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# The Investment Setting

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Questions
1. Discuss the overall purpose people have for investing. Define investment.
2. Discuss why you would expect the saving-borrowing pattern to differ by occupation for example, (for a doctor versus a plumber)
3. Discuss the three components of an investor's required rate of return on an investment.
4. Discuss the two major factors that determine the market NRFR. Explain which of these factors would be more volatile over the business cycle.
5. Briefly discuss the five fundamental factors that influence the risk premium of an investment.

You own stock in the Gentry Company, and you read in the financial press that a recent bond offering has raised the firm's debt/equity ratio from 35 percent to 55 percent. Discuss the effect of this change on the variability of the firm's net income stream, other factors being constant. Discuss how this change would affect your required rate of return on the common stock of the Gentry Company.
6. Explain why you would change your nominal required rate of return if you expected the rate of inflation to go from 0 (no inflation) to 4 percent. Give an example of what would happen if you did not change your required rate of return under these conditions.
7. Give an example of a liquid investment and an illiquid investment. Discuss why you consider each of them to be liquid or illiquid.

Problems
8. On February 1, you bought 100 shares of stock in the Francesca Corporation for \$34 a share and a year later you sold it for \$39 a share. During the year, you received a cash dividend of \$1.50 a share. Compute your HPR and HPY on this Francseca stock investment.

9.At the beginning of last year, you invested \$4,000 in 80 shares of the Chang Corporation. During the year, Chang paid dividends of \$5 per share. At the end of the year, you sold the 80 shares for \$59 a share. Compute your total HPY on these shares and indicate how much was due to the price change and how much was due to the dividend income.

10. The rates of return computed in Problems 1, 2, and 3 are nominal rates of return. Assuming that the rate of inflation during the year was 4 percent, compute the real rates of return on these investments. Compute the real rates of return if the rate of inflation was 8 percent

11. You are considering acquiring shares of common stock in the Madison Beer Corporation. Your rate of return expectations are as follows:
MADISON BEER CORP
POSSIBLE RATE OF RETURN PROBABILITY
-.10 .30
.00 .10
.10 .30
.25 .30

##### Solution Summary

The expert discusses the overall purpose people have for investing. Why you would expect the saving-borrowing patterns to differ by occupation for examples are given.

##### Solution Preview

Solutions: (also attached)
1. Investment is defined current commitment of dollars for a period of time to derive future payment that can compensate the investor for the time funds are committed, inflation and uncertainty of future payments. Following are the purpose for investment:
- To earn return and increase wealth: People do investment on a belief that they will earn good return and due to this the size of their wealth would increase.
- Financial flexibility: There are investment that are liquid (open investment) where investor is free to buy and see its investment any time. Some are closed investments that are meant for long term like (pension fund). This flexibility has attracted investment as per their needs.
- Tax advantages: There are some investments that investor do get tax advantage. Government provide tax benefits on certain investment to increase some sector or to encourage investment in certain assets.
- Diversification of portfolio: Some investors do investment to diversify its portfolio investment to minimize its risk on investments.
- They get better platform for the excess cash that they manage to save after consumption.

2. Saving or borrowing pattern differs by occupation because it depends on earnings and consumptions. If a doctor earns more, he/she will have more amounts to consume and save and may have freedom to borrow as per his/her earning whereas a plumber earns lesser than a doctor and due to this he has to manage that amount of money for consumption and savings. This ...

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###### Education
• MBA, Indian Institute of Finance
• Bsc, Madras University
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