Over a five-year period, the quarterly change in the price per share of common s

Question

Over a five-year period, the quarterly change in the price per share of common stock for a major oil company ranged from -8% to 12%. A financial analyst wants to learn what can be expected for price appreciation of this stock over the next two years. Using the fiveyear history as a basis, the analyst is willing to assume that the change in price for each quarter is uniformly distributed between -8% and 12%. Use simulation to provide information about the price per share for the stock over the coming two-year period (eight quarters).

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Solution

(a) Use the random numbers 0.52, 0.99, 0.12, 0.15, 0.50, 0.77, 0.40, and 0.52 to simulate the quarterly price change for each of the eight quarters. If required, round your answers to one decimal places. For those boxes in which you must enter subtractive or negative numbers use a minus sign. (Example: -300)

Explanation / Answer

Part A)

The return can be calculated with the use of following formula:

Return = Smallest Value + Random Number*(Largest Value - Smallest Value)

__________

Here, Smallest Value = -8% and Largest Value = 12%

Using these values, we can complete the table:

_____________

Part B)

The simulated price per share at the end of the two-year period has been calculated with the use of following table:

The stock price at the end of two years (after eight quarters) would be $92.14.

Notes:

The ending price of one quarter is the beginning price of the next quarter.

_____________

Part C)

The risk analysis would involve the performance of multiple simulations for the period under consideration (8 quarters or 2 years). This would help in determining different per share prices (with respect to each simulation) at the end of the relevant period. These variation in share prices would be useful in the identification of maximum gain/loss that can be realized/incurred on this share, thereby, providing opportunities for better and informed decision making.

Quarter Random Number (r) Smallest Value (a) Largest Value (b) Return % (a + r*(b-a)) 1 0.52 -8 12 2.4% 2 0.99 -8 12 11.8% 3 0.12 -8 12 -5.6% 4 0.15 -8 12 -5% 5 0.5 -8 12 2% 6 0.77 -8 12 7.4% 7 0.4 -8 12 0 8 0.52 -8 12 2.4%

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