1. Explain what is incorrect about this description of a Markowitz frontier: "The curves illustrate the maximum return at the various levels of risk that an investor is willing to assume. Investments above the curve have too much risk. Below the curve, the returns are too low. Goldilocks would say that the risk along the curve is not too hot and not too cold; it's just right."
2. In November, Columbia/HCA Healthcare, the nation's largest for-profit hospital company, issued $200 million in 100-year debt, rated A3 by Moody's and BBB+ by Standard & Poor's. A Wall Street Journal article said that "most investors avoid 100-year bonds like the plague," forcing the company to offer a 7.5 percent yield, compared to the 6.25 percent yields then prevailing on 30-year Treasury bonds. The Journal asked, (a) "Why would investors buy the IOU of a company when chances are they won't live to see their principal returned?," and also pointed out that (b) "even though investors get interest every year, by the time they get their principal back, inflation, even at its current low levels, would have eroded the principal's value to virtually nothing." Explain why these two concerns are of little importance and identify two much more important risks.
3. Each week Barron's reports a "Stock/Bond Yield Gap" showing the spread between the dividend yield on the Dow Jones Industrial stocks and the yield to maturity on best grade corporate bonds. In August 1986, for instance, this spread was -5.19 percent. How might investors use these data to gauge whether stocks are underpriced or overvalued?
4. Explain why you agree or disagree with the following comment: "A fast-growing company that can generate the bulk of the funds it needs internally is of course far more desirable than one that must rely heavily on outside borrowing or on the sale of stock, which would dilute the present shareholders' equity."
5. A "seven-and-seven loan" has an interest rate that is 7 percentage points over the prime rate and initial fees that are equal to 7% of the size of the loan. If the prime rate is 10%, what is the effective interest rate on a seven-and-seven 10-year loan with amortized monthly payments? (Just set up.) Explain why the effective interest rate would be higher or lower if this were a 5-year loan.
6. A "married put" is the simultaneous purchase of a stock and a put on that stock. For example, on October 22, 1991, Apple Computer common stock sold for 54 1/2 per share and a January 1992 put with an exercise price of 55 sold for 3 3/4. Graph the dollar profit on a married put as a function of the price of Apple stock on the date the put expires. What kind of strategy is a married put?
7. Between March 1985 and March 1986, bond rates dropped by about three percentage points, while the economy "muddled along," with essentially unchanged profit expectations. Do you think Tobin's q went up or down during this period? Does this change in q foretell an increase or decrease in business investment spending? Why might businesses change their investment plans even if profit expectations are unchanged?
8. Many investors look at the beta coefficients provided by investment advisors. Explain why this advice is misleading: "A stock with a low beta is safer than a high-beta stock, because the lower beta is, the less the stock's price fluctuates."
9. Irving Fisher compared the 1929 stock market crash to a run on a bank that had issued paper bank notes whose value exceeded the gold in its vaults. In his analogy, the bank was U.S. industry, the bank's paper money was stock, and the bank's real assets were the country's factories and machines. Explain why this is not an apt analogy.
10. An investment costs $100,000 and has two separate benefits, like income and capital gains. If one benefit provides an implicit annual return (relative to the initial $100,000 cost) of x% over 25 years and the other benefit provides an implicit annual return (relative to the initial $100,000 cost) of y% over 25 years, is the total implicit annual return equal to x + y percent?