Stock Price Estimate
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Consider a security with stock prices:
60 with probability one eighth i.e 1/8
70 with probability two eights i.e. 2/8
S(1) =
80 with probability three eights i.e. 3/8
100 with probability two eights i.e. 2/8
T = 0 is current period
T = 1 after 1 year
E(S(1)) should be expected value of the stock after 1 year.
Return = [E((S1)) - S(0)] / S(0)
The question is:
Compute the current price S(0) of the stock for which the standard deviation of return would be 15%.
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Solution Summary
We estimate the future price of a stock as well as the uncertainty of this estimate based on its expected future performance.
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We have
E(S(1)) = 1/8(60) + 2/8(70) + 3/8(80) + 2/8(100)
= 1/8(60 + 2*70 + 3*80 + 2*100)
= 1/8(640)
= 80.
We also have
E(S(1)^2) = 1/8(60^2) + ...
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