The price of a non-dividend-paying stock is $100. Suppose that the continuously compounded risk-free rate is 1%
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Question:
- The price of a non-dividend-paying stock is $100. Suppose that the continuously compounded risk-free rate is 1% per year, the market expected return is 7% (continuously compounded), the stock beta is 1.2, and the stock price volatility is 30% per year. Assume that the stock price follows the Geometric Brownian Motion.
- Solve for the expected stock return per year
- Solve for the risk-neutral probability that the stock price is in the range between $90 and $110 in year two.
Write your solution in the form of the cumulative normal distribution function. For example, you can write your answer in the form of N(1.25) without computing the final numerical result.
- What is the two-year 95% VaR if you short 100 shares of the stock today given that N-10.05=-1.645? Note that the stock price follows a log normal distribution rather than a normal distribution.
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