Economics homework， due 10/5

For essay questions, briefly answer each with a paragraph or two.

Each paragraph should contain a minimum of three sentences.

Yes and no answers are not acceptable.

1. You are the founder of IGRO, an Internet firm that delivers groceries.

Give an example of an idiosyncratic risk and a systematic risk your company faces.

2. Assume that the economy can experience high growth, normal growth, or recession.  Under these conditions, you expect the following stock market returns for the coming year:

State of the Economy	Probability	Return
High Growth	0.2	+30%
Normal Growth	0.7	+12%
Recession	0.1	-15%

 

Compute the expected value of a $1,000 investment over the coming year. If you invest $1,000 today, how much money do you expect to have next year? (5 points)

What is the percentage expected rate of return? (5 points)

3. Assume that the economy can experience high growth, normal growth, or recession.  Under these conditions, you expect the following stock market returns for the coming year:

State of the Economy	Probability	Return
High Growth	0.2	+30%
Normal Growth	0.7	+12%
Recession	0.1	-15%

 

Compute the standard deviation of the percentage return over the coming year.

4. Assume that the economy can experience high growth, normal growth, or recession.  Under these conditions, you expect the following stock market returns for the coming year:

State of the Economy	Probability	Return
High Growth	0.2	+30%
Normal Growth	0.7	+12%
Recession	0.1	-15%

 

If the risk-free return is 7 percent, what is the risk premium for a stock market investment?

5. Assume that the economy can experience high growth, normal growth, or recession.  Under these conditions, you expect the following stock market returns for the coming year:

State of the Economy	Probability	Return
High Growth	0.2	+30%
Normal Growth	0.7	+12%
Recession	0.1	-15%

 

Using the information from the table above, in dollar terms what is the value at risk associated with the $1,000 investment?

 

6. Banks pay substantial amounts to monitor the risks that they take.  One of the primary concerns of a bank’s “risk managers” is to compute the value at risk.  Why is value at risk so important for a bank (or any financial institution)?

7. Your favorite restaurant is closed by the county health department. Is this systematic risk or idiosyncratic risk? Briefly explain.

9. You are considering three investments, each with the same expected value and each with two possible payoffs. The investments are sold only in increments of $500.  You have $1,000 to invest and so you have the option of either splitting your money equally between two of the investments or placing all $1,000 in one of the investments.  If the payoffs from investment A are independent of the payoffs from investments B and C and the payoffs from B and C are perfectly negatively correlated with each other (meaning when B pays off, C doesn’t and vice versa), which investment strategy will minimize your risk?