1. Explain why you expect a stock's P/E to be either positively or negatively related to each of these three factors, in each case holding the other factors constant:
     1. The firm's growth rate of dividends and earnings
     2. Treasury bond rates
     3. The firm's plowback ratio

2. The Fed recently raised short-term interest rates to cool the economy and restrain inflation. Yet long-term interest rates were little affected and in fact sometimes fell, inverting the term structure. How would you explain this term-structure inversion?

3. A Claremont realtor recent put her home on the market for $1.3 million, explaining that she had priced it at 50% more per square foot than comparable properties because, when she bought the house in 1978, she paid 50% more per square foot than comparable properties. Is this argument persuasive?

4. Another realtor said that paying $30,000 above market value on a $400,000 home was of little concern if the buyer will live in the house for 30 years, since that averages out to only $30,000/360 = $83 a month. Explain why you either do or do not find this argument to be persuasive.

5. A mortgage lender allows the homebuyer to "lock in" a mortgage rate on a loan that will not be made for up to 30 days. For example, on April 10, 2000, LoansDirect agreed (for a $400 fee) to loan $400,000 at a 7.75% interest rate on May 10, 2000. On May 10, Loans Direct will sell this loan to an insurance company, pension fund, or other investor at a price that depends on the May 10 level of interest rates. Would LoansDirect be hurt most by an increase or decrease in interest rates between April 10 and May 10? Should they hedge this risk by buying or selling Treasury-bond futures? If interest rates do move in this unprofitable way, will the hedge be less successful if the spread between mortgage rates and T-bond rates widens or narrows?

6. Explain the theoretical rationale and weakness of judging mutual fund performance by the Sharpe ratio: (M - R)/S. Be sure to define M, R, and S.

7. A new faculty member has to decide whether to rent or buy a house to live in. This professor expects to live in the house for the rest of her life. The monthly rent is $3,000 and includes heat, electricity, and all utilities. The house costs $400,000 and: (a) with a $100,000 down payment, the monthly mortgage payments are $2201.29 on a 30-year 8% mortgage; (b) the monthly taxes, insurance, utilities, and maintenance are $1,000. Identify two extremely important errors in this analysis (other than ignoring the tax deductibility of certain expenses).

8. It has been argued that the value of technology stocks is positively related to interest rates because technology companies represent an option on future ventures that may prove extremely profitable, and that option values are positively related to interest rates. Does this argument characterize technology companies as put or call options? Explain why the value of such an option is positively related to interest rates.

9. OldEconomy Tractors currently pays a dividend of $10 a share, but expects its dividend to decline steadily by 5 percent a year. If shareholders require a 10 percent return on their investment, what price will they pay now for this stock? What will happen to the stock's intrinsic value as time passes? (Be specific.) Why would anyone ever invest in a negative-growth stock? Would you?

10. It has been estimated that to justify Yahoo's market value at the end of 1999, it would have to increase its economic value added by $1.2 billion every year: $1.2 billion in 1999, $2.4 billion in 2000, $3.6 billion in 2001, and so on forever. By comparison, WalMart's economic value added was $1.2 billion in 1998. Could Yahoo achieve these goals by using newly issued stock every year to acquire Walmart or other equally profitable companies?