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CHAPTER 2
ASSET CLASSES AND FINANCIAL INSTRUMENTS
2. While the DJIA has 30 large corporations in the index, it does not represent the
overall market nearly as well as the more than 5000 stocks contained in The Wilshire
index. The DJIA is simply too small.
3. Money market securities are short-term, relatively low risk, and highly liquid. Also,
their unit value almost never changes.
4. The major components of the money market are Treasury bills, certificates of deposit,
commercial paper, bankers’ acceptances, Eurodollars, repos, reserves, federal funds,
and brokers’ calls.
5. American Depositary Receipts, or ADRs, are certificates traded in U.S. markets that
represent ownership in shares of a foreign company. Investors may also purchase
shares of foreign companies on foreign exchanges. Lastly, investors may use
international mutual funds to own shares indirectly.
6. The coupons paid by municipal bonds are exempt from federal income tax and from
state tax in many states. Therefore, the higher the tax bracket that the investor is in,
the more valuable the tax-exempt feature to the investor.
7. The London Interbank Offer Rate (LIBOR)—a key reference rate in the money
market—is the rate at which large banks in London are willing to lend money among
themselves. The Fed funds rate is the rate of interest on very short-term loans among
financial institutions in the U.S.
8. General obligation bonds are backed by the taxing power of the local governments,
while revenue bonds have proceeds attached to specific projects. A revenue bond has
fewer guarantees, it is riskier in terms of default, and, therefore, you expect it to have
a higher yield.
10. Limited liability means that the most shareholders can lose in event of the failure of
the corporation is their original investment.
Copyright © 2017 McGraw-Hill Education. All rights reserved. No reproduction or distribution without the prior written
consent of McGraw-Hill Education.
Chapter 02 - Asset Classes and Financial Instruments
11. (a) A repurchase agreement is the sale of a security with a commitment to repurchase
the same security at a specified future date and a designated price.
12. Money market securities are referred to as ―cash equivalents‖ because of their great
liquidity. The prices of money market securities are very stable, and they can be
converted to cash (i.e., sold) on very short notice and with very low transaction costs.
a. The taxable bond. With a zero tax bracket, the after-tax yield for the taxable
bond is the same as the before-tax yield (5%), which is greater than the 4%
yield on the municipal bond.
b. The taxable bond. The after-tax yield for the taxable bond is: 0.05 x (1 – 0.10)
= 0.045 or 4.50%.
c. Neither. The after-tax yield for the taxable bond is: 0.05 x (1 – 0.20) = 0.4 or
4%. The after-tax yield of taxable bond is the same as that of the municipal
bond.
d. The municipal bond. The after-tax yield for the taxable bond is: 0.05 x (1 –
0.30) = 0.035 or 3.5%. The municipal bond offers the higher after-tax yield
for investors in tax brackets above 20%.
15. The after-tax yield on the corporate bonds is: 0.09 x (1 – 0.30) = 0.063 or 6.3%.
Therefore, the municipals must offer at least 6.3% yields.
rm
16. Using the formula of Equivalent taxable yield (r) = , we get:
-t
a. r = = 0.04 or 4.00%
-
b. r = = 0.0444 or 4.44%
-
c. r = = 0.05 or 5.00%
-
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consent of McGraw-Hill Education.
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Conclusion.
John Emery Bucher was born near Hanover, Pa., August 17,
1872. He entered Lehigh University in 1888 and graduated in 1891.
During the past three years he has been a graduate student in the
Johns Hopkins University.
Subjects: Chemistry, Mineralogy and Mathematics.
TRANSCRIBER’S NOTES
1. Silently corrected obvious typographical errors and
variations in spelling.
2. Retained archaic, non-standard, and uncertain spellings
as printed.
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