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Unit I Supplemental Practice Problems

# Unit I Supplemental Practice Problems - Unit I Supplemental...

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Unit I Supplemental Practice Problems 1. You plan to retire in 40 years. At that time you want to have enough money to receive \$200,000 a year for 20 years. How much must you save each year for the next 40 years if the rate of interest on your savings is 5%? Your first deposit will occur in one year and your first withdrawal will occur one year after retirement. 2. A stock is expected to pay a dividend of \$3 in one year and \$6 the next year. After that, it will grow at a rate of 2% forever. The discount rate is 12%. Find the price of the stock. 3. Stock ABC currently priced at \$20 can either increase to \$25 if the market goes up or decrease to \$15 if the market goes down. Stock DEF is currently priced at \$20 and can either increase to \$27 if the market goes up or decrease to \$15 if the market goes down. Explain why there is an opportunity to make an arbitrage profit and show how it would be done, making sure to show the results of your strategy for both possible outcomes. Unit I Supplemental Practice Problems p. 1 of 4 Version: January 3, 2011

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Solutions 1. It may be helpful, though it is certainly not necessary, to draw a diagram of the cash flows.
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