FIN 401 Lecture Notes - Lecture 2: S&P 500 Index, Spdr, Mutual Fund
Document Summary
Get access
Related Documents
Related Questions
One of the basic rights of common stockholders is the right to control. This means that stockholders must be consulted on all decisions that the firm makes before the board of directors or management can make a decision.
| True |
| False |
Question 52
Choose the correct statement regarding ETFs. (This is a multiple answer format question which means you should check all that apply...there may be more than one correct response).
| The maximum contribution to an ETF is $5000 per person per year |
| ETFs refer to a tax-sheltered retirement plan |
| An ETF is a security that is structured like a mutual fund (each share represents a portfolio of securities), but trades like a stock (bought sold through a brokerage account on stock exchanges) |
Question 53
You want to accumulate $195153. You currently have $12470 saved. How much must you add at the end of each week for the next 11 years in order to reach your goal if you earn 8.56%?
Question 54
All else equal, we would expect the stock price to increase when ___. (This is a multiple answer format question which means you should check all that apply...there may be more than one correct response).
| The required return decreases |
| The riskiness of the stock decreases |
| The expected growth rate increases |
Question 55
All else equal, an increase in the riskiness of a firm will cause the cost of capital to rise.
| True |
| False |
Question 56
You plan to retire in 5 years. At the point of retirement, you want to be able to withdraw $100,000 and then withdraw $80,000 at the end of each year forever. Assume that you earn a 7% rate of return and do not want to make any further contributions to your retirement fund, how much do you need today?
| There is not enough information to answer this question |
| $886,139.96 |
| $1,142,857.14 |
| None of these answers are correct |
| $871,880.24 |
Question 57
A bond indenture refers to a bond with a AA bond rating are higher.
| True |
| False |
Question 58
Which of the following is likely to lead to a weaker US dollar (all else equal)? (This is a multiple answer format question which means you should check all that apply...there may be more than one correct response).
| Interest rates in the US go up relative to global interest rates |
| Interest rates in the US go down relative to global interest rates |
| US imports increase relative to US exports |
Question 59
You are offered the opportunity to purchase a 7% coupon bond with 12 years remaining until maturity for $1105.26. Based on this, the Yield-to-Maturity for this bond is
| 7.52% |
| 4.95% |
| 5.77% |
| There is no solution |
| 14.31% |
Question 60
Stock A has an expected return of 8.4% and a standard deviation of 51.33%. Stock B has an expected return of 10.1% and a standard deviation of 40.11%. Assuming all investors must choose between these two stocks, we would expect Stock A to decrease in value and Stock B to increase in value until the expected return for Stock A rises above the expected return of Stock B.
| True |
| False |
Question 61
When comparing two individual investments to be held as stand-alone investments (not as part of a well diversified portfolio), standard deviation is a better risk measurement than beta.
| True |
| False |
You recently graduated from Suffolk University, and your job search led you to J&J Bagel, Inc. As you are finishing your employment paperwork, Jerry Chen, one of the co-owners of J&J Bagel, informs you about the companyâs new 401(k) plan. A 401(k) is a type of retirement plan, offered by many companies.
A 401(k) is tax deferred, which means that any deposits you make into the plan are deducted from your current income, so no current taxes are paid on these deposits. For example, if your annual salary is $30,000 and you contribute $1,500 to the 401(k) plan, you will pay taxes only on the $28,500 in income. No taxes will be due on any capital gains or plan income while you are invested in the plan, but you will pay taxes when you withdraw the money at retirement. You can contribute up to 15 percent of your salary to the plan. As is common, J&J Bagel has a 5 percent match program. This means that the company will match your contribution dollar-for-dollar up to 5 percent of your salary, but you must contribute to get the match. In other words, if you contribute 5 percent of your $30,000 salary (which is $1,500) towards the 401(k) plan, J&J Bagel will match your contribution by adding another $1,500 to your plan, so that $3,000 in total will be contributed to your 401(k) plan.
The 401(k) plan has several options for investments, most of which are mutual funds. As you know, a mutual fund is a portfolio of assets. When you purchase shares in a mutual fund, you are actually purchasing partial ownership of the fundâs assets, similar to purchasing shares of stock in a company. The return of the fund is the weighted average of the return of the assets owned by the fund, minus expenses. The largest expense is typically the management fee paid to the fund managers, who make all of the investment decisions for the fund. J&J Bagel uses Imperium Financial Services as its 401(k) plan administrator.
Jerry Chen then explains the following retirement investment options available for employees:
Company Stock. One option is stock in J&J Bagel. The company is currently privately held. The price you would pay for the stock is based on an annual appraisal, less a 20 percent discount. When you are interviewed by the owners, John Benson and Jerry Chen, they informed you that the company stock was expected to be publically sold in three to five years. If you needed to sell the stock before it became publicly traded, the company would buy it back at the then-current appraised value.
Imperium S&P 500 Index Fund. This mutual fund tracks the S&P 500 Index. Stocks in the fund are weighted exactly the same as they are in the S&P 500 Index. This means that the fundâs return is approximately the return of the S&P 500 Index, minus expenses. With an index fund, the manager is not required to research stocks and make investment decisions, so fund expenses are usually low. The Imperium S&P 500 Index Fund charges expenses of 0.20 percent of assets per year.1
Imperium Small-Cap Fund. This fund primarily invests in small capitalization stocks. As such, the returns of the fund are more volatile. The fund can also invest 10 percent of its assets in companies based outside of the U.S. This fund charges 1.7 percent of assets in expenses per year.
Imperium Large-Cap Fund. This fund invests primarily in large capitalization stocks of companies based in the U.S. The fund is managed by Jenna King and has outperformed the market in six out of the last eight years. The fund charges 1.5 percent in expenses.
Imperium Bond Fund. This fund invests in long-term corporate bonds issued by U.S. companies. The fund is restricted to investments in bonds with investment grade credit rating. This fund charges 1.4 percent in expenses.
Imperium Money Market Fund. This fund invests in short-term, high credit quality debt instruments, which include Treasury Bills. As such, the return on money market funds is only slightly higher than the return on Treasury Bills. Because of the credit quality and short-term nature of the investments, there is only a very slight risk of negative return. The fund charges 0.60 percent in expenses.
*1 The return on a mutual fund after accounting for management expenses is calculated as follows. If a fund charges 2 percent in expenses and it is expected to yield a 10 percent return before expenses, then the return on this fund after expenses will be (1 + 0.10)Ã(1 â 0.02) â 1 = 0.078 or 7.8 percent*
QUESTIONS
1. advantages/disadvantages do the mutual funds offer compared to company stock for your retirement investing?
2. One can assess investment risk by looking forward to how assets are expected to react to a particular set of circumstances or âstates of economyâ. Use the following set of assumptions for the coming year to compute the expected rates of return (before expenses) and the standard deviations for the mutual funds described above.
| Probability | S&P 500 index fund | Small-cap fund | large-cap fund | Bondfund | moneymarketfund | |
|---|---|---|---|---|---|---|
| Recession | 20% | -12% | -30% | -10% | 18% | 2% |
| Near Recession | 10% | -8% | -20% | -6% | 14% | 3% |
| Normal | 30% | 12% | 22% | 12% | 8% | 4% |
| Near Boom | 20% | 22% | 38% | 15% | -1% | 5% |
| Boom | 20% | 26% | 54% | 20% | -6% | 6% |
3. Given the expected returns calculated for each of the mutual funds above, estimate the betas of these funds. Assume a risk-free rate of 4 percent and the expected market return equal to the expected return on the S&P 500 Index.
4. If you decide to invest your money equally in the Small-Cap and Bond funds, what would your portfolioâs expected return and risk level (standard deviation and beta) be? (Hint: Adjust mutual fund returns for management expenses as explained in footnote 1.
5. What would happen if you were to put 70 percent of your portfolio in the Small-Cap fund and 30 percent in the S&P 500 Index fund? Would this combination be better for you?
6. The returns of the Imperium Small-Cap Fund are the most volatile of all the mutual funds offered in the 401(k) plan. Why would you ever want to invest in this fund? When you examine the expenses of the mutual funds, you will notice that this fund also has the highest expenses. Will this affect your decision to invest in this fund?
