FINA 4326

 
Investments Analysis Portfolio Management

Review for Midterm #1

Selected Problems From Lecture Slides and Assignments

Jayoung Nam
SMU Cox School of Business

FINA 4326
 Question: Assignment #1

An investor buys a share of preferred stock at $42 and sell it at year-

end at $42, and receives a $4 year-end dividend. The investor is in the
35% tax bracket. What is the after-tax return to the corporation, in
percentage? Round your answer to two decimal places.

FINA 4326
 Question

Municipal bond carries a coupon of 6.75% and is trading at

par. What is the equivalent taxable yield to a taxpayer in a
combined federal plus state 34% bracket?

FINA 4326
 Question

The coupon rate on a tax-exempt bond is 5.6%, and the rate on a

taxable bond is 8%. Both bonds sell at par. At what tax bracket
(marginal tax rate) would an investor be indifferent between the two
bonds?

FINA 4326
 Question

Mark the following statement True or False.

1. The Dow Jones Industrial Average Index is a price-weighted index.

2. S&P 500 index is a market-value-weighted index.

FINA 4326
 Short selling
Suppose you are bearish on stock A. It is currently trading at $10, but
you believe the stock will at $7.9 by the end of this month. You also
heard that the stock will pay a $4 dividend next Monday. You decide to
short sell 100 shares. What is your expected return? (suppose there
are no fees associated with the short sale)

Your expected profit/loss is the following:

FINA 4326
Note, that we cannot calculate the return (your initial investment is 0). In reality
though, you will have to post margin, which will constitute your initial investment (I).
 Short selling
Suppose you are bearish on stock A. It is currently trading at $10, but
you believe the price will fall to $8 soon. You decide to short sell 100
shares. The broker charges you a share loan fee/interest of 1%.
Assume you pay the fee when you close your short position. What is
your expected return?

FINA 4326
 Short selling and margin
Suppose your account/portfolio contains T-bills with a total value of
$5,100. The broker’s minimum margin requirement is 60%, and you
plan to short sell 100 shares of stock A. The stock is currently trading at
$92. Will the broker authorize the short sale?

FINA 4326
 Question: Assignment #3
Old Economy Traders opened an account to short sell 1,000 shares of
Internet Dreams at $40 per share. The initial margin requirement was
50%. The margin account pays no interest. 

A year later, the price of Internet Dreams has risen from $40 to $50, and
the stock has paid a dividend of $2 per share.

What is the rate of return, in percentage, on the investment? Round

your answer in two decimal places.

FINA 4326
 Question: Assignment #3
Your client purchased 50,000 shares of Proctor & Gamble on February 4, 2018
at $79.92 per share. She also purchased these shares on margin, borrowing
50% of the purchase price of these shares. The margin interest rate is 2% per
year, and the maintenance margin is 35%. She planned to sell her position on
February 4, 2019. 

A. She would have been subject to a margin call for a price  $ __________   or
lower.  Assume the annual margin interest rate would apply regardless of the
actual borrowing period.  Round your answer into two decimal places.

B. Assume she sells her entire position at $98.15 per share a year later. Her
return on this position over the last year will be  __________ %.  Round your
answer for two decimal places.

FINA 4326
 Example
Which one of the following portfolios cannot lie on the efficient frontier
as described by Markowitz?

Portfolio Expected Standard

return (%) deviation (%)
A. W 15 36
B. X 12 15
C. Z 5 7
D. Y 9 21

FINA 4326
 Example
Which statement about portfolio diversification is correct?

A. Proper diversification can reduce or eliminate systematic risk.

B. Diversification reduces the portfolio’s expected return because it

reduces a portfolio’s total risk.

C. As more securities are added to a portfolio, total risk typically can

be expected to fall at a decreasing rate.

D. The risk-reducing benefits of diversification do not occur

meaningfully until at least 30 individual securities are included in
the portfolio.

FINA 4326
 Example
Portfolio theory as described by Markowitz is most concerned with:

A. The elimination of systematic risk

B. The effect of diversification on portfolio risk

C. The identification of unsystematic risk

D. Active portfolio management to enhance return

FINA 4326
 Example
Stocks A, B, and C have the same expected return and standard
deviation. The following table shows the correlations between the
returns on these stocks.
Stock A Stock B Stock C
Stock A +1.0
Stock B +0.9 +1.0
Stock C +0.1 −0.4 +1.0

Given these correlations, the portfolio constructed from these stocks

having the lowest risk is a portfolio:

A. Equally invested in stocks A and B

B. Equally invested in stocks A and C
C. Equally invested in stocks B and C
D. Totally invested in stock C
FINA 4326