Present Value and the Risk/Return Trade-Off

Module 1 – CasePresent Value and the Risk/Return Trade-OffAssignment OverviewFor this assignment, make sure to first carefully review all of the
required readings about present value, future value, risk and return,
and the CAPM. Once you are relatively comfortable with these concepts,
try working through some of the examples in the background readings and
try computing the answers on your own. Once you are confident you both
understand the concepts and the computational steps, complete the
assignment below.Case AssignmentPresent your answers to the problem below in a Word document, and
also upload an Excel file with your computations. Excel is required for
Questions 2 and 3. Excel is optional for Questions 1 and 4, but you are
required to show your steps for all quantitative problems. Even if you
get the answer wrong, you can still get partial credit if you show your
work.Calculate the following:Suppose you wish to raise some money for your favorite local
charity. This charity needs $50,000 a year to run its operation and you
want to make sure that it is ensured an annual payment of this amount
from now on for every year in the foreseeable future. Given an interest
rate of 5%, how much would you have to fund this perpetuity to guarantee
the charity a payment of $50,000 per year?You decide to put $1,000 in a new bank account and don’t plan to
withdraw the money for 10 years. If your bank does continuous
compounding and the interest rate is 1%, what will be the value of this
bank account in 10 years?Suppose you won the lottery but not all of your winnings will come
in one year. Instead, you will get a series of annual payments over the
next five years. The table below tells you what your payment will be
every year for the next five years. Use the information in the table to
make the following computations:The present and future value of your lottery ticket if the interest rate is 8%The present and future value of your lottery ticket if the interest rate is 10%

Year

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1

5000

2

6000

3

7000

4

8000

5

9000

The table below gives the probability of different returns for three
different assets. Using this table, calculate the following:The expected return of each assetThe standard deviation of returns of each assetThe coefficient of variation of each assetBased on your answers to B) and C) above, which asset has the highest total risk and highest relative risk?Asset AAsset BAsset CProbabilityReturnProbabilityReturnProbabilityReturn0.350.1250.140.480.3200.850.390.5150.160.114Suppose the market return is 8%, the risk-free rate is 1% and the
beta for a given stock is 1.2. Answer the following questions based on
this information:What is the required return for this stock?If the beta increases by 50% (but beta remains at 1.2), what will be
the new required return for the stock? What is the percentage-wise
change in required return compared to your answer to A) above?If the market return increases by 50% (but beta remains at 1.2),
what will be the new required return for the stock? What is the
percentage-wise change in required return compared to your answer to A)
above?Suppose there are three different companies. The first one, Trendy
Tech Inc., has investors who are “fair-weather friends.” When the stock
market is going up, everybody wants to invest in Trendy Tech, but as
soon as the market goes down everyone jumps ships and sells their
shares. The second company is Oily Oil Inc. Oily’s stock price seems to
depend only on the price of oil and nothing else. Finally, there is
Conglomerated Conglomerate Inc. Conglomerated is a giant company with
holdings in almost every industry imaginable—from cell phones to grocery
stores and even amusement parks. Based on this information, which
company would you think has the highest beta? The lowest beta? Which one
do you think has a beta closest to 1?Assignment ExpectationsAnswer the assignment questions directly.Stay focused on the precise assignment questions. Do not go off on
tangents or devote a lot of space to summarizing general background
materials.For computational problems, make sure to show your work and explain your steps.For short answer/short essay questions, make sure to reference your
sources of information with both a bibliography and in-text citations.
See the Student Guide to Writing a High-Quality Academic Paper,
including pages 11-14 on in-text citations. Another resource is the
“Writing Style Guide,” which is found under “My Resources” in the TLC
Portal.

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