Investments and portfolio Management bodie kane marcus 10e solutions manual and test bank
Bodie - Investments -
10e, solutions
manual and test bank 0077861671
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CHAPTER
2: ASSET CLASSES AND FINANCIAL
INSTRUMENTS
PROBLEM SETS
1. Preferred stock is like long-term debt
in that it typically promises a fixed payment each year. In this way, it is a
perpetuity. Preferred stock is also like long-term debt in that it does not
give the holder voting rights in the firm.
Preferred stock is like equity in
that the firm is under no contractual obligation to make the preferred stock
dividend payments. Failure to make payments does not set off corporate
bankruptcy. With respect to the priority of claims to the assets of the firm in
the event of corporate bankruptcy, preferred stock has a higher priority than
common equity but a lower priority than bonds.
2. Money market securities are called cash equivalents because of their high level of liquidity. The
prices of money market securities are very stable, and they can be converted to
cash (i.e., sold) on very short notice and with very low transaction costs. Examples
of money market securities include Treasury bills, commercial paper, and
banker's acceptances, each of which is highly marketable and traded in the
secondary market.
3. (a) A
repurchase agreement is an agreement whereby the seller of a security agrees to
“repurchase” it from the buyer on an agreed upon date at an agreed upon price. Repos
are typically used by securities dealers as a means for obtaining funds to
purchase securities.
4. Spreads between risky commercial paper and risk-free
government securities will widen. Deterioration of the economy increases the
likelihood of default on commercial paper, making them more risky. Investors will demand a greater premium on all
risky debt securities, not just commercial paper.
5.
Corp.
Bonds
|
Preferred
Stock
|
Common
Stock
|
|
Voting rights (typically)
|
Yes
|
||
contractual obligation
|
Yes
|
||
Perpetual payments
|
Yes
|
Yes
|
|
Accumulated dividends
|
Yes
|
||
Fixed payments (typically)
|
Yes
|
Yes
|
|
Payment preference
|
First
|
Second
|
Third
|
6. Municipal bond interest is tax-exempt at the federal level
and possibly at the state level as well. When facing higher marginal tax rates,
a high-income investor would be more inclined to invest in tax-exempt
securities.
7. a. You would have to pay the ask price of:
161.1875% of
par value of $1,000 = $1611.875
b. The coupon rate
is 6.25% implying coupon payments of $62.50 annually
or, more precisely, $31.25 semiannually.
c. The yield to maturity on a fixed income
security is also known as its required return and is reported by The Wall Street Journal and others in
the financial press as the ask yield. In
this case, the yield to maturity is 2.113%.
An investor buying this security today and holding it until it matures
will earn an annual return of 2.113%.
Students will learn in a later chapter how to compute both the price and
the yield to maturity with a financial calculator.
8. Treasury bills are discount securities
that mature for $10,000. Therefore, a
specific T-bill price is simply the maturity value divided by one plus the
semi-annual return:
P = $10,000/1.02 =
$9,803.92
9. The total before-tax income is $4. After the 70% exclusion
for preferred stock dividends, the taxable income is: 0.30 ´ $4 = $1.20
Therefore,
taxes are: 0.30 ´
$1.20 = $0.36
After-tax
income is: $4.00 – $0.36 = $3.64
Rate of return is: $3.64/$40.00 =
9.10%
10. a. You
could buy: $5,000/$64.69
= 77.29
shares. Since it is not possible to
trade in fractions of shares, you could buy 77 shares of GD.
b. Your annual dividend income would be: 77 ´ $2.04 = $157.08
c. The price-to-earnings ratio is 9.31
and the price is $64.69.
Therefore:
$64.69/Earnings
per share = 9.3
Þ Earnings per share = $6.96
d. General Dynamics closed today at $64.69,
which was $0.65
higher than yesterday’s price of $64.04
11. a. 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 = 83.333
The rate of return is:
(83.333/80) -
1 = 4.17%
b. In the absence of a split, Stock C would sell for 110, so the
value of the index would be: 250/3 = 83.333 with a divisor of 3.
After
the split, stock C sells for 55. Therefore, we need to find the divisor (d)
such that: 83.333 = (95 + 45 + 55)/d Þ d = 2.340. The
divisor fell, which is always the case after one of the firms in an index
splits its shares.
c. The return is zero. The index remains unchanged because the
return for each stock separately equals zero.
12. a. Total market value at t = 0 is: ($9,000 + $10,000 + $20,000) = $39,000
Total market value at t = 1 is: ($9,500 + $9,000 + $22,000) = $40,500
Rate
of return = ($40,500/$39,000) – 1 = 3.85%
b.
The
return on each stock is as follows:
rA = (95/90) – 1 =
0.0556
rB = (45/50) – 1 = –0.10
rC = (110/100) – 1 =
0.10
The equally weighted average is:
[0.0556 + (-0.10) +
0.10]/3 = 0.0185 = 1.85%
13. The after-tax yield on the corporate bonds is: 0.09 ´ (1 – 0.30) = 0.063 =
6.30%
Therefore, municipals must offer a
yield to maturity of at least 6.30%.
14. Equation (2.2) shows that the equivalent taxable yield is: r = rm /(1 – t),
so simply substitute each tax rate in the denominator to obtain the following:
a. 4.00%
b. 4.44%
c. 5.00%
d. 5.71%
15. In an equally weighted index fund, each
stock is given equal weight regardless of its market capitalization. Smaller
cap stocks will have the same weight as larger cap stocks. The challenges are
as follows:
·
Given
equal weights placed to smaller cap and larger cap, equal-weighted indices
(EWI) will tend to be more volatile than their market-capitalization counterparts;
·
It
follows that EWIs are not good reflectors of the broad market that they represent;
EWIs underplay the economic importance of larger companies.
·
Turnover
rates will tend to be higher, as an EWI must be rebalanced back to its original
target. By design, many of the transactions would be among the smaller,
less-liquid stocks.
16. a. The
ten-year Treasury bond with the higher coupon rate will sell for a higher price
because its bondholder receives higher interest payments.
b. The
call option with the lower exercise price has more value than one with a higher
exercise price.
c. The put option written on the lower
priced stock has more value than one written on a higher priced stock.
17. a.
You bought the contract when the futures price was $7.8325 (see Figure
2.11 and
remember that the number to the right of the apostrophe represents an eighth of
a cent).
The contract closes at a price of $7.8725, which is $0.04 more
than the original futures price. The contract multiplier is 5000. Therefore,
the gain will be: $0.04 ´ 5000 = $200.00
b. Open interest is 135,778 contracts.
18. a. Owning
the call option gives you the right, but not the obligation, to buy at $180,
while the stock is trading in the secondary market at $193. Since the stock price exceeds the exercise
price, you exercise the call.
The payoff on the option will be: $193 - $180 = $13
The cost was originally $12.58, so the profit is: $13 - $12.58 = $0.42
b. Since the
stock price is greater than the exercise price, you will exercise the call. The
payoff on the option will be: $193 - $185 = $8
The option originally cost
$9.75, so the profit is $8 - $9.75 = -$1.75
c. Owning the put option gives you the right, but not the
obligation, to sell at $185, but you could sell in the secondary market for
$193, so there is no value in exercising the option. Since the stock price is greater
than the exercise price, you will not exercise the put. The loss on the put will be the initial cost of $12.01.
19. There is always a possibility that the
option will be in-the-money at some time prior to expiration. Investors will
pay something for this possibility of a positive payoff.
20.
Value of Call at Expiration
|
Initial Cost
|
Profit
|
|
a.
|
0
|
4
|
-4
|
b.
|
0
|
4
|
-4
|
c.
|
0
|
4
|
-4
|
d.
|
5
|
4
|
1
|
e.
|
10
|
4
|
6
|
Value of Put at Expiration
|
Initial Cost
|
Profit
|
|
a.
|
10
|
6
|
4
|
b.
|
5
|
6
|
-1
|
c.
|
0
|
6
|
-6
|
d.
|
0
|
6
|
-6
|
e.
|
0
|
6
|
-6
|
21. 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. Both positions, however, benefit if the price of the
underlying asset falls.
22. 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. Both positions, however, benefit if the price of the
underlying asset rises.
CFA
PROBLEMS
1.
(d)
There are tax advantages for corporations that own preferred shares.
2. The equivalent taxable yield is:
6.75%/(1 -
0.34) = 10.23%
3. (a) Writing
a call entails unlimited potential losses as the stock price rises.
4. a. The taxable bond. With a zero tax bracket,
the after-tax yield for the
taxable bond is the same as the
before-tax yield (5%), which is greater than the yield on the municipal bond.
b.
The taxable bond. The after-tax yield for
the taxable bond is:
0.05 ´ (1 – 0.10) = 4.5%
c. You are
indifferent. The after-tax yield for the taxable bond is:
0.05 ´ (1 – 0.20) = 4.0%
The after-tax yield is
the same as that of the municipal bond.
d. The municipal bond offers the higher
after-tax yield for investors in tax brackets above 20%.
5.
If
the after-tax yields are equal, then: 0.056 = 0.08 × (1 – t)
This implies that t = 0.30 =30%.
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