Can someone finish all 3 assignments for finance class?

1.1

Households make four kinds of economic decisions (textbook, pp. 4–5). Suppose you have two households with the same income. Household A has one income earner and Household B has two income earners. 
How would the four types of economic decisions differ between these two otherwise identical households?

(8 marks)

1.2

Three friends have just graduated, each with a B.Mgt. degree. One wants to start a restaurant and another wants to work as a subcontractor in a building trade. The third friend wants to put together a firm with a couple of other graduates to provide several kinds of complementary financial services including insurance, financial planning, and bookkeeping.
What form of business organization (textbook, pp. 8–9) would you suggest each of the three friends should use, and why?

(12 marks)

2.1

Adam Smith is often called the father of economics. His famous book, The Wealth of Nations,talks about an “invisible hand” which automatically allocates goods to the persons most able to put them to good use. The invisible hand operates through the price mechanism for goods and services, so that individuals who trade on the market, while seeking only their own good, are actually efficiently allocating society’s resources.
His ideas, if applied to modern capital markets, imply that these markets would efficiently allocate investment capital to the firms that would use the capital most efficiently in producing goods and services for society. But this would happen only if markets were left to operate without state intervention. 
Do you think modern governments should leave capital markets unregulated? Why or why not?

(6 marks)

2.2

Consider a business firm, organized as a proprietorship, which has $100,000 invested in assets—a bank loan of $80,000 and $20,000 personal capital invested by the proprietor. If the firm becomes insolvent, who is at risk? Why?

(6 marks)

2.3

In each of the following situations, moral hazard or adverse selection may be present. Indicate which you think is present, if any, and explain your choice.

(10 marks)

a.

An insurance company is thinking about issuing health insurance to a firm’s employees.

b.

An insurance company has issued health insurance to a firm’s employees on the basis of their medical histories.

c.

An investor is asking for a bank loan to support a new business she wants to operate. She is unwilling to submit to a credit check.

d.

An investor has purchased shares in a new software company. He is just a shareholder, and is not going to be involved in the daily operations of the firm.

A grandfather has just given his grandson $100 as a birthday present.

2.4

In each of the situations considered in question 2.3, what could be done to overcome the problem?

(10 marks)

3.1

Use the information in the table below to calculate the following ratios. Use the results to discuss and compare the financial positions of the two firms.

(14 marks)

Ratios:
Total Shareholder Return 
Return on Sales
Return on Assets
Return on Equity
Asset Turnover
Times Interest Earned
Debt Ratio (You’ll need to calculate the average debt during the year.)

Spaling

Preston

EBIT (Earnings before Interest and Taxes)

300,000

190,000

Interest Expense

10,000

15,000

Net income

200,000

100,000

Dividend payout ratio

35%

40%

Retention ratio

65%

60%

Sales

3,000,000

2,000,000

Average assets during the year

2,500,000

1,500,000

Average shareholders’ equity during the year

1,800,000

1,000,000

Market price per share

Beginning of year

20

18

End of year

15

20

Number of shares outstanding

150,000

50,000

3.2

Assume you have put $1,000 in a savings account at 10% annually compounded interest.

How much could you take out each year and still have the original $1,000 in the account?

If you left half of the interest earnings in the account, at what rate would the balance grow from year to year?

If you took out 80% of the interest earnings in the account, at what rate would the balance grow each year?

(6 marks)

3.3

Imagine a corporation with $1,000,000 of assets and a debt ratio of 40%. ROE (return on equity) is expected to be 20% for the foreseeable future. Assume the firm keeps the same amount of debt indefinitely (as opposed to keeping the same debt ratio).

What do you expect the firm’s earnings to be for the next 3 years if the firm doesn’t pay out any dividends or re-purchase any shares? 

If the firm doesn’t pay any dividends or re-purchase any shares, at what rate would the firm grow from year to year?

If the firm pays 50% of its earnings as dividends, at what rate would the firm grow from year to year?

If the firm uses 80% of its earnings to re-purchase shares from its shareholders, at what rate would the firm grow from year to year?

If the firm pays 50% of its earnings as dividends, and uses an additional 20% of its earnings to re-purchase shares from its shareholders, at what rate would the firm grow from year to year?

f.

What does the term “Sustainable Growth Rate” mean? Would the amounts you have calculated in parts b. to d. equal the Sustainable Growth Rate for the firm?

(12 marks)

4.1

Assume that the correct discount rate for the following cash flows is 8%. What is the present value of the following cash flows?

$50 at the end of 3 years

$50 at the end of 100 years

$50 received at the end of each year for 20 years

$50 received at the beginning of each year, totaling 20 payments.

(8 marks)

4.2

Assuming an 8% discount rate, what is the future value of the following cash flows?

future value in 3 years of $50 received now

future value in 100 years of $50 received now

future value at the end of 20 years of $50 received each year at the end of the year

future value at the end of 20 years of $50 received each year at the beginning of the year, again totaling 20 payments.

(8 marks)

4.3

Calculate the following values, assuming a discount rate of 8%:

present value of a perpetuity (also called a perpetual annuity) of $50 received each year at the end of each year

present value of an annuity of $50 received at the end of each year for 5 years

present value of an annuity of $50 received at the end of each year for 10 years, with the first payment to be received at the end of the 6th year

present value of a perpetuity of $50, with the first payment received at the end of the 16th year.

(8 marks)

4.4

Show (with a time line, for example) that the perpetuity in 4.3a. is exactly the same as the sum of the annuities and perpetuities in 4.3b. to 4.3d.

Show that their present values add up to the same amount.

(6 marks)

4.5

Jane is 20 years old today. Jane is going to put $1,000 into her savings account on her 21st birthday and again on every birthday for 20 payments (i.e., till her 40th birthday). She will earn 5%, paid annually. How much money will be in the account after she collects her interest and makes her 20th payment?

Calculate how much money she could take out each year for the 20 years from her 41stbirthday till her 60th birthday, assuming she still earns 5% and takes out the same amount each year, leaving exactly $0 in the account after removing her 20th payment.

(6 marks)

5.1

Assume you have $1 million now, and you have just retired from your jo

b.

You expect to live for 20 years, and you want to have the same level of consumption (

i.

e., purchasing power) for each of these 20 years, after adjusting for inflation. You also wish to leave the purchasing power equivalent of $100,000 today to your kids at the end of the 20 years as a bequest (or to pay them to take care of you).
You expect inflation to be 3% per year for the next 20 years, and nominal interest rates are expected to stay around 8% per year.

A.

Calculate the actual amount of consumption, in nominal dollars, using the stated assumptions.

How much do you need for your kids?

ii.

If you plan to consume $1.03 in year 1, how much will you need to have to keep the same real consumption in year 2? In year 10? In year 20?

iii.

How much, in nominal dollars, will $1 of retirement funds earn in year 1? Year 2? Year 10? Year 20?

i

v.

In an Excel spreadsheet (or in a manual table), calculate the following:

a.

annual investment earnings for each year

total savings after investment earnings for each year

c.

subtract annual consumption from total savings each year

d.

by trial and error, or with the Goal Seek command, determine the amount of consumption that will give you exactly $100,000, in today’s purchasing power, at the end of 20 years

Hint: You will need to make your annual consumption column dependent on the inflation rate, your investment earnings will grow at the nominal rate, and the bequest of $100,000 will grow at the inflation rate.

B.

Do the calculation again using real rates, and setting inflation to equal 0. If you set up your Excel spreadsheet carefully, you should be able to set the inflation rate to equal 0 and enter the real rate of return as the investment earning rate.
Feel free to use the spreadsheet below to help you answer this question.

 
5.1template.xls

What is the amount of real consumption in year 1? In year 2? In year 10? In year 20?

Show that this is consistent with your calculation using nominal rates.

How much, in real dollars, does that leave for your kids?

Show that your bequest is consistent with the nominal rate results above.

(30 marks)

5.2

Linus is 18 years old now, and is thinking about taking a 5-year university degree. The degree will cost him $25,000 each year. After he’s finished, he expects to make $50,000 per year for 10 years, $75,000 per year for another 10 years, and $100,000 per year for the final 10 years of his working career. If Linus lives to be 100, and if real interest rates stay at 5% per year throughout his life, what is the equal annual consumption he could enjoy until that date?

Linus is also considering another option. If he takes a job at the local grocery store, his starting wage will be $40,000 per year, and he will get a 3% raise, in real terms, each year until he retires at the age of 53. If Linus lives to be 100, what is the equal annual consumption he could enjoy until that date?

C.

From strictly a financial point of view, is Linus better off choosing option A or B?

(10 marks)

5.3

Are you better off playing the lottery or saving the money? Assume you can buy one ticket for $5, draws are made monthly, and a winning ticket correctly matches 6 different numbers of a total of 49 possible numbers. 
The probabilities: In order to win, you must pick all the numbers correctly. Your number has a 1 in 49 chance of being correct. Your second number, a 1 in 48 chance, and so on. There are exactly 49 x 48 x 47 x 46 x 45 x 44 = 10,068,347,520 ways to pick 6 numbers from 49 options.
But the order in which you pick them does not matter, so you actually have a few more ways to win. You can pick 6 different numbers in exactly 6 x 5 x 4 x 3 x 2 x 1 = 720 orders of choice. Any one of those orders would still win the lottery.
Putting this all together, your ticket has 720/10,068,347,520 = 1/13,983,816 chance of winning. This equates to a .000000071 percentage chance.
If you played one ticket every month from age 18 to age 65, you would have 47 x 12 = 564 plays. Your odds of not ever winning would be calculated using a binomial distribution to be .9999599568, meaning your chances of winning would be 1 – .9999599568 = .0000400432.
So, if the lottery winnings averaged $10 million over this time period, your expected return would be less than .0000400432 x $10 million = $400.43. 
(It’s less than $400.43 because your 564 plays are spread out over the next 47 years, so the present value of these future plays would be significantly less than if you were able to play all 564 immediately. The $400.43 assumes you play all 564 plays today, which makes it the highest possible expected value.)
REQUIRED:

What would your $400.43 be worth if you invested it at 1% real interest for 47 years?

If, instead, you wrote down your 6 numbers on a piece of paper, and deposited your $5 in a bank at 1% real interest, how much would you have at the end of the first year?

If you did this every year for 47 years, how much would you have at age 65?

D.

If you earned 5% real interest on your deposits, how much would you have at age 65?

E.

Which option would make you better off at age 65? How many times better off?

(10 marks)

5.4

Use the Excel spreadsheet named “
LeasevsBuyCCA.xls
” to answer the following question. You may choose to answer the question without using the spreadsheet, but be very careful to show all work, so your marker can follow your calculation and award part marks as necessary.
You want to buy a new car, but you’re not sure whether you should lease it or buy it. You can buy it for $50,000, and you expect that it will be worth $20,000 after you use it for 3 years. Alternatively, you could lease it for payments of $650 per month for the 3-year term, with the first payment due immediately. The lease company did not tell you what interest rate they’re using to calculate the monthly payments, but you know you could borrow money from your banker at an annual percentage rate (APR) of 8%.

Calculate the present value of the lease payments, assuming monthly compounding at the given APR of 8%.

Calculate the present value of the $20,000 salvage value, again using monthly compounding and the given APR of 8%. Which option do you prefer, lease or buy?

Calculate the amount of the salvage value which would make you indifferent between leasing and buying.

If you were able to use this car 100% for business, rendering the lease payments tax-deductible, or alternatively, allowing you to deduct depreciation using straight-line depreciation (depreciated to expected salvage value) and assuming your tax rate is 40%, would you prefer to buy or lease the car?

(10 marks)

6.1

You and your friends are thinking about starting a motorcycle company named Apple Valley Choppers. Your initial investment would be $500,000 for depreciable equipment, which should last 5 years, and your tax rate would be 40%. You could sell a chopper for $10,000, assuming your average variable cost per chopper is $3000, and assuming fixed costs, such as rent, utilities and salaries, would be $200,000 per year.

Accounting breakeven: How many choppers would you have to sell to break even, ignoring the costs of financing?

Financial breakeven: How many choppers would you have to sell to break even, if you required a 15% return? (Hint: Use the 15% as the discount rate and calculate net present value. In Excel, you may want to use the Goal Seek command, or simply use trial and error to find the correct amount.)

Assuming you could sell 60 choppers per year, what would be your IRR?

Assuming you could sell 60 choppers per year, what would your selling price have to be to generate a net present value of $150,000 at a 15% discount rate? 

If you could sell 60 choppers in the first year, and your sales volume increased by 5% each year until the end of year 5, what would the net present value be at a 15% discount rate?

F.

If you need to invest working capital equal to 10% of the next (coming) year‘s sales revenue, what would be the effect on the net present value of the project? Do you think that working capital investments always reduce the net present value of projects? (Assume a 15% discount rate, and sales volume increases by 5% each year.)

(20 marks)

6.2

Fill in the missing items in the following table. Assume that the real interest rate is 3% per year, and inflation is expected to be constant at 2% per year.

Year

Nominal cash flow

Real cash flow

0

–100,000

–100,000

1

+ 12,000

?

2

+22,000

?

3

+15,000

?

4

+10,000

?

Net present value

?

?

(10 marks)

7.1

Find a Web site that shows exchange rates for all major international currencies. At the time of writing, XE.com and oanda.com are examples of such sites.

is the British Pound shown? If not, why not? (You might have to do some investigation online if you’re not familiar with the history of European currency.)

What is the exchange rate between the Canadian dollar and the US dollar?

XE.com also allows you to see exchange rates for gold ounces (under “more currencies available”). What does XE.com (or a similar site) say 1 ounce of gold is worth in Canadian dollars? In US dollars? What does this imply is the exchange rate between Canadian dollars in US dollars? Is this the same as your answer to part B.?

If you saw that the US dollar price of gold was one dollar less than the price shown, how could you use that information to make an arbitrage profit?

(10 marks)

7.2

Fill in the following table using XE.com or a similar foreign-currency quote Web site. In each cell, record the number of units of the currency stated in the first cell of the column that would be required to buy one unit of currency as stated in the row heading. 
For example, if you sold US$1, how many European Euros could you buy? Enter that amount in the third column, second row. Continue until the table is filled completely.

sell/buy

US $1

European €1

Canadian $1

Japanese ¥1

US $1

1

European €1

1

Canadian $1

1

Japanese ¥1

1

Why are the numbers in the Japanese ¥ column so much higher than the numbers in the other rows?

(10 marks)

8.1

Look up the US Treasury yield curve online.

What is the promised yield for a 1-month T-bill?

For a 6-month T-bill?

A 1-year T-bill?

A 5-year T-bond?

A 10-year T-bond?

A 20-year T-bond?

iiv.

A 30-year T-bond?

iiiv.

On what date did you look up these yields?

ix.

On what Web site did you find these yields?

Is this yield curve flat, rising, or inverted?

Many introductory finance textbooks say, at the beginning of bond valuation problems, “Assume the yield curve is flat.” Another way of putting this is “Assume the term structure of interest rates is flat.” How would this assumption make the questions easier for students of introductory finance to solve?

(10 marks)

8.2

Fill in the missing items in the following table, using the Law of One Price. Assume all these bonds have the same risk and any coupon payments are paid annually.

Bond #

1

2

3

4

1-year
strip bond

2-year 
strip bond

2-year 6% coupon bond

2-year 7% coupon bond

Time 0 cash flow (i.e., Purchase Price for the bond)

–950

?

?

?

Time 1 cash flow

+1000

0

+60

+70

Time 2 cash flow

0

+1000

+1060

+1070

Yield

?

?

5.50%

?

(10 marks)

8.3

You are considering two investments from the bonds listed in question 8.2. Show that the cash flows from the following two investments would be identical.

60 units of Bond #1 + 1060 units of Bond #2, and

1000 units of Bond #3.

How many units of Bond #1 and #2 would you need to replicate the cash flows of 1000 units of Bond #4?

If the yield of Bond #3 is 5.5%, what would it cost to buy 1000 units of Bond #3?

What would it cost to buy 60 units of Bond #1?

From part A. above, infer the value of 1060 units of Bond #2.

What is the value of one unit of Bond #2? Yield of Bond #2?

What’s the value of 1000 units of Bond #4? Yield?

What have you learned about the Law of One Price from questions 8.2 and 8.3?

(10 marks)

8.4

Assume the yield curve on “plain vanilla” default-free bonds is flat at 5%, and you are thinking of buying a default-free bond. Specifically, you’re thinking of buying a bond issued by Risklessco, a company considered to be default-free by all major bond rating firms.
You will select one of the following three bonds, all identical except for the special features listed:

Face Value

Maturity

Coupon Rate (Paid Annually)

Yield to Maturity

Special Features

Price

A

1000

20 years

5.5%

5%

None

?

B

1000

20 years

5.5%

5%

Callable

Par

C

1000

20 years

5.5%

3.5%

Callable and Convertible into Risklessco Stock

?

Why is the yield on bonds A and B 5%? Why is the yield on bond C different?

What would be the price of Bond A?

If bond C is considered identical to bond B except for the conversion privilege, what is the value of the conversion privilege? Does the conversion privilege benefit the issuer of the bond or the purchaser? Is this consistent with the price you calculated for bond C?

Who does the callability provision benefit, the issuer or the purchaser? Is this consistent with the price you calculated for bond A?

(10 marks)

9.1

The Constant-Growth-Rate Discounted Dividend Model, as described equation 9.5 on page 247, says that:
P0 = D1 / (k – g)

A.

rearrange the terms to solve for:
i. g; and
ii.  D1.
As an example, to solve for k, we would do the following:
1.  Multiply both sides by (k – g) to get: P0 (k – g) = D1 
2.  Divide both sides by P0 by to get: (k – g) = D1 / P0
3.  Add g to both sides: k = D1 / P0 + g

(8 marks)

9.2

Notation: Let 
Pn = Price at time n

Dn = Dividend at time n

Yn = Earnings in period n
r = retention ratio = (Yn– Dn) / Yn = 1 – Dn/ Yn = 1 – dividend payout ratio
En = Equity at the end of year n
k = discount rate

g = dividend growth rate = r x ROE

ROE = Yn / En-1 for all n>0.
We will further assume that k and ROE are constant, and that r and g are constant after the first dividend is paid.

Using the Discounted Dividend Model, calculate the price P0 if 
D1 = 20, k = .15, g = r x ROE = .8 x .15 = .12, and Y1 = 100 per share 
 

B.

What, then, will P5 be if:
D6 = 20, k = .15, and g = r x ROE = .8 x .15 = .12? 
 

C.

If P5 = your result from part B, and assuming no dividends are paid until D6, what would be P0? P1? P2?
 

D.

Again, assuming the facts from part B, what is the relationship between P2 and P1 (i.e., P2/P1)? Explain why this is the result.
 

E.

If k = ROE, we can show that the price P0 doesn’t depend on r. To see this, let 
g = r x ROE, and ROE = Yn / En-1, and 
since r = (Yn – Dn) / Yn , then D1 = (1 – r) x Y1 and

P0

=

D1 / (k – g)

P0

=

[(1 – r) x Y1] / (k – g)

P0

=

[(1 – r) x Y1] / (k – g), but, since k = ROE = Y1 / E0

P0

=

[(1 – r) x Y1] / (ROE – r x ROE)

P0

=

[(1 – r) x Y1] / (Y1 / E0 – r x Y1 / E0)

P0

=

[(1 – r) x Y1] / (1 – r) x Y1 / E0), and cancelling (1 – r)

P0

=

Y1 / (Y1/E0) = Y1 x (E0 / Y1) = E0

So, you see that r is not in the final expression for P0, indicating that r (i.e., retention ration or, equivalently, dividend policy) doesn’t matter if k = ROE.
Check that changing r from .8 to .6 does not change your answer in part A of this question by re-calculating your result using r = .6.

(10 marks)

9.3

You are considering an investment in the shares of Kirk’s Information Inc. The company is still in its growth phase, so it won’t pay dividends for the next few years. Kirk’s accountant has determined that their first year’s earnings per share (EPS) is expected to be $20. The company expects a return on equity (ROE) of 25% in each of the next 5 years but in the sixth year they expect to earn 20%. In the seventh year and forever into the future, they expect to earn 15%. Also, at the end of the sixth year and every year after that, they expect to pay dividends at a rate of 70% of earnings, retaining the other 30% in the company. Kirk’s uses a discount rate of 15%.
 

Fill in the missing items in the following table:

Year

EPS

ROE

Expected Dividend
(end of year)

Present Value Of Dividend 
(at time 0)

0

n/a

n/a

n/a

n/a

1

20

25%

0

0

2

25 = 1.25 x 20

25%

0

0

3

?

25%

0

0

4

?

25%

0

0

5

?

25%

0

0

6

?

20%

?

?

7

?

15%

?

?

8

?

15%

?

?

B.

What would the dividend be in year 8?
 

Calculate the value of all future dividends at the beginning of year 8. (Hint: P7 depends on D8.) 
 

What is the present value of P7 at the beginning of year 1?
 

What is the value of the company now, at time 0?

(10 marks)
 

9.4

You own one share in a company called Invest Co. Inc. Examining the balance sheet, you have determined that the firm has $100,000 cash, equipment worth $900,000, and 100,000 shares outstanding.
Calculate the price/value of each share in the firm, and explain how your wealth is affected if:
 

The firm pays out dividends of $1 per share.
 

The firm buys back 10,000 shares for $10 cash each, and you choose to sell your share back to the company.
 

The firm buys back 10,000 shares for $10 cash each, and you choose not to sell your share back to the company.
 

The firm declares a 2-for-1 stock split.
 

The firm declares a 10% stock dividend.
 

F.

The firm buys new equipment for $100,000, which will be used to earn a return equal to the firm’s discount rate.

(12 marks)

10.1

Calculate the mean and standard deviation of the following securities’ returns:

Year

Computroids Inc.

Blazers Inc.

1

10%

5%

2

5%

6%

3

–3%

7%

4

12%

8%

5

10%

9%

Assuming these observations are drawn from a normally distributed probability space, we know that about 68% of values drawn from a normal distribution are within one standard deviation away from the mean or expected return; about 95% of the values are within two standard deviations; and about 99.7% lie within three standard deviations. 
Using your calculations from part A, calculate the 68%, 95%, and 99% confidence intervals for the two stocks. To calculate the 68%, you would calculate the top of the confidence interval range by adding one standard deviation to the expected return, and calculate the bottom of the confidence interval by subtracting one standard deviation from the expected return. For 95%, use two standard deviations, and for 99%, use three. 
Your answer should show three ranges from the bottom of the confidence interval to the top of the confidence interval. 
 

For each security, would a return of 14% fall into the 68% confidence interval range? If not, what confidence interval range would it fall into, or would it be outside all three confidence intervals? 
[This is the same as asking whether a return of 14% has less than a 68% probability of occuring by chance for that security. If it’s not inside the 68% confidence interval, it’s unlikely to occur, since it will only occur by chance 32% of the time. Of course, the 99% confidence interval is much more likely to include the observed return, simply by chance. Only 1% of the time will it fall outside the 99% CI. Pretty rare.]

(14 marks)

10.2

Some Internet research may be required to answer this question, although it’s not absolutely necessary. 
What could you do to protect your bond portfolio against the following kinds of risk?
 

Risk of an increasing interest rate

Risk of inflation increasing

Risk of volatility in the markets

(6 marks)

10.3

You are starting a new business, and you want to open an office in a local mall. You have been offered two alternative rental arrangements. You can pay the landlord 10% of your sales revenue, or you can pay a fixed fee of $1,000 per month. Describe the circumstances in which each of these arrangements would be your preferred choice.

(10 marks)

11.1

In the northeast United States and in eastern Canada, many people heat their houses with heating oil. Imagine you are one of these people, and you are expecting a cold winter, so you are planning your heating oil requirements for the season. The current price is $2.25 per US gallon, but you think that in six months, when you’ll need the oil, the price could be $3.00, or it could be $1.50. 
 

If you need 350 gallons to survive the winter, how much difference does the potential price variance make to your heating bills?
 

If your friend Tom is running a heating oil business, and selling 100,000 gallons over the winter season, how does the price variance affect Tom?
 

Which one of you benefits from the price increase? Which of you benefits from price decrease?
 

What are two strategies you can use to reduce the risk you face? Could you make an agreement with Tom to mitigate your risk?
 

Assuming you are both risk-averse, does such an agreement make you both better off?

(10 marks)
 

11.2

You have just received good news. You have a rich uncle in France who has decided to give you a monthly annuity of €2,000 per month. You are concerned that you will become accustomed to having these funds, but if the currency exchange rate moves against you, you may have to make do with less.
 

If you are living in Canada, what does it mean for the currency exchange rate to move against you?
 

Would moving to France mitigate some of the risk? If so, how? If not, why not?
 

If you want to stay in Canada, and your grandparents, who have retired to Provence, receive a Canadian pension of C$1100 each, what could you do to reduce the risk for all of you?

(9 marks)

11.3

You have learned about a number of ways of reducing risk, specifically hedging, insuring, and diversifying. In the table below, place an X in the cell for the technique being used to reduce risk.

Hedging

Insuring

Diversifying

1

Placing an advance order with Amazon.ca, which agrees to charge you the lower of the advance price, and the price at the time your order is filled.

2

Purchasing a call option on a stock you think may go up in price.

3

Selling 200 shares of IBM and buying a mutual fund that holds the same stocks as the S&P index.

4

Selling a debt owed to you for $.50 per dollar owed.

5

Agreeing to a long-term contract with a supplier at a fixed price.

6

Agreeing to a no-trade clause with the sports team that employs you.

7

Buying a Mac and a PC.

8

Paying a clown to perform for your child’s birthday party six months before the birthday.

(16 marks)

11.4

Suppose you own 100 shares of Dell Inc. stock. Today it is trading at $15 per share, but you’re worried Michael Dell might retire again, causing the price to go down. How would you protect yourself against his retirement, assuming you don’t want to sell the shares today?

(5 marks)