(b) (4 points) What is the covariance of the two stocks? (Hint: You can use the covariance formula as stated but you will need to change the problem to having 5 states of the world, each with 20% probability. An alternative approach is to alter the covariance formula to take weighted averages.) 7. (6 points) Upside Down Country Jackets, Inc. (UDCJ), has stock issued with beta value of 2.5. Currently, the risk-free rate is 8% and the rate of return to the market (as defined in class) is 14%. Dividends of $2 per year will be paid forever by UDCJ, starting later today. What is the present value of the stock? NOTE: YOU CAN TEAR THIS SHEET OFF AND USE AS EXTRA SCRATCH PAPER. PLEASE NOTE THAT ANYTHING ON THIS SHEET WILL NOT BE GRADED UNLESS EXPLICITLY SPECIFIED ON THE TEST. Perpetuity Logarithmic rule = ab c b = log c / log a Annuity Variance of a sample Variance of a distribution, with each outcome Growing perpetuity having the same probability of occurring Growing annuity Covariance formula Quadratic formula Correlation of A and B + + = 0 , where SD stands for standard deviation ax2 bx c Variance of a portfolio
(b) (4 points) What is the covariance of the two stocks? (Hint: You can use the covariance formula as stated but you will need to change the problem to having 5 states of the world, each with 20% probability. An alternative approach is to alter the covariance formula to take weighted averages.) 7. (6 points) Upside Down Country Jackets, Inc. (UDCJ), has stock issued with beta value of 2.5. Currently, the risk-free rate is 8% and the rate of return to the market (as defined in class) is 14%. Dividends of $2 per year will be paid forever by UDCJ, starting later today. What is the present value of the stock? NOTE: YOU CAN TEAR THIS SHEET OFF AND USE AS EXTRA SCRATCH PAPER. PLEASE NOTE THAT ANYTHING ON THIS SHEET WILL NOT BE GRADED UNLESS EXPLICITLY SPECIFIED ON THE TEST. Perpetuity Annuity Growing perpetuity Growing annuity Quadratic formula ax2 + bx + c = 0 Logarithmic rule ab = c b = log c / log a Variance of a sample Variance of a distribution, with each outcome having the same probability of occurring Covariance formula Correlation of A and B , where SD stands for standard deviation Variance of a portfolio
Test2C_Winter2017_10am.docx