03 Jun Question nstruction: There are five questions in this test. All questions are of equal value 20 points
Question
nstruction: There are five questions in this test. All questions are of equal value 20 points
each. All illegible answers will be marked incorrect, so please write legibly. To receive full
credit, do not leave any part of a question unanswered. I encourage originality in your writing
rather than copying from other sources. You have two options to submit your test. You can
submit it either in CMS online by the due date or, alternatively, you can also turn in the test
before class on the due date. Please copy the following pledge and sign it in your answer book.
PLEDGE: I pledge that I have neither received nor given unauthorized assistance during the
completion of this test.
________________________________________
(signature)
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) Uninvest.com,
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.
b.
c.
d.
What are the expected returns to investing in Uninvest and Speculate?
What are the standard deviations of the returns to Uninvest and Speculate?
If Julia is very risk-averse, which companys stock should she buy?
If Julia is risk-neutral (that is, she does not worry about risk at all), which com
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