in each of the following scenarios, which security should an investor buy? Assum
ID: 1236696 • Letter: I
Question
in each of the following scenarios, which security should an investor buy? Assume that the securities are identical in all ways except as described below. Explain your answer.(a) Security A has an expected return of 12 percent, whereas security B has an expected return of 10 percent.
(b) Interest on security C is 10 percent and is taxable, whereas interest on security D is 7 percent and is not taxable, and the investor's tax rate is 40 percent.
(c) Security E has 20 percent chance of default, whereas security F has a 15 percent chance of default.
(d) Secuirty G and security H are both debt securities that cost $1,000 and mature in one year. An investor incurs a transactions cost of $50 to purchase security G, which has an expected return of 8 percent. An incestor incurs no transactions cost to purchase security H, which has an expected return of 5 percent.
Explanation / Answer
a) A - If the only info you have is expected return, go for the higher one. b) D - The after tax yields are 10(1 - .4) = 6% vs 7% c) F - Lower default rate is better d) H - Total return is 5% vs 3% ((1000 * .08 ) - 50 ) / 1000
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