1. In October of 1992, the Los Angeles Times reported that the Elliot Wave Institute "recently came up with a prediction that is most controversial, mainly because it is so optimistic. The Dow Jones industrial average will top 100,000 points by the year 2060 in the biggest bull market of all time." At the time, the Dow was at 3150. If the Dow increases from 3150 to 100,000 over this 68-year period, what will be the annual compounded rate of increase?

2. In May of 1992, a Japanese newspaper, The Nikkei Weekly, reported that Japanese life insurance companies were placing "more emphasis on the overall yields of their bond investments, including capital gains as well as income....[Previously] life insurers had concentrated on high-coupon bonds, disregarding those with coupon rates of less than 6%. Tadao Nishioka, section chief at Nippon Life Insurance Co., says, “We used to buy bonds with coupon rates of 6% or more even if their prices were ¥10 above face value of ¥100."

   b. Show how to calculate the yield to maturity on a 10-year bond with a coupon rate of 6 percent and a price 10 percent above its face value. (Assume that the coupons are semi-annual.)

3. In July of 1993, Walt Disney Co. issued 100-year bonds with 7.5% coupons and 7.5% yields to maturity. Morgan Stanley (the investment bank handling this issue) estimated that "if long-term yields...were to rise one percentage point, investors in the Disney bond would have a total return of negative 4.19% over the [first] year. If long-term rates were to fall one percentage point, however, the return would be nearly 23%."
   a. Did this bond initially sell at a premium or discount from par value?

   b. Estimate the duration of this bond. (Give a specific numerical answer, not a formula.)

4. Identify the economic event that is most likely to explain this April 1993, headline in The Wall Street Journal: "Zero-Coupon Returns Lead Bond Funds With Average 7.05% Gain in 1st Quarter." Explain your reasoning.

5. A July 1993 article in The Wall Street Journal reported that "many companies are using excess cash to buy their own shares rather than build new plants."
   a. The Journal observed that, "Of course, that cash could go into dividend increases. But corporate finance officers find some compelling arguments in favor of stock repurchases." Identify one compelling argument.

   b. Explain the observation by The Wall Street Journal that share repurchases substantially boosted the prices of some stocks, but had little or no effect on the prices of other stocks.

6. Professor Smith has bought yet another house and is comparing a 15-year and 30-year fixed-rate amortized mortgage at 7 percent. Without doing any calculations,
   a. Which loan has the higher monthly payments?

   b. Which loan has the higher unpaid balance after 5 years?

   c. Which loan has the higher total payments over the length of the loan?

   d. If the mortgage is paid off after 5 years, which loan's stream of payments (including the unpaid balance after 5 years) has the higher present value at a 7 percent required return?

   e. If the mortgage is paid off after 5 years, which loan's stream of payments (including the unpaid balance after 5 years) has the higher present value at a 10 percent required return?

7. Explain this April 1993 quotation from The Wall Street Journal:
"Suppose you buy a 10-year Treasury note today at a yield to maturity of 6% and interest rates shoot up to 8%. What happens to your investment?
A. You lose money.
B. You make money.
C. Nothing happens.
D. All of the above.
The answer: D. All of the above.
How is that possible? The trick is how long you hold the investment."

8. On October 13, 1992, the yield to maturity on 1-year Treasury zeros was 3.4 percent and the yield on 20-year Treasury zeros was 8.2 percent. If an investment bank wanted to bet that the term structure would flatten, would it buy 1-year zeros and sell 20-year zeros, or vice versa? Why would the investment bank buy one and sell the other, instead of just buying one or the other?

9. A 25 percent margin requirement would require an investor to put up 25 percent of the cost of buying a stock. Thus $750 is the most that can be borrowed for the purchase of $1,000 worth of stock. What is the degree of leverage if an investor borrows $750 to purchase $1,000 worth of stock?

10. Explain why the following advice from Peter Lynch, legendary manager of Fidelity's Magellan Fund, is reasonable but not compelling. "Find the long-term growth rate (say Company X’s is 12 percent), add the dividend yield (Company X pays 3 percent), and divide by the P/E ratio (Company X’s is 10). 12 plus 3 divided by 10 is 1.5. Less than 1 is poor, and 1.5 is okay, but what you’re really looking for is a 2 or better. A company with a 15 percent growth rate, a 3 percent dividend, and a P/E of 6 would have a fabulous 3." Use a specific numerical example to illustrate your reasoning.