Financial Instruments

Respond to the following questions using grammatically correct language.

  1. Martha Stewart was accused of insider trading for selling ImClone stocks a day before the stock went down in value. The charges of securities fraud were thrown out but she served 5 months in prison for obstruction of justice and lying to investigators. Do you think what Martha did (insider trading) was unethical from financial management point of view? Explain.

[Answer here.]

  • Explain why wealth maximization is more desirable than profit maximization as a goal for any company.

[Answer here.]

  • Classify the following transactions as taking place in the primary or secondary markets by placing an “X” in the appropriate cells for questions 3 and 4.

Markets

TransactionsPrimary MarketSecondary Market
IBM issues 200 million dollars of new common stock.  
The New Company issues 50 million dollars of common stock in an IPO.  
IBM sells 5 million dollars of GM preferred stock from its marketable securities portfolio.  
The Magellan Fund buys 100 million dollars of previously issued IBM bonds.  
Prudential Insurance Co. sells 10 million dollars of GM common stock.  
  1. Classify the following financial instruments as money market securities or capital market securities:

Financial Instruments

TransactionsMoney MarketCapital Market
Federal Funds.  
Common Stock.  
Corporate Bonds.  
Mortgages.  
Negotiable Certificates of Deposit.  
U.S. Treasury Bills.  
U.S. Treasury Notes.  
U.S. Treasury Bonds.  
State and Government Bonds.  
  • Explain the shape of the yield curve with respect to the unbiased expectations and liquidity premium theories.

[Answer here.]

  • Imagine a particular security’s default risk premium is 2 percent. For all securities, the inflation risk premium is 1.75 percent and the real risk-free rate is 3.50 percent. The security’s liquidity risk premium is 0.25 percent and maturity risk premium is 0.85 percent. The security has no special covenants. Calculate the security’s equilibrium rate of return. Show your work.

[Answer here; show your work.]

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