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Test 3

Test 3. Spring 2014, 10 am Class. Multiple Choice #1. From May 2011 to May 2014, Disney stock increased in value by 93.71%. What is the geometric average annual rate of return for this stock?. Multiple Choice #2.

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Test 3

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  1. Test 3 Spring 2014, 10 am Class

  2. Multiple Choice #1 From May 2011 to May 2014, Disney stock increased in value by 93.71%. What is the geometric average annual rate of return for this stock?

  3. Multiple Choice #2 Over the last year, the annual inflation rate was 7%. Over the next year, the annual inflation rate will be 11%. If the annual real rate of return is always 5%, how many percentage points does the nominal rate of return increase from last year to next year? Last Year Nominal: Next Year Nominal: Change:

  4. Multiple Choice #3 BlocketyBlop, Inc. will pay annual dividends forever, starting 10 years from today. The first dividend will be $5, and each subsequent dividend will grow by 6%. If the effective annual discount rate is 11%, what is the present value of this stock?

  5. Multiple Choice #4 & #5 A company cannot issue stocks or bonds, and if it acts as a cash cow, its earnings at the end of each year will be $2 million (forever). 4. If the effective annual interest rate is 10% and the company acts as a cash cow, what is the present value of the company?

  6. Multiple Choice #4 & #5 A company cannot issue stocks or bonds, and if it acts as a cash cow, its earnings at the end of each year will be $2 million (forever). 5. If the return on retained earnings is 15% and the company retains 30% of its annual earnings (starting now), how much will earnings grow over the coming year? Earnings Growth:

  7. Multiple Choice #6 Richard invests $3,000 in a project today and will receive $800 per year forever, starting 15 months from today. He uses the discounted payback period method, with a period of 3.5 years, to determine the present value of his investment. If his effective annual discount rate is 10%, what is the present value of the positive cash flows within the payback period?

  8. Multiple Choice #7 An annuity pays $50 today and grows 10% annually. The final payment will be 14 years from today. If the effective annual interest rate is 10%, what is the present value of the annuity?

  9. Multiple Choice #8 The historical equity risk premium for a country is 8.4%, and the standard deviation of stocks’ rate of return in the same country is 24.5%. What is the Sharpe ratio in this country?

  10. Multiple Choice #9 A stock is currently worth $90. Over each of the next 3 years, the stock will either go up or down by $3, each with equal probability. Each year’s price change is independent of the previous year’s. What is the probability that a put option with exercise price of $95 will have a positive value on its expiration date? Zero Value: Positive Value:

  11. Multiple Choice #10 Wan-Ru will receive $1,200 every two years forever, starting one year from now. If the effective annual interest rate is 20%, what is the present value of this perpetuity?

  12. Free Response #11 Billy buys a share of Bo Bob Bubbaroo stock today for $50. One year from today, the stock’s value will come from a normal distribution with mean $51 and standard deviation of $1. If Billy currently owns a European put option, with an exercise price of $53 and an expiration date of one year from today, what is the probability that the option will have a positive value when it expires? Explain your answer using math, a graph, and/or 50 words or less. (Hint: You can assume that in a normal distribution, 68.26% of outcomes are within 1 standard deviation; 95.44% within 2 standard deviations; and 99.74% within 3 standard deviations.)

  13. Free Response #11 Unshaded Area: Shaded Area:

  14. Free Response #12 Stock in Banana Cradle Kids Supplies (BCKS) is currently worth $70. The price of the stock is assumed to increase by 5% for each of the next 10 years. Molly currently owns an American call option with an exercise price of $80, an expiration date 5 years from today, and a beta of 1.5. A risk-free asset has a 5% rate of return, and the market rate of return is 12%. If she owns the option until the day it expires, what is the present value of the option? Stock Price in 5 Years: Discount Rate:

  15. Free Response #13 An unlevered firm has a weighted average cost of capital of 14%. If the firm changes its capital structure so that three-quarters of the firm’s value is in stocks and one-quarter of the firm’s value is in bonds, what is the expected return on equity on the levered firm? You can assume that the cost of debt is 8%.

  16. Free Response #14 Skyler takes out a 30-year, fixed-rate mortgage of $500,000 today. The stated annual interest rate for this loan is 7.2%, compounded monthly. Skyler will make payments of $5,000 per month for the next 120 months, starting one month from today. A balloon payment will also be made 132 months from now to completely pay off the loan. How large will this balloon payment be?

  17. Free Response #15 Manuel makes an investment that requires a $1,000 payment today and another payment of $1,330 in 2 years. He will receive $2,325 from this investment in one year. • Find all internal rates of return for this investment.

  18. Free Response #15 Manuel makes an investment that requires a $1,000 payment today and another payment of $1,330 in 2 years. He will receive $2,325 from this investment in one year. • Find two effective annual discount rates such that the net present value of the project is positive. Any such that

  19. Free Response #16 Billy will receive $4,000 every year for 20 years, starting one year from today. He prefers a 40-year annuity instead, which would start paying one year from today. Assuming an effective annual interest rate of 5%, how much will he receive per year if he converts to the 40-year annuity?

  20. Free Response #17 There are three known states of the world, each with equal probability of occurring: X, Y, and Z. Abbelgab stock has a 10% rate of return in State X, 15% in State Y, and 5% in State Z. Bluggarb stock has a 4% rate of return in State X, 16% in State Y, and 22% in State Z. • What is the expected rate of return of each stock?

  21. Free Response #17 There are three known states of the world, each with equal probability of occurring: X, Y, and Z. Abbelgab stock has a 10% rate of return in State X, 15% in State Y, and 5% in State Z. Bluggarb stock has a 4% rate of return in State X, 16% in State Y, and 22% in State Z. • What is the standard deviation of Abbelgab stock?

  22. Free Response #17 There are three known states of the world, each with equal probability of occurring: X, Y, and Z. Abbelgab stock has a 10% rate of return in State X, 15% in State Y, and 5% in State Z. Bluggarb stock has a 4% rate of return in State X, 16% in State Y, and 22% in State Z. • What is the correlation between Abbelgab and Bluggarb?

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