Chapter 2

Exercise
1. Calculate the present value of a $1,000 zero-coupon bond with five years to maturity
if the yield to maturity is 6%.
2. A lottery claims its grand prize is $10 million, payable over 20 years at $500,000 per
year. If the first payment is made immediately, what is this grand prize really worth?
Use an interest rate of 6%.
3. Consider a bond with a 7% annual coupon and a face value of $1,000. Complete the
following table.
Years to Yield to Current
Maturity Maturity Price
3 5
3 7
6 7
9 7
9 9
What relationship do you observe between yield to maturity and the current market
value?
4. Consider a coupon bond that has a $1,000 par value and a coupon rate of 10%. The
bond is currently selling for $1,150 and has eight years to maturity. What is the bond’s
yield to maturity?
5. You are willing to pay $15,625 now to purchase a perpetuity that will pay you and
your heirs $1,250 each year, forever, starting at the end of this year. If your required
rate of return does not change, how much would you be willing to pay if this were a 20-
year, annual payment, ordinary annuity instead of a perpetuity?
6. Property taxes in DeKalb County are roughly 2.66% of the purchase price every year.
If you just bought a $100,000 home, what is the PV of all the future property
tax payments? Assume that the house remains worth $100,000 forever, property tax
rates never change, and that a 9% interest rate is used for discounting.
7. Assume you just deposited $1,000 into a bank account. The current real interest rate
is 2%, and inflation is expected to be 6% over the next year. What nominal rate would
you require from the bank over the next year? How much money will you have
at the end of one year? If you are saving to buy a stereo that currently sells for $1,050,
will you have enough to buy it?
8. A 10-year, 7% coupon bond with a face value of $1,000 is currently selling for
$871.65. Compute your rate of return if you sell the bond next year for $880.10.
9. You have paid $980.30 for an 8% coupon bond with a face value of $1,000 that
matures in five years. You plan on holding the bond for one year. If you want to earn a
9% rate of return on this investment, what price must you sell the bond for? Is this
realistic?
 10. 14. A bank has two 3-year commercial loans with a present value of $70 million.
The first is a $30 million loan that requires a single payment of $37.8 million in three
years, with no other payments till then. The second loan is for $40 million. It requires
an annual interest payment of $3.6 million. The principal of $40 million is due in three
years.
a. What is the duration of the bank’s commercial loan portfolio?
b. What will happen to the value of its portfolio if the general level of interest rates
increases from 8% to 8.5%?
11. Consider a bond that promises the following cash flows. The yield to maturity is
12%.

Year 0 1 2 3 4
Promi
sed 160 160 170 180 230
You plan to buy this bond, hold it for 2.5 years, and then sell the bond.
Payme
a. What total cash will nts
you receive from the bond after the 2.5 years? Assume that
periodic cash lows are reinvested at 12%.
b. If immediately after you buy this bond all market interest rates drop to 11%
(including your reinvestment rate), what will be the impact on your total cash flow after
2.5 years? How does this compare to part (a)?
c. Assuming all market interest rates are 12%, what is the duration of this bond?

Chapter 3
Exercises
1. What would be your annualized discount rate % and your annualized investment rate %
on the purchase of a 182-day Treasury bill for $4,925 that pays $5,000 at maturity?
2. What are the annualized discount rate % and your annualized investment rate % on a
Treasury bill that you purchase for $9,940 that will mature in 91 days for $10,000?
3. If you want to earn an annualized discount rate of 3.5%, what is the most you can pay
for a 91-day Treasury bill that pays $5,000 at maturity?
4. What is the annualized discount and investment rate % on a Treasury bill that you
purchase for $9,900 that will mature in 91 days for $10,000?
5. The price of 182-day commercial paper is $7,840. If the annualized investment rate is
4.093%, what will the paper pay at maturity?
6. How much would you pay for a Treasury bill that matures in 182 days and pays $10,000
if you require a 1.8% discount rate?
7. The price of $8,000 face value commercial paper is $7,930. If the annualized discount
rate is 4%, when will the paper mature? If the annualized investment rate % is 4%, when
will the paper mature?
8. How much would you pay for a Treasury bill that matures in one year and pays $10,000
if you require a 3% discount rate?
9. The annualized discount rate on a particular money market instrument is 3.75%. The
face value is $200,000, and it matures in 51 days. What is its price? What would be the
price if it had 71 days to maturity?
10. The annualized yield is 3% for 91-day commercial paper and 3.5% for 182-day
commercial paper. What is the expected 91-day commercial paper rate 91days from now?
11. In a Treasury auction of $2.1 billion par value 91-day T-bills, the following bids were
submitted:
Bidder Bid Amount($ million) Price ($)
1 500 0.9940
2 750 0.9901
3 1.5 0.9925
4 1 0.9936
5 600 0.9939

If only these competitive bids are received, who will receive T-bills, in what quantity, and
at what price?
12. If the Treasury also received $750 million in noncompetitive bids, who will receive T-
bills, in what quantity, and at what price? (Refer to the table in problem 11.)

Chapter 4
Exercises
1. A bond makes an annual $80 interest payment (8% coupon). The bond has five years
before it matures, at which time it will pay $1,000. Assuming a discount rate of 10%,
what should be the price of the bond?
2. A zero-coupon bond has a par value of $1,000 and matures in 20 years. Investors
require a 10% annual return on these bonds. For what price should the bond sell? (Note:
Zero-coupon bonds do not pay interest.)
3. Consider the two bonds described below:
Bond A Bond B
Maturity (years) 15 20
Coupon rate (%)(paid 10 6
semiannually)
Par value $1,000 $1,000

a. If both bonds had a required return of 8%, what would the bonds’ prices be?
b. Describe what it means if a bond sells at a discount, a premium, and at its face amount
(par value). Are these two bonds selling at a discount, premium, or par?
c. If the required return on the two bonds rose to 10%, what would the bonds’ prices
be?
 4. A two-year $1,000 par zero-coupon bond is currently priced at $819.00. A two-year
$1,000 annuity is currently priced at $1,712.52. If you want to invest $50,000 in one of
the two securities, which is a better buy? (Hint: Compute the yield of each security.)
5. The yield on a corporate bond is 10%, and it is currently selling at par. The marginal
tax rate is 20%. A par value municipal bond with a coupon rate of 8.50% is available.
Which security is a better buy?
6. If the municipal bond rate is 4.25% and the corporate bond rate is 6.25%, what is the
marginal tax rate, assuming investors are indifferent between the two bonds?
7. M&E, Inc., has an outstanding convertible bond. The bond can be converted into 20
shares of common equity (currently trading at $52/share). The bond has five years of
remaining maturity, a $1,000 par value, and a 6% annual coupon. M&E’s straight debt
is currently trading to yield 5%. What is the minimum price of the bond?
8. A 10-year, $1,000 par value bond with a 5% annual coupon is trading to yield 6%.
What is the current yield?
9. A $1,000 par bond with an annual coupon has only one year until maturity. Its current
yield is 6.713%, and its yield to maturity is 10%. What is the price of the bond?
10. A one-year discount bond with a face value of $1,000 was purchased for $900. What
is the yield to maturity? What is the yield on a discount basis?
11. A 10-year $1,000 par value bond has a 9% semiannual coupon and a nominal yield
to maturity of 8.8%. What is the price of the bond?

Chapter 5
Exercises
eBay, Inc., went public in September of 1998. The following information on shares
outstanding was listed in the final prospectus filed with the SEC.
In the IPO, eBay issued 3,500,000 new shares. The initial price to the public was
$18.00 per share. The final firstday closing price was $44.88.
1. If the investment bankers retained $1.26 per share as fees, what were the net proceeds
to eBay? What was the market capitalization of the new shares of eBay?
2. Two common statistics in IPOs are underpricingand money left on the table.
Underpricing is defined as percentage change between the offering price and the first
day closing price. Money left on the table is the difference between the first day closing
price and the offering price, multiplied by the number of shares offered. Calculate the
underpricing and money left on the table for eBay. What does this suggest about the
efficiency of the IPO process?
3. The shares of Misheak, Inc., are expected to generate the following possible returns
over the next 12 months:
Return (%) Probability
–5 .10
5 .25
10 .30
 15 .25
25 .10
If the stock is currently trading at $25 per share, what is the expected price in one year?
Assume that the stock pays no dividends.
4. Suppose SoftPeople, Inc., is selling at $19.00 and currently pays an annual dividend
of $0.65 per share. Analysts project that the stock will be priced around $23.00 in one
year. What is the expected return?
5. Suppose Microsoft, Inc., is trading at $27.29 per share. It pays an annual dividend of
$0.32 per share, and analysts have set a one-year target price around $33.30 per share.
What is the expected return of this stock?
6. LaserAce is selling at $22.00 per share. The most recent annual dividend paid was
$0.80. Using the Gordon growth model, if the market requires a return of 11%, what is
the expected dividend growth rate for LaserAce?
7. Huskie Motors just paid an annual dividend of $1.00 per share. Management has
promised shareholders to increase dividends at a constant rate of 5%. If the required
return is 12%, what is the current price per share?
8. Suppose Microsoft, Inc., is trading at $27.29 per share. It pays an annual dividend of
$0.32 per share, which is double last year’s dividend of $0.16 per share. If this trend is
expected to continue, what is the required return on Microsoft?
9. Gordon & Co.’s stock has just paid its annual dividend of $1.10 per share. Analysts
believe that Gordon will maintain its historic dividend growth rate of 3%. If the required
return is 8%, what is the expected price of the stock next year?
10. Macro Systems just paid an annual dividend of $0.32 per share. Its dividend is
expected to double for the next four years (D1 through D4), after which it will grow at
a more modest pace of 1% per year. If the required return is 13%, what is the current
price?
11. Nat-T-Cat Industries just went public. As a growing firm, it is not expected to pay
a dividend for the first five years. After that, investors expect Nat-T-Cat to pay an
annual dividend of $1.00 per share (i.e., D6 = 1.00), with no growth. If the required
return is 10%, what is the current stock price?

Chapter 6
Exercises
1. Profit from T-Bill Futures Spratt Company purchased T-bill futures contracts when
the quoted price was 93.50. When this position was closed out, the quoted price was
94.75. Determine the profit or loss per contract, ignoring transaction costs.
2. Profit from T-Bill Futures Suerth Investments, Inc., purchased T-bill futures
contracts when the quoted price was 95.00. When this position was closed out, the
quoted price was 93.60. Determine the profit or loss per contract, ignoring transaction
costs.
 3. Profit from T-Bill Futures Toland Company sold T-bill futures contracts when the
quoted price was 94.00. When this position was closed out, the quoted price was 93.20.
Determine the profit or loss per contract, ignoring transaction costs.
4. Profit from T-Bill Futures Rude Dynamics, Inc., sold T-bill futures contracts when
the quoted price was 93.26. When this position was closed out, the quoted price was
93.90. Determine the profit or loss per contract, ignoring transaction costs.
5. Profit from T-Bond Futures Egan Company purchased a futures contract on Treasury
bonds that specified a price of 91-00. When the position was closed out, the price of the
Treasury bond futures contract was 90-10. Determine the profit or loss,
ignoring transaction costs.
6. Profit from T-Bond Futures R. C. Clark sold a futures contract on Treasury bonds
that specified a price of 92-10. When the position was closed out, the price of the
Treasury bond futures contract was 93-00. Determine the profit or loss, ignoring
transaction costs.
7. Profit from Stock Index Futures Marks Insurance Company sold S&P 500 stock
index futures that specified an index of 1690. When the position was closed out, the
index specified by the futures contract was 1720. Determine the profit or loss, ignoring
transaction costs.

Chapter 7
Exercises
1. Writing Call Options A call option on Illinois stock specifies an exercise price of
$38. Today, the stock’s price is $40. The premium on the call option is $5. Assume the
option will not be exercised until maturity, if at all. Complete the following table:
ASSUMED STOCK PRICE AT NET PROFIT OR LOSS PER
THE TIME THE CALL OPTION SHARE TO BE EARNED BY THE
IS ABOUT TO EXPIRE WRITER (SELLER) OF THE
CALL OPTION

$37
39
41
43
45
48
2. Purchasing Call Options A call option on Michigan stock specifies an exercise price
of $55. Today, the stock’s price is $54 per share. The premium on the call option is $3.
Assume the option will not be exercised until maturity, if at all. Complete the following
table for a speculator who purchases the call
option:
 ASSUMED STOCK PRICE AT NET PROFIT OR LOSS PER
THE TIME THE CALL OPTION SHARE TO BE EARNED BY
IS ABOUT TO EXPIRE THE SPECULATOR
$50
52
54
56
58
60
62

3. Purchasing Put Options A put option on Iowa stock specifies an exercise price of
$71. Today, the stock’s price is $68. The premium on the put option is $8. Assume the
option will not be exercised until maturity, if at all. Complete the following table for a
speculator who purchases the put option (and currently does not own the stock):
ASSUMED STOCK PRICE AT THE NET PROFIT OR LOSS PER
TIME THE PUT OPTION IS SHARE TO BE EARNED BY THE
ABOUT TO EXPIRE SPECULATOR

$60
64
68
70
72
74
76

4. Writing Put Options A put option on Indiana stock specifies an exercise price of $23.
Today, the stock’s price is $24. The premium on the put option is $3. Assume the option
will not be exercised until maturity, if at all. Complete the following table:
ASSUMED STOCK PRICE AT THE NET PROFIT OR LOSS PER SHARE
TIME THE PUT OPTION IS ABOUT TO BE EARNED BY THE WRITER
TO EXPIRE (OR SELLER) OF THE PUT OPTION
$20
21
22
23
24
25
26
5. Covered Call Strategy
a. Evanston Insurance, Inc., has purchased shares of Stock E at $50 per share. It will
sell the stock in six months. It considers using a strategy of covered call writing to
partially hedge its position in this stock. The exercise price is $53, the expiration date
is six months, and the premium on the call option is $2. Complete the following table:
POSSIBLE PRICE OF PROFIT OR LOSS PER PROFIT OR LOSS PER
STOCK E IN SIX SHARE IF A COVERED SHARE IF A COVERED
MONTHS CALL STRATEGY IS CALL STRATEGY IS
USED NOT USED
$47
50
52
55
57
60
b. Assume that each of the six stock prices in the table’s first column has an equal
probability of occurring. Compare the probability distribution of the profits (or losses)
per share when using covered call writing versus not using it. Would you recommend
covered call writing in this situation? Explain.
6. Put Options on Futures Purdue Savings and Loan Association purchased a put option
on Treasury bond futures with a September delivery date and an exercise price of 91–
16. The put option has a premium of 1–16. Assume that the price of the Treasury bond
futures decreases to 88–16. Should Purdue exercise the option or let it expire? What is
Purdue’s net gain or loss after accounting for the premium paid on the
option?
7. Call Options on Futures Wisconsin, Inc., purchased a call option on Treasury bond
futures at a premium of 2–00. The exercise price is 92–08. If the price of the Treasury
bond futures rises to 93–08, should Wisconsin exercise the call option or let it expire?
What is Wisconsin’s net gain or loss after accounting for the premium paid on the
option?
8. Call Options on Futures DePaul Insurance Company purchased a call option on an
S&P 500 futures contract. The option premium is quoted as $6. The exercise price is
1430. Assume the index on the futures contract becomes 1440. Should DePaul exercise
the call option or let it expire? What is the net gain or loss to DePaul after accounting
for the premium paid for the option?
9. Covered Call Strategy Coral, Inc., has purchased shares of Stock M at $28 per share.
Coral will sell the stock in six months. It considers using a strategy of covered call
writing to partially hedge its position in this stock. The exercise price is $32, the
expiration date is six months, and the premium on the call option is $2.50. Complete
the following table:
 POSSIBLE PRICE OF STOCK M IN PROFIT OR LOSS PER SHARE IF
SIX MONTHS COVERED CALL STRATEGY IS
USED

$25
28
33
36

Chapter 8
Exercises
1. Vanilla Swaps Cleveland Insurance Company has just negotiated a three-year plain
vanilla swap in which it will exchange fixed payments of 8 percent for floating payments
of LIBOR plus 1 percent. The notional principal is $50 million. LIBOR is expected to be
7 percent, 9 percent, and 10 percent (respectively) at the end of each of the next three years.
a. Determine the net dollar amount to be received (or paid) by Cleveland each year.
b. Determine the dollar amount to be received (or paid) by the counterparty on this interest
rate swap each year based on the assumed forecasts of LIBOR.
2. Interest Rate Caps Northbrook Bank purchases a four-year cap for a fee of 3 percent of
notional principal valued at $100 million, with an interest rate ceiling of 9 percent and
LIBOR as the index representing the market interest rate. Assume that LIBOR is expected
to be 8 percent, 10 percent, 12 percent, and 13 percent (respectively) at the end of each of
the next four years.
a. Determine the initial fee paid, and also determine the expected payments to be received
by Northbrook if LIBOR moves as forecasted.
b. Determine the dollar amount to be received (or paid) by the seller of the interest rate cap
based on the assumed forecasts of LIBOR.
3. Interest Rate Floors Iowa City Bank purchases a three-year interest rate floor for a fee
of 2 percent of notional principal valued at $80 million, with an interest rate floor of 6
percent and LIBOR representing the interest rate index. The bank expects LIBOR to be
6 percent, 5 percent, and 4 percent (respectively) at the end of each of the next three years.
a. Determine the initial fee paid, and also determine the expected payments to be received
by Iowa City if LIBOR moves as forecasted.
b. Determine the dollar amounts to be received (or paid) by the seller of the interest rate
floor based on the assumed forecasts of LIBOR.

Chapter 10
Exercises
1. On January 1, the shares and prices for a mutual fund at 4:00 p.m. are as follows:
Stock Shares owned Price
 1 1,000 $1.92
2 5,000 $51.18
3 2,800 $29.08
4 9,200 $67.19
5 3,000 $4.51
Cash n.a. $5,353.40
Stock 3 announces record earnings, and the price of stock 3 jumps to $32.44 in after-
market trading. If the fund (illegally) allows investors to buy at the current NAV, how
many shares will $25,000 buy? If the fund waits until the price adjusts, how many
shares can be purchased? What is the gain to such illegal trades? Assume 5,000 shares
are outstanding.
2. A mutual fund charges a 5% upfront load plus reports an expense ratio of 1.34%. If
an investor plans on holding a fund for 30 years, what is the average annual fee, as a
percent, paid by the investors?
3. A mutual fund offers “A” shares, which have a 5% upfront load and an expense ratio
of 0.76%. The fund also offers “B” shares, which have a 3% back-end load
and an expense ratio of 0.87%. Which shares make more sense for an investor looking
over an 18-year horizon?
4. A mutual fund reported year-end total assets of $1,508 million and an expense ratio
of 0.90%. What total fees is the fund charging each year?
5. A $1 million fund is charging a back-end load of 1%, 12b-1 fees of 1%, and an
expense ratio of 1.9%. Prior to deducting expenses, what must the fund value be
at the end of the year for investors to break even?
Questions 6–12 trace a sequence of transactions involving a single mutual fund.
6. On January 1 a mutual fund has the following assets and prices at 4:00 p.m.
Stock Shares owned Price
1 1,000 $1.97
2 5,000 $48.26
3 1,000 $26.44
4 10,000 $67.49
5 3,000 $2.59
Calculate the net asset value (NAV) for the fund. Assume that 8,000 shares are
outstanding for the fund.
7. An investor sends the fund a check for $50,000. If there is no front-end load, calculate
the new number of shares and price per share. Assume the manager
purchases 1,800 shares of stock 3, and the rest is held as cash.
8. On January 2 the prices at 4:00 p.m. are as follows:
Stock Shares owned Price
1 1,000 $2.03
2 5,000 $51.37
3 2,800 $29.08
 4 10,000 $67.19
5 3,000 $4.42
Cash n.a. $2,408.00
Calculate the net asset value (NAV) for the fund.
9. Assume the new investor then sells the 420 shares. What is his profit? What is the
annualized return? The fund sells 800 shares of stock 4 to raise the needed funds.
Assume 250 trading days per year.
10. To discourage short-term investing in its fund, the fund now charges a 5% upfront
load and a 2% backend load. The same investor decides to put $50,000 back into the
fund. Calculate the new number of shares outstanding. Assume the fund manager buys
back as many round-lot shares of stock 4 with the cash.
11. On January 3 the prices at 4:00 p.m. are as follows:
Stock Shares owned Price
1 1,000 $1.92
2 5,000 $51.18
3 2,800 $29.08
4 9,900 $67.19
5 3,000 $4.51
Cash n.a. $5,353.40
Calculate the new NAV.
12. Unhappy with the results, the new investor then sells the 389.09 shares. What is his
profit? What is the new fund value?

Chapter 11
Exercises
1. Research indicates that the 1,000,000 cars in your city experience unrecoverable losses
of $250,000,000 per year from theft, collisions, and so on. If 30% of premiums are used to
cover expenses, what premium must be charged to car owners?
2. A home products manufacturer estimates that the probability of being sued for product
defects is 1% per year per product manufactured. If the firm currently manufactures 20
products, what is the probability that the firm will experience no lawsuits in a given year?
3. Kio Outfitters estimated the losses and probabilities from past experience in the table in
the next column. What is the probability Kio will experience a loss of $5,000 or greater?
If an insurance company offers a loss policy with a $1,500 deductible, what is the most Kio
will pay?
Loss ($) Probability (%)
30,000 0.25
15,000 0.75
10,000 1.50
5,000 2.50
1,000 5.00
 250 5.00
0 75.00
4. A client needs assistance with retirement planning. Here are the facts:
 The client, Dave, is 21 years old. He wants to retire at 65.
 Dave has disposable income of $2000 per month
 The IRA Dave has chosen has an average annual return 8%.
If Dave contributes half of his disposable income to the account, what will it be worth at
65? How much would he need to contribute to have $5,000,000 at 65?
5. When opening an IRA account, investors have two options. With a regular IRA account,
funds added are not taxed initially, but are taxed when withdrawn. With a Roth IRA, the
funds are taxed initially, but not when withdrawn. If an investor wants to contribute
$15,000 before taxes to an IRA, what will be the difference after 30 years between the two
options? Assume that the investor is currently in the 25% tax bracket, and that the IRA will
earn 6% per year.
6. An employee contributes $200 a year (at the end of the year) to her pension plan. What
would be the total contributions and value of the account after five years? Assume that the
plan earns 15% per year over the period.
7. Paul’s car slid off the icy road, causing $2,500 in damage to his car. He was also treated
for minor injuries, costing $1,300. His car insurance has a $500 deductible, after which the
full loss is paid. His health insurance has a $100 deductible and covers 75% of
medical cost (total). What were Paul’s out-of-pocket costs from the incident?