Activity Instructions
Read the following scenarios and complete the corresponding questions. Answer in complete and grammatically correct sentences.  I am looking for your thought process in the answers to the questions, so be complete in your answers and demonstrate your knowledge.

Scenario 1 (length: as needed)
Suppose the market for a certain pharmaceutical drug consists of domestic (United States) consumers and foreign consumers. The drug’s marginal cost is constant at $5 per dose. The demand schedules for both regions are given below. 

1. Assuming the markets cannot be separated (and thus the same price must be charged to both regions), what is the marginal revenue for the quantities that you can determine?  What price should be charged to maximize profit?
2. If the markets can be separated, determine the marginal revenues in each market. If the firm must set a single price for the drug in each market (the prices can vary between markets), what price should be charged in the foreign market? In the domestic market?  What happens to the company’s profit?

Scenario 2 (length: as needed)
Apple (relatively) recently introduced different “versions” of the iPhone and iPad—in particular, currently Apple sells four versions of the iPad (iPad Air, iPad with Retina display, iPad mini with Retina display, and the iPad mini– http://www.apple.com/ipad/compare/). Note that the “top of the line” iPad and iPad mini are available with hard drives that range from 16GB to 128GB, and with the A7 chip. The other versions of the iPad and iPad mini are only available with a 16GB hard drive and feature slower chips (A6X and A5), but at a lower price than the top of the line models.

1. Briefly explain why continuing to sell the older models when the newer generation’s models are introduced is an example of price discrimination. How does this help Apple reach a larger market? 
2. Why are the lower tier models are currently only available with the 16GB hard drive, when previously (when they were the top of the line models) they were available with larger hard drives?
3. When the iPad mini was first introduced, industry experts estimated that for every 4 million iPad minis that were sold, sales of the full-sized iPad would decrease by 1 million units. Assuming that is the case, explain why introducing the iPad mini was a good idea, even with some level of cannibalization.

Scenario 3 (length: as needed)
The marginal cost of producing a particular item is $2.50. Suppose a consumer is willing to purchase one item at $10, a second unit of that item at $9, a third unit of that item at $8, and so on. This means that the consumer’s demand schedule looks like:

1. If the firm must set a single price and sell all of its units, what price will it select to maximize profits? What will the profit be?
   1. Suppose the firm can apply a ‘volume discount’, pricing the first good at $10, pricing the second unit at $9, and pricing the third unit at $8, and so on. What is the smallest per-unit price the firm will want to offer? Assuming the volume discount ends at (or before) that price, what will the firm’s profit be?

Scenario 4 (length: as needed)
You are in charge of setting the optimal price for tickets for a local hockey team.  The demand schedule for hockey tickets is below:

1. What price maximizes the revenue from tickets? (Note, since marginal costs are assumed to be zero, this also maximizes profits)
   1. Each spectator also spends money parking and on concessions. The team owns both the nearby lots and the concession stands at the arena. The team has estimated that concession profits increase by $5 per person, and for every four spectators, one parking permit that is priced at $10 is purchased. With these new sources of revenue, what is the optimal ticket price?

Writing Requirements

Length: as indicated (Show your calculations where appropriate.)

1-inch margins

Double spaced

12-point Times New Roman font

This activity will be graded based on thoroughness and correctness of responses. For the numerical and graphical questions, to achieve full marks you must also show your work.

Master the basic techniques of microeconomic analysis such as demand, supply and equilibrium; production and cost theory; and market structure and pricing.

Apply economic reasoning to understand and improve managerial decision-making and grasp the analytical foundations underlying a firm’s competitive strategy.

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FROM BOOK — Reilly, F., & Brown, K. (2012). Investment analysis & portfolio management (10th ed.). Mason, OH: South-Western Cengage Learning.

LINK TO THE BOOK

Chapter 21 – questions 1,2,4,5,6,7,8, 10 (page 813).

1. We have futures contracts on Treasury bonds, but we do not have futures contracts on individual corporate bonds. We have cattle and hog futures but no chicken futures. Explain why the market has developed in this manner. What do you think are the most important characteristics for the success of a new futures contract concept?

2. “Hedgers trade price risk for basis risk.” What is meant by this statement? In particular, explain the concept of the basis in a hedge transaction and how forward and futures contracts can be selected to minimize risk.

4. A multinational corporation is about to embark on a major financial restructuring program. One critical stage will be the issuance of seven-year Eurobonds sometime within the next month. The CFO is concerned with recent instability in capital markets and with the particular event that market yields rise prior to issuance, forcing the corporation to pay a higher coupon rate on the bonds. It is decided to hedge that risk by selling 10-year Treasury note futures contracts. Notice that this is a classic cross hedge wherein 10-year Treasury notes are used to manage the risk of 7-year Eurobonds. Describe the nature of the basis risk in the hedge. In particular what specific events with respect to the shape of the Treasury yield curve and the Eurobond spread over Treasuries could render the hedge ineffective? In other words, under what circumstances would the hedge fail and make the corporation worse off?

5. You are the chief financial officer of a large multinational company, and six months from now you will be receiving a settlement payment of $50 million, which you plan to invest in 10-year U.S. Treasury bonds. Your interest rate forecast indicates that the yield curve will drop dramatically in the next two quarters. You are considering ways that you can guard against the possible decline in interest rates before you have the funds available to invest.

a. Briefly describe the hedging strategy using the 10-year Treasury note futures contract that would provide the best protection against this possible decline in yields.

b. Suppose that six months after you have entered into a futures contract as suggested in Part a, interest rates increases in the market actually increase substantially due to an unexpected change in monetary policy. Discuss how this increase in interest rates will affect the futures position you entered into.

c. Discuss whether you would have been better off (1) with the hedge position or (2) without the hedge position in this situation.

6. You own an equally weighted portfolio of 50 different stocks worth about $5,000,000. The stocks are from several different industries, and the portfolio is reasonably well diversified. Which do you think would provide you with the best overall hedge: a single position in an index futures or 50 different positions in futures contracts on the individual stocks? What are the most important factors to consider in making this decision?

7. Since their introduction, stock index futures contracts have become very popular and are now widely traded by finance professionals. Many factors, including (1) the current price of the underlying stock index, (2) the time to contract maturity, and (3) the dividends paid to the stocks in the underlying index, will affect the settlement price of a stock index futures contract. What is the fourth primary factor involved in stock index futures contract pricing, and how does this factor affect settlement prices?

8. It is often stated that a stock index arbitrage trade is easier to implement when the stock index futures contract price is above its theoretical level than when it is below that value. What institutional realities might make this statement true? Describe the steps involved in forming the arbitrage transaction in both circumstances. To the extent that the statement is valid, what does it suggest about the ability of the stock index futures market to remain efficient?

10. Explain why the currency of Country A, whose interest rates are twice as great as those in Country B, must trade at a forward discount. If there were no difference between the spot and forward exchange rates in this interest rate environment, what arbitrage trade could be constructed to take advantage of the situation?

Chapter 22 – questions 1,2,4,5,7, 10 (page 861).

1. Straddles have been described as “volatility plays.” Explain what this means for both long and short straddle positions. Given the fact that volatility is a primary factor in how options are priced, under what conditions might an investor who believes that markets are efficient ever want to create a straddle?

2. Put-call-forward parity and range forward positions both involve the purchase of a call option and the sale of a put option (or vice versa) on the same underlying asset. Describe the relationship between these two trading strategies. Is one a special case of the other?

4. In the Black-Scholes option pricing model, there are six factors that affect the value of call options on stocks. Three of these factors include (1) the current price of the underlying stock, (2) the time to maturity for the option contract, and (3) the dividend on the stock. Identify the remaining three factors, and explain how they affect the value of call options.

5. “Although options are risky investments, they are valued by virtue of their ability to convert the underlying asset into a synthetic risk-free security.” Explain what this statement means, being sure to describe the basic three-step process for valuing option contracts.

7. Describe the condition under which it would be rational to exercise both an American-style put and call stock option before the expiration date. In both cases, comment specifically on the role that dividends play.

10. On October 19, 1987, the stock market (as measured by the Dow Jones Industrial Average) lost almost one-quarter of its value in a single day. Nevertheless, some traders made a profit buying call options on the stock index and then liquidating their positions before the market closed. Explain how this is possible, assuming that it was not a case of the traders taking advantage of spurious upward ticks in stock prices.

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FROM BOOK — Reilly, F., & Brown, K. (2012). Investment analysis & portfolio management (10th ed.). Mason, OH: South-Western Cengage Learning.

Chapter 17 – questions 1,2,3,4,5,6,7,8,9, 10.

1. Explain the difference between calling a bond and a bond refunding.
2. Identify the three most important determinants of the price of a bond. Describe the effect of each.
3. Given a change in the level of interest rates, discuss how two major factors will influence the relative change in price for individual bonds.
4. Briefly describe two indenture provisions that can affect the maturity of a bond.
5. Explain the differences in taxation of income from municipal bonds, from U.S. Treasury bonds, and from corporate bonds.
6. For several institutional participants in the bond market, explain what type of bond each is likely to purchase and why.
7. Why should investors be aware of the trading volume for bonds in their portfolio?
8. What is the purpose of bond ratings?
9. Based on the data in Exhibit 17.2, discuss the makeup of the Japanese bond market and how and why it differs from the U.S. market. Find Exhibit 17.2 in the link below (page 596).

1. Discuss the positives and negatives of investing in a government agency issue rather than a straight Treasure bond.

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1   Discuss the rationale for expecting an efficient capital market. What factor would you look for to differentiate the market efficiency for two alternative stocks? 100 words

2  Define and discuss the weak-form EMH. Describe the two sets of tests used to examine the weak-from EMH. 100 words

3  Define and discuss the semistrong-form EMH. Describe the two sets of tests used to examine the semistrong-form EMH 100 words

4  What is meant by the term abnormal rate of return? 70 words

7  Describe the results of a study that supported the semistrong-form EMH. Discuss the nature of the test and specifically why the results support the hypothesis. 100 words

8  Describe the results of a study that did NOT support the semistrong-form EMH. Discuss the nature of the test and specifically why the results did not support the hypothesis. 100 words

10  Define and discuss the strong-form EMH. Why do some observers contend that the strong-form hypothesis really requires a perfect market in addition to an efficient market? BE SPECIFIC . 100 words

12 Describe the results of a study that did NOT support the strong-form EMH. Discuss the test involved and specifically why the results reported did not support the hypothesis. 70 words

14  Describe the general goal of behavioral finance. 100 words

16  What does the EMH imply for the use of technical analysis? 70 words

17  What does the EMH imply for fundamental analysis? Discuss specifically what it does not imply. 100 words

18  In a work of efficient capital markets, what do you have to do to be a superior analyst? How would you test whether an analyst was superior. 100 words

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Q 26/27

1. Discuss the overall purpose people have for investing. Define investment.

4. Discuss why you would expect the saving-borrowing pattern to differ by occupation (for example, for a doctor versus a plumber).

 7.   Discuss the three components of an investor’s required rate of return on an investment. 

8.   Discuss the two major factors that determine the market nominal risk-free rate (NRFR).Explain which of these factors would be more volatile over the business cycle. 

9.   Briefly discuss the five fundamental factors that influence the risk premium of an investment. 

10.   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.

12.   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. 

15.   Give an example of a liquid investment and an illiquid investment. Discuss why you con-sider each of them to be liquid or illiquid.

P27/28

1.   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 Francesca stock investment. 

3.   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. 

4.   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. 

6.   You are considering acquiring shares of common stock in the Madison Beer Corporation. Your rate of return expectations are as follows: 

MADISON BEER CORP.

Compute the expected return [E( R̭i )] on your investment in Madison Beer.

12.   Assume that the consensus required rate of return on common stocks is 14 percent. In addition, you read in   Fortune   that the expected rate of inflation is 5 percent and the estimated long-term real growth rate of the economy is 3 percent. What interest rate would you expect on U.S. government T-bills? What is the approximate risk premium for common stocks implied by these data?

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