Discussion Case 1: Tins case is available in MyFinancelab.
Pete and Jessica, on the advice of their next-door neighbor, recently purchased 500 shares of a small-capitalization Internet stock, trading at $80 per share. Their neighbor told them that the stock was a "real money maker" because it recently had a two-for-one stock split and would probably split again soon. Even better, according to the neighbor, the company was expected to earn $1 per share and pay a $0.25 dividend next year. Pete and Jessica have so far been less than impressed with the stock's performance-the stock has underperformed the S&P 500 Index this year. Pete and Jessica have come to you for some independent advice.
Questions
1. Assuming that the stock actually splits two for one, how many shares will Pete and Jessica own? What will be the market value of their stock after the split? How will the split affect the value of their holdings? Was their next-door neighbor correct in thinking that the stock split made the stock a "real money maker"?
2. Using the information provided, calculate the stock's P/E ratio. Would you classify this investment as a growth or value stock?
3. Since Pete, in particular, is worried about the price of the stock, explain to him how and why corporate earnings are so important in the valuation of common stocks.
4. Should Pete and Jessica be using the S&P 500 Index as a benchmark for this stock? Why or why not? What benchmark recommendation would you make?
5. Yesterday they received a cold call from a stockbroker wanting to sell them an initial public offering in a cable television company. Jessica was worried because the broker promised a "no-lose guarantee:*Should they invest with this type of broker?
6. Name at least five things Pete and Jessica need to look out for when making stock investments.
Discussion Case 2: This case is available in MyFinanceLab.
Miguel, a recent college graduate who heard that you know something about investing, wants to ask about investing in bonds. Miguel indicated that, according to his friends, the stock mar¬ket was too volatile and bonds were a safer place to invest. Miguel admitted that he really didn't know much about either stocks or bonds but that he hoped to start saving so that he could purchase a house in the next 5 years. Miguel also mentioned that he had heard about preferred stock and real estate as alternatives to bonds. His roommate recommended that he buy a pre¬ferred stock that pays a $4.50 annual dividend or purchase farmland outside of his hometown. Answer the following questions in a way that will help Miguel learn investment concepts.
Questions
1. List four advantages and four disadvantages of investing in bonds.
2. If Miguel thinks that interest rates are going to increase, what type and maturity of bond should he purchase? What type and maturity should he avoid? Why?
3. Develop a checklist of rules that Miguel should use when purchasing a bond.
4. To be as safe as possible, what bond maturity should Miguel choose to meet his home purchase goal? What type(s) of risk does this strategy reduce or avoid?
5. Explain to Miguel why he might want to consider investing in preferred stock rather than bonds.
6. What is the fair market value of the preferred stock that Miguel is considering purchasing if his required rate of return is 8 percent?