Question

• If you were able to put together a portfolio that completely eliminated all risk, what return would you expect to earn and why?

• If someone called you and told you that he/she could guarantee you high returns on your investments with little or no risk, what would you do and why.

• When there is uncertainty in the marketplace, what happens to yield spreads and why?

• Your grandfather has great faith in bonds and has heard about some “high yield bonds” that are available. He has asked you for your opinion. What advice will you give him?

• Why do venture capital companies often choose preferred stock for their equity position?

• Explain how supply and demand influences the price of common stock.

• A company has a vacant building on its property that is completely depreciated and it proposes to use it for an expansion project. What cost if any, should it use for that building?

• How does the use of accelerated depreciation encourage investment?

Answer 1

1. If you are able to eliminate all risk of a portfolio , you will be able to earn only risk free rate of return or arbitrage opportunity return.

2. If finance, higher the return higher the risk. Except for arbitrage opportunity, every transaction has risk. So, you should check the underlying security and their specification and understand their risk.

3. if uncertainty in market place increases, yield spread increases.

4. High yield bonds has higher risk or they are basically junk bond. One should not invest in a junk bond for longer period of time i.e. more risk. Hence, I would say, if the investment period is for very short term, go for it or leave it, as this is a high risk investment.

5. Venture capital take very high risk by investing into a newborn company. Preferred capital has preference over equity capital. If the new company decides not to pay dividend to equity shareholder but they should pay preferred dividend. Hence, preferred capital has less risk than equity capital but in case the new company succeeds, then venture capital will also make capital gain on their investment. So, Preferred capital is less risky but gives more or less same return as equity capital. Hence, venture capital prefers preferred capital.

6. If demand increases, price of stock increase and vice versa. And if the supply increases, price of stock decreases and vice versa.

7. The cost need to re-construct the building should be used for that building.

8. Accelerated depreciation decrease the tax significantly and hence, it increases the free cash flow. That's why it encourages investment.