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# Investment in Stocks and Bonds

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Chapter 11, question 1, page 350;
Discuss the difference between the top-down and bottom-up approaches. What is the major assumption that causes the difference in these two approaches?

Problems 1, 2, 4, 5, page 350
1. What is the value to you of a 9 percent coupon bond with a par value of \$10,000 that matures in 10 years if you require a 7 percent return? Use semiannual compounding.

2. What would be the value of the bond in Problem 1 if you required an 11 percent rate of return?

4. The Baron Basketball Company (BBC) earned \$10 a share last year and paid a dividend of \$6 a share. Next year, you expect BBC to earn \$11 and continue its payout ratio. Assume that you expect to sell the stock for \$132 a year from now. If you require 12 percent on this stock, how much would you be willing to pay for it?

5. Given the expected earnings and dividend payments in Problem 4, if you expected a selling price of \$110 and required an 8 percent return on this investment, how much would you pay for the BBC stock?

please see the attachment.

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#### Solution Preview

Please see attached file:
Chapter 11, question 1, page 350;
Discuss the difference between the top-down and bottom-up approaches. What is the major assumption that causes the difference in these two approaches?

The Top down approach is the E-I-C (Economy-Industry-Company) analysis. In this appraoch, the security analyst first assess the economic conditions, then selects an industry that would best perform in the that economy, and then selects individual firms within that industry that are the best investments.

The Bottom-up approach is the opposite of the Top-down approach. In the Bottom-up approach, the analyst begins with a company, then investigate the industry of that company, and then assesses weather the economy is favoring that industry. The Bottom -Up approach is also sometimes called "Stock Picking" because this analysis starts with a stock.

"Top-down investors believe that picking individual companies is secondary because if the economic conditions are not right for the industryin which a company operates in, then it will be difficult for the company to generates profits, no matter how efficient it is.
Such investors may sometimes miss good companies that are still performing well, even in a depressed economy or industry.

"

"Bottom up investors do extensive research on individual companies as part of the security analysis process. If a company's prospects are strong, the economic, market or industry cycles are of little or no concern. In fact, the bottom up investors often use the downturn in the stock market to buy stocks at depressed levels and wait for these stock to rise in value when the market recovers to notch up big gains.
Thus, bottom up ...

#### Solution Summary

Calculates the value of stocks and bonds.

\$2.19

## Investments

Issel Corporation had the following transactions pertaining to debt investments

Jan 1 Purchased 60 8%, 1,000 Hollis Co. bonds for \$60,000 cash plus brokerage fees of \$900. Interest is payable semiannually on July 1 and January 1.

July 1 Received semiannual interest on Hollis Co bonds.

July 1 Sold 30 Hollis Co bonds for \$34,000 less \$500 brokerage fees.

(a) Journalize the transactions
(b) Prepare the adjusting entry for the accrual of interest at December 31.

Satazar Company had the following pertaining to stock investments.

Feb 1 Purchased 800 shares of Hippo common stock (2%) for \$8,000 cash plus brokerage fees of \$200.

July 1 Received cash dividends of \$1 per share on Hippo common stock.

Sept 1 Sold 300 shares of Hippo common stock for \$4,400 less brokerage fees of \$100.

Dec 1 Received cash dividends of \$1 per share on Hippo common stock

(a) Journalize the transactions
(b) Explain how dividend revenues and the gain (loss) on sale of bonds should be reported in the income statement

Hermes Inc had the following transactions pertaining to investments in common stock.

Jan 1 Purchased 2,00 shares of Lanier Corporation common stock (5%) for \$140,000 cash plus \$2,100 broker's commission

July 1 received a cash dividend of \$3 per share

Dec 1 Sold 500 shares of Lanier Corporation common stock for \$37,000 cash less \$800 broker's commission

Dec 31 received a cash dividend of \$3 per share

Journalize the transactions

Strawder Farms is a grower of hybrid seed corn for DeKalb Genetics Corporation. I has had two exceptionally good years and has elected to invest its excess funds in bonds. The following selected transactions relate to bonds acquired as an investment by Strawder Farms whose fiscal year ends on December 31

2005
Jan 1 Purchased at par \$800,000 of Lesley Corporation 10-year 9% bonds dated January 1, 2005 directly from the issuing corporation.

July 1 received the semiannual interest on the Lesley bonds.

Dec 31 Accrual of interest at year-end on the Lesley bonds

(Assume that all intervening transactions and adjustments have been properly recorded and the number of bonds owned has not changed from December 31, 2005 to December 31, 2007)

2008
Jan 1 received the semiannual interest on the Lesley bonds

Jan 1 Sold \$400,000 Lesley bonds at 114. The broker deducted \$7,000 for commissions and fees on sale.

July 1 received the semiannual interest on the Lesley bonds.

Dec 31 Accrual of interest at the end-year on the Lesley bonds

(a) Journalize the listed transactions for the years 2005 and 2008
(b) Assume that the fair value of the bonds at December 31, 2005, was\$770,000. These bonds are classified as available for sale securities. Prepare the adjusting entry to record these bonds at fair value
(c) Based on the analysis in part (b) show the balance sheet presentations of the bonds and interest available at December 31,2005. Assume the investments are considered long-term. Indicate where any unrealized gain/loss is reported in the financial statements.

In January 2005, the management of Ralley Company concludes that it has sufficient cash to purchase some short-term investments in debt and stock securities. During the year the following transactions occurred:

Feb 1 Purchased 600 shares of IBT common stock for \$40,000 plus brokerage fees of \$800

Mar 1 Purchased 500 shares of IMA common stock for \$15,000 plus brokerage fees of \$300.

Apr 10 Purchased 60, \$1,000 12% CRE bonds for \$60,000, plus \$1,200 brokerage fees. Interest is payable semiannually on Apr 1 and October 1.

July 1 Received a cash dividend of \$0.06 per share on the IBT common stock

Aug 1 Sold 300 shares of IBT common stock at \$70 per share less brokerage fees of \$350.

Sept 1 Received a \$1 pr share cash dividend on the IMA common stock

Oct 1 Received the semiannual interest on the CRE bonds

Oct 1 Sold the CRE bonds for \$65,000 less \$1,000 brkerage fees

At December 31 the fair value of the IBT common stock was \$66 per share. The fair value of the IMA common stock was \$30 per share.

(a) journalize the transactions and post to the accounts Debit Investments and Stock Investments (T-accounts)
(b) Prepare the adjusting entry at December 31,2005 to report the investments at fair value. All securities are considered to be trading securities.
(c) Show the balance sheet presentation of investment securities at December 31, 2005
(d) Identify the income statement accounts and give the statement classification of each account.

On December 31, 2005 Carlin Associates owned the following securities held as long term investments.

Common Stock Shares Cost
Ace Co 2,000 \$50,000
Burns Co 6,000 36,000
Cruz Co 1,200 24,000

On this date the total and fair value of the securities was equal to its cost. The securities are not held for influence or control over the investors. In 2006 the following transactions occurred:

July 1 Received \$1 per share semiannual cash dividend on Burns Co. common stock

Aug 1 Received \$0.050 per share cash dividend on Ace Co common stock

Sept 1 Sold 2,000 shares of Burns Co common stock for cash at \$7 per share less brokerage fees of \$300

Oct 1 Sold 600 shares of Ace Co common stock for cash at \$28 per share less brokerage fees of \$600

Nov 1 Received \$1 per share cash dividend on Cruz Co common stock

Dec 15 Received \$0.50 per share cash dividend on Ace Co common stock

Dec 31 Received \$1 per share semiannual cash dividend on Burns Co common stock.

At December 31, the fair values per share of the common stock were Ace Co \$24, Burns Co \$6 and Cruz Co \$19

(a) Journalize the 2006 transactions and post to the account Stock Investments (T-account).
(b) Prepare the adjusting entry at December 31, 2006 to show the securities at fair value. The stock should be classified as available for sale securities.
(c) Show the balance sheet presentation of the investments at December 31, 2006. At this date Carlin Associates has common stock \$2,000,000 and retained earnings \$1,200,000

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