Part A:
1. Explain and describe securities, their importance to an economy, the general forms they take, parties to their exchange, and why they're created and exchanged.
2. The corporate board of directors wants a firm's investment portfolio to be diversified and to achieve growth not less than 10 percent per year by investing in stocks. The board does not believe it's feasible to seek growth exceeding 11 percent per year in stocks. The investment policy calls for a long-term perspective. The stock market, including all forms of stocks, is expected to return 9 percent in the long term.
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Current allocation
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Asset Class
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Beta
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Allocation
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Growth Stock
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1.5
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10 percent
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Foreign Stocks
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1.8
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10 percent
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Income Stocks
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.75
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80 percent
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What changes should you recommend to the current allocation of stocks? Limit your answer to the three listed asset classifications, and be sure each class is represented by at least 10 percent of the recommended portfolio. Make the allocations of growth and foreign stocks as close to the same as possible, and have all allocations in multiples of 10 percent. Include in your answer the return you expect of your recommended portfolio and how you arrived at the conclusion.
3. Suppose your boss, who believes he's a savvy investor, has recently retired and wants to live on the interest and capital gains earned in his portfolio without tapping principal. He tells you he refuses to invest in securities issued by governments and corporations outside of the United States, and he wants your opinion about how to invest. How should you explain the benefits and risks of foreign investing for a retired person? Include an example of each benefit and risk, and explain the importance of each.
Part B:
1. What role do investment bankers assume, and what gives investment bankers the ability to perform their role better than the organizations that hire them?
2. Which of the following positions is less risky to an investor with no other positions?
- Writing a naked call on XYZ stock
- Buying a naked put on XYZ stock
Explain how you arrived at your answer.
3. An individual investor is deciding how much to spend on the purchase of a computerized stock selection and screening program that claims to identify stocks that beat the market. Why is the degree of market efficiency important?
4. Give two reasons why a corporation would enter a currency futures contract.
5. Which of the following bonds trades at a smaller discount to its present value? Explain how you arrived at your answer. Bond A's market value is $1,301, it pays an annual coupon of $200, and it will mature in five years, paying $1,000. The applicable discount rate is 10 percent. Bond B's market value is $1,050, it pays an annual coupon of $100, and it will mature in three years, paying $1,000. The applicable discount rate is 8 percent.
Part C:
If you were an employed 25-year-old investor eligible to maximize and deduct contributions to individual and employer retirement accounts, and if you held the beliefs that (a) income taxes will rise in the future and (b) the investments are likely to grow at the historical rate, which of the following tax shelter options would you consider most beneficial if your employer offered a 401 k with matching? Assume the annual limit on IRAs is $4,000 and the employee's annual limit on 401 ks is $14,000. Also assume that your personal cash flow would permit any one of the options.
A. Only contribute $12,000 to the 401k, $2,000 to a Roth IRA, and $2,000 to a traditional IRA.
B. Only contribute $8,000 to the 401k, $4,000 to a Roth IRA, and $4,000 to a traditional IRA.
C. Only contribute $12,000 to the 401k and $4,000 to a Roth IRA.
D. Only contribute $12,000 to the 401k and $4,000 to a traditional IRA.
2. Your research into a potential stock investment included performing regression analysis of the returns of the S&P 500 (the market) on the returns of the stock. The results yielded the following statistics: Alpha (the value of y when the value of x is zero) = -.0005; beta (the slope) = +.007 and R2 = .13. What conclusions can you draw from these results?
A. The stock's returns are negatively correlated with the market because of the negative alpha value.
B. 0.05% of the stock's returns can be explained by the market's returns because of the absolute value of alpha.
C. The stock's returns can't be explained by the market's returns because of the low R2 value.
D. The positive beta value indicates the stock's returns are more volatile than the market's returns.
3. If an investor believes a significant rise in inflation is imminent, which of the following asset classes or investments should be avoided?
A. Fixed-income instruments
B. Cash and cash equivalents
C. Common stocks of firms whose asset values will rise in an inflationary environment
D. Interest rate options (long)
4. What is the most important conclusion an investor would draw upon finding a positive net income value and a negative value for cash flow? Assume the results are from the same period and the same corporation, and that the current net income is greater than last year's net income.
A. The corporation overcame threats to cash flow, but still managed a profit.
B. The P/E ratio may be positive, but the negative price/cash flow ratio suggests potential future problems funding operations.
C. Stock price are driven by earnings growth, so the market will view this as a favorable result.
D. Net income has risen, and cash flow has declined.
5. Which of the following asset allocations would be most suitable for a young family with small children? "Emergency" assets are cash and cash equivalents, "Income" are investments that earn income with growth secondary, and "Growth" are assets whose value is expected to grow with income secondary.
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Emergency
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Income
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Growth
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A
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10%
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80%
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10%
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B
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20%
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50%
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30%
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C
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50%
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30%
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20%
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D
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60%
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10%
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30%
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Part D: Fill-in-the-Blank.
1. If you illustrated the Capital Asset Pricing Model, the Capital Market Line would intersect the Y-axis at a value above zero because of the ______.
2. An investor averse to a) buying individual securities because of the diversification problem and b) reporting capital gains may benefit by using a/an ______ trust because the fund can be diversified and turnover is limited.
3. Investors with a long-time horizon can tolerate higher risk investments because the ______ of returns diminishes when calculations are performed over longer periods of time.
4. If a coupon-paying bond's yield to maturity is less than its current yield, the bond's value is greater than ______.
5. Assume a call option's value is $10 and its strike price is $30. The value of the underlying asset must be less than or equal to ______.