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Chapter 17: Q1. (page 369)
Suppose that you invest $100 today in a risk-free investment and let the 4 percent annual interest rate compound. Rounded to full dollars, what will be the value of your investment 4 years from now?
The value of the investment after 4 years from now will be $117.
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What are mutual funds? What different types of mutual funds are there? And why do you think they are so popular with investors?
Corporations often distribute profits to their shareholders in the form of dividends, which are quarterly payments sent to shareholders. Suppose that you have the chance to buy a share in a fashion company called Rogue Designs for \(35 and that the company will pay dividends of \)2 per year on that share. What is the annual percentage rate of return? Next, suppose that you and other investors could get a 12 percent per year rate of return on the stocks of other very similar fashion companies. If investors care only about rates of return, what should happen to the share price of Rogue Designs? (Hint: This is an arbitrage situation.)
Consider an asset that costs \(120 today. You are going to hold it for 1 year and then sell it. Suppose that there is a 25 percent chance that it will be worth \)100 in a year, a 25 percent chance that it will be worth \(115 in a year, and a 50 percent chance that it will be worth \)140 in a year. What is its average expected rate of return? Next, figure out what the investment鈥檚 average expected rate of return would be if its current price were $130 today. Does the increase in the current price increase or decrease the asset鈥檚 average expected rate of return? At what price would the asset have a zero average expected rate of return?
Suppose that the city of New York issues bonds to raise money to pay for a new tunnel linking New Jersey and Manhattan. An investor named Susan buys one of the bonds on the same day that the city of New York pays a contractor for completing the first stage of construction. Is Susan making an economic or a financial investment? What about the city of New York?
Why is it so hard for actively managed funds to generate higher rates of return than passively managed index funds having similar levels of risk? Is there a simple way for an actively managed fund to increase its average expected rate of return?
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