Thanks to visit codestin.com
Credit goes to www.scribd.com

Scribd
Upload
6 views5 pages

Week 7 - Tutorial Problem Set

The document presents a series of financial problems related to stock investments and forecasting random variables. It includes calculations for expected stock prices, annual returns, and forecasting using adaptive expectations. Additionally, it explores the implications of shocks on a random variable and the predictability of future values based on different assumptions.

Uploaded by

H pm
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
6 views5 pages

Week 7 - Tutorial Problem Set

The document presents a series of financial problems related to stock investments and forecasting random variables. It includes calculations for expected stock prices, annual returns, and forecasting using adaptive expectations. Additionally, it explores the implications of shocks on a random variable and the predictability of future values based on different assumptions.

Uploaded by

H pm
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd
You are on page 1/ 5

1. You’re considering purchasing shares in Don Rodrigo’s Circus Company.

The current
price of the stock is $158.14, and you expect the next five years of dividend payments to
be $1.12, $2.28, $2.85, $3.53, and $3.25.
a. If you require an 8.4% annual return, what price must you be able to sell the
stock for in five years time?

b. Suppose after receiving the first dividend payment, the price changes to your
answer from part a. What annual return would you receive if you sold after only
one year?

c. After your sale in part b, you choose to hold onto your money instead of
reinvesting it. Calculate your average annual return over a five year horizon from
selling the stock after one year and not reinvesting it. (Hint: this is the same as
calculating the return on a simple loan with one lump-sum payment after five
years)
2. A stock is currently selling for $24.19. You expect it to pay a dividend of $0.07 next year,
and this dividend payment will grow by 4% every year. What is the implied return of the
stock?

3. A random variable 𝑧 has the following form:


𝑧 = 0.5 𝑧 +𝑊

where 𝑊 refers to a one-off shock in period t. In most periods, 𝑊 = 0.


a) You know the initial value of the variable is 𝑧 = 6. If there are no shocks for the next 3
periods, calculate 𝑧 .

b) Now suppose there is a shock in period 4, so 𝑊 = 7. Calculate 𝑧 , 𝑧 , 𝑧 .


c) In period 1, after observing 𝑧 , you begin forecasting the value of 𝑧 . Using adaptive
expectations with the weight on the correction term 𝐾 = 0.75, compute your forecast for
periods 2, 3, 4, 5, and 6.

d) Construct your forecast errors. Did they exhibit any pattern? Why?
e) How would you rationally forecast 𝑧 ? Describe the forecasting rule that delivers rational
expectations, compute the forecast for each period and construct the forecast errors.

f) What do you notice about your rational expectations forecast errors? Why?
g) Suppose 𝑊 takes on a different random value each period, but on average these values
cancel out, so its average is still 0 (that is, 𝐸[𝑊 = 0]). How would you describe the
process for 𝑧 now? Would you expect future values to be predictable on average?

h) In addition to 𝑊 taking on random values each period, what happens to 𝑧 if the weight
on past values becomes 1? That is:
𝑧 =𝑧 +𝑊
Is 𝑧 still predictable on average?

You might also like