1. Explain the error in management's reasoning: "We are considering the construction of a shopping center. Because we will finance this project by borrowing money from Citibank at 12 percent, this is the interest rate that we should use to discount the project's cash flow."

2. The Nikkei 225 average of Japanese stock prices fell from a peak of 38,915 on December 29, 1989 to 17,948 on April 15, 1992. What was the annual compound decrease in prices during this 2 1/4-year period?

3. At a 1994 Town Meeting, the residents of Brewster, Massachusetts, were offered the following choice of regulatory signs at 15 town landings. Which would you recommend?

   a.fiberglass signs that would cost $15,000 and last 10 years.

   b. metal signs that would cost only $3,000, but need to be relettered and reinstalled every other year for $2,000 on each occasion and replaced after five years for $3,000, giving a total cost of $16,000.

4. The Encyclopedia of Investments states that, "The effective rate of return [on a Treasury bond]...is normally referred to as the security's yield to maturity." Identify two alternative conditions under which an investor's realized rate of return is equal to the bond's yield to maturity if the bond is held until maturity.

5. The Southeast, Southwest, and Western Power Associations are power companies owned and operated by the federal government. President Clinton has proposed selling these power companies for $4.5 billion, which represents the present value (using a 7 percent discount rate) of their debt obligations to the U.S. Treasury. Explain why this price may be wildly unrealistic, using a hypothetical example to illustrate your reasoning.

6. In 1986 a columnist bemoaned the tax breaks that are given to real estate investments: "In general, generous tax breaks for rental and owner-occupied housing have not served to make housing more affordable or to increase the supply. Most of the value of these breaks has simply been capitalized into higher prices for land and existing structures." Explain why high market prices either should or should not influence housing construction.

7. In July of 1994, Standard & Poor's announced that it would supplement its bond credit ratings (AAA, BB, etc.) by giving an r rating to hundreds of bonds where there are "other risks involved that override the credit risk." What risk could be more important than the credit risk?

8. The federal government's budget is calculated on a cash-flow basis, with the annual deficit equal to the dollars disbursed that year minus the dollars received. In 1987, several private borrowers from the Federal Export-Import Bank (a government agency) prepaid $1.5 billion in loans. Why do you think these borrowers voluntarily repaid their loans early? Explain how a loan prepayment either increased or reduced the Bank's 1987 deficit. Do you think that these loan prepayments strengthened or weakened the financial condition of the Export-Import Bank?

9. In March of 1987, Martin T. Sosnoff offered $28 a share for Caeser's World, which had 40 million shares outstanding at the time. In response, the company's management proposed: (a) borrowing $1 billion in order to pay shareholders a special cash dividend of $25 a share; (b) giving top management 1.5 million shares of stock before the dividend; and (c) giving top management another 1.5 million shares after the dividend. In theory, how should each of these three actions affect the price of Caesar's World stock? Be as specific as you can.

10. In August of 1994, Ned Davis Research looked at monthly S&P 500 data since 1948 in order to calculate the average percentage increase in stock prices during comparable periods: