Jan 25, 2018 in Research

book Exercises

Exercise 1: How would the productive economy of a country be affected if there were no markets in which to trade financial assets?

If there were no markets in which to trade financial assets, the economy of a particular country would greatly be affected. The term “market” is defined by Merriam-Webster as “the course of commercial activity by which the exchange of commodities is effected” the highlight of this definition being the word “exchange” (Market, 2013). Without an opportunity to exchange securities and commodities, economical growth would be a hard-to-reach goal. In a speech, Duisenberg adds, “the financial system is also particularly important in reallocating capital and thus providing the basis for the continuous restructuring of the economy that is needed to support growth” (2001).

Exercise 2: The average rate of return on investments in large stocks has outpaced that on investments in T Bills by over 8% since 1926. Why then does anyone invest in T Bills?

Treasury Bills or so-called T Bills were introduced by the US government as a security or a medium used for the investment. These bills are sold for less than its face value and, after a maturity period, its whole amount is given back to those who bought it. In a way, when one purchases a T Bill, one is also lending money to the government in order to help finance the nation’s debt. Even though the average rate of return on investments in large stocks has outpaced that on investments in T Bills by over 8% since 1926, T Bills are still being used because of a number of reasons: they are simple, affordable and reliable. Siddons also notes that T Bills that are exempted from state and local taxes, are easily tradable because they are a highly liquid form of the investment, and that they are convertible to cash since it can be sold on the secondary market (Siddons, 2013).

Exercise 3: In compensation for your work, you are being paid $10,000 today and $10,000 in a year’s time. You wish to purchase a car which is worth $17,500 today and you believe that its price will decrease to $16,000 in a year’s time. The cost of money currently stands at 5% per annum. What are your alternatives?

Since the value of the car is expected to depreciate at the end of the year, it might be good for the car buyer to wait until the price of the car is at an affordable cost depending on the car buyer’s financial capabilities. However, if the buyer needs to buy the car sooner, at 5% per annum cost of money, he/she will have to consider other alternatives in financing his/her car. A common method of financing a car is through the loans. Parker writes in an article that “an analyst with financial products researcher Canstar Cannex, Joshua Zenas, says a car purchase isn't regarded as good debt because the borrowing isn't for something that will appreciate in value” (Parker, 2010). It may thus be wise to avoid or minimize borrowing money to purchase a car. Obringer suggests the following sources of finance: dealership, bank or credit union, online financial institution, home equity loan, family member or friend (Obringer, 2013).

Exercise 4: Explain how the European Commission, European governments and the ECB have responded to the sovereign debt crisis affecting Euro-based economies?

The European Commission has created guides with regards to aiding European countries who urgently need help. The Commission’s focus is on “responding to people’s needs”, “targeting those in real need” and “improving people’s integration into society” (A stronger safety net for those in need, 2013). On the other hand, European governments, led by the European Union, have reportedly been concentrating on the bailing out of the countries with struggling economies such as Greece, Ireland and Portugal. These countries were granted billions of Euros of loans to help bring back their economies to stability. The European Central Bank, led by its president Mario Draghi, has declared to grant loans with the lowest interest rates to European nations (Kenny, 2013).

Exercise 5: The Closed Fund is a closed-end investment fund company with an investment portfolio company currently worth $200m. It has liabilities of $30 million and 5 million shares outstanding. What is the NAV of the fund? If the fund sells at $36 per share, what is the premium/ discount as a percentage of the NAV?

Net Asset Value is equal to the sum of market value of all the securities and cash and equivalent holdings, less the fund liabilities, divided by the total outstanding fund shares. Using the formula, the NAV for the fund would be $34, given that the company is worth $200 million with liabilities of $30 million and 5 million in shares. If the fund sells at $36 per share, then the premium/discount as a percentage of the NAV is 5.56%.

Exercise 6: Consider a mutual fund with $200 million in assets and 10 million shares outstanding at the start of the year. The fund invests in a portfolio of stocks which provides a dividend income at the end of the year of $2 million. The stocks included in the portfolio increase in price by 18% during the year, but no securities are sold and there is no capital distribution. The fund charges management fees of 1% based on the year end portfolio asset value. What is the NAV at the start and the end of the year? What is the rate of return for the investor?

The Net Asset Value at the beginning of the year is equal to $200 million in assets, less than liabilities, divided by 10 million shares. Since there was no value for the liabilities mentioned, the NAV then is $20 at the beginning of the year. Given that the fund charges management fees of 1% based on the year end portfolio asset value, the NAV at the end of the year is $19.80 since 1% of $20 is $0.20. The fund then invests $2 million in a portfolio of stocks, in which the value increases by 18% at the end of the year. Using the formula for Rate of Return on Investments, the rate would still be 18%.

Exercise 7: You purchased 1,000 shares in New Fund at a price of $20 per share at the start of the year. You paid an entry fee of 4%. The securities in which the fund invests have increased in value by 12% during the year. The fund has incurred expenses (including management fees) of 1.2% of its assets (on an average basis) during the year. What is your rate of return and actual gain if you sell your shares at the end of the year?

The buyer has initially purchased a total of $20,000 in shares. Paying the 4% entry fee would cost him another $800. During the year, the fund has incurred expenses of 1.2% of its assets, which amounts to $240. At the end of the year, the securities that the fund invested in would increase by 12%, which would be equal to $22,400. The rate of return on investment would be 6.46% and the actual gain would be $1,360.


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