# Term paper on Contemporary Financial Management

Question A. Calculate the holding period return on a before-tax basis for each of these four investment vehicles.

1) Common stock

Overall, holding period return is calculated as follows: HPR = (Income + Ending value �� Beginning Value)/Beginning Value (Moyer et al., 2012). In the considered case, holding period is the past calendar year. For common stock, the holding period return is: HPR = (400*(\$.0.20+\$0.20+\$0.25+\$0.25) + 400*18.75 �� 400*\$17.25))/ 400*\$17.25 = (400*\$0.9 + 400*\$18.75 �� 400*\$17.25) / \$6900 = (\$360 + \$7500 – \$6,900) / \$6,900 = \$960 / \$6,900 = 13.91%

2) Industrial bonds

HPR = (Income + Ending Value �� Starting Value ) / Starting Value = 8*(\$1,000*9.25%/100% + 96.375%*\$1,000 / 100% – 97.000%*\$1,000 / 100%) / 8*(97.000%*\$1,000 / 100%) = 8*(\$92.50 + \$963.75 – \$970) / 8*\$970 = 8*\$86.25 / 8*\$970 = 8.89%

3) Mutual fund shares

For mutual funds, HPR can be calculated as follows: HPR = (Income + Capital gain + NAV Ending �� NAV Beginning) / NAV Beginning. For the Stalchecks’ portfolio, HPR = (500*\$0.60 + 500*\$0.50 + 500*\$20.02 �� 500*\$19.45) / 500*\$19.45 = (\$300 + \$250 + \$10,010 – \$9,725) / \$9,725 = \$835 / \$9,725 = 8.59%

4) Options

For options, HPR can be calculated as follows: HPR = (Total ending value of contracts �� Total beginning value of contracts) / Total beginning value of contracts = (\$29,000 – \$26,000) / \$26,000 = \$3,000 / \$26,000 = 11.54%

Question B. Assuming that the Stalchecks’ ordinary income is currently being taxed at a combined (federal and state) tax rate of 38%, and that they would pay a 15% capital gains tax on dividends and capital gains for holding periods longer than 12 months, determine the after-tax HPR for each of their four investment vehicles.

1) Common stock

Income for common stock is taxable and will be taxed at 38% rate; change of stock value represents an unrealized capital gain and is not taxed (Moyer et al., 2012). After-tax value of stock income will be 400*(\$.0.20+\$0.20+\$0.25+\$0.25)*(1-0.38) = \$360*0.62 = \$223.20. Therefore, after-tax HPR = (\$223.20 + \$7,500 – \$6,900) / \$6,900 = \$823.20 / \$6,900 = 11.93%

2) Industrial bonds

Income for industrial bonds is taxable and will be taxed at 38% rate; change of bond quote represents an unrealized capital gain and is not taxed. After-tax value of bond income will be 8*\$1,000*0.0925*(1-0.38) = 8*\$92.50*0.62=\$458.8. Therefore, after-tax HPR = (\$458.8 + 8*\$963.75 �� 8*\$970) / (8*\$970) = (\$458.8 + \$7,710 – \$7,760) / \$7,760 = \$408.8 / \$7,760 = 5.27%

3) Mutual fund shares

Income and capital gains for mutual funds are taxable and will be taxed at 38% rate; change of NAV represents an unrealized capital gain and is not taxed. After-tax value of income and capital gains for mutual fund will be 500*(\$0.50 + \$0.60)*(1-0.38) = 500*\$1.1*0.62 = \$341. After-tax HPR = (\$341 + \$10,010 – \$9,725) / \$9,725 = \$626 / \$9,725 = \$6.44%.

4) Options

The options were not exercised in the holding period, and therefore all changes of option value represent unrealized capital gains, and are not taxed. Therefore, after-tax HPR for options will be the same as before-tax HPR and equals to 11.54%.

Question C. Recognizing that all gains on the Stalchecks’ investments were unrealized, calculate the before-tax portfolio HPR for their four-vehicle portfolio during the past calendar year. Evaluate this return relative to its current income and capital gain components.

The return of the portfolio can be calculated as (Income + Ending Value �� Beginning Value) / Beginning Value. Before-tax income generated by all investments = Income from common stock + Bond income + Mutual fund dividends and gains = 400*(\$.0.20+\$0.20+\$0.25+\$0.25) + 8*(\$1,000*0.0925) + (500*\$0.60 + 500*\$0.50) = \$360 + \$740 + \$550 = \$1,650.

Beginning value of the portfolio = \$6,900 + \$7,760 + \$9,725 + \$26,000 = \$50,385.

Ending value of the portfolio = \$7,500 + \$7,710 + \$10,010 + \$29,000 = \$54,220.

Unrealized capital gains during the past calendar year were \$54,220 – \$50,385 = \$3,835. HPR of the portfolio = (Income + Capital Gains) / Beginning Value = (\$1,650 + \$3,835) / \$50,385 = \$5,485 / \$50,385 = 10.89%. In this HPR, the current income component is \$1,650 / \$50,385 = 3.27%, and capital gains component is \$3,835 / \$50,385 = 7.61%. Overall, the capital gains component is by 2.32 times greater than the current income component of the HPR.