# C48-Additional-sample-questions-Ch7-DRAFT-SOLUTIONS.doc

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University of Toronto Scarborough

Economics for Management Studies

MGEC71H3

Jack Parkinson

Spring

Description

ECMC48 Sample QuestionsSketch Solutions for full marks additional detail may be required1Explain in words how pricing a stock is similar to pricing a bond Assume the stock is held for n periods and then is sold AND does not pay any dividends What kind of bond is this like Hint You may write down the mathematics if this helpsSolutionDeriving the price called pricing or valuing a unit of stock in a corporation is very much like pricing valuing a bond At any moment in time the value price is equal to the present discounted value of the expected future cash flow derived using an appropriate discount rate Of course key issues arewhat do those cash flows consist of and how many periods do they occur oversince these monies are not certain what is their expected timingsize andconsidering the riskiness and uncertainty surrounding this cash flow how to arrive at an appropriate risk adjusted discount rate to employ when doing our NPVIf the stock pays no dividends and is held for n periods and then sold this is like pricing an nperiod pure discount bondFPPrice of an nperiod pure discount bondni1WherePthe bond price todayNPV of the future cash flow coming from the bondFFace value of the bond ie how much it is worth when it maturesiannualised nperiod discount ratecomparable nperiod nominal rate of interest nnumber of periodsyears from now until the bond maturesF is paidPnPPrice of a unit of stockn0k1eWherePthe price of the stock todayNPV of the future cash flow coming from the 0stockPthe expected price of the stock nperiods from now when you sell itnkannualised nperiod discount rate on equity of this degree of riskiness e1nnumber of periodsyears from now until the stock is sold2Explain in words how pricing a stock is similar to pricing a bond Assume the stock is held for n periods and then is sold AND pays a dividend of D per year What kind of bond is this like Hint You may write down the mathematics if this helpsSolutionPricing a unit of stock is like pricing a bond see Q1 aboveIf the stock pays dividends of D per year and is held for n periods and then sold this is like pricing an nperiod coupon discount bondFCCCPPrice of an nperiod coupon bondnn2i1iii111WherePthe bond price todayNPV of the future cash flow coming from the bondFFace value of the bond ie how much it is worth when it maturesiannualised nperiod discount ratecomparable nperiod nominal rate of interestCannual coupon payment nnumber of periodsyears from now until the bond maturesF is paidPDDDnPPrice of a unit of dividend paying stocknn20k1kkk111eeeeWherePthe price of the stock todayNPV of the future cash flow coming from the 0stockPthe expected price of the stock nperiods from now when you sell itnkannualised nperiod discount rate on equity of this degree of riskiness eDannual dividend paymentnnumber of periodsyears from now until the stock is sold2

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