1. State of Nature.........Probability........State Dependent Return A.........S

Question

1. State of Nature.........Probability........State Dependent Return A.........State Dependent Return B Recession....................70%..........................-.08................................................-.04 Expansion....................30%..........................0.28...............................................0.16

What comes closest to the variance of Stock A and the standard deviation of Stock B?

Variance of Stock A = .0000, Standard deviation of Stock B = .0000

Variance of Stock A = .0272, Standard deviation of Stock B = .0917

Variance of Stock A = .0115, Standard deviation of Stock B = .1033

Variance of Stock A = .0272, Standard deviation of Stock B = .1033

Variance of Stock A = .0115, Standard deviation of Stock B = .0917

2. Doug just received a settlement from a lawsuit that pays him $125,000 immediately, followed by amounts of $125,000 at the end of each year over the next 10 years with one exception – lawyer fees reduce the amount in Year 3 to $75,000. However, the lawsuit allows Doug to receive the equivalent present value today. Using an interest rate of 6.5%, which of the following comes closest to the equivalent present value?

$ 1,200,000

$ 666,666

$ 857,145

$ 898,604

$ 982,211

a.

Variance of Stock A = .0000, Standard deviation of Stock B = .0000

b.

Variance of Stock A = .0272, Standard deviation of Stock B = .0917

c.

Variance of Stock A = .0115, Standard deviation of Stock B = .1033

d.

Variance of Stock A = .0272, Standard deviation of Stock B = .1033

e.

Variance of Stock A = .0115, Standard deviation of Stock B = .0917

Explanation / Answer

2.d.$ 898,604

Present value of cash inflow = Each period cash inflow*cumulative discount factor = 125000 x         7.189 = 898,604

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