Reference no: EM133081773

1. a,) A zero-coupon bond has a face value of $120.00 and matures in 2 years. The rate of return on equally risky assets is 5% (.05). What will its price be today? Suppose you sell it next year when the rate of return on equally risky assets is 7% (.07). What rate of return did you earn holding the asset for a year?

b.) A stock is expected to pay an annual dividend of $6 each year into the indefinite future. Rates of return on equally risky assets are 4% (.04). The stock price is $170. Is there a bubble on this stock? How do you know ? How big is the bubble? To be consistent with no arbitrage possibilities, what price are people expecting the stock will have next year? Explain.

c.) You win the lottery. You can either have $850,000 right now, or $1,000,000 paid in 5 annual installments of $200,000 starting next year. If the interest rate is 6% .(06), which will you choose? Why? What if the interest rate is 4% (.04)? Explain. (Hint: you can use the formula for pricing a fixed-payment loan here.)