ps0 - Graduate School of Business University of Chicago...

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Unformatted text preview: Graduate School of Business University of Chicago Professor Robert Novy-Marx BUS 35100 Winter 2008 Problem Set #0 Background and Preliminaries The course is highly technical and builds on concepts from the “Investments” class, B35000. This problem set is designed to check whether you have the necessary background for this course. In general you will be able to work on the problem set in larger groups, but in order me to assess where the class stands right now it is important that you each do this first assignment individually. If you find this problem difficult, this is ok. If this problem set seems impossible, however, please think hard about whether you want to take this course. If you don’t know, please contact me. Some of these questions may seem tedious. However, these questions are important, because they make sure that you will be comfortable with switching back and forth between continuous time (where we have continuous compounding) and discrete time (where we discount using simple interest rates). This is important for you, because derivative pricing models use both continuous time ( e.g., Black Scholes) and discrete time ( e.g., Binomial Trees). Both types of models are used at banks – often even for the same pricing application – and so you will want to be able to master both. Answers should be typed (or printed legibly) and are due at the beginning of the first class. No late assignments will be accepted. If you are unable to attend class you may email me your solution. Please do not fax solutions, as I am usually unable to read the output from our fax machine. Please include a prefered return mail folder, and its location. Problem sets submitted without a prefered return location will not be returned. 1 Conventions: Here are some conventions that we will adopt throughout the course. These conventions are so common in finance that you may have seen them before in B35000, in finance books, or at work. 1. Interest rates are annualized . This is true, even when we are using semiannual or quarterly compounding. The frequency of the compounding has nothing to do with whether the interest rate is annualized or not. So always assume it is annualized. 2. The word “logarithm” refers to the natural logarithm . Don’t get confused by the symbols log and ln, they both denote the natural logarithm in finance. On your calculator, you need to find the natural logarithm. If you don’t know which is which on your calculator or Excel, Question 1 will give you a way to check whether you are using the natural logarithm, using the exponential function. 3. Time is measured in years. For example, if t is today and T is the time at which a bond matures, then T NUL t D 2 means the bond matures 2 years from now. T NUL t D 0.5 means the bond matures 6 months from now....
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This note was uploaded on 08/14/2009 for the course BUS 35100 taught by Professor Novy-marx during the Winter '07 term at CHIC.

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ps0 - Graduate School of Business University of Chicago...

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