N(d2) is equal to the probability the Stock Price will be above the Strike Price at expiry i.e., the call will expire in the money
The world is risk neutral and interest rates are 20%. With probability ¼, your firm will be worth $60 next year. With probability ¾, it will be worth $100. What interest rate do you have to promise to raise $70 in debt today? In a perfect world, if the firm value is $76 under the debt-laden capital structure (say $70+$6), but the managers chose the $75 capital structure (say, all equity), what would you do? How does the cost of...
explain each step please
2. Consider a world in which a risk-neutral monopolist offers a product for sale. The product costs c = $60. In each period, the product can either be fully functional or totally defective. It is totally defective with probability 0.2 and is thus fully operative with probability p = 0.8. These events are independent across periods. Consumers, who are all risk-neutral, have valuation of V = $120 for a fully-functional product and zero for a totally...
2. Consider a world in which a risk-neutral monopolist offers a product for sale. The product costs c = $60. In each period, the product can either be fully functional or totally defective. It is totally defective with probability 0.2 and is thus fully operative with probability p = 0.8. These events are independent across periods. Consumers, who are all risk-neutral, have valuation of V = $120 for a fully-functional product and zero for a totally defective product. In any...
In risk-neutral valuation, we recognize that investors are risk-averse and thus modify the probability of an increase in a stock price from the real probability. (a) True (b) False
Problem 2 Suppose that each 100 risk-neutral person faces a risk of $10,000 loss with probability 0.01. The risks are independent, so the probability that any person incurs a loss does not affect others' probability. Each has an initial investment of $40,000. (a) Calculate the expected loss that each person faces. (b) Calculate the expected wealth without insurance. (c) Suppose each of the 100 individual purchases $1 into mutual insurance. The loss is fully covered with insurance Calculate the expected...
Problem 1. Do the following utility functions represent risk-averse, risk-neutral or risk-loving preferences? Motivate your answers. In each question, w is the wealth. (a) u(w)10w3 c) u(w)-e4 (d) u(w)-1- e
In a world that is not perfect but risk neutral, assume that the firm has projects worth $100 in the down-state, $500 in the up-state. The cost of capital for projects is 25%. However, if you could finance it with 50-50 debt, the cash flow rights alone are enough to make the cost of capital a lower 20%. Managers are intransigent and do not want to switch to this new capital structure. You only have $60 of capital and cannot...
A risk-neutral investor predicts that the stock price of COV will be 112 with a probability of 0.55 and 86 with a probability of 0.45 in 3 months. Assuming a one-period binomial model, what is the price of a European call option with a strike price 100? 6.17 Cannot be determined 6.46 6.60
2. (a) Explain the terms risk averse, risk loving and risk neutral with the aid of diagrams. Jane's utility (U) depends upon her income( Y) according to the following table U(Y) 50 7 100 9.5 150 200一一 14 250 300 350 12 16.5 17 19 She has received a prize with an uncertain value. In particular, with probability 0.25 she wins $300 and with probability 0.75 she wins $100. (b) What is the expected payoff from this prize? What is...
What does a relative risk (RR) represent (The fraction in the slides-which group is the numerator and which group is the denominator). Remember a RR or OR(odds ratio) compares the risk of disease in those exposed to the risk of disease in those unexposed. What does it generally mean when you have a RR=1, RR<1or a RR>1