ANSWERS TO CONCEPT QUESTIONS, PROBLEMS AND QUESTIONS, AND CASES

CONCEPT QUESTIONS
Concept Check 11-1 (p. 293)
1. Why should an investor develop specific investment goals?
The goal setting process is important because it forces investors to consider what they want to
accomplish in the future. You may want to remind students that these goals are not set in
concrete, but can be changed if necessary. (p. 2!
2. What factors should you consider when performing a financial chec"up?
# financial chec"up allows investors to determine if they are ready to invest. The four factors
to consider are$ (1! wor" to balance your budget% (2! obtain ade&uate insurance protection% ('!
start an emergency fund% and ((! have access to other sources of cash for emergency needs.
(p. 2)*!
'. +elow are suggestions that you can use to help you accumulate the money needed to fund an
investment program. +eside each suggestion indicate if this is an action that seems logical
given your current financial condition. Then e,plain your answer in the space provided.
-uggestion .elpful /,planation
0ay Yourself 1irst Yes 2o
/mployer3sponsored
retirement programs
Yes 2o
/lective savings programs Yes 2o
-pecial savings efforts
one or two months each
year
Yes 2o
4ifts, inheritances, and
windfalls
Yes 2o
While individual student answers vary, all of the suggestions presented in 5uestion ' are
effective methods that can be used to establish a long3term investment program. (pp. 2)13
2)2!
(. 6n your own words, describe the time value of money concept and how it affects your
investment programs.
The time value of money allows people to invest money over a period of time. #t the end of
the investment period, people receive not only what they have invested, but also the earnings
(dividends and interest! the investment has earned. 1or most people, accumulation is built on
the principle of investing small sums of money over a long period of time. Thus, the time
value of money can really help people accumulate wealth. (pp. 2)132)'!
Concept Check 11-2 (p. 298)
1. Why are safety and ris" two sides of the same coin?
You cannot evaluate any investment without assessing how the factor of safety relates to the
factor of ris". -afety in an investment means minimal ris" of loss. 7n the other hand, ris" in
an investment means a measure of uncertainty about the outcome. (pp. 2)(32)8!
2. 6n your own words, describe each of the four components of the ris" factor.
The four components of the ris" factor are$
a. inflation ris" 9 that your investment will not "eep pace with inflation.
b. interest rate ris" 9 that the value of your investment will increase or decrease because of
an increase or decrease of interest rates in the economy.
c. business failure ris" 9 that an investment in stoc" or corporate bonds will decrease in
value or become worthless because the corporation that issued the stoc" or bond goes out
of business.
d. mar"et ris" 9 that your investment will increase or decrease in value because of the
actions of investors in the mar"etplace. (pp. 2):32);!
'. .ow do income, growth, and li&uidity affect the choice of an investment?
/ach of these factors can affect the choice of investments. 6nvestors purchase certain
investments because they want a predictable return or distribution of income from the
investment. 4rowth means that their investment will increase in value. <i&uidity is the ability
to buy or sell an investment &uic"ly without substantially affecting the investment=s value.
>sually, investors must give up some of one factor to get more of another factor. (pp. 2);3
2)!
Concept Check 11-3 (p. 302)
1. #ssume you must choose an investment that will help you obtain your investment goals.
?an" the following investments from 1 (low! to : (high! and then @ustify your choice for your
investment portfolio. (-ee /,hibit 113' for help evaluating each investment.!
6nvestment ?an"
(1 A low% : A high!
Bustification
Common stoc"s
0referred stoc"s
Corporate bonds
4overnment bonds
Dutual funds
?eal estate
While student tolerance for ris" will affect each person=s answers, the information in /,hibit
113' will serve as a helpful guideline to assess student answers for this &uestion. (pp. 2))3
'**!
2. Why should investors be concerned with asset allocation and the time their investments have
to wor" for them?
+oth asset allocation and the time their investments have to wor" affect the choice of
investments. #sset allocation is the process of spreading your assets among several different
types of investments to lessen ris". The term is a fancy way of saying you need to diversify
and avoid the pitfall of putting all your eggs in one bas"etEa common mista"e made by
investors. The amount of time that your investments have to wor" for you is another
important factor when managing your investment portfolio. 6f you can leave your
investments alone and let them wor" for 8 to 1* years or more, then you can invest in stoc"s
and mutual funds. 7n the other hand, if you need your investment money in two years or
less, you should probably invest in short3term government bonds, highly rated corporate
bonds, or certificates of deposit. +y ta"ing a more conservative approach for short3term
investments, you reduce the possibility of having to sell your investments at a loss because of
depressed mar"et values or a staggering economy. (pp. 2))3'**!
'. Why should you monitor the value of your investment?
Without monitoring the value of investments, it is impossible to "now if the investments are
increasing or decreasing in value. 6t should also be pointed out that this information can help
investors decide to hold specific investments, invest additional money in the investments, or
sell the investments. (p. '*1!
Concept Check 11-4 (p. 310)
1. What is the difference between a treasury bill, a treasury note, and federal agency debt
issues?
Treasury bills are issued with maturities as long as one year although typical maturities are (
wee"s, 1' wee"s, or 2: wee"s. Treasury notes are issued with maturities of more than one
year but not more than ten years. 6n addition to treasury bills and treasury notes issued by the
Treasury Fepartment, debt securities are issued by federal agencies and &uasi3federal
agencies, which include 1ederal 2ational Dortgage #ssociation, 1ederal .ousing
#dministration, the 4overnment 2ational Dortgage #ssociation, and the 1ederal .ome <oan
Dortgage Corporation. #lthough these debt issues are, for practical purposes, ris" free, they
offer a slightly higher interest rate than government securities issued by the Treasury
Fepartment. (pp. '*'3'*(!
2. /,plain the difference between a general obligation bond and a revenue bond.
# general obligation bond is a bond bac"ed by the full faith, credit, and unlimited ta,ing
power of the government that issued it. # revenue bond is a bond that is repaid from the
income generated by the pro@ect it is designed to finance. (p. '*(!
'. Calculate the ta,able e&uivalent yield in the following situations. (p. '*8!
Ta,3/,empt Yield /&uivalent Yield for a
Ta,payer in the 28G
Ta, +rac"et
/&uivalent Yield for a
Ta,payer in the 2G
Ta, +rac"et
/&uivalent Yield for a
Ta,payer in the ''G
Ta, +rac"et
(.8G :G :.28G :.;G
8.8G ;.' ;.:G .2G
(. Calculate the annual interest and the semiannual interest payment for corporate bond issues
with a face value of H1,***. (p.'*:!
#nnual 6nterest
?ate
#nnual 6nterest -emiannual
6nterest 0ayment
:G H:* H'*
:.8G H:8 H'2.8*
;G H;* H'8
;.8G H;8 H';.8*
8. 6n your own words describe why corporations issue corporate bonds.
Corporations sell corporate bonds to help pay for ma@or purchases or to finance their ongoing
business activities. They usually sell bonds when it is difficult or impossible to sell common
stoc" or preferred stoc". (p. '*:!
:. <ist three reasons investors purchase corporate bonds.
6nvestors purchase corporate bonds for (1! interest income, (2! dollar appreciation of bond
value, and ('! repayment at maturity. (pp. '*3'1*!
Concept Check 11-5 (p. 314)
1. What type of information is found on a corporation=s Web page? .ow could this information
be used to evaluate a bond issue?
6nformation about the firm=s finances is contained in its Web home page. +y accessing a
corporation=s home page, an investor should find the answers to the following &uestions$ (1!
6s the firm profitable? (2! #re sales revenues increasing? ('! #re the firm=s long3term
liabilities increasing? 6n fact, there are many &uestions that bondholders should as" before
ma"ing a decision to buy a bond and many of the answers are available on the firm=s Web
site. (pp. '113'12!
2. Calculate the current mar"et value for the following bonds. (p. '12!
1ace Ialue 2ewspaper 5uotation Current Dar"et Ialue
H1,*** ( H(*
H1,*** )2 H)2*
H1,*** ;;.8 H;;8
'. /,plain what the following bond ratings mean for investors.
+ond ?ating /,planation
#aa +onds that are @udged to be of high &uality by all standards.
+++ +onds that are considered medium3grade obligations.
+ +onds that generally lac" characteristics of a desirable investment.
CC +onds that represent obligations that are highly speculative.
1or more information for these and other bond ratings, you may want to refer to /,hibit 1138.
(p. '1'!
PO!"E#S $N% QUESTIONS
1. Choose a current issue of Kiplingers Personal Finance Magazine, Money, or Consumers
Report and summariJe an article that provides suggestions on how you could use your money
more effectively.
-tudent answers will vary, but you may want to use this &uestion to reinforce the importance
of effective money management. (pp. 232)'!
2. Bane and +ill Collins have total ta"e3home pay of H',)** a month. Their monthly e,penses
total H2,**. Calculate the minimum amount this couple needs to establish an emergency
fund. .ow did you calculate this amount?
The minimum amount for an emergency fund for the Collins is H,(**, as illustrated below.
(p. 2)*!
H2,** ' months (minimum! A H,(** /mergency 1und
'. <ist three personal factors that might lead some investors to emphasiJe income rather than
growth in their investment planning.
Note: You may want to discuss uestions ! and " at t#e same time. $uestion ! emp#asizes
w#y in%estors c#oose in%estments t#at pro%ide income. $uestion " emp#asizes w#y in%estors
c#oose growt#&oriented in%estments.
The age of the investor should be considered when answering this &uestion. #n older investor
approaching retirement may be more interested in income. Younger investors may want to
concentrate on growth because they will not reach retirement age until twenty to thirty years
from now. #lso, some individuals need income because of their particular life situations. 1or
e,ample, a widow with three children may need income for today as opposed to growth for
the future. 1inally, different individuals have different feelings about the income and growth
factors of a possible investment. (p. 2);!
(. <ist three personal factors that might lead some investors to emphasiJe growth rather than
income in their investment planning.
The age of the investor should be considered when answering this &uestion. #n older investor
approaching retirement may be more interested in income. Younger investors may want to
concentrate on growth because they will not reach retirement age until twenty to thirty years
from now. #lso, some individuals need income because of their particular life situations. 1or
e,ample, a widow with three children may need income for today as opposed to growth for
the future. 1inally, different individuals have different feelings about the income and growth
factors of a possible investment. (p 2);!
8. .ow can portfolio management and asset allocation help reduce investment ris"? /,plain
why your age and how the time factor affect the choice of investments for your portfolio.
#sset allocation is the process of spreading your assets among several types of investments to
lessen ris". 1actors that may affect the percentage of assets invested in specific investments
include your age and the time your assets have to wor". This topic is covered on pages 2))3
'** in the te,t. While discussing this &uestion, you may also want to discuss the other
suggestions for improving investment returns described on pages '**3'*2.
:. +ased on the following information, construct a graph that illustrates price movement for a
share of the Washington >tilities +ond 1und. 2ote$ you may want to review the material
presented in the 1igure 6t 7utK bo,ed feature in this chapter. (p. '*1!
Banuary H1:.:* Buly H1(.**
1ebruary 18.8* #ugust 1'.1*
Darch 1;.2* -eptember 18.2*
#pril 1.)* 7ctober 1:.;*
Day 1).* 2ovember 1.(*
Bune 1:.8* Fecember 1).*
$11
$12
$13
$14
$15
$16
$17
$18
$19
$20
$21
$22
$23
$24
Jan Feb Mar Apr May Jun Jul Aug Sep Oct No !ec
;. >se the following table to compare >.-. Treasury bills, Treasury notes, and Treasury bonds.
Minimum 'mount Maturity Range (ow )nterest is
Paid
Treasury bills LLLLLLLLLLLLLLL LLLLLLLLLLLLLLL LLLLLLLLLLLLLLL
Treasury notes LLLLLLLLLLLLLLL LLLLLLLLLLLLLLL LLLLLLLLLLLLLLL
Treasury bonds LLLLLLLLLLLLLLL LLLLLLLLLLLLLLL LLLLLLLLLLLLLLL
T&e'()&* +,--(, sometimes called T3bills, are issued in minimum units of H1,*** with
additional increments of H1,*** and maturities that may be as long as one year. T3bills are
discounted securities, which means that these securities are sold at less than face value. #t
maturity, the owner of the bond receives the face value.
T&e'()&* note( are issued in H1,*** units. The maturity for H1,*** treasury notes is more
than one year but not more than ten years. 6nterest for Treasury notes is paid every si,
months.
T&e'()&* +on.( are issued in minimum units of H1,*** with maturities ranging from ten to
thirty years. 6nterest on Treasury bonds is paid every si, months. The Treasury Fepartment
no longer issues bonds, but they are still available in the secondary mar"et. (p. '*(!
. #ssume that you are in the '8 percent ta, brac"et and that you purchase a 8 1M( percent
municipal bond. >se the formula presented in this chapter to calculate the ta, e&uivalent yield
for this investment.
Ta, e&uivalent yield A ta,3e,empt yield divided by (1.* minus current ta, rate! (p. '*8!
Ta, e&uivalent yield A 8 1M( percent (*.*828! divided by (1.* minus *.'8! A *.** A .*
percent
). 6n your own words, e,plain how each of the following factors is a reason to invest in bonds.
a. 6nterest income
b. 0ossible increase in value
c. ?epayment at maturity
a. 6nterest income is a primary reason why investors choose to invest in either corporate or
government bonds. 6nterest is calculated on the face value of the bond and is usually paid
every si, months. (pp. '*3'*)!
b. 4enerally, bonds are issued with a stated face value. 7nce issued, the price may be higher
or lower than its face value. 1inancial returns for comparable investments and interest
rates in the economy are two factors that may cause the mar"et value of a bond to
increase or decrease. (pp. '*)3'1*!
c. Whenever you purchase a bond, you have two options$ you may "eep the bond until
maturity and then redeem it, or you may sell the bond at any time to another investor. 6n
either case, the value of your bond is closely tied to the corporation=s ability to repay its
bond indebtedness. (p. '1*!
1*. #ssume that three years ago you purchased corporate bond that pays :.8 percent. The
purchase price was H1,***. #lso assume that three years after your bond investment,
comparable bonds are paying percent.
a. What is the annual dollar amount of interest that you receive from your bond investment.
The annual dollar amount of interest is H:8. (p. '*:!
:.8G A *.*:8
1ace value , 6nterest rate A #mount of annual interest
H1,*** face value , *.*:8 A H:8.
b. #ssuming that comparable bonds are paying percent, what is the appro,imate dollar
value for which you could sell your bond?
The appro,imate dollar value is H12.8* (p. '*)!
G A *.*
Follar amount of annual interest Comparable interest rate A #ppro,imate mar"et value
H:8 .* A H12.8*
c. 6n your own words, e,plain why your bond increased or decreased in value.
The price of a corporate bond may fluctuate until the maturity date. Changes in overall
interest rates in the economy are the primary cause of most bond price fluctuations. The
value of corporate bonds decreases when overall interest rates increase. 6n contrast, the
value of corporate bonds rises when overall interest rates decrease. The mar"et value of a
bond may also be affected by the financial condition of the company. (pp. '*)3'1*!
11. Choose a corporate bond that you would consider purchasing. Then, using information
obtained on the 6nternet or in the library, answer the &uestions in Your 0ersonal 1inancial
0lan -heet ':. +ased on your research, would you still purchase this bond?
#nswers will vary depending on the bond that students choose and the source of the
information used for evaluation purposes. (pp. '113'1'!
12. Fetermine the current yield on a corporate bond investment that has a face value of H1,***,
pays ; percent interest, and has a current mar"et value of H2*.
The current yield is .8G (p. '12!
#nnual income amount Current mar"et value A Current yield
H;* H2* A *.*8 A .8G
INTENET CONNECTION (p. 31/)
#fter obtaining this data, students should be able to discuss the importance of investment
planning, and researching conservative investments.
C$SE IN POINT (pp. 31/-318)
1. The Tilsons lost almost half of the value of their investment portfolio in @ust three years.
What did they do wrong?
6n fact, the Tilsons did at least two things wrong. 1irst, they didn=t learn how to evaluate
potential investments until after they had lost a lot of money. -econd, once they invested
their money, they didn=t trac" the value of their investments. 4ood investors evaluate
investments before they spend their money% the best investors continue to evaluate their
investments after the initial purchase. #lthough it appears the Tilsons learned a valuable
lesson, it was an e,pensive lesson.
2. Iisit the Dotley 1ool Web site at www.fool.com. Fescribe the type of investment
information that is available.
To answer this &uestion, students will want to visit the actual Web site. There they will find
information on preparing for an investment program. They can also obtain information on
investing basics, how to get started, and information on specific investment alternatives.
'. 6f you were beginning an investment program, would you use the information provided by
the Dotley 1ool or similar Web sites? /,plain your answer.
Today, many students would prefer to use the 6nternet to obtain information about a variety of
topics. Certainly, investments are no e,ception to this assumption. You may want to use this
&uestion to encourage students to give the Dotley 1ool Web site or similar Web sites a try.
#fter all, there are a number of advantages to using the 6nternet. The ability to obtain up3to3
date information &uic"ly is a big plus that "eeps both beginning and e,perienced investors
coming bac" to financial and investment Web sites.