RiskChapterHWKey

# RiskChapterHWKey - Homework Solutions Introduction to Risk...

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Homework Solutions Introduction to Risk, Return, and the Opportunity Cost of Capital 17. a.Interest rates tend to fall at the outset of a recession and rise during boom periods. Because bond prices move inversely with interest rates, bonds provide higher returns during recessions when interest rates fall. b. r stock = [0.2 × ( - 5%)] + (0.6 × 15%) + (0.2 × 25%) = 13.0% r bonds = (0.2 × 14%) + (0.6 × 8%) + (0.2 × 4%) = 8.4% Variance(stocks) = [0.2 × ( - 5 - 13) 2 ] + [0.6 × (15 - 13) 2 ] + [0.2 × (25 – 13) 2 ] = 96 Standard deviation = % 80 . 9 96 = Variance(bonds) = [0.2 × (14 - 8.4) 2 ] + [0.6 × (8 - 8.4) 2 ] + [0.2 × (4 - 8.4) 2 ] = 10.24 Standard deviation = % 20 . 3 24 . 10 = c.Stocks have both higher expected return and higher volatility. More risk averse investors will choose bonds, while those who are less risk averse might choose stocks. 10-1

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20. Risk reduction is most pronounced when the stock returns vary against each other. When one firm does poorly, the other will tend to do well, thereby stabilizing the
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RiskChapterHWKey - Homework Solutions Introduction to Risk...

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