M & B 4th Edition by Dean Croushore

Exercise 8

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 per - cent, 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 a 20 percent chance of default, whereas security F has a 15 percent chance of default.
d Security 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 investor incurs no transactions cost to purchase security H, which has an expected return of 5 percent.