Preview Extract

CHAPTER 2
FINANCIAL MARKETS AND INSTRUMENTS
1.
2.
Money market securities are called โcash equivalentsโ because of their great
liquidity. The prices of money market securities are very stable, and they can be
converted to cash (i.e., sold) on very short notice and with very low transaction
costs.
a. rBEY
=
10000 โ P 365
๏ด n
P
=
10000 โ 9600 365
= .083565, or 8.36%
9600
182
b. One reason is that the discount yield is computed by dividing the dollar discount
from par by the par value, $10,000, rather than by the billโs price, $9,600. A second
reason is that the discount yield is annualized by a 360-day rather than a 365-day
year.
3.
P = 1,000 [1 โ rBD (n/360)] where rBD is the discount yield.
Pask = 1,000[1 โ .0681(60/360)] = $988.65
Pbid = 1,000 [1 โ .0690(60/360)] = $988.50
4.
rBEY
=
1,000 โ P 365
๏ด n
P
=
1,000 โ 988.65 365
๏ด
= 6.98%,
60
988.65
which exceeds the discount yield, rBD = 6.81%.
To obtain the effective annual yield, rEAY, note that the 60-day growth factor for
1,000
invested funds is
= 1.01148. Annualizing this growth rate results in
988.65
2-1
1 + rEAY = (
5.
1,000 365/60
)
= 1.0719 which implies that rEAY = 7.19%.
988.65
According to equation 2.2:
P = 10,000/[1 + rBEY ร (n/365)]
P = 10,000/[1 + .05 ร (91/365)] = $ 9,875.34
6.
a. i.
4
1 + r = (10,000/9,764) = 1.1002
r = 10.02%
ii.
2
1 + r = (10,000/9,539) = 1.0990
r = 9.90%
The three-month bill offers a higher effective annual yield.
7.
b. i.
rBD =
ii.
rBD =
10000 โ 9764 12
ร 3 = .0944 = 9.44%
10000
10000 โ 9539
12
ร
10000
6 = .0922 = 9.22%
90
a. Price = $1,000 ร [1 โ .03 ร 360 ] = $992.5
b. 90-day return =
1,000 โ 992.5
= .007557 = .7557%
992.5
365
c. rBEY = .7557% ร 90 = 3.06%
d. Effective annual yield = (1.007557)365/90 โ 1 = .0310 = 3.10%
2-2
8.
The bill has a maturity of one half-year, and an annualized discount of 9.18%.
Therefore, its actual percentage discount from par value is 9.18% ร 1/2 = 4.59%.
The bill will sell for $100,000 ร (1โ .0459) = $95,410.
9.
The total before-tax income is $4. Since the dividend income is fully excluded from
taxable income, the after-tax income is also $4, for a rate of return of 10%.
10. a. The index at t = 0 is (60 + 80 + 20)/3 = 53.33. At t = 1, it is (70 + 70 + 25)/3 = 55,
for a rate of return of 3.13%.
b.
Stock
Q
P0
Market
Value
P1
Market Value
A
200
60
12,000
70
14,000
B
500
80
40,000
70
35,000
C
600
20
12,000
25
15,000
The index at t = 0 is (12,000 + 40,000 + 12,000)/100 = 640. At t = 1, it is also 640,
so the rate of return is zero.
c.
Before Splits
After Splits
Stock
P0
Q
P0
Q
P1
A
60
200
30
400
35
B
80
500
20
2,000
17.5
C
20
600
20
600
25
After the splits the index has to remain unchanged so the divisor (which initially
was 3) has to be reset. The sum of the three prices after the split is 70, while the
index value before splits was 53.33. Therefore 70/d = 53.33 and the new divisor
must be 1.3125. The index at t = 1 is (35 + 17.5 + 25)/1.3125 = 59.05 for a return of
10.71%.
d. The total market value of A and B as well as that of the market remain unchanged
after the two splits so that the return on the value-weighted index is not affected by
the splits (and it is zero).
2-3
11. a. The index at t = 0 is (90 + 50 + 100)/3 = 80. At t = 1, it is 250/3 = 83.333, for a
rate of return of 4.17%.
b. In the absence of a split, stock C would sell for 110, and the index would be 250/3 =
83.333. After the split, stock C sells at 55. Therefore, we need to set the divisor d
such that 83.333 = (95 + 45 + 55)/d, meaning that d = 2.34.
c. The return is zero. The index remains unchanged, as it should, since the return on
each stock separately equals zero.
12. a. Total market value at t = 0 is (9,000 + 10,000 + 20,000) = 39,000. Market value at
t = 1 is (9,500 + 9,000 + 22,000) = 40,500. Rate of return = 40,500/39,000 โ 1 =
3.85%.
b. The return on each stock is as follows:
rA = 95/90 โ 1 = .0556
rB = 45/50 โ 1 = โ.10
rC = 110/100 โ 1 = .10
The equally weighted average is .0185 = 1.85%
13. a. The higher coupon bond.
b. The call with the lower exercise price.
c. The put on the lower priced stock.
d. The bill with the lower yield.
14.
Preferred stock is like long-term debt in that it typically promises a fixed payment
each year. In this way, it is a perpetuity. Preferred stock is also like long-term debt
in that it does not give the holder voting rights in the firm.
Preferred stock is like equity in that the firm is under no contractual obligation to
make the preferred stock dividend payments. Failure to make payments does not
set off corporate bankruptcy. With respect to the priority of claims to the assets of
the firm in the event of corporate bankruptcy, preferred stock has a higher priority
than common equity but a lower priority than bonds.
2-4
15.
Value of call at expiration
โ
Initial cost
=
Profit
a.
$0
$4
$โ4
b.
$0
$4
$โ4
c.
$0
$4
$โ4
d.
$5
$4
$1
e.
$10
$4
$6
16.
There is always a chance that the option will be in the money at some point prior to
expiration. Investors will pay something for this chance of a positive payoff.
17.
A call option conveys the right to buy the underlying asset at the exercise price. A
long position in a futures contract carries an obligation to buy the underlying asset
at the futures price.
18.
A put option conveys the right to sell the underlying asset at the exercise price. A
short position in a futures contract carries an obligation to buy the underlying asset
at the futures price.
19.
Individual response. However, on the day that we tried this experiment, 18 of
the 25 stocks met this criterion, leading us to conclude that returns on stock
investments can be quite volatile.
20.
The spread will widen. Deterioration of the economy increases credit risk,
that is, the likelihood of default. Investors will demand a greater premium on
debt securities subject to default risk.
21. a. Because the stock price exceeds the exercise price, you will choose to exercise.
The payoff on the option will be $28 โ $24 = $4. The option originally cost $5.90,
so the loss is $5.90 โ $4.00 = $1.90. There is a loss after considering options cost,
so you will not exercise. Rate of return will be โ$1.90/$24 = โ7.92 percent.
b. If the exercise price were $25, and the stock price $24, you would not exercise. The
loss on the call would be the initial cost, which was $4.90. Rate of return will be โ
$4.90/$25 = โ19.60 percent.
c. If the put has an exercise price of $24, you would not exercise for any stock price of
$24 or above. The loss on the put would be the initial cost, which was $.09. With a
share price of $22, the put would be exercised for a gain of $2 ($24 โ $22) which
2-5
would give a profit of $1.91 ($2 gain โ $.09 cost). Rate of return will be $1.91/$22
= 8.68 percent.
22. a. Aecon closed at $11.22.
b. Assuming that you buy at the closing price, you could buy $5,000/$11.22 = 445.63
shares, which we will take to be 446.
c. The dividend is 2.9% of $11.22, which is probably an annual amount of $.33; your
dividend income would be 446 ๏ด $ .33 = $145.12 annually.
d. The price-to-earnings ratio is 8.8, and price is $11.22 Therefore,
Earnings (EPS) = $11.22/8.8 ๏
EPS = $1.28
23. a. You bought the contract when the futures price was 713 (see Figure 2.9). The
contract closes at a price of $720, which is $7 higher than the original futures price.
Therefore, you will incur a gain of $7 ๏ด 200 = $1,400.
b. Open interest on the index is 144,856 contracts.
2-6
24. d
25. a. Writing a call entails unlimited potential losses as the stock price rises.
2-7

## Document Preview (7 of 385 Pages)

You are viewing preview pages of the document. Purchase to get full access instantly.

-37%

### Solution Manual for Investments, Eighth Canadian Edition

$18.99 ~~$29.99~~Save:$11.00(37%)

24/7 Live Chat

Instant Download

100% Confidential

Store

##### Benjamin Harris

0 (0 Reviews)

## Best Selling

Solution Manual for Designing the User Interface: Strategies for Effective Human-Computer Interaction, 6th Edition

$18.99 ~~$29.99~~Save:$11.00(37%)

Chemistry: Principles And Reactions, 7th Edition Test Bank

$18.99 ~~$29.99~~Save:$11.00(37%)

Test Bank for Hospitality Facilities Management and Design, 4th Edition

$18.99 ~~$29.99~~Save:$11.00(37%)

2023-2024 ATI Pediatrics Proctored Exam with Answers (139 Solved Questions)

$18.99 ~~$29.99~~Save:$11.00(37%)

Data Structures and Other Objects Using C++ 4th Edition Solution Manual

$18.99 ~~$29.99~~Save:$11.00(37%)

The World Of Customer Service, 3rd Edition Test Bank

$18.99 ~~$29.99~~Save:$11.00(37%)