A. What was your realized return? b. How much of the return came from dividend yield, and how much came from capital gain?

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FIN515 Unit4 Practice Set Solutions

FIN515 Unit 4 Practice Set Solutions

10-4. You bought a stock 1 year ago for $50 per share and sold it today for $55 per share. It paid a $1 per share dividend today.
a. What was your realized return?
b. How much of the return came from dividend yield, and how much came from capital gain?
Compute the realized return and dividend yield on this equity investment.

The realized return on the equity investment is 12%. The dividend yield is 10%.
10-5. Repeat Problem 4 assuming that the stock fell $5 to $45 instead.
a. Is your capital gain different? Why or why not?
b. Is your dividend yield different? Why or why not?
Compute the capital gain and dividend yield under the assumption that the stock price has fallen to $45.
a. Yes, the capital gain is different, because the difference between the current price and the purchase price is different than in Problem 1.
b. The dividend yield does not change, because the dividend is the same as in Problem 1.
The capital gain changes with the new lower price; the dividend yield does not change.
10-20. Consider two local banks. Bank A has 100 loans outstanding, each for $1 million, that it expects will be repaid today. Each loan has a 5% probability of default, in which case the bank is not repaid anything. The chance of default is independent across all the loans. Bank B has only one loan of $100 million outstanding, which it also expects will be repaid today. It also has a 5% probability of not being repaid. Explain the difference between the type of risk each bank faces. Which bank faces less risk? Why?
The expected payoffs are the same, but Bank A is less risky. (See the solution to Problem 10–21 for a full explanation of the banks’ relative risk levels.)
10-22. Consider the following two, completely separate, economies. The expected return and volatility of all stocks in both economies is the same. In the first economy, all stocks move together—in good times all prices rise together, and in bad times they all fall together. In the second economy, stock returns are independent—one stock increasing in price has no effect on the prices of other stocks. Assuming you are risk-averse and you could choose one of the two economies in which to invest, which one would you choose? Explain.
A risk-averse investor would choose the economy in which stock returns are independent, because this risk can be diversified away in a large portfolio.

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