A stock price has an expected return of 9% and a volatility of 25%. It is currently $40.

What is the
probability that it will be less than $30 in 18 months?
We can use the Black-Scholes model to estimate the probability of the stock price being less than
$30 in 18 months. The formula for the probability of a stock price being less than a certain level
is:

P(S < K) = N(d2)

where N(d2) is the cumulative distribution function of a standard normal distribution evaluated at
d2, which is given by:

d2 = (ln(S/K) + (r - σ^2/2)t) / (σ√t)

where S is the current stock price, K is the strike price (in this case $30), r is the expected return, σ
is the volatility, and t is the time to expiration (in this case 1.5 years or 18 months).

Plugging in the values, we get:

d2 = (ln(40/30) + (0.09 - 0.25^2/2) x 1.5) / (0.25 x √1.5) = -0.8819

Using a standard normal distribution table or a calculator, we can find that N(d2) is
approximately 0.1894. Therefore, the probability that the stock price will be less than
$30 in 18 months is:

P(S < 30) = N(d2) = 0.1894 or about 18.94%.

An investor owns 10,000 shares of a particular stock. The current market price is $80. What is the
``worst case'' value of the portfolio in six months. For the purposes of this question, define the
worst case value of the portfolio as the value which is such that there is only a 1% chance of the
actual value being lower. Assume that the expected return and volatility of the stock price are 8%
and 20%, respectively.
The worst-case value of the portfolio is the value such that there is only a 1% chance of the actual
value being lower. This means we want to find the 1st percentile of the distribution of possible
portfolio values in 6 months. We can use the following formula to calculate the future value of
the portfolio:

FV = PV x e^(r + 0.5*σ^2)t

where PV is the present value (in this case, 10,000 shares x $80 = $800,000), r is the
expected return (8%), σ is the volatility (20%), and t is the time horizon (6 months or
0.5 years).

We want to find the value, V, such that there is only a 1% chance of the actual value
being lower. Mathematically, we can express this as:

P(FV ≤ V) = 0.01
Taking the natural logarithm of both sides and rearranging, we get:

ln(V/PV) = r - 0.5σ^2 - zσ*sqrt(t)

where z is the inverse of the standard normal cumulative distribution function

evaluated at 0.01, which is approximately -2.33.

Plugging in the values, we get:

ln(V/$800,000) = 0.08 - 0.5*(0.20^2) - (-2.33)*(0.20)*sqrt(0.5) = -0.0665

Solving for V, we get:

V = $800,000 x e^-0.0665 = $727,010.94

Therefore, the worst-case value of the portfolio in 6 months is approximately

$727,010.94.

Portfolio A consists of a one-year zero-coupon bond with a face value of $2,000 and a 10-year
zero-coupon bond with a face value of $6,000. Portfolio B consists of a 5.95-year zero-coupon
bond with a face value of $5,000. The current yield on all bonds is 10% per annum (continuously
compounded) (a) Show that both portfolios have the same duration. (b) Show that the
percentage changes in the values of the two portfolios for a 0.1% per annum increase in yields
are the same. (c) What are the percentage changes in the values of the two portfolios for a 5%
per annum increase in yields?
(a) To calculate the duration of a zero-coupon bond, we use the formula:

Duration = time to maturity

Therefore, the duration of the one-year zero-coupon bond in Portfolio A is 1 year,

and the duration of the 10-year zero-coupon bond is 10 years. The weighted average
duration of Portfolio A is:

(1/11) x 1 year + (10/11) x 10 years = 9.1818 years

The duration of the 5.95-year zero-coupon bond in Portfolio B is 5.95 years, which is
the same as the weighted average duration of Portfolio A. Therefore, both portfolios
have the same duration.

(b) The percentage change in the value of a bond for a small change in yield is given
by:

ΔP/P = -D × Δy
where ΔP is the change in price, P is the initial price, D is the duration, and Δy is the
change in yield expressed as a decimal.

For Portfolio A, the initial value is $2,000 for the one-year zero-coupon bond and
$6,000 for the 10-year zero-coupon bond, for a total initial value of $8,000. The
duration of Portfolio A

is 9.1818 years. For a 0.1% per annum increase in yield, Δy = 0.001, and the
percentage change in the value of Portfolio A is:

ΔP/P = -9.1818 × 0.001 = -0.0092 or -0.92%

For Portfolio B, the initial value is $5,000 and the duration is 5.95 years. For a 0.1%
per annum increase in yield, Δy = 0.001, and the percentage change in the value of
Portfolio B is:

ΔP/P = -5.95 × 0.001 = -0.00595 or -0.595%

Therefore, the percentage changes in the values of the two portfolios for a 0.1% per
annum increase in yields are not the same.

(c) For a 5% per annum increase in yields, Δy = 0.05. Using the same formula as
above, the percentage change in the value of Portfolio A is:

ΔP/P = -9.1818 × 0.05 = -0.4591 or -45.91%

The percentage change in the value of Portfolio B is:

ΔP/P = -5.95 × 0.05 = -0.2975 or -29.75%

Therefore, the percentage changes in the values of the two portfolios for a 5% per
annum increase in yields are not the same.