An investor buys three shares of xyz at the beginning

Finance Problem

FIN-321

Homework 1 – Fall 2017

Due: Thursday, October 5, at the beginning of class (in person)

Each student needs to submit their own handwritten (legible!) answers.

1. The wealth of an economy is generated by real assets. The availability of tradable financial

assets has no effect on the wealth of an economy. Do you agree? Why or why not?

2. A mutual fund company such as Vanguard is a financial intermediary.

a. Give two examples of financial assets created by Vanguard.

b. Why does an institution such as Vanguard create the financial assets in your above example

and not people like you and me?

Common text for questions 3 and 4:

An investor buys three shares of XYZ at the beginning of 2002 for $100 apiece. After one year,

the share price has increased to $110 and he receives a dividend per share of $4. Right after

receiving the dividend, he buys two additional shares at $110. After another year, the share price

has dropped to $90, but the investor still receives a dividend per share of $4. Right after

receiving the dividend, he sells one share at $90. After another year, the share price has gone up

to $95, the investor receives a dividend per share of $4 and sells all shares at $95 immediately

after receiving dividends.

3. What are the arithmetic and geometric average time-weighted rates of return and what is the

dollar-weighted rate of return of the investor in the above example (for the dollar-weighted

return assume that (i) the cash flows from dividends received at the end of a given year are based

on the number of shares held at the beginning of that year, and (ii) cash flows from dividends

occur on the same day as the cash flows from buying and selling shares)?

4. Why is the dollar-weighted average rate of return in the above example lower than the

geometric average rate of return?