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11 the expected dollar return on the investment in

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11. The expected dollar return on the investment in equities is \$18,000 compared to the \$5,000 expected return for T-bills. Therefore, the expected risk premium is \$13,000. 12. E(r) = [0.2 × ( 25%)] + [0.3 × 10%] + [0.5 × 24%] =10% 13. E(r X ) = [0.2 × ( 20%)] + [0.5 × 18%] + [0.3 × 50%] =20% E(r Y) = [0.2 × ( 15%)] + [0.5 × 20%] + [0.3 × 10%] =10% 14. σ X 2 = [0.2 × (– 20 – 20) 2 ] + [0.5 × (18 – 20) 2 ] + [0.3 × (50 – 20) 2 ] = 592 σ X = 24.33% σ Y 2 = [0.2 × (– 15 – 10) 2 ] + [0.5 × (20 – 10) 2 ] + [0.3 × (10 – 10) 2 ] = 175 σ X = 13.23% 15. E(r) = (0.9 × 20%) + (0.1 × 10%) =19% 16. The probability that the economy will be neutral is 0.50, or 50%. Given a neutral economy, the stock will experience poor performance 30% of the time. The probability of both poor stock performance and a neutral economy is therefore: 0.30 × 0.50 = 0.15 = 15% 17. E(r) = (0.1 × 15%) + (0.6 × 13%) + (0.3 × 7%) = 11.4%

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5-5 18. a. Probability Distribution of the HPR on the Stock Market and Put: STOCK PUT State of the Economy Probability Ending Price + Dividend HPR Ending Value HPR Boom 0.30 \$134 34% \$ 0.00 100% Normal Growth 0.50 \$114 14% \$ 0.00 100% Recession 0.20 \$ 84 16% \$ 29.50 146% Remember that the cost of the index fund is \$100 per share, and the cost of the put option is \$12. b. The cost of one share of the index fund plus a put option is \$112. The probability distribution of the HPR on the portfolio is: State of the Economy Probability Ending Price + Put + \$4 Dividend HPR Boom 0.30 \$134.00 19.6% = (134 112)/112 Normal Growth 0.50 \$114.00 1.8% = (114 112)/112 Recession 0.20 \$113.50 1.3% = (113.50 112)/112 c. Buying the put option guarantees the investor a minimum HPR of 1.3% regardless of what happens to the stock's price. Thus, it offers insurance against a price decline. 19. The probability distribution of the dollar return on CD plus call option is: State of the Economy Probability Ending Value of CD Ending Value of Call Combined Value Boom 0.30 \$114.00 \$19.50 \$133.50 Normal Growth 0.50 \$114.00 \$ 0.00 \$114.00 Recession 0.20 \$114.00 \$ 0.00 \$114.00
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11 The expected dollar return on the investment in equities...

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