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 = by. So y=logb(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
102=100, then we also all know that
log10(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. Logx(x2) = 2 (because x2=x2)
ii. Log5(25) = 2 (because 52=25)
iii. Log9(81) = 2 (because 92=81)

b. More generally, when b is the nth root of X,

y is always n:
i. LogX(Xn) = n (because Xn=Xn)
ii. Log3(27) = 3 (because33 = 27)
iii. Log2(16) = 4 (because 24 = 16)
c. When X is 1, y=0, no matter what the base
is:
i. Logb(1) = 0 (because b0=1, for all b)
ii. Log20(1)=0 (because 200=1)
iii. Log3.14(1)=0 (because 3.140=1)
d. When the b = X, y=1.
i. Logx(X)=1 (because X1=X, for all X)
ii. Log10(10)=1 (because 101=10)
iii. Log.15(.15)=1 (because .151=.15)
e. Concept check: You should be able to
explain why there is no solution to Log10(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 Loge(X),
we simply write ln(X), and understand they
2

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?

xn
x 2 x3
exp( x) 1 x ...
2! 3!
n 0 n !
x
exp( x) lim 1
x 0
n

This is a graph of Y= exp(x) or Y=ex

-5

-4

-3

-2

-1

If we go back to the definition of a logarithm,

then we know that for ln(X) - the same as
Loge(X) - y must solve the equation: ey=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. eln(x) = X if X > 0
Convince yourself! The solution to ln(x) is
the value of y that solves for ey=X. So if we
replace ln(x) with the value of y that causes
ey=X, we are left with ey, 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
zx=yb, 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.
4

Doing this to both sides will preserve their

equality.
In other words, if zx=yb 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) = eln(y). and
by the first property eln(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(ex) = x
Convince yourself! Lets rewrite this in a
way that looks more like the definition of a
logarithm: Loge(ex). y is the exponent that
solves for by=x, so here we would have
ey=ex, the only way for the RHS=LHS is if
y=x.
4. ln(xz) = zln(x)
This one might seem less obvious, but it is
straightforward. Again, lets rewrite the
5

equation: loge(xz). We want a y that solves

for ey=xz. Lets 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 ax+z = ax*az
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=ex around
the values where y is close to 0.
Now lets see why this matters in finance!

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

Or more generally (that is, using the formula for

n periods of compounding at interest rate r)
1

.1
2

$10 1

Three times a year? $10 1

365 time a year? $10 1

11.025
11.0337

11.05156

Infinitely many times a year (called continuous

compounding)?
$10 lim 1

$10

$10

11.025

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?
Lets 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. Lets 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

.02

$20,000

ln $20,000

ln 1.02

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. 45x+2 = 73x-1
2. log3(x + 2) = 1 + log3(x -2)
3. True or False (explain): logbb10 logb1 = 10
4. Are the following solutions possible?
i. Log3(80) = 5?
ii. Log6(93) = 2.3?
iii. Log5(120) = 2.95?
5. In 2004 Cheech invested $10 at 10% for 10
years. In 2008 Chong decided he didnt want
10

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?

11

2. Graphing / Linear & quadratic equations

/ slopes
LINEAR EQUATIONS
Functions describe how different variables are
related. We use them all the time. If youve ever
made a banana split, youve 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
Lets 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
12

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, (x1, y1) and (x2, y2)
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.

13

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 yintercept. It is the value y takes on if x is 0.
In the general formula for a line, a is the yintercept. 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. Lets 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
14

coordinate Ill 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
Lets look at a graph!

15

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

Slope=Rise/Run=3

Intercept = 5

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:

16

For these coordinates, find: a. The equation of

the line passing through both points b. the xintercept. 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?
c. 100 shares? If the price of shares had instead
increased to $12/share, what is the minimum
number of shares Moe would have had to invest
in order to break even?
17

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
18

rightside up). We call the functions that describe

such lines quadratic functions.
A quadratic equation takes on the form:
Y = a + bX + cX2
Even though the functional form of the
relationship between x and y has changed from
being linear to quadratic, we can still find a yintercept 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*02 = 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.

19

Lets look at an example. If we know: a=6, b=4,

c=-2 we have
Y=6+4*X - 2*X2

-5

-4

-3

-2

-1

Lets 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 (77)/(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
20

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:

y dy
Slope

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:
21

First, rewrite the equation with all exponents!

Y = a + bx + cx2
= a*x0 + b*x1 + cx2 (because x0=1 and x1=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*x0-1 + 1*b*x1-1 + 2cx2-1
= 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.)
22

For example, in the equation Y=6+4*X - 2*X2

We can calculate the slope by taking a first
derivative:
Y
= 6X0 + 4X1 2X2
dy/dx = 0*6X0-1 + 1*4X1-1 2*2X2-1
= 4 4X
Or we can jump straight to the formula for the
slope of a quadratic function:
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

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
24

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 (1), and moves to rectangles of width
.005 (.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!

16

18

18

16

25

1 6

28

Using the exact same process, but with = .05

we get that the area is 21:

.5 3.5

7.5

7.5

3.5

21

.05

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

.5 3.5

7.5

7.5

3.5

21

The actual area under the curve is:

21

1
3

A few practice problems:

Find the slope and y-intercept for following
equations.
1. y = x2
2. y = 4+2x +3x2
3. y = .5 3x + 2x2
Between x = -1 and x = 1, which has a larger
area, a or b. Justify your answer:
4. a. y=x or
26

.05

b. y = -x2
5. a. y=x or
b. y = -x2 +5
6. a. y=x+20 or
b. y = -x2 +5

27

3. Some Statistics
Expectations and Other Properties of Linear
Combinations of Random Variables
(Portfolio Math)
Lets start out assuming that A and B are sets of
random variables (a1, a2, an) and (b1, b2,
bn). Because A and B are sets of random
variables, they have a distribution with a mean.
The mean for A (or B) is:

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,
28

then we have n=2. Also, lets call the number of

parts in A na, and in B nb. We can also call each
part of Z, Z1 and Z2 (or Zi, 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):

Because we dont 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.

29

1 n
1 n
Z 0.2 Ai 0.8 Bi 0.2 A 0.8 B
n i 1
n i 1
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 dont move around much.
(If the variance is 0, they dont move at all!
Constants have a variance of 0.) Random
variables with a large variation are like spring
breakers at an electronic show theyre all over
the place.
As for the formula for the variance of a single
random variable X, we know from Sharad that:

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
30

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:

1 n
Var ( A B ) Ai Bi A B
n i 1

2
1 n
Ai A Bi B
n i 1
2
2
1 n
Ai A Bi B 2( Ai A)( Bi B )
n i 1

Var ( A) Var ( B ) 2 Ai A Bi B
n

i 1

Var ( A) Var ( B ) 2Cov( A, 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) = a2Var(X) + b2Var(Y) + abCov(X,Y)

31

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 dont move together at all.
Formally, the correlation is defined as:
,

Where x is shorthand for the standard deviation

of X, which is the square root of the Var(X).
32

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?

33

Exponents and Logarithms

1. 45x+2 = 73x1
5
5
4
5
4
5 ln 4

2 ln 4
2 ln 4
3
7
3 ln 7

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

2. log3(x + 2) = 1 + log3(x 2)

2
1

2

2

2

2

3. True or False (explain): logbb10 logb1 = 10

Break it up into parts

logbb10 = 10 logbb
and, logbb = 1
so, logbb10 = 10*1 = 10

logb1 = 0

So we have:
logbb10 logb1 = 10 0 = 10

So, True!
4. Are the following solutions possible?
iv. Log3(80) = 5? No, 34=81, so y<4<5.
v. Log6(93) = 2.3? Yes, 62=36 and 63=216, so 2<y<3.
34

vi. Log5(120) = 2.95? Yes, 52=25 and 53=125, so 2<y<3.

5. In 2004 Cheech invested $10 at 10% for 10 years. In 2008
Chong decided he didnt 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 $xchong so that:
$ycheech = $xcheech(1+r)n = $10(1+.1)10
to equal:
$ychong = $xchong(1+r)n = $xchong(1+.1)6
So we want:
$10(1.1)10 =$xchong(1+.1)6
$10(1.1)10/(1+.1)6 =$xchong
$10(1.1)4 =$14.64 =$xchong


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?

Lets 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?

35

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:
(106)/(31) = 4/2 = 2 = b
Next we need the yintercept, use the first coordinate:
6 = a + 2*1
6 = a + 2
4 = a
Our equation is:
Y = 4 + 2x

b. The xintercept is:
0 = 4 + 2x
4 = 2x
2 = x, 2 is the xintercept!

c. Our slope is 2, our yintercept 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:
(10.52.5)/(102) = 8/8 = 1 = b
Next we need the yintercept, use the first coordinate:
2.5 = a + 1*2
2.5 = a + 2
.5 = a
Our equation is:
Y = .5 + x

b. The xintercept is:
0 = .5 + x
.5 = x, .5 is the xintercept!

c. Our slope is 1, our yintercept 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 yintercept, use the second coordinate:
3 = a + 7*1
3 = a + 7
10 = a
Our equation is:
y = 7x 10

b. The xintercept is:
0 = 7x 10

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

c. Our slope is 7, our yintercept 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))/(84) = 2/4 = .5 = b
Next we need the yintercept, use the second coordinate:
3 = a + .5*4
3 = a 2
1 = a
Our equation is:
y = 1 .5x

b. The xintercept is:
0 = .5x 1
1 = .5x
1/.5= x, 2 is the xintercept!

c. Our slope is .5, our yintercept 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 yintercept is

$100. Thus the equation of the line is:
Y = $100 $5Xshares
b. How much did he lose if he bought 10 shares?
Simply replace Xshares with 10:
Y = $100 $5*10
= $150
c. 100 shares?
Simply replace Xshares with 100:
Y = $100 $5*100
= $600
d. If the price of shares had instead increased to
$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 yintercept is still
$100. Thus the equation of the line is:
Y = $100 +$2Xshares
If Moe breaks even, then y = 0. So replace Y with 0 in the
above equation and solve for Xshares:

0 = $100 +$2Xshares
$100 = $2Xshares
50 = Xshares
QUADRATIC EQUATIONS
Find the slope and yintercept for following equations.
1. y = x2
Slope: b = 0, a = 2, so by our formula, b + 2*a*x the slope is 2x!
yintercept: When x = 0, y = 0. Also, a = 0. The yintercept is 0!

2. y = 4+2x +3x2
Slope: b = 2, a = 3, so by our formula, the slope is 2+6x!
yintercept: When x = 0, y = 4. Also, a = 4. The yintercept 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!

yintercept: When x = 0, y = .5. Also, a = .5. The yintercept 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 = x2

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 x2 + 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

21
6

3.5

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

1
6

1

6

1
2
6

2 3.5

2. Calculate the variance of the sum of two dice throws.
The variance of a single dice throw is:
1
6

3.5

2.5

3.5
1.5

3.5
3

3.5

4
6
.5

.5
6

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3.5
1.5

5
2.5

3.5

3.5

17.5
35

6
12
The variance of the sum of the two dice throws is:
Var(d1) + Var(d2) + 2Cov(d1,d2)
Because each throw is independent, the covariance is 0, so this
reduces:
2*Var(d1) = 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:
1
2
9 6 3 4

3
3
Second, the variance:

3
3

9

1 1
4 2

9 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 na such that:
10
8
9
6
10
10
SO
9
60
8

10
So
8
80 9
60
So

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