Chapter 7 - Solutions
Questions and Problems
BASIC
7.1
Returns:
Describe the difference between a total holding period return and an expected
return.
LO 2, LO3
Solution:
The holding period return is the total return over some investment or “holding” period. It
consists of a capital appreciation component and an income component. The holding
period return reflects past performance. The expected return is a return that is based on
the probability-weighted average of the possible returns from an investment. It describes
a possible return (or even a return that may not be possible) for a yet- to-occur investment
period.
7.3
Expected returns:
You have chosen biology as your college major because you would
like to be a medical doctor. However, you find that the probability of being accepted into
medical school is about 10 percent. If you are accepted into medical school, then your
starting salary when you graduate will be $300,000 per year. However, if you are not
accepted, then you would choose to work in a zoo, where you will earn $40,000 per year.
Without considering the additional educational years or the time value of money, what is
your expected starting salary as well as the standard deviation of that starting salary?
LO 3
Solution:
E(salary) = 0.9($40,000) + (0.1) ($300,000) = $66,000