1. "I bought XXX stock because it is the largest advertising agency in the world and its stock was selling for only $2 a share." Give two distinct and quite different reasons why the fundamental value of shares of the largest advertising agency in the world could be only $2 a share, when the fundamental values of shares of smaller advertising agencies are more than $20 a share.

2. "My husband and I are in the process of securing a $32,000 home equity loan through an out-of-state lender at an interest rate of 12.5%....[T]he processing costs will be about $5,000. Does that sound reasonable?" [letter to "Money Talk, Los Angeles Times, July 30, 2000.] Calculate the effective interest rate, assuming a 15-year amortized loan.

3. "Imagine you're looking at a newfangled invention called the 'dollar machine.' Once a year, for ten years, it spits out a brand-new dollar bill. How would you value this contraption?.... Let's say you expect a rate of return equal to the stock market's historic rate of about 11 percent growth per year. If so, you might decide to pay just $3.52 for the machine. $3.52 invested for ten years earning 11 percent annually becomes $10 [that is, $3.52(1.11)10 = $10.]" [The [Motley] Fool School]. Carefully explain why, if you have an 11% required return, you would pay (a) $3.52, (b) more than $3.52, or (c) less than $3.52 for this dollar machine. You do not need to make any calculations to answer this question.

4.A Washington Times writer observed that

The money center banks are highly profitable indeed. Bankers Trust's $371.2 million 1985 profit set a record, and for the seventh year in a row the bank was able to raise its cash dividend, then send its shareholders one share of stock for each one they owned.

5. On October 1, 1974, a Wall Street Journal editorial criticized the myopic focus of many corporate executives on earnings per share:

A lot of executives believe that if they can figure out a way to boost reported earnings, their stock prices will go up even if the higher earnings do not represent any underlying economic change. In other words, the executives think they are smart and the market is dumb....
   The market is smart. Apparently the dumb one is the corporate executive caught up in the earnings-per-share mystique.

6. A famous stock adviser once suggested that a conspiracy between stock specialists and bankers is suggested by the fact that "when you're having a decline in stock prices you can always anticipate an increase in interest rates." What he apparently meant is that when specialists lower stock prices so that insiders can accumulate stocks cheaply, banks raise interest rates so that the public cannot borrow money to purchase stocks at these bargain prices. Provide a reasonable non-conspiratorial explanation for the observation that a drop in stock prices is often accompanied by an increase in interest rates.

7. Here are some excerpts from a 1986 New York Times article:

"In my view, making long-term fixed-rate mortgages is simply not a viable strategy any longer," said Dennis Jacobe, director of research at the United States League of Savings Associations.
   The widespread issuance of fixed-rate mortgages in the 1970's led to the collapse or merger of nearly a quarter of the nation's 4,000 savings associations then existing...Of those that survived, some remain in extremely poor shape....
   Adjustable-rate mortgages reached their height of popularity in late 1984, when 70 percent of the mortgages issued by savings and loan associations were adjustable-rate, according to the savings league.
   ...Fixed-rate loans, [however], were the only type Washington
   "You can't be reckless, but right now we're in a deflationary cycle...," Mr. Knutson [the company's president and chief executive] said. Referring to 1981, he added that "you can't operate based on one devastating period; otherwise you leave too much profitability on the table."

     b. Some S&Ls have moved to shorter-term mortgages and longer-term deposits. If the duration of their liabilities is greater than the duration of their assets, are they protected from interest rate fluctuations?

     c. Why do you suppose many S&Ls now wish they had issued fixed-rate mortgages during 1981-1984?

8. President Bill Clinton proposed selling the Southeast, Southwest, and Western Power Associations to its customers for $4.5 billion, which represents the present value (using a 7 percent discount rate) of their debt obligations to the U.S. Treasury. Explain why this price may be wildly unrealistic, using a hypothetical example to illustrate your reasoning.

9. Merrill Lynch routinely tracks the characteristics of the stocks in the S&P 500 and has found that stocks with relatively high dividend yields consistently have low projected earnings growth. For instance in April 1986, for the 100 stocks with the lowest dividend yield (an average D/P of 0.6 percent), the earnings per share were expected to grow by 35 percent in 1986. For the 100 stocks with the highest dividend yield (an average of 6.4 percent), earnings per share were projected to increase by only 6 percent in 1986. How do you explain this empirical finding?

10. Bonds can be bought on margin--30 percent for corporate bonds and as little as 5 percent for Treasury bonds. Why would anyone want to buy Treasury bonds on margin, since the loan rate charged by the broker is presumably higher than the interest rate on Treasury bonds?