Finance problems 3 answer for students use it as sample

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April 23rd, 2020

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Forecasting of future rates of return on the stock market through the use of a 5- or 10-year average of historical returns is considered to be good. However, 10 years is not believed to be a sufficient amount of time when it comes to estimating average rate of return (Rapach & Zhou, 2013). The time not being well sifficient makes the 5- or 10-year average to be a bit misleading when forecasting average rate of return.

The statement that stocks offer higher long-run rates of return compared to bonds is true. They have greater returns potential compared to bonds. But the volatility of stock is very high (This means that the measure of dispersion when it comes to the returns is high. Higher volatility makes the stock be riskier). Stocks have higher standard deviation of returns. The investment that is preferable to a person relies on the amount of risk that the person is in a position to tolerate. This matter is very complicated, and it relies on a number of factors. One factor that becomes very important is the investment time horizon (Eraker & Ready, 2015). For example, if an investor or investors have a short time horizon, then it means that stocks are generally not the prefered option. Stocks will be a prefered option if the investment time horizon is a bit long.

“Each of the following statements is dangerous or misleading. Explain why.

a. A long-term United States government bond is always absolutely safe.

b. All investors should prefer stocks to bonds because stocks offer higher long-run rates of return.

c. The best practical forecast of future rates of return on the stock market is a 5- or 10-year average of historical returns.

“

Problem 7-11

Each of the following statements is dangerous or misleading. Explain why.
a. A long-term United States government bond is always absolutely safe.
b. All investors should prefer stocks to bonds because stocks offer higher long-run rates of return.
c. The best practical forecast of future rates of return on the stock market is a 5- or 10-year average of historical returns.

Answers:

A long-term bond of the government of the United States is always totally safe. Ths is in terms of dollars received. However, there seems to be a problem where the price of bond always fluctuates when there is change in the interest rates. Apart from the change in the interest rate, fluctuation also takes place when there is a change in the rate at which the payment of coupon received can easily be invested. Additiiionally, the payment are in the form of nominal dollars (Saez & Zucman, 2014). This calls for inflation risk to be considered.

References

Rapach, D. E., & Zhou, G. (2013). Forecasting stock returns. Handbook of Economic Forecasting, 2(Part A), 328-383.

Eraker, B., & Ready, M. (2015). Do investors overpay for stocks with lottery-like payoffs? An examination of the returns of OTC stocks. Journal of Financial Economics, 115(3), 486-504

Saez, E., & Zucman, G. (2014). Wealth inequality in the United States since 1913: Evidence from capitalized income tax data (No. w20625). National bureau of economic research

Problem 8-6

Suppose that the Treasury bill rate were 6% rather than 4%. Assume that the expected return on the market stays at 10%. Use the betas in Table 8.2 (p. 193) – also provided below.

a. Calculate the expected return from Dell.
b. Find the highest expected return that is offered by one of these stocks.
c. Find the lowest expected return that is offered by one of these stocks.
d. Would Ford offer a higher or lower expected return if the interest rate were 6% rather than 4%? Assume that the expected market return stays at 10%.
e. Would Exxon Mobil offer a higher or lower expected return if the interest rate were 8%?

Answers:

Formula

Calculation

A. Dell’s expected return

Rf + (Beta (Rm – Rf))

6.0

B./C.

Stock

Beta (B)

Revised T Bill Risk-Free Rate

Market Return

Expected return

Amazon

2.16

Ford

1.75

Dell

1.41

Starbucks

1.16

Boeing

1.14

Disney

0.96

Newmont

0.63

Exxon Mobil

0.55

Johnson & Johnson

0.5

Campbell Soup

0.3

B. Highest

C. Lowest

D. FORD will offer a ________expected return at 6%.

Higher or lower?

Interest rate

Rate of return

4.04

E. Exxon will offer a _______ expected return at 8%.

Higher or lower?

Interest rate

Rate of return

5.3

3.5

Problem 8-18

Some true or false questions about the APT:
a. The APT factors cannot reflect diversifiable risks.
b. The market rate of return cannot be an APT factor.
c. There is no theory that specifically identifies the APT factors. d. The APT model could be true but not very useful, for example, if the relevant factors change unpredictably.

Respond to each question – true or false – and why.

Answer:

T/F

TRUE

this is true as per the definition, but the factors are representive of macroeconomic risks that are not easily eliminated by diversification

FALSE

because ATP does not in any way specify the factors

TRUE

since investors will not be in a possition to take on non-diversifiable risk only if it entails a positive risk premium

TRUE

there is no widely accepted theory regarding how the factors should be.

Problem 7-2

The following table shows the nominal returns on U.S. Stocks and the rate of inflation:

Year

Nominal Return (%)

Inflation (%)

2004

12.5

3.3

2005

6.4

3.4

2006

15.8

2.5

2007

5.6

4.1

2008

-37.2

0.1

a) What was the standard deviation of the market returns?

b) Calculate the average real return.

Answers:

a) What was the standard deviation of the market returns?

Find the standard deviation by completing the table with the appropriate formulas

Year

Nominal Return (%)

Difference from Average

Squared Difference

TIP: Click on the cell for directions

2004

12.5

2.2

4.84

2005

6.4

3.6

12.96

2006

15.8

-5.5

30.25

2007

5.6

-4.7

22.09

2008

-37.2

47.5

2256.00

Total 2004-2008

10.3

2326.14

Average

2.06

465.20

Std. Deviation

19.29

Use SQRT function for this answer only

b) Calculate the average real return.

Find the average real return by completing the table with the appropriate formulas

Year

Nominal Return (%)

Inflation (%)

Real Return (%)

TIP: Click on the cell for directions

2004

12.5

3.3

15.800

2005

6.4

3.4

9.800

2006

15.8

2.5

18.300

2007

5.6

4.1

9.700

2008

-37.2

0.1

-37.100

Average

1650.00%

			Instructions


NAME:


	To complete the homework assignments in the templates provided:

	1.	The question is provided for each problem. You may need to refer to your textbook for additional information in a few cases.


	2.	You will enter the required information into the shaded cells.

	3.	The cells are coded:

		a) T requires a text answer. Essay questions require references; use the textbook.

		b) C requires a calculation, using Excel formulas or functions. You cannot perform the operation on a calculator and then type the answer in the cell. You will enter the calculation in the cell, and only the final answer will show in the cell. I will be able to review your calculation and correct, if necessary.




		c) F requires a number only. In some problems, a “Step 1” is added to help you solve the problem.

		d) Formula requires a written formula, not the numbers. For example, the rate of return = [(1 + nominal)/ (1+inflation)]-1, or D (debt) + E (equity) = V (value).


	4.	Name your assignment file as “lastnamefirstinitial-FINC600-Week#“, and submit by midnight ET, Day 7.

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