Fin 550

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discussion wk1

•From the e-Activity, predict the performance of the DOW for the next two years. Provide support for your prediction.

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•Analyze the factors that influence investment decisions at different stages in an investor’s life cycle, and make a recommendation at which stage the average investor should consider financial investments. Provide support for your recommendation.

 

HOMEWORK WK1

•Chapter 1: Problems 5(a-d), 7, 9, and 12

 

 5. During the past five years, you owned two stocks that had the following annual rates of

 

return:

 

Year                                 Stock T               Stock B

 

1                                    0.19                      0.08

 

2                                    0.08                      0.03

 

3                                   −0.12                  −0.09

 

4                                   −0.03                    0.02

 

5                                     0.15                    0.04

 

 

 

a. Compute the arithmetic mean annual rate of return for each stock. Which stock is

 

most desirable by this measure?

 

b. Compute the standard deviation of the annual rate of return for each stock. (Use

 

Chapter 1 Appendix if necessary.) By this measure, which is the preferable stock?

 

c. Compute the coefficient of variation for each stock. (Use the Chapter 1 Appendix if

 

necessary.) By this relative measure of risk, which stock is preferable?

 

d. Compute the geometric mean rate of return for each stock. Discuss the difference

 

between the arithmetic mean return and the geometric mean return for each stock.

 

Discuss the differences in the mean returns relative to the standard deviation of the

 

return for each stock.

 

 

 

7. A stockbroker calls you and suggests that you invest in the Lauren Computer Company.

 

After analyzing the firm’s annual report and other material, you believe that the distribution

 

of expected rates of return is as follows:

 

LAUREN COMPUTER CO.

 

Possible Rate of Return                                                  Probability

 

−0.60                                                                                     0.05

 

−0.30                                                                                     0.20

 

−0.10                                                                                     0.10

 

0.20                                                                                       0.30

 

0.40                                                                                       0.20

 

0.80                                                                                       0.15

 

Compute the expected return [E(Ri)] on Lauren Computer stock.

 

 

 

9      During the past year, you had a portfolio that contained U.S. government T-bills, longterm

 

government bonds, and common stocks. The rates of return on each of them were

 

as follows:

 

U.S. government T-bills 5.50%

 

U.S. government long-term bonds 7.50

 

U.S. common stocks 11.60

 

During the year, the consumer price index, which measures the rate of inflation, went

 

from 160 to 172 (1982 – 1984 = 100). Compute the rate of inflation during this year.

 

Compute the real rates of return on each of the investments in your portfolio based on

 

the inflation rate.

 

 

 

12. Assume that the consensus required rate of return on common stocks is 14 percent. In

 

addition, you read in Fortune that the expected rate of inflation is 5 percent and the

 

estimated long-term real growth rate of the economy is 3 percent. What interest rate would you expect on U.S. government T-bills? What is the approximate risk premium for

 

common stocks implied by these data?

 

 

 

 

 

 

 

 

 

 

 

•Chapter 1: Problems 5(a-d), 7, 9, and 12

 

•Chapter 2: Problems 4(a-b), 5(a-b), and 6(a-b)

 

 

 

4. a. Someone in the 36 percent tax bracket can earn 9 percent annually on her investments

 

in a tax-exempt IRA account. What will be the value of a one-time $10,000 investment

 

in 5 years? 10 years? 20 years?

 

b. Suppose the preceding 9 percent return is taxable rather than tax-deferred and the taxes

 

are paid annually. What will be the after-tax value of her $10,000 investment after 5, 10,

 

and 20 years?

 

5. a. Someone in the 15 percent tax bracket can earn 10 percent on his investments in a taxexempt

 

IRA account. What will be the value of a $10,000 investment in 5 years? 10

 

years? 20 years?

 

b. Suppose the preceding 10 percent return is taxable rather than tax-deferred. What will

 

be the after-tax value of his $10,000 investment after 5, 10, and 20 years?

 

6. Assume that the rate of inflation during all these periods was 3 percent a year. Compute

 

the real value of the two tax-deferred portfolios in problems 4a and 5a.

 

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