How risk is measured and how investor compensated for risk

Reference no: EM131223491

Question 1
What are the characteristics of financial instruments in terms of standardization and information?

Question 2
Define risk, how risk is measured and how an investor is compensated for risk.

Question 3
Describe Basel III and liquidity standards. How do these types of rules impact financial institutions?

Question 4
Describe the types, roles and structure of financial intermediaries.

Question 5
Describe the major regulators of depository institutions, who they supervise, and the general examination process. What do bank examiners look for?

Question 6
Consider a game in which a coin will be flipped three times. For each heads you will be paid $100. Assume that the coin comes up heads with probability ?.
a. Construct a table of the possibilities and probabilities in this game.

b. Compute the expected value of the game.

c. How much would you be willing to pay to play this game?

d. Consider the effect of a change in the game so that if tails come up two times in a row, you get nothing. How would your answers to parts a-c change?

Question 7
You are considering buying a new house, and have found that a $100,000, 30-year fixed-rate mortgage is available with an interest rate of 7 percent. This mortgage requires 360 monthly payments of approximately $651 each. If the interest rate rises to 8 percent, what will happen to your monthly payment? Compare the percentage change in the monthly payment with the percentage change in the interest rate.

Question 8
Assume that the economy can experience high growth, normal growth, or recession. Under these conditions, you expect the following stock market returns for the coming year:

State of the Economy	Probability	Return
High Growth	0.2	+30%
Normal Growth	0.7	+12%
Recession	0.1	-15%

a. Compute the expected value of a $1,000 investment over the coming year. If you invest $1,000 today, how much money do you expect to have next year? What is the percentage expected rate of return?

b. Compute the standard deviation of the percentage return over the coming year.

c. If the risk-free return is 7 percent, what is the risk premium for a stock market investment?

Question 9
Recently, some lucky person won the lottery. The lottery winnings were reported to be $85.5 million. In reality, the winner got a choice of $2.85 million per year for 30 years or $46 million today.

a. Explain briefly why winning $2.85 million per year for 30 years is not equivalent to winning $85.5 million.

b. The evening news interviewed a group of people the day after the winner was announced. When asked, most of them responded that, if they were the lucky winner, they would take the $46 million up-front payment. Suppose (just for a moment) that you were that lucky winner. How would you decide between the annual installments or the up-front payment?

Question 10
Compute the present value of a $100 investment made 6 months, 5 years, and 10 years from now at 4 percent interest.

Question 11
Consider a coupon bond with a $1,000 face value and a coupon payment equal to 5 percent of the face value per year.
a. If there is one year to maturity, find the yield to maturity if the price of the bond is $990.

b. Explain why finding the yield to maturity is difficult if there are two years to maturity and you do not have a financial calculator.

Question 12
Compute the future value of $100 at an 8 percent interest rate 5, 10, and 15 years into the future. What would the future value be over these time horizons if the interest rate were 5 percent?

Question 13
You are an officer of a commercial bank and wish to sell a car loan that the bank owns as an asset to another bank. Using equation A5 in the Appendix to Chapter 4, compute the price you expect to receive for the loan if the annual interest rate is 6 percent, the car payment is $430 per month, and the loan term is five years.

Question 14
Assuming that the current interest rate is 3 percent, compute the present value of a five-year, 5 percent coupon bond with a face value of $1,000. What happens when the interest rate goes to 4 percent? What happens when the interest rate goes to 2 percent?

Question 15
For each of the following events, explain whether it represents systematic risk or idiosyncratic risk and explain why. (LO3)
a. Your favorite restaurant is closed by the county health department.

b. The government of Spain defaults on its bonds, causing the breakup of the euro area.

c. Freezing weather in Florida destroys the orange crop.

d. Solar flares destroy earth-orbiting communications satellites, knocking out cellphone service worldwide.

Reference no: EM131223491

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