## Info

A bubble is a run-away market, in which rationality has temporarily disappeared. There is a lot of debate as to whether bubbles in the stock market ever occurred. A strong case can be made that technology stocks experienced a bubble from around f 998 to 2000. It is often called the dot-com bubble, the internet bubble, or simply the tech bubble. There is no convincing explanation based on fundamentals that can explain both why the Nasdaq Index had climbed from 2,280 in March i999 to 5,000 on...

## End of Chapter Problems

Q6.28 Is this morning's CNN forecast of tomorrow's temperature a random variable Is tomorrow's temperature a random variable Q 6.29 Does a higher reward (expected rate of return) always come with more risk Q6.30 Is the average individual in a betting pool effectively more, equally, or less risk-averse than the overall pool Q 6.31 A financial instrument will pay off as follows Probability 50 25 12.5 6.25 3.125 3.125 Payoff 100 110 130 170 250 500 (a) What price today would make this a fair bet...

## C

Ed Altman (from New York University) collected corporate bond statistics from 1971 to 2003. Figure 6.2 gives a sketch of how likely default (defined as missing at least one coupon payment) was for a given credit rating High-Quality Borrowers Very few investment grade bonds default and especially right after issue when they still carry the original credit rating. The probability of default is less than 3 in total over a 10-year horizon (0.3 per annum). Low-Quality Borrowers In an average year,...

## Credit Ratings and Default Rates

The Rating Agencies the most important are Moody's and Standard& Poor's. The Ratings most important is junk vs. investment grade. To make it easier for lenders to judge the probability of default, a number of data vendors for credit-ratings have appeared. For individuals, Experian and Dun& Bradstreet provide credit-ratings you should request one for yourself if you have never seen one. For corporations, the two biggest credit rating agencies are Moody's and Standard& Poor's. (There are...

## Annuities

The second type of cash flow stream that lends itself to a quick formula is an annuity, which An Annuity pays the is a stream of equal cash flows for a given number of periods. Unlike a perpetuity, payments same amount for T stop after T periods. For example, if the interest rate is 10 per period, what is the value of an years' annuity that pays 5 per period for 3 periods Let us first do this the slow way. You can hand-compute the net present value to be PV + 55 + 55 S12 4343 1.10 1.102 + L103...

## To The Student

What do you need to understand this book You do not need any specific background in finance. You do need to be thoroughly comfortable with arithmetic and generally comfortable with algebra. You do need mathematical aptitude, but you do not need to know advanced mathematical constructs, such as calculus. Knowledge of statistics would be very helpful, but the book will explain the relevant concepts when the need arises. You should own a S20 scientific calculator. A financial calculator is not...

## End of Main Chapter Problems

Q 3.25 A tall Starbucks coffee costs 1.65 a day. If the bank's quoted interest rate is 6 per annum, compounded daily, and if the Starbucks price never changed, what would an endless, inheritable free subscription to Starbucks coffee be worth today Q 3.26 If you could pay for your mortgage forever, how much would you have to pay per month for a 1,000,000 mortgage, at a 6.5 annual interest rate Work out an answer change if the 6.5 is a bank quote and one if it is a true interest rate Q 3.27 What...