Fundamentals of Investments: Valuation and Management – 10th Edition by Bradford D. Jordan & Thomas W. Miller | Complete Solutions Manual

SOLUTION MANUAL FOR # #


Fundamentals of Investments Valuation and Management, 10th Edition Jordan
# # # # # # # #



Chapter 1-21 #




Chapter 1 #


A Brief History of Risk and Return
# # # # # #




Concept Questions #




1. For #both #risk #and #return, #increasing #order #is #b, #c, #a, #d. #On #average, #the #higher #the #risk #of #an
#investment, #the #higher #is #its #expected #return.



2. Since #the #price #didn’t #change, #the #capital #gains #yield #was #zero. #If #the #total #return #was #four
#percent, #then #the #dividend #yield #must #be #four #percent.



3. It #is #impossible #to #lose #more #than #–100 #percent #of #your #investment. #Therefore, #return #distributions
# are #cut #off #on #the #lower #tail #at #–100 #percent; #if #returns #were #truly #normally #distributed, #you #could

#lose #much #more.



4. To #calculate #an #arithmetic #return, #you #sum #the #returns #and #divide #by #the #number #of #returns. #As
#such, #arithmetic #returns #do #not #account #for #the #effects #of #compounding #(and, #in #particular, #the

#effect #of #volatility). #Geometric #returns #do #account #for #the #effects #of #compounding #and #for

#changes #in #the #base #used #for #each #year’s #calculation #of #returns. #As #an #investor, #the #more

#important #return #of #an #asset #is # the #geometric #return.



5. Blume’s #formula #uses #the #arithmetic #and #geometric #returns #along #with #the #number #of #observations
#to #approximate #a #holding #period #return. #When #predicting #a #holding #period #return, #the #arithmetic

#return #will #tend #to #be #too #high #and #the #geometric #return #will #tend #to #be #too #low. #Blume’s #formula

#adjusts #these #returns #for #different #holding #period #expected #returns.



6. T-bill #rates #were #highest #in #the #early #eighties #since #inflation #at #the #time #was #relatively #high. #As
#we #discuss #in #our #chapter #on #interest #rates, #rates #on #T-bills #will #almost #always #be #slightly #higher

#than #the #expected #rate #of #inflation.



7. Risk #premiums #are #about #the #same #regardless #of #whether #we #account #for #inflation. #The #reason #is
#that #risk #premiums #are #the #difference #between #two #returns, #so #inflation #essentially #nets #out.



8. Returns, #risk #premiums, #and #volatility #would #all #be #lower #than #we #estimated #because #aftertax
#returns #are #smaller #than #pretax #returns.



9. We #have #seen #that #T-bills #barely #kept #up #with #inflation #before #taxes. #After #taxes, #investors #in #T-
bills #actually #lost #ground #(assuming #anything #other #than #a #very #low #tax #rate). #Thus, #an #all #T-bill
#strategy #will #probably #lose #money #in #real #dollars #for #a #taxable #investor.



10. It #is #important #not #to #lose #sight #of #the #fact #that #the #results #we #have #discussed #cover #over #80 #years,
# well #beyond #the #investing #lifetime #for #most #of #us. #There #have #been #extended #periods #during

#which #small # stocks # have # done # terribly. # Thus, # one # reason # most # investors # will # choose # not # to

# pursue # a # 100

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© # MCGRAW # HILL # LLC. # ALL # RIGHTS # RESERVED. # NO # REPRODUCTION # OR # DISTRIBUTION # WITHOUT # THE # PRIOR
# WRITTEN # CONSENT #OF #MCGRAW #HILL #LLC.

, percent #stock #(particularly #small-cap #stocks) #strategy #is #that #many #investors #have #relatively #short
#horizons, #and #high #volatility #investments #may #be #very #inappropriate #in #such #cases. #There #are

#other #reasons, #but #we #will #defer #discussion #of #these #to #later #chapters.



11.

Solutions #to #Questions #and #Problems

NOTE: #All #end #of #chapter #problems #were #solved #using #a #spreadsheet. #Many #problems #require #multiple
#steps. #Due #to #space #and #readability #constraints, #when #these #intermediate #steps #are #included #in #this

#solutions #manual, #rounding #may #appear #to #have #occurred. #However, #the #final #answer #for #each

#problem #is #found #without #rounding #during #any #step #in #the #problem.



Core #Questions

1. Total #dollar #return #= #100($41 #– #$37 #+ #$.28) #= #$428.00
Whether #you #choose #to #sell #the #stock #does #not #affect #the #gain #or #loss #for #the #year; #your #stock #is
#worth #what #it #would #bring #if #you #sold #it. #Whether #you #choose #to #do #so #or #not #is #irrelevant

#(ignoring #commissions #and #taxes).




2. Capital #gains #yield $41 # – # $37#/  # .1081, # or #10.81%
#  #$37

Dividend #yield  # $.28#/  # .0076, # or #.76%
#$37


Total #rate #of #return    # 11.57%
# 10.81% # .76%



3. Dollar #return #= #500($34 #– #$37 #+ #$.28) #= #–$1,360
Capital #gains #yield #  # $34 # – # $37#/#$37 –#.0811, # or # –#8.11%
# 


Dividend #yield  # $.28#/  # .0076, # or #.76%
#$37

Total #rate #of #return #= #–8.11% #+ #.76% #= #–7.35%

4.
a. average #return #= #6.0%, #average #risk #premium #= #2.7%
b. average #return #= #3.3%, #average #risk #premium #= #0%
c. average #return #= #12.3%, #average #risk #premium #= #9.0%
d. average #return #= #16.3%, #average #risk #premium #= #13.0%

5. Cherry#average #return 17%  # 11% # –   # 14%#/#5  # 8.60%
#  # 2% # 3%


Straw #average #return 16%  # 18% # –  # 1% 22%#/#5  # 10.20%
#  # 6% # 




6. Cherry: #RA 8.60%
# 

Var  # 1#/ #4 #.17 # –2 ##.086 .11 – # .086  –.02 – # .086 .03 – # .086 
2 2 2 2
 
# # # #
 # .00623
# .14 # – # .086
# # # # # #



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© # MCGRAW # HILL # LLC. # ALL # RIGHTS # RESERVED. # NO # REPRODUCTION # OR # DISTRIBUTION # WITHOUT # THE # PRIOR
# WRITTEN # CONSENT #OF #MCGRAW #HILL #LLC.

,  
.00623
1/2
Standard #deviation .0789, # or #7.89%
# 

#




Straw: #RB 10.20%
# 




3
© # MCGRAW # HILL # LLC. # ALL # RIGHTS # RESERVED. # NO # REPRODUCTION # OR # DISTRIBUTION # WITHOUT # THE # PRIOR
# WRITTEN # CONSENT #OF #MCGRAW #HILL #LLC.

, Var  # 1#/ #4#.16 # – # .102 .18 – # .102 –.06 – # .102 .01 – # .102 .22 – # .102  #.01452
2 2 2 2 2


# # # #


    
# # # # #


.01452
1/#2
Standard #deviation .1205, # or #12.05%
#  
#




7. The # capital # gains # yield # is # $59 # – # $65#/ – .0923#, # or # –9.23% # (notice # the # negative # sign).
#$65 # 
With #a #dividend #yield #of #1.2 #percent, #the #total #return #is #–8.03%.


1 # # .171 # # .111 # #.021 # # .031 .14
(1/5) #
8. Geometric #return – #1 .0837, # or #8.37%
#
# # 




9. Arithmetic #return .21 .12  # .07 # –#.13 # –  # .26#/  # .0817, # or #8.17%
#  #  # .04 #6



#1 .211 .121 .071 # – # .131 # – # .041 .26
(1/6) #
Geometric – #1 .0730, # or #7.30%
#  #  # 
#return
#  # 




Intermediate #Questions

10. That’s #plus #or #minus #one #standard #deviation, #so #about #two-thirds #of #the #time, #or #two #years #out #of
#three. #In #one #year #out #of #three, #you #will #be #outside #this #range, #implying #that #you #will #be #below #it

#one #year #out #of #six #and #above #it #one #year #out #of #six.



11. You #lose #money #if #you #have #a #negative #return. #With #a #12 #percent #expected #return #and #a #6 #percent
#standard #deviation, #a #zero #return #is #two #standard #deviations #below #the #average. #The #odds #of #being

#outside #(above #or #below) #two #standard #deviations #are #5 #percent; #the #odds #of #being #below #are #half

# that, #or #2.5 #percent. #(It’s #actually #2.28 #percent.) #You #should #expect #to #lose #money #only #2.5 #years

#out #of #every #100. #It’s #a #pretty #safe #investment.



12. The #average #return #is # 6.0 #percent, #with #a #standard #deviation #of # 9.8 #percent, #so #Prob(Return #< # –3.8 #or
Return  15.8 #)  # 1/ #3#, #but #we #are #only #interested #in #one #tail; # Prob#Return – 3.9  # 1/ #6
# 


, #which #is #half #of # 1/ #3 # (or #about #16%) #.
95%: #6.0 #± #2σ #= #6.0 #± #2(9.8) #= #–13.6% #to #25.6%
99%: #6.0 #± #3σ #= #6.0 #± #3(9.8) #= #–23.4% #to #35.4%

13. Expected # return # = # 16.4%; # σ # = # 31.2%. # Doubling # your # money # is # a # 100% # return, # so # if # the # return
distribution #is #normal, # Z #  # 100 # – # 16.4#/ #31.2 #  # 2.68 # standard #deviations; #this #is #in-between #two
and #three #standard #deviations, #so #the #probability #is #small, #somewhere #between #.5% #and #2.5%
#(why?). #Referring # to # the # nearest # Z # table, # the # actual # probability # is # = # 0.369%, # or # less # than

# every # 100 # years.


Tripling # # your # # money # # would # # be Z #  # 200 # – # 16.4#/ #31.2 #  # 5.88 # # standard # # deviations; # # this
corresponds #to #a #probability #of #(much) #less #than #0.01%. #(The #actual #answer #is #less #than #once
#every #1 #million #years, #so #don’t #hold #your #breath.)



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© # MCGRAW # HILL # LLC. # ALL # RIGHTS # RESERVED. # NO # REPRODUCTION # OR # DISTRIBUTION # WITHOUT # THE # PRIOR
# WRITTEN # CONSENT #OF #MCGRAW #HILL #LLC.