## Junk Bonds

Junk bonds, also known as high-yield bonds, are nothing more than speculative grade (low-rated or unrated) bonds. Before 1977, almost all junk bonds were fallen angels, that is, bonds issued by firms that originally had investment grade ratings but that had since been downgraded. In 1977, however, firms began to issue original-issue junk. Much of the credit for this innovation is given to Drexel Burnham Lambert, and especially its trader, Michael Milken. Drexel had long enjoyed a niche as a...

## Ft

In an inflationary period, the use of FIFO will make which one of the following more realistic than the use of LIFO 12. A company acquires a machine with an estimated 10-year service life. If the company uses the Accelerated Cost Recovery System depreciation method instead of the straight-line method a. Income will be higher in the 10th year. b. Total depreciation expense for the 10 years will be lower. c. Depreciation expense will be lower in the first year. d. Scrapping the machine after...

## Self Destructing Patterns

It should be abundantly clear from our presentations that most of technical analysis is based on ideas totally at odds with the foundations of the efficient market hypothesis. The EMH follows from the idea that rational profit-seeking investors will act on new information so quickly that prices will nearly always reflect all publicly available information. Technical analysis, on the other hand, posits the existence of long-lived trends that play out slowly and predictably. Such patterns, if...

## Index Arbitrage and the Triple Witching Hour

Whenever the actual futures price differs from its parity value, there is an opportunity for profit. This is why the parity relationships are so important. One of the most notable developments in trading activity has been the advent of index arbitrage, an investment strategy that exploits divergences between the actual futures price on a stock market index and its theoretically correct parity value. In principle, index arbitrage is simple. If the futures price is too high, short the futures...

## Info

Based on these data, calculate a value for Tennant common stock by applying the constant growth dividend discount model. Assume an investor's required rate of return is a five percentage point premium over the current risk-free rate of return of 7 . b. To your disappointment, the calculation you completed in part (a) results in a value below the stock's current market price. Consequently, you apply the constant growth DDM using the same required rate of return as in your calculation for part...

## First Take Care of Asset Allocation Needs

If you want to build a top-performing mutual-fund portfolio, you should start by hunting for top-performing funds, right Too many investors gamely set out to find top-notch funds without first settling on an overall portfolio strategy. Result These investors wind up with a mishmash of funds that don't add up to a decent portfolio. . . . . . . So what should you do With more than 11,000 stock, bond, and money-market funds to choose from, you couldn't possibly analyze all the funds available....

## Information On Mutual Funds

The first place to find information on a mutual fund is in its prospectus. The Securities and Exchange Commission requires that the prospectus describe the fund's investment objectives and policies in a concise Statement of Investment Objectives as well as in lengthy discussions of investment policies and risks. The fund's investment adviser and its portfolio manager also are described. The prospectus also presents the costs associated with purchasing shares in the fund in a fee table. Sales...

## How Pension Funds Lost in Market Boom

In one of the happiest reports to come out of Detroit lately, General Motors proclaimed Tuesday that its U.S. pension funds are now fully funded on an economic basis. Less noticed was GM's admission that, in accounting terms, it is still a few cents well, 3 billion shy of the mark. Wait a minute. If GM's pension plans were 9.3 billion in the hole when the year began, and if the company, to its credit, shoveled in 10.4 billion more during the year, how come its pension deficit wasn't wiped out...

## Realistic Benefits from International Diversification

While recent realized returns can be highly misleading estimates of expected future returns, they are more useful for measuring prospective risk. There are two compelling reasons for this. First, market efficiency (or even near efficiency) implies that stock prices will be impossible to predict with any accuracy, but no such implication applies to risk measures. Second, it is a statistical fact that errors in estimates of standard deviation and correlation from realized data are of a lower...

## Mutual Funds And Other Investment Companies

AFTER STUDYING THIS CHAPTER YOU SHOULD BE ABLE TO Cite advantages and disadvantages of investing with an investment company rather than buying securities directly. Contrast open-end mutual funds with closed-end funds and unit investment trusts. Define net asset value and measure the rate of return on a mutual fund. Classify mutual funds according to investment style. Demonstrate the impact of expenses and turnover on mutual fund investment performance. http www.brill.com http www.mfea.com http...

## Performance Attribution Procedures

Rather than focus on risk-adjusted returns, practitioners often want simply to ascertain which decisions resulted in superior or inferior performance. Superior investment performance depends on an ability to be in the right securities at the right time. Such timing and selection ability may be considered broadly, such as being in equities as opposed to fixed-income securities when the stock market is performing well. Or it may be defined at a more detailed level, such as choosing the relatively...

## Check

The Standard & Poor's Composite 500 (S& P 500) stock index represents an improvement over the Dow Jones averages in two ways. First, it is a more broadly based index of 500 firms. Second, it is a market value-weighted index. In the case of the firms XYZ and ABC in Example 2.2, the S& P 500 would give ABC five times the weight given to XYZ because the market value of its outstanding equity is five times larger, 500 million versus 100 million. The S& P 500 is computed by calculating...

## Active versus Passive Policies

One choice that must be confronted by all investors, individual as well as institutional, is the degree to which the portfolio will be actively versus passively managed. Recall that passive management is based on the belief that security prices usually are at close to fair levels. Instead of spending time and other resources attempting to beat the market, that is, to find mis-priced securities with unusually attractive risk-return characteristics, the investor simply assumes that she will be...

## Related Websites

http www.bloomberg.com markets rates.html These sites give general price information. These sites contain detailed information on bonds. They are comprehensive and have many related links. corporates index.htm http www.moodys.com http www.fitchinv.com The above sites provide information on bond ratings. http www.stls.frb.org fred This site has extended information on various interest rates. These rates can be downloaded into a spreadsheet format for analysis. In the previous chapters on risk...

## Principal Financial Group

FtiBDcrtiyi a< it4i)ievWfi is Pe s WB.Wifl iret rHstf SSIBSAK rte irxforimra' Banc of America Securities LLC Bear, Steams & Co. Inc. A.G. Edwards & Sons, Inc. Fox-Pitt, Kelton Inc. Ramirez & Co., Inc. UBS Warburg Banc of America Securities Limited Bear, Steams International Limited A.G. Edwards & Sons, Inc. Fox-Pitt, Kelton Ramirez & Co., Inc. UBS Warburg ABN AMRO Rothschild BNP Pari bas Commerzbank Securities Cr dit Lyonnais interested investors, the investment bankers...

## Webmaster

The bond section of the Smart Money website has a section called the Living Yield Curve. It has a graph that allows you to compare the shape of the yield curve at different points in time. Go to Smart Money's website at http www.smartmoney.com onebond index.cfm story yieldcurve. Then, use the site to answer the following questions 1. What is considered a normal yield curve 2. Compare the yield curve for December 2001 with the average yield curve. According to their explanations what would the...

## Balance Sheet Valuation Methods

The net worth of common equity according to a firm's balance sheet. Net amount that can be realized by selling the assets of a firm and paying off the debt. Ratio of market value of the firm to replacement cost. A common valuation measure is book value, which is the net worth of a company as shown on the balance sheet. Table 12.1 gives the balance sheet totals for Intel to illustrate how to calculate book value per share. Book value of Intel stock at the end of September 2001 was 5.35 per share...

## Fincorp Put Option With Strike Price 60 Trading On The Acme Options Exchange

An executive compensation scheme might provide a manager a bonus of 1,000 for every dollar by which the company's stock price exceeds some cutoff level. In what way is this arrangement equivalent to issuing the manager call options on the firm's stock 15. Consider the following options portfolio. You write a January maturity call option on Microsoft with exercise price 75. You write a January maturity Microsoft put option with exercise price 70. a. Graph the payoff of this portfolio at...

## Problem Sets

Which one of the following statements about the value of a call option at expiration is a. A short position in a call option will result in a loss if the stock price exceeds the exercise price. b. The value of a long position equals zero or the stock price minus the exercise price, whichever is higher. c. The value of a long position equals zero or the exercise price minus the stock price, whichever is higher. d. A short position in a call option has a zero value for all stock prices equal...

## Delta Hedging for Portfolio Insurance

Portfolio insurance, the high-tech hedging strategy that helped grease the slide in the 1987 stock market crash, is alive and well. And just as in 1987, it doesn't always work out as planned, as some financial institutions found out in the recent European bond market turmoil. Banks, securities firms, and other big traders rely heavily on portfolio insurance to contain their potential losses when they buy and sell options. But since portfolio insurance got a bad name after it backfired on...

## Intrinsic Value Versus Market Price

The most popular model for assessing the value of a firm as a going concern starts from the observation that the return on a stock investment comprises cash dividends and capital gains or losses. We begin by assuming a one-year holding period and supposing that ABC stock has an expected dividend per share, E D1 , of 4 that the current price of a share, P0, is 48 and that the expected price at the end of a year, E P1 , is 52. For now, don't worry about how you derive your forecast of next year's...

## The Business Cycle

The economy recurrently experiences periods of expansion and contraction, although the length and depth of these cycles can be irregular. These recurring patterns of recession and recovery are called business cycles. Figure 11.4 presents graphs of several measures of production and output for the years 1967-2001. The production series all show clear variation around a generally rising trend. The bottom graph of capacity utilization also evidences a clear cyclical although irregular pattern. The...

## In What Ways Is Owning A Corporate Bond Similar To Writing A Put Option A Call Option

Corporation has been trading in a narrow price range for the past month, and you are convinced it is going to break far out of that range in the next three months. You do not know whether it will go up or down, however. The current price of the stock is 100 per share, the price of a three-month call option with an exercise price of 100 is 10, and a put with the same expiration date and exercise price costs 7. a. What would be a simple options strategy to...

## Figure

8 The Efficient Market Hypothesis 275 low capitalization stocks should enable an investor to earn excess returns. After all, any investor can measure firm size costlessly. One would not expect such minimal effort to yield such large rewards. Later studies Keim, 1983 Reinganum, 1983 and Blume and Stambaugh, 1983 showed that the small-firm effect occurs virtually entirely in the first two weeks of January. The size effect is in fact a small-firm-in-January effect. Some researchers believe the...

## The Great Divide New vs Old Economy

The stock market has divided the world into two camps new-economy companies and old-economy companies. The gulf between them could not be wider. New-economy companies do technology, including the Internet. Old-economy companies do everything else. The stocks of new-economy companies command in 1999 tremendous price-earnings ratios, anywhere from 70 for Microsoft to 450 for America Online. Old-economy companies have ordinary multiples in the 10 to 25 range. A higher multiple reflects greater...

## Mf Corp Roe Capitalization Shares Three Years

Intrinsic value, 415 liquidation value, 414 market capitalization rate, 416 plowback ratio, 421 present value of growth opportunities PVGO , 422 multiple, 428 replacement cost, 414 Tobin's q, 414 two-stage DDM, 424 A common stock pays an annual dividend per share of 2.10. The risk-free rate is 7 and the risk premium for this stock is 4 . If the annual dividend is expected to remain at 2.10, what is the value of the stock Which of the following assumptions does the constant growth dividend...

## Nucor Corporation

Stock price Dec. 30, 1997 53.00 1998 estimated book value 25.00 Indicated dividend 0.40 Beta 1.10 Risk-free return 7.0 High-grade corporate bond yield 9.0 Risk premium stocks over bonds 5.0 a. Calculate the expected stock market return. Show your calculations. b. Calculate the implied total return of Nucor stock. c. Calculate the required return of Nucor stock using the CAPM. d. Briefly discuss the attractiveness of Nucor based on these data. 20. The stock of Nogro Corporation is currently...

## Life Cycles and Multistage Growth Models

As useful as the constant growth DDM formula is, you need to remember that it is based on a simplifying assumption, namely, that the dividend growth rate will be constant forever. In fact, firms typically pass through life cycles with very different dividend profiles in different phases. In early years, there are ample opportunities for profitable reinvestment in the company. Payout ratios are low, and growth is correspondingly rapid. In later years, the firm matures, production capacity is...

## Shorter Clearer Mutual Fund Disclosure May Omit Vital Investment Information

Mutual-fund investors will receive shorter and clearer disclosure documents, under new rules adopted by the Securities and Exchange Commission. But despite all the hoopla surrounding the improvements including a new profile prospectus and an easier-to-read full prospectus there's still a slew of vital information fund investors don't get from any disclosure documents, long or short. Of course, more information isn't necessarily better. As it is, investors rarely read fund disclosure documents,...

## The Investment Process

An investor's portfolio is simply his collection of investment assets. Once the portfolio is established, it is updated or rebalanced by selling existing securities and using the proceeds to buy new securities, by investing additional funds to increase the overall size of the portfolio, or by selling securities to decrease the size of the portfolio. Investment assets can be categorized into broad asset classes, such as stocks, bonds, real estate, commodities, and so on. Investors make two types...

## Suppose That The Returns On The Stock Fund Presented In Spreadsheet 6.1 Were

What is the expected return on this three-asset portfolio Bodie-Kane-Marcus I II. Portfolio Theory I 6. Efficient Diversification I I The McGraw-Hill Essentials of Investments, Companies, 2003 2. An investor is considering adding another investment to a portfolio. To achieve the maximum diversification benefits, the investor should add, if possible, an investment that has which of the following correlation coefficients with the other investments in the portfolio 3. Consistent with capital...

## The Risk Return Trade Off

Investors invest for anticipated future returns, but those returns rarely can be predicted precisely. There will almost always be risk associated with investments. Actual or realized returns will almost always deviate from the expected return anticipated at the start of the investment period. For example, in 1931 the worst calendar year for the market since 1926 , the stock market lost 43 of its value. In 1933 the best year , the stock market gained 54 . You can be sure that investors did not...

## Pension Funds Pay Lifetime Annuities To Recipients. If A Firm Remains In Businessindefinitely The Pension Obligation

Philip Morris has issued bonds that pay annually with the following characteristics Bodie-Kane-Marcus Essentials of Investments, Fifth Edition a. Calculate modified duration using the information above. b. Explain why modified duration is a better measure than maturity when calculating the bond's sensitivity to changes in interest rates. c. Identify the direction of change in modified duration if i. The coupon of the bond were 4 , not 8 . ii. The maturity of the bond were 7 years, not 15...

## Long-term Treasury Bonds Currently Are Selling At Yields To Maturity Of Nearly 8 . You Expect Interest Rates To Fall.

A member of a firm's investment committee is very interested in learning about the management of fixed-income portfolios. He would like to know how fixed-income managers position portfolios to capitalize on their expectations concerning three factors which influence interest rates a. Changes in the level of interest rates. b. Changes in yield spreads across between sectors. c. Changes in yield spreads as to a particular instrument. Assuming that no investment policy limitations apply,...

## Multifactor Generalization of the APT and CAPM

We've assumed all along that there is only one systematic factor affecting stock returns. This assumption may be too simplistic. It is easy to think of several factors that might affect stock returns business cycles, interest rate fluctuations, inflation rates, oil prices, and so on. Presumably, exposure to any of these factors singly or together will affect a stock's perceived A well-diversified portfolio constructed to have a beta of 1.0 on one factor and a beta of zero on any other factor....

## Key Terms

Which of the following assumptions imply ies an informationally efficient market a. Many profit-maximizing participants, each acting independently of the others, analyze and value securities. b. The timing of one news announcement is generally dependent on other news announcements. c. Security prices adjust rapidly to reflect new information. d. A risk-free asset exists, and investors can borrow and lend unlimited amounts at the risk-free rate. 2. If markets are efficient, what should be the...

## You Know That Firm Xyz Is Very Poorly Run. On A Scale Of 1 Worst To 10 Best You Would Give It A Score Of 3. The Market

Suppose, after conducting an analysis of past stock prices, you come up with the following observations. Which would appear to contradict the weak form of the efficient market hypothesis Explain. a. The average rate of return is significantly greater than zero. b. The correlation between the market return one week and the return the following week is zero. c. One could have made superior returns by buying stock after a 10 rise in price and selling after a 10 fall. d. One could have made...

## Efficient Diversification With Many Risky Assets

We can extend the two-risky-assets portfolio construction methodology to cover the case of many risky assets and a risk-free asset. First, we offer an overview. As in the two-risky-assets example, the problem has three separate steps. To begin, we identify the best possible or most efficient risk-return combinations available from the universe of risky assets. Next we determine the optimal portfolio of risky assets by finding the portfolio that supports the steepest CAL. Finally, we choose an...

## Hpr

Ending price - Beginning price Cash dividend Beginning price This definition of the HPR assumes that the dividend is paid at the end of the holding period. To the extent that dividends are received earlier, the definition ignores reinvestment income between the receipt of the dividend and the end of the holding period. Recall also that the percentage return from dividends is called the dividend yield, and so the dividend yield plus the capital gains yield equals the HPR. This definition of...

## Your Assistant Gives You The Following Diagram As The Efficient Frontier Of The Group Of Stocks You Asked Him To Analyse

Could the equilibrium rf be greater than 10 Hint Can a particular stock portfolio be substituted for the risk-free asset 13. Assume expected returns and standard deviations for all securities, as well as the risk-free rate for lending and borrowing, are known. Will investors arrive at the same optimal risky portfolio Explain. 14. Your assistant gives you the following diagram as the efficient frontier of the group of stocks you asked him to analyze. The diagram looks a bit odd, but your...

## Tabulate And Draw The Investment Opportunity Set Of The Two Risky Funds. Use Investment Proportions For The Stock Fund

The correlation between the fund returns is 0.15. 6. Tabulate and draw the investment opportunity set of the two risky funds. Use investment proportions for the stock fund of 0 to 100 in increments of 20 . What expected return and standard deviation does your graph show for the minimum variance portfolio 7. Draw a tangent from the risk-free rate to the opportunity set. What does your graph show for the expected return and standard deviation of the optimal risky portfolio 8. What is the...

## Enron Tech Bubble Are WakeUp Calls

Mutual-fund firms and financial planners have droned on about the topic for years. But suddenly, it's at the epicenter of lawsuits, congressional hearings and presidential reform proposals. Diversification that most basic of investing principles has returned with a vengeance. During the late 1990s, many people scoffed at being diversified, because the idea of investing in a mix of stocks, bonds and other financial assets meant missing out on some of the soaring gains of tech stocks. But with...

## SEC Prepares for a New World of Stock Trading

What should our securities markets look like to serve today's investor best Congress addressed this very question a generation ago, when markets were threatened with fragmentation from an increasing number of competing dealers and exchanges. This led the SEC to establish the national market system, which enabled investors to obtain the best quotes on stocks from any of the major exchanges. Today it is the proliferation of electronic exchanges and after-hours trading venues that threatens to...

## Calculate The Expected Holding-period Return And Standard Deviation Of The Holding-period Return. All Three Scenarios

Bodie-Kane-Marcus Essentials of Investments, Fifth Edition 5. Risk and Return Past and Prologue Use Equations 5.3-5.5 to compute the mean and standard deviation of the HPR on stocks. Compare your revised parameters with the ones in the text. 5. The stock of Business Adventures sells for 40 a share. Its likely dividend payout and end-of-year price depend on the state of the economy by the end of the year as follows a. Calculate the expected holding-period return and standard deviation of the...

## Global Financial Instruments

AFTER STUDYING THIS CHAPTER YOU SHOULD BE ABLE TO Distinguish among the major assets that trade in money markets and in capital markets. Describe the construction of stock market indexes. Calculate the profit or loss on investments in options and futures contracts. This site provides a list of links related to all aspects of business, including extensive sites related to finance and investment. http www.finpipe.com This is an excellent general site that is dedicated to finance education. It...

## Xyz Stock Price And Dividend History Are As Follows

The expected return of the stock is 14. XYZ stock price and dividend history are as follows Year Beginning-of-Year Price Dividend Paid at Year-End An investor buys three shares of XYZ at the beginning of 1999 buys another two shares at the beginning of 2000, sells one share at the beginning of 2001, and sells all four remaining shares at the beginning of 2002. a. What are the arithmetic and geometric average time-weighted rates of return for the investor b. What is the dollar-weighted rate of...

## You Manage An Equity Fund With An Expected Risk Premium Of 10 And An Expected Standard Deviation Of 14 . The Rate On

Show your client the maximum fee you could charge as a percent of the investment in your fund deducted at the end of the year that would still leave him at least as well off investing in your fund as in the passive one. Hint The fee will lower the slope of your client's CAL by reducing the expected return net of the fee. 24. What do you think would happen to the expected return on stocks if investors perceived an increase in the volatility of stocks 25. The change from a straight to a kinked...

## Here Is Some Price Information On Fincorp Stock. Suppose First That Fincorp Trades In A Dealer Market.

Limit Buy Orders Limit Sell Orders a. If a market buy order for 100 shares comes in, at what price will it be filled b. At what price would the next market buy order be filled c. If you were the specialist, would you want to increase or decrease your inventory of this stock 7. You are bullish on Telecom stock. The current market price is 50 per share, and you have 5,000 of your own to invest. You borrow an additional 5,000 from your broker at an interest rate of 8 per year and invest 10,000 in...

## Am Buying A Firm With An Expected Perpetual Cash Flow Of 1 000 But Am Unsure Of Its Risk. If I Think The Beta Of The

In problems 15-17 below, assume the risk-free rate is 8 and the expected rate of return on the market is 18 . 15. A share of stock is now selling for 100. It will pay a dividend of 9 per share at the end of the year. Its beta is 1.0. What do investors expect the stock to sell for at the end of the year I am buying a firm with an expected perpetual cash flow of 1,000 but am unsure of its risk. If I think the beta of the firm is zero, when the beta is really 1.0, how much more will I offer for...

## If The Apt Is To Be A Useful Theory The Number Of Systematic Factors In The Economy Must Be Small.

Construct an arbitrage portfolio using these stocks. b. How might these prices change when equilibrium is restored Give an example where a change in stock C's price is sufficient to restore equilibrium, assuming the dollar payoffs to stock C remain the same. 23. Assume both portfolios A and B are well diversified, that E rA 14 and E rB 14.8 . If the economy has only one factor, and 3A 1.0 while 3B 1.1, what must be the risk-free rate 24. Assume a market index represents the common factor,...

## Investments Background And Issues

AFTER STUDYING THIS CHAPTER YOU SHOULD BE ABLE TO Distinguish between real assets and financial assets. Describe the major steps in the construction of an investment portfolio. Identify major participants in financial markets. Identify types of financial markets and recent trends in those markets. This site provides a list of links related to all aspects of business, including extensive sites related to finance and investment. http www.corpgov.net Dedicated to corporate governance issues, this...

## O U

The rate of return on investments in large stocks has outpaced that on investments in Treasury bills by over 8 since 1926. Why, then, does anyone invest in Treasury bills 15. What are some advantages and disadvantages of top-down versus bottom-up investing styles 16. You see an advertisement for a book that claims to show how you can make 1 million with no risk and with no money down. Will you buy the book

## Investment Banking

Public offerings of both stocks and bonds typically are marketed by investment bankers who in this role are called underwriters. More than one investment banker usually markets the securities. A lead firm forms an underwriting syndicate of other investment bankers to share the responsibility for the stock issue. Investment bankers advise the firm regarding the terms on which it should attempt to sell the securities. A preliminary registration statement must be filed with the Securities and...

## The Money Market

Financial markets are traditionally segmented into money markets and capital markets. Money market instruments include short-term, marketable, liquid, low-risk debt securities. Money market instruments sometimes are called cash equivalents, or just cash for short. Capital markets, in contrast, include longer-term and riskier securities. Securities in the capital market are much more diverse than those found within the money market. For this reason, we will subdivide the capital market into four...