Exam 14: The Basic Tools of Finance: Part A

What does "random walk" mean? According to the efficient markets hypothesis,should stock prices follow a random walk?

Bill gets medical insurance and then exercises less.Lilly has health concerns and so applies for medical insurance.Identify each of these as moral hazard or adverse selection.

If a savings account pays 7% interest,then according to the rule of 70 how long will it take for the account balance to double?

Write the rule of 70.Suppose that your great-great-grandmother put $50 in a savings account 100 years ago and the account is now worth $1,600.Use the rule of 70 to determine about what interest rate she earned.

Suppose your bank account pays a 5% interest rate.You are considering purchasing a share of stock in DH Corporation for $250.The stock will pay you a $10 dividend at the end of years 1,2,3,4,and 5.You expect to be able to sell the stock at the end of year 5 for $300.Is DH a good investment? Provide evidence to support your answer.

Scenario 27-1 Lisa has a utility function where W is Lisa's wealth in millions of dollars and U is the utility she obtains. -Refer to Scenario 27-1.Suppose Lisa is faced with a choice between two options.With option A Lisa receives a guaranteed $9 million.With option B Lisa faces a lottery that pays $4 million with probability 0.4 and pays $16 million with probability 0.6.Given Lisa's utility function,will she prefer option A or option B? Provide evidence to support your answer.

A company has an investment project that will cost $2 million today and yield a payoff of $3 million in 5 years.If the interest rate is 9%,should the firm undertake the project? Show evidence to support your answer.

Scenario 27-1 Lisa has a utility function where W is Lisa's wealth in millions of dollars and U is the utility she obtains. -Refer to Scenario 27-1.Use the following diagram to graph Lisa's utility function for 0 $\leq$ W $\leq$ 25

Your boss asks you to do fundamental analysis of a corporation.What value is she asking for and how would you estimate this value?

Suppose you place $500 into a savings account that will pay you 6% interest per year.What will be the future value of the savings account in 15 years?

Write the formula for finding the future value in n years of $x today.

Suppose you invest $10,000 at 7% interest to be withdrawn by your heirs in 100 years.According to the rule of 70,approximately how much will your heirs be able to withdraw?

Scenario 27-1 Lisa has a utility function where W is Lisa's wealth in millions of dollars and U is the utility she obtains. -Refer to Scenario 27-1.Suppose Lisa is faced with a choice between two options.With option A Lisa receives a guaranteed $9 million.With option B Lisa faces a lottery that pays $16 million with probability P and pays $4 million with probability (1-P).Given Lisa's utility function,how high does P need to be before Lisa will prefer option B?

If a savings account pays 3.5% interest,then according to the rule of 70 how long will it take for the account balance to double?

How does moral hazard matter in the market for insurance?

Should a person who is risk averse hold a portfolio with no stock and only bonds? Explain.

Suppose you place $1,000 into a savings account that will pay you 4% interest per year.What will be the future value of the savings account in 10 years?

If the interest rate is 8 percent,then what is the present value of $5,000 to be received in ten years?

Can insurance be thought of as diversification? Defend your answer.

Suppose the interest rate is 3% and that you are to receive three annual payments of $1,000,with the first payment today,the second payment one year from now,and the third payment two years from now.What is the present value of this stream of payments?