Week 2 Textbook Problems

FIN/402

Case Problem 4.1 A-F (page 154)

a.

The preferred investment should be investment B since it the higher NPV.

b.

The preferred investment should be investment A because it has a lower negative dollar amount NPV even though investment B had a bigger discount rate.

c.

Investment A IRR is 4.37% which is above 4% and investment B is 5.39% which is below 8%.

d.

Since Investment A had a better NPV I thought that is would have a better IRR but this is not always the case because even though Investment B had a greater negative NPV it still yielded a higher IRR.

e.

Investment A has less risk and a lower discount rate of 8%. As for Investment B is has a lot more risk and a much higher discount rate of 12%. At the current discount rates investment A has smaller negative NPV while investment B has higher negative NPV. Dave should go with Investment A.

f.

FV = $50.00*(1+3%)^10

FV = $50.00*1.3439

FV = 67.20

Dave’s $50.00 investment would have grown to $67.20 by the end of 2026.

Case Problem 4.2 A-D (page 155)

a.

b.

The standard deviation for stock X is 8.90% and the standard deviation for stock Y is 2.78%.

c.

The expected return from stock X is 11.74% and the expected return from stock Y is 11.14%. As far as the return on the stocks, they offer about the same return. The standard deviation of stock X is considerably greater at 8.9% when comparing stock Y which is at 2.78%. A higher standard deviation indicates a higher risk. Sincce X has the higher standard diviation I would prefer Stock Y.

d.

Although stock X and Y they both have the same return but stock X has a higher risk. There should be a balance between risk and reward in investing.

Case Problem 5.1 A-E (page 208)

a.

Walt’s beliefs come from an older model of investing that may have been taught to him from his elders. First a large portfolio is not needed to grow funds. Secondly placing all the capital in mutual funds can still be susceptible to undiversifiable risk.

b.

Shane is incorrect because I stock and mutual fund with the same beta would still have different types of risk. Mutual funds are diversified where single stocks are not. Beta is used when there is diversification.

c.

The traditional approach to portfolio management involved the investor creating a wide, balanced amount of stocks and bonds. Walt believes that this is the best method of holding a portfolio. Shane was not of this belief.

d.

The modern portfolio theory involves statistics to create a portfolio plan which are supposed to contain a large amount of benefits from stocks that are uncorrelated. Typically stocks that are not correlated tend to bring diversification which is needed to reduce the total risk. Undiversified risk is the inevitable portion of total risk that can be measured using beta. Shane recognizes the MPT for being able to diversify a portfolio be does not realize the beta of stocks and mutual funds are different. Walt does not understand the MPT.

e.

A blended method could be achieved be first determining how much risk the investor is willing to tolerate. Then diversify the portfolio by acquiring different securities from different indistrries. Use beta to create diversification throughout the portfolio. Choose a portfolio that would generate the highest return based on the amount of tolerable risk.

Case Problem 5.2 A-E (page 209)

a.

Since Susan has a secure job that fully supports her, she does not have to worry about the income from her portfolio to pay expenses. She however is interest in growth and is interested in capital gains. One focus could be starting a retirement fund since she has yet to create one.

b.

Susan’s father was in retirement and his portfolio helped sustain his lifestyle at that age. The total yield of the portfolio was 9.88% mostly coming from bonds. The other half was composed of common stock and mutual funds all of which were low risk. The current allocation is:

47% Bonds

c.

• 29% Common stock
• 24% Mutual funds

Since Susan is not concerned with income and is in a high tax bracket, she should invest more in common stock (65%) which would lower her tax liability. Holding about 25% in mutual funds could be a start for a retirement fund and 10% in bonds for diversification.

d.

The father was focused on income since he was retired and had a lower gross income that Susan. On the other hand, Susan is far from retirement and makes a large amount of money. In order for Susan to reduce her tax liability, she should move the assets around in the portfolio to fit her lifestyle and build for her future. A larger amount of stocks are more appropriate for her since she can take on higher risk.

e.

The inherited portfolio is low-risk and she would benefit from taking a growth strategy instead of an income portfolio. Capital gains are more advantageous to Susan because earnings will reinvest themselves instead of paying dividends. Stocks are a higher risk security that she would benefit from.

Case Problem 13.1 A-E (page 543)

a.

b.

c.

d.

e.

• The Jensen’s Alpha is 10.68 which means the Stalcheck’s portfolio has been over performing in comparison. However, I believe that it is reasonable to use this measure to evaluate the portfolio as it is the investment vehicles comprising the portfolio were chosen with the goal of getting a better return than the market

The Stalchecks’ portfolio has been performing well and better than average. Their portfolio is diversely distributed among stocks, bonds, a mutual fund, and options. I am not sure industries the securities are in but the portfolio is doing well.