## Check

1. Compare the 4.81% yield on the Federal Home Loan Bank bond maturing in 9-08 (September 2008) with the 4.31% yield on the November 2008 T-bond. The differential can be attributed largely to the difference in default risk.

2. A 6% taxable return is equivalent to an after-tax return of 6(1 — .28) = 4.32%. Therefore, you would be better off in the taxable bond. The equivalent taxable yield of the tax-free bond is 4/(1 — .28) = 5.55%. So a taxable bond would have to pay a 5.55% yield to provide the same after-tax return as a tax-free bond offering a 4% yield.

3. a. You are entitled to a prorated share of IBM's dividend payments and to vote in any of IBM's stockholder meetings.

b. Your potential gain is unlimited because IBM's stock price has no upper bound.

c. Your outlay was \$95 X 100 = \$9,500. Because of limited liability, this is the most you can lose.

4. The price-weighted index increases from 62.50 [= (100 + 25)/2] to 65 [= (110 + 20)/2)], a gain of 4%. An investment of one share in each company requires an outlay of \$125 that would increase in value to \$130, for a return of 4% (5/125), which equals the return to the price-weighted index.

5. The market value-weighted index return is calculated by computing the increase in value of the stock portfolio. The portfolio of the two stocks starts with an initial value of \$100 million + \$500 million = \$600 million and falls in value to \$110 million + \$400 million = \$510 million, a loss of 90/600 = .15, or 15%. The index portfolio return is a weighted average of the returns on each stock with weights of % on XYZ and 5-6 on ABC (weights proportional to relative investments). Because the return on XYZ is 10%, while that on ABC is — 20%, the index portfolio return is (16)10 + (56) (— 20) = — 15%, equal to the return on the market value-weighted index.

6. The payoff to the call option is 104 — 100 = \$4. The call cost \$1.80. The profit is \$2.20 per share. The put will pay off zero—it expires worthless since the stock price exceeds the exercise price. The loss is the cost of the put, \$0.80.

Bodie-Kane-Marcus: Essentials of Investments, Fifth Edition

I. Elements of Investments I 3. How Securities Are Traded

Bodie-Kane-Marcus: Essentials of Investments, Fifth Edition

I. Elements of Investments I 3. How Securities Are Traded