# FINANCE MANAGERS

WEEK 6

Start by reading and following these instructions:

1. Quickly skim the questions or assignment below and the assignment rubric to help you focus.
2. Read the required chapter(s) of the textbook and any additional recommended resources. Some answers may require you to do additional research on the Internet or in other reference sources. Choose your sources carefully.
3. Consider the discussion and the any insights you gained from it.
4. Create your Assignment submission and be sure to cite your sources, use APA style as required, check your spelling.

Assignment:

Answer these essay questions:

1. Using Probability Distributions. Suppose the returns on long-term corporate bonds and T-bills are normally distributed. Based on the historical record, use the NORMDIST function in Excel° to answer the following questions:
2. What is the probability that in any given year, the return on long-term corporate bonds will be greater than 10 percent? Less than 0 percent?
3. What is the probability that in any given year, the return on T-bills will be greater than 10 percent? Less than 0 percent?
4. In 1979, the return on long-term corporate bonds was —4.18 percent. How likely is it that such a low return will recur at some point in the future? T-bills had a return of 10.56 percent in this same year. How likely is it that such a high return on T-bills will recur at some point in the future?
6. Company Stock. One option is stock in S&S Air. The company is currently privately held. The price you would pay for the stock is based on an annual appraisal, less a 20 percent discount. When you interviewed with the owners, Mark Sexton and Todd Story, they informed you that the company stock was expected to be publicly sold in three to five years. If you needed to sell the stock before it became publicly traded, the company would buy it back at the then-current appraised value.
7. Arias S&P 500 Index Fund. This mutual fund tracks the S&P 500. Stocks in the fund are weighted exactly the same as they are in the S&P 500. This means that the fund’s return is approximately the return of the S&P 500, minus expenses. With an index fund, the manager is not required to research stocks and make investment decisions, so fund expenses are usually low. The Arias S&P 500 Index Fund charges expenses of 0.20 percent of assets per year.
8. Arias Small-Cap Fund. This fund primarily in-vests in small capitalization stocks. As such, the returns of the fund are more volatile. The fund can also invest 10 percent of its assets in companies based outside the United States. This fund charges 1.70 percent of assets in expenses per year.
9. Arias Large-Company Stock Fund. This fund invests primarily in large capitalization stocks of companies based in the United States. The fund is managed by Melissa Arias and has outperformed the market in six of the last eight years. The fund charges 1.50 percent in expenses.
10. Arias Bond Fund. This fund invests in long-term corporate bonds issued by U.S. domiciled companies. The fund is restricted to investments in bonds with an investment grade credit rating. This fund charges 1.40 percent in expenses.
11. Arias Money Market Fund. This fund invests in short-term, high credit quality debt instruments, which include Treasury bills. As such, the return on money market funds is only slightly higher than the return on Treasury bills. Because of the credit quality and short-term nature of the investments, there is only a very slight risk of negative return. The fund charges 0.60 percent in expenses.

QUESTIONS

1. What advantages/disadvantages do the mutual funds offer compared to company stock for your retirement investing?
2. Notice that, for every dollar you invest, S&S Air also invests a dollar. What return on your investment does this represent? What does your answer suggest about matching programs?
3. Assume you decide you should invest at least part of your money in large capitalization stocks of companies based in the United States. What are the advantages and disadvantages of choosing the Arias Large-Company Stock Fund com-pared to the Arias S&P 500 Index Fund?
4. The returns of the Arias Small-Cap Fund are the most volatile of all the mutual funds offered in the 401 (k) plan. Why would you ever want to invest in this fund? When you examine the expenses of the mutual funds, you will notice that this fund also has the highest expenses. Will this affect your decision to invest in this fund?
5. A measure of risk-adjusted performance that is often used in practice is the Sharpe ratio. The Sharpe ratio is calculated as the risk premium of an asset divided by its standard deviation. The standard deviations and returns for the funds over the past 10 years are listed below. Assuming a risk-free rate of 4 percent, calculate the Sharpe ratio for each of these. In broad terms, what do you suppose the Sharpe ratio is intended to measure?
 10-Year Annual Return Standard Deviation Arias S&P 500 Index Fund 9.15% 19.35% Arias Small-Cap Fund 14.05% 26.82% Arias Large-Company Stock Fund 9.53% 23.82% Arias Bond Fund 8.73% 11.45%
1. Work out this exercise on risk and return. Suppose you observe the following situation as depicted in the table below. If the risk-free rate is 8%, are these securities correctly priced? What would the risk-free rate have to be if they are correctly priced?
 SECURITY BETA EXPECTED RETURN Cooley, Inc. 1.6 19% Moyer Co. 1.2 16%

1. You have \$10,000 to invest in a stock portfolio. Your choices are Stock X with an expected return of 14 percent and Stock Y with an expected return of 11 percent. If your goal is to create a portfolio with an expected return of 12.4 percent, how much money will you invest in Stock X? In Stock Y?

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