Question

What is the purpose of interest?

The variance of Firm A is 8%. The variance of firm B is 10%. Firm B should have a higher required return." True or false. Why?

What is risk aversion? Why would this affect the fair return?

A. You have decided that you can save $5000 per year. The rate is 6%. How much will you have accumulated after 10 years? B. You put $210000 in an account earning 10%. How long until it grows to $1000000?

A. You are in my will! When I die you will receive $21,000. The fair return is 5%. What is the value of your inheritance now if I am expected to live for 10 more years? B. You owe me $125128 but can only pay me $12,000 per year. If the agreed upon rate is 7%, how long will it take to repay me?

Timco is twice as risky as the market. The market is expected to earn 11%. The risk free rate is 2%. You think Timco can earn 15%. Should you invest in Timco? Why or why not? Show numbers to justify your decision.

Answer 1

As per rules I will answer the first 4 sub parts of the question

1: Interest is the cost of a loan. It is paid as an incentive to give funds. It is tax deductible expense.

2: True. Higher variance means higher risk. In that scenario, a stock having higher risk should provide higher returns to attract investors.

3. Risk aversion means avoiding risk. This would cause the investors to invest in safe areas rather than high risk investments. Safer investments have low returns and hence higher risk aversion will reduce the fair returns.

4 : a: FV of annuity = P*(1+r)^n-1 / r

= 5000*(1.06^10 -1)/0.06

= $65903.97

b: FV= PV*(1+r)^n

1000,000= 210000*1.1^n

1.1^n = 4.761905

n = 16.37 years