Forward prices of a generic asset The purpose of these problem is to guide you and introduce you the “no-arbitrage” condition required to compute forward prices. For the following problems, assume the following information: There is an asset A. The price of the asset today, denoted by ?0, is ?0 = $100. The CCIR (yearly) is 6%.

Problem 1: No storage cost, and no convenience yield. Assume that asset A has no storage cost and there is no convenience yield. Suppose that someone is willing to enter a forward contract of Asset A for delivery in one year from now at ?0,1 = $109

a. We don’t know a priori if there is a mispricing. Compute an arbitrage portfolio to exploit the potential mispricing. Hint: start by borrowing today $100

b. Now suppose that someone is willing to enter a forward contract of Asset A for delivery in one year from now at ?0,1 = $103 . Compute an arbitrage portfolio to exploit the potential mispricing. Hint: start by short-selling the asset

c. What would be the forward price that makes the profit in a) and b) zero?

d. Now try to find the general pricing formula. Suppose that the rate is ?, the spot price is ?0 and someone is willing to enter a forward at a forward price of ?0,? for delivery at time t=T. Replicate your portfolio/strategy in a) using this new information. What is the no-arbitrage forward price?

Suppose you calculate the value of a stock to be $100 per share. No dividend growth is expected and the firm’s shareholders require a 10% return on their investment. Your boss challenges your assumption that dividends will pay forever. “I expect the corporation will die in 90 years” he says. By how much should you revise your share price valuation downward based on your boss’s assumption?

Select one:

a. $0.02

b. $10

c. $100

d. Not enough information to solve this problem

Suppose that Jim uses his budget to purchase 100 units of Good X and 100 units of Good Y. When the price of Good X rises, he purchases 55 units of Good X and 95 units of Good Y. An economist calculates his compensated budget and finds that in that scenario, Jim would buy 60 units of Good X and 105 units of Good Y.

Calculate the substitution effect.

(Remember to include a negative sign (-) if the effect reduces the quantity.)

The market for a particular chemical, called Negext, is described by the following equations:

Demand: Qd=100-5P

Supply:Qs=5P

For each unit of negext produced, 4 units of pollution are emitted, and each unit of pollution imposes a cost on society of $1. Suppose that the government restrict emission to 100 units of pollution. Graph the Negext market under this contraint. find the new equilibrium price and quantity and show them on your graph.compute how this policy affects consumer surplus, producer surplus and the cost of pollution.

Suppose you calculate the value of a stock to be $100 per share. No dividend growth is expected and the firm’s shareholders require a 10% return on their investment. Your boss challenges your assumption that dividends will pay forever. “I expect the corporation will die in 90 years” he says. By how much should you revise your share price valuation downward based on your boss’s assumption?

Select one:

a. $0.02

b. $10

c. $100

d. Not enough information to solve this problem

Suppose we are analyzing the market for oranges in 2017. Graphically illustrate the impact of each of the following events on consumer or producer surplus.

A. In 2017, Wildfires destroyed a majority of orange farms, reducing the orange production substantially, and what would be the impacts on consumer surplus? (Graphical analysis + Written discussions = at least 100 words)

B. The price of apple, orange substitute, decreased in 2017. What would be the impacts on producer surplus? (Graphical analysis + Written discussions = at least 100 words)

Odd-even pricing is setting prices that end in certain numbers. For example, products selling below $50 often end in the number 5 or the number 9-such as 49 cents or $24.95. Prices for higher-priced products are often $1 or $2 below the next even dollar figure-such as $99 rather than $100.

Why do you think consumers will react better to a price that is $99 than $100?

What type of products typically utilizes Odd-even pricing?

Tom consumes, among other things, telephone services. He pays a fixed tax t on every phone call he makes (in addition to the regular price), and ends up paying $100 every year in telephone taxes. Show that Tom would actually prefer to pay flat tax of $100 and make phone calls taxfree. You should assume that Tom is rational, and that he has strictly convex and monotonic preferences over telephone calls and "other goods."

Problem 1.2 Product Pricing

Your boss asked you for the per unit price of a new product at 200 units and at 400 units given that:

Material Cost is linear from $25/unit for 100 units to $20/unit for 600 units

Labor Hours are 2.2 hours/unit for 100 to 299 units and 2.0 hours/unit for 300 to 599 units

Labor Rate is $15/hour

Overhead is 120% of labor dollars

Markup is 28% of COGS dollars.