Question 1

Returns on Mondays are generally much more negative than returns on other days of the week.How would you best explain this? (Give only one reason,and specify whether it is consistent with notions of market efficiency.)

Accepted Answer

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Question 2

a.Define the duration of a bond.Why is duration often thought of as a measure of risk for a bond? 
b.What is the duration of a two-year zero-coupon bond? How about a two year 10% coupon bond (one coupon per year)? 
c.How does a given bond's duration change when interest rates in the market rise? 
d.Explain how duration is used in setting up an immunization strategy.
a. Define the duration of a bond. Why is duration often thought of as a measure of risk for a bond?
b. What is the duration of a two-year zero-coupon bond? How about a two year 10% coupon bond (one coupon per year)?
c. How does a given bond's duration change when interest rates in the market rise?
d. Explain how duration is used in setting up an immunization strategy.

Accepted Answer

The answer of a.Define the duration of a bond.Why is...

Question 3

Tests of market efficiency are often referred to as joint tests of two hypotheses: that the market is efficient and that an expected returns model holds.Explain.Is it ever possible to test market efficiency alone (i.e.,without also testing some type of asset-pricing model)?

Accepted Answer

The answer of Tests of market efficiency are often referred...

Question 4

a. Would a 10-year, 15% U.S. Treasury note be priced in the market to yield more, less, or the same as a 10-year, 8% Treasury note? Explain.
b. How would you expect the yields on the following two bonds to compare with each other? Both are rated A.
ABC Corp. 18s of 2011, callable in 2007
PDQ Corp. 18s of 2009, non-callable
c. How would the yields on the bonds in part b compare if their coupons were 8 instead of 18?

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The answer of a. Would a 10-year, 15% U.S. Treasury...

Question 5

Suppose the U.S.Treasury issues $50 billion of 10-year notes over the next month to finance the budget deficit.Describe what should happen to the term structure of interest rates according to each of the following theories:
a. segmented markets
b. pure expectations
c. preferred habitat
d. liquidity preference
What do you think would actually happen?

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Question 6

The only significant cost of storing gold is the interest on the money you have tied up in it.Suppose you can borrow money at 10% to buy gold and that today's price of gold is $460 per troy ounce.Gold futures contracts are available now.The future for delivery in six months is at $480,and the future for delivery in twelve months is at $506.Devise two ways you might exploit this situation to make an excess profit.Are there risks involved?

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Question 7

a.Explain why futures trading is a zero-sum game.Are options also a zero-sum game? What about buying warrants?
 b.Suppose you are long 100 shares of XYZ stock at 50 and you have written a December 50 call option against your long position.Do you want the stock price to go up or down tomorrow? Explain.
 c.Answer part b if you have written a December 50 put option instead of the call option.

Accepted Answer

The answer of a.Explain why futures trading is a zero-sum...

Question 8

Is it possible for:
a. a stock to have a standard deviation of return lower than the market portfolio if the stock's beta is greater than 1.0?
b. all of the stockholders of XYZ Corporation to believe XYZ is undervalued?
c. everyone to expect the stock market to go down in the next month?
d. someone who sells stock short to make money even if the stock goes up?
e. everyone to expect the Treasury 14s of 2011 to go down in price over the next month?

Accepted Answer

The answer of Is it possible for:
a. a stock to...

Question 9

Merle Linch,an up-and-coming security analyst has found an exciting investment strategy based on a correlation between the television programs a firm sponsors and the market performance of its stock.Over the period 1970-1982,he finds that those companies that sponsored football and hockey games did significantly better than the rest of the market,yielding 9.4% a year on average versus 8.4% for the Dow Jones Industrials and 8.5% for the S&P 500 index.He writes up his findings in a market letter for general distribution to his firm's clients.His research is also noticed and publicized by the companies whose stock Linch is recommending on the basis of his "contact sports" theory.
a. How else might you explain what Linch has observed?
b. Precisely how should one test such a theory statistically?
c. What would you expect to find if you did test Linch's theory rigorously? Explain.
d. Suppose the "contact sports" theory is verified. What will happen in markets now that everyone is aware of it? How long should people be able to earn excess profits by buying these stocks?

Accepted Answer

The answer of Merle Linch,an up-and-coming security analyst has found...

Question 10

Herbert Avocado has just come up with an idea for a new type of financial intermediary,which is designed to take advantage of the opportunity presented by an inverted yield cure,such as the one that existed in 1981 when one-year bonds were yielding 16% and 30-year bonds were at 14%.When the yield curve becomes inverted,Avocado's firm will issue long-term bonds and use the proceeds to buy one-year instruments that have higher yields and are less risky.Avocado is now just waiting for the yield curve to become downward sloping again so that he can get his firm off the ground and make his fortune.What do you think of his plan?

Accepted Answer

The answer of Herbert Avocado has just come up with...

Question 11

In November 1978,the Fed announced a stringent new program to combat inflation,which had gotten out of hand.The response in the financial markets was the Treasury bill yields increased while long-term yields dropped.Can you explain why?

Accepted Answer

The answer of In November 1978,the Fed announced a stringent...

Question 12

For each of the following assets,discuss all of the essential aspects of return,risk,and other factors,such as marketability,that investors should consider before the asset:
a. three-month T-bills
b. a 20-year, 8% coupon corporate bond selling for 65 (don't calculate the yield to maturity)
c. municipal bonds
d. a house in the suburbs
e. a 20-year, 15% mortgage on a house in the suburbs (i.e, you would be the lender)
f. U.S. Treasury 10 5/8s of 2015

Accepted Answer

The answer of For each of the following assets,discuss all...

Question 13

You want to invest $1 million in the S&P 500 index for one year.There are two ways to go about it.You could actually buy all the stocks in the index according to their index investment weights,or you could buy an S&P index futures contract (and put the $1 million in a risk-free investment for one year).The S&P index is now at 350,and an S&P index future with a one-year maturity is selling at 355.The riskless rate is 8%,and the dividend yield on the S&P index is 6%.Assume that the S&P contract size is equal to the index,and that all cash flows to the future occur at maturity (i.e.,there is no daily resettlement).
a. What should you do and why?
b. Under your strategy for part a, how much money will you have at the end of the year if the S&P index closes at 380?

Accepted Answer

The answer of You want to invest $1 million in...

Question 14

Consider a forecast of the next period's earnings.How much information is in past earnings?

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The answer of Consider a forecast of the next period's...

Question 15

You work for a large insurance company and have been assigned to explain to a customer (a large pension fund)how strategies of 1)exact matching and 2)duration matching will help in meeting a projected set of pension fund liabilities.Explain what each technique entails and how it works.Examples would be useful.Be sure to conclude your report with a discussion of the advantages and disadvantages of each technique.

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The answer of You work for a large insurance company...

Question 16

What is the phenomenon of the size effect in stock performance? How does it relate to the "turn-of-the-year" ("year-end")effect? Can you suggest any good reason why the returns of small stocks,after adjusting for beta,still do better than those for large stocks? What strategy would you follow to exploit this anomaly? What factors do you have to keep in mind?

Accepted Answer

The answer of What is the phenomenon of the size...

Question 17

You are examining the pricing of futures on the S&P 500.The spot level of the S&P 500 index is 250,and the riskless rate is 5%.It is January 1,2003,and the futures contract expires March 31,2003.The dividend yield by month of year is as follows:
month: Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec
yield: 0.1% 0.1% 0.5% 0.1% 0.1% 0.5% 0.1% 0.1% 0.5% 0.1% 0.1% 0.5%
a. What is the theoretical price of this futures contract?
b. Will this contract ever sell for less than the spot level of the index? If so, what is the earliest time at which this will happen? (Assume that the riskless rate and the dividend yield do not change between January 1, 2003, and March 31, 2003.)
c. Assume now that this contract is correctly priced (= theoretical price) and that you have a portfolio of $50 million that you would like insured against market movements until March. If the portfolio has a beta of 1.25, how would you protect yourself against market risk?
d. Assuming you protect yourself against market movements, what would your expected return be on the protected portfolio through March 1990?

Accepted Answer

The answer of You are examining the pricing of futures...

Question 18

What is an "event study"? Discuss a specific example to explain the objectives,methodology,and results of an event study.

Accepted Answer

The answer of What is an "event study"? Discuss a...

Question 19

One explanation of the "year-end" ("turn-of-the-year" or "January")effect has to do with sales and purchases related to the tax year.
a. Present the "tax-effect" hypothesis.
b. Studies have shown that the January effect occurs internationally, even in countries where the tax year does not start in January. Speculate on a good reason for this.

Accepted Answer

The answer of One explanation of the "year-end" ("turn-of-the-year" or...

Question 20

You are testing the effect of merger announcements on stock prices.(This type of testing is called an "event study.") Your procedure is as follows:
Step 1: You select the twenty biggest mergers of the year.
Step 2: You isolate the date the merger becomes effective as the key date around which you will examine the data.
Step 3: You look at the returns for the five days after the effective merger date.
After looking at the returns in step 3 (you found an average of 0.13%),you conclude that you could not have made money on merger announcements.Are there any flaws that you can detect in this test? How could you correct for them? Can you devise a stronger test?

Accepted Answer

The answer of You are testing the effect of merger...

Quiz 4: Security Analysis and Portfolio Theory

Returns on Mondays are generally much more negative than returns on other days of the week.How would you best explain this? (Give only one reason,and specify whether it is consistent with notions of market efficiency.)

Tests of market efficiency are often referred to as joint tests of two hypotheses: that the market is efficient and that an expected returns model holds.Explain.Is it ever possible to test market efficiency alone (i.e.,without also testing some type of asset-pricing model)?

In November 1978,the Fed announced a stringent new program to combat inflation,which had gotten out of hand.The response in the financial markets was the Treasury bill yields increased while long-term yields dropped.Can you explain why?

Consider a forecast of the next period's earnings.How much information is in past earnings?

What is an "event study"? Discuss a specific example to explain the objectives,methodology,and results of an event study.