Finance problems 3 ANSWER FOR STUDENTS use it as sample

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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.

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 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.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. 
  
  
  
  
  
  
  
  
  
  
  
          
          
 b.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. 
  
  
  
  
  
  
  
  
  
  
  
  
          
          
          
 c.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. 
  
  
  
  
  
  
  
  
  
  
  
  
          
  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:      
 FormulaCalculation  
A.  Dell's expected returnRf + (Beta (Rm - Rf))6.0  
       
B./C.      
StockBeta (B)Revised T Bill Risk-Free RateMarket ReturnExpected return  
Amazon2.16FFC  
Ford1.75FFC  
Dell1.41FFC  
Starbucks1.16FFC  
Boeing1.14FFC  
Disney0.96FFC  
Newmont0.63FFC  
Exxon Mobil0.55FFC  
Johnson & Johnson0.5FFC  
Campbell Soup0.3FFC  
       
B.  Highest10  
C.  Lowest6  
       
D.   FORD will offer a ________expected return at 6%.   Higher or lower? 
Interest rate4%6%    
Rate of return104.04    
       
E.  Exxon  will offer a _______ expected return at 8%.   Higher or lower? 
Interest rate4%8%    
Rate of return5.33.5    
       

 

 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                
 a.TRUE this is true as per the definition, but the factors are representive of macroeconomic risks that are not easily eliminated by diversification       
           
           
           
           
           
           
           
           
           
           
           
                   
                   
 b.FALSE because ATP does not in any way specify the factors       
           
           
           
           
           
           
           
           
           
           
                   
                   
 c.TRUE since investors will not be in a possition to take on non-diversifiable risk only if it entails a positive risk premium       
           
           
           
           
           
           
           
           
           
           
                   
                   
 d.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:    
           
           
   YearNominal Return (%)Inflation (%)     
   200412.53.3     
   20056.43.4     
   200615.82.5     
   20075.64.1     
   2008-37.20.1     
           
  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    
           
   YearNominal Return (%)Difference from AverageSquared DifferenceTIP: Click on the cell for directions  
   200412.52.24.84    
   20056.43.612.96    
   200615.8-5.530.25    
   20075.6-4.722.09    
   2008-37.247.52256.00    
           
   Total 2004-200810.3 2326.14    
   Average2.06 465.20    
   Std. Deviation  19.29Use 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    
           
   YearNominal Return (%)Inflation (%)Real Return (%)TIP: Click on the cell for directions  
   200412.53.315.800    
   20056.43.49.800    
   200615.82.518.300    
   20075.64.19.700    
   2008-37.20.1-37.100    
           
   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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