1. Financial engineering has been disparaged as nothing more than paper shuffling. Critics argue that resources used for rearranging wealth ( that is, bundling and unbundling financial assets) might be better spent on creating wealth ( that is, creating real assets). Evaluate this criticism. Are any benefits realized by creating an array of derivative securities from various primary securities?

2. What are the differences between equity and fixed- income securities? ( LO 1- 5)

3. What is the difference between a primary asset and a derivative asset? ( LO 1- 1)

4. What is the difference between asset allocation and security selection? ( LO 1- 4)

5. What are the differences between real and financial assets? ( LO 1- 2)

6. How does investment banking differ from commercial banking? ( LO 1- 5)

7. For each transaction, identify the real and/ or financial assets that trade hands. Are any financial assets created or destroyed in the transaction? ( LO 1- 2)

a. Toyota takes out a bank loan to finance the construction of a new factory.

b. Toyota pays off its loan.

c. Toyota uses $ 10 million of cash on hand to purchase additional inventory of spare auto parts.

8. Suppose that in a wave of pessimism, housing prices fall by 10% across the entire economy. (LO 1-2)

a. Has the stock of real assets of the economy changed?

b. Are individuals less wealthy?

c. Can you reconcile your answers to ( a ) and ( b )?

9. The average rate of return on investments in large stocks has outpaced that on investments in

Treasury bills by about 7% since 1926. Why, then, does anyone invest in Treasury bills?


1. A municipal bond carries a coupon of 6 ¾ % and is trading at par. What is the equivalent taxable yield to a taxpayer in a combined federal plus state 34% tax bracket?

2. The coupon rate on a tax- exempt bond is 5.6%, and the rate on a taxable bond is 8%. Both bonds sell at par. At what tax bracket marginal tax rate) would an investor be indifferent between the two bonds?

3Why do most professionals consider the Wilshire 5000 a better index of the performance of the broad stock market than the Dow Jones Industrial Average? ( LO 2- 2)

4. What is meant by the LIBOR rate? The Federal funds rate? TED Spread? ( LO 2- 1)

5. Why are corporations more apt to hold preferred stock than are other potential investors? (LO 2-1)

6. A municipal bond carries a coupon rate of 6 ¾ % and is trading at par. What would be the equivalent taxable yield of this bond to a taxpayer in a 35% tax bracket? ( LO 2- 1) 7. Suppose that short- term municipal bonds currently offer yields of 4%, while comparable taxable bonds pay 5%. Which gives you the higher after- tax yield if your tax bracket is: ( LO 2- 1)

a. Zero

b. 10%

c. 20%

d. 30%

8. Consider the three stocks in the following table. Pt represents price at time t, and Q t represents shares outstanding at time t. Stock C splits two- for- one in the last period. ( LO 2- 2)




























a. Calculate the rate of return on a price- weighted index of the three stocks for the first period ( t = 0 to t = 1).

b. What must happen to the divisor for the price- weighted index in year 2?

c. Calculate the rate of return of the price- weighted index for the second period ( t= 1 to t=2)

9. Using the data in the previous problem, calculate the first- period rates of return on the following indexes of the three stocks: ( LO 2- 2)

a. A market value– weighted index

b. An equally weighted index

10. Find the after-tax return to a corporation that buys a share of preferred stock at $40, sells it at year-end at $40, and receives a $4 year-end dividend. The firm is in the 30% tax bracket. (for the purpose of exercise, assume 70% exclusion in dividend for tax purpose)

11. Preferred stock yields often are lower than yields on bonds of the same quality because of: ( LO 2- 1)

a. Marketability

b. Risk

c. Taxation

d. Call protection

Part C

· What are overall investment process and some key elements involved in the investment process

· What are the differences in financial and real assets and the major components of the investment process

· Explain various financial instruments available to the potential investor

· How to perform after tax yields calculation

· What are the various market indexes and price weighted index divisor