Congress and the president have decided to increase the Federal tax rate in an effort to reduce the budget deficit. Suppose that Caroline Weslin will pay 35 percent of her bonus to the Federal government for taxes if she accepts the bonus today and 40 percent if she receives her bonus in two years. Will the increase in tax rates affect her decision?
Let me throw a different question at you and one that won’t be quite as obvious. Let’s think about the same question but reverse the tax rates. It’s a much more interesting question this way. So, what if she could take her bonus now and be taxed at 40% or take her bonus 2 years from now and be taxed at 35%. Which should she choose?
- What is the key economic principle involved in calculating the present value and future value of multiple cash flows?
- Given that you know the risk as well as the expected return for two stocks, discuss what process you might utilize to determine which of the two stocks is a better buy. You may assume that the two stocks will be the only assets held in your portfolio.
- You may have heard the statement that you should not include your home as an asset in your investment portfolio. Assume that your house will comprise up to 75 percent of your assets in the early part of your investment life. Evaluate the implications of omitting it from your portfolio when calculating the risk of your overall investment portfolio.
- Explain why bond prices and interest rates are negatively related. What is the role of the coupon rate and term to maturity in this relation?
- Why can the market price of a stock differ from its true (intrinsic) value?