Chapter 11 - McGrawHill Exercises

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Basic 1. Rate of Return. A stock is selling today for $40 per share. At the end of the $44. What is the total rate of return on the stock? What are the dividend yie 2. Rate of Return. Return to (&) problem 1. Suppose the year-end stock price afi yield and capital gains yield in this case? Why is the dividend yield unaffectc 3. Real Versus Nominal Returns. You purchase 100 shares of stock for $40 a sh end. What is the rate of return on your investment for these end-of-year stoc return? Assume an inflation rate of 3%. ( LO2) a. $38 b. $40 c. $42 4. Real Versus Nominal Returns. The Costaguanan stock market provided a rat during the year was 80%. In Canada, in contrast, the stock market return wa country’s stock market provided the higher real rate of return? ( LO2) 5. Real Versus Nominal Returns. The inflation rate in Canada between 1973 an of return on Treasury bills, government bonds, and common stocks in that | 6. Real Versus Nominal Returns. Do you think it is possible for risk-free Treasu they offer a negative real expected rate of return? ( LO2)

year, it pays a dividend of $2 per share and sells for :1d and capital gains yield? ({5 LO2) ter the dividend is paid is $36. What are the dividend :d? (@ L02) iare. The stock pays a $2 per share dividend at year- k prices? What is your real (inflation-adjusted) rate of e of return of 95%. The inflation rate in Costaguana 1s only 14%, but the inflation rate was only 3%. Which d 2018 averaged 3.96%. What was the average real rate seriod? Use the data in (@ Table 11.1. (& LO2) ry bills to offer a negative nominal interest rate? Might

1 7. Market Indexes. The accompanying table shows annual stock prices on the Dar ¢ Construct 2 stock market indexes, one using equal weights, as in the Dow Jones | weights, as in the S&P/TSX Composite Index. ( LO2) San Tome National Miner Mining, 184 Sulaco Market, Central Railway, ~ Shippi Million* 42 Million* 64 Million* 38 Milli 2010 55.10 80.00 21.45 82.5 2011 58.15 144.62 24.04 115.5 2012 58.45 135.93 26.53 138.9 2013 5243 74.61 2353 212.0 2014 52.50 75.01 32.46 174.6 I'8. Stock Market History. Using the data in (% problem 7, calculate the average rate each stock as well as for an equal-weighted portfolio of all the stocks using Excel. LO3) diversification? (|

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:s Salaam Stock Exchange for 2010-2014. Industrial Average, the other using market-value va ng, Azuera, Inc., ion* 16 Million* i0 135.00 2 151.22 0 166.99 12 149.42 2 177.27 Page 375 of return and standard deviation of return for Do you observe any benefits from

mrermeaqiate 9. Risk Premiums. Here are annual stock market, Government of Canada bon¢ 2018: Year TSX Return (%) T-Bill Return (%) Governme 2014 10.10 91 2015 -7.50 .52 2016 19.86 48 2017 8.94 1.06 2018 -9.17 1.68 a. What were the risk premiums on the TSX and on long-term government b. What were the average risk premiums for the TSX and long-term governr c. Calculate the standard deviation of each risk premium using the approac LO2) 10. Market Indexes. In 1990, the S&P/TSX Composite Index was at a level of al 16.300. Would you expect the S&P/TSX in 2019 to be more or less likely to day than in 1990? Does this mean the market was riskier in 2019 than it was

d, and Treasury bill rates of return from 2014 to nt Long Bond Return (%) bonds in each year? (@ LO1) ment bonds? ( LO1) :h in %) Table 11.3. Do they make sense? ( bout 3,400. In early August 2019, it was about move up or down by more than 40 points in a sin 19907 (& LO2)

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-g/ 11. Maturity Premiums. Investments in long-term government bonds produced a 1 1977-1981. How should we interpret this? Did bond investors in 1977 expect these 5 years of bond returns tell us about the normal future maturity premiur 12. Risk Premiums. What will happen to the opportunity cost of capital if investo and less willing to bear investment risk? (@ LO1) 13. Risk Premiums and Discount Rates. You believe that a stock with the same mz at a price of $50. The stock will pay a dividend at year-end of $2. What price v today? Hint: Start by checking today’s 3-month Treasury bill rate. ( LO1) f/ 14. Scenario Analysis. The common stock of Leaning Tower of Pita, Inc., a restau to investors next year: Probability Dividend Boom 3 $5 Normal economy 5 2 Recession 2 0 The company goes out of business if a recession hits. Calculate the expected r to Leaning Tower of Pita shareholders. The stock is selling today for $90. ( 15. Portfolio Risk. Who would view the stock of Leaning Tower of Pita (see [’ pr owner of a gambling casino or a successful bankruptcy lawyer? Explain. ( L

negative average return during the period to earn a negative maturity premium? What do m? (& Lo s suddenly become especially conservative arket risk as the S&P/TSX will sell at year-end will you be willing to pay for the stock irant chain, will generate the following payoffs Stock Price $195 100 0 -ate of return and standard deviation of return LO1) oblem 14) as a risk-reducing investment-the 03)

16. Scenario Analysis. The common stock of Escapist Films sells for $25 a share and Probability Dividend Stc Boom 3 $0 Normal economy .5 1 Recession 2 3 Calculate the expected return and standard deviation of Escapist. Then calculate of a portfolio half invested in Escapist and half in Leaning Tower of Pita (from € standard deviation is lower than either stock’s. Explain why this happens. ( LC

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offers the following payoffs next year: ick Price $18 26 34 the expected return and standard deviation Bl problem 14). Show that the portfolio 13)

17. Scenario Analysis. Consider the following scenario analysis: Rate of Scenario Probability Stocks Recession 2 5% Normal economy 6 +15 Boom 2 +25 a. Is it reasonable to assume that bonds will provide higher returns in recessior b. Calculate the expected rate of return and standard deviation for each investr ¢. Which investment would you prefer? (@ LO1) 18. Portfolio Analysis. Use the data in % problem 17 and consider a portfolio with LO3) a. What is the rate of return on the portfolio in each scenario? b. What are the expected rate of return and standard deviation of the portfolio ¢. Would you prefer to invest in the portfolio, in stocks only, or in bonds only? d. Calculate the correlation coefficient for the bond and stock returns.

ns than in booms? (@ LO2) ment. ( LO2) weights of .60 in stocks and .40 in bonds. (

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19. Risk Premium. If the stock market return in 2019 turns out to be —20%, what wi risk premium? Does this make sense? ( LO1) 20. Diversification. In which of the following situations would you get the largest rec across two stocks? In each case, is the correlation less than, greater than, or equ a. The stock returns vary with each other. b. The stock returns are independent. c¢. The stock returns vary against each other. 21. Market Risk. Which firm from each pair would you expect to have greater mark a. General Steel or General Food Supplies b. Exotic World Tours Agency or General Cinemas 22. Risk and Return. A stock will provide a rate of return of either —=20% or +30%. a. If both possibilities are equally likely, calculate the expected return and stanc b. If Treasury bills yield 5%, and investors believe that the stock offers a satisfac market risk of the stock? ( LO4)

ill happen to our estimate of the “normal” duction in risk by spreading your portfolio 1al to zero? ( LO3) wet risk? Explain your choice. (@ LO4) dard deviation. (& LO2) ctory expected return, what must be the

23. Unique Versus Market Risk. Sassafras Oil is staking all its remaining capital on ¥ There is a 10% chance of discovering a field with reserves of 50 million barrels. | reserves to Big Oil, at a price depending on the state of the economy. Thus the Value of Reserves, per Barrel Value of Reserves, 50 Boom $4 $200,000 Normal economy $5 $250,000 Recession $6 $300,000 Is Sassafras Oil a risky investment for a diversified investor in the stock market- Tower of Pita, described in (& problem 14? Explain. (@ LO4) 24. Portfolio Risk and Return. The expected return on Big Time Toys is 9% and its s return on Chemical Industries is 8% and its standard deviation is 25%. a. Suppose the correlation coefficient for the two stocks’ returns is .20. What ar deviation of a portfolio with 30% invested in Big Time Toys and the rest in C b. If the correlation coefficient is .70, recalculate the portfolio expected return ¢ portfolio weights are unchanged. LO2) c. Explain the difference between your answers to (a) and (b). ( LO3)

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wildcat exploration off the Cote d'Huile. If it finds oil, it will immediately sell the yossible payoffs are as follows: ) Million Barrels Value of Dryholes 1,000 0 1,000 0 1,000 0 compared to, say, the stock of Leaning tandard deviation is 20%. The expected -e the expected return and standard hemical Industries? ( LO2) and standard deviation, assuming the

25. Portfolio Risk and Return. Using the data in (¥ problem 9, a. Calculate the average rate of return and standard deviation of return for the 1 between 2014 and 2018. (& LO2) b. Form a portfolio with one-third in each of the 3 securities and calculate its av Can you see any benefit from diversification? ( LO3) | 26. Correlation. Using the Excel function CORREL, calculate the correlation betwe of the other four stocks mentioned in (¥ problem 7. Which stock offers the best 27. Internet. Rates of return on U.S. stock, bond, and bill indexes are available to dc adamodar. Click on “Current Data” and look for “Historical Returns on Stocks, spreadsheet. Calculate the average market risk premium for the NYSE stocks, us for successive 10-year periods and for the entire period. Repeat, using the long-te security. a. Is the overall market risk premium bigger or smaller when the risk-free securi government bond? ( LO1) b. Compare the risk premiums over time. Do you think the results suggest that t Explain. (& LO1)

[SX, government bonds, and Treasury bills rerage rate of return and standard deviation. en the return on San Tome Mining and each diversification benefit? ( LO3) »wnload for free at (% pages.stern.nyu.edu/ ~ Bonds and Bills—=US” and download the sing the Treasury bill as the risk-free security :rm government bond as the risk-free ty is the Treasury bill or the long-term the risk premium may have been changing?

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28. Internet. A large variety of mutual funds are available to Canadian investors. Sc particular industries; others, known as “index funds,” simply invest in the mark m/globe-investor/funds-and-etfs/fund-lookup, look up “AGF Canada Class,” and « standard deviation of its monthly return). Now find the 3-year risk (standard de different industry (sector) funds. Are they larger or smaller than the Index fund do you interpret your results? ( LO4) 29. Internet. Using [ ca.finance.yahoo.com, download monthly stock prices for M historical prices, then on Monthly Data. Find the December closing stock prict “Dividends Only” button and download the per-share dividends paid in the sar capital gains yield, and rate of return for each year. Repeat for the Ford Motor ¢ each company’s profile, and describe the main business activities of these comy dividend yields, and capital gains yields and try to explain the differences betwe 30. Internet. Using (% ca.Finance.Yahoo.com, download the monthly prices over a your choice. Calculate the monthly rates of return for each stock using “Adj. Cl splits). a. Using the Excel functions for average (AVERAGE) and sample standard de' the standard deviation of the returns for each of the firms. ( LO2) b. Using Excel’s correlation function (CORREL) or CORRELATION functio find the correlations between each pair of 5 stocks. What are the highest an¢ ¢. Pick one more stock that is in the same industry of one of your other stocks the same industry. Are the correlations higher than those you found in part

sme, called “sector funds,” specialize in et index. Go to @ www.theglobeandmail.co click on its name to find its 3-year risk (the :viation) for 4 other mutual funds for 1? Read the information on their page. How ‘agna International (MGA) by clicking on e for the most recent 4 years. Then click on 1e year. Calculate the annual dividend yield, Company (F) and Microsoft (MSFT). Read sanies. Compare their rates of return, zen the companies. (@ LO4) S-year period for 5 Canadian companies of lose” (which includes dividends and stock viation (STDEV), calculate the average and n from the Data Analysis tool pack (add-ins), d lowest correlations? ( LO3) . Find correlations between pairs of stocks in (b)? Is this surprising? (& LO3)

31. Internet. Use the monthly returns of the 5 companies you chose in the previous weighted portfolio of the 5 stocks (that is, a portfolio with equal investment in e return each month is the equal-weighted average of the stocks’ rates of return. U return and standard deviation. Compare the portfolio statistics that of those of t diversification do you find? ( LO3)

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question to look at the return on an equally ach stock each month). The portfolio rate of 'se Excel to calculate the portfolio’s average ‘he stocks. What evidence of portfolio

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