34.1 Suppose
that the city of New York issues bonds to raise money to pay for a new
tunnel linking New Jersey and Manhattan. An investor named Susan buys
one of the bonds on the same day that the city of New York pays a
contractor for completing the first stage of construction. Is Susan
making an economic or a financial investment? What about the city of New
York?
Get solution
34.2 What is compound interest? How does it relate to the formula: X dollars today = (1 + i)t X dollars in t years? What is present value? How does it relate to the formula: X/(1 + i)t dollars today = x dollars in t years?
Get solution
34.3 How
do stocks and bonds differ in terms of the future payments that they
are expected to make? Which type of investment (stocks or bonds) is
considered to be more risky? Given what you know, which investment
(stocks or bonds) do you think commonly goes by the nickname “fixed
income”?
Get solution
34.4 What are mutual funds? What different types of mutual funds are there? And why do you think they are so popular with investors?
Get solution
34.5 Corporations
often distribute profits to their shareholders in the form of
dividends, which are simply checks mailed out to shareholders. Suppose
that you have the chance to buy a share in a fashion company called
Rogue Designs for $35 and that the company will pay dividends of $2 per
year on that share every year. What is the annual percentage rate of
return? Next, suppose that you and other investors could get a 12
percent per year rate of return by owning the stocks of other very
similar fashion companies. If investors care only about rates of return,
what should happen to the share price of Rogue Designs? (Hint: This is
an arbitrage situation.)
Get solution
34.6 Why
is it reasonable to ignore diversifiable risk and care only about
nondiversifiable risk? What about investors who put all their money into
only a single risky stock? Can they properly ignore diversifiable risk?
Get solution
34.7 If
we compare the betas of various investment opportunities, why do the
assets that have higher betas also have higher average expected rates of
return?
Get solution
34.8 In
this chapter we discussed short-term U.S. government bonds. But the
U.S. government also issues longer-term bonds with horizons of up to 30
years. Why do 20-year bonds issued by the U.S. government have lower
rates of return than 20-year bonds issued by corporations? And which
would you consider more likely, that longer- term U.S. government bonds
have a higher interest rate than short-term U.S. government bonds, or
vice versa? Explain.
Get solution
34.9 What
determines the vertical intercept of the Security Market Line (SML)?
What determines its slope? And what will happen to an asset's price if
it initially plots onto a point above the SML?
Get solution
34.10 Suppose
that the Federal Reserve thinks that a stock market bubble is occurring
and wants to reduce stock prices. What should it do to interest rates?
Get solution
34.11 Consider
another situation involving the SML. Suppose that the risk-free
interest rate stays the same, but that investors' dislike of risk grows
more intense. Given this change, will average expected rates of return
rise or fall? Next, compare what will happen to the rates of return on
low-risk and high-risk investments. Which will have a larger increase in
average expected rates of return, investments with high betas or
investments with low betas? And will high-beta or low-beta investments
show larger percentage changes in their prices?.
Get solution
34.12 LAST WORD
Why is it so hard for actively managed funds to generate higher rates
of return than passively managed index funds having similar levels of
risk? Is there a simple way for an actively managed fund to increase its average expected rate of return?
Get solution
