In some of the problems I will just type the formula and let you find the answer.  As I said in class, this is a good assignment for essay type questions and the study guide is better prep for the m/c questions. 

 

1.   With a discount rate of 10%, the present value of the Yankees’ offer is: $5,000,000 + ($4,000,000/1.1) + ($5,000,000/1.12) + ($8,000,000/1.13) =. The present value of the Giants’ offer is: $5,000,000 + ($6,500,000/1.1) + ($6,000,000/1.13) = . So, based on the present value criterion, the Yanks are making the more valuable offer. With a discount rate of 5%, the present value of the offers are the same type of calculation with just a different discount rate.

 

2.  Just a basic PV type of problem.  Good for a small essay question. 

The present value is $5000.

3.    This is just a single payment in 5 years and not multiple payments as some thought.  PV = 5000 / (1.08)5 

4.  This is just a smaller version of parts a and from #6. 

5.  I did not specifically talk about perpetuities and will not place it on the test so no need for you to study this.

6.  This is the big one that I emails.  No way for me to ask the whole question, but I could do part. 

7.  If the risk-free rate of return is 3% and if a risky asset is available with a return of 5% and a standard deviation of 4%, what is the maximum rate of return you can achieve if you are willing to accept a standard deviation of 2%?  What percent of your wealth would have to be invested in the risky asset?

You have defined the level of risk on your portfolio to be no more than 2%, but the market is 4%

2% = X 4%    So you should divide 1/2--1/2.

The return will be  3%(1/2) + 5%(1/2) = 4%


2.  What is the price of risk in problem 1?  Should have been 7 not problem 1.

 

(5% - 3%) / 4% = 50%   Crazy number in part because the risk is so low in this problem.

 

3.  If an individual stock has a beta of 1.6, the return on the market is 7%, and the risk-free rate of return is 3%, what expected rate of return should this stock offer according to the Capital Asset Pricing Model?

The return based on CAPM is = 3% + 1.6 (7% - 3%)