Posted: September 18th, 2017

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Econ351 Summer Session 2 Assignment 4

Due July 31th in class

There are 3 questions in this assignment. Please show both your final answers and the way you reach them. Good luck!

1. Behavioral finance is a brand-new field in analyzing prices in the market. In fact, most of the explanations come from psychological observations of daily lives.

(1) Provide a real world example that is not mentioned in class to show that people prefer things without changes.

(2) Provide a real world example that is not mentioned in class to show that people are usually over-confident.

(3) Provide a real world example that is not mentioned in class to show that people are more likely to be influenced by their neighbors rather than a randomly picked individual.

2. A coupon bond has a face value of $1,000 and maturity 5 years. The required rate of return for the bond is 5%.

(1) The bond is sold at a price of $1,000 now. Calculate the coupon rate of the bond.

(2) Year by year, calculate the current yield and the capital gain for the bond. Are the rate of returns constant?

(3) Now that an unexpected shock happens suddenly at the end of year 3 which drives the required rate of return to 7%. What is the average return of the bond for the whole 5 years?

3. The firm, Beta, is under a bad management such that the dividend payment is expected to decrease at a rate of 4% per year. Suppose the recent dividend payment is $3 per share and the stock price is $30.

(1) What is the required return of the stock?

(2) If nothing else happens what is your expectation about the stock price next year? What is the trend of stock prices over time?

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