Question

1.

If the cost of investment is $1,500. The revenue earned during the next 6 years was $100, $200, $300, $400, $500 and $600. Calculate the payback period?
(a)
5
(b)
5.5
(c)
4.5
(d)
5.01

2.

The effect of increase in volatility of price of stock on value of ‘option’ (keeping other factors constant)?
(a)
Decrease in value of option.
(b)
Indeterminate from given information.
(c)
No effect.
(d)
Increase in value of option.

Answer 1

1) Payback Period is a metric used in capital budgeting decisions. It is the time required for an investment to recover its initial cash outlay or to reach a break-even point.

Yr	Cash flow	Cumulative cash flows
0	-1500	-1500
1	100	-1400
2	200	-1200
3	300	-900
4	400	-500
5	500	0
6	600	600

We reach break-even in year 5, hence the payback period is option a) 5

2) The effect of increase in volatility of price of stock on value of ‘option’

A high level of volatility means that the stock price is highly volatile and that there is high uncertainty about the price of the stock. Due to this uncertainty, people buy options to reduce their risk.

A higher volatility means higher upside risk or higher downside risk. When price rises, call option price increases and when the price drops, the value of put options increases.

Hence An increase in volatility of stock price increases the value of call and put options

The answer is d) Increase in value of an option

If you have any doubts please let me know in the comments. Please give a positive rating if the answer is helpful to you. Thanks.