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.
After-tax rate of return = 9.10%
Preferred stock is a “non-voting” share of ownership of a fraction in a corporation, proportionate to the number of shares owned. It usually pays a fixed dividend.
The total before-tax income is $4. After the 70% exclusion, taxable income is:
0.30 x $4 = $1.20
Taxes = 0.30 x $1.20 = $0.36
After-tax income = $4 – $0.36 = $3.64
After-tax rate of return = $3.64 / $40 = 9.10%
You are bullish on Telecom stock. The current market price is $50 per share, and you have $5,000 of your own to invest. You borrow an additional $5,000 from your broker at an interest rate of 8% per year and invest $10,000 in the stock.
a. What will be your rate of return if the price of Telecom stock goes up by 10% during the next year? (Ignore the expected dividend.)
b. How far does the price of Telecom stock have to fall for you to get a margin call if the maintenance margin is 30%? Assume the price fall happens immediately.
Now reconsider the previous problem (as below) assuming that Fincorp sells in an exchange market like the NYSE.
a. Is there any chance for price improvement in the market orders considered in parts ( a ) and ( b )?
b. Is there any chance of an immediate trade at $55.37 for the limit buy order in part ( d )?
Suppose you observe the investment performance of 350 portfolio managers for five years and rank them by investment returns during each year. After five years, you find that 11 of the funds have investment returns that place the fund in the top half of the sample in each and every year of your sample. Such consistency of performance indicates to you that these must be the funds whose managers are in fact skilled, and you invest your money in these funds. Is your conclusion warranted?
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