National Chengchi University

Department of Finance
ETP Graduate Investments
Fall 2014

Case Discussion Questions

Instructor: Professor Edward H. Chow

CASE STUDY: FINANCIAL BUBBLE

CASE: TROUBLE WITH A BUBBLE (9-808-067)

1. Why did Irving Fisher believe that stock prices had reached a permanently high
plateau?
2. Why did the stock market crash in 1929?
3. Why did influential individuals like Fisher, Keynes and Rockefeller believe that
the downturn would only be temporary?

Case study: investment banking business and global financial crisis

Case: Investment banking in 2008 (A): Rise and fall of the Bear (KEL378)

1. What role did Bears culture play in its positioning vis--vis its competitors, and
what role might that culture have played in its demise?
2. How did Bears potential collapse differ from that of LTCM in the eyes of the
Federal Reserve?
3. What would Bear have done differently to avoid its fate?
A. - In the early 2000s?
B. - During the summer of 2007?
C. - During the week of March 10, 2008?
4. Who stood to benefit from Bears implosion?
5. Is market perception of liquidity more important for an investment bank than it is
for an traditional manufacturing or distribution business? If so, why?
6. How could Bear have addressed perceptions of its liquidity? Could it have
stopped the run on the bank, and if so, how?
7. Did Bears failure undermine the viability of so called pure-play investment
banks?
8. What role should the Fed play in maintaining order in world securities markets?

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Case: Investment banking in 2008 (B): A brave new world (KEL380)

1. Why were proponents of deregulation so successful in the late 1990s? How

much can we blame deregulation for the meltdown in the investment banking
industry? And how could the government have foreseen and/or stopped the
domino effect before the crisis of 2008?
2. Could any one of the investment banks have remained competitive without
following the industry trend of taking on increasing amount of leverage to boost
returns on investments? If so, how?
3. Why was Lehman Brothers allowed to fail while Bears Stern was not?
4. Did the compensation structure of investment banking industry encourage
executives and employees to take on excessive risk to boost short-term profits?
Why or why not?
5. How much of the industry-wide crisis stemmed from investment banks
financials and current economic climate as opposed to investor panic and
speculation?
6. Both Bear and Lehman bailed out their proprietary hedge funds. Did they have
any other option? What would have happened had they not done so?
7. Could Morgan Stanley and Goldman Sachs survived without becoming bank
holding companies? What were the benefits and disadvantages of becoming
bank holding companies? What does designation as bank holding companies
mean for the way Morgan and Goldman operate going forward?

Case study: Risk and return analysis

Case: Beta Management Company (9-292-122)

1. What is Wolfes current investment strategy? What kind of adjustment is she

considering?
2. Calculate the variability (standard deviation) of the stock returns of California
REIT (CREIT) and Brown Group (BG) during the past two years. How variable
are they compared with Vanguard Index 500 Trust? Which stock appears to be
riskiest?
3. Suppose Betas position had been 99% of equity funds invested in the index fund,
and 1% in the individual stock. Calculate the variability of this portfolio using
each stock. How does each stock affect the variability of the equity investment,
and which stock is riskiest? Explain how this makes sense in view of your
answer to Question 2 above.
4. Perform a regression of each stocks monthly returns on the Index returns to

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 compute the beta for each stock. This regression is called the Market Model in
the literature. How does this relate to the situation described in Question 3
above?
5. How might the expected return for each stock relate to its riskiness?
6. Try to derive the Capital Asset Pricing Model (CAPM) equation for the two
stocks. Try to work out this question by assuming that Betas position had been
99% of equity funds invested in the index fund, and 1% in a riskless money
market account. Imagine that you can switch from the money market account to
CREIT, BG, or the index fund. Think about the condition for Sarah to be
indifferent between switching to CREIT (or BG) and switching to the index.

Case study: International investment and exchange rate risk

Case: Innocents Abroad: Currencies and International Stock Returns (5-206-
012)

1. Complete the analyses outlined at the end of the case in the section Building the
Client Presentation.
2. How do these analyses support or detract from the case for international
investment?
3. Develop a presentation to Henry Bosse using the analysis from the case.
4. An Excel data file is available on the website for students to use.

Case study: Asset allocation

Case: Investment Policy at the Hewlett Foundation (2005) (5-206-114)

1. What are the financial issues facing the Hewlett Foundation (HF)? In particular, is
HFs newly proposed asset allocation policy adequate to meet the foundations
long-term spending goal of sustaining a long-term real (or inflation-adjusted)
payout ratio of 5%, while preserving capital in real terms? Is it adequate to meet
its short-term objective of maintaining consistent spending without sharp
fluctuations?
2. How does HF manage their assets?
3. Is HFs donor stock sale program a good idea?
4. Are a member of HPs Investment Committee, would you agree with the
proposals to:
A. Double to 20% the allocation to absolute return strategies?
B. Implement the bondization and equitization overlay program?

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 C. Make the 5% commitment to Sirius V?
5. With respect to b), what would be the effect of the bondization and equitization
overlay program on the expected return of the absolute return portfolio? Which
contracts would be the most effective for HF to utilize?

Case study: Market efficiency and investment strategy

Case: Dimensional Fund Advisors, 2002 (9-203-026)

1. What is DFAs business strategy? What do you think of the firm? Are the DFA
people really believers in efficient markets?
2. Do the Fama-French findings make sense? Should we expect small stocks to
outperform large stocks in the future? Value stocks to outperform growth stocks?
3. Why has DFAs small stock fund performed so well?
4. Is DFAs tax-managed fund family likely to be successful, or remain just a small
niche market?
5. What should be the firms strategy going forward?

Case Study: Security design and selection

Case: Corning: Convertible Preferred Stock (9-206-018)

1. Describe Cornings business. How has the firm performed? What accounts for the
changes in valuation in Corning stock in Exhibit 2? Trying to avoid hindsight
bias-and this is very hard to do-could Cornings troubles have been forecasted
before 2001?
2. Evaluate Cornings financing strategy. How has the firm raised capital in the past?
3. Why does Corning need to raise capital? Why might it be difficult or undesirable
to raise equity, given its financial leverage and credit rating? Working through
the example below will help you understand the debt overhang problem. Why
might it be difficult or undesirable to raise equity, even if its financial leverage
were lower?
4. Debt and Incentive Exercise: Suppose that the face value of Corning debt is $4
billion and that the value of its assets will either be $10 billion (to creditors and
shareholders) or $2 billion (to creditors in bankruptcy), with equal probability.
Compute the market value of debt and the market value of equity per share,
ignoring discounting. What happens to the market value of per share if Corning
raises $400 million and invests the proceeds in projects that deliver $500 million
in value for sure, i.e. regardless of the value the rest of Cornings assets?
5. Why is JP Morgan proposing this particular security? Who are likely buyers?

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6. Draw a payoff diagram for the convertible security in Exhibit 10. Value the
security as the sum of its parts. Would you buy the Corning convertible preferred
shares at par? If your answer is yes, what other investments, if any, would you
make concurrently?
7. What are risks of this offering for Corning?
8. What should Flaws do?

Case study: Fixed income analysis and behavioral finance

Case: Washington Mutuals covered bonds (9-209-093)

1. How does a covered bond compare to an unsecured obligation of a financial

institution? To a mortgage-backed security?
2. In late July 2008, the US Treasury Secretary said that covered bonds had the
potential to increase mortgage financing, improve underwriting standards, and
strengthen U.S. financial institutions. Do you agree?
3. Using data from the case, what is your best estimate of the value of the covered
bonds?
4. In September 2008, would you recommend Washington Mutuals covered bonds
as an investment?

Case study: Private equity and investment analysis

Case: Tad OMalley: The investment conundrum (9-808-125)

Please review the case the three PowerPoint presentations. As you read over the
material, consider how Tad should structure his presentation at the partners meeting?
Among the issues you may wish to consider are:
1. which company should he recommend?
2. Which uncertainties should he highlight?
3. Are there valuation issues that he should point out?
4. What organizational issues are likely to influence the partners decision?

Case study: Implementation efficiency

Case: The Nikkei 225 Reconstitution (9-207-109)

1. Suppose you are a portfolio manager for MBA Advisor Nikkei Index Fund, which
has 100 billion of assets linked to Nikkei 225 index. What should you do
when you hear the news of index redefinition? In your preparation, you should
consider:

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 A. The construction of the Nikkei index and the portfolio weights it gives rise
to.
B. The effect of your trading on the prices of the index constituents.

2. You have heard that many portfolio managers submit market on close orders for
Friday, April 21. They reason that this allows them to lock in the new index
value, achieving zero tracking error. Do you think this is sensible? If you could
do something different, what would it be?
3. Taka Haneda is expecting several billion dollars of customer orders in the coming
week. What should he do? Is this a risky arbitrage? How will you know when
to exit the trade?

Case study: Corporate governance and investment

Case: Milking Money out of Parmalat, Francesca Toninato, 2005 (0-305-041,
IES119)

1. How were the foundations of Parmalat laid? What were Mr. Tanzis major
business intuitions?
2. What were the roots of Parmalats financial problems? What was the usual
mechanism used at the base of the scandal?
3. Keeping in mind that Parmalat investigation is still under way, and no sentence
has yet been handed down, can you briefly summarize the major players
involved and their respective responsibilities?
4. Do you think that Parmalat is purly an Italian scandal? Was the Collecchio Group
aligned with Italian corporate governance best practices?

Case study: Financial ethics

Case: Conflicts on a Trading Floor (A) (9-394-060)

1. What are the stakes for the protagonist in Conflict on a Trading Floor? What
options are available?
2. Which would you choose?
3. Recently many investors lost a lot of money because they were misled by
financial advisors to have bought structured products unsuitable for them. I
chose this case for us to think about how we should treat our clients.