Theory of Investment Problem Set 1 Due on Oct 25, 2012 (BEFORE class) Please submit an ELECTRONIC version via

email to liminwen@sem.tsinghua.edu.cn Problem 1 A stock has had the following year-end prices and dividends: Year 0 1 2 3 4 5 Price $23.25 25.61 26.72 25.18 27.12 30.43 Dividend $ .15 0.18 0.20 0.24 0.28

What are the arithmetic and geometric returns for the stock?

Problem 2 An investment has an expected return of 8 percent per year with a standard deviation of 4 percent. Assuming that the returns on this investment are at least roughly normally distributed, what percentage of the time do you expect to lose money? Problem 3 The rate of return on Cherry Jalopies, Inc., stock over the last five years was 17 percent, 11 percent, 2 percent, 3 percent, and 14 percent. Over the same period, the return on Straw Construction Companys stock was 16 percent, 18 percent, 6 percent, 1 percent, and 22 percent. Calculate the variances and the standard deviations for Cherry and Straw.

Problem 4

Lisa owns a stock that has an average geometric return of 11.34 percent and an average arithmetic return of 11.51 percent over the past six years. What average annual rate of return should Lisa expect to earn over the next four years?

Problem 5 Over the past four years, the common stock of JL Steel Co. produced annual returns of 7.2, 4.8, 10.2, and 12.6 percent, respectively. During those same years, U.S. Treasury bills returned 3.2, 3.4, 4.2, and 4.5 percent, respectively. What is the standard deviation of the risk premium on JL Steel Co. stock for this time period? Problem 6 Scott purchased 200 shares of Frozen Foods stock for $48 a share. Four months later, he received a dividend of $0.22 a share and also sold the shares for $42 each. What was his annualized rate of return on this investment?
Problem 7

Which one of the following statements is correct? A. The standard deviation of the returns on Treasury bills is zero. B. Large-company stocks are historically riskier than small-company stocks. C. The variance is a means of measuring the volatility of returns on an investment. D. A risky asset will always have a higher annual rate of return than a riskless asset. E. There is an indirect relationship between risk and return.
Problem 8

For the period 1926-2009, long-term government bonds had an average return that ______ the average return on long-term corporate bonds while having a standard deviation that _______ the standard deviation of the long-term corporate bonds. A. exceeded; was less than B. exceeded; equaled C. exceeded; exceeded D. was less than; exceeded E. was less than; was less than
Problem 9

The stock of Flop Industries is trading at $17. You feel the stock price will decline, so you short 900 shares at an initial margin of 60 percent. If the maintenance margin is 30 percent, at what share price will you receive a margin call?

Problem 10

You just sold short 750 shares of Wetscope, Inc., a fledgling software firm, at $96 per share. You cover your short when the price hits $86.50 per share one year later. If the company paid $.75 per share in dividends over this period, what is your rate of return on the investment? Assume an initial margin of 60 percent.

Problem 11 Youve just opened a margin account with $11,000 at your local brokerage firm. You instruct your broker to purchase 600 shares of Landon Golf stock, which currently sells for $46 per share. Suppose the call money rate is 6 percent and your broker charges you a spread of 1.25 percent over this rate. You hold the stock for six months and sell at a price of $53 per share. The company paid a dividend of $.25 per share the day before you sold your stock. 1. What is your total dollar return from this investment? 2. What is your effective annual rate of return?
Problem 12

Robin sold 800 shares of a non-dividend paying stock this morning for a total of $29,440. She had purchased these shares on margin nine months ago at a cost per share of $35. The initial margin requirement on this stock is 60 percent and the maintenance margin is 30 percent. Robin pays 1.2 percent over the call money rate of 4.9 percent. What is her total dollar return on this investment? Problem 13 Today, you short sold 1,100 shares of Jasper Industrial stock at $48 a share. The initial margin is 60 percent and the maintenance margin is 30 percent. Which one of the following is correct concerning your account balance sheet for this transaction? A. You have an asset of $31,680 from the sale proceeds. B. You have a liability from the short position of $21,120. C. Your account equity is $21,120. D. Your initial margin deposit is $15,840. E. Your total assets are $84,480. Problem 14 The short interest on Blue Water Cruisers stock was 218,900 when the market opened this morning. During the day, 187,400 shares were covered and 171,600 shares were sold short. What was the short interest on this stock at the end of the trading day?

Problem 15 A short sale: A. creates a long position in a stock. B. involves the borrowing of securities. C. is the purchase of less than 100 shares of a stock. D. is a bullish outlook towards a security. E. is the resale of a security within four hours of purchase. Problem 16 You purchased 1,200 shares of stock at $52 a share. The stock is currently selling for $54 a share. The initial margin was 70 percent and the maintenance margin is 30 percent. What is your current margin position? Problem 17 If you opt to purchase shares of stock on margin rather than with cash, you will: A. decrease your maximum potential rate of return. B. increase your maximum potential rate of return. C. guarantee yourself a profit. D. eliminate any potential profit. E. have equal rates of return regardless of how the purchase is made.

Problem 18 The holding-period return (HPR) on a share of stock is equal to A. the capital gain yield during the period, plus the inflation rate. B. the capital gain yield during the period, plus the dividend yield. C. the current yield, plus the dividend yield. D. the dividend yield, plus the risk premium. E. the change in stock price.

Problem 19 Given $100,000 to invest, what is the expected risk premium in dollars of investing in equities versus risk-free T-bills based on the following table? Action Probability Expected Return Invest in equities 0.6 $50,000 0.4 -$30,000 Invest in risk-free T-bill 1.0 $5,000

Problem 20 Bear Market Market Probability Stock X Stock Y 0.2 -20% -15% Normal Market 0.5 18% 20% Bull 0.3 50% 10%

Assume that of your $2,000 portfolio, you invest $18,000 in stock X and $2,000 in stock Y. What is the expected return on your portfolio? Problem 21 Based on the historical record during year 1926-2009, what is the approximate probability that an investment in small stocks will double in value in a single year? How about triple in a single year? Problem 22 Go to finance.yahoo.com and enter the ticker symbol for your favorite stock. Now, look for the historical prices and find the monthly closing stock price for the last six years.(1) Calculate the annual arithmetic average return, the standard deviation, and the geometric return for this period. (2) how many shares are sold short in the current month?