Investment Analysis (FIN 670)
Fall 2009
Homework 1
Instructions: please read carefully
•
•
You should show your work how to get the answer for each calculation
question to get full credit.
The due date is Tue, Sep 22, 2009. Late homework will not be graded.
Name(s):
Student ID
Chapter 1
1. There would be no _______________ in an efficient stock market.
a.
b.
c.
d.
underpriced or overpriced stocks
returns higher than 100%
commission costs
taxes
1. a
2. A _______________ represents an ownership share in a corporation.
a.
b.
c.
d.
e.
bond
preferred stock
common stock
All of the above.
B and C
2. e
3. In securities markets, the risk-return trade-off implies that assets with higher risk will offer
investors _______________ expected returns.
a.
b.
c.
d.
higher
lower
the same
None of the above.
3. a
4. Allocation of the investment portfolio across broad asset classes refers to the
_______________.
a.
b.
c.
d.
security analysis
top-down portfolio construction
asset allocation
None of the above.
4. c
5. American Depository Receipts are claims to _______________.
a.
b.
c.
d.
foreign stocks
American stocks
North American stocks
European stocks
5. a
6. Firms that specialize in helping companies raise capital by selling securities are called
_______________.
a.
b.
c.
d.
6. c
industrial banks
commercial banks
investment banks
None of the above.
7. _______________ are financial assets.
a.
b.
c.
d.
Options
Factories
Commercial properties
All of the above are financial assets.
7. a
8. Portfolio manager with a passive investment strategy will manage a portfolio by
______________.
a.
b.
c.
d.
holding a diversified portfolio
selecting mispriced securities
timing the performance of securities
None of the above.
8. a
9. Corporate bonds are _______________ securities.
a.
b.
c.
d.
fixed-income
money-market
derivatives
real
9. a
Chapter 2
10. Commercial papers are short-term debt issued by _______________ companies
a.
b.
c.
d.
large and well-known
small and well-known
financial
commercial
10. a
11. Preferred stock dividends are _______________.
a.
b.
c.
d.
tax exempted
cumulative
non-cumulative
risk free
11. b
12. The price which the owner of a put option will receive from selling the stock named in the
option contract is called the _______________.
a.
b.
c.
d.
12. c
put price
expiration price
exercise price
none of the above
13. In the event of the company's bankruptcy, _______________.
a. the firm's bondholders are personally liable for the firm's obligations
b. the most shareholders can lose is their original investment in the firm's stock plus any
legal costs
c. bondholders have claim to what is left from the liquidation of the firm's assets after
paying shareholders
d. common shareholders are the last in line to receive their claims on the firm's assets
13. d
14. Money Market securities are characterized by _______________.
a. long maturity and high liquidity
b. long maturity and low liquidity
c. short maturity and low liquidity
d. short maturity and high liquidity
14. d
15. Which bond has a lower after-tax yield to maturity to you who are in a 20% tax bracket: a
municipal bond that was issued in your state with a yield of 6% and a similar corporate bond
with a yield of 6%?
a. Corporate bond
b. Municipal bond
c. They should have the same after-tax yield to you.
d. Cannot be determined.
15. a
16. Investors purchase Treasury bills at a _______________ and will receive the
_______________ at maturity.
a.
b.
c.
d.
discount; face value
premium; face value and interest
discount; face value and interest
premium; face value
16. a
17. The buyer of an orange juice futures contract has _______________ to _______________ a
certain quantity of orange juice on the maturity date, at a specific price.
a.
b.
c.
d.
17. a
an obligation, buy
an obligation, sell
the right, sell
the right, buy
18. The divisor of the Dow Jones Industry Average is updated when one of the companies
_______________.
a.
b.
c.
d.
is replaced by another
issues a stock split
has negative earnings
A and B above.
18. d
19. If a treasury note has a bid price of $982.50, the quoted bid price in the Wall Street Journal
would be __________.
A) 98:08
B) 98:25
C) 98:50
D) 98:40
19. a
(98+08/32)% of par (1000) = 982.50
20. Which one of the following is not a money market instrument?
A) a Treasury bond
B) a negotiable certificate of deposit
C) a Eurodollar account
D) a Treasury bill
E) commercial paper
20. a
21. Which of the following is true of the Dow Jones Industrial Average?
A)
B)
C)
D)
E)
The divisor must be adjusted for stock splits.
It is a price-weighted average of 30 large industrial firms.
It is a value-weighted average of 30 large industrial firms.
It is an equally weighted average of 30 large industrial firms.
A and B
21. e
The Dow Jones Industrial Average is a price-weighted index of 30 large industrial firms and
the divisor must be adjusted when any of the stocks on the index split.
22. Which of the following statements is (are) true regarding municipal bonds?
I) A municipal bond is a debt obligation issued by state or local governments.
II) A municipal bond is a debt obligation issued by the federal government.
III) The interest income from a municipal bond is exempt from federal income
taxation.
IV) The interest income from a municipal bond is exempt from state and local taxation
in the issuing state.
A)
B)
C)
D)
E)
I and II only
I and III only
I, II, and III only
I, III, and IV only
I and IV only
22. D
A municipal bond is a debt obligation issued by state or local governments, the interest
income from a municipal bond is exempt from federal income taxation, and the interest
income from a municipal bond is exempt from state and local taxation in the issuing state
23.
The price quotations of Treasury bonds in the Wall Street Journal show an ask price of
104:08 and a bid price of 104:04. As a buyer of the bond what is the dollar price
you expect to pay?
A)
B)
C)
D)
E)
$1,048.00
$1,042.50
$1,044.00
$1,041.20
$1,040.40
23. b
You pay the asking price of the dealer, 104 8/32, or 104.25% of $1,000, or $1042.50
24. Federally sponsored agency debt
A)
B)
C)
D)
E)
has a small positive yield spread relative to U.S. Treasuries.
is legally insured by the U.S. Treasury.
probably would be backed by the U.S. Treasury in the event of a near-default.
A and C
B and C
24. D
Federally sponsored agencies, such as the FHLB, are not government owned. These agencies'
debt is not insured by the U.S. Treasury, but probably would be backed by the Treasury in the
event of an agency near-default. As a result, the issues are very safe and carry a yield only
slightly higher than that of U. S. Treasuries.
25. Freddie Mac and Ginnie Mae were organized to provide
A)
B)
C)
D)
E)
a primary market for mortgage transactions.
liquidity for the mortgage market.
a primary market for farm loan transactions.
liquidity for the farm loan market.
a source of funds for government agencies.
25. B
Freddie Mac and Ginnie Mae were organized to provide liquidity for the mortgage market.
26. Which of the following are characteristics of preferred stock?
I) It pays its holder a fixed amount of income each year, at the discretion of its
managers.
II) It gives its holder voting power in the firm.
III) Its dividends are usually cumulative.
IV) Failure to pay dividends may result in bankruptcy proceedings.
A)
B)
C)
D)
E)
I, III, and IV
I, II, and III
I and III
I, II, and IV
I, II, III, and IV
26. C
Preferred stock pays its holder a fixed amount of income each year, at the discretion of its
managers, and its dividends are usually cumulative.
27. With regard to a futures contract, the long position is held by
A)
B)
C)
D)
E)
the
the
the
the
the
trader
trader
trader
trader
trader
who
who
who
who
who
bought the contract at the largest discount
has to travel the farthest distance to deliver the commodity.
plans to hold the contract open for the lengthiest time period.
commits to purchasing the commodity on the delivery date.
commits to delivering the commodity on the delivery date.
27. D
With regard to a futures contract, the long position is held by the trader who commits to
purchasing the commodity on the delivery date.
28. Why do call options with exercise prices higher than the price of the underlying stock sell for
positive prices?
There is always a chance that the market stock price will be higher than the exercise price.
Investors will pay something for this chance of a positive payoff.
29. Explain the difference between a put option and a short position in a futures contract.
A put option conveys the right to sell the underlying asset at the exercise price. A short
position in a futures contract carries an obligation to sell the underlying asset at the
futures price.
30. Explain the difference between a call option and a long position in a future contract
A call option conveys the right to buy the underlying asset at the exercise price. A long
position in a futures contract carries an obligation to buy the underlying asset at the
futures price.
31. Look at the following information of GE options and answer the following question
Suppose you buy a November expiration call option with exercise price $40.
a. If the stock price in November is $42, will you exercise your call? What are the profit and rate
of return on your position?
Since the stock price exceeds the exercise price, you will exercise the call.
The payoff on the option will be: $42 − $40 = $2
The option originally cost $2.14, so the profit is: $2.00 − $2.14 = −$0.14 or -$14 for
1 contract
Rate of return = −$0.14/$2.14 = −0.0654 = −6.54%
b. What if you had bought the November call with exercise price 42.50? (If the stock price in
November is $42, will you exercise your call? What are the profit and rate of return on your
position?)
If the call has an exercise price of $42.50, you would not exercise for any stock price of
$42.50 or less. The loss on the call would be the initial cost: $0.72*100 = $72
c. What if you had bought November put with exercise price 42.50? (If the stock price in
November is $42, will you exercise your put? What are the profit and rate of return on your
position?)
Since the stock price is less than the exercise price, you will exercise the put.
The payoff on the option will be: $42.50 − $42.00 = $0.50
The option originally cost $1.83 so the profit is: $0.50 − $1.83 = −$1.33
Or -$133 for 1 contract
Rate of return = −$1.33/$1.83 = −0.7268 = −72.68%
32. Consider the three stocks in the following table, Pt represents the price at time t, Qt represents
shares outstanding at time t. Stock C splits 2-for-1 in the last period.
P0
Q0
P1
Q1
P2
Q2
A
90
100
95
100
95
100
B
50
200
45
200
45
200
C
100
200
110
200
55
400
a. Calculate the rate of return on a price weighted index of the three stocks for the first period (t=0
to t=1)
At t = 0, the value of the index is: (90 + 50 + 100)/3 = 80
At t = 1, the value of the index is: (95 + 45 + 110)/3 = 83.3333
The rate of return is: (83.3333/80) – 1 = 4.167%
b. What must happen to the divisor for the price weighted index in year 2 (when the stock C has
the split 2-for-1)
the value of the index in year 2 would be: (95 + 45 + 110)/3 = 83.33
After the split, stock C sells at 55. Therefore, we need to set the divisor
(d) such that:
83.33= (95 + 45 + 55)/d
d = 2.34
c. The rate of return is zero. The index remains unchanged, as it should, since the return
on each stock separately equals zero.
32. Look at the futures listings for the S&P 500 index
a. Suppose you buy one contract for March delivery. If contract closes in March at a level of
1300, what will your profit be?
You bought the contract when the futures price was 1427.50 (see Figure 2.12). The contract
closes at a price of 1300, which is 127.50 less than the original futures price. The
contract multiplier is $250. Therefore, the loss will be:
127.50 × $250 = $31,875
b. How many March maturity contracts are outstanding?
Open interest is 601,655 contracts.