Orb Trust (Orb) has historically leaned toward a passive management style of its portfolios. The only model that Orb’s senior management has promoted in the past is the capital asset pricing model (CAPM). Now Orb’s management has asked one of its analysts, Kevin McCracken, CFA, to investigate the use of the arbitrage pricing theory (APT) model. McCracken believes that a two-factor APT model is adequate, where the factors are the sensitivity to changes in real GDP and changes in inflation. McCracken has concluded that the factor risk premium for real GDP is 8% while the factor risk premium for inflation is 2%. He estimates for Orb’s High Growth Fund that the sensitivities to these two factors are 1.25 and 1.5, respectively. Using his APT results, he computes the equilibrium expected return of the fund. For comparison purposes, he then uses fundamental analysis to compute the actually expected return of Orb’s High Growth Fund. McCracken finds that the two estimates of the Orb High Growth Fund’s expected return are equal. McCracken asks a fellow analyst, Sue Kwon, to provide an estimate of the expected return of Orb’s Large Cap Fund based on fundamental analysis. Kwon, who manages the fund, says that the expected return is 8.5% above the risk-free rate. McCracken then applies the APT model to the Large Cap Fund. He finds that the sensitivities to real GDP and inflation are .75 and 1.25, respectively. McCracken’s manager at Orb, Jay Stiles, asks McCracken to construct a portfolio that has a unit sensitivity to real GDP growth but is not affected by inflation. McCracken is confident in his APT estimates for the High Growth Fund and the Large Cap Fund. He then computes the sensitivities for a third fund, Orb’s Utility Fund, which has sensitivities equal to 1.0 and 2.0, respectively. McCracken will use his APT results for these three funds to accomplish the task of creating a portfolio with a unit exposure to real GDP and no exposure to inflation. He calls the fund the “GDP Fund.” Stiles says such a GDP Fund would be good for clients who are retirees who live off the steady income of their investments. McCracken does not agree with Stiles, but says that the fund would be a good choice if upcoming supply-side macroeconomic policies of the government are successful. With respect to McCracken’s APT model estimate of Orb’s Large Cap Fund and the information Kwon provides, is an arbitrage opportunity available?
> Joan McKay is a portfolio manager for a bank trust department. McKay meets with two clients, Kevin Murray and Lisa York, to review their investment objectives. Each client expresses an interest in changing his or her individual investment objectives. Bot
> Group the nine stocks into three portfolios, maximizing the dispersion of the betas of the three resultant portfolios. Repeat the test and explain any changes in the results.
> Summarize your test results and compare them to the results reported in the text.
> Suppose you own your own business, which now makes up about half your net worth. On the basis of what you have learned in this chapter, how would you structure your portfolio of financial assets?
> Can you identify a factor portfolio for the second factor?
> Do the data suggest a two-factor economy?
> All of the following actions are consistent with feelings of regret except: a. Selling losers quickly. b. Hiring a full-service broker. c. Holding on to losers too long.
> Some advocates of behavioral finance agree with efficient market advocates that indexing is the optimal investment strategy for most investors. But their reasons for this conclusion differ greatly. Compare and contrast the rationale for indexing accordin
> Even if behavioral biases do not affect equilibrium asset prices, why might it still be important for investors to be aware of them?
> What sorts of factors might limit the ability of rational investors to take advantage of any “pricing errors” that result from the actions of “behavioral investors”?
> Log in to Connect and link to the material for Chapter 12, where you will find five years of weekly returns for the S&P 500 and Fidelity’s Select Banking Fund (ticker FSRBX). a. Set up a spreadsheet to calculate the relative strength of the banking secto
> Briefly explain whether investors should expect a higher return on portfolio A than on portfolio B according to the capital asset pricing model.
> Log in to Connect and link to the material for Chapter 12, where you will find five years of weekly returns for the S&P 500. a. Set up a spreadsheet to calculate the 26-week moving average of the index. Set the value of the index at the beginning of the
> Why would an advocate of the efficient market hypothesis believe that even if many investors exhibit the behavioral biases discussed in the chapter, security prices might still be set efficiently?
> Using the data in Table 12A, compute a five-day moving average for Computers, Inc. Can you identify any buy or sell signals?
> Table 12A presents price data for Computers, Inc., and a computer industry index. Does Computers, Inc., show relative strength over this period?
> What is meant by data mining, and why must technical analysts be careful not to engage in it?
> Explain how some of the behavioral biases discussed in the chapter might contribute to the success of technical trading rules.
> If prices are as likely to increase as decrease, why do investors earn positive returns from the market on average?
> Why are the following “effects” considered efficient market anomalies? Are there rational explanations for any of these effects? a. P/E effect. b. Book-to-market effect. c. Momentum effect. d. Small-firm effect.
> “Constantly fluctuating stock prices suggest that the market does not know how to price stocks.” Comment.
> At a cocktail party, your co-worker tells you that he has beaten the market for each of the last three years. Suppose you believe him. Does this shake your belief in efficient markets?
> Dudley Trudy, CFA, recently met with one of his clients. Trudy typically invests in a master list of 30 equities drawn from several industries. As the meeting concluded, the client made the following statement: “I trust your stock-picking ability and bel
> Suppose that as the economy moves through a business cycle, risk premiums also change. For example, in a recession, when people are concerned about their jobs, risk tolerance might be lower and risk premiums might be higher. In a booming economy, toleran
> Examine the accompanying figure, which presents cumulative abnormal returns both before and after dates on which insiders buy or sell shares in their firms. How do you interpret this figure? What are we to make of the pattern of CARs before and after the
> Shares of small firms with thinly traded stocks tend to show positive CAPM alphas. Is this a violation of the efficient market hypothesis?
> Suppose that during a certain week the Fed announces a new monetary growth policy, Congress surprisingly passes legislation restricting imports of foreign automobiles, and Ford comes out with a new car model that it believes will increase profits substan
> Dollar-cost averaging means that you buy equal dollar amounts of a stock every period, for example, $500 per month. The strategy is based on the idea that when the stock price is low, your fixed monthly purchase will buy more shares, and when the price i
> Investors expect the market rate of return in the coming year to be 12%. The T-bill rate is 4%. Changing Fortunes Industries’ stock has a beta of .5. The market value of its outstanding equity is $100 million. a. Using the CAPM, what is your best guess c
> A successful firm like Microsoft has consistently generated large profits for years. Is this a violation of the EMH?
> The monthly rate of return on T-bills is 1%. The market went up this month by 1.5%. In addition, AmbChaser, Inc., which has an equity beta of 2, surprisingly just won a lawsuit that awards it $1 million immediately. a. If the original value of AmbChaser
> Which of the following hypothetical phenomena would be either consistent with or a violation of the efficient market hypothesis? Explain briefly. a. Nearly half of all professionally managed mutual funds are able to outperform the S&P 500 in a typical ye
> “If the business cycle is predictable, and a stock has a positive beta, the stock’s returns also must be predictable.” Respond.
> Abigail Grace has a $900,000 fully diversified portfolio. She subsequently inherits ABC Company common stock worth $100,000. Her financial adviser provided her with the following estimates: / The correlation coefficient of ABC stock returns with the or
> Which of the following would be a viable way to earn abnormally high trading profits if markets are semistrong-form efficient? a. Buy shares in companies with low P/E ratios. b. Buy shares in companies with recent above-average price changes. c. Buy shar
> Respond to each of the following comments. a. If stock prices follow a random walk, then capital markets are little different from a casino. b. A good part of a company’s future prospects are predictable. Given this fact, stock prices can’t possibly foll
> The SML relationship states that the expected risk premium on a security in a one-factor model must be directly proportional to the security’s beta. Suppose that this were not the case. For example, suppose that expected return rises mo
> Assume that security returns are generated by the single-index model, where Ri is the excess return for security i and RM is the market’s excess return. The risk-free rate is 2%. Suppose also that there are three securities, A, B, and C
> Assume that stock market returns have the market index as a common factor, and that all stocks in the economy have a beta of 1 on the market index. Firm-specific returns all have a standard deviation of 30%. Suppose that an analyst studies 20 stocks and
> Assume that both portfolios A and B are well diversified, that E(rA) = 12%, and E(rB) = 9%. If the economy has only one factor, and βA = 1.2, whereas βB = .8, what must be the risk-free rate?
> Consider the following data for a one-factor economy. Both portfolios are well diversified. Suppose that another portfolio, portfolio E, is well diversified with a beta of .6 and expected return of 8%. Would an arbitrage opportunity exist? If so, what wo
> Suppose that there are two independent economic factors, F1 and F2. The risk-free rate is 6%, and all stocks have independent firm-specific components with a standard deviation of 45%. Portfolios A and B are both well-diversified with the following prope
> If the APT is to be a useful theory, the number of systematic factors in the economy must be small. Why?
> The APT itself does not provide guidance concerning the factors that one might expect to determine risk premiums. How should researchers decide which factors to investigate? Why, for example, is industrial production a reasonable factor to test for a ris
> George Stephenson’s current portfolio of $2 million is invested as follows: Stephenson soon expects to receive an additional $2 million and plans to invest the entire amount in an index fund that best complements the current portfolio.
> Small firms generally have relatively high loadings (high betas) on the SMB (small minus big) factor. a. Explain why this is not surprising. b. Now suppose two unrelated small firms merge. Each will be operated as an independent unit of the merged compan
> Assume a universe of n (large) securities for which the largest residual variance is not larger than n σM2. Construct as many different weighting schemes as you can that generate well diversified portfolios.
> Orb Trust (Orb) has historically leaned toward a passive management style of its portfolios. The only model that Orb’s senior management has promoted in the past is the capital asset pricing model (CAPM). Now Orb’s management has asked one of its analyst
> Orb Trust (Orb) has historically leaned toward a passive management style of its portfolios. The only model that Orb’s senior management has promoted in the past is the capital asset pricing model (CAPM). Now Orb’s management has asked one of its analyst
> As a finance intern at Pork Products, Jennifer Wainwright’s assignment is to come up with fresh insights concerning the firm’s cost of capital. She decides that this would be a good opportunity to try out the new material on the APT that she learned last
> Suppose that the market can be described by the following three sources of systematic risk with associated risk premiums. Factor Risk Premium Industrial production (I ) ………………………………6% Interest rates(R)
> Consider the following multifactor (APT) model of security returns for a particular stock. / a. If T-bills currently offer a 6% yield, find the expected rate of return on this stock if the market views the stock as fairly priced. b. Suppose that the mar
> Suppose that two factors have been identified for the U.S. economy: the growth rate of industrial production, IP, and the inflation rate, IR. IP is expected to be 3%, and IR 5%. A stock with a beta of 1 on IP and .5 on IR currently is expected to provide
> Consider the following table, which gives a security analyst’s expected return on two stocks in two particular scenarios for the rate of return on the market: a. What are the betas of the two stocks? b. What is the expected rate of retu
> Statistics for three stocks, A, B, and C, are shown in the following tables. Using only the information provided in the tables, and given a choice between a portfolio made up of equal amounts of stocks A and B or a portfolio made up of equal amounts of s
> Suppose that your wealth is $250,000. You buy a $200,000 house and invest the remainder in a risk-free asset paying an annual interest rate of 6%. There is a probability of .001 that your house will burn to the ground and its value will be reduced to zer
> The following units of a particular item were available for sale during the calendar year: The firm uses the weighted average cost method with a perpetual inventory system. Determine the cost of merchandise sold for each sale and the inventory balance a
> The following units of an item were available for sale during the year: Beginning inventory ……... 21,600 units at $20.00 Sale ……………………………. 14,400 units at $40.00 First purchase ……………... 48,000 units at $25.20 Sale …………………………… 36,000 units at $40.00 Secon
> Patrick Miller is the owner and operator of Chicopee LLC, a motivational consulting business. At the end of its accounting period, December 31, 20Y8, Chicopee has assets of $518,000 and liabilities of $165,000. Using the accounting equation, determine th
> The revenues and expenses of Zenith Travel Service for the year ended August 31, 20Y4, follow: Fees earned …………………….. $899,600 Office expense …………………… 353,800 Miscellaneous expense ……….… 14,400 Wages expense …………………. 539,800 Prepare an income statement f
> Peachtree Delivery Service is owned and operated by Terry Young. The following selected transactions were completed by Peachtree Delivery Service during February: 1. Received cash from owner as additional investment, $65,200. 2. Billed customers for deli
> The units of an item available for sale during the year were as follows: There are 17 units of the item in the physical inventory at December 31. The periodic inventory system is used. Determine the inventory cost using (a) The first-in, first-out (FIFO
> Beginning inventory, purchases, and sales for J101 are as follows: Assuming a perpetual inventory system and using the weighted average method, determine (a) The weighted average unit cost after the October 22 purchase, (b) The cost of the merchandise s
> Beginning inventory, purchases, and sales for H76 are as follows: Assuming a perpetual inventory system and using the weighted average method, determine (a) The weighted average unit cost after the July 23 purchase, (b) The cost of the merchandise sold
> Beginning inventory, purchases, and sales for Item GY9 are as follows: Assuming a perpetual inventory system and using the last-in, first-out (LIFO) method, determine (a) The cost of merchandise sold on March 27 and (b) The inventory on March 31.
> Beginning inventory, purchases, and sales for Item FK7 are as follows: Assuming a perpetual inventory system and using the last-in, first-out (LIFO) method, determine (a) The cost of merchandise sold on September 27 and (b) The inventory on September 30
> Using the income statement for Up-in-the-Air Travel Service shown in Practice Exercise 1-4A, prepare a statement of owner’s equity for the year ended April 30, 20Y7. Jerome Foley, the owner, invested an additional $52,000 in the busines
> Beginning inventory, purchases, and sales for Item Doodad are as follows: Assuming a perpetual inventory system and using the first-in, first-out (FIFO) method, determine (a) The cost of merchandise sold on July 24 and (b) The inventory on July 31.
> Beginning inventory, purchases, and sales for Item Copper are as follows: Assuming a perpetual inventory system and using the first-in, first-out (FIFO) method, determine (a) The cost of merchandise sold on March 25 and (b) The inventory on March 31.
> The following three identical units of Item B are purchased during June: Assume that one unit is sold on June 27 for $270. Determine the gross profit for June and ending inventory on June 30 using the (a) First-in, first-out (FIFO); (b) Last-in, first-o
> Financial statement data for years ending December 31 for Salsa Company follow: a. Determine the inventory turnover for 20Y7 and 20Y6. Round to one decimal place. b. Determine the days’ sales in inventory for 20Y7 and 20Y6. Use 365 day
> Financial statement data for years ending December 31 for Amsterdam Company follow: a. Determine the inventory turnover for 20Y4 and 20Y3. Round to one decimal place. b. Determine the days’ sales in inventory for 20Y4 and 20Y3. Use 365
> During the taking of its physical inventory on December 31, 20Y7, Combine Engine Company incorrectly counted its inventory as $274,100 instead of the correct amount of $270,700. Indicate the effect of the misstatement on Combine Engine’s December 31, 20Y
> During the taking of its physical inventory on August 31, 20Y7, Robin Interiors Company incorrectly counted its inventory as $543,500 instead of the correct amount of $560,700. Indicate the effect of the misstatement on Robin Interiors’ August 31, 20Y7,
> On the basis of the following data, determine the value of the inventory at the lower of cost or market. Apply lower of cost or market to each inventory item, as shown in Exhibit 9. / Exhibit 9:
> On the basis of the following data, determine the value of the inventory at the lower of cost or market. Apply lower of cost or market to each inventory item, as shown in Exhibit 9. Exhibit 9:
> The units of an item available for sale during the year were as follows: There are 73 units of the item in the physical inventory at December 31. The periodic inventory system is used. Determine the inventory cost using (a) The first-in, first-out (FIFO
> Are closing entries recorded before or after preparing the (a) Adjusted trial balance, (b) Financial statements, (c) Post-closing trial balance?
> The following three identical units of Item Alpha are purchased during April: Assume that one unit is sold on April 30 for $132. Determine the gross profit for April and ending inventory on April 30 using the (a) First-in, first-out (FIFO); (b) Last-in,
> Sally Co. sold merchandise to Buck Co. on account, $58,900, terms 2/15, n/30. The cost of the merchandise sold is $35,200. Journalize the entries for Sally Co. and Buck Co. for the sale, purchase, and payment of amount due. Assume that all discounts are
> Determine the amount to be paid in full settlement of each of two invoices, (a) and (b), assuming that credit for returns and allowances was received prior to payment and that all invoices were paid within the discount period.
> Determine the amount to be paid in full settlement of each of two invoices, (a) and (b), assuming that credit for returns and allowances was received prior to payment and that all invoices were paid within the discount period.
> Journalize the following merchandise transactions: a. Sold merchandise on account, $78,600 with terms 1/10, n/30. The cost of the merchandise sold was $47,200. b. Received payment less the discount. c. Issued a $900 credit memo for damaged merchandise. T
> Journalize the following merchandise transactions: a. Sold merchandise on account, $94,800 with terms 2/10, n/30. The cost of the merchandise sold was $56,900. b. Received payment less the discount. c. Issued a $500 credit memo for damaged merchandise. T
> Wiseman Company purchased merchandise on account from a supplier for $85,000, terms 1/10, n/30. Wiseman Company returned $9,800 of the merchandise and received full credit. a. If Wiseman Company pays the invoice within the discount period, what is the am
> Flounder Company purchased merchandise on account from a supplier for $32,100, terms 2/10, n/30. Flounder Company returned $8,600 of the merchandise and received full credit. a. If Flounder Company pays the invoice within the discount period, what is the
> During the current year, merchandise is sold for $21,100 cash and $341,700 on account. The cost of the merchandise sold is $217,200. What is the amount of the gross profit?
> Financial statement data for the years ending December 31, 20Y3 and 20Y2, for Lawson Company follow: a. Determine the asset turnover for 20Y3 and 20Y2. b. Is the change in the asset turnover from 20Y2 to 20Y3 favorable or unfavorable?
> The revenues and expenses of Up-in-the-Air Travel Service for the year ended April 30, 20Y7, follow: Fees earned ………………… $1,870,000 Office expense …………….……. 343,000 Miscellaneous expense ……….. 21,000 Wages expense ……………….. 1,115,000 Prepare an income sta
> Financial statement data for the years ending December 31, 20Y3 and 20Y2, for Linstrum Company follow: a. Determine the asset turnover for 20Y3 and 20Y2. b. Is the change in the asset turnover from 20Y2 to 20Y3 favorable or unfavorable?
> Assume the following data for Casper Company before its year-end adjustments: Sales for the year …………………………………….. $1,750,000 Estimated percent of refunds for the year …………… 0.6% Journalize the adjusting entry for customer refunds and allowances.
> Assume the following data for Lusk Inc. before its year-end adjustments: Sales for the year …………………………………… $3,600,000 Estimated percent of refunds for the year ………….. 0.8% Journalize the adjusting entry for customer refunds and allowances.
> Stanley Flooring Company’s perpetual inventory records indicate that $1,129,000 of merchandise should be on hand on December 31, 20Y1. The physical inventory indicates that $1,109,300 of merchandise is actually on hand. Journalize the adjusting entry for
> Novelty Furnishings Company’s perpetual inventory records indicate that $755,000 of merchandise should be on hand on November 30, 20Y1. The physical inventory indicates that $742,000 of merchandise is actually on hand. Journalize the adjusting entry for
> Statham Co. sold merchandise to Bloomingdale Co. on account, $147,600, terms FOB shipping point, 2/10, n/30. The cost of the merchandise sold is $88,600. Statham Co. paid freight of $2,400. Journalize the entries for Statham Co. and Bloomingdale Co. for
> During the current year, merchandise is sold for $366,100 cash and $1,420,000 on account. The cost of the merchandise sold is $1,014,300. What is the amount of the gross profit?
> Verity Company does business in two customer segments: Retail and Wholesale. The following annual revenue information was determined from the accounting system’s invoice information: Prepare horizontal and vertical analyses of the segm
> The debits and credits from two transactions are presented in the following creditor’s (supplier’s) account: Describe each transaction and the source of each posting.
> The debits and credits from two transactions are presented in the following creditor’s (supplier’s) account: Describe each transaction and the source of each posting.
> Cross Country Delivery Service is owned and operated by Pedro Gonzalez. The following selected transactions were completed by Cross Country Delivery Service during May: 1. Received cash from owner as additional investment, $25,050. 2. Paid advertising ex
