Financial Instruments

Week 2

Exercises

1. What are the advantages of investing in the common stock rather than the corporate bonds
of a company? Compare the certainty of returns for a bond with those for a common stock.

2. Discuss three factors that cause U.S. investors to consider including global securities in
their portfolios.

3. Discuss why international diversification reduces portfolio risk. Specifically, why would
you expect low correlation in the rates of return for domestic and foreign securities?

4. When you invest in Japanese or German bonds, what major additional risks must you
consider besides yield changes within the country?

5. Some investors believe that international investing introduces additional risks. Discuss
these risks and how they can affect your return. Give an example.

6. TMP has been experiencing increasing demand from its institutional clients for
information and assistance related to international investment management. Recognizing that
this is an area of growing importance, the firm has hired an experienced analyst/portfolio
manager specializing in international equities and market strategy. His first assignment is to
represent TMP before a client company’s investment committee to discuss the possibility of
changing their present “U.S. securities only” investment approach to one including
international investments. He is told that the committee wants a presentation that fully and
objectively examines the basic, substantive considerations on which the committee should
focus its attention, including both theory and evidence. The company’s pension plan has no
legal or other barriers to adoption of an international approach; no non-U.S. pension
liabilities currently exist.

a. Identify and briefly discuss three reasons for adding international securities to the pension
portfolio and three problems associated with such an approach.

b. Assume that the committee has adopted a policy to include international securities in its
pension portfolio. Identify and briefly discuss three additional policy-level investment
decisions the committee must make before management selection and actual implementation
can begin.

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7. Define market and briefly discuss the characteristics of a good market.

8. Define liquidity and discuss the factors that contribute to it. Give examples of a liquid
asset and an illiquid asset, and discuss why they are considered liquid and illiquid.

9. Define a primary and secondary market for securities and discuss how they differ. Discuss
why the primary market is dependent on the secondary market.

10. Briefly explain the difference between a competitive bid underwriting and a negotiated
underwriting.

11. Briefly define each of the following terms and give an example:
a. Market order
b. Limit order
c. Short sale
d. Stop loss order

12. The initial margin requirement is 60 percent. You have $40,000 to invest in a stock
selling for $80 a share. Ignoring taxes and commissions, show in detail the impact on your
rate of return if the stock rises to $100 a share and if it declines to $40 a share assuming (a)
you pay cash for the stock, and (b) you buy it using maximum leverage.