Econ 134A Test 2, Form A John Hartman March 4, 2014 Instructions: YOU WILL TURN IN YOUR SCANTRON AND THE PROBLEMS PAGE. MAKE SURE ALL WORK AND ANSWERS ARE PROVIDED ON THESE. You have 65 minutes to complete this test, unless you arrive late. Late arrival will lower the time available to you, and you must finish at the same time as all other students. Cheating will not be tolerated during any test. Any suspected cheating will be reported to the relevant authorities on this issue. You are allowed to use a nonprogrammable four-function or scientific calculator that is NOT a communication device. You are NOT allowed to have a calculator that stores formulas, buttons that automatically calculate IRR, NPV, or any other concept covered in this class. You are NOT allowed to have a calculator that has the ability to produce graphs. If you use a calculator that does not meet these requirements, you will be assumed to be cheating. Unless otherwise specified, you can assume the following: Negative internal rates of return are not possible. Equivalent annual cost problems are in real dollars. You are allowed to turn in your test early if there are at least 10 minutes remaining. As a courtesy to your classmates, you will not be allowed to leave during the final 10 minutes of the test. Your test should have 10 multiple choice questions (20 points) and 2 problems (15 points). The maximum possible point total is 36 points. If your test is incomplete, it is your responsibility to notify a proctor to get a new test. Grading: For your reference, an example of a well-labeled graph is below: Filling in scantron correctly, putting name, perm #, and TA on problems page, & having photo ID ___/1 (automatic unless something is incorrect) Multiple choice portion _____/20 Problems _____/15 Total score _____/36 MULTIPLE CHOICE: Answer the following questions on your scantron. Each correct answer is worth 2 points. All incorrect or blank answers are worth 0 points. If there is an answer that does not exactly match the correct answer, choose the closest answer. 1. Thunder Chargers Printers is expected to pay out dividends as follows: A $C dividend will be paid today. Each subsequent dividend will be paid yearly, and grow by 4% per year. The final dividend will be paid 30 years from today. After the final dividend is paid, the company will go out of business and never pay anything to stock holders again. Find C if the effective annual discount rate is 8% and the current stock value is $45 per share. A. $0.50 B. $1 C. $1.50 D. $2 E. $3 2. In the hypothetical country of Egonischle, the annual rate of return for long-term government bonds for the last 6 years was 20%, 15%, –50%, 25%, 30%, and 10%. What is the geometric average rate of return during this period? A. 3.5% B. 4.5% C. 5.5% D. 7% E. 8.3% 3. Two stocks, X and Y, have a covariance of zero. Suppose that you invest in a portfolio of 70% of your money in stock X and 30% of your money in stock Y. what is the standard deviation of this portfolio if the standard deviation of stock X’s return is 15% and the standard deviation of stock Y’s return is 25%? A. 13% B. 15% C. 17% D. 20% E. 25% 4. Joe owns a bond. The bond has three remaining annual coupon payments of $600 per year, starting later today. It also has a face value payment of $1000 on the date of the last coupon payment. If the stated annual discount rate is 8%, compounded monthly, what is the present value of this bond? A. $2517 B. $2518 C. $2520 D. $2527 E. $2535 Use the following information to answer the next two questions: Assume that the risk-free return in the market is currently 5%, and a stock with beta (ß) of 4 has an expected return of 17%. 5. What is the expected return on the market portfolio (as defined in lecture)? A. 6% B. 7% C. 8% D. 9% E. 10% 6. What is the risk premium? A. 2% B. 3% C. 4% D. 5% E. 6% 7. Yakima Yak Food, Inc. will start paying out dividends 10 years from today. The first dividend 10 years from today will be $8. Each subsequent dividend will be 12% higher than the previous dividend, and dividends will be paid forever. The effective annual discount rate for this stock is 17%. What is the present value of this stock? A. $33 B. $39 C. $46 D. $54 E. $64 8. From Jan. 1, 1910, to Jan. 1, 1991, the historical average annual rate of return in the hypothetical county of Ipaly was 14%. The annual standard deviation of the rate of return was 27%. What is the lower bound of the 95.4% confidence interval for the annual rate of return based on this information? Hint: You need to be within 2 standard errors of the average to find the upper and lower bounds of the 95.4% confidence interval. A. 8% B. 8.6% C. 11% D. 11.7% E. 13.7% Use the following information to answer the next two questions: Charlie Quack Soda stock exhibits price changes that are a random walk. In a given day, the value of the stock goes up by $3 with probability 0.2 and down by $1 with probability 0.8. The stock’s current value is $70. 9. What is the probability that the value of the stock will be more than $76 three days from today? A. 51% B. 38% C. 10% D. 1% E. 0% 10. What is the probability that the value of the stock will be the same three days from now (relative to today)? A. 51% B. 38% C. 10% D. 1% E. 0% Name___________________ Perm #____________ Day/time/TA of section_____________________ 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. 1. Phoenix currently owns a share of stock in Mel’s Kitchen Supplies, Inc. Without any re-investment of their earnings, the company will earn $40 per share every year forever. The effective annual discount rate for the company is 14%. Assume that the next dividend payment will be made in 1 year. Suppose that Mel’s Kitchen Supplies could retain all of its earnings 5 years from today, and earn 25% on these earnings the following year. Also assume that there are no other opportunities to retain earnings. (In other words, no dividend would be paid 5 years from today if Mel’s Kitchen Supplies retains all of its earnings that year, and would continue to act as a cash cow in the other years.) (a) (1 point) What is the present value of this stock if it continues to act as a cash cow? (b) (3 points) Should Mel’s Kitchen Supplies retain its earnings 5 years from today? Why/why not? (c) (4 points) How much does the present value of Mel’s Kitchen Supplies change if the company retains its earnings 5 years from today? 2. (7 points) A bond with face value of $X pays a $70 coupon twice, 4 months from today and 10 months from today. The bond matures 10 months from today, and the bond currently sells for $650. If the effective annual interest rate for this bond is 11%, then what is X?