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Calculate the present value in each of the following cases. Show your work.




1. Calculate the present value in each of the following cases. Show your work.;a. You are negotiating a book deal for your newest novel in which an economist singlehandedly saves the world. The publisher offers to pay you an advance of $1 million today plus;$500,000 at the end of each of the next three years. What is the present value of these;payments, given your rate of discount of 5 percent?;b. You counter the publishers offer with a counter-offer that will pay you $1.5 million today plus;$5 per book sold in each of the next three years. You think you will sell 80,000 books each year;in that period, but the publisher thinks you will only sell 40,000 books each year. Explain why;both you and the publisher like this offer better than the deal in part a.;2. Julia is considering buying stock in only one of the following companies: (i);which runs a Web site geared toward older peoples retirement income and has a 10 percent;probability of returning 20 percent this year and a 90 percent probability of returning 7 percent;or (ii) Speculate, Inc., which invests in derivative securities and has a 50 percent chance of;returning 0 percent this year and a 50 percent chance of returning 50 percent.;a. What are the expected returns to investing in Uninvest and Speculate? b. What are the;standard deviations of the returns to Uninvest and Speculate? c. If Julia is very risk-averse;which companys stock should she buy? d. If Julia is risk-neutral (that is, she does not worry;about risk at all), which companys stock should she buy?;-----3. Consider three alternative bonds that you might invest in, each of which matures in one;year. The following table shows the probability that you will receive each possible return. For;example, if you buy bond A, the probability is 90 percent that your return will be 20 percent and;the probability is 10 percent that your return will be 100 percent (in other words, you lose the;entire amount invested).;Bond Probability Return Bond A 90% 20% 10% -100% Bond B 75% 40% 25% -40% Bond C;60% 10% 40% -10%;a. Calculate the expected return for all three bonds in percentage terms. Show all your work. In;your calculations, you may round after two significant digits. b. Calculate the standard deviations;of the returns on these bonds. Show all your work. If you are extremely risk averse, which of the;three bonds would you buy? Why? c. Would a risk-averse investor ever buy Bond A instead of;one of the other bonds? Why or why not?;-----4. In each of the following scenarios, which security should an investor buy? Assume that;the securities are identical in all ways except as described below. Explain your answer.;a. Security A has an expected return of 12 percent, whereas security B has an expected return;of 10 percent. b. Interest on security C is 10 percent and is taxable, whereas interest on security;D is 7 percent and is not taxable, and the investors tax rate is 40 percent. c. Security E has a;20 percent chance of default, whereas security F has a 15 percent chance of default. d. Security;G and security H are both debt securities that cost $1,000 and mature in one year. An investor;incurs a transactions cost of $50 to purchase security G, which has an expected return of 8;percent. An investor incurs no transactions cost to purchase security H, which has an expected;return of 5 percent.;------5. Explain the reasons why bonds are risky. Give examples to support your answer.


Paper#18184 | Written in 18-Jul-2015

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