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Test3A Winter2016.docx
Test3A_Winter2016.docx
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Test3A Winter2016.docx-Name ...
Test3A_Winter2016.docx-Name_______________________________________ Perm #_______________________________ Econ 134A John
Test3A Winter2016.docx-Name ...
Test3A_Winter2016.docx-Name_______________________________________ Perm #_______________________________ Econ 134A John
Page 3
Use the following information to answer the next three questions: Redondo Springs Miniature Racers stock
exhibits price changes that are a random walk. In any given day, the value of the stock goes up by $1 with
probability 0.3 and goes down by $0.50 with probability 0.7. The stock’s current value is $60.
4. What is the probability that the value of the stock will be the same three days from today?
A. 44%
B. 34%
C. 19%
D. 6%
E. 0%
5. What is the probability that the value of the stock will be the same two days from today?
A. 44%
B. 34%
C. 19%
D. 6%
E. 0%
6. Suppose that you own a call option with an expiration date four days from today. The exercise price on the
option is $63. What is the present value of the option if the effective annual interest rate for this option is
25%?
A. $0.01
B. $0.25
C. $0.50
D. $0.75
E. $1.00
Page 4
7. The expected return on a security is 30%. The risk-free rate is assumed to be 7%. The expected return on
the market is 15%. Use the CAPM model derived in class to determine the beta of this security.
A. 3
B. 2.5
C. 2
D. 1.5
E. 1
8. Marshmallow Toothpick Structures, Inc. (MTS) has $80,000 that it must invest today in one or more of
the following three investments:
Investment I: Invest $40,000 today, and receive $58,000
one year
from today.
Investment II: Invest $50,000 today, and receive $70,000
two years
from today.
Investment III: Invest $X today, and receive $(1.5*X)
one year
from today.
X can be any non-negative amount that MTS wants. Any investments in future years will have a net present
value of 0. What is the largest net present value that be earned from the investments made today? Assume
that the effective annual discount rate is 20%.
A. $30,000
B. $25,000
C. $20,000
D. $18,000
E. $16,000
9. Liv invests $300 in a project today, and receives $250 one year from today and $50 two years from today.
Her NPV from the project is $0, and she receives one final payment four years from today. If her annual
discount rate is 7%, then the final payment is _____.
A. $0
B. $15
C. $30
D. $45
E. $60
10. How was the word “underwater” used as a finance term in lecture?
A. The drop in an asset’s value after a bubble bursts
B. Owing more on a house than what the house is worth
C. A stock that is worth less than the price paid for it
D. A put option that is in the money
E. An airfare below Spirit Airline’s “Bare Fare”
Page 5
For the following problems, you will need to write out the solution. You must show all work to receive
credit. Each problem (or part of problem) shows the maximum point value. Provide at least four
significant digits to each answer or you may not receive full credit for a correct solution.
Show all
work in order to receive credit.
You will receive partial credit for incorrect solutions in some
instances.
Clearly circle your answer(s) or else you may not receive full credit for a complete and
correct solution.
11. (7 points) Kora buys
one
put option with an exercise price of $100 (per share) today,
one
call option with
an exercise price of $120 (per share), and
one
share of stock currently valued at $80. The expiration date of
all of these options is one month from now. Each option is for buying or selling one share. For simplicity in
this problem, you can assume that the discount rate is 0%. Draw a well-labeled graph that shows the value of
a combination of the two options and one share of stock, as a function of the value of the stock at expiration.
The vertical intercept should have the value of the combination of the assets. The horizontal intercept should
have the value of the stock on the expiration date. Make sure to label your intercepts and other relevant
numbers on each axis, where relevant. (Hint: You may want to look at the front page of the test to see a well-
labeled graph.) Explain your answer in words, math, and/or using additional graphs. Include enough detail so
that everything on the graph is unambiguous.
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