%.

a. Calculate Sharpe's measure for Niki Malone's portfolio for the year just ended.

b. Compare the performance of Niki's portfolio found in part a to that of Hector Smith's portfolio, which has a Sharpe's measure of 0.43. Which portfolio performed better? Why?

c. Calculate Sharpe's measure for the market portfolio for the year just ended.

d. Use your findings in parts a and c to discuss the performance of Niki's portfolio relative to the market during the year just ended.

5. During the year just ended, Anna Schultz's portfolio, which has a beta of 0.90, earned a return of 8.6%. The risk-free rate is currently 7.3%, and the return on the market portfolio during the year just ended was 9.2%.

a. Calculate Treynor's measure for Anna's portfolio for the year just ended.

b. Compare the performance of Anna's portfolio found in part a to that of Stacey Quant's portfolio, which has a Treynor's measure of 1.25%. Which portfolio performed better? Explain.

c. Calculate Treynor's measure for the market portfolio for the year just ended.

d. Use your findings in parts a. and c. to discuss the performance of Anna's portfolio relative to the market during the year just ended.

6. Chee Chew’s portfolio has a beta of 1.3 and earned a return of 12.9% during the year just ended. The risk-free rate is currently 7.8%. The return on the market port-folio during the year just ended was 11.0%

a. Calculate Jensen’s measure (Jensen’s alpha) for Chee’s portfolio for the year just ended.

b. Compare the performance of CHee’s portfolio found in part a. to that of Carri Uhl’s portfolio, which has a Jensen’s measure of -0.24. Which portfolio performed better? Explain.

c. Use your findings in part a. to discuss the performance of Chee’s portfolio during the period just ended.

7. The risk-free rate is currently 8.1 %. Use the data in the accompanying table for Fio family's portfolio and the market portfolio during the year just ended to answer the questions that follow.

Data Item Fios' Portfolio Market Portfolio

Rate of return 12.8% 11.2%

Standard deviation of return 13.5% 9.6%

Beta 1.10 1.00

a. Calculate Sharpe's measure for the portfolio and the market. Compare the 2 measures, and assess the performance of the Fios' portfolio during the year just ended.

b. Calculate Treynor's measure for the portfolio and the market. Compare the two, and assess the performance of the Fios' portfolio during the year just ended.

c. Calculate Jensen's measure (Jensen's alpha). Use it to assess the performance of the Fios' portfolio during the year just ended.

d. On the basis of your findings in parts a, b, and c, assess the performance of the Fios' portfolio during the year just ended.


MM Mutual

Time Period Stock Price Shares Fund NAV Shares

1 $20.00 1,000 $20.00 1,000

2 $25.00 $21.00 _____

a. Assume you are using a constant-dollar plan with a rebalancing trigger of $1,500. The stock price represents your speculative portfolio, and the MM mutual fund represents your conservative portfolio. What action, if any, should you take in time period 2? Be specific.

b. Now assume you are using a constant-ratio plan with a rebalance trigger of speculative-to-conservative of 1.25. What action, if any, should you take in time period 2? Be specific.


MM Mutual

Time Period Stock Price Shares Fund NAV Shares

1 $20.00 1,000 $20.00 1,000

2 $30.00 1,000 $19.00 1,000

Assume you are using a variable-ratio plan. You have decided that when the speculative portfolio reaches 60% of the total, you will reduce its proportion to 45%. What action, if any, should you take in time period 2? Be specific.


1. Can the market really have a measurable effect on the price behavior of individual securities? Explain.

2. Briefly describe each of the following, and note how it is computed and how it is used by technicians:

a. Relative strength index.

b. Moving averages.

3. What is the random walk hypothesis, and how does it apply to stocks? What is an efficient market? How can a market be efficient if its prices behave in a random fashion?

4. Explain why it is difficult, if not impossible, to consistently outperform an efficient market.

a. Does this mean that high rates of return are not available in the stock market?

b. How can an investor earn a high rate of return in an efficient market?

5. What are market anomalies and how do they come about? Do they support or refute the EMH? Briefly describe each of the following:

a. The January effect.

b. The PIE effect.

c. The size effect.

6. Briefly explain how behavioral finance can affect each of the following:

a. The predictability of stock returns.

b. Investor behavior.

c. Analyst behavior.

7. Briefly define each of the following, and note the conditions that would suggest the market is technically strong

a. Breadth of the market

b. Relative strength index (RSI)

8. Briefly define each of the following terms, and describe how it can affect investors’ decisions:

a. Loss aversion

b. Representativeness

c. Narrow framing

d. Overconfidence

e. Biased self-attribution

9. You find the closing prices for a stock you own. You want to use a 10-day moving average to monitor the stock. Calculate the 10-day moving average for days 11 through 20. Based on the data in the table below, are there any signals you should act on? Explain.

Day Closing Price Day Closing Price

1 $25.25 11 $30.00

2 26.00 12 30.00

3 27.00 13 31.00

4 28.00 14 31.50

5 27.00 15 31.00

6 28.00 16 32.00

7 27.50 17 29.00

8 29.00 18 29.00

9 27.00 19 28.00

10 28.00 20 27.00


1. Describe the general concept of economic analysis. Is this type of analysis necessary, and can it really help the individual investor make a decision about a stock? Explain.

2. What is industry analysis, and why is it important?

3. Billy Jean owns 200 shares of MJ Corporation. The company’s board of directors recently declared a cash dividend of 50 cents a share payable April 18 (a Wednesday) to shareholders of record on March 22 (a Thursday).

a. How much in dividends, if any, will Billy receive if he sells his stock on March 20?

b. Assume Billy decides to hold onto the stock rather than sell it. If he belongs to the company’s dividend reinvestment plan, how many new shares of stock will he receive if the stock currently trading at $40, and the plan offers a 5% discount on the share price of the stock? (Assume that all of Billy’s dividends are diverted to the plan.) Will Billy have to pay any taxed on these dividends, given that he is taking them in stock rather than cash?

Case Problem: Some Financial Ratios Are Real Eye-Openers

Jack Arnold is a resident of Lubbock, Texas, where he is a prosperous rancher and businessman. He has also built up a sizable portfolio of common stock, which, he believes, is due to the fact that he thoroughly evaluates each stock he invests in. As Jack says, "Y'all can't be too careful about these things! Anytime I'm fixin’ to invest in a stock, you can bet I'm gonna learn as much as I can about the company." Jack prefers to compute his own ratios even though he could easily obtain analytical reports from his broker at no cost. (In fact, Billy Bob Smith, his broker, has been volunteering such services for years.) Recently, Jack has been keeping an eye on a small chemical stock. The firm, South Plains Chemical Company, is big in the fertilizer business-which is something Jack knows a lot about. Not long ago, he received a copy of the firm's latest financial statements (summarized here) and decided to take a closer look at the company.

South Plains Chemical Company Balance Sheet

($ Thousands)

__________________________________________________________________

Cash $ 1,250

Accounts receivable 8,000Current liabilities $ 10,000

Inventory 12,000Long-term debt 8,000

Current assets 21,250Stockholders' equity 12,000

Fixed and other assets 8,750 Total liabilities and

Total assets $30,000 stockholders' equity $ 30,000

Income Statement

($ Thousands)

_________________________________________________________

Sales $50,000

Cost of goods sold 25,000

Operating expenses 15,000

Operating profit 10,000

Interest expense 2,500

Taxes 2,500

Net profit $ 5,000

Dividends paid to common stockholders

($ in thousands) $1,250

Number of common shares outstanding 5 million

Recent market price of the common stock $25

Questions

a. Compute the following ratios, using the South Plains Chemical Company figures.

Latest Industry Latest Industry

Averages Averages

Liquidity Profitability

a. Net working capital N/A h. Net profit margin 8.5%

b. Current ratio 1.95 i. Return on assets 22.5%

j. ROE 32.2%

Activity

c. Receivables turnover 5.95 Common Stock Ratios

d. Inventory turnover 4.50 k. Earnings per share $2.00

e. Total asset turnover 2.65 l. Price/earnings ratio 20.0

m. Dividends per share $1.00

Leverage n. Dividend yield 2.5%

f. Debt-equity ratio 0.45 o. Payout ratio 50.0%

g. Times interest earned 6.75 p. Book value per share $6.25

q. Price-to-book-value ratio 6.4

b. Compare the company ratios you prepared to the industry figures given in part a. What are the company's strengths? What are its weaknesses?

c. What is your overall assessment of South Plains Chemical? Do you think Jack should continue with his evaluation of the stock? Explain.


1. An investor estimates that next year's sales for New World Products should £mount to about $75 million. The company has 2.5 million shares outstanding, generates a net profit margin of about 5%, and has a payout ratio of 50%. All figures are expected to hold for next year. Given this information, compute the following.

a. Estimated net earnings for next year.

b. Next year's dividends per share.

c. The expected price of the stock (assuming the PIE ratio is 24.5 times earnings).

d. The expected holding period return (latest stock price: $25 per share).

2. Charlene Lewis is thinking about buying some shares of Education, Inc., at $50 per share. She expects the price of the stock to rise to $75 over the next 3 years. During that time she also expects to receive annual dividends of $5 per share.

a. What is the intrinsic worth of this stock, given a 10% required rate of return?

b. What is its expected return?

3. Amalgamated Aircraft Parts, Inc., is expected to pay a dividend of $1.50 in the coming year. The required rate of return is 16%, and dividends are expected to grow at 7% per year. Using the dividend valuation model, find the intrinsic value of the company's common shares.

4. Larry, Moe, and Curley are brothers. They're all serious investors, but each has a different approach to valuing stocks. Larry, the oldest, likes to use a I-year holding period to value common shares. Mae, the middle brother, likes to use multiyear holding periods. Curley, the youngest of the three, prefers the dividend valuation model.

As it turns out, right now, all three of them are looking at the same stock American Home Care Products, Inc. (AHCP). The company has been listed on the NYSE for over 50 years, and is widely regarded as a mature, rock-solid, dividend-paying stock. The brothers have gathered the following information about AHCP's stock:

Current dividend (Do) = $2.50/share

Expected growth rate (g) = 9.0%

Required rate of return (k) = 12.0%

All three of them agree that these variables are appropriate, and they will use them in valuing the stock. Larry and Moe intend to use the D&E approach; Curley is going to use the constant-growth DVM. Larry will use a 1-year holding period; he estimates that with a 9% growth rate, the price of the stock will increase to $98.80 by the end of the year. Mae will use a 3-year holding period; with the same 9% growth rate, he projects the future price of the stock will be $117.40 by the end of his investment horizon. Curley will use the constant-growth DVM, so his holding period isn't needed.

a. Use the information provided above to value the stocks first for Larry, then for Moe, then for Curley.

b. Comment on your findings. Which approach seems to make the most sense?

5. Let's assume that you're thinking about buying stock in West Coast Electronics. So far in your analysis, you've uncovered the following information: The stock pays annual dividends of $2.50 a share (and that's not expected to change within the next few years-nor are any of the other variables). It trades at a PIE of 18 times earnings and has a beta of 1.15. In addition, you plan on using a risk-free rate of 7% in the CAPM, along with a market return of 14%. You would like to hold the stock for 3 years, at the end of which time you think EPS will peak at about $7 a share. Given that the stock currently trades at $70, use the IRR approach to find this security's expected return. Now use the present-value (dividends-and-earnings) model to put a price on this stock. Does this look like a good investment to you? Explain.

6. This year, Shoreline Light and Gas (SLL&G) paid its stockholders an annual dividend of $3 a share. A major brokerage firm recently put out a report on SLL&G stating that, in its opinion, the company's annual dividends should grow at the rate of 10% per year for each of the next 5 years and then level off and grow at the rate of 6% a year thereafter.

a. Use the variable-growth DVM and a required rate of return of 12% to find the maximum price you should be willing to pay for this stock.

b. Redo the SLL&G problem in part a, this time assuming that after year 5, dividends stop growing altogether (for year 6 and beyond, g = 0). Use all the other information given to find the stock's intrinsic value.

c. Contrast your two answers and comment on your findings. How important is growth to this valuation model?

7. Assume there are three companies that in the past year paid exactly the same annual dividend of $2.25 a share. In addition, the future annual rate of growth in dividends for each of the three companies has been estimated as follows:

Buggies-Are-Us Steady Freddie. Inc. Gang Buster Group

g=0 g= 6% Year 1 $2.53

(i.e., dividends are (for the 2 $2.85

expected to remain foreseeable future) 3 $3.20

at $2.25/share) 4 $3.60

Year 5 and beyond: g = 6%

Assume also that as the result of a strange set of circumstances, these three companies all have the same required rate of return (k = 10%).

a. Use the appropriate DVM to value each of these companies.

b. Comment briefly on the comparative values of these three companies. What is the major cause of the differences among these three valuations?

8. A particular company currently has sales of $250 million; sales are expected to grow by 20% next year (year 1). For the year after next (year 2), the growth rate in sales is expected to equal 10%. Over each of the next 2 years, the company is expected to have a net profit margin of 8% and a payout ratio of 50%, and to maintain the common stock outstanding at 15 million shares. The stock always trades at a PIE of 15 times earnings, and the investor has a required rate of return of 20%. Given this information:

a. Find the stock's intrinsic value (its justified price).

b. Use the IRR approach to determine the stock's expected return, given that it is currently trading at $15 per share.

c. Find the holding period returns for this stock for year 1 and for year 2.

9. Assume a major investment service has just given Oasis Electronics its highest investment rating, along with a strong buy recommendation. As a result, you decide to take a look for yourself and to place a value on the company's stock. Here's what you find: This year, Oasis paid its stockholders an annual dividend of $3 a share, but because of its high rate of growth in earnings, its dividends are expected to grow at the rate of 12 % a year for the next 4 years and then to level out at 9% a year. So far, you've learned that the stock has a beta of 1.80, the risk-free rate of return is 6%, and the expected return on the market is 11 %. Using the CAPM to find the required rate of return, put a value on this stock.


1. Assume that you pay $850 for a long-term bond that carries a 7½% coupon. Over the course of the next 12 months, interest rates drop sharply. As a result, you sell the bond at a price of $962.50.

a. Find the current yield that existed on this bond at the beginning of the year. What was it by the end of the one-year holding period?

b. Determine the holding period return on this investment.

2. In early January 2001, you purchased $30,000 worth of some Baa-rated corporate bonds. The bonds carried a coupon of 8 7/8% and mature in 2015. You paid 94.125 when you bought the bonds. Over the 5-year period from 2001 through 2005, the bonds were priced in the market as follows:

Quoted Prices

Beginning of End of Year-End

Year the Year the Year Bond Yields

2001 94.125 100.625 8.82%

2002 100.625 102 8.70

2003 102 104.625 8.48

2004 104.625 110.125 8.05

2005 110.125 121.250 7.33

Coupon payments were made on schedule throughout the 5-year period.

a. Find the annual holding period returns for 2001 through 2005. (See Chapter 5 for the HPR formula.)

b. Use the return information in Table 10.1 to evaluate the investment performance of this bond. How do you think it stacks up against the market? Explain.

3. Rhett purchased a 13% zero-coupon bond with a l5-year maturity and a

$20,000 par value 15 years ago. The bond matures tomorrow. How much will Rhett receive in total from this investment, assuming all payments are made on these bonds as expected?

4. You are considering investing $850 in Success Corporation. You can buy common stock at $25 per share; this stock pays no dividends. You can also buy a convertible bond that is currently trading at $850 and has a conversion ratio of 30. It pays $50 per year in interest. Given you expect the price of the stock to rise to $35 per share in one year, which instrument should you purchase?


1. Zack buys a 10% corporate bond with a current yield of 6%. How much did he pay for the bond?

2. Which of the following three bonds offers the highest current yield?

a. A 9 ½ %, 20-year bond quoted at 97 ¾

b. A 16%, 15-year bond quoted at 164 5/8.

c. A 5 1/4 %, 18-year bond quoted at 54.

3. Using semiannual compounding, find the prices of the following bonds:

a. A 10.5%, 15-year bond priced to yield 8%.

b. A 7%, 10-year bond priced to yield 8%.

c. A 12%, l0-year bond priced at 10%.

Repeat the problem using annual compounding. Then comment on the differences you found in the prices of the bonds.

4. Assume that an investor is looking at 2 bonds: Bond A is a 20-year, 9%

(semiannual pay) bond that is priced to yield 10.5%. Bond B is a 20-year, 8% (annual pay) bond that is priced to yield 7.5%. Both bonds carry 5-year call deferments and call prices (in 5 years) of $1,050.

a. Which bond has the higher current yield?

b. Which bond has the higher YTM?

c. Which bond has the higher YTC?

5. Using annual compounding, find the yield-to-maturity for each of the

following bonds.

a. A 9.5%, 20-year bond priced at $957.43.

b. A 16%, 15-year bond priced at $1,684.76.

c. A 5.5%, 18-year bond priced at $510.65.

Now assume that each of the above three bonds is callable as follows: Bond a is callable in 7 years at a call price of $1,095; bond b is callable in 5 years at $1,250; and bond c is callable in 3 years at $1,050. Use annual compounding to find the yield-to-call for each bond.


1. You believe that oil prices will be rising more than expected, and that

rising prices will result in lower earnings for industrial companies that use a lot of petroleum related products in their operations. You also believe that the effects on this sector will be magnified because consumer demand will fall as oil prices rise. You locate an exchange traded fund, XLB, that represents a basket of industrial companies. You don't want to short the ETF because you don't have enough margin in your account. XLB is currently trading at $23. You decide to buy a put option (for 100 shares) with a strike price of $24, priced at $1.20. It turns out that you are correct. At expiration, XLB is trading at $20. Calculate your profit.

XLB: Materials-$23.00

Calls Puts

Strike Expiration Price Strike Expiration Price

$20 November $0.25 $20 November $1.55

$24 November $0.25 $24 November $1.20

2. Refer to the table for XLB above. What happens if you are wrong and the price of XLB increases to $25 on the expiration date?

3. Milley Myles holds 600 shares of Bony Music. She bought the stock several years ago at 48.50, and the shares are now trading at 75. Milley is concerned that the market is beginning to soften. She doesn’t want to sell the stock, but she would like to be able to protect the profit she’s made. She decides to hedge her position by buying 6 puts on Bony Music. The three-month puts carry a strike price of 75 and are currently trading a 2.50.

a. How much profit or loss will Milley make on this deal if the price of Bony Music does indeed drop to $60 a share by the expiration date on the puts?

b. How would he do if the stock kept going up in price and reached $90 a share by the expiration date?

c. What do you see as the major advantages of using puts as hedge vehicles?

d. Would Milley have been better off using in-the-money puts—that is, put with and $85 strike price that are trading at 10.50? How about using out-of-the-money puts—says, those with a $70 strike price, trading at 1.00? Explain.


1. What is a futures contract? Briefly explain how it is used as an investment vehicle.

2. What is the one source of return on futures contracts? What measure is used to calculate the return on a commodities contract?

3. What is the difference between physical commodities and financial futures? What are their similarities?

4. Discuss how stock-index futures can be used for speculation and for hedging. What advantages are there to speculating with stock-index futures rather than specific issues of common stock?

5. Jeff Rink considers himself a shrewd commodities investor. Not long ago he bought one July cotton contract at $0.54 a pound, and he recently sold it at $0.58 a pound. How much profit did he make? What was his return on invested capital if he had to put up a $1,260 initial deposit?

6. An American currency speculator feels strongly that the value of the Canadian dollar is going to fall relative to the U.S. dollar over the short run. If the wants to profit from these expectations, what kind of position (long or short) should he takes in Canadian dollar futures contracts? How much money would he make from each contract if Canadian dollar futures contracts moved from an initial quote of 0.6775 to an ending quote of 0.6250?

7. On 30 November, a UK exporter sells goods worth £10 million to a French importer on three months’ credit. The customer is billed in euros, for which the spot rate versus sterling is €1.6/£1. The three-month forward rate is €1.62/£1.

a. What is the amount invoiced?

b. If the spot rate is €1.7/£1 at settlement date, what is the exporter’s gain/ loss, assuming it does not hedge?

c. If the spot rate is €1.5/£1 at the settlement date, what is the exporter’s gain/ loss, assuming it does not hedge?

d. If the exporter takes forward cover, what is the cost of the hedge

i. Compared to the current spot rate?

ii. Compared to case (b)?

iii. Compared to case (c)?


1. What is a mutual fund? Discuss the mutual fund concept, including the importance of diversification and professional management.

2. What are the advantages and disadvantages of mutual fund ownership?

3. One year ago, Super Star Closed-End Fund had a NAV of $10.40 and was selling at an 18% discount. Today, its NAV is $11.69 and it is priced at a 4% premium. During the year, Super Star paid dividends of $0.40 and had a capital gains distribution of $0.95. On the basis of the above information, calculate each of the following:

a. Super Star’s NAV-based holding period return of the year.

b. Super Star’s market-based holding period return for the year. Did the market/discount hurt or add value to the investor’s return? Explain.

c. Repeat the market-based holding period return calculation, except this time assume the fund started the year at an 18% premium and ended it at a 4% discount. (Assume the beginning and ending NAVs remain at $10.40 and $11.69, respectively.) Is there any change in this measure of return? Why?

IB tut

Documents

latest industry

relative strength

exporters

day moving

dividend valuation

pays quarterly

holding period

net profit