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Pre-Core Finance Math Review

Note: You should be comfortable with the following…

1.Exponents and logarithms

A logarithm (to base b) of a number s is the exponent y that satisfies x = b y . So y=log b (X). On your calculator, the log button is always in base 10. Following the definition of a logarithm (“log” for short), because we all know that 10 2 =100, then we also all know that log 10 (100)=2, because you must square 10 to get

100.

Some further examples will illustrate the concept of a logarithm and establish some important properties:

a. When the base, b, is the square root of the X value, y is always 2:

 i. Log x (x 2 ) = 2 (because x 2 =x 2 ) ii. Log 5 (25) = 2 (because 5 2 =25) iii. Log 9 (81) = 2 (because 9 2 =81)

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b. More generally, when b is the nth root of X, y is always n:

 i. Log X (X n ) = n (because X n =X n ) ii. Log 3 (27) = 3 (because3 3 = 27) iii. Log 2 (16) = 4 (because 2 4 = 16)

c. When X is 1, y=0, no matter what the base is:

 i. Log b (1) = 0 (because b 0 =1, for all b) ii. Log 20 (1)=0 (because 20 0 =1) iii. Log 3.14 (1)=0 (because 3.14 0 =1)

d.When the b = X, y=1.

 i. Log x (X)=1 (because X 1 =X, for all X) ii. Log 10 (10)=1 (because 10 1 =10) iii. Log .15 (.15)=1 (because .15 1 =.15)

e. Concept check: You should be able to explain why there is no solution to Log 10 (0). Hint: Start at the definition of a logarithm.

The most common base (in finance) is e=2.71828… When b=e, we call the log function the “natural” log. Instead of writing out Log e (X), we simply write ln(X), and understand they

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mean the same thing. Take care when using your calculator and Excel to use the ln button and NOT the log button. Remember, the later is in base 10!

Why is it natural? n
2
3
x
xx 
exp( x )
 
 
1
x
n !
2!
3!
n  0
n
x
exp( )
x
lim
1
x  0
 
n
 
This is a graph of Y= exp(x) or Y=e x
-5
-4
-3
-2
-1
0
1
2
3
4
5

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If we go back to the definition of a logarithm, then we know that for ln(X) - the same as Log e (X) - y must solve the equation: e y =X. With that bit of information, we can deduce a few useful properties that you must know to be successful in this course. Note: Never forget, ln is a special log with base e. All properties of log apply to ln!:

1. e ln(x) = X

if

X > 0

Convince yourself! The solution to ln(x) is the value of y that solves for e y =X. So if we replace ln(x) with the value of y that causes

e y =X, we are left with e y , which by definition must equal X.

2.“Taking the natural log”… Bring it down, log it around, no more annoying exponents on the wall!: Sometimes we need to get rid of an exponent to solve for a variable; the natural log lets us do this easily. Consider: If z x =y b , we can solve for y by “taking the ln of both sides”. To “take the ln” we “bring the exponents down” and “log the base”.

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Doing this to both sides will preserve their equality.

In other words, if z x =y b then it must be true that xln(z) = bln(y), so (x/b)ln(z) = ln(y).

We can use a trick that involves the first property to further isolate y:

If (x/b)ln(z) = ln(y), then e (x/b)ln(z) = e ln(y) . and by the first property e ln(y) = y.

We now have e (x/b)ln(z) = y. In a moment we will see how this can be further reduced.

3. ln(e x ) = x Convince yourself! Let’s rewrite this in a way that looks more like the definition of a logarithm: Log e (e x ). y is the exponent that solves for b y =x, so here we would have e y =e x , the only way for the RHS=LHS is if y=x.

4. ln(x z ) = zln(x) This one might seem less obvious, but it is straightforward. Again, let’s rewrite the

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equation: log e (x z ). We want a y that solves for e y =x z . Let’s take the natural log of both sides: yln(e) = zln(x). Notice that ln(e) = 1 (do you know why? Go back to pg. 2, part c.). So we have: y = zln(x)!

5. ln(xz) = ln(x) + ln(z) Can you do this on your own? Hint: You will need to use the fact that a x+z = a x *a z

6. ln(x/z) = ln(x) – ln(z) Can you do this on your own?

7. ln(1+x) ~ x for small x You should be able to explain what this means, and why it is true. Hint: If x is 0, what is ln(1+x)? This was a property of logs! Now look at the graph of y=e x around the values where y is close to 0.

Now let’s see why this matters in finance!

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Example: Consider \$10 placed in the bank at 10% interest compounded annually with interest paid at the end of the period. How much do you have at the end of the year?

Formula (in words):

(initial investment) + (interest earned on investment)

With numbers:

\$10 + 10% * \$10 = \$11 = 10 (1+r)

What if interest is compounded twice a year?

In words:

(initial investment) + (interest earned on investment for 6 months) + (interest earned on investment for 6 more months) + (interest earned on interest for 6 months)

With numbers:

= 10 + .5(.10)10 + .5(.10)(10) + .5(.10).5(.10)10

= 10 + 2(.5*.10*10) + (.5*.10) 2 *10

= 10(1+(.10/2)) 2 = 11.025

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Or more generally (that is, using the formula for n periods of compounding at interest rate r)

1 \$10 1 .1 11.025

2

Three times a year? \$10 1 .

11.0337

365 time a year? \$10 1

11.05156

.

Infinitely many times a year (called continuous compounding)?

\$10 ∗ lim 1 \$10 \$10 . 11.025

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Another example with logs: Brian wants to have \$5,000,000 when he retires. He currently has \$25 to invest and does not plan to make any additional investments. The only option available to Brian is a bank savings account that pays 2% per year (compounded annually). How many years will it take for Brian to reach retirement?

Let’s start off using a basic finance formula that tells us how many \$y we will have for investing \$x at interest rate r for n years:

y = x(1+r) n

We know we want y = \$5,000,000, r = .02, and x = 25. Let’s replace the missing variables and solve for n. We have; 5,000,000 = 25(1.02) n .

Solve for n. Rearrange both sides and take natural logs:

\$5,000,000

\$25

1 .02

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\$20,000 1.02

ln \$20,000 ln 1.02

616.386

In our first class together, we will make heavy use of these techniques. You should be able to solve the following practice problems (solutions at the end):

Solve for x:

1. 4 5x+2 = 7 3x-1

2. log 3 (x + 2) = 1 + log 3 (x -2)

3. True or False (explain): log b b 10 – log b 1 = 10

4. Are the following solutions possible?

 i. Log 3 (80) = 5? ii. Log 6 (93) = 2.3? iii. Log 5 (120) = 2.95?

5. In 2004 Cheech invested \$10 at 10% for 10

years. In 2008 Chong decided he didn’t want

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Cheech to be richer than he would be in 2014. Chong could only find a 10% investment vehicle. How much does Chong need to invest today, so that 6 years later, in 2014, he and Cheech will have equal investments?

6. You have two options. A: I will give you

either a penny today, and then double your pay every day forward for exactly 4 weeks. Or B: I will give you \$10,000 and allow you to earn

10% compounded CONTINUOUSLY for 28 days. Which is the better deal, and how much better (in dollars) a deal is it?

7. An \$1,000 investment is made in a trust

fund at an annual percentage rate of 12%, compounded monthly. How long will it take the investment to reach \$2,000?

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2.

Graphing / Linear & quadratic equations

/ slopes

LINEAR EQUATIONS Functions describe how different variables are related. We use them all the time. If you’ve ever made a banana split, you’ve used a function. A split equals two scoops of ice cream plus a banana. Mixed drink recipes, cake recipes, etc are all functions. The most basic function is the function for a straight line, with a slope b, that crosses the y axis at point a.

In general a linear equation takes on the form:

y = a + bx For example: y = 3x + 2

Let’s use that example formula to define a few key terms:

a. A slope tells us how much y changes (“how much does the equation rise”) when we change X by 1 unit (“as the equation runs across the graph”). In the general equation for a line, b is the slope. Here, I need to add

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1

more x unit to get 3 more y units. If I want

1 more y unit, I only need 1/3 of an X unit. The mnemonic for the formula for a slop is “rise over run”, and the actual formula is:

Where the numerator is the change in y and the denominator is the change in x.

If we have two points, (x 1 , y 1 ) and (x 2 , y 2 ) on the same line, but we do not have the equation of the line, we can still calculate a slope, because we still have a change in x and a change in y:

For example: If you have the coordinates (2,4) and (6,16), you could calculate the slope: (16-4)/(6-2) = 12/4 = 3. The slope of the line passing through the two points is 3.

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Note: A negative slope implies a downward sloping line. A positive slope implies an upward sloping line.

b.Where the line crosses the y-axis is the y- intercept. It is the value y takes on if x is 0. In the general formula for a line, a is the y- intercept. Similarly, the x-intercept is where the line crosses the x-axis. It is also the value that x takes on when y = 0.

In our example, y = 3x + 2, if x=0, then y=2. a=2, this is our y-intercept.

If y=0, then 0 = 3x + 2, so 3x = -2, so x = -2/3 is the x-intercept!

If you are only given two points, you can still find the y-intercept for the line passing through the two points. Let’s go back to the example from the slope section. If we are given the two points, (2,4) and (6,16), we already know the slope of the line passing through those two points is 3. To solve for the y-intercept, we would pick either

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coordinate – I’ll use the first, but you confirm the second pair yields the same solution on your own – and set up the usual equation of a line. We will substitute 3 for b, 2 for x, and 4 for y:

4 = a+3*2 4 = a+6 -2 = a

So the y-intercept is -2. This means the coordinate (0,-2) is also on the line, and it means the equation for the line in general is:

y = -2 + 3x

Let’s look at a graph!

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Example: If we have a line that crosses the y- axis at y=5 and has a slope of 3, the formula for that line is Y = 5+3X. We could graph this line:

Y

Intercept = 5 Slope=Rise/Run=3

X

We know the slope is 3 because b=3, and we know the y-intercept is 5 because a=5.

Try these practice problems to make sure you understand how linear functions work:

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For these coordinates, find: a. The equation of the line passing through both points b. the x- intercept. c. identify the slope and y-intercept. d. does the line slope up or down?

1. (1, 6) and (3, 10)

2. (2, 2.5) and (10, 10.5)

3. (-1, -17) and (1, -3)

4. (4, 3) and (8, -5)

5. Moe hires a broker to invest in \$10/share

shares of Dannon. He pays the broker \$100 for this. A month later Dannon has a PR nightmare on their hands with an EColi outbreak. The price of shares drops to \$5 each. a. Write an equation to express how much Moe lost as a function of the number of shares he purchased.

b. How much did he lose if he bought 10 shares?

increased to \$12/share, what is the minimum number of shares Moe would have had to invest in order to break even?

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QUADRATIC FUNCTIONS The previous formula (y = a + bx) works for straight lines. That is, for relationships between x and y where the rate at which y changes as x changes remains constant. (Prices have constant rates of change. If gas is \$2/gallon, then you have to pay \$2 dollars for each extra gallon of gas you wish to purchase, no matter how many gallons you buy.) The problem is that sometimes we work with “non-linear” relationships, and we need an equation to handle that.

Think of the height of a baseball as it travels in time. First the ball goes up (it has a positive slope), then it comes down (it changes and has a negative slope). Because the slope of the ball changes, a linear equation - which has only one slope – could never describe the relationship between the height of the ball and time. In fact, not only does the path ball have both a positive and negative slope, it also has a curved shape to it. Linear equations can only describe straight lines, not curved ones. In math, we say that curved lines have “non-linear” slopes. The most basic curved line is a “bell” (upside down or

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rightside up). We call the functions that describe such lines quadratic functions.

A quadratic equation takes on the form:

Y = a + bX + cX 2

Even though the functional form of the relationship between x and y has changed from being linear to quadratic, we can still find a y- intercept and a slope.

Recall, the y-intercept is the value of y when x=0. So if we replace all Xs with 0s in the general quadratic equation we get:

Y = a + b*0 + c*0 2 = a

Even for a quadratic equation, the y-intercept is a!

For a slope, you will need a little bit of calculus, but the concept is the same. We are interested in how y changes as x changes.

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Let’s look at an example. If we know: a=6, b=4, c=-2 we have Y=6+4*X - 2*X 2
-5
-4
-3
-2
-1
0
1
2
3
4
5

Let’s see what happens if we try to use the usual formula for the slop of a line by testing some different points. If we pick the points (0,7) and (2,7) we find that the slope of the line is (7- 7)/(2-0) = 0/2 = 0. A slope of 0 indicates a flat line. Clearly the line is curved, so this is not the slope. If we use the points (0.7) and (1,8) we

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find a slope of 1. A slope of 1 indicates a 45 degree, straight line. Clearly the graph is not straight. This is also not the slope of the line. Notice also that the calculated slope changes depending on which points we choose. That is because the slope of the line is changing based on what x is. In other words the slope requires an equation that depends on (“is a function of”) x!

In calculus the notation for a slop changes a bit:

Slope

  y dy    x dx

In general, if you have a quadratic equation, the slope is the first derivative of y with respect to x (“how fast y changes when x changes”). The formula looks like this:

dy/dx = b+2cx

Where does this come from? For a quadratic equation, we take a first derivative as follows:

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First, rewrite the equation with all exponents!

Y

= a + bx + cx 2

= a*x 0 + b*x 1 + cx 2 (because x 0 =1 and x 1 =x)

Now, to take a first derivative with respect to x, term by term, we multiply each term by the exponent attached to x and subtract 1 from the exponent attached to x:

dy/dx

= 0a*x 0-1 + 1*b*x 1-1 + 2cx 2-1 = b+2cx

…Notice, as previously mentioned, the formula for the slope of a quadratic function has an x in it. Go back and look at the graph! When x=0, small changes in x hardly affect y. When x=3, small changes in x lead to larger changes in y. This is reflected in how steep or shallow the line is at a given point. A steep line has a larger (absolute value) slope than a shallow line. (If you forget this, just remember a flat line has a

slope of 0, a shallow line is closer to being flat,

and 0 is the smallest (absolute value) number a

slope can take on.)

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For example, in the equation Y=6+4*X - 2*X 2 We can calculate the slope by taking a first derivative:

Y

dy/dx

= 6X 0 + 4X 1 – 2X 2 = 0*6X 0-1 + 1*4X 1-1 – 2*2X 2-1 = 4 – 4X

Or we can jump straight to the formula for the

dy/dx = b + 2*cX

= 4 – 4X

We get the same answer either way. One way requires learning a little calculus; the other requires memorizing a formula. Either way works!

23 What about the area under the curve?
-5
-4
-3
-2
-1
0
1
2
3
4
5

The process of finding the area under a curve involves a bit of integration. An example of the process for finding the area under the curve between points -1 and 3 follows.

In words, the idea is to break up the curve into smaller and smaller rectangular segments of equal width, and add up the area of the rectangular segments to estimate the area under the curve. This is only an estimate because above each rectangular segment will be a bit of

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unaccounted for space under the curve and above the rectangle.

The more narrow the segments, the smaller the total unaccounted for space becomes. As the rectangular segments become more and more narrow, we work towards rectangles so narrow that there are no gaps between the top of the rectangles and the curve itself.

The illustration below starts with rectangles of width 1 (Δ1), and moves to rectangles of width .005 (Δ.005). Notice how the estimated areas get closer and closer to the actual area, 21.333!

Look back at the graph! For rectangles of width 1, starting at -1, the maximum height of a rectangle that fits entirely under the curve and has base points [-1, 0] has a height of 6. Between [0, 1] and [1, 2] the maximum height is 8. Between [2, 3] the maximum height is 6. If we calculate the area of each of those four rectangles and sum them, we get 28!

1∗6 1∗8 1∗8 1∗6 1∗ 6 8 8 6 28 1

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Using the exact same process, but with Δ = .05 we get that the area is 21:

.5 3.5 6 7.5 8 7.5 6 3.5 21 .05

 If we set Δ = .005 we get that the area is 21.32:

.5 3.5 6 7.5 8 7.5 6 3.5 21 .05

The actual area under the curve is:

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1

3

A few practice problems:

Find the slope and y-intercept for following

equations.

1. y = x 2

2. y = 4+2x +3x 2

3. y = .5 – 3x + 2x 2

Between x = -1 and x = 1, which has a larger area, a or b. Justify your answer:

4. a. y=x or

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b.

y = -x 2

5. a. y=x or

b. y = -x 2 +5

6. a. y=x+20 or

b. y = -x 2 +5

3.

Some Statistics

Expectations and Other Properties of Linear Combinations of Random Variables (Portfolio Math)

Let’s start out assuming that A and B are sets of random variables (a 1 , a 2 , … a n ) and (b 1 , b 2 , … b n ). Because A and B are sets of random variables, they have a distribution with a mean. The mean for A (or B) is:

1

̅ ,

In finance we often look at average returns of portfolios. A portfolio is a mix of stock holdings, and each stock has a particular distribution. When looking at portfolios, we are often interested in knowing the mean return of a portfolio, which is a combination of random variables.

Consider, what is the mean of Z if Z=A+B from before? If we call n the number of “parts” of Z,

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then we have n=2. Also, let’s call the number of parts in A n a , and in B n b . We can also call each part of Z, Z 1 and Z 2 (or Z i , where i = 1 for A and 2 for B). Doing this allows us to write things more compactly, and gives rise to a general formula for the mean of the sum of two equally weighted variables (equally weighted because there is 1 part A and 1 part B):

̅

1

1

1

1

Because we don’t always have an equal mix of two parts, we need to know how to find the mean of a “linear combination” of A and B? Say, for example 20% A and 80% B?

Z = 0.2A + 0.8 B

Now A and B are NOT equally weighted. But that is okay, all we need to do is weight each term in our formula for the mean of Z by the same amount each term is weighted in the original equation for Z.

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Z

0.2

1

n

n

i

1

A

i

0.8

1

n

n

i

1

B

i



0.2

AB

0.8

That was easy, what about the variance? Recall, the variance of a random variable tells us how wide the variation (“wiggle”) is in the possible outcomes of a variable. Random variables with a very small variation are like senior citizen square dancers, they don’t move around much. (If the variance is 0, they don’t move at all! Constants have a variance of 0.) Random variables with a large variation are like spring breakers at an electronic show… they’re all over the place.

As for the formula for the variance of a single random variable X, we know from Sharad that:

1

Just like we want to know what the average of a linear combination of two variables is, we might be equally interested in the variance of two

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random variables. The variance of a portfolio of stocks tells us how risky the portfolio is. We usually want to maximize our expected return and minimize our risk. Smaller variances are thus more desirable than larger ones. But what is the variance of Z=A+B, two equally weighted variables? For A and B with variances Var(A) and Var(B), and covariance Cov(A,B), we have:

Var ( A



B

)

1

n

1

n

1

n

n

i 1

n

i 1

n

i 1

A

i

B

A

 

i

A AB

i

i

 

B

A A

i

2

 B

i

B

2

B

2

2

2(

A

AB )(

ii

()

Var A

Var () B



Var A

()

Var B

()

2

2

n

i 1

Cov (,) A B

A

A

B

i



i

B

B

)

Similar to the mean, if we have variables with unequal weights, it is possible to modify the formula for variance to accurately reflect the unequal weights on the stocks in a portfolio.

Var(aX + bY) = a 2 Var(X) + b 2 Var(Y) + abCov(X,Y)

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The final thing yet discussed: Covariance. What does covariance mean in practice?

Not a whole lot, but its cousin, correlation, is quite helpful and meaningful. Correlation is Covariance scaled by standard deviations. Correlation tells us whether or not two random variables are “wiggling” mostly together (large and positive), mostly oppositely (large and negative), or if two variable are wiggling to two different tunes entirely, with seemingly unrelated movements (somewhere in the middle). A correlation of 1 means two variables always move at the same time and in the same direction. A correlation of -1 means two variables always move in opposite directions at the same time. A correlation of 0 means two variables don’t move together at all. Formally, the correlation is defined as:

,

,

,

Where σ x is shorthand for the standard deviation of X, which is the square root of the Var(X).

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We will compute the mean and variance of returns on the stock market in class.

Some practice problems:

1. Calculate the mean value of the sum of two

dice throws.

2. Calculate the variance of the sum of two dice throws.

3. If I have a portfolio that is half A and half B

and A has a mean of 10 and a variance of 3, and B has a mean of 5 and a variance of 1, and the two have a covariance of -1, find the expected return of this portfolio, and the variance of the portfolio.

4.Set up and solve a formula that you could use to answer the following question: For the same stocks A and B, if I have 10 shares of B, how many shares of A would I need to have an expected portfolio return of 8?

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Exponents and Logarithms

1.

2.

3.

4.

iv.

v.

4 5 x+2 = 7 3 x1

5 2 ln 4 3 1 ln 7 5 4 2 ln 4 3 7 ln 7 5 4 3 7 2 ln 4 ln 7 5 ln 4 3 ln 7 2 ln 4 ln 7

log 3 ( x + 2) = 1 + log 3 ( x 2)

1 2 2

1 2

2

3 2 2

True or False (explain): log b b 10 log b 1 = 10 Break it up into parts…

log b b 10 = 10 log b b and, log b b=1 so, log b b 10 = 10*1 = 10

log b 1=0

So we have:

log b b 10 – log b 1 = 10 – 0 = 10

So, True!

Are the following solutions possible ?

Log 3 (80) = 5? No, 3 4 =81, so y<4<5.

Log 6 (93) = 2.3? Yes, 6 2 =36 and 6 3 =216, so 2<y<3.

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vi.

Log 5 (120) = 2.95? Yes, 5 2 =25 and 5 3 =125, so 2<y<3.

5. In 2004 Cheech invested \$10 at 10% for 10 years. In 2008 Chong decided he didn’t want Cheech to be richer than he would be in 2014. Chong could only find a 10% investment vehicle. How much does Chong need to invest today, so that 6 years later, in 2014, he and Cheech will have equal investments?

We want to find \$x chong so that:

\$y cheech = \$x cheech (1+r) n = \$10(1+.1) 10 to equal:

\$y chong = \$x chong (1+r) n = \$x chong (1+.1) 6 So we want:

\$10(1.1) 10 =\$x chong (1+.1) 6 \$10(1.1) 10 /(1+.1) 6 =\$x chong \$10(1.1) 4 =\$14.64 =\$x chong

6. You have two options. A: I will either let you invest a penny today, and then double your investment every day for exactly 4 weeks. Or B: I will give you \$10,000 and allow you to earn 10% compounded CONTINUOUSLY for 28 days. Which is the better deal, and how much better (in dollars) a deal is it?

Let’s evaluate the two options!

A pays: \$.01(1+1.0) 28 = \$2,684,354.56

B pays: \$10,000e .10 = \$11,051.71

So A is the better deal. It pays 2,673,302.83 more than B pays!

7. An \$1,000 investment is made in a trust fund at an annual percentage rate of 12%, compounded monthly. How long

will it take the investment to reach \$2,000?

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Note: We are compounding MONTHLY, so our rate is not simply .12, it is .12/12 (12 payments a year), so we will use .01 as our r!

We want to find a length of time, t, such that:

\$1,000(1+.01) 12t = \$2,000

12t

because there will be 12 payments per year.

\$1 (1+.01) 12t = \$2 12t* ln(1.01) = ln(2) t = ln(2)/12*ln(1.01) t = 5.81 years (appx. 5 years and 10 months)

Linear Equations

1. (1,6) and (3, 10)

a. To find the equation of the line we need to first get the slope:

(10‐6)/(3‐1) = 4/2 = 2 = b Next we need the y‐intercept, use the first coordinate:

6 = a + 2*1

6=a+2

4=a

Our equation is:

Y = 4 + 2x

b. The x‐intercept is:

0 = 4 + 2x ‐4 = 2x ‐2 = x, 2 is the xintercept!

c. Our slope is 2, our y intercept is 4

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d.

Because the slope is positive, the line slopes UPWARDS

2. (2, 2.5) and (10, 10.5)

a. To find the equation of the line we need to first get the slope:

(10.5‐2.5)/(10‐2) = 8/8 = 1 = b

Next we need the y‐intercept, use the first coordinate:

 2.5 = a + 1*2 2.5 = a + 2

.5 = a

Our equation is:

Y = .5 + x

b. The x‐intercept is:

0 = .5 + x ‐.5 = x, ‐.5 is the xintercept!

c. Our slope is 1, our y intercept is .5

d. Because the slope is positive, the line slopes UPWARDS

3. (‐1, ‐17) and (1, ‐3)

a. To find the equation of the line we need to first get the slope:

(‐3‐(‐17))/(1‐(‐1)) = 14/2 = 7 = b Next we need the y‐intercept, use the second coordinate:

‐3 = a + 7*1 ‐3 = a + 7 ‐10 = a Our equation is:

y = 7x 10

b. The x‐intercept is:

0 = 7x – 10

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10 = 7x 10/7 = x, 10/7 is the xintercept!

c. Our slope is 7, our y intercept is 10

d. Because the slope is positive, the line slopes UPWARDS

4. (4, ‐3) and (8, ‐5)

a. To find the equation of the line we need to first get the slope:

(‐5‐(‐3))/(8‐4) = ‐2/4 = ‐.5 = b Next we need the y‐intercept, use the second coordinate:

‐3 = a + ‐.5*4 ‐3 = a ‐2 ‐1 = a Our equation is:

y = 1 .5x

b. The x‐intercept is:

0 = ‐.5x – 1 1 = ‐.5x 1/‐.5= x, 2 is the xintercept!

c. Our slope is .5, our y intercept is 1

d. Because the slope is negative, the line slopes

DOWNWARDS

5. Moe hires a broker to invest in \$10/share shares of Dannon. He pays the broker \$100 for his services. A month later Dannon has a PR nightmare on their hands with an EColi outbreak. The price of shares drops to \$5 each. a. Write an equation to express how much Moe lost as a function of the number of shares he purchased. The price was 10 and it is now 5, so he lost \$5 per share. The slope of this line is ‐5. Because Moe paid \$100, even if he

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bought 0 shares, he is still out \$100, so the y‐intercept is ‐ \$100. Thus the equation of the line is:

Y = \$100 \$5X shares

b. How much did he lose if he bought 10 shares?

Simply replace X shares with 10:

Y = ‐\$100 ‐\$5*10

= \$150

c. 100 shares?

Simply replace X shares with 100:

Y = ‐\$100 ‐\$5*100

= \$600

\$12/share, what is the minimum number of shares Moe would have had to invest in to break even?

Now instead of losing \$5 per share, Moe gains \$2 per share. The slope of this line is 2. Because the y‐intercept is still ‐ \$100. Thus the equation of the line is:

Y = ‐\$100 +\$2X shares If Moe breaks even, then y = 0. So replace Y with 0 in the above equation and solve for X shares :

0 = ‐\$100 +\$2X shares \$100 = \$2X shares

50 = X shares

Find the slope and y intercept for following equations.

1. y = x2

Slope: b = 0, a = 2, so by our formula, b + 2*a*x the slope is 2x! y intercept: When x = 0, y = 0. Also, a = 0. The y intercept is 0!

2. y = 4+2x +3x2

Slope: b = 2, a = 3, so by our formula, the slope is 2+6x! y intercept: When x = 0, y = 4. Also, a = 4. The y intercept is 4!

3. y = .5 3x + 2x2

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Slope: b = ‐3, a = 2, so by our formula, b + 2*a*x, the slope is 4x3! y intercept: When x = 0, y = .5. Also, a = .5. The y intercept is .5!

Between x = 1 and x = 1, which has a larger area, a or b. Justify your answer:

 4. a. y=x or Because the line y=x is entirely above y = ‐x 2 b. y = ‐x2 5. a. y=x or b. y = ‐x2 +5 Because this line is entirely above y=x 6. a. y=x+20 or Because this line is entirely above –x 2 +5

b. y = ‐x2 +5

If you enter those equations on your graphing calculator, you can see

this very clearly.

STATISTICS

1. Calculate the mean value of the sum of two dice throws. The mean of the sum is the sum of the means. For a single dice throw, the average value is:

1

6

1 2 3 4 5 6 21

6

6

3.5

So for the sum of two dice throws, the average is:

1

6 6 2∗ 6 2 ∗ 3.5

1

1

2. Calculate the variance of the sum of two dice throws. The variance of a single dice throw is:

1

6 3.5

1 3.5 2 3.5 3 3.5 4 3.5 5 3.5 6 3.5

6

2.5 1.5 .5 .5 1.5 2.5

6

40

17.5 35

6 12 The variance of the sum of the two dice throws is:

Var(d 1 ) + Var(d 2 ) + 2Cov(d 1 ,d 2 ) Because each throw is independent, the covariance is 0, so this reduces:

2*Var(d 1 ) = 70/12 = 5.8

3. If I have a portfolio that is 1/3 A and 2/3 B and A has a mean

of 9 and a variance of 3, and B has a mean of 6 and a variance of 1, and the two have a covariance of 1, find the expected

return of this portfolio, and the variance of the portfolio. First, the return:

∗9 3 2 ∗6 3 4

1

3

Second, the variance:

∗3 ∗1 1

3

9 4 9

2

9

4. Set up and solve a formula that you could use to answer the

following question: For the same stocks A and B, if I have 10

shares of B, how many shares of A would I need to have an expected portfolio return of 8? We want n a such that:

SO

So…

8

10 ∗9

10

10 6

8 9 60 10

8 80 9 60

So…

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