Chapter 02 – Asset Classes and Financial Instruments
CHAPTER 2
ASSET CLASSES AND FINANCIAL INSTRUMENTS
1. Common stock is an ownership share in a publicly held corporation. Common
shareholders have voting rights and may receive dividends. Preferred stock represents
2. While the DJIA has 30 large corporations in the index, it does not represent the
4. The major components of the money market are Treasury bills, certificates of deposit,
5. American Depositary Receipts, or ADRs, are certificates traded in U.S. markets that
6. The coupons paid by municipal bonds are exempt from federal income tax and from
7. The London Interbank Offer Rate (LIBOR)—a key reference rate in the money
8. General obligation bonds are backed by the taxing power of the local governments,
9. Corporations may exclude 70% of dividends received from domestic corporations in
the computation of their taxable income.
10. Limited liability means that the most shareholders can lose in event of the failure of
12. Money market securities are referred to as “cash equivalents” because of their great
13. Equivalent taxable yield = Rate on municipal bond
1－ Tax rate = rm
1－ t = .0675
1 － 0.35 = .1038 or
14. After-tax yield = Rate on the taxable bond x (1 － Tax rate)
a. The taxable bond. With a zero tax bracket, the after-tax yield for the taxable
c. Neither. The after-tax yield for the taxable bond is: 0.05 x (1 – 0.20) = 0.4 or
0.30) = 0.035 or 3.5%. The municipal bond offers the higher after-tax yield
for investors in tax brackets above 20%.
15. The after-tax yield on the corporate bonds is: 0.09 x (1 – 0.30) = 0.063 or 6.3%.
16. Using the formula of Equivalent taxable yield (r) = rm
1－ t , we get:
a. r = 0.04
1 － 0 = 0.04 or 4.00%
17. a. You would have to pay the asked price of:
121.41 = 121.41% of par = $1,214.14
b. The coupon rate is 4.50%, implying coupon payments of $45.00 annually or,
18. a. The closing price today is $127.75, which is $0.90 above yesterday’s price.
Therefore, yesterday’s closing price was: $127.75 － $0.90 = $126.85.
19. a. At t = 0, the value of the index is: ($90 + $50 + $100)/3 = 80
At t = 1, the value of the index is: ($95 + $45 + $110)/3 = 83.33
b. In the absence of a split, stock C would sell for $110, and the value of the
After the split, stock C sells at $55; however, the value of the index should not
be affected by the split. We need to set the divisor (d) such that:
return on each stock separately equals zero.
20. a. Total market value at t = 0 is:
($90 x 100) + ($50 x 200) + ($200 x 100) = $39,000
b. The return on each stock is as follows:
RA = V1
V0 － 1 = ($95/$90) – 1 = 0.0556 or 5.56%
21. The fund would require constant readjustment since every change in the price of a
stock would bring the fund asset allocation out of balance.
22. In this case, the value of the divisor will increase by an amount necessary to maintain
23. Bank discount of 87 days: 0.034 x 87 days
360 days = 0.008217
a. Price: $10,000 x (1 – 0.008217) = $9,917.83
24.
a. The higher coupon bond: The 10-year T-bond with a 10% coupon
25. a. The December maturity futures price is $3.88 per bushel. If the contract
closes at $3.95 per bushel in December, your profit / loss on each contract (for
26. a. Yes. As long as the stock price at expiration exceeds the exercise price, it
makes sense to exercise the call.
Gross profit is: ($102 – $100) x 100 shares = $200
b. Yes, exercise.
Gross profit is: ($102 – $95) x 100 shares = $700
c. A put with an exercise price of $100 would expire worthless for any stock
price equal to or greater than $100. An investment in such a put would have a
rate of return over the holding period of –100%.
27. a. Long call
28. There is always a chance that the option will expire in the money. Investors will pay
something for this chance of a positive payoff.
29. Long call for $4:
Value of call
at expiration
Initial Cost
Profit
a.
0
4
-4
b.
0
4
-4
c.
0
4
-4
d.
5
4
e.
4
Chapter 02 – Asset Classes and Financial Instruments
Long put for $6:
Value of put
at expiration
Initial Cost
Profit
a.
10
6
4
b.
5
6
-1
c.
0
6
-6
d.
0
6
-6
e.
0
6
-6
30. The spread will widen. Deterioration of the economy increases credit risk, that is, the
31. Six stocks have a 52-week high at least 40% above the 52-week low. It can be
concluded that individual stocks are much more volatile than a group of stocks.
52-wk
high
52-wk
low
Price ratio
(High-Low)/Low
46.84
36.13
0.30
76.82
56.57
0.36
32.44
14.02
1.31
37.39
25.5
0.47
69.87
45.27
0.54
14.07
12.12
0.16
19.77
15.01
0.32
62.5
39.01
0.60
34.61
20.21
0.71
128.34
83.61
0.53
28.09
23.5
0.20
32. The total before-tax income is $4. The corporations may exclude 70% of dividends
received from domestic corporations in the computation of their taxable income; the
33. A put option conveys the right to sell the underlying asset at the exercise price. A
34. 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.
Chapter 02 – Asset Classes and Financial Instruments
CFA 1