Bufn 740 Hw 1

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Homework 1
DC51 Yifei Wu UID:112583057

4. Although we stated that real assets comprise the true productive capacity of an economy, it is hard to conceive of a modern economy without well-developed financial markets and security types. How would the productive capacity of the U.S. economy be affected if there were no markets in which one could trade financial assets?

Answer
a. In a capitalist system, financial markets play a central role in the allocation of capital resources. The best resources always tend to come to the companies with the best prospect. The company’s management will find it easy to issue new shares or borrow funds to finance research and development, build new production facilities, and expand its operations. If, on the other hand, a company’s prospects seem poor, investors will bid down its stock price. The company will have to downsize and may eventually disappear. This process greatly improved the efficiency of the productive capacity of the U.S. economy. b. Financial markets allow individuals to separate decisions concerning current consumption from constraints that otherwise would be imposed by current earnings. c. Financial markets can allocate the risk of real assets. On one hand, when considering investing on the same project, risk-tolerant investors can buy high risk financial assets for more profit, while the more conservative ones can buy low risk assets that promise to provide a fixed payment. Everyone get satisfied and get equal payment compared to the risk. On the other hand, This allocation of risk also benefits the firms that need to raise capital to finance their investments. When investors are able to select security types with the risk-return characteristics that best suit their preferences, each security can be sold for the best possible price. This facilitates the process of building the economy’s stock of real assets. d. Financial assets and the ability to buy and sell those assets in the financial markets allow for easy separation of ownership and management. This gives the firm a stability that the owner-managed firm cannot achieve.

8. Suppose investors can earn a return of 2% per 6 months on a Treasury note with 6 months remaining until maturity. What price would you expect a 6-month maturity Treasury bill to sell for?

Solution
Assume the price of the Treasury note is P when the Treasury note is mature. The expected selling price now would be P/(1+2%)

3. Suppose you short sell 100 shares of IBM, now selling at $120 per share. a. What is your maximum possible loss?
b. What happens to the maximum loss if you simultaneously place a stop-buy order at $128?

Solution:
a. Assume the ending price of the stock is P per share and the The maximum possible loss is 100×(120-P)
b. In this case, the maximum possible loss would be 100×(120-P+P-128)=$800

6. Dée Trader opens a brokerage account and purchases 300 shares of Internet Dreams at $40 per share. She borrows $4,000 from her broker to help pay for the purchase. The interest rate on the loan is 8%. a. What is the margin in Dée’s account when she first purchases the stock? b. If the share price falls to $30 per share by the end of the year, what is the remaining margin in her account? If the maintenance margin requirement is 30%, will she receive a margin call? c. What is the rate of return on her investment?

Solution
a. Solve: 300×40-4000=$8000
b. Remaining Margin:300×30-4000=$5000
Remaining percentage margin: 5000/300×30=55.5%
55.5%>30%
So, she will not receive a margin call.
c. In this case, rate of return=(ending equity-initial equity)/initial investment Initial equity=$8000
Ending equity=5000-4000×8%=$4680
R= (4680-8000)/8000=-41.50%

10. You are bearish on Telecom and decide to sell short 100 shares at the current market price of $50 per share. a. How much in cash or securities must you put into your brokerage account if the broker’s initial margin requirement is...
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