Problem+Set+3

Problem+Set+3 - Use Equations 5.11 and 5.12 to compute the...

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Problem Set 3, Chapter 5 6. You are considering the choice between investing $50,000 in a conventional 1-year bank CD offering an interest rate of 5% and a 1-year “Inflation Plus” CD offering 1.5% per year plus the rte of inflation. a. Which is the safer investment? b. Which offers the higher expected return? c. If you expect the rate of inflation to be 3% over the next year, which is the better investment? d. If we observe a risk-free nominal interest rate of 5% per year and a risk free real rate of 1.5% on inflation-indexed bonds, can we infer that the market expected rate of inflation is 3.5% per year? 7. Suppose your expectations regarding the stock price are as follows: State of the Market Probability Ending Price HPR(including dividends) Boom 0.35 $140 44.5% Normal Growth 0.30 110 14.0 Recession 0.35 80 -16.5
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Unformatted text preview: Use Equations 5.11 and 5.12 to compute the mean and standard deviation of the HPR on the stocks. 8. Derive the probability distribution of the 1-year HPR on a 30-year US treasury bond with an 8% coupon if it is currently selling at par and the probability distribution of its yield to maturity a year from now is as follows: State of the Economy Probability YTM Boom 0.20 11.0% Normal Growth 0.50 8.0 Recession 0.30 7.0 For simplicity, assume the entire 8% coupon is paid at the end of the year rather than every 6 months. CFA problems: 1. Given $100,000 to invest, what is the expected risk premium in dollars of in vesting in equities versus risk-free T-bill ( US Treasury bills) based on the following table: Action Probability Expected return Invest in equities 0.6 $50,000 0.4 -$30,000 Invest in risk-free T-bill 1.0 $5,000...
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