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Expected stock return per year

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The price of a non-dividend-paying stock is $100. Suppose that the continuously compounded risk-free rate is 1% per year, the market expected return is 7%, the stock beta is 1.2, and the stock price volatility is 30% per year. Assume that the stock price follows the Geometric Brownian Motion.

a) Solve for the expected stock return per year

b) A derivative pays off $100 if the stock price is in the range between $90 and $110 in year two and 0 otherwise. Determine its current price. You can write the result in terms of the cumulative normal distribution function like N(1).

c) What is the 2-year no-arbitrage forward price written on 100 shares of the stock today?

d) What is the two-year 95% VaR if you short such a forward today given that N-1(0.05)=-1.645? Note that the stock price follows a log normal distribution rather than a normal distribution.

Reference no: EM133114227

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