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1. Stock X has an expected return of 10 percent, a beta coefficient of 0.9, and a standard
deviation of expected returns of 35 percent. Stock Y has an expected return of 12.5 percent, a
beta coefficient of 1.2, and a standard deviation of expected returns of
risk-free rate is 6 percent, and the market risk premium is 5 percent.

25 percent. The

a. Calculate each stocks coefficient of variation.

b. Which stock is riskier for diversified investors?
c. Calculate each stocks required rate of return.
d. On the basis of the two stocksexpected and required returns, which stock would be most
attractive to a diversified investor?
e. Calculate the required return of a portfolio that has $7,500 invested in Stock X and $2,500
invested in Stock Y.
f. If the market risk premium increased to 6 percent, which of the two stocks would have the
largest increase in their required return?(30%)
2. You just started your first job, and you want to buy a house within 3 years. You are
currently saving for the down payment. You plan to save $5,000 the first year. You also
anticipate that the amount you save each year will rise by 10 percent a year as your salary
increases over time. Interest rates are assumed to be 7 percent, and all savings occur at year
end. How much money will you have for a down payment in 3 years? (10%)
2.Suppose you are the money manager of a $4 million investment fund. The fund consists of 4
stocks with the following investments and betas:
Stock
Investment
Beta
A
$400,000
1.50
B
600,000
(0.50)
C
1,000,000
1.25
D
2,000,000
0.75
If the market required rate of return is 14 percent and the risk-free rate is 6 percent, what is
the funds required rate of return? (10%)
3. The prize in last weeks Florida lottery was estimated to be worth $35 million. If you were
lucky enough to win, the state will pay you $1.75 million per year over the next 20 years.
Assume that he first installment is received immediately. If interest rates are 8 percent, what
is the present value of the prize? (5%)

2.The McAlhany Investment Fund has total capital of $500 million invested in 4 stocks:
Stock

Investment

Beta

$160,000,000

1.50

180,000,000

(0.50)

C
D

90,000,000
70,000,000

1.25
0.75

The current risk-free rate is nine percent, whereas market returns have the following
estimated probability distribution for the next period:
Probability

Market return

0.3
10%
0.4
13
0.3
20
a. Compute the expected return for the market.
b. Compute the standard deviations for the market.
c. Compute the beta coefficient for the investment fund.
d. Compute the funds required rate of return?
e. Suppose John McAlany, the president, receives a proposal for a new stock. The investment
needed to take a position in the stock is $60 million, it will have an expected return of 16
percent, and its estimated beta coefficient is 2.0. Should the new stock be purchased? At what
expected rate of return should McAlany be indifferent to purchasing the stock?(25%)
3. As the manager of Oaks Mall Jewelry, you want to sell on credit, giving customers 4
months in which to pay. However, you will have to borrow from the bank to carry the
accounts receivable. The bank will charge a nominal 15 percent, but with monthly
compounding. You want to quote a nominal rate to your customers that will exactly cover
your financing cost. What nominal annual rate should you quote to your credit
customers?(10%)

1.Stocks X and Y have the following probability distributions of expected future returns:
Probability
X
Y
0.1
(10%)
(35%)
0.2
2
0
0.4
12
20
0.2
20
25
0.1
38
45

a. Calculate the expected rate of return, k , for Stock Y.( k X =12%)

b. Calculate the standard deviation of expected returns for Stock X.( Y =20.35%)

c. Calculate the coefficient of variation for Stock Y. Is it possible that most investors might
regard Stock Y as being less risky than Stock X? Explain.(20%)
3.You just started your first job, and you want to buy a house within 3 years. You are currently
saving for the down payment. You plan to save $5,000 the first year. You also anticipate that
the amount you save each year will rise by 10 percent a year as your salary increases over
time. Interest rates are assumed to be 7 percent, and all savings occur at year end. How much
money will you have for a down payment in 3 years? (10%)
4. Assume that AT&Ts pension fund managers are considering two alternative securities as
investments: (1)Security Z (for zero intermediate year cash flows), which costs $422.41 today,
pays nothing during its 10-year life, and then pays $1,000 after 10 years or (2) Security B,
which has a cost today of $1,000 and which pays $80 at the end of each of the next 9 years
and then $1,080 at the end of Year 10.
a. What is the rate of return on each security?
b. Assuming that the cash flows for each security had to be reinvested at the 12 percent
market interest rate, what actual, after-the-fact rate of return would the fund have earned on
each security?(20%)
5. A 15-year security has a price of $340.4689. The security pays $50 at the end of each of the
next 5 years, and then it pays a different fixed cash flow amount at the end of each of the
following 10 years. Interest rates are 9 percent. What is the annual cash flow amount between
Years 6 and 15?(10%)
6. Kaufman Enterprises has bonds outstanding with a $1,000 face value and 10 years left until
maturity. The bonds have an 11 percent annual coupon payment. The current price of these
bonds is $1,175. The bonds may be called in 5 years at 109 percent of face value.
a. What is the yield to maturity of these bonds?
b. What is the yield to call for these bonds, if called in 5 years?
c. Which yield might investors expect to earn on these bonds, and why?(20%)
5.The Garraty Company has two bond issues outstanding. Both bonds pays $100 annual
interest plus $1,000 at maturity. Bond L has a maturity of 15 years, and Bond S a maturity of
1 year.
a. What will be the value of each of theses bonds when the going rate of interest is 8 percent?
Assume that there is only one more interest payment to be made on Bond S.
b. Which bond (the longer-term bond or the shorter-term bond) does fluctuate more when
interest rates change?(15%)

6.It is now January 1, 2001, and you are considering the purchase of an outstanding Racette
Corporation bond that was issued on January 1, 1999. The Racette bond has a 9.5 percent
annual coupon and a 30-year original maturity (it matures on December 31, 2028). There is
a 5-year call protection (until December 31, 2003), after which time the bond can be called
at 109 (that is, at 109 percent of par, or $1,090). Interest rates have declined since the bond
was issued, and the bond is now selling at 116.575 percent of par, or $1,165.75. You want to
determine both the yield to maturity and the yield to call for this bond.
a. What is the yield to maturity in 2001 for the Racette bond? What is its yield to call? (14%)
b. If you bought this bond, which return do you think you would actually earn? Explain
your reasoning. (6%)
6.Jason worked various jobs during his teenage years to save money for college. Now it is his
20th birthday, and he is about to begin his college studies at the University of South Florida. A
few months ago, Jason received a scholarship that will cover all of his college tuition for a
period not to exceed five years. The money he saved will be used for living expenses while he
is in college; in worked as a teenager allowed him to save a total of $15,000, which currently
is invested at 12 percent in a financial asset that pays interest monthly, Because Jason will be
a full-time student, he expects to graduate four years from today, on his 24th birthday. How
much can Jason withdraw every month while he is in college if the first withdrawal occurs
today?(20%)
5.Sue Sharpe, manager of Oaks Mall Jewelry, wants to sell on credit, giving customers three
months in which to pay. However, Sue will have to borrow from her bank to carry the
accounts payable. The bank will charge a simple 12 percent, but with monthly compounding.
Sue wants to quote a simple rate to her customers that will exactly cover her financing costs.
What simple annual rate should she quote to her credit customers?(10%)
5.To complete your last year in business school and then go through law school, you will need
$10,000 per year for four years, starting next year. Your rich uncle offers to put you through
school, and he will deposit in a bank paying seven percent interest a sum of money that is
sufficient to provide the four payments of $10,000 each. His deposit will be made today. How
much will be in the account immediately after you make the first withdrawal?(10%)
6.Sue wants to buy a car that costs $12,000. She has arranged to borrow the total purchase
price of the car from her credit union at a simple interest rate equal to 12 percent. The loan
requires monthly payments for a period of two years. If the first payment is due in one month
after purchasing the car, what will be the amount of Sues monthly payments on the loan?

7.? ? ?

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8. A father is planning a savings program to put his daughter through college. His daughter is
now 13 years old. She plans to enroll at the university in five years, and it should take her
four years to complete her education. Currently, the cost per year is $12,500, but a five
percent inflation rate in these costs is forecasted. The daughter recently received $8,000
from her grandfathers estate; this money, which is invested in a mutual fund paying eight
percent interest compound annually, will be used to help meet the costs of the daughters
education. The rest of the costs will be met by money the father will deposit in the savings
account. He will make six equal deposits to the account to the account in each year from
now until his daughter starts college. These deposits will begin today and will also earn ten
percent interest. How large must each deposit be for him to be able to put his daughter
through college?