1.

Professor Smith was bragging about her abilities as an investor in the stock market: “In the last month, I earned 8% on my
without studying 15 years at university.” Did Mr. Jackson really outperform Mrs. Smith?

Mr. Jackson indeed achieved a higher percentage return compared to Mrs. Smith, but it is important to consider the context a
associated with their investments, it is difficult to make a definitive judgment on who performed better as an investor. Also, in
which was mentioned in the chapter 8 of the book. Comparing something with little to no similarities can be pointless. With th
their investment and/or portfolio.
2. Can a corporate bond have a lower expected return than a government bond? Can it have lower ex post return?

It may be possible for a corporate bond to have a lower expected return than a government bond, but I don't think it will easil
issued by private companies, which means there is a higher chance of default compared to government bonds that are backed
expected returns for corporate bonds. It is also possible for a corporate bond to have a lower ex post return than a governmen
bankrupt, the bondholders may not receive the full amount of their investment back, resulting in a lower ex post return. On th
higher chance of receiving the expected return.

no,
3. It’s 1 January 2007 and you’re considering buying a $1,000 face-value U.S. Treasury bill that matures in 1 year. The interes

a. If you buy the T-Bill now, how much will you pay?

TREASURY BILL PURCHASE PRICE

Face Value 1000 <-- Treasury bill face value
Maturity 1 <-- years to maturity
Interest Rate 7% <-- Interest rate/discount rate
Purchase Price 934.58 <-- =B6/(1+B8)^1

b. If the interest rate remains 7% annually, how much will the bill be worth on 1 February 2007?
1 March? 1 April? . . . 1 December?

INTEREST ON THE TREASURY BILL

Purchase Price 934.58 <-- Treasury bill purchase price
Payoff on Maturity 1000 <-- Treasury bill face value
Interest 7% <-- =B15/B14-1

THE PRICE OF THE TREASURY BILL THROUGHOUT THE YEAR

Date Bill Price
1-Jan-07 934.58 <-- FV = PV (1 + i)^t
1-Feb-07 936.56 <-- =B21*((0.7/330)+1)^1
1-Mar-07 938.75 <-- =B22*((0.7/300)+1)^1
1-Apr-07 941.18 <-- =B23*((0.7/270)+1)^1
1-May-07 943.93 <-- =B24*((0.7/240)+1)^1
1-Jun-07 947.07 <-- =B25*((0.7/210)+1)^1
1-Jul-07 950.76 <-- =B26*((0.7/180)+1)^1
1-Aug-07 955.19 <-- =B27*((0.7/150)+1)^1
1-Sep-07 960.76 <-- =B28*((0.7/120)+1)^1
1-Oct-07 968.24 <-- =B29*((0.7/90)+1)^1
1-Nov-07 979.53 <-- =B30*((0.7/60)+1)^1
1-Dec-07 1002.39 <-- =B31*((0.7/30)+1)^1
ill that matures in 1 year. The interest rate is 7% annually.

To get the Purchase Price, the formula was based from the Annualized Rate of Return
formula. 1/n
Annualized Rate of Return = ( Face Value
Present Value
) -1
1/n
Purchase Price = ( Face Value
1 + Annualized Rate of Return
)

To get the monthly Treasury Bill Price, I used the Future Value formula.
4. Diana bought bonds issued by the ZZZ company, a small high-tech company from Newfoundland. The bond is zero-coupo

a. If the price of the bond is $756.14, what is the annual expected return of Diana’s bond?

COMPUTING THE EX-ANTE YIELD

Face Value 1,000.00
Purchase Price 756.14
Maturity 2
Annualized Rate of Return 15.00% <-- =((B6/B7)^(1/B8))-1

b. One day after Diana bought her bond, ZZZ was purchased by the electronic giant ABA, which has a very low default proba
Diana gain from the takeover?

TREASURY BILL PURCHASE PRICE

Face Value 1000
Maturity 2 <-- years to maturity
Interest Rate 6.50% <-- new annual return
New Price 969.00 <-- =B15/(1+B17)^(1/2)
Gain from the takeover 212.86 <-- =B18-B7
from Newfoundland. The bond is zero-coupon, has a face value of $1,000, and matures in 2 years. Diana intends to keep the bond unti

ana’s bond?

1/n
Annualized Rate of Return = ( Face Value
Present Value
) -1

giant ABA, which has a very low default probability. Investors demand only a 6.5% annual return on ABA’s bonds. What will be the new

1/n
Present Value = ( Face Value
1 + Annualized Rate of Return
)
nds to keep the bond until maturity.

nds. What will be the new price of the ZZZ bonds and how much will
5. On 15 March 2002, you purchased a 2-year Treasury bond with face value of $10,000 and a 4%
coupon (payable semiannually). The price of the bond was $9,750. The bond promises a coupon
of $200 on 15 September 2002, 15 March 2003, 15 September 2003, and 15 March 2004 (on this
last date on
a. Based thethe
bond will repay
following, its facethe
compute value).
annualized IRR of the bond purchase.

Date Cash Flow

2-Mar-15 -9,750
2-Mar-15 200
3-Mar-15 200
3-Mar-15 200
4-Mar-15 10,200

Semiannual IRR 2.67% <-- =IRR(B6:B10)

Annualized IRR
This is the YTM! 5.41% <-- =(1+B12)^2-1
b. Immediately after receiving the $200 bond interest payment on 15 September 2002, you sold
the bond for $10,000. What was your ex post annualized yield? What was the ex ante annualized yield of the buyer of the bon

COMPUTING THE EX-ANTE YIELD

Month the T-bill is bought 2-Mar-15
Price 9,750
YIELD TO MATURITY
Per month 1.0042 <- =(10000/B19)^(1/6)
Annualized 5.19% <- =B21^12-1

COMPUTING THE EX-POST YIELD

Bought March 15, 2002 9,750
Sold September 15, 2002 10,000
YIELD TO MATURITY
Per month 1.0042 <-- =(B26/B25)^(1/6)
Annualized 5.19% <- =(B28)^12-1
4%
n
his

d
ed yield of the buyer of the bond?
6. During a stamp collector convention the chairman spoke about the profitability of investing in rare stamps. “Last year I in
of 33%. For comparison the average return in the stock market in the last 30 years was only 16%.” Find (at least) three prob

I used the three concepts of an asset's risk for the problems that I saw from the chairman's argument:

1. HORIZON - The chairman states that he invested in rare stamps last year and they are now worth $200,000, implying an ann
Without knowing the specific time period, it is difficult to determine the true annual return and compare it accurately to the a

2. SAFETY - The chairman claims that the rare stamps are worth $200,000 according to the catalog. However, the catalog valu
difficult to sell or convert into cash quickly. Therefore, the safety of investing in rare stamps can be questionable, especially wh

3. LIQUIDITY - Rare stamps are not as liquid as stocks, which are traded on stock exchanges and can be easily bought or sold. T
can pose challenges when it comes to realizing the value of the investment
7. A basic assumption of economics is that investors are risk averse, meaning when they view Asset A as riskier than Asset B
A “fair bet” is a bet whose expected return is zero. Here’s an example of a fair bet: Pay $1 to get $2 if a coin flip yields heads

Will a risk-aversive investor agree to a fair bet?

The risk-aversive investor won't be willing to invest in such a fair bet knowing that the return is low, and there is an expected r
possible that the investor won't because, again, the expected return is zero.
8. A risk-neutral investor is willing to make bets with an expected return of zero. Suppose a riskneutral investor is offered th
$2, . . . . What is the maximum price the riskneutral investor is willing to pay to play this game?

Die Result
1
2
3
4
utral investor is offered the chance to participate in a die-toss game. If the die comes up 1, the payoff is $1, if the die comes up 2, the pa
, if the die comes up 2, the payoff is
9. On Planet Apathy all investors are indifferent to risk. The annual expected returns of government bonds are 5%. Does tha
No, the average stock returns should not necessarily be 5%. This is because the expected return of an asset is based on its risk
expected return. Stocks, on the other hand, have higher potential returns but also higher risk. Therefore, the average stock re
10. One of the ways in which the United States helps foreign countries is to guarantee their bank
loans. Explain (in short) the benefits for foreign countries in getting those guaranties. (Footnote 1
is a good place to start your answer.)
The benefits for foreign countries in getting guarantees on their bank loans from the United States include increased access to
to lenders that the loan will be repaid even if the borrower defaults. This reduces the perceived risk for lenders and encourage
credit rating as well, making it easier for them to borrow money in the future.