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FIN 402 Final Exam Guide

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FIN 402 Investment Fundamentals and Portfolio Management Final Exam Guide True/False 1.___ ___ The balance sheet shows what assets the firm controls at a point in time and how it financed the assets. 2.___ ___ Free cash flow = Cash flow from operations – Capital expenditures + Disposition of property and equipment. 3.___ ___ The income statement indicates the flow of sales, expenses, and earnings during a period of time. 4.___ ___ Financial ratios are used in stock and bond valuation models. 5.___ ___ A good portfolio is a collection of individually good assets. 6.___ ___ If the covariance of two stocks is positive, these stocks tend to move together over time. 7.___ ___ Increasing the correlation among assets in a portfolio results in an increase in the standard deviation of the portfolio.


8.___ __ In a three asset portfolio the standard deviation of the portfolio is one third of the square root of the sum of the individual standard deviations. 9.___ __ Combining assets that are not perfectly correlated does affect both the expected return of the portfolio as well as the risk of the portfolio. 10.__ ___ Bond rating agencies include the analysis of financial ratios in arriving at corporate bond ratings. Multiple choice (4 points each) Multiple Choice 11. In the context of the Capital Asset Pricing Model (CAPM) the relevant measure of risk is 12. According to the Capital Asset Pricing Model (CAPM) a well diversified portfolio's rate of return is a function of 13. The premise of behavioral finance is that 14. The efficient market hypothesis ____________. 15. The CAPM is not testable unless 16. The duration of a bond is a function of the bond's A. coupon rate. B. yield to maturity. C. time to maturity. D. All of these are correct. E. None of these is correct. 17. Treasury STRIPS are Problems/Essay: Problem 1(15 points): Be sure to show your work for computations. Use CAPM methodology to compute the following: Problem 2 (15 points) High Tech Chip Company paid a dividend last year of $2.50. The expected ROE for next year is 12.5%. An appropriate


required return on the stock is 11%. If the firm has a plowback ratio of 60%, the dividend in the coming year should be: g = .125 X .6 = 7.5%; $2.50(1.075) = $2.69 Essay question (12 points) Discuss some reasons why an investor with a long time horizon might choose to invest in common stocks, even though they have historically been riskier than government bonds or Tbills. ==============================================

FIN 402 Week 1 Assignment Capital Markets and Investment Banking Process Paper

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FIN 402 Week 1 Assignment Case Problem 1.2 Preparing Carolyn Bowen’s Investment Plan

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Case Problem 1.2 Preparing Carolyn Bowen’s Investment Plan Carolyn Bowen, who just turned 55, is employed as an administrative assistant for the Xcon Corporation, where she has worked for the past 20 years. She is in good health, lives alone, and has two grown children. A few months ago her husband died, leaving her with only their home and the proceeds from a $75,000 life insurance policy. After she paid medical and funeral expenses, $60,000 of the life insurance proceeds remained. In addition to the life insurance proceeds, Carolyn has $37,500 in a savings account, which she had accumulated over the past 10 years. Recognizing that she is within 10 years of retirement, Carolyn wishes to invest her limited resources so she will be able to live comfortably once she retires. Carolyn is quite superstitious. After consulting with a number of psychics and studying her family tree, she is certain she will not live past 80. She plans to retire at either 62 or 65, whichever will allow her to meet her long-run financial goals. After talking with a number of knowledgeable individuals—including, of course, the psychics—Carolyn estimates that to live comfortably in retirement, she will need $45,000 per year before taxes. This amount will be required annually for 18 years if she retires at 62 or for 15 years if she retires at 65. As part of her financial plan, Carolyn intends to sell her home at retirement and rent an apartment. She has estimated that she will net $112,500 if she sells the house when she is 62 and $127,500 if she sells it when she is 65. Carolyn has no financial dependents and is not concerned about leaving a sizable estate to her heirs. If Carolyn retires at age 62, she will receive from Social Security and an employer-sponsored pension plan a total of $1,359 per month ($16,308 annually); if she waits until age 65 to retire, her total retirement income will be $1,688 per month ($20,256 annually). For convenience, Carolyn has already decided to convert all her assets at the time of retirement into a stream of


annual income and she will at that time purchase an annuity by paying a single premium. The annuity will have a life just equal to the number of years remaining until her 80th birthday. If Carolyn retires at age 62 and buys an annuity at that time, for each $1,000 that she puts into the annuity she will receive an annual benefit equal to $79 for the subsequent 18 years. If she waits until age 65 to retire, each $1,000 invested in the annuity will produce an annual benefit of $89.94 for the 15 years. Carolyn plans to place any funds currently available into a savings account paying 6% compounded annually until retirement. She does not expect to be able to save or invest any additional funds between now and retirement. For every dollar that Carolyn invests today, she will have $1.50 by age 62; if she leaves the money invested until age 65, she will have $1.79 for each dollar invested today. Questions a. Assume that Carolyn places currently available funds in the savings account. Determine the amount of money Carolyn will have available at retirement once she sells her house if she retires at (1) age 62 and (2) age 65. b. Using the results from item a, determine the level of annual income that will be provided to Carolyn through purchase of an annuity at (1) age 62 and (2) age 65. c. With the results found in the preceding questions, determine the total annual retirement income Carolyn will have if she retires at (1) age 62 and (2) age 65. d. From your findings, do you think Carolyn will be able to achieve her long-run financial goal by retiring at (1) age 62 or (2) age 65? Explain. e. Evaluate Carolyn’s investment plan in terms of her use of a savings account and an annuity rather than other investments. Comment on the risk and return characteristics of her plan. What recommendations might you offer Carolyn? Be specific. ==============================================

FIN 402 Week 1 Assignment Case Problem 1.2, 2.1, 2.2, 3.1, 12.1


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FIN 402 Week 1 Assignment Case Problem 1.2 Preparing Carolyn Bowen’s Investment Plan FIN 402 Week 1 Assignment Case Problem 2.1 Dara’s Dilemma: What to Buy? FIN 402 Week 1 Assignment Case Problem 2.2 Ravi Dumar’s High-Flying Margin Account FIN 402 Week 1 Assignment Case Problem 3.1 The Perezes’ Good Fortune FIN 402 Week 1 Assignment Case Problem 12.1 Reverend Mark Thomas Ponders Mutual Funds ==============================================

FIN 402 Week 1 Assignment Case Problem 2.1Dara’s Dilemma: What to Buy?

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Case Problem 2.1Dara’s Dilemma: What to Buy? Dara Simmons, a 40year-old financial analyst and divorced mother of two teenage children,


considers herself a savvy investor. She has increased her investment portfolio considerably over the past five years. Although she has been fairly conservative with her investments, she now feels more confident in her investment knowledge and would like to branch out into some new areas that could bring higher returns. She has between $20,000 and $25,000 to invest. Attracted to the hot market for technology stocks, Dara was interested in purchasing a tech IPO stock and identified NewestHighTech.com, a company that makes sophisticated computer chips for wireless Internet connections, as a likely prospect. The 1-yearold company had received some favorable press when it got early-stage financing and again when its chip was accepted by a major cell phone manufacturer. Dara also was considering an investment in 400 shares of Casinos International common stock, currently selling for $54 per share. After a discussion with a friend who is an economist with a major commercial bank, Dara believes that the long-running bull market is due to cool off and that economic activity will slow down. With the aid of her stockbroker, Dara researches Casinos International’s current financial situation and finds that the future success of the company may hinge on the outcome of pending court proceedings on the firm’s application to open a new floating casino on a nearby river. If the permit is granted, it seems likely that the firm’s stock will experience a rapid increase in value, regardless of economic conditions. On the other hand, if the company fails to get the permit, the falling stock price will make it a good candidate for a short sale. Dara felt that the following alternatives were open to her: • Alternative 1: Invest $20,000 in NewestHighTech.com when it goes public. • Alternative 2: Buy Casinos International now at $54 per share and follow the company closely. • Alternative 3: Sell Casinos short at $54 in anticipation that the company’s fortunes will change for the worse. • Alternative 4: Wait to see what happens with the casino permit and then decide whether to buy or short sell the Casinos International stock. Questions a. Evaluate each of these alternatives. On the basis of the limited information presented, recommend the one you feel is best. b. If Casinos International’s stock price rises to $60, what will happen under alternatives 2 and 3? Evaluate the pros and cons of these outcomes. c.


If the stock price drops to $45, what will happen under alternatives 2 and 3? Evaluate the pros and cons of these outcomes. ==============================================

FIN 402 Week 1 Assignment Case Problem 2.2 Ravi Dumar’s High-Flying Margin Account

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Case Problem 2.2 Ravi Dumar’s High-Flying Margin Account Ravi Dumar is a stockbroker who lives with his wife, Sasha, and their five children in Milwaukee, Wisconsin. Ravi firmly believes that the only way to make money in the market is to follow an aggressive investment posture—for example, to use margin trading. In fact, Ravi has built himself a substantial margin account over the years. He currently holds $75,000 worth of stock in his margin account, though the debit balance in the account amounts to only $30,000. Recently Ravi uncovered a stock that, on the basis of extensive analysis, he feels is about to take off. The stock, Running Shoes (RS), currently trades at $20 per share. Ravi feels it should soar to at least $50 within a year. RS pays no dividends, the prevailing initial margin requirement is 50%, and margin loans are now carrying an annual interest charge of 10%. Because Ravi feels so strongly about RS, he wants to do some pyramiding by using his margin account to purchase 1,000 shares of the stock. Questions a. Discuss the concept of pyramiding as it applies to this investment situation. b.


What is the present margin position (in percent) of Ravi’s account? c. Ravi buys the 1,000 shares of RS through his margin account (bear in mind that this is a $20,000 transaction). 1. What will the margin position of the account be after the RS transaction if Ravi follows the prevailing initial margin (50%) and uses $10,000 of his money to buy the stock? 2. What if he uses only $2,500 equity and obtains a margin loan for the balance ($17,500)? 3. How do you explain the fact that the stock can be purchased with only 12.5% margin when the prevailing initial margin requirement is 50%? d. Assume that Ravi buys 1,000 shares of RS stock at $20 per share with a minimum cash investment of $2,500 and that the stock does take off and its price rises to $40 per share in one year. 1. What is the return on invested capital for this transaction? 2. What return would Ravi have earned if he had bought the stock without margin—that is, if he had used all his own money? e. What do you think of Ravi’s idea to pyramid? What are the risks and rewards of this strategy? ==============================================

FIN 402 Week 1 Assignment Case Problem 3.1 The Perezes’ Good Fortune

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Case Problem 3.1 The Perezes’ Good Fortune Angel and Marie Perez own a small pool hall located in southern New Jersey. They enjoy


running the business, which they have owned for nearly three years. Angel, a retired professional pool shooter, saved for nearly 10 years to buy this business, which he and his wife own free and clear. The income from the pool hall is adequate to allow Angel, Marie, and their children, Mary (age 10) and José (age 4), to live comfortably. Although he lacks formal education beyond the 10th grade, Angel has become an avid reader. He enjoys reading about current events and personal finance, particularly investing. He especially likes Money magazine, from which he has gained numerous ideas for better managing the family’s finances. Because of the long hours required to run the business, Angel can devote 3 to 4 hours a day (on the job) to reading. Recently Angel and Marie were notified that Marie’s uncle had died and left them a portfolio of stocks and bonds with a current market value of $300,000. They were elated to learn of their good fortune but decided it would be best not to change their lifestyle as a result of this inheritance. Instead, they want their newfound wealth to provide for their children’s college educations as well as their own retirement. They decided that, like their uncle, they would keep these funds invested in stocks and bonds. Angel felt that in view of this plan, he needed to acquaint himself with the securities currently in the portfolio. He knew that to manage the portfolio himself, he would have to stay abreast of the securities markets as well as the economy in general. He also realized that he would need to follow each security in the portfolio and continuously evaluate possible alternative securities that could be substituted as conditions warranted. Because Angel enjoyed using his spare time to follow the market, he strongly believed that with proper information, he could manage the portfolio. Given the amount of money involved, Angel was not too concerned with the information costs; rather, he wanted the best information he could get at a reasonable price. Questions a. Explain what role the Wall Street Journal and/or Barron’s might play in meeting Angel’s needs. What other general sources of economic and current event information would you recommend to Angel? Explain. b. How might Angel be able to use the services of Standard & Poor’s Corporation, Mergent, and theValue Line Investment Survey to learn about the securities in the portfolio? Indicate which, if any, of these services you would recommend, and


why. c. Recommend some specific online investment information sources and tools to help Angel and Marie manage their investments. d. Explain to Angel the need to find a good stockbroker and the role the stockbroker could play in providing information and advice. Should he consider hiring a financial advisor to manage the portfolio? e. Give Angel a summary prescription for obtaining information and advice that will help to ensure the preservation and growth of the family’s newfound wealth. ==============================================

FIN 402 Week 1 Assignment Case Problem 12.1 Reverend Mark Thomas Ponders Mutual Funds

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Case Problem 12.1 Reverend Mark Thomas Ponders Mutual Funds The Reverend Mark Thomas is the minister of a church in the San Diego area. He is married, has one young child, and earns a ―modest income.‖ Because religious organizations are not notorious for their generous retirement programs, the reverend has decided he should do some investing on his own. He would like to set up a program that enables him to supplement the church’s retirement program and at the same time provide some funds for his child’s college education (which is still some 12 years away). He is not out to break any investment records but wants some backup to provide for the long-run needs of his family. Although


he has a modest income, Mark Thomas believes that with careful planning, he can probably invest about $250 a quarter (and, with luck, increase this amount over time). He currently has about $15,000 in a savings account that he would be willing to use to begin this program. In view of his investment objectives, he is not interested in taking a lot of risk. Because his knowledge of investments extends to savings accounts, Series EE savings bonds, and a little bit about mutual funds, he approaches you for some investment advice. Questions a. In light of Mark’s long-term investment goals, do you think mutual funds are an appropriate investment vehicle for him? b. Do you think he should use his $15,000 savings to start a mutual fund investment program? c. What type of mutual fund investment program would you set up for the reverend? Include in your answer some discussion of the types of funds you would consider, the investment objectives you would set, and any investment services (e.g., withdrawal plans) you would seek. Would taxes be an important consideration in your investment advice? Explain. ==============================================

FIN 402 Week 1 DQ 1

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What are capital market instruments? How are they used? Which is most important? Explain your answer. ==============================================


FIN 402 Week 1 DQ 2

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What is an asset class? How are asset classes selected? What factors affect the selection? ==============================================

FIN 402 Week 1 DQ 3

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What is a derivative? What are the different types of derivatives? How do businesses use derivatives to mitigate risks? ==============================================


FIN 402 Week 1 Individual Problem Set

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The Problem Set is provided to you to enable you to practice the concepts outlined in the textbook. Select THREE completed problems from the assignment and post your solutions to those problems.

1. Creating prices for securities and allowing for liquidity are functions of

2. Which of the following best describes the function of an investment banker selling an issue on a "best efforts" basis?

3. From the investment banker's point of view, the major reason syndicates are formed in the distribution of large issues is for the purpose of


4. ___________ has two major functions: to handle special orders, such as purchases with a price contingency; and to maintain continuous, liquid, orderly markets

5. The Securities Investor Protection Corporation (SPIC) was established to

6. In order to be listed on an exchange, a firm must meet minimum standards pertaining to the following criteria:

7. Active trading in markets and competition among securities analysts helps ensure that I. Security prices approach informational efficiency II. Riskier securities are priced to offer higher potential returns III. Investors are unlikely to be able to consistently find under- or overvalued securities

8. __________ assets generate net income to the economy and __________ assets define allocation of income among investors.

9. Asset allocation refers to the __________.


10. _____ is an example of an agency problem

11. _____ is a mechanism to mitigate potential agency problems

12. After much investigation an investor finds that Intel stock is currently under priced. This is an example of

13. Suppose an investor is considering one of two investments which are identical in all respects except for risk. If the investor anticipates a fair return for the risk of the security they invest in they can expect to

14. In a perfectly efficient market the best investment strategy is probably a/an

15. An investor in a T-bill earns interest by

16. Which one of the following is a true statement?

17. An individual who goes short in a futures position

18. Investors will earn lower rates of returns on TIPS than equivalent default risk standard bonds if __________________________.


19. An investor purchases one municipal and one corporate bond that pay rates of return of 6.00% and 7.60% respectively. If the investor is in the 15% tax bracket, his after tax rates of return on the municipal and corporate bonds would be respectively

20. June call and put options on King Books Inc are available with exercise prices of $30, $35 and $40. Among the different exercise prices, the call option with the _____ exercise price and the put option 21. If you thought prices of stock would be rising over the next few months you may wish to

22. Private placements can be advantageous rather than public issue because I. private placements are cheaper to market than public issues II. private placements may still be sold to the general public under SEC Rule 144A III. privately placed securities trade on secondary markets

23. The issue process where investors submit bids for a new issue and the shares in an IPO are allocated to the highest bidders until the entire issue is sold is called a

24. Restrictions on trading involving insider information apply to __________.


25. You purchased 100 shares of ABC common stock on margin at $40 per share. Assume the initial margin is 50% and the maintenance margin is 35%. You will get a margin call if the stock drops below _________. ==============================================

FIN 402 Week 1 Individual Weekly Question

FOR MORE CLASSES VISIT www.fin402guide.com Submit your Weekly Questions, with original questions, in a Microsoft Word or text file. Be sure to show your work to earn full credit.

Do not use Investopedia, About.com, Wikipedia, or other generic internet websites as sources. Use credible sources only. Also, do not use quotes in lieu of a response in your own words. ==============================================

FIN 402 Week 2 Assignment Asset Classes Paper

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FIN 402 Week 2 Assignment Case Problem 2.1 Traditional Versus Modern Portfolio Theory Who’s Right

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Case Problem 2.1 Traditional Versus Modern Portfolio Theory: Who’s Right? Walt Davies and Shane O’Brien are district managers for Lee, Inc. Over the years, as they moved through the firm’s sales organization, they became (and still remain) close friends. Walt, who is 33 years old, currently lives in Princeton, New Jersey. Shane, who is 35, lives in Houston, Texas. Recently, at the national sales meeting, they were discussing various company matters, as well as bringing each other up to date on their families, when the subject of investments came up. Each had always been fascinated by the stock market, and now that they had achieved some degree of financial success, they had begun actively investing. As they discussed their investments, Walt said he thought the only way an individual who does not have hundreds of thousands of dollars can invest safely is to buy mutual fund shares. He emphasized that to be safe, a person needs to hold a broadly diversified portfolio and


that only those with a lot of money and time can achieve independently the diversification that can be readily obtained by purchasing mutual fund shares. Shane totally disagreed. He said, ―Diversification! Who needs it?‖ He thought that what one must do is look carefully at stocks possessing desired risk-return characteristics and then invest all one’s money in the single best stock. Walt told him he was crazy. He said, ―There is no way to measure risk conveniently—you’re just gambling.‖ Shane disagreed. He explained how his stockbroker had acquainted him with beta, which is a measure of risk. Shane said that the higher the beta, the more risky the stock, and therefore the higher its return. By looking up the betas for potential stock investments on the Internet, he can pick stocks that have an acceptable risk level for him. Shane explained that with beta, one does not need to diversify; one merely needs to be willing to accept the risk reflected by beta and then hope for the best. The conversation continued, with Walt indicating that although he knew nothing about beta, he didn’t believe one could safely invest in a single stock. Shane continued to argue that his broker had explained to him that betas can be calculated not just for a single stock but also for a portfolio of stocks, such as a mutual fund. He said, ―What’s the difference between a stock with a beta of, say, 1.2 and a mutual fund with a beta of 1.2? They have the same risk and should therefore provide similar returns.‖ As Walt and Shane continued to discuss their differing opinions relative to investment strategy, they began to get angry with each other. Neither was able to convince the other that he was right. The level of their voices now raised, they attracted the attention of the company’s vice president of finance, Elinor Green, who was standing nearby. She came over and indicated she had overheard their argument about investments and thought that, given her expertise on financial matters, she might be able to resolve their disagreement. She asked them to explain the crux of their disagreement, and each reviewed his own viewpoint. After hearing their views, Elinor responded, ―I have some good news and some bad news for each of you. There is some validity to what each of you says, but there also are some errors in each of your explanations. Walt tends to support the traditional approach to portfolio management. Shane’s views are more supportive of modern portfolio


theory.‖ Just then, the company president interrupted them, needing to talk to Elinor immediately. Elinor apologized for having to leave and offered to continue their discussion later that evening. Questions a. Analyze Walt’s argument and explain why a mutual fund investment may be overdiversified. Also explain why one does not necessarily have to have hundreds of thousands of dollars to diversify adequately. b. Analyze Shane’s argument and explain the major error in his logic relative to the use of beta as a substitute for diversification. Explain the key assumption underlying the use of beta as a risk measure. c. Briefly describe the traditional approach to portfolio management and relate it to the approaches supported by Walt and Shane. d. Briefly describe modern portfolio theory and relate it to the approaches supported by Walt and Shane. Be sure to mention diversifiable risk, undiversifiable risk, and total risk, along with the role of beta. e. Explain how the traditional approach and modern portfolio theory can be blended into an approach to portfolio management that might prove useful to the individual investor. Relate this to reconciling Walt’s and Shane’s differing points of view. ==============================================

FIN 402 Week 2 Assignment Case Problem 4.1 Coates’s Decision

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Case Problem 4.1 Coates’s Decision On January 1, 2017, Dave Coates, a 23-year-old mathematics teacher at Xavier High School, received a tax refund of $1,100. Because Dave didn’t need this money for his current living expenses, he decided to make a long-term investment. After surveying a number of alternative investments costing no more than $1,100, Dave isolated two that seemed most suitable to his needs. Each of the investments cost $1,050 and was expected to provide income over a 10-year period. Investment A provided a relatively certain stream of income. Dave was a little less certain of the income provided by investment B. From his search for suitable alternatives, Dave found that the appropriate discount rate for a relatively certain investment was 4%. Because he felt a bit uncomfortable with an investment like B, he estimated that such an investment would have to provide a return at least 4% higher than investment A. Although Dave planned to reinvest funds returned from the investments in other vehicles providing similar returns, he wished to keep the extra $50 ($1,100 − $1,050) invested for the full 10 years in a savings account paying 3% interest compounded annually. As he makes his investment decision, Dave has asked for your help in answering the questions that follow the expected return data for these investments. Questions a. Assuming that investments A and B are equally risky and using the 4% discount rate, apply the present value technique to assess the acceptability of each investment and to determine the preferred investment. Explain your findings. b.Recognizing that investment B is more risky than investment A, reassess the two alternatives, adding the 4% risk premium to the 4% discount rate for investment A and therefore applying a 8% discount rate to investment B. Compare your findings relative to acceptability and preference to those found for question a. c. From your findings in questions a and b, indicate whether the IRR for investment A is above or below 4% and whether that for investment B is above or below 8%. Explain. d. Use the present value technique to estimate the IRR on each investment. Compare your findings and contrast them with your response to question c. e. From the information given, which, if either, of the two investments would you recommend that Dave make? Explain your answer. f. Indicate to Dave how much money the extra $50 will have


grown to by the end of 2026, assuming he makes no withdrawals from the savings account. ==============================================

FIN 402 Week 2 Assignment Case Problem 4.1, 4.2, 2.1, 5.2, 13.1 (Part a,b,c,d)

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FIN 402 Week 2 Assignment Case Problem 4.1 Coates’s Decision FIN 402 Week 2 Assignment Case Problem 4.2 The Risk-Return Tradeoff Molly O’Rourke’s Stock Purchase Decision FIN 402 Week 2 Assignment Case Problem 2.1 Traditional Versus Modern Portfolio Theory Who’s Right FIN 402 Week 2 Assignment Case Problem 5.2 Susan Lussier’s Inherited Portfolio Does It Meet Her Needs FIN 402 Week 2 Assignment Case Problem 13.1 Assessing the Stalchecks’s Portfolio Performance (Part a,b,c,d) ==============================================

FIN 402 Week 2 Assignment Case Problem 4.2 The RiskReturn Tradeoff Molly O’Rourke’s Stock Purchase Decision


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Case Problem 4.2 The Risk-Return Tradeoff: Molly O’Rourke’s Stock Purchase Decision Over the past 10 years, Molly O’Rourke has slowly built a diversified portfolio of common stock. Currently her portfolio includes 20 different common stock issues and has a total market value of $82,500. Molly is at present considering the addition of 50 shares of either of two common stock issues—X or Y. To assess the return and risk of each of these issues, she has gathered dividend income and share price data for both over the last 10 years (2007–2016). Molly’s investigation of the outlook for these issues suggests that each will, on average, tend to behave in the future just as it has in the past. She therefore believes that the expected return can be estimated by finding the average HPR over the past 10 years for each of the stocks. The historical dividend income and stock price data collected by Molly are given in the accompanying table. Questions a. Determine the HPR for each stock in each of the preceding 10 years. Find the expected return for each stock, using the approach specified by Molly. b. Use the HPRs and expected return calculated in question a to find the standard deviation of the HPRs for each stock over the 10-year period. c. Use your findings to evaluate and discuss the return and risk associated with stocks X and Y. Which stock seems preferable? Explain. d. Ignoring her existing portfolio, what recommendations would you give Molly with regard to stocks X and Y? ==============================================


FIN 402 Week 2 Assignment Case Problem 5.2 Susan Lussier’s Inherited Portfolio Does It Meet Her Needs

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Case Problem 5.2 Susan Lussier’s Inherited Portfolio: Does It Meet Her Needs? Susan Lussier is 35 years old and employed as a tax accountant for a major oil and gas exploration company. She earns nearly $135,000 a year from her salary and from participation in the company’s drilling activities. An expert on oil and gas taxation, she is not worried about job security—she is content with her income and finds it adequate to allow her to buy and do whatever she wishes. Her current philosophy is to live each day to its fullest, not concerning herself with retirement, which is too far in the future to require her current attention. A month ago, Susan’s only surviving parent, her father, was killed in a sailing accident. He had retired in La Jolla, California, two years earlier and had spent most of his time sailing. Prior to retirement, he managed a children’s clothing manufacturing firm in South Carolina. Upon retirement he sold his stock in the firm and invested the proceeds in a security portfolio that provided him with supplemental retirement income of over $30,000 per year. In his will, he left his entire estate to Susan. The estate was structured in such a way that in addition to a few family heirlooms, Susan received a security portfolio having a market value of nearly $350,000 and about $10,000 in cash. Susan’s father’s portfolio contained 10 securities: 5 bonds, 2 common stocks, and 3 mutual funds. The following table lists the securities and their key characteristics. The common stocks were issued by large, mature, well-


known firms that had exhibited continuing patterns of dividend payment over the past five years. The stocks offered only moderate growth potential—probably no more than 2% to 3% appreciation per year. The mutual funds in the portfolio were income funds invested in diversified portfolios of income-oriented stocks and bonds. They provided stable streams of dividend income but offered little opportunity for capital appreciation. Now that Susan owns the portfolio, she wishes to determine whether it is suitable for her situation. She realizes that the high level of income provided by the portfolio will be taxed at a rate (federal plus state) of about 40%. Because she does not currently need it, Susan plans to invest the after-tax income primarily in common stocks offering high capital gain potential. During the coming years she clearly needs to avoid generating taxable income. (Susan is already paying out a sizable portion of her income in taxes.) She feels fortunate to have received the portfolio and wants to make certain it provides her with the maximum benefits, given her financial situation. The $10,000 cash left to her will be especially useful in paying brokers’ commissions associated with making portfolio adjustments. Questions a. Briefly assess Susan’s financial situation and develop a portfolio objective for her that is consistent with her needs. b. Evaluate the portfolio left to Susan by her father. Assess its apparent objective and evaluate how well it may be doing in fulfilling this objective. Use the total cost values to describe the asset allocation scheme reflected in the portfolio. Comment on the risk, return, and tax implications of this portfolio. c. If Susan decided to invest in a security portfolio consistent with her needs— indicated in response to question a—describe the nature and mix, if any, of securities you would recommend she purchase. Discuss the risk, return, and tax implications of such a portfolio. d. From the response to question b, compare the nature of the security portfolio inherited by Susan with what you believe would be an appropriate security portfolio for her, based on the response to question c. e. What recommendations would you give Susan about the inherited portfolio? Explain the steps she should take to adjust the portfolio to her needs. ==============================================


FIN 402 Week 2 Assignment Case Problem 13.1 Assessing the Stalchecks’s Portfolio Performance (Part a,b,c,d)

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Case Problem 13.1 Assessing the Stalchecks’s Portfolio Performance Mary and Nick Stalcheck have an investment portfolio containing four investments. It was developed to provide them with a balance between current income and capital appreciation. Rather than acquire mutual fund shares or diversify within a given class of investments, they developed their portfolio with the idea of diversifying across various asset classes. The portfolio currently contains common stock, industrial bonds, mutual fund shares, and options. They acquired each of these investments during the past three years, and they plan to purchase other investments sometime in the future. Currently, the Stalchecks are interested in measuring the return on their investment and assessing how well they have done relative to the market. They hope that the return earned over the past calendar year is in excess of what they would have earned by investing in a portfolio consisting of the S&P 500 Stock Composite Index. Their research has indicated that the risk-free rate was 7.2% and that the (before-tax) return on the S&P 500 portfolio was 10.1% during the past year. With the aid of a friend, they have been able to estimate the beta of their portfolio, which was 1.20. In their analysis, they have planned to ignore taxes because they feel their earnings have been adequately sheltered. Because they did not make any portfolio transactions during the past year, all of the Stalchecks’s investments


have been held more than 12 months, and they would have to consider only unrealized capital gains, if any. To make the necessary calculations, the Stalchecks have gathered the following information on each investment in their portfolio. Common stock. They own 400 shares of KJ Enterprises common stock. KJ is a diversified manufacturer of metal pipe and is known for its unbroken stream of dividends. Over the past few years, it has entered new markets and, as a result, has offered moderate capital appreciation potential. Its share price has risen from $17.25 at the start of the last calendar year to $18.75 at the end of the year. During the year, quarterly cash dividends of $0.20, $0.20, $0.25, and $0.25 were paid. Industrial bonds. The Stalchecks own eight Cal Industries bonds. The bonds have a $1,000 par value, have a 9.250% coupon, and are due in 2027. They are A-rated by Moody’s. The bonds were quoted at 97.000 at the beginning of the year and ended the calendar year at 96.375%. Mutual fund. The Stalchecks hold 500 shares in the Holt Fund, a balanced, no-load mutual fund. The dividend distributions on the fund during the year consisted of $0.60 in investment income and $0.50 in capital gains. The fund’s NAV at the beginning of the calendar year was $19.45, and it ended the year at $20.02. Options. The Stalchecks own 100 options contracts on the stock of a company they follow. The value of these contracts totaled $26,000 at the beginning of the calendar year. At year-end the total value of the options contracts was $29,000. Questions a. Calculate the holding period return on a before-tax basis for each of these four investments. b. Assuming that the Stalchecks’s ordinary income is currently being taxed at a combined (federal and state) tax rate of 38% and that they would pay a 15% capital gains tax on dividends and capital gains for holding periods longer than 12 months, determine the after-tax HPR for each of their four investments. c. Recognizing that all gains on the Stalchecks’s investments were unrealized, calculate the before-tax portfolio HPR for their four-investment portfolio during the past calendar year. Evaluate this return relative to its current income and capital gain components. d. Use the HPR calculated in question c to compute Jensen’s measure (Jensen’s alpha). Use that measure to analyze the performance of the Stalchecks’s portfolio on a risk-adjusted, market-


adjusted basis. Comment on your finding. Is it reasonable to use Jensen’s measure to evaluate a four-investment portfolio? Why or why not? e. On the basis of your analysis in questions a, c, and d, what, if any, recommendations might you offer the Stalchecks relative to the revision of their portfolio? Explain your recommendations. ==============================================

FIN 402 Week 2 DQ 1

FOR MORE CLASSES VISIT www.fin402guide.com What are different ratio categories? Which category is most important to bondholders? Why? Which category is most important to stockholders? Why? ==============================================

FIN 402 Week 2 DQ 2

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What are liquidity ratios? Why are they important? How may an investor use liquidity ratios when making investment decisions? ==============================================

FIN 402 Week 2 DQ 3

FOR MORE CLASSES VISIT www.fin402guide.com What are different ratio categories? Which category is most important to bondholders? Why? Which category is most important to stockholders? Why? ==============================================

FIN 402 Week 2 Learning Team Assignment Portfolio Selection Paper (2 Papers)

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Resources: Electronic Reserve Readings, Internet, University Library Select one publicly traded bond. Select five organizations from the following list. These organizations represent the stocks that comprise your portfolio. Cisco Systems, Inc.® Citigroup® Dell® Disney® Ford Motor Company® General Electric Company® The Home Depot, Inc.® Lockheed Martin Corporation® Microsoft® Motorola, Inc.® Proctor & Gamble® Time Warner Inc.® United Parcel Service of America, Inc.® Wal-Mart Stores, Inc.® Obtain faculty approval of your selections prior to beginning the assignment.


Conduct research on the selected securities. Examine the organizations’ 10K and investment reports, general economic data, and Federal Reserve data. Prepare a 1,750- to 2,450-word paper in which you describe the selected securities. Format your paper consistent with APA guidelines. ==============================================

FIN 402 Week 2 Weekly Problem Set

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The Problem Set is provided to you to enable you to practice the concepts outlined in the textbook. Select THREE completed problems from the assignment and post your solutions to those problems. In your solutions, provide an explanation as to why you choose the answer.

1. If RF = 6 percent, b = 1.3, and the ERP = 6.5 percent, compute Ke(the required rate of return).


2. If in problem 1 the beta (b) were 1.9 and the other values remained the same, what is the new value of Ke? What is the relationship between a higher beta and the required rate of return (Ke)?

3. Assume the same facts as in problem 2, but with an ERP of 9 percent. What is the new value for Ke? What does this tell you about investors’ feelings toward risk based on the new ERP?

4. Assume D1 = $1.60, Ke= 13 percent, g = 8 percent. Using Formula 7– 5, for the constant growth dividend valuation model, computeP0.

5. J. Jones investment bankers will use a combined earnings and dividend model to determine the value of the Allen Corporation. The approach they take is basically the same as that in Table 7–2 in the chapter. Estimated earnings per share for the next five years are: 2008 $3.20 2009 3.60 2010 4.10 2011 4.62


2012 5.20

a. If 40 percent of earnings are paid out in dividends and the discount rate is 11 percent, determine the present value of dividends. Round all values you compute to two places to the right of the decimal point throughout this problem. b. If it is anticipated that the stock will trade at a P/E of 15 times 2012 earnings, determine the stock’s price at that point in time and discount back the stock price for five years at 11 percent. c. Add together parts a andb to determine the stock price under this combined earnings and dividend model.

6. A company has $200,000 in inventory, which represents 20 percent of current assets. Current assets represent 50 percent of total assets. Total debt represents 30 percent of total assets. What is stockholders’ equity?

7. In the year 2007, the average firm in the S&P 500 Index had a total market value of fives times stockholders’ equity (book value). Assume a firm had total assets of $10 million, total debt of $6 million, and net income of $600,000. a. What is the percent return on equity? b. What is the percent return on total market value? Does this appear to be an adequate return on the actual market value of the firm?


8. A firm has the following financial data: Current assets

$600,000

Fixed assets

400,000

Current liabilities

300,000

Inventory

200,000

If inventory increases by $100,000, what will be the impact on the current ratio, the quick ratio, and the net-working-capital-to-total-assets ratio? Show the ratios before and after the changes.

9. Given the following financial data, compute:

10. Assume the following financial data:


Shares outstanding...................................................................... 24,000

a. Compute the P/E ratio (stock price to earnings per share). b. Compute the book value per share (note that book value equals stockholders’ equity). c. Compute the ratio of stock price to book value per share. d. Compute the dividend yield. e. Compute the payout ratio. 11. Security Analyst A thinks the Collins Corporation is worth 14 times current earnings. Security Analyst B has a different approach. He assumes that 45 percent of earnings (per share) will be paid out in dividends and the stock should provide a 4 percent current dividend yield. Assume total earnings are $12 million and that 5 million shares are outstanding. a. Compute the value of the stock based on Security Analyst A’s approach. b. Compute the value of the stock based on Security Analyst B’s approach. c. Security Analyst C uses the constant dividend valuation model approach presented in Chapter 7 as Formula 7–5 on page 147. She uses Security Analyst B’s assumption about dividends (per share) and assigns a growth rate, g, of 9 percent and a required rate of return (Ke) of 12 percent. Is her value higher or lower than that of the other security analysts?


12. Using the formula for the security market line (Formula 21–7 on page 534), if the risk-free rate (RF) is 7 percent, the beta (bi) is 1.25, and the market rate of return (KM) is 11.8 percent, compute the anticipated rate of return (Ki).

13. If another security had a lower beta than indicated in problem 10, would Kibe lower or higher? What is the logic behind your answer in terms of risk?

14. The capital market line (CML) as defined by the capital asset pricing model is characterized by all of the following except

15. The beta coefficient is a measure of

16. Systematic risk is rewarded with a premium in the marketplace because

17. Which of the following are assumptions of the capital asset pricing model?

18. The correlation coefficient:


19. The standard deviation of a risk-free asset is:

20. A good way to minimize risk and receive an optimum return on your portfolio is:

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FIN 402 Week 2 Weekly Question

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1. (2 point) Calculate the expected return of the following stocks using CAPM. You can use internet websites to get Beta figures, such as Yahoo! Finance, Google Finance, MSN Money, Marketwatch, etc. Use 4% as the risk free rate and 6% as the risk premium. a.

Proctor & Gamble (PG)

b.

Microsoft (MSFT)

c.

Macy’s (M)

d.

JP Morgan Chase (JPM)


e.

Southern Company (SO)

2. (2 points) Look up Microsoft’s financials on the internet. Sites to use include those listed above as well as the SEC’s website – www.sec.gov. Select two ratios from each of the following categories (8 calculations in total) and show your calculations. Be sure to show the formula and your calculations. No points will be given if work is not shown even if you get the correct answer. Categories: a.

Profitability ratios

b.

Asset-utilization ratios

c.

Liquidity ratios

d.

Debt ratios

3. (1 point) Identify two leading indicators for the economy and two lagging indicators. Discuss 1. what these metrics indicate about the economy and 2. what is the most recent statistic on your selected indicators and what that may mean for our current economy.

Example: Retail sales – leading indicator; shows consumer’s confidence in the economy – if they are willing to spend more money, they feel more confident about their job situation; currently, retail sales are just under 3% yoy and shows consumers are still willing to spend ==============================================

FIN 402 Week 3 Assignment Case Problem 6.1 Sara Decides to Take the Plunge


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Case Problem 6.1 Sara Decides to Take the Plunge Sara Thomas is a child psychologist who has built a thriving practice in her hometown of Boise, Idaho. Over the past several years she has been able to accumulate a substantial sum of money. She has worked long and hard to be successful, but she never imagined anything like this. Even so, success has not spoiled Sara. Still single, she keeps to her old circle of friends. One of her closest friends is Terry Jenkins, who happens to be a stockbroker and who acts as Sara’s financial advisor. Not long ago Sara attended a seminar on investing in the stock market, and since then she’s been doing some reading about the market. She has concluded that keeping all of her money in low-yielding savings accounts doesn’t make sense. As a result, Sara has decided to move part of her money to stocks. One evening, Sara told Terry about her decision and explained that she had found several stocks that she thought looked ―sort of interesting.‖ She described them as follows: • North Atlantic Swim Suit Company. This highly speculative stock pays no dividends. Although the earnings of NASS have been a bit erratic, Sara feels that its growth prospects have never been brighter—―what with more people than ever going to the beaches the way they are these days,‖ she says. • Town and Country Computer. This is a long-established computer firm that pays a modest dividend yield (of about 1.50%). It is considered a quality growth stock. From one of the stock reports she read, Sara understands that T&C offers excellent long-term growth and capital gains potential. • Southeastern Public Utility Company. This income stock pays a dividend yield of around 5%. Although it’s a solid company, it has limited growth prospects because of its location. • International Gold


Mines, Inc. This stock has performed quite well in the past, especially when inflation has become a problem. Sara feels that if it can do so well in inflationary times, it will do even better in a strong economy. Unfortunately, the stock has experienced wide price swings in the past. It pays almost no dividends. Questions a. What do you think of the idea of Sara keeping ―substantial sums‖ of money in savings accounts? Would common stocks make better investments for her than savings accounts? Explain. b. What is your opinion of the four stocks Sara has described? Do you think they are suitable for her investment needs? Explain. c. What kind of common stock investment program would you recommend for Sara? What investment objectives do you think she should set for herself, and how can common stocks help her achieve her goals? ==============================================

FIN 402 Week 3 Assignment Case Problem 6.1, 6.2, 7.1, 7.2, 8.1, 8.2, 9.2

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FIN 402 Week 3 Assignment Case Problem 6.1 Sara Decides to Take the Plunge FIN 402 Week 3 Assignment Case Problem 6.2 Wally Wonders Whether There’s a Place for Dividends FIN 402 Week 3 Assignment Case Problem 7.1 Some Financial Ratios Are Real EyeOpeners FIN 402 Week 3 Assignment Case Problem 7.2 Doris Looks at


an Auto Issue FIN 402 Week 3 Assignment Case Problem 8.1 Chris Looks for a Way to Invest His Wealth FIN 402 Week 3 Assignment Case Problem 8.2 An Analysis of a High-Flying Stock FIN 402 Week 3 Assignment Case Problem 9.2 Deb Takes Measure of the Market ==============================================

FIN 402 Week 3 Assignment Case Problem 6.2 Wally Wonders Whether There’s a Place for Dividends

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Case Problem 6.2 Wally Wonders Whether There’s a Place for Dividends Wally Wilson is a commercial artist who makes a good living by doing freelance work—mostly layouts and illustrations—for local ad agencies and major institutional clients (such as large department stores). Wally has been investing in the stock market for some time, buying mostly high-quality growth stocks as a way to achieve long-term growth and capital appreciation. He feels that with the limited time he has to devote to his security holdings, high-quality issues are his best bet. He has become a bit perplexed lately with the market, disturbed that some of his growth stocks aren’t doing even as well as many good-grade income shares. He therefore decides to have a chat with his broker, Al Fried. During their conversation, it becomes clear that both Al and Wally are thinking along the same lines. Al points out that dividend yields on income shares are indeed way up and that, because of the state


of the economy, the outlook for growth stocks is not particularly bright. He suggests that Wally seriously consider putting some of his money into income shares to capture the high dividend yields that are available. After all, as Al says, ―the bottom line is not so much where the payoff comes from as how much it amounts to!‖ They then talk about a highyield public utility stock, Hydro-Electric Light and Power. Al digs up some forecast information about Hydro-Electric and presents it to Wally for his consideration: The stock currently trades at $60 per share. Al thinks that within five years it should be trading at $75 to $80 a share. Wally realizes that to buy the Hydro-Electric stock, he will have to sell his holdings of CapCo Industries—a highly regarded growth stock that Wally is disenchanted with because of recent substandard performance. Questions a. How would you describe Wally’s present investment program? How do you think it fits him and his investment objectives? b. Consider the Hydro-Electric stock. 1. Determine the amount of annual dividends Hydro-Electric can be expected to pay over the years 2016 to 2020. 2. Compute the total dollar return that Wally will make from Hydro-Electric if he invests $6,000 in the stock and all the dividend and price expectations are realized. 3. If Wally participates in the company’s dividend reinvestment plan, how many shares of stock will he have by the end of 2020? What will they be worth if the stock trades at $80 on December 31, 2020? Assume that the stock can be purchased through the dividend reinvestment plan at a net price of $50 a share in 2016, $55 in 2017, $60 in 2018, $65 in 2019, and $70 in 2020. Use fractional shares, to 2 decimals, in your computations. Also, assume that, as in part b, Wally starts with 100 shares of stock and all dividend expectations are realized. c. Would Wally be going to a different investment strategy if he decided to buy shares in Hydro-Electric? If the switch is made, how would you describe his new investment program? What do you think of this new approach? Is it likely to lead to more trading on Wally’s behalf? If so, can you reconcile that with the limited amount of time he has to devote to his portfolio? ==============================================


FIN 402 Week 3 Assignment Case Problem 7.2 Doris Looks at an Auto Issue

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Case Problem 7.2 Doris Looks at an Auto Issue Doris Wise is a young career woman. She lives in Phoenix, Arizona, where she owns and operates a highly successful modeling agency. Doris manages her modest but rapidly growing investment portfolio, made up mostly of high-grade common stocks. Because she’s young and single and has no pressing family requirements, Doris has invested primarily in stocks that offer the potential for attractive capital gains. Her broker recently recommended an auto company stock and sent her some literature and analytical reports to study. One report, prepared by the brokerage house she deals with, provided an up-to-date look at the economy, an extensive study of the auto industry, and an equally extensive review of several auto companies (including the one her broker recommended). She feels strongly about the merits of security analysis and believes it is important to spend time studying a stock before making an investment decision. Questions a. Doris tries to stay informed about the economy on a regular basis. At the present time, most economists agree that the economy is getting stronger. What information about the economy do you think Doris would find helpful in evaluating an auto stock? Prepare a list—and be specific. Which three items of economic information (from your list) do you feel are most important? Explain. b. In relation to a study of the auto industry, briefly note the importance of each of the


following. 1. Auto imports 2. The United Auto Workers union 3. Interest rates 4. The price of a gallon of gas c. A variety of financial ratios and measures are provided about one of the auto companies and its stock. These are incomplete, however, so some additional information will have to be computed. Specifically, we know the following: ==============================================

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