FIN 420 ANSWERS AND QUESTIONS SET A+
✔✔Commodity Funds - ✔✔Investment objective: Hedge against inflation. Commodity
funds: Contain stocks in commodity producing companies, commodity linked derivative
instruments, and commodity futures. These funds are volatile.
✔✔Mutual Fund Considerations - ✔✔Low expenses Closing funds Bringing out "hot"
funds Advertising short-term performance Depth and clarity of shareholder
communications Investment policies and restrictions Management ownership of their
own funds Investment personnel turnover Large bonuses for executives
✔✔Mutual Fund Investing: Pitfalls - ✔✔New funds with great records Top-ranked funds
Fund performance, loads, and fees Tax liabilities Disappearing underachievers
Misleading long-term performance
✔✔Mutual Fund Suitability - ✔✔Investor primary objectives: Seek capital appreciation
and growth Seek safety of principal Seek income Seek liquidity Seek tax efficiencies
Low or high-risk tolerance Low or high return requirements
✔✔Mutual Fund Suitability - ✔✔Stock funds are suitable for investors seeking growth,
and have higher risk tolerances Bond funds are suitable for investors seeking income
Government bond funds are suitable for investors seeking income and safety Corporate
bond funds are suitable for investors seeking income and have moderate risk tolerances
Money market funds are suitable for investors seeking liquidity at the trade-off of lower
returns
✔✔Technology stock funds are suitable for investors with a - ✔✔high risk tolerance,
long term horizon, and is seeking aggressive growth
✔✔Balanced funds are suitable for investor seeking - ✔✔conservative growth and
generate income
✔✔Junk bonds are suitable for investors seeking to - ✔✔maximize income and have
higher risk tolerances
, ✔✔Municipal bond funds are suitable for investors seeking income in a - ✔✔taxable
account and have a high tax brackets
✔✔Investors seeking income-producing stock should select a - ✔✔large-cap stock fund,
a preferred stock fund, or a utility stock fund (equity income)
✔✔Total return includes the cash flows (interest or dividends) and any capital
appreciation over a period of time. We can compute the total return by using a holding
period return formula: - ✔✔Single undefined period (often a year) Overstates
(understates) returns for a period greater (less) than a year Does not consider the
timing of cash flows Does not take into consideration time value of money
(compounding)
✔✔Example: A share of stock was purchased for $25 and sold for $27. The stock
distributed $1.25 in dividends. What is the holding period return? - ✔✔(27 - 25 +
1.25)/25 = 13% ; CGY = (27-25)/25 = 8% : DY = 1.25/25 = 5%
✔✔Simple Return --> - ✔✔Total return (income and capital appreciation) over
ownership period Does not take into consideration compounding Ignores time value of
money
✔✔Compounded Return --> - ✔✔Interim cash flows are reinvested (compounded)
Takes into consideration the time value of money
✔✔Simple and Compounded Returns --> An investor deposits $1,000 in a one-year CD
that pays an annual interest rate of 4% compounded quarterly. What is the compounded
return on this investment? - ✔✔N 4 (4 x 1 = 4) | I 1 ( = 1) | PV -1,000 | PMT 0 | FV ?
1040.60
✔✔Arithmetic mean --> - ✔✔noncompounded return that divides the total period return
by the number of periods. The average, or mean return No reinvested returns Not
widely used to evaluate past returns
✔✔An investor has earned the following series of returns on an investment:Year 1:
15.20% Year 2: 9.10% Year 3: 6.50% Year 4: 18.30% Year 5: 16.80% = 65.90% -
✔✔Arithmetic mean = 13.18% (65.90% ÷ 5)
✔✔Geometric mean return takes into consideration compounding of the interim returns.
- ✔✔Commonly used to evaluate and report past returns Geometric will be lower or the
same as arithmetic Takes into consideration the time value of money | Where r is each
period's return, and n is the number of periods
✔✔Compute the geometric mean for the following returns: Year 1: 15.20% Year 2:
9.10% Year 3: 6.50% Year 4: 18.30% Year 5: 16.80% - ✔✔1st step =
✔✔Commodity Funds - ✔✔Investment objective: Hedge against inflation. Commodity
funds: Contain stocks in commodity producing companies, commodity linked derivative
instruments, and commodity futures. These funds are volatile.
✔✔Mutual Fund Considerations - ✔✔Low expenses Closing funds Bringing out "hot"
funds Advertising short-term performance Depth and clarity of shareholder
communications Investment policies and restrictions Management ownership of their
own funds Investment personnel turnover Large bonuses for executives
✔✔Mutual Fund Investing: Pitfalls - ✔✔New funds with great records Top-ranked funds
Fund performance, loads, and fees Tax liabilities Disappearing underachievers
Misleading long-term performance
✔✔Mutual Fund Suitability - ✔✔Investor primary objectives: Seek capital appreciation
and growth Seek safety of principal Seek income Seek liquidity Seek tax efficiencies
Low or high-risk tolerance Low or high return requirements
✔✔Mutual Fund Suitability - ✔✔Stock funds are suitable for investors seeking growth,
and have higher risk tolerances Bond funds are suitable for investors seeking income
Government bond funds are suitable for investors seeking income and safety Corporate
bond funds are suitable for investors seeking income and have moderate risk tolerances
Money market funds are suitable for investors seeking liquidity at the trade-off of lower
returns
✔✔Technology stock funds are suitable for investors with a - ✔✔high risk tolerance,
long term horizon, and is seeking aggressive growth
✔✔Balanced funds are suitable for investor seeking - ✔✔conservative growth and
generate income
✔✔Junk bonds are suitable for investors seeking to - ✔✔maximize income and have
higher risk tolerances
, ✔✔Municipal bond funds are suitable for investors seeking income in a - ✔✔taxable
account and have a high tax brackets
✔✔Investors seeking income-producing stock should select a - ✔✔large-cap stock fund,
a preferred stock fund, or a utility stock fund (equity income)
✔✔Total return includes the cash flows (interest or dividends) and any capital
appreciation over a period of time. We can compute the total return by using a holding
period return formula: - ✔✔Single undefined period (often a year) Overstates
(understates) returns for a period greater (less) than a year Does not consider the
timing of cash flows Does not take into consideration time value of money
(compounding)
✔✔Example: A share of stock was purchased for $25 and sold for $27. The stock
distributed $1.25 in dividends. What is the holding period return? - ✔✔(27 - 25 +
1.25)/25 = 13% ; CGY = (27-25)/25 = 8% : DY = 1.25/25 = 5%
✔✔Simple Return --> - ✔✔Total return (income and capital appreciation) over
ownership period Does not take into consideration compounding Ignores time value of
money
✔✔Compounded Return --> - ✔✔Interim cash flows are reinvested (compounded)
Takes into consideration the time value of money
✔✔Simple and Compounded Returns --> An investor deposits $1,000 in a one-year CD
that pays an annual interest rate of 4% compounded quarterly. What is the compounded
return on this investment? - ✔✔N 4 (4 x 1 = 4) | I 1 ( = 1) | PV -1,000 | PMT 0 | FV ?
1040.60
✔✔Arithmetic mean --> - ✔✔noncompounded return that divides the total period return
by the number of periods. The average, or mean return No reinvested returns Not
widely used to evaluate past returns
✔✔An investor has earned the following series of returns on an investment:Year 1:
15.20% Year 2: 9.10% Year 3: 6.50% Year 4: 18.30% Year 5: 16.80% = 65.90% -
✔✔Arithmetic mean = 13.18% (65.90% ÷ 5)
✔✔Geometric mean return takes into consideration compounding of the interim returns.
- ✔✔Commonly used to evaluate and report past returns Geometric will be lower or the
same as arithmetic Takes into consideration the time value of money | Where r is each
period's return, and n is the number of periods
✔✔Compute the geometric mean for the following returns: Year 1: 15.20% Year 2:
9.10% Year 3: 6.50% Year 4: 18.30% Year 5: 16.80% - ✔✔1st step =
