1. P = D/(R - g) implies P/E = d/(R - g). Therefore, P/E is
     1. positively related to the firm's growth rate of dividends and earnings
     2. negatively related to Treasury bond rates
     3. positively related to the firm's payout ratio d, and inversely related to the plowback ratio 1 - d. Holding g constant, a firm that needs a high plowback ratio to grow is worth less.

2. This inversion of the term structure suggests that investors expect the current rise in interest rates to be temporary, and that interest rates several years from now will be lower than they are today--which is consistent with a successful Fed policy that raises current interest rates, but reduces the future rate of inflation.

3. No, the market value of the house depends on what it is worth to people now, not what she paid for it.

4. Well, $30,000 is $30,000. I'd rather have the money to spend on something else than overpay for a house. There is also a Consumer Reports error. The present value of $83/month for 30 years is $30,000 only if the required rate of return is zero. At a 5% required return, $159/month for 30 years has a present value of $30,000.

5. Loans Direct will be hurt by a rise in mortgage rates that reduces the market value of the monthly loan payments due on a $400,000 loan at 7.75%. They can hedge this risk by selling Treasury bond futures, which will be increasingly profitable if interest rates rise and bond prices fall. This hedge will be less successful if mortgage rates rise more than T-bond rates, widening the spread. (Mortgage rates are above T-bond rates because of the greater default risk.)

6. The symbol M stands for the fund's mean return, S for its standard deviation, and R for the return on safe T-bills. Using a mean-standard deviation diagram with investors allocating their money between safe T-bills and a single mutual fund, it can be seen that a fund with a high Sharpe ratio offers investors an opportunity locus that lies above the opportunity locus of funds with lower Sharpe ratios. This an investor choosing between funds should choose the fund with the highest Sharpe ratio. On the other hand, if investors can allocate their money among safe T-bills and more than one mutual fund, the Jensen ratio, (M - R)/beta is more appropriate.

7. This analysis ignores these important points: the $100,000 down payment has an opportunity cost; the monthly mortgage payments include principal as well as interest; the mortgage payments will stop after 30 years, but the rent will not; and the rent and some expenses will grow over time.

8. This argument characterizes technology companies as call options that can make profitable investments in the future for a relatively low cost. The value of a call option is positively related to interest rates because the low price of a call option relative to the price of the underlying asset allows the investor to invest the difference in the interim.

9. Using the constant-dividend-growth model with D = $10, R = 0.10, and g = -0.05: P = D/(R - g) = $10/(0.10 - (-.05)) = $66.67. The stock's value will, along with its dividends, decline by 5% a year. The return is still 10%: a 15% dividend plus a 5% capital loss. If the stock is priced to give investors their required return, they should be willing to invest in it; the low price and large dividend yield offset the capital losses.

10. Not unless it can acquire Walmart and other profitable companies for less than the present value of their assets and economic value added or there are very profitable synergies or economies of scale. You canŐt create value by buying something for what it is worth, unless there are synergies or economies of scale. The conservation of value tells us that the value of Yahoo plus Walmart is equal to the value of Yahoo plus the value of Walmart. If Yahoo by itself is worth nothing, the value of Yahoo plus Walmart is only equal to the value of Walmart.