Suggested Answers to Discussion Questions
1.1 a. Since you fall into the category of a young investor, after meeting basic liquidity needs
your key investment goals should be to save for the education of your children and quite possibly
b. You should consider the effects of taxes when investing, maximizing your use of tax sheltered
investments such as 401(k) plans and taking advantage of the preferential tax treatment of capital
c. Since you have a relatively long investment horizon, it is appropriate to focus your portfolio on
1.2 Short-term investments play an important part in your investment program. Most importantly, they
will provide a pool of reserves that can be used for emergencies such as replacing cars, appliances,
Type of Investment
Minimum
Balance Interest Rate
Federal
Insurance
Method and Ease of
Withdrawing Funds
a. Passbook savings
account
None Close to 0.00%
in recent years.
Yes, up to
$250,000 per
account
In person or through
teller machines; very
easy
c. Money market
No legal
Slightly above
Yes, up to
Limited check-
d. Asset management
Typically
Similar to
Yes, up to
Limited check-
e. Series I savings bond Initial deposit is
At or near
No, but federal
Penalty of three
g. Certificate of deposit Tailored to
investor needs
Slightly above
asset
management
account
No, but as
secure as most
bank savings
and checking
accounts
Penalty for early
withdrawal
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2 Smart/Gitman/Joehnk • Fundamentals of Investing, Thirteenth Edition
Type of Investment
Minimum
Balance Interest Rate
Federal
Insurance
Method and Ease of
Withdrawing Funds
denomi-nations;
certificates of
market, but not open
Solutions to Problems
1.1 a. Goal $500,000
b. Saving $104.75 each year produces $5,000 in savings at retirement, but Stefani needs to
1.2 a. Tax on the Smith’s income of $130,000. Looking at the joint tax return rates, we find:
Tax on the Jones’s income of $65,000. Looking at the joint tax return rates, we
find:
b. The Smith’s make twice as much as the Joneses.
1.3 a. $50,000/$50 1,000 shares of stock.
b. 1,000 shares $2 $2,000 per year before tax. $2,000 0.85 $1,700 after tax.
f. Assuming that the Consalvos have 100% confidence in their forecasted price and dividends, they
should purchase the stock. Even though the annual interest from the bonds is more than the
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Chapter 1 The Investment Environment 3
1.4 a. Their ordinary income is $128,000, consisting of $125,000 of salary and wages, $1,000 in
interest income, and $2,000 of short-term capital gains.
Mike and Julie will be in the 25% marginal tax bracket based on their taxable income, which
This gain is a short-term capital gain and is taxed like ordinary income. Since the Bedard’s are in the
25% tax bracket, they will be $500 in taxes on this $2,000 gain.
1.5 a. If they remain single, their tax bills will be the same because they make the same
income. So each will pay:
$16,550 = $26,712.50.
In this case, Kim and Kanye pay the same total taxes whether they are married or single.
b. If they remain single, they will each pay the following in taxes:
So their combined tax bill is double that amount or $42,351.50.
Notice that in this scenario, Kim and Kanye pay a “marriage penalty” because their combined
taxes are higher when they are married than when they are single. The reason for this is that the
income levels that define the upper bound of each tax bracket are not always twice as much for
married couples as for single tax payers. For example, for single taxpayers, the upper limit of the
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4 Smart/Gitman/Joehnk • Fundamentals of Investing, Thirteenth Edition
Solutions to Case Problems
Case 1.1 Investments or Golf?
This case illustrates the many facets of the investment process; it involves much more than common stock.
The authors recognize the value of physical education and emphasize the importance of sports, but a course
in investments offers the student a lifetime of financial benefits. Thus, our arguments for selecting the
investments course should not be interpreted as a negative statement on physical education but rather as a
positive discussion of the merits of investments.
a. The term investments refers to the process of identifying, evaluating, selecting, and monitoring the
placement of funds with a view toward preserving or increasing value and/or earning a positive return.
Judd has simply identified one investment (stock). He will not know how to evaluate, select or
b. Clearly, Judd has ignored short-term securities, bonds, options, commodities and financial futures,
mutual funds, real estate, tangibles, tax shelters, and limited partnerships. Each one of these choices
c. Judd does not have the knowledge needed to carry out the investment process described in Question a.
Knowing about common stocks is not the same as understanding investments, and it is not necessarily
There are other considerations, too. Does Judd have plans for the future when he will need the money?
If so, is it a short-term or a long-term need? Answers to these questions will help determine whether
Case 1.2 Preparing Carolyn Bowen’s Investment Plan
This case allows students to evaluate a proposed investment plan aimed at achieving certain retirement
goals.
a. The amount currently available to Carolyn includes $60,000 from the proceeds of the life insurance
and $37,500 from her savings account, or a total of $97,500. At 6% compounded annually, her money
will be worth:
(You can find this in Excel by typing the formula fv(0.06,7,0,97500).)
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Chapter 1 The Investment Environment 5
$97,500 (1.06)10 $174,608
b. Value of Carolyn’s assets at 62 Value of savings account Value of house:
Because Carolyn receives $79 for each $1,000 that she invests in the annuity, we can calculate her
Similarly, if Carolyn’s assets at age 65 are $302,108, and if for each $1,000 that she invests in the
c.
Annual Retirement Income
Age 62 Retirement Age 65 Retirement
Annual Social Security & Pension
Fund Benefits $16,308 $20,256
d. Carolyn needs $45,000 per year (before taxes) of retirement income. Without considering the change
in her tax status upon retirement, she will not satisfy this goal if she retires at age 62. At age 65, she
e. Carolyn’s plan is extremely conservative and low risk. The returns from the plan are very secure and
probably assured. Carolyn can be confident that the accumulated worth of her investments will be
available to her at retirement. Her plan to retire at age 65 meets her retirement-income goal. Carolyn’s
plan offers low risk and low return. Through only a slight increase in risk, she might improve her
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