Finance Chapter 10 Taxes triggered by portfolio sales earlier

ANSWERS TO CHAPTER QUESTIONS

Chapter 10 Financial Investments

1) Under CAPM company risk is diversified away because the better than expected

2) Under the efficient markets hypothesis all information is included in the price of a

stock at any point in time. Results that are over or under expectations are random.

Therefore you cannot systematically outperform the market.

3) No. Under the weak form of the EMH you cannot use price or volume information to

4) No. Under the semi strong form of the efficient markets hypothesis all public

5) While investing internationally generally has greater risk than domestic investing, it

6) Because it has no correlation with stocks and therefore can reduce overall portfolio

risk while providing competitive returns.

7) The strengths of mutual funds include:

a) Low cost of supervision.

b) Expert portfolio manager

c) Telephone information assistance

8) The weaknesses of mutual funds include:

a) Cost greater than managing a portfolio yourself.

b) Taxes triggered by portfolio sales earlier than if managing a portfolio yourself.

9) Money market funds, certificates of deposit with maturity tied to date of need,

perhaps short term bond funds, and treasury bills.

10) Certificate of deposit tied to date of need, short term bonds funds, possibly some

11) A diversified portfolio of stock and bond mutual funds, a 65% stock, 25% bond, 10%

money market funds is one approach.

12) Low cost mutual funds, less need for supervision, no temptation to sell at wrong time.

14) Income taxes come from dividend and interest income depending whether it is a stock

15) Yes. Correlations have nothing to do with returns, only with risk.

16) If stocks systematically move in opposite directions they have correlation, negative

correlation.

ANSWERS TO CHAPTER PROBLEMS

Chapter 10 Financial Investments

1) Gennaro purchased a stock for $24 which paid $2.00 at the end of each year in

dividends (dividends remained level over time). He sold it four years later for

$28 at the time of the last dividend payment. What was his IRR?

Calculator Solution

General Calculator

Approach

Specific HP12C

Specific TI BA II Plus

ENTER

g

Enter cash inflow Year 1-3

2

CFj

g

ENTER

↓

Enter number of years

3

Enter cash inflow Year 4

30

ENTER

Calculate the internal rate

of return

11.8%

Excel Solution

3

4

5

8

Solution

19

A B C D E F

Inputs

Period 0 1 2 3 4

f

IRR

CPT

Gennaro’s IRR was 11.8 percent.

2) A stock has an expected rate of return of 9% and the risk free rate is 3%. What

is the risk premium?

Solution

Excel Solution

3

4

A B C D

Inputs

ANSWERS TO CASE APPLICATION QUESTIONS

Chapter 10 Financial Investments

1) As mentioned in an earlier portion of the case study it is symptomatic of their

different risk tolerances. However Richard’s approach seems to go beyond normal

2) Asset allocation recommended for people vary all over the lot. However most

3) The word gulch may be symbolic of the potential for loss here. There is no

indication of a reasonable analysis of or verification of someone else’s

fundamental scrutiny of this company. The words “couldn’t lose” to many

financial planners can be translated into “can’t win.”

4) Any logical answer taking into account past performance relative to a relevant

Answers to CFP® Questions

Question

Answer

Author’s Explanation

Question 10.1

C

Question 10.2

D

Question 10.3

D

Question 10.4

A

Alternatives incorrectly stated in the book. See errata below.

Question 10.5

C

Question 10.6

A

Question 10.7

C

ERRATA TO CFP® CERTIFICATION EXAMINATION QUESTIONS AND

PROBLEMS

10.4

Alternatives are incorrectly stated in the book. Correct alternatives should be:

a. (4), (5) and (6) only

The correct answer is a.