Chapter 11

Vinicius Alves de Jesus

3. After reading this chapter, it isn’t surprising that you’re becoming an investment wizard. With your
newfound expertise, you purchase 100 shares of KSU Corporation for $37 per share. Assume the price
goes up to $45 per share over the next 12 months and you receive a qualified dividend of $0.50 per share.
What would be your total return on your KSU Corporation investment? Assuming you continue to hold
the stock, calculate your after-tax return. How is your realized after-tax return different if you sell the
stock? In both cases, assume you are in the 25 percent federal marginal tax bracket and 15 percent long-
term capital gains and qualified dividends tax bracket and there is no state income tax on investment
income.

$45 - $37 = $8

$8*100 shares = $800

$0.50*100 shares = $50

$800 + $50 = $850 total return before taxes

$850*0.75 = $637.5 return after taxes

7. Arianna just made a fantastic investment: She purchased 400 shares in Great Gains Corporation for
$21.50 per share. Yesterday the stock closed at $56.50 per share. In order to lock in her gains, she has
decided to employ a stop-loss order. Assuming she sets the order at $56, what is likely to happen? Why
might this not be a wise decision? At what price would you recommend setting the stop-loss order? Why?

The stock price is probably going to go down soon, triggering the stop loss and selling her
shares. Since the stock market is generally so volatile, this might not be a good decision. The stock
price could go down and right back up again, making her miss out on potential gains. I would
recommend her to set the stop-loss order at $47, that way she protects most of the gains made from
a potential crash, while giving some room for the natural stock market price fluctuation.

11. Match each of the following behaviors with the appropriate bias, as discussed in the chapter.

a. Wanda owns shares in Happy Clam Oil Exploration, but due to recent events, the share price is
down 30 percent from when she bought. She doesn’t want to sell now because it had previously
been up as much as 25 percent. Disposition Effect
b. Drew doesn’t believe his friends who tell him that he cannot time the market. He has been
successful in making profits from his trades this past month and plans to continue his day trading.
Overconfidence
c. Yusuf has been watching the gold market go up and up, so he decides that since everyone is
buying gold, he needs to do so as well. Herd Behavior