Problem 1. Downup company has the following return history: for the first 6 years, the stock went down 10% each year (this period is remembered as the "down" period by Downup shareholders), then in the next six years the stock went up 15% each year ("the UP phase"). Hotcold was established in the same year as the rival Downup. The return history for Hotcold was as follows: in the first six years the stock went up by 8% each year, but for the next 6 years the stock went down by 4%.
a. What is the arithmetic mean return of the two stocks?
b. What's their geometric mean return?
c. Which one would you rather have bought, in retrospect? Why?
Problem 2. A share of stock sells for $50 today. It will pay a $1 dividend per share at the end of the year. The risk free rate is 6% and the expected return on the market is 16%. The stock's beta is 0.8. What do investors expect the stock to sell for at the end of the year?