Money and Banking (MGT411) - Assignment # 1 solution

Assignment 1

Fall 2009

Money and Banking (MGT411)

Last Date of Submission: November 10, 2009

Marks: 20

Question # 1 (Marks 4)

Determine the future value of an investment of Rs.100 for 12 months at the following interest rates:

a- 5%

b- 1%

Question # 2 (Marks 6)

According to the data given below, calculate the GDP deflator and inflation rate.

Years

Nominal GDP

Real GDP

GDP deflator

Inflation rate

1997

Rs. 60,000

Rs. 60,000

1998

70,100

65,200

1999

81,200

74,600

Question # 3 (Marks 10)

Assume that the economy can experience high growth, normal growth, or recession. You

expect the following stock-market returns for the coming year under these conditions:

State of the Economy

Probability

Return

High Growth

0.3

+30%

Normal Growth

0.4

+12%

Recession

0.2

-15%

a. Compute the expected value of a Rs.1000 investment both in dollars and as a

percentage over the coming year.

b. Compute the standard deviation of the return as a percentage over the coming

year.

c. If the risk-free return is 7 percent, what is the risk premium for a stock market

investment?

____________________________________________________

JUST GET IDEA FROM THESE SOLUTIONS:

Question # 1

FV=PV*(1+i) ^n

(a)

PV=100, i=5%, n = 1 year(12 months)

FV=100*(1+.05) ^1

FV=Rs.105

(b)

PV=100, i=1%, n=12 months = 1 year

By putting the values:

FV=100*(1+.01) ^1

FV=Rs.101

Question# 2

Years	Nominal GDP	Real GDP	GDP Deflator	Inflation Rate
1997	Rs. 60000	Rs. 60000	100.0	n.a
1998	70100	65200	107.98	7.98
1999	81200	74600	108.85

Working:

GDP for year 1997 = (Nominal GDP / Real GBP)*100

= (60000/60000 )*100= 100

Rest Calculate yourself: P

Inflation Rate for year 1998 = (GDP deflation for year 1998/ GDP deflation for year 1999)*100

=(107.98-100)/100

= 0.079755*100 = 7.98

Rest Calculate yourself: P

Question # 3

Expected Value = 0.3(1000)(1+30%) + 0.4(1000)(1+12%) + 0.2(1000)(1-

15%) = 1008

Expected Return = 0.3(30%) + 0.4(12%) + 0.2(-15%) = 10.8%

Standard Deviation= nahi ata :D

c. Risk Premium =10.8% - SD = answer

.................

Assume that the economy can experience high growth, normal grow

recession.You expect the following stock-market returns for the coming y

dertheseconditions

Stateofthe

Economy.....................Probability..................................Return

HighGrowth..................... 0.2........................................+30%

NormalGrowth...................0.7 ......................................+12%

Recession ................... 0.1......................................-15%

A .Compute the expected value of a $1000 investment both in dollars

as a percentage over the coming year. Answer:Given the ab

information,we can construct a frequency distribution of

payo pro leofthisinvestment.

Stateofthe

Economy..................................Probability....................................Payof

HighGrowth .................................0.2...........................................$1300

NormalGrowth .............................0.7...........................................$1120

Recession.....................................0.1..........................................$850

Given this we can construct the expected payo from this investment

EV =(1300 * .2)+(1120 * .7)+(850 * .1)

EV =$1129

We n da expected valueof $1129 or and expected pro tof $129

which as a percentage of the initial investmentis 129 /1000 =12:9%:

--------------

Solution number 3.....

Answer:

a. Expected Value = 0.3(1000)(1+30%) + 0.4(1000)(1+12%) + 0.2(1000)

(1-15%) = 1008

Expected Return = 0.3(30%) + 0.4(12%) + 0.2(-15%) = 10.8%

b. Standard Deviation

= 0.3(30 -12.9%)2 + 0.4(12 -12.9%)2 + 0.2(-15 -12.9%)2

= 87.723 + 0.324 + 155.682

= 243.729

Take Under root of above Value..

=15.611

c. Risk Premium = 10.8% - 7% = 3.8%

_____________

b. Compute the standard deviation of the return as a percentage over the coming year.

Standard deviation is the square root of the variance

• At first we have to find out the Variance:

TO FIND THE VARIANCE WE HAVE TO TAKE FEW STEPS:

STEP: 1

To compute the expected value:

Expected Value =Sum of payoffs times probabilities

Expected Value = 0.3(1000) (1+30%) +0.4(1000) (1+12%) +0.2(1000) (1-15%)

= 1008

STEP: 2

Subtract expected value from each possible payoff

390 – 1008 = -618

448 – 1008 = -560

170 – 1008 = -838

STEP: 3

Square each of the Result

$-618^2 = 381,924(dollars) ^2

$-560^2= 313,600(dollars) ^2

$-838^2 = 702,244(dollars) ^2

STEP: 4

Multiply each result times its probability and adds up the results:

.3(381,924($) ^2) + .4(313,600($) ^2) + .2(702,244($) ^2)

=114577($) ^2 + 125440($) ^2=140449($) ^2

Variance = 380466($) ^2

Thus,

The standard deviation is the square root of the variance

Standard Deviation = 1/2 [380466(dollars) ^2]

Standard Deviation = $616.9