Problems for Lecture 5 1. The stock of FM423.com is trading at $25 today. Exactly one year ago, the stock was trading at $32.50. (a) Compute the realized return on holding FM423.com over 1 year. Assume that the stock has not been paying any dividends. (b) Assume instead that the stock paid quarterly dividends of $1.25, $2.45, $0.25, $0.25. The first dividend payment was made exactly 9 months ago and the last dividend payment was today. Compute the stock's realized return assuming that dividends were reinvested in the stock when its (ex- dividend) price was $30.15, $26.25, $24 and $25 (price today), respectively. (c) The economy is sliding into a recession, and FM423.com announced that it would suspend its dividend payments for at least one year. Analysts have computed the price of FM423.com's stock one year from now under three possible scenarios: State Price of FM423.com Probability Recession $15 0.4 Unchanged $29 0.4 Boom $35 0.2 Compute the expected return on holding the stock of FM423.com for one year. 1 2. You consider investing in two stocks, A and B. The expected return on stock A is 11% and the standard deviation is 16%. The expected return on stock B is 17% and the standard deviation is 26%. (a) The correlation between stocks A and B is 0.3. Compute the expected return and standard deviation of a portfolio that has 0% A, 10% A, 20% A, etc, until 100% A. Plot the portfolio frontier formed by these portfolios. (b) Repeat the previous question, assuming that the correlation is 0.8. (c) Explain intuitively why the portfolio frontier is different in the two cases