Suppose the SPY index will either go up 10% or down 10% by the end of next week. In addition, you know that the probability of either case occurring is 50%. The index currently sells for $320. Take these details as facts. An associate at your firm (call him trader A) argues that a bull market is on its way, and that there is in fact a 70% chance of the 10% increase, and a 30% chance of a 10% decrease. A second associate (call him trader B) argues that a bear market is on its way, and that the probabilities are just the opposite; a 30% chance of the 10% increase, and a 70% chance of a 10% decrease. Both traders are willing to buy and sell at a price equal to their own expected value of the stock price. You have $320 for investment. How much money can you make on a quick arbitrage trade?

Suppose the SPY index will either go up 10% or down 10% by the end of next week. In addition, you know that the probability of either case occurring is 50%. The index currently sells for $320. Take these details as facts. An associate at your firm (call him trader A) argues that a bull market is on its way, and that there is in fact a 70% chance of the 10% increase, and a 30% chance of a 10% decrease. A second associate (call him trader B) argues that a bear market is on its way, and that the probabilities are just the opposite; a 30% chance of the 10% increase, and a 70% chance of a 10% decrease. Both traders are willing to buy and sell at a price equal to their own expected value of the stock price. You have $320 for investment. How much money can you make on a quick arbitrage trade?

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter8: Analysis Of Risk And Return

Section: Chapter Questions

Problem 3P

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Suppose the SPY index will either go up 10% or down 10% by the end of next week. In addition, you know that the probability of either case occurring is 50%. The index currently sells for $320. Take these details as facts. An associate at your firm (call him trader A) argues that a bull market is on its way, and that there is in fact a 70% chance of the 10% increase, and a 30% chance of a 10% decrease. A second associate (call him trader B) argues that a bear market is on its way, and that the probabilities are just the opposite; a 30% chance of the 10% increase, and a 70% chance of a 10% decrease. Now suppose trader A catches on and won't trade, leaving only trader B willing to buy and sell at a price equal to their own expected value of the stock price. You have $320 for investment. How much money can you make on a quick arbitrage trade using trader B (and perhaps a short sale)?
On November 1, an analyst who has been studying a ﬁrm called Computer Sciences believes that the company will make a major announcement before the end of the year. Computer Sciences currently is priced at 27.63 and has a beta of 0.95. The analyst believes that the stock can advance about 10 percent if the market does not move. The analyst mm the market might decline by as much as 5 percent, leaving the stock with a return of 0.10 + (-0.05 x 0.95) = 0.0525. To capture the full 10 percent alpha, the analyst recommends the sale of a particular stock index futures. The March contract currently is priced at 393. Assume that the investor owns 100,000 shares of the stock. Set up a transaction by determining the appropriate number of futures contracts. Then determine the effective return on the stock if, on December 31, the stock is sold at 28.88, the futures contract 18' at 432.30, and the multiplier, is 500. Explain your results.
Your broker has developed a list of firms, their betas, and the return he expects the stock to yield over the next twelve months (labeled "Expected Return"). You have estimated that the risk-free rate is 5% and the return to the market will be 12%. Assuming that CAPM is correct, which stock should you purchase? Firm Beta Expected Return Anderson, Inc. 0.90 10.5% Delta Vanlines 1.25 13.0% Nathan's Bakeries 1.60 16.0% Z-man Electronics 1.90 19.0%
Suppose that the consensus forecast of security analysts of your favorite company is that earnings next year will be $5.00 per share. The company plows back 50% of its earnings and if the Chief Financial Officer (CFO) estimates that the company's return on equity (ROE) is 16%. Assuming the plowback ratio and the ROE are expected to remain constant forever: If you believe that the company's required rate of return is 10%, what is your estimate of the price of the company's stock? *Make sure to input all currency answers without any currency symbols or commas, and use two decimal places of precision.
Suppose that the consensus forecast of security analysts of your favorite company is that earnings next year will be $5.00 per share. The company plows back 50% of its earnings and if the Chief Financial Officer (CFO) estimates that the company's return on equity (ROE) is 16%. Assuming the plowback ratio and the ROE are expected to remain constant forever: Suppose you observe that the stock is selling for $50.00 per share, what would you conclude about either your belief of the stock’s required rate of return or the CFO’s estimate of the company’s return on equity? (select all that apply)
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Suppose that the consensus forecast of security analysts of your favorite company is that earnings next year will be $5.00 per share. The company plows back 50% of its earnings and if the Chief Financial Officer (CFO) estimates that the company's return on equity (ROE) is 16%. Assuming the plowback ratio and the ROE are expected to remain constant forever: Suppose that you are confident that 10% is the required rate of return on the stock. What does the market price of $50.00 per share imply about the market’s estimate of the company’s expected return on equity? (please give a number)
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Suppose that the price of corn is risky, with a beta of .5. The monthly storage cost is $.03 per bushel, and the current spot price is $5.50, with an expected spot price in three months of $5.88. If the expected rate of return on the market is 0.9% per month, with a risk-free rate of 0.5% per month, would you store corn for three months?
You expect the price of a stock to increase by 20% in the following year, with a standard deviation of 30%. The stock currently trades at $50. You pursue a strategy of buying 100 shares of the stock on margin. The initial margin requirement is 50%. The annual interest on margin debt is 5% per year. (a) What is the expected return and standard deviation of your strategy? (assume there is no margin call.) (b) The maintenance margin is 30%. Six months after you establish your trade, you receive a margin call. What is the price of the stock when this happens?
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Your stockbroker has called to tell you about two stocks: Uber Technologies, Inc. (UBER) and Lyft, Inc. (LYFT). She tells you that UBER is selling for $22.00 per share and that she expects the price in one year to be $49.00. LYFT is selling for $13.00 per share and she expects the price in one year to be $41.00. The expected return on UBER has a standard deviation of 20 percent, while the expected return on LYFT has a standard deviation of 30 percent. The market risk premium for the S & P 500 has averaged 7.0 percent. The beta for UBER is 1.33 and the beta for LYFT is 1.88. The 10-year Treasury bond rate is currently 3.00%. Neither UBER nor LYFT pays a cash dividend. Determine the probability for each stock that you would earn a negative return. Determine the probability for each stock that you would earn more than your required rate of return. c) Explain why you would or would not buy either or both of the two stocks.