2. a. A “fixed-income manager” is in charge of the bond portfolio.
b. A portfolio duration equal to 80% of the duration of the Lehman index would be profitable if future interest rates are higher than the values embedded in the term-structure.
c. A portfolio duration equal to 80% of the duration of the Lehman index would be profitable if future interest rates are lower than the values embedded in the term-structure.
d. They don’t want their fixed-income manager to make large bets that might cause them to drastically underperform other fixed-income managers—and cause their customers to flee.

3. The nominal value of an invested dollar went from 1 to (1 - 0.147)(1 - 0.264) and the price level went from 1 to (1 + 0.087)(1 + 0.129). Therefore, real wealth fell by 49%:

The annual real rate of return was -28.5%:

An approximation would use the real returns -14.7 - 8.7 = -23.4 in 1973 and -26.4 - 12.9 = -39.3 in 1974, so that $1 goes to $1(1 - .234)(1 - .393) = 0.4650, and the approximate annual real rate of return is -31.8%:

4. Using the constant-dividend-growth model:

5. If interest rates increase, the market value of the mortgages (and of the mutual fund shares) will drop. If interest rates decrease, many homeowners will refinance their mortgages, reducing the portfolio’s average interest rate.

6. We can use the conservation of value principle since the spinoff has no effect on earnings. Company BIG has a total market value of $200 million. Liquid Assets should be valued at $50 million since this is the market value of its assets. Games should consequently be valued at $150 million. Therefore the price per share should be $15.00 for Games stock and $5.00 for Liquid Assets stock. This makes sense since each shareholder has traded 2 share of Big worth a total of $20 for 1 share of Games and 1 shares of Liquid assets, which are worth a total of $20.

7. The total shareholder return is the dividend yield plus the capital gain

The conservation of value principle tells us that dividend payments reduce a stock’s price. If the firm reduces its dividends, the stock’s price should be higher than it would otherwise be.

8. If this rate cut is widely expected, it will already be reflected in (higher) bond and stock prices.

9. Setting the NPV equal to 0:

Solving for X:

10. Tobin’s q is be greater than 1 if a company’s market price is higher than the replacement cost of its assets; this happens if the firm’s profit rate is higher than the shareholder’s required return.