YEAR STOCK MARKET RETURN T-BILL RETURN
2003 31.64 1.02
2004 12.62 1.2
2005 6.38 2.98
2006 15.77 4.8
2007 5.62 4.66
Question 1: Risk Premiums and Discount Rates. Top hedge fund manager Diana Sauros believes that a a stock with the same market risk as the S and P 500 will sell at year-end at a price of $50.
The stock will pay a dividend at year-end of $2. What price should be willing to pay for the stock today? (Hing: Start by checking today's 1-year Treasury rates)
Question 2: Scenario Analysis. The common stock of Leaning Tower of Pita, Inc., a restaurant chain, will generate the following payoffs to investors next year:
Dividend Stock Price
Boom $5 $195
Normal Economy 2 100
Recession 0 0
The company goes out of business if a recession hits. Calculate the expected rate of return and standard deviation of return to Leaning Tower of Pita Shareholder.
Assume for simplicity that the three possible sates of the economy are equally likely. The stock is selling today for $80
Question 3: Risk and Return. A stock will provide a rate of return of either 20% or +28%
a. If both possibilities are equally likely, calculate the expected return and standard deviation.
b. If Treasury bills yield 4% and investors believe that the stock offer a satisfactory expected return, what must the market risk of the stock be?
Vale of reserves per Barrel Value of Reserves, 50 Million Barrels value of Dryholes
Boom $4 200,000,000 0
Normal economy 5 250,000,000 0
Recession 6 300,000,000 0
Is Sassafras Oil a Risky investment for a diversified investor in the stock market-compare, say, to the stock of Leaning Tower of Pita, described in Problem above. Explain.