ch02 - Ch 02 Mini Case 3/8/2001 CHAPTER 2 MINI CASE...

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Ch 02 Mini Case 3/8/2001 CHAPTER 2 MINI CASE SITUATION Assume that you recently graduated with a major in finance, and you just landed a job as a financial planner with Barney Smith Inc., a large financial services corporation. Your first assignment is to invest $100,000 for a client. Because the funds are to be invested in a business at the end of 1 year, you have been instructed to plan for a 1 year holding period. Further, your boss has restricted you to the following investment alternatives, shown with their probabilities and associtated outcomes. Barney Smith's economic forecasting staff has developed estimates for the state of the economy and its security analyst have developed a sophisticated computer program which was used to estimate the rate of return on each state of the economy. Alta Industries is an electronics firm; Repo Men collects past due debts; and American Foam manufactures mattresses and various foam products. Barney Smith also maintains an "index fund" which owns a market-weighted fraction of all publicly traded stocks; you can invest in that fund, and thus obtain average stock market results. Given the situation as described, answer the following questions. Return on Investment What is the return on an investment that costs $1,000 and is sold a year later for $1,100? Inputs Amount Invested $1,000 Amount Received $1,100 Dollar Return = $Received - $Invested $1,100 - $1,000 Dollar Return = $100 Percentage Return = $Return / $Invested $100 / $1,000 Percentage Return = 10.00% Returns on Alternative Investments Estimated Rate of Return State of Economy Probability T-Bills Alta Inds Repo Men American Foam Stock X Stock Y -20 0 15 50 Rate of Return Probability Distribution Riskier Stock
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Recession 0.1 8.00% -22.00% 28.00% 10.00% Below Average 0.2 8.00% -2.00% 14.70% -10.00% Average 0.4 8.00% 20.00% 0.00% 7.00% Above Average 0.2 8.00% 35.00% -10.00% 45.00% Boom 0.1 8.00% 50.00% -20.00% 30.00% k 8% 17.40% 1.74% 13.80% Standard Deviation 0% 20.0% 13.4% 18.8% CV 0.00 1.15 7.68 1.36 b Expected Return vs. Risk Security Expected Return Risk Alta Inds. 17.40% 20.0% Market 15.00% 15.3% Am F 13.80% 18.8% T-bills 8.00% 0% Repo Men 1.74% 13.4% PORTFOLIO RETURNS The expected return on a portfolio is simply a weighted average of the expected returns of the individual assets in t
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ch02 - Ch 02 Mini Case 3/8/2001 CHAPTER 2 MINI CASE...

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