2. An investment management firm says that its “fixed-income manager will maintain a portfolio duration between 80% and 120% of the duration of the Lehman Brothers Aggregate Index.”
a. What is a “fixed-income manager”?
b. When would a fixed-income manager want a portfolio duration equal to 80% of the duration of the Lehman index?
c. When would a fixed-income manager want a portfolio duration equal to 120% of the duration of the Lehman index?
d. Why do you suppose they don’t allow their fixed-income manager to go outside the 80% - 120% range?

3. The nominal return on the S&P500 (dividends plus capital gains) was -14.7 percent in 1973 and -26.4 percent in 1974. Consumer prices increased by 8.7 percent in 1973 and by 12.9 percent in 1974. What was the annual real rate of return for S&P500 investors over this two-year period? (Show how to calculate the exact value, not an approximation.)

4. The New York Times reported that parking spaces in midtown Manhattan could be rented for an average cost of $6,888/year ($574/month) or purchased for an average price of $165,019. Using the annual rent and a 10% required rate of return, what annual rate of growth of rents would justify this price?

5. Ginnie Mae mutual funds buy a pool of residential mortgages that are guaranteed by the Government National Mortgage Association. Investors in these funds receive the monthly mortgage payments that are made by homeowners. While investors are protected against default, they can be hurt both by a rise in market interest rates and by a decline. Explain how this is possible.

6. Company BIG has 20 million shares outstanding with a market price of $10/share. It has a Games division that has a book value of $40 million and $10 million in earnings this year; it also has a Liquid Assets division that holds $50 million in Treasury bills that earned $2 million this year. Big spins off the Liquid Assets division by creating two new companies, Games and Liquid Assets. Each Big shareholder receives 1 share of Games and 1 share of Liquid Assets in exchange for 2 shares of BIG, which no longer exists. The spinoff will have no effect on the earnings of either the Games division or the Liquid Assets division. Predict the prices of each company’s shares.

7. If executive compensation is based on how much the stock price increases during the next 12 months, rather than total shareholder return during the next 12 months, identify an action that a company’s management might take that should make the stock price higher than it would otherwise be 12 months from now without improving shareholder return. (Do not use splits or reverse-splits.) Be sure to define total shareholder return!

8. Explain the error in this commentary: “It is widely expected that the Fed will cut interest rates at its next meeting. Investors should therefore buy long-term bonds immediately and wait to buy stocks until after the Fed meets.”

9. You will save $X a year for 5 years, beginning a year from today, in order to accumulate sufficient wealth to pay an annual prize of $10,000 a year forever, beginning 6 years from now. If your rate of return is 8%, what is the appropriate value of $X?

10. A Wall Street Journal columnist wrote:

A century ago, when buying stock was a lot like placing a bet at the tracks, science had little to do with what we now know as market analysis. If there was anything close to a market theory, it was that a company was worth the net value of its visible assets. Any amount that its stock price rose above that level was somehow illegitimate. The difference between a stock’s market price and the value of its underlying assets was known as ‘water,’ a term used with derision.

a. What is the value of Tobin’s q if a company’s market price is higher than the replacement cost of its assets?
b. How would Tobin explain a company’s market price being higher than the replacement cost of its assets?