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How does inflation impact returns? In this example, you will see how the Fisher equation can be used to determine the best investment option. Suppose Jim has $2,000 to invest and he is not sure what will happen to inflation over the coming year, but the overall market expectation is for inflation to be around 3%. Jim is still uncertain, but he decides to hedge his bets and buy a $1,000 one-year bond paying a 4% annual coupon rate (Bond A). He puts the other $1,000 into a different one-year bond that is indexed to inflation that pays a 1% coupon rate plus an inflation premium that is linked to the consumer price index (Bond B). At the end of the year, the CPI shows that inflation was actually 5% for the year. How did Jim fare with his investments?
Questions to pose:
1. Which investment generated the highest return?
2. What do these results indicate about investor expectations?
An investor was expecting a return of 14.7% on her portfolio with a beta of 1.13 before the market risk premium decreased from 8 to 7%. Based on this change, what return should she now expect on the portfolio?
Charles River Associates is considering whether to call either of the two perpetual bond issues the company currently has outstanding. If the bond is called, it will be refunded, that is, a new bond issue will be made with a lower coupon rate. The pr..
A firm has total assets of $150 million, liabilities of $90 million, and a return on assets of 8%. What is the return on equity? A company’s stock is trading at $35 a share. The company has a P/E ratio of 16, and pays $0.30 in dividends per share. Wh..
Lockboxes should be located?
Soving for n with non annual periods approximately how many years would it take for an investment to grow sixfold if it were invested at 16 percent compounded monthly? assume that you invest $1 today. If you invest $1 at 16% compounded monthly, about..
Miller Manufacturing has a target debt–equity ratio of .40. Its cost of equity is 13 percent, and its cost of debt is 4 percent. If the tax rate is 38 percent, what is the company’s WACC?
Swenson Markets would like to sell an additional 1,000 shares of stock using a Dutch auction. However, every bidder will pay the price of the last bidder to receive any shares. In other words, everyone will pay the lowest price of all successful bidd..
A small company that manufactures vibration isolation platforms is trying to decide whether it should upgrade the current assembly system (System D), which is rather labor-intensive, with one that is more highly automated (System C). Some components ..
You manage an equity fund with an expected risk premium of 12% and a standard deviation of 34%. The rate on Treasury bills is 6.4%. Your client chooses to invest $80,000 of her portfolio in your equity fund and $120,000 in a T-bill money market fund...
What is the average direct labor cost rate and What is the overhead rate.
The 7 percent bonds issued by Modern Kitchens pay semi annually, mature in eight years, and have a $1,000 face value. Currently, the bonds sell for $1,032. What is the yield to maturity?
The real risk-free rate, r*, is 2.1%. Inflation is expected to average 3.2% a year for the next 4 years, after which time inflation is expected to average 4.05% a year. Assume that there is no maturity risk premium. An 8-year corporate bond has a yie..
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