HW6_Answers

HW6_Answers - Answers to End-of-Chapter Questions Q6-2. Why...

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Answers to End-of-Chapter Questions Q6-2. Why do real returns matter more than nominal returns? A6-2. If the reason that people invest is to have more money to spend later in life, then the real return measures the increase in spending power over time. It is not how much money you have that counts, it’s how much you can buy with that money. Q6-5. Do the rankings of investment alternatives depend on whether we rank based on nominal returns or real returns? A6-5. Nominal and real returns provide different measures of an investment’s absolute returns, but the relative rankings do not change (as long as the measure of inflation used to convert nominal re- turns into real ones is the same for each investment). In Figures 6.1 and 6.2, the ranking of invest- ments is the same. Q6-13. Classify each of the following events as a source of systematic or unsystematic risk. a. Alan Greenspan retires as Chairman of the Federal Reserve and Arnold Schwarzenegger is appointed to take his place. b. Martha Stewart is convicted of insider trading and is sentenced to prison. c. An OPEC embargo raises the world market price of oil. d. A major consumer products firm loses a product liability case. e. The Supreme Court rules that no employer can layoff an employee without first giving 30 days notice. A6-13. a, c, and e are systematic risks because they affect most firms in the market. Item b primarily af- fects Martha Stewart’s company, and likewise, d mainly affects the firm involved in the lawsuit, so these are unsystematic risks. However, one could argue that the Martha Stewart case has a sys- tematic component if investors believe that by convicting Martha, the government has effectively deterred many other insider traders from trading. Answers to End-of-Chapter Problems P6-1. You purchase 1,000 shares of Spears Grinders Inc. stock for $45 per share. A year later, the stock pays a dividend of $1.25 per share and it sells for $49. a. Calculate your total dollar return. b. Calculate your total percentage return. c. Do the answers to parts (a) and (b) depend on whether you sell the stock after one year or continue to hold it? A6-1. a. 1,000 × ($1.25 + $4) = $5,250 b. ($49 + $1.25 - $45)/$45 = 0.1167 or 11.67%. c. The answer does not depend on whether you sell the stock or hold it. P6-7. In this advanced problem, let’s look at the behavior of ordinary Treasury bonds and inflation-in- dexed bonds or TIPS as described in the opening focus. We will simplify a little by assuming an- nual interest payments rather than semiannual. Suppose over the next five years, investors expect 3 percent inflation each year. The Treasury issues a five-year ordinary bond that pays $55 interest each year. The Treasury issues a five-year TIPS that pays a coupon rate of 2 percent. With TIPS,
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the coupon payment is determined by multiplying the coupon rate times the inflation-adjusted principal value. Like ordinary bonds, TIPS begin with a par value or principal value of $1,000. However, that principal increases over time as inflation occurs. Assuming that inflation is in fact
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HW6_Answers - Answers to End-of-Chapter Questions Q6-2. Why...

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