Solution Manual for Fundamentals of Investments Valuation an
zl zl zl zl zl zl zl
d Management, 10th Edition by Bradford Jordan and
zl zl zl zl zl zl zl
Thomas Miller and Steve Dolvin
zl zl zl zl
1
,Solution Manual for Fundamentals of Investments Valuation an zl zl zl zl zl zl zl
d Management, 10th Edition by Bradford Jordan and
zl zl zl zl zl zl zl
Thomas Miller and Steve Dolvin zl zl zl zl
SOLUTION MANUAL FOR zl zl
Fundamentals of Investments Valuation and Management, 10th Edition Jordan zl zl zl zl zl zl zl zl
Chapter1-21 zl
Chapter 1 zl
A Brief History of Risk and Return
zl zl zl zl zl zl
Concept Questions zl
1. For both risk and return, increasing order is b, c, a, d. On average, the higher the risk of an investment, the
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
higher is its expected return. zl zl zl zl
2. Since the price didn’t change, the capital gains yield was zero. If the total return was four percent, then the
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
dividend yield must be four percent. zl zl zl zl zl
3. It is impossible to lose more than –
zl zl zl zl zl zl zl
100 percent of your investment. Therefore, return distributions are cut off on the lower tail at –
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
100 percent; if returns were truly normally distributed, you could lose much more.
zl zl zl zl zl zl zl zl zl zl zl zl
4. To calculate an arithmetic return, you sum the returns and divide by the number of returns. As such, arit
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
hmetic returns do not account for the effects of compounding (and, in particular, the effect of volatility)
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
. Geometric returns do account for the effects of compounding and for changes in the base used for each
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl z
year’s calculation of returns. As an investor, the more important return of an asset is the geometric retur
l zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
n.
5. Blume’s formula uses the arithmetic and geometric returns along with the number of observations to ap
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
proximate a holding period return. When predicting a holding period return, the arithmetic return will te
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
nd to be too high and the geometric return will tend to be too low. Blume’s formula adjusts these returns fo
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
r different holding period expected returns.
zl zl zl zl zl
6. T-
bill rates were highest in the early eighties since inflation at the time was relatively high. As we discuss
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
in our chapter on interest rates, rates on T-
zl zl zl zl zl zl zl zl
bills will almost always be slightly higher than the expected rate of inflation.
zl zl zl zl zl zl zl zl zl zl zl zl
7. Risk premiums are about the same regardless of whether we account for inflation. The reason is that ris
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
k premiums are the difference between two returns, so inflation essentially nets out.
zl zl zl zl zl zl zl zl zl zl zl zl
8. Returns, risk premiums, and volatility would all be lower than we estimated because aftertax returns are
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
smaller than pretax returns.
zl zl zl zl
2
,Solution Manual for Fundamentals of Investments Valuation an zl zl zl zl zl zl zl
d Management, 10th Edition by Bradford Jordan and
zl zl zl zl zl zl zl
Thomas Miller and Steve Dolvin zl zl zl zl
9. We have seen that T-bills barely kept up with inflation before taxes. After taxes, investors in T-
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
bills actually lost ground (assuming anything other than a very low tax rate). Thus, an all T-
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
bill strategy will probably lose money in real dollars for a taxable investor.
zl zl zl zl zl zl zl zl zl zl zl zl
10. It is important not to lose sight of the fact that the results we have discussed cover over 80 years, well be
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
yond the investing lifetime for most of us. There have been extended periods during which small stocks
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
have done terribly. Thus, one reason most investors will choose not to pursue a 100 percent stock (partic
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
ularly small- zl
cap stocks) strategy is that many investors have relatively short horizons, and high volatility investments
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
may be very inappropriate in such cases. There are other reasons, but we will defer discussion of these t
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
o later chapters.zl zl
11.
Solutions to Questions and Problems zl zl zl zl
NOTE: All end of chapter problems were solved using a spreadsheet. Many problems require multiple steps. Due
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl z
to space and readability constraints, when these intermediate steps are included in this solutions manual, ro
l zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
unding may appear to have occurred. However, the final answer for each problem is found without rounding
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
during any step in the problem.
zl zl zl zl zl
Core Questions zl
1. Total dollar return = 100($41 – $37 + $.28) = $428.00
zl zl zl zl zl zl zl zl zl zl
Whether you choose to sell the stock does not affect the gain or loss for the year; your stock is worth wh
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
at it would bring if you sold it. Whether you choose to do so or not is irrelevant (ignoring commissions
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
and taxes). zl
2. Capital gains yield zl zl z l z l z l $41 – $37 zl zl z l z l / $37 zl z l z l .1081, or 10.81% Dividend yield zl zl zl zl z l z l $.28/$37 z l z l .0076, or .76%
zl zl
Total rate of return zl zl zl z l z l 10.81% z l z l .76% z l z l 11.57%
3. Dollar return = 500($34 – $37 + $.28) = –$1,360
zl zl zl zl zl zl zl zl zl
Capital gains yield $34 – $37 /$37 –.0811, or –8.11%
z l z l z l z l z l z l z l z l z l z l z l z l z l z l z l
Dividend yield $.28/$37 .0076, or .76% Total rate of return = – zl zl zl zl zl zl zl zl zl
zl 8.11% + .76% = –7.35% zl zl zl zl
4.
a. average return = 6.0%, average risk premium = 2.7% zl zl zl zl zl zl zl zl
b. average return = 3.3%, average risk premium = 0% zl zl zl zl zl zl zl zl
c. average return = 12.3%, average risk premium = 9.0% zl zl zl zl zl zl zl zl
d. average return = 16.3%, average risk premium = 13.0% zl zl zl zl zl zl zl zl
3
, Solution Manual for Fundamentals of Investments Valuation an zl zl zl zl zl zl zl
d Management, 10th Edition by Bradford Jordan and
zl zl zl zl zl zl zl
Thomas Miller and Steve Dolvin zl zl zl zl
5. Cherry average return zl zl 17% 11% – 2% zl zl 3% 14% /5 z l z l 8.60% Straw average return zl zl zl zl
16% 18% – 6% zl zl 1% 22% /5 z l z l 10.20%
6. Cherry: RA zl 8.60%
Var 1/ 4 zl .17 – .086 zl zl z l z l
2
.11 – .086 zl zl z l z l
2
–.02 – .086 zl zl z l z l
2
.03 – .086 zl zl z l z l
2
.14 – .086
zl zl z l z l
2
.0062
1/2
Standard deviation zl .00623 z l z l .0789, or 7.89% zl zl
Straw: RB zl 10.20%
Var 1/ 4 zl .16 – .102 zl zl
2
.18 – .102 zl zl z l z l
2
–.06 – .102 zl zl z l z l
2
.01 – .102 zl zl z l z l
2
.22 – .102 zl zl z l z l
2
.01452 zl
1/2
Standard deviation zl .01452 z l z l .1205, or 12.05% zl zl
7. The capital gains yield is
zl zl zl zl $59 – $65 /$65 zl zl z l –.0923, or – zl zl
9.23% (notice the negative sign). With a dividend yield of 1.2 percent, the total return is –8.03%.
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
8. Geometric return zl 1 .17 1 .11 1 .02 1 .03 1 .14 (1/5)z l
– 1 .0837,
zl
or 8.37%
zl
9. Arithmetic return zl .21 .12 .07 –.13 – .04 zl zl zl . z l z l zl .0817, or 8.17% zl zl
(1/6)
Geometric return zl 1 .21 1 .12 1 .07 1 – .13
zl zl 1 – .04
zl zl 1 .26 – 1
z l
.0730, or 7.30% zl zl
Intermediate Questions zl
10. That’s plus or minus one standard deviation, so about two-
zl zl zl zl zl zl zl zl zl
thirds of the time, or two years out of three. In one year out of three, you will be outside this range, implying
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
that you will be below it one year out of six and above it one year out of six.
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
4
zl zl zl zl zl zl zl
d Management, 10th Edition by Bradford Jordan and
zl zl zl zl zl zl zl
Thomas Miller and Steve Dolvin
zl zl zl zl
1
,Solution Manual for Fundamentals of Investments Valuation an zl zl zl zl zl zl zl
d Management, 10th Edition by Bradford Jordan and
zl zl zl zl zl zl zl
Thomas Miller and Steve Dolvin zl zl zl zl
SOLUTION MANUAL FOR zl zl
Fundamentals of Investments Valuation and Management, 10th Edition Jordan zl zl zl zl zl zl zl zl
Chapter1-21 zl
Chapter 1 zl
A Brief History of Risk and Return
zl zl zl zl zl zl
Concept Questions zl
1. For both risk and return, increasing order is b, c, a, d. On average, the higher the risk of an investment, the
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
higher is its expected return. zl zl zl zl
2. Since the price didn’t change, the capital gains yield was zero. If the total return was four percent, then the
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
dividend yield must be four percent. zl zl zl zl zl
3. It is impossible to lose more than –
zl zl zl zl zl zl zl
100 percent of your investment. Therefore, return distributions are cut off on the lower tail at –
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
100 percent; if returns were truly normally distributed, you could lose much more.
zl zl zl zl zl zl zl zl zl zl zl zl
4. To calculate an arithmetic return, you sum the returns and divide by the number of returns. As such, arit
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
hmetic returns do not account for the effects of compounding (and, in particular, the effect of volatility)
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
. Geometric returns do account for the effects of compounding and for changes in the base used for each
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl z
year’s calculation of returns. As an investor, the more important return of an asset is the geometric retur
l zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
n.
5. Blume’s formula uses the arithmetic and geometric returns along with the number of observations to ap
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
proximate a holding period return. When predicting a holding period return, the arithmetic return will te
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
nd to be too high and the geometric return will tend to be too low. Blume’s formula adjusts these returns fo
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
r different holding period expected returns.
zl zl zl zl zl
6. T-
bill rates were highest in the early eighties since inflation at the time was relatively high. As we discuss
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
in our chapter on interest rates, rates on T-
zl zl zl zl zl zl zl zl
bills will almost always be slightly higher than the expected rate of inflation.
zl zl zl zl zl zl zl zl zl zl zl zl
7. Risk premiums are about the same regardless of whether we account for inflation. The reason is that ris
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
k premiums are the difference between two returns, so inflation essentially nets out.
zl zl zl zl zl zl zl zl zl zl zl zl
8. Returns, risk premiums, and volatility would all be lower than we estimated because aftertax returns are
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
smaller than pretax returns.
zl zl zl zl
2
,Solution Manual for Fundamentals of Investments Valuation an zl zl zl zl zl zl zl
d Management, 10th Edition by Bradford Jordan and
zl zl zl zl zl zl zl
Thomas Miller and Steve Dolvin zl zl zl zl
9. We have seen that T-bills barely kept up with inflation before taxes. After taxes, investors in T-
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
bills actually lost ground (assuming anything other than a very low tax rate). Thus, an all T-
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
bill strategy will probably lose money in real dollars for a taxable investor.
zl zl zl zl zl zl zl zl zl zl zl zl
10. It is important not to lose sight of the fact that the results we have discussed cover over 80 years, well be
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
yond the investing lifetime for most of us. There have been extended periods during which small stocks
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
have done terribly. Thus, one reason most investors will choose not to pursue a 100 percent stock (partic
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
ularly small- zl
cap stocks) strategy is that many investors have relatively short horizons, and high volatility investments
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
may be very inappropriate in such cases. There are other reasons, but we will defer discussion of these t
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
o later chapters.zl zl
11.
Solutions to Questions and Problems zl zl zl zl
NOTE: All end of chapter problems were solved using a spreadsheet. Many problems require multiple steps. Due
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl z
to space and readability constraints, when these intermediate steps are included in this solutions manual, ro
l zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
unding may appear to have occurred. However, the final answer for each problem is found without rounding
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
during any step in the problem.
zl zl zl zl zl
Core Questions zl
1. Total dollar return = 100($41 – $37 + $.28) = $428.00
zl zl zl zl zl zl zl zl zl zl
Whether you choose to sell the stock does not affect the gain or loss for the year; your stock is worth wh
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
at it would bring if you sold it. Whether you choose to do so or not is irrelevant (ignoring commissions
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
and taxes). zl
2. Capital gains yield zl zl z l z l z l $41 – $37 zl zl z l z l / $37 zl z l z l .1081, or 10.81% Dividend yield zl zl zl zl z l z l $.28/$37 z l z l .0076, or .76%
zl zl
Total rate of return zl zl zl z l z l 10.81% z l z l .76% z l z l 11.57%
3. Dollar return = 500($34 – $37 + $.28) = –$1,360
zl zl zl zl zl zl zl zl zl
Capital gains yield $34 – $37 /$37 –.0811, or –8.11%
z l z l z l z l z l z l z l z l z l z l z l z l z l z l z l
Dividend yield $.28/$37 .0076, or .76% Total rate of return = – zl zl zl zl zl zl zl zl zl
zl 8.11% + .76% = –7.35% zl zl zl zl
4.
a. average return = 6.0%, average risk premium = 2.7% zl zl zl zl zl zl zl zl
b. average return = 3.3%, average risk premium = 0% zl zl zl zl zl zl zl zl
c. average return = 12.3%, average risk premium = 9.0% zl zl zl zl zl zl zl zl
d. average return = 16.3%, average risk premium = 13.0% zl zl zl zl zl zl zl zl
3
, Solution Manual for Fundamentals of Investments Valuation an zl zl zl zl zl zl zl
d Management, 10th Edition by Bradford Jordan and
zl zl zl zl zl zl zl
Thomas Miller and Steve Dolvin zl zl zl zl
5. Cherry average return zl zl 17% 11% – 2% zl zl 3% 14% /5 z l z l 8.60% Straw average return zl zl zl zl
16% 18% – 6% zl zl 1% 22% /5 z l z l 10.20%
6. Cherry: RA zl 8.60%
Var 1/ 4 zl .17 – .086 zl zl z l z l
2
.11 – .086 zl zl z l z l
2
–.02 – .086 zl zl z l z l
2
.03 – .086 zl zl z l z l
2
.14 – .086
zl zl z l z l
2
.0062
1/2
Standard deviation zl .00623 z l z l .0789, or 7.89% zl zl
Straw: RB zl 10.20%
Var 1/ 4 zl .16 – .102 zl zl
2
.18 – .102 zl zl z l z l
2
–.06 – .102 zl zl z l z l
2
.01 – .102 zl zl z l z l
2
.22 – .102 zl zl z l z l
2
.01452 zl
1/2
Standard deviation zl .01452 z l z l .1205, or 12.05% zl zl
7. The capital gains yield is
zl zl zl zl $59 – $65 /$65 zl zl z l –.0923, or – zl zl
9.23% (notice the negative sign). With a dividend yield of 1.2 percent, the total return is –8.03%.
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
8. Geometric return zl 1 .17 1 .11 1 .02 1 .03 1 .14 (1/5)z l
– 1 .0837,
zl
or 8.37%
zl
9. Arithmetic return zl .21 .12 .07 –.13 – .04 zl zl zl . z l z l zl .0817, or 8.17% zl zl
(1/6)
Geometric return zl 1 .21 1 .12 1 .07 1 – .13
zl zl 1 – .04
zl zl 1 .26 – 1
z l
.0730, or 7.30% zl zl
Intermediate Questions zl
10. That’s plus or minus one standard deviation, so about two-
zl zl zl zl zl zl zl zl zl
thirds of the time, or two years out of three. In one year out of three, you will be outside this range, implying
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
that you will be below it one year out of six and above it one year out of six.
zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl zl
4
