Question

14. Suppose that short- term municipal bonds currently offer yields of 4%, while comparable taxable bonds pay 5%. Which gives you the higher after- tax yield if your tax bracket is: ( LO 2- 1)

a. Zero

b. 10%

c. 20%

d. 30%

19. Consider the three stocks in the following table. P_t represents price at time t, and Q t represents shares outstanding at time t. Stock C splits two- for- one in the last period. ( LO 2- 2)

	P0	Q0	P1	Q1	P2	Q2
A	90	100	95	100	95	100
B	50	200	45	200	45	200
C	100	200	110	200	55	400

a. Calculate the rate of return on a price- weighted index of the three stocks for the first period ( t = 0 to t = 1).

b. What must happen to the divisor for the price- weighted index in year 2?

c. Calculate the rate of return of the price- weighted index for the second period ( t= 1 to t=2)

20. Using the data in the previous problem, calculate the first- period rates of return on the following indexes of the three stocks: ( LO 2- 2)

a. A market value– weighted index

b. An equally weighted index

32. Find the after-tax return to a corporation that buys a share of preferred stock at $40, sells it at year-end at $40, and receives a $4 year-end dividend. The firm is in the 30% tax bracket. (LO 2-1)

CFA Problems
1. Preferred stock yields often are lower than yields on bonds of the same quality because of: ( LO 2- 1)

a. Marketability

b. Risk

c. Taxation

d. Call protection

Answer 1

14. a) at 0%

r * (1-t) i.e. .05 * (1-0) i.e. .05 or 5%

b) at 10%

  r * (1-t) i.e. .05 * (1-.10) i.e. .045 or 4.5%

c) at 20%

  r * (1-t) i.e. .05 * (1-.20) i.e. .04 or 4%

d) at 30%

   r * (1-t) i.e. .05 * (1-.30) i.e. .035 or 3.5%

at 0% tax rate after- tax yield @ 5% will be the highest.

15.

a) Calculation of the rate of return on a price- weighted index of the three stocks for the first period ( t = 0 to t = 1) :

At t = 0, The Index Value will be ( 90+50+100)/3 = 80 ;

At t=1 ,Index Value will be (95+45+110)/3 = 83.33

Rate of Return for the first period is (83.33 - 80) / 80 *100 = 4.1625%

b) We need the new divisor becouse stock split doesn't effect the Index Value.

So, (95+45+55)/d = 83.33

So,d = 2.34

c)Since there is no changes in Return for Period 2 in comparison with period 1,there is NIL Rate of Return.

20. calculation of the first- period rates of return from the data given in last problem of the three stocks:

a. A market value– weighted index

at t= 0, Market Value = (90 * 100)+(50*200)*(100*200) i.e. $39,000

at t= 1,Market Value = (95*100)+(45*200)+(110*200) i.e. $40,500

Rate of Return = ($40500 - $39000) / $39000 * 100 i.e. 3.85%

b) An equally weighted index

For Stock A = (95-90)/90 *100 = 5.56%

For Stock B = (45-50)/50*100 = (10%) &

For Stock C = (110-100)/100*100 = 10%

RoR under equally weighted index = (5.56-10+10)/3 = 1.85%

32. after-tax return to a corporation that buys a share of preferred stock at $40, sells it at year-end at $40, and receives a $4 year-end dividend. The firm is in the 30% tax bracket:

Dividend received at the end =$4

After Tax Dividend is D(1-t) i.e. $2.80

So,RoR will be = $2.80/$40*100 = 7%

1. Preferred stock yields often are lower than yields on bonds of the same quality because of Taxation.