Answers to Problems Chapter 1:

1.

Ending Value of Investment (including Cash Flows) Beginning Value of Investment 39 1.50 40 .50 1.191 34 34 HPY HPR - 1 1.191 - 1 .191 19.1% HPR

2.

61 3 64 .985 65 65 HPY HPR - 1 .985 - 1 - .015 - 1.5% HPR

$4,000 used to purchase 80 shares = $50 per share
(59 x 80) (5 x 80) 4,720 400 5,120 1.280 4,000 4,000 4,000 HPY HPR - 1 1.280 - 1 .280 28% HPR
59 x 80 4,720 1.180 4,000 4,000 HPY (Price Increase Alone) 1.180 - 1 .180 18% HPR (Price Increase Alone)

3.

Therefore: HPY (Total) = HPY (Price Increase) + HPY (Div) .280 = .180 + HPY (Div) .10 = HPY (Dividends)

4.

" Real" Rate of Return

Holding Period Return 1 1 Rate of Inflation

For Problem #1: HPR = 1.191

1.191 1.191 1 1 1.145 1 .145 14.5% 1 .04 1.04 1.191 1.191 at 8% inflation : 1 1 1.103 1 .103 10.3% 1 .08 1.08 at 4% inflation :

For Problem #2: HPR = .985

.985 1 .947 1 .053 5.3% 1.04 .985 at 8% inflation : 1 .912 1 .088 8.8% 1.08 at 4% inflation :

For Problem #3: HPR = 1.280

1.280 1 1.231 1 .231 23.1% 1.04 1.280 at 8% inflation : 1 1.185 1 .185 18.5% 1.08 at 4% inflation :
5(a). HPYi n i 1 (.19) (.08) (.12) (.03) (.15) AM T 5 .27 .054 5 (.08) (.03) (.09) (.02) (.04) AM B 5 .08 .016 5 Stock T is more desirable because the arithmetic mean annual rate of return is higher. Arithemetic Mean (AM)
n

Chapter 4: 1(a). Assume you pay cash for the stock: Number of shares you could purchase = $40,000/$80 = 500 shares. (1) If the stock is later sold at $100 a share, the total shares proceeds would be $100 x 500 shares = $50,000. Therefore, the rate of return from investing in the stock is as follows:
$50 ,000 $40 ,000 25 .00 % $40 ,000

(2)

If stock is later sold at $40 a share, the total shares proceeds would be $40 x $500 shares = $20,000. Therefore, the rate of return from investing in the stock would be:
$20 ,000 $40 ,000 50 .00 % $40 ,000

1(b).

Assuming you use the maximum amount of leverage in buying the stock, the leverage factor for a 60 percent margin requirement is = 1/percentage margin requirement = 1/.60 = 5/3. Thus, the rate of return on the stock if it is later sold at $100 a share = 25.00% x 5/3 = 41.67%. In contrast, the rate of return on the stock if it is sold for $40 a share: = -50.00% x 5/3 = -83.33%.

2(a).

Since the margin is 40 percent and Lauren currently has $50,000 on deposit in her margin account, if Lauren uses the maximum allowable margin her $50,000 deposit must represent 40% of her total investment. Thus, $50,000 = .4x then x = $125,000. This sum represents $50,000 of her own funds (equity) and $75,000 of borrowed funds. Since the shares are priced at $35 each, Lauren can purchase $125,000 / $35 = 3,571 shares (rounded). Total Profit = Total Return - Total Investment (1) If stock rises to $45/share, Laurens total return is: 3,571 shares x $45 = $160,695. Total profit = $160,695 - $125,000 = $35,695 Laurens profit is computed as: $160,695 - $75,000 borrowing = $85,695; since her initial equity was $50,000, her profit is $85,695 - $50,000 = $35,695, which is the same as we computed above. (2) If stock falls to $25/share, Laurens total return is: 3,571 shares x $25 = $89,275. Total loss = $89,275 - $125,000 = -$35,725.

2(b).

2(c)

Market Value - Debit Balance Market Value where Market Value = Price per share x Number of shares. Margin
Initial Loan Value = Total Investment - Initial Margin. = $125,000 - $50,000 = $75,000 Therefore, if maintenance margin is 30 percent:
.30 (3,571 shares x Price) - $75,000 (3,571 shares x Price)

.30 (3,571 x Price) 1,071.3 x Price -2,499.7 x Price Price

= (3,571 x Price) - $75,000. = (3,571 x Price) - $75,000 = -$75,000 = $30.00

5(a).

I want to protect some of the profit I have; should prices drop I will still have a profit of $15/share. With the stop loss: ($40 - $25)/$25 = 60% Without the stop loss: ($30 - $25)/$25 = 20%

5(b).

6(a).

Assuming that you pay cash for the stock:

($45 x 300) - ($30 x 300) 13,500 - 9000 50 % ($30 x 300) 9000 This is the return earned over 2 years so the annualized returns is (1 + 0.50)1/2 -1 = 22.47% Rate of Return

6(b).

Assuming that you used the maximum leverage in buying the stock, the leverage factor for a 60 percent margin requirement is = 1/margin requirement = 1/.60 = 1.67. Thus, the rate of return on the stock if it is later sold at $45 a share = 50% x 1.67 = 83.33%. The annualized return is (1 + 0.8333)1/2 1 = 35.4%

Chapter 5: 1(a). Given a three security series and a price change from period t to t+1, the percentage change in the series would be 42.85 percent. Period t $ 60 20 18 $ 98 Divisor3 3 Average 32.67 A B C Sum Period t+1 $ 80 35 25 $140 46.67

Percentagechange
1(b). Stock A B C Total

46.67 - 32.67 14.00 42.85% 32.67 32.67

Period t Price/Share # of Shares $60 1,000,000 20 10,000,000 18 30,000,000

Market Value $ 60,000,000 200,000,000 540,000,000 $800,000,000

Stock A B C Total

Period t+1 Price/Share # of Shares $80 1,000,000 35 10,000,000 25 30,000,000

Market Value $ 80,000,000 350,000,000 750,000,000 $1,180,000,000

Percentagechange
1(c).

1,180 - 800 380 47.50% 800 800

The percentage change for the price-weighted series is a simple average of the differences in price from one period to the next. Equal weights are applied to each price change. The percentage change for the value-weighted series is a weighted average of the differences in price from one period t to t+1. These weights are the relative market values for each stock. Thus, Stock C carries the greatest weight followed by B and then A. Because Stock B had the greatest percentage increase (75%) and the second largest weight, the percentage change would be larger for this series than the price-weighted series.

2(a).

Period t

Stock A B C Total Stock A B C Total

Price/Share # of Shares $60 16.67 20 50.00 18 55.56 Period t+1 Price/Share # of Shares $80 16.67 35 50.00 25 55.56

Market Value $ 1,000,000 1,000,000 1,000,000 $3,000,000 Market Value $ 1,333.60 1,750.00 1,389.00 $4,472.60

Percentage change

4,472.60 - 3,000 1,472.60 49.09% 3,000 3,000

2(b).

80 60 20 33.33% 60 60 35 20 15 75.00% 20 20 25 - 18 7 38.89% 18 18

Arithmetic average

33.33% 75.00% 38.89% 3 147.22% 49.07% 3

The answers are the same (slight difference due to rounding). This is what you would expect since Part A represents the percentage change of an equal-weighted series and Part B applies an equal weight to the separate stocks in calculating the arithmetic average.

2(c).

Geometric average is the nth root of the product of n items.

1/3 Geometric average [(1.3333)(1.75) (1.3889)] 1 [3.2407]1 / 3 1 1.4798 1 .4798 or 47.98%

The geometric average is less than the arithmetic average. This is because variability of return has a greater affect on the arithmetic average than the geometric average.

4(a).
DJIA Pit / D adj
i 1 30

Day 1 Company A B C Price/Share 12 23 52

Day 2

Company A B C

(Before Split) Price/Share 10 22 55

(After Split) Price/Share 10 44 55

Day 3

(Before Split)

(After Split)

Company A B C

Price/Share 14 46 52

Price/Share 14 46 26

Day 4

Company A B C

Price/Share 13 47 25

Day 5

Company A B C

Price/Share 12 45 26

4(b).

Since the index is a price-weighted average, the higher priced stocks carry more weight. But when a split occurs, the new divisor ensures that the new value for the series is the same as it would have been without the split. Hence, the main effect of a split is just a repositioning of the relative weight that a particular stock carries in determining the index. For example, a 10% price change for company B would carry more weight in determining the percent change in the index in Day 3 after the reverse split that increased its price, than its weight on Day 2.

Chapter 7:

1.

[E(Ri)] for Lauren Labs Possible Expected Probability Returns 0.10 -0.20 0.15 -0.05 0.20 0.10 0.25 0.15 0.20 0.20 0.10 0.40 Return -0.0200 -0.0075 0.0200 0.0375 0.0400 0.0400 E(Ri) = 0.1100

2. Market Stock Disney Starbucks Harley Davidson Intel Walgreens TOTAL Value $15,000 17,000 32,000 23,000 7,000 94,000 Weight 0.160 0.181 0.340 0.245 0.074 1.0000 Security Return (Ri) 0.14 -0.04 0.18 0.16 0.05 Portfolio Return Wi x Ri 0.022 -0.007 0.061 0.039 0.004 0.119

3. Month

Madison Cookies(Ri)

Sophie Electric(Rj)

Ri-E(Ri)

Rj-E(Rj)

[Ri-E(Ri)] x [Rj-E(Rj)]

1 2 3 4 5 6 Sum 3(a).

-.04 .06 -.07 .12 -.02 .05 .10

.07 -.02 -.10 .15 -.06 .02 .06

-.057 .043 -.087 .103 -.037 .033

.06 -.03 -.11 .14 -.07 .01

-.0034 -.0013 .0096 .0144 .0026 .0003 .0222

E(RMadison) = .10/6 = .0167

E(RSophie) = .06/6 = .01

3(b).

Madison .0257 / 5 .0051 .0717 Sophie .04120 / 5 .0082 .0908

3(c).

COVij = 1/5 (.0222) = .0044

3(d).
rij .0044 (. 0717 ) (. 0908 )

.0044 .006510 .6758

One should have expected a positive correlation between the two stocks, since they tend to move in the same direction(s). Risk can be reduced by combining assets that have low positive or negative correlations, which is not the case for Madison Cookies and Sophie Electric.