October 31, 2002
Frohlich Investments Finance 4504
Fall 2002 Midterm
Total points 109 (9 extra credit)
Name ______
In signing your test you assert that you have not used any human assistance in any manner or mode.
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Short Answers: (2 points per question—total of 34 points) Be brief but complete on Short Answer Questions. Please type answers.
1. Would it be useful to the analyst to compare industry data to basic economic data such as the GDP or consumer spending?
2. Briefly explain the fees charged by funds.
3. Distinguish between direct and indirect investing.
4. Why are upward sloping yield curves more consistent with the usual risk-return tradeoff than downward sloping yield curves?
5. What are the main differences between a closed-end and an open-end investment company?
6 Compare the cash flows an investor expects from coupon bonds, zero-coupon bonds, and preferred stock.
7. Why do stock investors pay attention to the bond market?
8. Would one expect to find higher P/E ratios in an aggressive growth fund or in a growth and income fund?
9. Jack invests primarily in U.S. Treasury bills. Since T-bills are short-term, they must be replaced as they mature, causing a lot of turnover. Mack invests primarily in three growth-oriented stock mutual funds, adding to them monthly. ( Consider load vs no-load funds and automatic deposit into fund) Both have been following their investment strategies over the past 10 years. Would Jack or Mack be more interested in inflation adjusted returns on their investments? Which would be more interested in transactions costs?
10. Would you recommend a 65-year old retiree to invest all of his/her retirement assets in an income fund?
11. When constructing a portfolio, standard deviations are typically calculated from historical data. Why may that be a problem?
12. How is the total book value of equity affected by stock splits? Stock dividends? Are the book values of common stock, capital in excess of par, or retained earnings affected by either?
13. Will risk-averse investors ever include commodity futures or options in their portfolios? Explain.
14. You have decided to invest in an aggressive growth fund for long-run future needs. You have a publication listing a number of such funds with their most recent 12-month total returns. Is this a good predictor of future performance?
15. Are T-bills totally risk-free? Explain.
16. How is the individual investor's income tax position affected by owning investment companies compared to owning securities directly?
17. Which classification of funds are expected to have the lowest management fees?
Essay Questions/Problems (75 points) SHOW ALL WORK
1. ( 5 points) Some market scholars talk about tiers of stocks in the markets. A
top tier on the NYSE would be the largest, most widely held stocks.
Second and third tiers would consist of stocks that are less widely
held and followed by fewer analysts. Is it possible that the market
might be more efficient for the top tier and progressively less
efficient for the lower tiers? Discuss the EMH, the three levels,and
how it relates to the the efficiency of the tiers of stocks in the market.
2. ( 4 points) If an astute (or lucky) market analyst were to find a "money
machine" system that consistently beat the market, would the system
eventually become self-defeating?
3. (5 points) Under the Efficient Market Hypothesis, securities in the market are
assumed to be fairly priced. Does this mean that security analysis
is a waste of time?
4. A. (4 points) Using the last working day of October 2002 WSJ (ATTACH COPY OF SECTION USED), draw a yield curve using Treasuries. Using a WSJ from the last working day of October 2001 ((ATTACH COPY OF SECTION of WSJ USED OR A COPY OF THE WEB PAGE) draw another yield curve on the same graph. Using a WSJ from the last working day of October 2000 ((ATTACH COPY OF SECTION of WSJ USED OR A COPY OF THE WEB PAGE) draw another yield curve on the same graph. Using a WSJ or the Web from the last working day of October 1999 (ATTACH COPY OF SECTION of WSJ USED OR A COPY OF THE WEB PAGE) draw another yield curve on the same graph. Create individual tables for all 4 yield curves indicating the points you are using on your graph.
Be sure to label your graph. [Note you will have four yield curves on the same graph. You will have four tables with appropriate yields.]
B. (3 points) What has happened to the level of the yield curve from (1) 1999 to 2000, (2) 2000 to 2001 and (3) 2001 to 2002?
Explain using Liquidity Preference Theory—why the level has from (1) 1999 to 2000, (2) 2000 to 2001 and (3) 2001 to 2002. Refer to the change in Money Supply, GDP, CPI [provide documentation as to changes in these]
C. (4 points) (1) Explain the current curve using the unbiased expectation theory.
(2) Explain the October 2000 curve using the segmentation theory.
5. RETIREMENT CASE ( 40 points)
Investment Decisions Are More Than Security Selection or Allocation Mix
Guidelines on the Retirement Fund:
Employee can choose between the funds listed in the following table. They may choose any or all fund(s).
Company matches the employee’s contribution to the plan (maximum 5% of Gross Salary) by investing in the same allocation mix as designated by the employee (10% Fund A, 70% Fund B, etc.).
In addition, ESOP places stock into the company stock, Federal Signal Stock. 100 shares are added to the individual’s plan per year.
After Five years of employment the employee can transfer 50% of the cumulative total of the Federal Signal Stock value to any other fund(s).
Fund / YTDReturn / 1 Year
Return / 5 Year
return / 10 Year
return
Vanguard Short-Term Bond Index Fund Investor Shares / 4.51 / 3.67 / 4.33 /
N/A
Vanguard Total Bond Market Index Fund (Bond Fund) / 5.76 / 4.38 / 4.75 / 4.40Vanguard Wellington Fund (Balanced Fund) / -9.71 / -4.28 / 1.21 / 7.44
Vanguard 500 Index Fund (Stock Fund) / -28.2 / -12.00 / -2.21 / 8.07
Vanguard Primecap Fund (Stock Fund) / -26.15 / -13.4 / -0.28 / 12.35
Vanguard Explorer Fund (Stock Fund) / -26.81 / -29.00 / -1.58 / 7.00
Vanguard International Growth Fund (Int’l Stock) / -20.65 / -18.9 / -6.54 / 3.99
Federal Signal Stock (fss) (ESOP) / -23.3 / -12.8 / -4.4 / 6.8
Currently your client’s retirement funds are invested as follows:
FundVanguard Short-Term Bond Index Fund Investor Shares / 73,397.64
Vanguard 500 Index Fund / 15,874.00
Vanguard Wellington Fund / 33,000.00
Federal Signal Stock (Stock symbol FSS) (ESOP) / 14,985.44
Total / 137,257.08
Your client may opt at retirement to withdraw a set dollar amount per month from the 401-k while leaving the balance invested and earning a return on those remaining funds in the plan.
Your client currently takes home $2800 (after tax) per month. He has been contributing $214 per month to the 40l-K plan which was matched by his employer up to 5% of his gross salary. He is currently contributing $375 per month to the 40l-K plan which is matched by his employer up to 5% of his gross salary. The max contribution is $11,000 of gross income. http://www.irs.gov/taxtopics/page/0,,id%3D16216,00.html
The client plans to retire in 5 years and would like to remain at his current level of after-tax take-home pay ($2800). You will need to find the social security tax rate, the medicare tax rate, and your client’s federal tax rate. Your client is married. You must determine whether medicare, social security, and federal income tax are paid on gross salary, regardless of deductions for 401-k plans.
See: http://www.bankrate.com/brm/itax/tax_adviser/20020813a.asp?prodtype=itax
http://www.bankrate.com/nsc/definitions.asp?channelid=10
Your client knows he will receive social security plus the retirement benefits. You must estimate your client’s social security payments. He has a wife that has never worked and they will both be 65 in 5 years and plan to retire then. How much will the couple receive in social security (both the wife and husband will receive social security)? Both the wife and husband will receive retirement benefits at the same time. See the following sites:
http://www.ssa.gov
Client’s Retirement amount:
http://www.ssa.gov/retire2/
Women-Spouse-Non-working Spouse Issues:
http://www.ssa.gov/policy/pubs/SSB/v62n3y1999/artUsingDatafor.pdf#xml=http://www.ssa.gov/search97cgi/s97_cgi?action=View&VdkVgwKey=http%3A%2F%2Fwww%2Essa%2Egov%2Fpolicy%2Fpubs%2FSSB%2Fv62n3y1999%2FartUsingDatafor%2Epdf&doctype=xml&Collection=SSA&QueryZip=spouse+benefits%3COR%3E+%28keywords+%3Ccontains%3Espouse+benefits%29&
http://ssa-custhelp.ssa.gov/cgi-bin/ssa.cfg/php/enduser/std_alp.php?p_sid=cHRun6tg&p_lva=&p_li=&p_page=1&p_cat_lvl1=3&p_cat_lvl2=%7Eany%7E&p_search_text=spouse&p_new_search=1&p_search_type=3
http://ssa-custhelp.ssa.gov/cgi-bin/ssa.cfg/php/enduser/std_adp.php?p_sid=cHRun6tg&p_lva=&p_faqid=504&p_created=975940445&p_sp=cF9zcmNoPTEmcF9ncmlkc29ydD0mcF9yb3dfY250PTMxJnBfc2VhcmNoX3RleHQ9c3BvdXNlJnBfc2VhcmNoX3R5cGU9MyZwX2NhdF9sdmwxPTMmcF9jYXRfbHZsMj1_YW55fiZwX3BhZ2U9MQ**&p_li=
Analysis of Current Situation:
1. Compute the client’s gross income.
2002 federal personal income tax rates(Ordinary taxable income. To see the rates for 2001, click here)
Tax rate / Single filers / Married filing jointly or qualifying widow/widower / Married filing separately / Head of household10% / Up to $6,000 / Up to
$12,000 / Up to $6,000 / Up to $10,000
15% / $6,001 - $27,950 / $12,001 - $46,700 / $6,001 - $23,350 / $10,001 - $37,450
27% / $27,951 - $67,700 / $46,701 - $112,850 / $23,351 - $56,425 / $37,451 - $96,700
30% / $67,701 - $141,250 / $112,851 - $171,950 / $56,426 - $85,975 / $96,701 - $156,600
35% / $141,251- $307,050 / $171,951 - $307,050 / $85,976 - $153,525 / $156,601 - $307,050
38.6% / $307,051
or more / $307,051
or more / $153,526
or more / $307,051
or more
2. Estimate your client’s social security (you will need to calculate the client’s gross salary). Part of their social security is taxable.
http://ssa-custhelp.ssa.gov/cgi-bin/ssa.cfg/php/enduser/std_alp.php?p_sid=RZRto6tg&p_lva=&p_li=&p_page=1&p_cat_lvl1=%7Eany%7E&p_cat_lvl2=%7Eany%7E&p_search_text=tax+deferred+benefits&p_new_search=1&p_search_type=3
3. Compute the risk (the portfolio’s Beta) and the inflation-adjusted return of the current retirement portfolio (see spreadsheet on your instructor’s Web page for the calculating the portfolio’s return).
4. Determine the before-tax amount needed to be withdrawn monthly from the retirement portfolio to meet your client’s desired monthly $2800 after-tax cash flow.
You will need to convert the net monthly after-tax cash flow needed after considering the non-taxable portion of the couple’s social security to a before tax amount. Part of their social security is taxable.
http://www.ssa.gov/cgi-bin/cqcgi/@ssa.env?CQ_SESSION_KEY=XLHZJPFYJEPI&CQ_CUR_DOCUMENT=1&CQ_RESULTS_DOC_TEXT=YES
Payment of medicare premiums still occur during retirement.
http://www.medicare.gov/Basics/Amounts2002.asp
Considering their taxable social security monthly payment, what must your client receive from his 401-K plan monthly to reach his objective of a monthly $2800 after tax amount.for the couples expected life-time of 25 years during retirement?
5. Compute the anticipated retirement funds value upon retirement in 5 years under the current investment plan’s inflation adjusted return.
The client will be contributing $375 per month to the 40l-K plan which is matched by his employer up to 5% of his gross salary. In addition, the ESOP will have an additional 100 shares contributed yearly over the remaining five years.
6. Determine how long the retirement funds would last if monthly before-tax withdrawals were made in the amount that you calculated to supplement the social security payments using the portfolio return you calculated.
7. Using the anticipated retirement fund’s inflation-adjusted return compute what portfolio value would be necessary to have upon the couple’s retirement to achieve their objective of monthly $2800 after tax payments .if the couples expects to live an additional 25 years after retirement?
8.Compute the inflation-adjusted rate for a portfolio that would be necessary to achieve the couples objective.
6. (10 points) Using Federal Signal Stock (FSS)
Download the stock’s monthly prices from 1996 through 2001
Compute the monthly returns including dividends for this period
Download the monthly prices from 1996 through 2001 for the S&P 500
Compute the monthly returns for this period
Run a regression to find Federal Signal’s alpha and Beta
Compare your Beta with the Yahoo .com beta for FSS---try to explain any differences
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